Q2 2023 Petco Health and Wellness Company Inc Earnings Call

[music].

Good morning, everyone and welcome to Pet goes second quarter 2023 earnings Conference call. All participants will be in a listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero.

After todays presentation, there will be an opportunity to ask questions to ask a question you May press Star and then one on your Touchtone telephone.

To withdraw your question you May press Star and two.

Please also note today's event is being recorded at this time I'd like to turn the floor over to Cathy Yao Vice President of Investor Relations. Kathy you may begin.

Good morning, and thank you for joining <unk> second quarter 2023 earnings Conference call. In addition to the earnings release, there is a presentation and info graphic available to download on our website at IR Dot Petco Satcom summarizing our results.

On the call with me today are Ron Coughlin, Heico's, Chief Executive Officer, and Brian Librettist Peck, our Chief Financial Officer.

Before they begin I would like to remind everyone that on this call. We will make certain forward looking statements, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from such statements. These risks and uncertainties include those set out in our earnings materials in our SEC filings.

In addition on today's call, we will refer to certain non-GAAP financial measures reconciliations of these measures can be found in our earnings release presentation and our SEC filings.

And finally during the Q&A portion of today's call. We ask that you. Please keep to one question and one follow up with that let me turn it over to Ron.

Thank you Kathy and welcome everyone before I begin I want to thank our 29000 Petco partners for enduring commitment to providing the very best for pets and pet parents I'm proud of the work our teams deliver every single day.

This morning, I like to focus my remarks on three key topics first I'll briefly review our Q2 results.

I'll discuss actions that will generate approximately $150 million in savings from a combination of run rate cost efficiencies and productivity enhancements by the end of fiscal 2025.

These will help drive both gross margin and Opex with a greater weighting to gross margin and finally I'll outline the continued progress we're making on our roadmap for accelerated profitable growth.

For the quarter, we delivered solid top line growth net revenue was up 3% year over year at $1 5 billion.

Comparable sales driven by standout results in services and sustained momentum in average basket trends also grew 3%. This translated to 7% growth on a two year stack.

Our services business once again delivered exceptional performance growing 17% and is now over $700 million run rate business. Our veterinary business continues to scale and both vet and grooming are capturing more market share and.

In our consumables business continues its solid growth trajectory.

We believe the strength of our differentiated pet health and wellness offering and the value proposition of our unique 360 degree ecosystem and Omnichannel delivery model is the right one to capture the long term megatrends of Humanization and <unk> and are fundamental pillars of our long term strategy.

While we demonstrated our ability to grow we recognize that we're operating in a tougher consumer discretionary environment than we forecasted as we entered the year and as a result, we're not yet where I want us to be translating topline growth to the bottom line.

Our surprise and companion animal businesses remained more pressured than anticipated impacting our profitability for the year relative to our expectations with food. We also continue to see a bifurcation among pet parents with ongoing migration to more premium foods on the one hand, and an uptick in value seeking behaviors amongst a second cohort.

Due to the broader discretionary environment and its associated impact on our supply as a companion animal businesses.

As well as the pricing actions, we're undertaking to ensure we're price competitive on key products and Skus. We are revising our adjusted EBITDA and adjusted EPS Guide for the year.

Brian will provide more color on our expectations shortly.

We remain relentlessly focused on controlling our controllable to optimally navigate today's consumer dynamics.

We have a focused plan to deliver our revised targets, while we continue to make progress against our long term strategic priorities.

First we're taking additional actions to protect profitability.

We are implementing tight cost controls and programmatic initiatives across the business.

Through a comprehensive cost and efficiency program, we have identified and are actively working multiple areas to unlock a $150 million and run rate cost savings by the end of fiscal 2025 of which we project $40 million in savings by the end of year one.

Typically over the last year, including in Q2, we adjusted our workforce, reducing our corporate and field leadership head count by a cumulative total of approximately 25%, including the closure of open rules.

As a leadership team we are acutely aware of the impact. These actions have on colleagues that we care deeply about we did not take these decisions lately while difficult. They are best for our business ensures our workforce matches the capability needed to support our long term strategy. These.

These actions position us as a leaner and more effective organization.

Beyond this year, we've identified broader programmatic initiatives to further enhance profitability. These include refinements to our supply chain, including shipping and distribution enhancements such as automation meaningful G&A efficiencies and improvements in merchandise operations, Brian will elaborate further.

