Q2 2024 Petco Health and Wellness Co Inc Earnings Call
It can be found in our earnings release presentation and SEC filings.
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 Joe.
Joe: Good afternoon, everyone and thank you for joining us today.
I could not be more excited to lead petco through this pivotal time for the company.
Speaker Change: And shape. The next chapter of this extraordinary mission driven approach of improving the lives of pets and pet parents.
On behalf of the Petco Board I'd like to thank Mike Monahan for stepping in as interim CEO and for his tireless work to stabilize our operations and drive continued improvements in performance over the last six months.
His passion for our business is focused on strengthening our retail fundamentals and his work to realign our cost structure is set us on a path for improved profitability.
We will continue to build on this going forward.
Before giving a brief overview of our priorities for the remainder of the year.
Speaker Change: I'd like to spend a few moments on why I came to petco.
I believe and Petco is deep rooted mission to improve lives for pets and their parents pets have always been a central part of my life.
Speaker Change: Having grown up with dogs and seeing my children do the same I've experienced firsthand the immense joy pet spring to our family including mine.
Pat: Today Pat.
Pat: <unk> is an incredible brand.
Pat: Which sits at a critical juncture.
Speaker Change: While we maintain a differentiated proposition within the resilient pet category the category, which is expected to reach $200 billion in sales within five years, there are clear opportunities to significantly improve our operating and financial performance spin.
Speaker Change: Specifically there are three things about petco that excite me.
Speaker Change: One.
Speaker Change: Our integrated store and digital footprint.
Speaker Change: Which are positioned effectively and create an incredible customer experience brought to life across multiple channels.
Speaker Change: My initial visits have already exposed to some of the most knowledgeable and enthusiastic people I've met in retail I must say our partners in the pet care centers.
Speaker Change: Truly care about our customers pets I've been impressed.
Speaker Change: Number two delivering.
Speaker Change: Delivering a differentiated offering.
Speaker Change: That can bring and make petco, a destination for pets and pet parents.
Speaker Change: As a tourism I've seen through my decades in retail.
Speaker Change: We present, our customers with unique and.
Speaker Change: And trend right product.
Speaker Change: We will accelerate our return to retail excellence meeting pet parent needs and getting back to the heart and soul of pet parenting.
Speaker Change: Number three our.
Speaker Change: Our breadth of services offering <unk>.
Including our <unk> platform.
Speaker Change: This is our biggest competitive distinction from online only and mass players and has the potential to power our business as a significant long term growth driver.
Speaker Change: In addition to these three.
Speaker Change: I also want to share my observations in my first few weeks at Petco.
Speaker Change: I believe in and I'm fully committed to what the team and the board have been working on over the last six months.
Speaker Change: In the past that is set for us to continue.
Speaker Change: I also believe that as we maintain this disciplined and holistic approach to retail execution and do so with a focus on fewer and clearer priorities.
Speaker Change: We can better leverage <unk> unique strengths.
Speaker Change: In doing so will.
Speaker Change: We'll not only capture greater share of the category that we currently command, but deliver tangible and sustained profit improvement and significant long term shareholder value.
Speaker Change: Simply put I love pets, and I love retail and although I've only been at Petco, a very short while.
Speaker Change: And filled with optimism for the opportunities we have to reestablish trust and our financial discipline and grow the pet co brand.
Speaker Change: Before I hand, it over to Brian to review the quarter.
Speaker Change: I wanted to share how we're approaching the rest of this year.
Speaker Change: Our top priority is to prove improve profitability.
Brian: Focusing specifically on things that we will have the greatest impact to our business.
Brian: Entire company is aligned on four key initiatives, namely number one returning to retail fundamentals number two meeting and exceeding customer expectations.
Number three capturing market share through improved basket.
Speaker Change: And number four dill.
<unk> meaningful improvement to the bottom line through a disciplined approach to costs.
Brian: If the first half of this year was about setting the trajectory of our transformation.
The back half is about executing against it and setting the stage for future profitable growth.
Brian: Let me be clear on where we are today.
Brian: We are not starting over all.
Brian: I'll be working hand in hand, with the leadership team to build on the momentum of the last six months.
Brian: And move with urgency to fix what needs fixing at the foundational level for our long term success.