We're confident these actions will better position us for the short medium and long term, while enabling us to prioritize capital allocation on our key initiatives of that digital and debt reduction.

Turning to the second component of our strategic actions will strengthen our positioning with pet parents with the surgical use of assortment value in store experience and marketing.

We are actively evolving our assortment to align with the trends that we're seeing.

Supplementing our rapidly growing premium offerings with more value based options. This includes reintroducing the number one selling cat food brand fancy feast this week.

Both our customers and pet care centre teams are very excited about as well as diamond Naturals, both will drive incremental customers to the franchise more to come here.

He will complement the product moves with targeted pricing actions to address competitive gaps in key traffic driving brands and Skus. We've taken similar action several times throughout my tenure here and they have delivered customers' unit and revenue growth with breakeven impact to margin within a year and accretion thereafter.

Additionally, once again, we delivered margin expansion within services and digital and we expect those to continue to help offset mixed pressures.

As we ensure we have the right products at the right price for the right customer, we'll also lean into seasonal programs like Halloween and holiday and we recently brought back our popular supplies perks program to stimulate additional supplies purchases.

And we'll continue to enhance the customer experience, whether it's online on the app or in store our investments into labor continue to pay off with partner retention up nearly 800 basis points year over year.

Combined we believe these actions should meaningfully accelerate our capability to drive profitable growth and deliver for our customers and we will do this without compromising on progress against our differentiating long term strategic priorities now.

Now turning to the results of the quarter across services are differentiated merchandize mix and Omnichannel.

In the quarter, our total pet scene and that increased 26% year over year. We ended Q2 with 269 hospitals and are on track to approach 300 hospitals by year end.

As our hospitals mature or economics become increasingly attractive vetco clinics continue to outperform our expectations and remain complimentary to our hospital business. These mobile clinics up 23% year over year to a total of 1400 clinics a week support routine wellness visits in an affordable way. They also remain a <unk>.

<unk> of talent for our full time, thats with 21% of our full time vet recruits this year coming from our clinic pool.

In total we brought 364 bets into our ecosystem in Q2 up 59% year over year, including that's available for our clinic business.

<unk> revenue growth was strong and we continue to gain market share in a fragmented market up nearly 100 basis points year over year growing basket transactions and center store sales.

<unk> continued momentum has been accelerated by a clean grooming launch earlier this year with services and products free of Parabens, fillets, and chemical dyes as well as in nearly 500 basis point year over year improvement in Gruma retention.

In merchandise our key challenges in the supplies business, which was down 9% in the quarter categories like apparel creates and toys remained soft as consumers slowed spending and these products. We are taking targeted actions in this area to drive performance, including improving price competitiveness screen, the offering to more value oriented initiatives.

And expect stabilization over time.

Remained nimble in our response to capturing opportunities when they arise as a result of the extreme heat we were able to drive our flea and tick business, leading to Rx sales up nearly 20% year over year.

As we look to the back half of the year, our supplies offerings will benefit from lower input costs and lower freight expense, particularly in Q4.

Looking beyond this consumables remained solid in the quarter consumables grew 7% with strength in both premium up 8% year over year and non premium up 4% year over year, specifically, we continue to see strong fresh frozen growth with 10% revenue growth and 12% customer growth year over year and these are some of our high.

This value customers.

Our delivery model continues to be a differentiator for petco meeting the needs of pet parents, who prefer to shop in an omnichannel fashion across the business, we saw a 2% brick and mortar growth and 9% digital growth driven by strength in basket trends and net Pat growth.

Ah repeat delivering <unk> revenue continued to grow as did same day delivery orders supporting our value proposition as an integrated omnichannel player.

Looking ahead, we will continue to optimize investments across all our marketing channels in store and online.

Typically we will tighten the focus of our marketing dollars on driving traffic to capture share and propel profitable growth. This will include deepening our relationships with our existing 25 million customers. So that we are well positioned for the eventual recovery and discretionary.

A key lever here is our valuable vital care Premier program, where members grew 75000 to 660000 in the quarter. These high value customers spend more than triple what non member spend.

Lab supplies trips contributed to a modest 60000 total customer decline.

Finally, as we think about increasing customer touch points, we were proud to announce the expansion of our low shop in shop partnership this quarter.

Expanding to 300 locations, including 75 with vet clinics. This furthers our footprint in rural markets at zero capital outlay from Petco. These locations are already performing ahead of expectations. We expect the partnership to be incrementally positive to our topline dollar accretive to our profit and will enable us to capture.