Brian: In doing so we will be working diligently and with speed to provide that every part of our business is operating efficiently and effectively delivering meaningful near term improvements to cash flow and enhanced EBITDA performance.
Moreover.
Brian: <unk> will embed these changes into the DNA of how we operate every day.
Brian: Delivering accretive run rate savings in fiscal 2025 and.
Brian: And setting a solid financial and operating foundation.
Brian: Facilitate petco has returned to profitable growth.
We have much work to do.
Brian: And I look forward to sharing an update on our 2020 for progress on our Q3 earnings call.
Brian: Like to close by extending my thanks to the nearly 30000 petco partners across our stores distribution centers and support centers.
Without doubt.
Brian: This business has been through significant change over the last six months.
Brian: Through it all though their hard work their faith in the future of this brand.
Brian: And they are proactive approach to supporting each other.
Brian: Petco has continued to deliver for pets and pet parent team during this time.
Speaker Change: Everything I've seen since joining.
Speaker Change: Mirrored what I was told during my hiring process. This.
Speaker Change: This gives me confidence we are on the right path to return to retail excellence and restore the underlying fundamentals of this business.
Speaker Change: We'll continue to build on our mission and return this iconic brand to its winning ways.
Speaker Change: Thank you and with that I'll pass it onto Brian.
Brian: Thanks, Joel and good afternoon, everyone.
Brian: Before I begin I would also like to take this opportunity to thank Mike for his leadership over the past few quarters.
Brian: And to formally welcome Joel to the Pepco team.
Brian: We're delighted to have you on can already feel the impact of your energy and enthusiasm for the brand and the category.
Brian: For the quarter net revenue was $1 $5 2 billion down 50 basis points year over year with comparable sales up 30 basis points year over year.
Brian: Across our business consumables grew 1%, while discretionary categories remains soft at negative 5%.
Services and other which is comprised of services wholesale and recently disposed noncore businesses delivered 3% revenue growth.
Brian: Services, specifically were up 10% driven by ongoing strength in our vet hospitals mobile clinics and grooming.
Brian: Moving down the P&L gross profit was $581 million down 210 basis points from prior year.
Brian: Gross margin for the quarter was 38, 1% down 60 basis points from prior year, driven by softness in our discretionary categories and up 30 basis points from Q1, driven by a combination of cost savings initiatives and operational efficiencies.
Brian: SG&A as a percentage of revenue increased by 80 basis points year over year to 37, 9%, which as we anticipated was driven predominantly by planned onetime investments needed in store labor.
Brian: Looking ahead, we continue to streamline nonessential tasking to allow partners more time to focus on improving the in store customer experience through selling and interacting with customers and overtime yield efficiencies in our labor model.
Brian: Q2, adjusted EBITDA was $83 5 million with an adjusted EBITDA margin rate of five 5%.
Brian: Adjusted EPS was negative <unk> <unk> compared to <unk> <unk> per share in the prior year.
Brian: Turning to cost transformation and take out we continue to make progress against key work streams, including.
Brian: Merchandising as we continue to review and rationalize our assortment to better align in store and online merchandising with the needs of pet parents.
Brian: Operational efficiencies in our supply chain, which include renegotiation of multiyear contracts with shipping partners, reducing split shipments and incremental improvements in distribution center labor.
Brian: Recalibrating marketing at both the top and bottom of the funnel, so that we attract and retain the highest lifetime value customers possible.
Brian: And instituting a more holistic process with indirect procurement across the business.
Turning to the balance sheet liquidity remained strong at $655 million inclusive of $128 million in cash and cash equivalents and $528 million of availability on our revolving credit facility.
Brian: Free cash flow was $42 million driven by lower inventory levels achieved as part of our ongoing approach to disciplined inventory management.
Brian: And while modestly down from $45 million in the prior year. This keeps us firmly on track to meet our expectations to be free cash flow positive for fiscal 2024.
Brian: I'll now turn to outlook.
Brian: For the third quarter, we expect revenue of approximately $1 5 billion.
Brian: Adjusted EBITDA between $76 million to $80 million and adjusted EPS between negative <unk> <unk> and negative <unk>.
Brian: Additionally for the full year, we continue to expect net interest expense of approximately $145 million inclusive of the estimated impacts of our hedges against the forward rate curve and 272 million weighted average fully diluted shares which is unchanged.
Brian: And $140 million of capital expenditures for the full year, which is also unchanged.
To Echo Joe's remarks, the entire petco team is focused on controlling what we can to deliver structural improvements to our underlying financials and work towards clear and achievable targets on the path to sustained and profitable growth.
Speaker Change: The first half of this year has brought meaningful change in the way, we operate our business and combined with <unk> energy and expertise I am confident we have set the right foundation for sustained progress on our business for the full year and beyond.
Speaker Change: You for your time and with that we'll be happy to take your questions.
Speaker Change: We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
Speaker Change: If you are using a speakerphone please pick up your handset before pressing the keys.
Speaker Change: If at any time. Your question has been addressed and you would like to withdraw your question. Please press Star then two.
Speaker Change: In the interest of time, we ask that you. Please limit yourself to one question and one follow up at this time, we will pause momentarily to assemble our roster.
Zach <unk>: And our first question today comes from Zach <unk> with Wells Fargo. Please go ahead.
Zach: Hey, good afternoon.
Zach <unk>: First of all congrats to you Joel and I'd love to dig in more on your initial impressions.
Speaker Change: This is a business that I think many would say had perhaps too many growth drivers in the air overtime.
Speaker Change: And maybe last side of the core so as you think about strategic direction going forward curious how you think about the balance of investing in growth pillars like that and your stores, but also simplifying the business and perhaps taking cost out of the system.
Speaker Change: Yes, hey, Thanks, Zack I appreciate the support look I think where we got to start on that one is.
Speaker Change: Our focus right now our number one priority is on improving profitability and that's what we've got to do first and as I said in my prepared remarks.
Speaker Change: I believe in and what Mike was working on with the management team is working on and we put together a great strategy on how to return this company to great fundamentals around EBITDA performance. The second half of this year. It's now about executing him having said that what I would really focus on and really.
Zach <unk>: To your question is we've got to strengthen retail fundamentals and I think everybody defines retail fundamentals differently and I think for the stage and where we're at at Petco three things come to mind, Zach first as merchandize excellence and this is a unique business its comprised probably.
Zach <unk>: About two thirds consumable one thirds discretionary.
Speaker Change: Life at Walmart was all about consumables, we simply got to be in stock on consumables and Thats what were working on to improve our consumable business discretionary that's about delivering unique trend right product and Thats. What I spent 10 years at five working on and we're going to get great at that the second area is this.
Speaker Change: As a service business driven business and we got to get that right and as I think about the fundamentals around service, it's about staffing right.
Speaker Change: Companion animals, we gotta be knowledgeable, but that's got to be open the groomers it got to be trained.
Speaker Change: About clean well Merchandised stores, our digital offering is got to be easy and efficient and so on and so forth. Then finally, Zach we got to be masters of efficiency retail is not a high margin game and so therefore, we've got to have strict discipline around inventory.
Zach <unk>: <unk> expense control supply chain management leverage and so long answer to your question, but we've got to get those retail fundamentals in order before we start to focus on growth again.
But I've been a growth guy for a long time, we're going to pivot to offense, but right now it's focus on profitability.
Zach <unk>: Zach.
Zach <unk>: Got it I appreciate the time, Joel and just for Brian.
Speaker Change: Thanks for the Q3 guide it looks like you expect Q3 to look pretty similar to Q2 from a top line perspective, but as we look at the puts and takes around margins youre either expecting a really nice inflection on the gross margin line as you lap the year ago price actions or you are taking.
Speaker Change: SG&A dollars quite a bit down on a year over year basis, or maybe a combination of both so any clarity you can offer on those points.
Speaker Change: Yes, Thanks, Zach I would just echo Joe's comments that our number one priority and focus is improving profitability in the business in the near term and the long term.
Speaker Change: And also driving free cash flow improvement.
Speaker Change: Look this remains a dynamic retail environments of our Q3 Q3 guide offers us the best view of what we know today and our focus is on executing against that in terms of the balance between gross margin and SG&A. What I will tell you is yes, let me start with SG&A in the second quarter, So SG&A up roughly $9 million total year.
Speaker Change: For year that was driven by planned onetime investments in store labor very consistent with Q1.
Speaker Change: We're committed to solid retail execution as Joel said and that means meeting the customer where they are and allowing our pet care Center partners the opportunity to do so.