New customers.

As I close I am proud of the progress <unk> made over the last five years, including our vet Buildout and the evolution of our 360 degree Omnichannel model.

That said I am not satisfied with where we are and we have an aggressive plan across product price competitiveness marketing in store and digital experience to ensure we deliver I am confident that we have the right blue chip team to execute this plan as the actions we outlined today will forge an even stronger business.

And with that I'll hand, it over to Brian .

Thanks, Ron and good morning, everyone.

To build on Ron's remarks, I also want to extend my thanks to our Petco partners and their continued dedication to the health and wellness of pets.

For the quarter net revenue was $1 5 billion, an increase of 3% year over year.

Comparable sales driven by sustained strength in average basket trends grew 3% year over year and 7% on a two year stack.

Our digital business showed strength with 9% year over year growth in the quarter.

Total services grew 17% year over year, driven by the strengthened veteran grooming under the leadership of our exceptional services team and is now a $700 million plus run rate business.

And merchandize consumables were up 7% year over year in the quarter, while our discretionary supplies in companion animals businesses experienced ongoing softness down 9% year over year.

Moving down the P&L gross profit was roughly flat year over year in the second quarter at $593 million.

Q2 gross margin of 38, 7% was down 140 basis points year over year.

The decline was primarily attributable to business mix shifts with strength in services and digital and continued softness in discretionary categories.

As a reminder in services our labor sits in cost of sales. So while services has a lower gross margin than enterprise and the long term. It is helpful to adjusted EBITDA.

In Q2, SG&A as a percentage of revenue increased 40 basis points year over year to 37, 2% driven primarily by an increase in stock based compensation and onetime costs, primarily related to head count reduction.

Excluding stock based compensation and onetime cost this quarter, our SG&A as a percentage of revenue would have decreased 50 basis points year over year.

We also had a tangible increase in payroll expense from the one time step up we made to our $15 per hour minimum wage last December as we continue to invest in our partners a move that is increasing retention.

Q2, adjusted EBITDA was $113 million down 15, 7% from prior year with an adjusted EBITDA margin rate of seven 4% down 170 basis points year over year.

Q2, adjusted EPS was <unk> <unk>, a decrease of 10 from the prior year driven in part by a <unk> <unk> year over year increase in interest expense based on $267 million weighted average fully diluted shares and a normalized effective tax rate of 26%.

Turning to our balance sheet, our liquidity position remains strong we ended the quarter with $619 million inclusive of $173 million in cash and cash equivalents and $446 million of availability on our revolving credit facility.

In Q2, we paid down $25 million in principal and another $15 million last week.

Year to date, we have now paid down $75 million toward our target debt paydown of $100 million for the year.

Our capex of $52 million was down 26% year over year as we lapped last year's freezer build out.

I also want to touch on inventory briefly.

Overall, we remain pleased with our inventory performance with in stock improvements for the quarter and inventory turnover cycle remaining strong our inventory dollars are down 7% year over year.

We generated free cash flow of $45 million in the quarter up $72 million year over year underscoring our enduring focus on steering this business strategically through this environment.

Year to date, we have generated a total of $20 million in free cash flow, a $56 million improvement to a loss of $36 million in the first six months of 2022.

As I turn to our outlook, although our long term strategy focused on the Mega trends of Humanization and premium inflation remains we also acknowledged that discretionary pressures remain and consumers are more value sensitive during this environment.

To address this we are implementing strategic actions that will better position us for profitable growth in 2024 and beyond.

Given the current consumer dynamics outlined above and the expected timing of benefits from our strategic cost actions, which will primarily start to benefit in 2024.

We are lowering our adjusted EBITDA, adjusted EPS and capital expenditures outlook for fiscal 2023.

We've updated our guidance to <unk>.

Revenue of $6, one five to $6 $2 $75 billion, which is unchanged adjusted.

Adjusted EBITDA of $460 million to $480 million.

Interest expense of $145 million to $155 million, which is unchanged adjust.

Adjusted EPS of <unk> 24 to 30 on 269 million weighted average fully diluted shares.

$215 million to $225 million of capital expenditures and.

And we continue to expect to add a total of $50 to 55, one vet hospitals in 2023, and approximately 10 <unk> locations.