I would not expect much fundamental difference between what you saw in SG&A in Q1 and Q2 in the third quarter.
Speaker Change: And our next question comes from Peter Benedict with Baird. Please go ahead.
Peter Benedict: Hey, guys.
Thanks for taking the question Joe welcome.
Peter Benedict: Brian I guess my first question is just around just around the EBITDA the.
Peter Benedict: Adjusted EBITDA view I think you guys were expecting kind of sequential improvement across the year.
Speaker Change: Obviously the outlook for <unk> is a little below what you just said I'm not sure if <unk> came in better than expected.
Speaker Change: You're just leaving yourself some room to operate just kind of curious whats changed versus.
Your thought process 90 days. So that's my first question.
Speaker Change: Yes, thanks for the question, Peter and not much else to add Q2 did come in a little bit better than expected I would tell you gross margin for the second quarter came in better than our expectations driven by a couple of things I think youre seeing some of the benefit of the cost initiatives that we have in place taking taking shape. We also saw some good improve.
Speaker Change: And the services business sequentially and year over year for that matter. So those things held up I will tell you is you know just as well as act Peter It's a dynamic retail environment and our guide for Q3 reflects what we expect for the quarter.
Speaker Change: Now, let me make sense of I guess the other question would just be around kind of what you are kind of seeing in the business in terms of.
Speaker Change: Not just consumer behavior, but.
Peter Benedict: Really what's going on with pet food pricing and how the vendors are kind of behaving gear.
Speaker Change: Anything you can share in terms of your views on how pricing may be trending.
Speaker Change: In particular, our dog food space as we look out in your outlook for the balance of the year. Thank you.
Speaker Change: Yes, Thanks, Peter I would say, we've seen relative consistency across the board.
Speaker Change: I'll start with the customer the customer remains choice full and are seeking value and we need to make sure that our assortment meets the customer where they need and we have the breadth of offerings to satisfy that customer desire. We continue to see strength in our services business. It was up 10% this quarter with notable strength in VAT, both owned vet hospitals and the <unk> business.
Speaker Change: Consumables was positive for the quarter at 1%, 8% on a two year. So we continue to see some of the similar strength in pockets of our business and we saw a bit of a modest improvement in the discretionary categories. So all in all I would wrap it up and say there hasnt been that much change in both the behavior of the consumer and our pricing relative to what we saw last.
Quarter.
Speaker Change: And our next question comes from Steven Forbes with Guggenheim. Please go ahead.
Steven Forbes: Good evening, Joe Brian.
Speaker Change: <unk> as well.
Steven Forbes: Joe maybe just to start talk about profit improvement I think many of US here I was just trying to gauge where you would see the opportunity so any way to rank quarter sort of.
Speaker Change: The profit improvement opportunities as we see them today that first costing us distribution efficiencies assortment evolution. Your metrics you mentioned in socks, and what is the current timeframe.
Speaker Change: You are speaking about internally to execute against those profit improvement agenda.
Speaker Change: Okay.
Speaker Change: Steve it's been a while since Ive seen you.
Speaker Change: Yes.
In terms of rank order merchandising is by far and away our greatest opportunity to deliver profitability.
Speaker Change: Simply you got to get more discipline, there or improve.
Speaker Change: Our vendor partnerships and with the due diligence we're putting in merchandising, we're going to make a lot of progress in that.
Speaker Change: Look.
In terms of timing and Brian you lean in but we committed to a $150 million and I believe we're still on track on that $150 million run rate savings exiting 2025 as you know Stephen we are on track for that we continue to look for opportunities to both augment those savings and accelerate those savings where possible jaws right the biggest.
Speaker Change: The opportunity is in merchandising, we see additional opportunities in areas like marketing, where you can get returned in one of two ways. One is how much you spend in the second is how you spend it and making sure that we are fully optimizing the top and bottom of funnel across marketing I mentioned investments in store labor, while we're making those investments were simultaneously.
Speaker Change: Looking for opportunities to take task out of our store labor model, which.
Speaker Change: <unk> two things both of which are good number one you help simplify the operations for that Pet care Center partner, who is employed by us and number two you give them more opportunities to meet the customer.
Speaker Change: And then just a quick follow up.
Ryan: Ryan you mentioned the improvement in services gross margin.