Our updated adjusted EBITDA Guide anticipates continued pressure on gross margins given continued mixed pressures away from discretionary along with strategic pricing actions, we are undertaking to accelerate growth and retention, which we have seen positive returns on in prior iterations.

When the discretionary environment stabilizes, coupled with the outcome of our cost actions and productivity, we expect our gross margins will stabilize.

Importantly, we've seen continued improvement in services in E. Comm gross margins as a reminder, on services. The P&L geography of labor sits in cost of sales, which means the business has a lower gross margin than enterprise.

Our lower Capex guidance still anticipates, the buildout of our vet and rural locations as provided in the updated guidance.

Beyond this year, we have identified additional programmatic initiatives to drive efficiencies and further reduce costs, which includes merchandise supply chain and broader G&A opportunities.

Some to an estimated $150 million on a run rate basis by the end of fiscal 2025, and an estimated $40 million run rate savings in year, one split across the follow up.

In supply chain, we expect to further streamline our Dcs and optimize our network on the first leg of our long term distribution strategy.

We are working to further optimize our rich and automate our Dcs. So that we can ship more efficiently from Dcs to stores.

We also have additional opportunities to further drive that E comm shipping costs.

In merchandise, we plan to extract additional savings by right sizing input costs from our vendors.

In G&A, we will continue to optimize labor within rpc's through leveraging technologies, such as our handheld zebra devices to assistant tasking and inventory management.

Additionally for certain roles, we are shifting our resources to lower cost locations.

And of course, we plan to remain tactical across real estate marketing and other opportunities.

We're confident these actions better position us for the short medium and long term, while allowing us to prioritize capital allocation on our key initiatives of.

Digital and debt reduction.

To conclude the entire <unk> leadership team and I remain focused on navigating the short term through disciplined execution in this environment.

We are committed to adapting and evolving our business thoughtfully to meet the current cyclical impacts to pet parents in our business, while remaining well positioned for the long term and delivering profitable growth as a leader in the resilient and secular Lee favorable pet category.

Thank you for your time and with that we'd be happy to take your questions.

Ladies and gentlemen at this time, we will begin the question and answer session.

You May ask your question by pressing Star and then one on a touchtone telephone.

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Once again that is star and then one to join the question queue, we will pause momentarily to assemble the roster.

Our first question today comes from Oliver Winter missile from Evercore ISI. Please go ahead with your question.

Great. Thanks, Brian .

Brian maybe.

First question for you.

Looking like the the decrease in interest EBITA margin EPS, but top line.

Stays the same so is that just a continued mix shift to more of the consumables away from supplies in the second half if you could maybe talk a little bit about the seasonality.

And that and then the <unk>.

Second part is.

Reduction in EBITDA, just based on gross margin or do you see also.

SG&A pressures thank you.

Hey, Ali Thanks for the question, let me start on a macro basis, we continue to see consumers wallets shift towards services with some uncertainty moving forward specific to us our initial full year guidance assumed a modest stabilization in discretionary spend on a dollar basis in the back half of the year and we have not seen that discretionary.

Our expense stabilize and as a result of these factors continued to further.

Pressure gross margin so specific to your question, yes. The reduction in the EBITDA guide is directly related to the change in our outlook for the discretionary categories companion animal and supplies and the vast majority of that reduction is related to gross margin.

We do have cost actions in place. The team is energized we're already getting some quick wins from those cost actions, while though primarily benefit 2024 and 2025, there will be some modest benefit in 2023.

And the majority of those actions impact gross margin.

Thanks, very much good luck.

Thanks Oliver.

Our next question comes from Zach <unk> from Wells Fargo. Please go ahead with your question.

Hey, guys. This is David Lance on for Zach. Thanks for taking our questions. You noted that you are taking price increases to be more excuse me price actions to be more competitive curious if you could talk about what side of the business, that's coming on and how youre discretionary pricing stacks up versus peers.

Yeah. Thanks, David.

From a competitive standpoint, we can't really elaborate from a pricing standpoint, we can say the consumers today are looking for value, we're taking actions to drive that value customer engagement and drive units on historically when we when we've taken these actions as Brian stated, we have seen a breakeven within the year.

But it's really to address gaps in key product categories.

That drive both traffic and pricing perception.

That's helpful. And then the guide implies flat to down comps in two H. So just curious if you could talk through the rationale there and maybe the trajectory of the business as we exited the quarter.

Yes.