Ryan: As reported any conceptualization on what's driving that.
Ryan: Is it a function of a reduction in the gross burden right as you pulled back on best stores or is there something more structural occurring within that margin profile. Thank you.
Yeah. Thanks, Steve number of different things, let me start with grooming agreement continues to be a business that operates at scale and it's a productivity based model. So so long as you remain highly productive and grooming. The gross margin flows through nicely and we saw that Q2 was a good quarter for us grooming wise just based on the seasonality of that business.
Secondly, yes, the maturation of the Bert model, a combination of the growth algo being lower so less harsh.
Hospitals being added at the front end does help that said underneath that our leadership team on services has done a really terrific job in making sure that first of all providing the best care for pet parents and their pets, but secondly doing in a way that's highly efficient for us to help improve the structural.
Ryan: Margin underneath those.
Ryan: Those vet hospitals, the last area I'd say is the <unk> mobile clinics continue to be terrific for us high growth.
Ryan: Not a large capital investment very quick return on that investment and when operating at scale that model really works.
Again, if you have a question. Please press Star then one.
Speaker Change: And our next question comes from Seth Basham with Wedbush. Please go ahead.
Seth Basham: Thanks, a lot good afternoon, and I'll add my congratulations Joel if I could just double click on something you mentioned earlier with one of the biggest opportunities being in merchandising can you just peel back the layers for us and tell us exactly where you see the biggest opportunities is it getting more margin from vendors that consolidating vendors is it changing the assortment.
<unk> is it the supply chain of the vendors just give us a little bit more insight as to where you see the biggest opportunities. Please.
Seth Basham: Yes, Thanks Seth.
Quite honestly, it's everything you just outlined.
But to be specific and put it in my words, we've got more work to do on the assortment and so we're in the process of end to end review, our total assortment and Thats looking at specifically looking at how we're priced so that not only do we remain competitive but that it generates a reasonable.
Seth Basham: Margin.
Seth Basham: Our in stock metrics as I mentioned earlier, a really important, especially in our consumable business and I think we've got a ways to go on improving our in stock on our consumable business.
Seth Basham: You mentioned vendor partner performance that is equally as important to us we have a unique profile with some categories that only petco carries and so we've got to work on enhancing that relationship with our vendors and getting the maximum and maximizing the leverage there. So that we can continue to grow.
Seth Basham: So some of these special unique categories.
Speaker Change: And so we're really kind of looking up and down the entire thing from a global consumable side as well as the discretionary side and both of those are really leveraging my experience both from Walmart as well as at five so that we can get better across all areas, but I am confident that petco has a great merchandising.
Speaker Change: It just needs a little tweaking to.
Speaker Change: Better leverage it and deliver EBITDA performance.
Speaker Change: That's helpful and then as a follow up question. If you guys could provide any perspective on where you think the industry is already bottoming or are we seeing pet adoption on a net basis improve at household formation starting to improve why do you think we will see a turn in those metrics if that hasnt improved yet thank you.
Speaker Change: Yes, let me start with the second part of your question.
Speaker Change: In terms of adoptions adoptions have slowed.
Speaker Change: The good news is that intakes are actually lower than last year and materially lower than 2019, and when you think of intakes. You don't just think of relinquishment. In fact relinquishment is not the biggest driver of MTX loss pets are almost 50% of all incoming pets into shelters and we have data from thousands of shelters through Petco love.
Speaker Change: Almost 50% of intakes are actually loss pets. So it's critically important for pet parents to make sure. They take the appropriate controls whether that be chips or other means to track their pets. So that we can slow down the intakes into shelters adoptions have slowed a bit those are down from last year as our intakes in terms of the broader industry.
Speaker Change: We're focused on what we control right now and controlling what we can with a focus on improving profitability and cash flow of the business.
Offering pet parents the products they need with an exceptional shopping experience while simultaneously addressing our cost structure.
Speaker Change: All of that will help improve our position in the current environment and help set us up to win as the industry returns to its historical levels of mid single digit growth.
Speaker Change: I don't want to prognosticate on when that would be but I will tell you. It's in the not too distant future.
Speaker Change: And our next question will come from Michael Lasser with UBS. Please go ahead.
Michael Lasser: Good evening. Thank you so much for taking my question fuel as you have observed the organization. During your early early part of your 10 year. What is your diagnosis for what caused pick who.
Michael Lasser: Diluted play and how do the elements of your plan address those shortcomings. Thank you.
Michael Lasser: Thanks, Michael good to hear from you.
Speaker Change: Honest, Michael My focus hasn't been on what caused us to lose their way.
Speaker Change: Focused on what are we doing about fixing it and do I believe in the work that's been done and I said it on my prepared remarks, I'll say it again Michael.
Speaker Change: My assessment is we are completely on the right track, we've got the right strategy, there's been complete dedication from Mike from the management team.
Everybody all the partners and now we've just got to go execute Mike and Thats really where the focus has been.
Mike: I can't speak for the past I wasn't here.
Speaker Change: But what got me excited about joining petco is that.
Mike: What's not broken is the brand.
Mike: Not broken is the passion our pet.
Mike: Our partners have out in the field for our customers and for our pet parents.
Mike: And so everything that we've got to fix is in our control and we are well on our way to starting to make progress against that and I believe in the strategy. That's been outlined and now we've just got to go make it happen Michael.
Michael Lasser: My follow up question is how does the company financial leverage.
Michael Lasser: <unk> influence your strategy and do you think there could be a store portfolio review that would lead to some significant amount of store closures.
Michael Lasser: Yes.
Speaker Change: Good question, Michael and.
Speaker Change: What I would tell you is I've looked at the higher plan the entire strategic plan.
Speaker Change: Mass closing is not one of them.
Speaker Change: I do not see that as something we need to do but having said that Michael look we're looking under every rock everything's on the table and our store isn't profitable, we'll close it but it's more of a fluid rolling situation as stores come up for lease, but we do not have a large <unk>.
Speaker Change: <unk> stores that are EBITDA negative.
Speaker Change: And a result in us having to do a mass set of closing that's for sure.
Kamil Rawala: And our next question comes from Kamil <unk> Raw Wala with Jefferies. Please go ahead.
Speaker Change: Hey, guys.
Kamil Rawala: A couple of questions I guess the first.
Joe: Joe you've been there.
Joe: Short period of time, keeping with the current strategy. Obviously makes sense for are there any kind of notable refinements in that strategy or areas that you really want to press forward to press ahead and other things that maybe are less.
Speaker Change: Less important than they might have been before.
Speaker Change: I guess, we're all press ahead is going to be.
Speaker Change: We just got to move faster right and I think about.
Speaker Change: Wanted to get back to playing offense.
Speaker Change: Those of you that followed me at <unk> for a number of years before we can play offense at five.
Speaker Change: We had to get our people systems and infrastructure in place and as I think about petco, but we've got to do right now is cut costs.
Speaker Change: <unk>, which means have urgency and be decisive and we got to prioritize projects. We got to reduce the number of projects. We're doing so what we're focused on is meaningful and has a significant difference in impact for both our partners and our customers. So I think if anything it's just about speed and.
Speaker Change: Execution than it is about changing the strategy here in the short term.
Speaker Change: Okay got it and then any thoughts on the current format of the store and if theres any refinements that need to be there.
Speaker Change: Well look I think we've got opportunities in our current stores in.
Speaker Change: The first phase, though is we've got to get.
Speaker Change: Profitability back in course, so that we can focus on our debt leverage we can focus on returning to.
Speaker Change: Increasing our EBITDA and then we will turn to the portfolio of stores.
Speaker Change: I can tell you I've been encouraged about is we know how to do a store right. If we put our mind to it and I was recently in our Union Square store I think Thats a phenomenal store. It shows you what what our Petco team can do when we put our best foot forward and Thats. The type of image I want first our brand long term, but right now we've got.
Stay focused on near term profitability.
And our next question comes from Steven Zaccone with Citi. Please go ahead.
Steven Zaccone: Great. Thanks, very much for taking my question Congrats Joe on the new role.
Steven Zaccone: I wanted to ask a question just going back to this discussion around market share.
Steven Zaccone: Referenced trying to capture more market share and Petco has some has some really large competitors right. So when you've been in stories and you've done your initial assessment of the business do you see a bigger opportunity to gain more market share with those existing customers that are coming in to kind of increase their basket or is there a bigger opportunity.
Speaker Change: Turning here to drive new customer growth and maybe get some lapsed customers to return to the store.