You are right. If you look at the overall revenue guidance I will go back to macro we continue to see pressure on consumers' wallets, especially in discretionary and overall, we did see growth in the first half with continued momentum in services and consumables, primarily but that discretionary category remains pressured so given that environment, we felt like maintaining.

Our revenue guide was most appropriate.

Got it thanks.

Our next question comes from Simeon Gutman from Morgan Stanley . Please go ahead with your question.

Good morning, I wanted to ask what's assumed for discretionary companion for rest of the year, if theres a mix percentage and as you plan for 'twenty four.

Just taking the tact of being extra conservative or should that category flatten out and grow for next year.

Yes, let me start <unk> and then I'll turn it over to Ron to talk about 2024, So as I said earlier, our initial guide assumes some stabilization in that in that discretionary category. If you look at Q2, we declined 9%. If you look at Q1, we were down 8%, obviously, our expectations in Q2 weren't in line with.

What we previously assumed.

Won't get into a specific number I think if you look at the minus nine in Q2, we have not assumed much recovery from that for the balance of the year and now I'll turn it over to Rob to talk about 'twenty four yes, hi, Simeon.

Current projections for the overall category for 24 by mid single digit with a stabilization of supplies.

Winning 24 that happens.

We will see but we're not we're not waiting we're going to take actions, we're taking actions on our supplies perks, which actually enrollments were up 11% versus when we ran that before we're taking action on costs, we have favorable cost progress on our suppliers, we have favorable freight which allows us to have more flexibility.

In terms of providing value to customers. So we're taking actions category call for 2004 at this point is mid single digits with a stabilization in supplies.

Thanks, if I can ask one follow up I don't know if I can on the promotion of <unk> of the industry seems like it's picking up I'm curious how you would describe it and as you planned second half is that is I guess I don't know if pricing actions as discounted or promotions or it's a price optimization.

Yes, good question.

Supply and demand are have rebalanced versus year ago. So the industry is returning to pre pandemic promotional levels. There is a consumer who is looking for more value and we're making sure that we provide it.

And the promotions that we run our traffic positive revenue driving and for the most part profit dollar neutral. So it is a effective tool in generating customers, we've seen positive reactions to them, but it's really a return to pre pandemic promotional levels based upon supply now being more.

More in balance with demand.

Okay. Thanks, guys. Good luck.

Thanks Simeon.

Yeah.

Our next question comes from Anna <unk> from Needham <unk> Company. Please go ahead with your question.

Great. Thanks, so much good morning, I wanted to follow up on the sales cadence that you saw during the quarter. I think you had said previously that may was more in line with <unk>. So that's mid single digits. So should we think about the June and July slowed and what are you seeing in the business so far.

In August and then I had a follow up as well.

Hi, Anna.

Thanks for the question in terms of linearity, we had non comp noise with events shifting from month to month versus a year ago. What I can say is we werent happy with surprise in May June or July , which is driving our guidance change servicer remains strong across all three months and food showed solid growth across.

The quarter in terms of August .

We haven't seen a significant change in our trend line, but we're taking action and we're seeing some initial green shoots on some of those actions.

Okay, Great that's helpful and just as a follow up on gross margins.

<unk> come in line with your expectations for the quarter, just any color that you could share on the puts and takes on the gross margin line as implied by the annual guide I think Ron you had mentioned some of the benefits from the cost actions on our gross margin starting to trickle in.

This year as well.

Yes, I can take that one on.

So in terms of gross margin relatively in line with our with our expectations overall and that was despite the discretionary category not coming in in line with our expectations. So the change of the guide as Lou mentioned is primarily related to our renewed expectations on that supplies and discretionary category on the cost actions Ron did mentioned that.

They are heavily weighted towards gross margin, but the benefits of those cost actions will mostly benefit 2024 and 2025 some of the benefits in 2023 or more on the SG&A line from some of the head count actions that we've taken.

Alright fair enough. Thanks, so much Greg.

Thanks, John .

Our next question comes from Steven Forbes from Guggenheim. Please go ahead with your question.

Good morning, Ron Brian .

Rob you mentioned premium consumables up a notch.

<unk> core.

But given some of the comments you made about assortment and just the consumer in general curious if you can provide unit volume color between those two subcategories and how you're thinking about the current mix of the business from a go to market strategy.

Thanks for the question, we continue to see a bifurcation in demand, we're still seeing strong growth on premium offerings like fresh frozen origin, Cana, which continue to be our performing that said at the category level, we do see an increase in value seeking behaviors amongst a subsegment, we supplemented our value.

Offers like our launch of fancy feast, and Diamond Naturals with price points that are appealing to our customers.

And additionally, the cost enhancements on supplies and related freight will be weaved into the second half to allow us to be more cost competitive on those products as well. So it's really a story of bifurcation.

Strong demand on the high end and increased demand on the value side as well.

Thank you maybe just a quick follow up for Brian .

The level of capital spending expectations.

Can you expand on where you are deep prioritizing capital spending this year.

Recent change and then any comment on sort of initial appointment.

As it pertains to balancing sort of your strategic growth initiatives with other investment need like automation.

To capture some of the savings that you noted.

Yes. Good question, Steve first let me let me address 2023, so we've maintained our target of 50 to 55 hospitals in 2023 in a small town and rural Buildout of about 10, and we've also maintained our commitment to pay down $100 million of debt. This year in terms of our capital allocation priorities, we're already at 70, 525%.

Q2, we did another 15 last week. So already 15 in Q3 gets us to 75 in terms of 2024, I don't expect those capital allocation priorities to change dramatically.

We will continue to focus on debt pay down we will continue to lean into areas like that and other strategic priorities with high ROI.

Adjustments of the Capex guide for this year did not trade off any of those strategic priorities. It was in other ancillary areas, where we were able to make some trade offs to maintain our cash balance and make sure we were managing our working capital appropriately.

Thank you.

Thank you.

Our next question comes from Seth Basham from Wedbush Securities. Please go ahead with your question.

Thanks, a lot and good morning. My question is just trying to better understand some of the merchandising and pricing changes that youre, making first in supplies typically arent traffic driving so what's leading you to the decision to have to invest in price and supplies and then secondly, and bringing back things like <unk> and the supplies Perks program.

Are those removed in the first place.

Thanks for the question. So let me let me bifurcate, we didn't we didn't provide indication of where we're taking pricing.

We find is food is a traffic driver similar to the grocery model and that can drag supplies. There are certain categories that are <unk>.

Price perception defining within supplies, which is why we are encouraged by the fact that we have lower cost flowing through and lower freight costs coming through.

And those categories are strategic in terms of creating a price perception, which them with.

Contribute to traffic.

Okay. That's helpful. And then the decision to remove fantasies previously in our supplies <unk> program can you give some context there.

On fancy feast, we took a decision back in 2018 around artificial ingredients.

<unk> products that are brought into our stores today have been reformulated and have eliminated all artificial <unk>, which is really positive thing. It's a win for necessarily it's a win for us and a win for our customers. We're really excited about it and fancy feast is absolutely a great traffic driver yes.

Yeah and on the supply stroke program, Seth we tend to pulse in and out of those programs based on our expectations for elasticity in demand and so that was not dormant for very long and we tend we just made the decision to pulse backend.

Thank you.

Thanks.

Yes.

Our next question comes from Michael Lasser from UBS. Please go ahead with your question.

Good morning, Thanks, a lot for taking my question so pick those adjusted EBITDA margin for this year.

<unk> is now expected to be around 200 basis points below the level. It was in 2019.

As you diagnose why that is whats changed still out the business to drive such significant margin compression how much of it relates to external factors.

Increased competition and how does all of this inform your view of <unk>.

What the company's long term EBITDA margin outlook.

Yes, thanks for the question Michael.

The change from 2019.

It is primarily related to the cyclical pressure that we have in the discretionary business that pressure has a direct impact on gross margin that gross margin impact as a direct impact on adjusted EBITDA, We're confident that the cyclical impact will stabilize when that stabilizes coupled with our cost actions. We're confident that gross margin will stabilize we do.

Have a $150 million of cost actions in place to help return EBITDA to profitable growth in the future. If you look at the impact on gross margin as well I'll remind you that services sits labor for services sits in cost of sales. If you take services out of our model in the quarter. Our gross margin would actually have been a little bit over 41% So as services.

Has grown materially from 2019 up 17% again in Q2 that has an impact on rate on the gross margin line.

It's really a story of discretionary and given that's our highest profit category the cyclical pressure of discretionary on the P&L.

Okay.

My follow up question is.

On the comp outlook, especially as you head into the holidays.

What are you assuming as your base case for <unk> com.

Especially given the uncertain macroeconomic environment.

What would drive upside and what would drive downside to this.