Speaker Change: Yes.
Steve: Steve Great question.
Speaker Change: Ultimately, we got to get back to growth.
Steve: <unk>.
Speaker Change: Not afraid of the competition.
Steve: Retail is a competitive game.
Steve: I believe that pet coke and compete with anybody what we need to do though is we got a firmly articulate.
Steve: Our points of differentiation and then go deliver them.
Speaker Change: And what's been great in my short time being here is how aligned the organization is how much everybody here wants to win and so as we move from the strategy phase to this execution phase around profitability, that's really going to open up some opportunities to then go focus on market share and so.
Speaker Change: Our first signs of market share gain arent going to necessarily be about unit store growth.
Speaker Change: It's about truly leveraging our current store base, we can grow services and Bryan talked a lot about that and how we're already winning there.
Bryan: We can continue to improve the in store experience <unk> got some ideas on entering new categories.
Bryan: Put that all together it really helps.
Prove the four wall EBITDA of our existing fleet that will be the first phase and where youll start to see growth out of this company.
Let's stay focused on the profitability piece and we've got to deliver that for all of you and earn the respect back here in the second half of 'twenty four.
Bryan: Okay understood and then.
Bryan: Brian a question for you just on the driver of the comp.
Brian: How should we think about that slightly positive comp was it was it driven by a little bit more by ticket was there improvement in transactions and then how should we think about the back half of the year or at least the third quarter since you've given guidance there.
Speaker Change: Yes, thanks, Steve without getting into too much detail. It was more driven by ticket than it was by traffic.
Speaker Change: And our next question comes from Oliver Winter mental with Evercore ISI.
Speaker Change: Please go ahead.
Speaker Change: Yes, Thank you and welcome Joel.
Speaker Change: My first question is you mentioned a focus on profitability looking at the gross margin rate.
Joel: Above 42.
Joel: Time of IPO dropped below 38.
Speaker Change: Is there anything that you can help us with how you envision the profitability of the business to to improve over the next few years and what are the drivers. There is it more gross margin SG&A is that merch margin a little bit more details would be helpful.
Speaker Change: Yes, Thanks, Oliver let me start with that one.
Speaker Change: You mentioned back to.
Speaker Change: Our gross margin levels of 42.
Speaker Change: That was at a time when we had discretionary categories growing in some quarters in excess of 30% I would tell you that the biggest driver of gross margin deterioration over the past several years has been the decline in those categories, which as you know prior to this quarter were down eight or 9% per quarter for a few years throughout not minus five today, we've seen modest improvement there we do.
Speaker Change: Those categories to return to growth, we're not we have not baked that into our guide in the third quarter. However, we do expect that to occur that said we are focused on controlling what we can what you saw show up in the second quarter with the sequential gross margin improvement was some of the operational efficiencies starting to take hold we saw good improvement.
Speaker Change: In supply chain, we saw good improvement in services gross margin quarter on quarter that was coming off of improving from Q4 to Q1. So we do see opportunity in gross margin. We've got a lot of initiatives a lot of major things in flight isolated in a couple of initiatives.
Speaker Change: We talked about merchandising across the board, taking a holistic approach as Joel touched on there is opportunity for it therefore us there's opportunity within our opex structure. Once we get past some of these investments needed to make sure that the customer experiences in store.
Speaker Change: Got it. Thank you and then the follow up is on free cash flow I think first first half as a break.
Speaker Change: Breakeven, but then you're expecting growth in 2024, so maybe can you point to some drivers of free cash flow growth in the second half. Thank you.
Oliver Winter: Yes, Thanks Oliver.
Speaker Change: Four major levers to drive free cash flow for this company that matter.
Speaker Change: Profitability accounts payable inventory and Capex, we've taken a disciplined approach to capex for the year and we've held that guide at $140 million.
Speaker Change: Supporting the business appropriately with that level and also investing in several high ROI projects helped drive the future growth of the business team did a great job on accounts payable last year, and we've held where we kind of exited last year and then what you saw in Q2 some of our disciplined inventory management show up in free cash flow the biggest driver, though and the biggest.
Speaker Change: Lever for us is to improve profitability and that's our primary focus.
Speaker Change: And our next question comes from Simeon Gutman with Morgan Stanley. Please go ahead.
Simeon Gutman: Hi. This is morning on for Simeon I guess, just following up on prior questions regarding strategies I think you mentioned like merchandising improving vendor partnerships investments in store labor can you just give any color on maybe how you plan to fund these strategic initiatives.
Simeon Gutman: Yes.
These are these are initiatives that that fund themselves. When we talk about initiatives, we're not talking about major investments back into the business I mentioned the store labor investment, but those show up in the P&L for fairly transparently in Q1, and Q2 that was the driver of SG&A improvement, but more if you think about the whole bucket of initiatives where <unk>.
<unk> $150 million of run rate savings exiting 2025, so I would not think of these initiatives as investments into the business, but opportunities to free up capacity inside the business to a reinvest in the business be.
Speaker Change: Dropped some of that profitability to the bottom line and seed mitigate against.
Speaker Change: Any unforeseen headwinds.
Speaker Change: Got it that's helpful. And then I guess a follow up is just wondering what are the attach rate of service among pet owners and how can this improve.
Speaker Change: I'm not sure I'm going to be able to give you. The attach rate you are looking for what I will tell you is.
Speaker Change: The services business is strong so if I look at the buckets of our business, where we're leveraging strengths as opposed to trying to fix something that's broken services is one of those areas grooming remains a very resilient strong business operating at high capacity, but that business is growing at a multiple of the services business, both in hospitals and Rebecca mobile <unk>.
Speaker Change: <unk>. So I think we're meeting pet parents needs across services and as Joel mentioned in his introductory comments, it's a key differentiator for us against both mass retail and.
Joel: Online only competitors.
Joel: And our next question comes from Kendall Toscano with Bank of America. Please go ahead.
Kendall Toscano: Hi, Thanks for taking my question and congrats on the new role.
Kendall Toscano: So my first question was just on <unk>.
Brian I know you mentioned that overall the comp was more ticket than traffic driven but curious if you zoom in on me.
Speaker Change: Services business, and particularly that where you had some pretty nice growth during the quarter with that also the case there.
Brian: Yes, that's both the vet business is maturing for us so.
Speaker Change: Although we have slowed down the growth of new bed adds this year, we added a meaningful amount of events over the past two and a half years those first take.
Brian: Up to five years to mature fully so we still have.
Brian: Thats ramping in capacity in line with the economic model that we laid out so that would be different than the overall business, because we're actually improving both transactions and basket in that business.
Speaker Change: Got it okay. That's helpful.
Speaker Change #100: And then my next question was just in terms of the product category margins.
Speaker Change #101: It looks like in services, you had some pretty nice year over year gross margin expansion, but then in the products business.
Speaker Change #102: The margin has actually got a little bit worse compared to the first quarter just.
Speaker Change #102: Just wondering if that was in line with expectations and what drove that and also how we should think about the products business into <unk>. As you are lapping assortment changes from last year.
Speaker Change #103: Yeah, let me start with services.
Speaker Change #104: Each of our services business businesses major businesses grooming and that improved their gross margin rate sequentially and year over year now Beth has because of the nature of it being a maturing business has a lower gross margin rate than grooming as it grew faster.
<unk> been grooming the fact that the overall services business improved the gross margin rate.
Speaker Change #105: Speaks to the strength of what's happening underneath that model within product year over year. The biggest the biggest change in product gross margin is actually the discretionary weakness, where you still saw a minus 5% relative to 1% consumables growth and you have fundamentally materially different margin profiles between those two the change quarter on quarter, just has to do with kind of <unk>.
Speaker Change #105: Within the mix, it's not a meaningful change in that product margin Kendall. So I would say we continue to ramp.
Speaker Change #105: Some of our newly introduced brands, we did see particular strength in fresh frozen so from a lifetime value standpoint that is a very very attractive category, where we think we're uniquely positioned to take share over time.
Kendall Toscano: However, the margin profiles, a little bit different so its kind of mix within there.
Benjamin <unk>: This concludes our question and answer session I would like to turn the conference back over to Benjamin <unk> for any closing remarks.
Benjamin <unk>: Thank you everyone and again, Joe welcome to Petco, we're delighted to have you hit that concludes today's earnings call. The team will be available after to answer further questions. Let's say thank you so much.
Speaker Change #107: The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Speaker Change #107: Yes.