Comp expectations.

Yes, im not going to get into the quarter's Michael but I will tell you that we felt like the revenue maintaining the revenue guide was the most appropriate thing to do given some of that uncertainty. We would expect that services would continue to be strong we're happy with our consumables performance this quarter up 7%, but that discretionary category remains under pressure. So if you look at the back.

Half of the year.

That would imply as somebody.

Earlier as somewhat of a deceleration in comp we felt like that was the best guide based on what we know today.

Thank you very much and good luck.

Thank you.

Our next question comes from Stephens <unk> from Citi. Please go ahead with your question.

Great. Good morning, Thanks for taking my question.

So to follow up on Michael's question. What do you think is the optimal mix of discretionary for this business because on the one hand, yes. It is challenging from a cyclical perspective, but on the other hand some of your growth drivers in the business since you've come public REIT or premium <unk> and food and then services, which are lower gross margin.

Right businesses, so I am curious for what's the optimal mix of discretionary over time and if it continues to trend lower how do you think about the margin drivers to improve EBITDA margin rate over the next couple of years.

Thanks for the thanks for the question.

We like our.

Discretionary business, our supplies business companion animal business, there are high margin businesses, so outside of a economic cycle like the one we're in they helped drive our strong profitability.

And our customer delight or <unk> and we have differentiation.

From our own brands and in that category actually roughly 50% plus is owned brands. So it is a very attractive profit driver for us on a timely basis.

As you cited.

Things like digital things like services or.

Gross margin dilutive.

But in both those cases, we are driving margin enhancements in those silos, which help offset that and as Brian has cited from a services standpoint gross margin.

<unk> by the Labor if you look at on an EBITDA basis in the mid to long term, it's equivalent to roughly equivalent to our total enterprise.

Okay, but to follow up on that then so if we think about the vet hospital side of the business right now which is getting some scale can you say, whether that's EBITDA margin accretive to the business today will it be EBITA margin accretive in the next couple of years. Thank you.

Yes, Steve Thanks for the question today. It is not so if you think about the vet model. The great news about that that model is the unit economics continue to track along or along with or ahead of our model depending on the cohort. Most recent cohorts are ahead of model that model has EBIT EBITDA dollars and gross margin dollars as Duluth.

Live in the first year roughly breakeven in year, two on a path to 20% EBITDA in year five we're on track with that if you look at our overall cohorts with 269 hospitals. We've added roughly 150 to 175 of those in the last two plus years, which means the average age of our hospital. It's just over two years.

The average EBITDA rate of those hospitals is just over that breakeven amount now the good news with that is they are maturing as those hospitals mature the heart of that model will be accretive to our overall model and at that inflection point become actually accretive to the overall enterprise EBITDA rate.

Okay. Thanks very much.

Thank you.

Once again, if you would like to ask a question. Please press star and then one so it's all of your questions you May Press Star two.

Our next question comes from Greg <unk> from Gordon Haskett. Please go ahead with your question.

Just wanted to follow up on the.

<unk>.

Was wondering if you're still seeing.

Store centre store lift from Nevada, similar to past quarters.

Is that mainly traffic driven.

And just a follow up what was the biggest bucket out of that 150 million savings.

Of the various buckets that you laid out thank you.

Thanks, Nick a question Greg so.

From a vet standpoint, we really like the impact it has on the rest of the store so.

From a center store lift standpoint, we've re validated in the four to five point lift on center store when we put in of that which is a great impact.

Our locations with vets are growing tangibly faster than the locations without beds.

And in terms of traffic, yes. It is a very effective traffic driver for us in fact, 15% of the that customers are new to petco. So thats one of the advantages from from that model and on the cost actions that the larger buckets of the cost actions are on merchandise and supply.

Chain, which will impact the gross margin line on an overweight basis, while there is opportunities in SG&A, we have more opportunities in cost of sales.

And ladies and gentlemen, with that we'll be concluding our question and answer session I would like to turn the conference back over to Ron Kaufman for any closing remarks.

Thank you for your time and your questions as we close I want to reiterate that we're confident in our plan to navigate the current environment and we remain resolute that we are well positioned to capture the long term megatrends of the growing and resilient pet category.

Thank you.

That concludes Petcare second finance.

<unk> conference call. Thank you.

Yes.

Okay.

And ladies and gentlemen, with that we will conclude today's conference call and presentation. You may now disconnect your lines.

Goodbye.