Petco Health and Wellness Company, Inc. (NASDAQ:WOOF) Q4 2023 Earnings Call Transcript

Petco Health and Wellness Company, Inc. (NASDAQ:WOOF) Q4 2023 Earnings Call Transcript March 13, 2024

Petco Health and Wellness Company, Inc. beats earnings expectations. Reported EPS is $0.02, expectations were $0.019. WOOF isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the Petco Fourth Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now, like to turn the conference over to Cathy Yao. Please go ahead.

Cathy Yao: Good morning, and thank you for joining Petco’s fourth quarter and full year 2023 earnings conference call. In addition to the earnings release, there is a presentation available to download on our website at ir.petco.com, summarizing our results. On the call with me today are Mike Mohan, Petco’s Interim Chief Executive Officer; and Brian LaRose, Petco’s Chief Financial Officer. Before they begin, I would like to remind everyone that on this call we will be making 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 and 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 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. We will allow for 30 minutes for Q&A. With that, let me turn it over to Mike.

Mike Mohan: Thank you, Cathy. Good morning everyone, and thank you for joining us today. I’m going to spend some time, discussing the leadership changes that we’ve announced today, while Brian will take us through our financial results, and initial expectations for the year ahead. As you will have seen from today’s news, I’ve been appointed by the Board, to serve as interim CEO, while we conduct a comprehensive search, for a new CEO. Ron Coughlin has stepped down as CEO and Chairman, and will serve as an advisor to the Board, during the transition. I am honored to be here with you today, and serve such an incredible company, with a mission that matters to improve the lives of pets and pet parents. I’ve served as Petco’s Lead Independent Director for the last three years, and I’m proud to be stepping into lead our 29,000 dedicated Petco partners, who bring our mission to life every day.

The Board has spent some time with the executive team, over the past several months, to assess our operating and financial results. I’m confident that given our position, as a leader in pet health and wellness, we will be able to improve performance in the years ahead. I want to share my initial perspective on the business, and what we’ll do, to drive improvement. Petco is an iconic brand in the pet care category that, is benefiting from the long-term megatrends of humanization and premiumization, supporting consistent and resilient category growth, in a market that is expected to approach, $200 billion in sales, by the end of this decade. Petco has a combination of differentiated products, a commitment to veterinary, and other services, and an omni-channel model that taken together is unmatched in our industry.

With the only full service pet health and wellness ecosystem, Petco sits at the forefront of the industry, and is uniquely positioned, to win for the long-term. While we have made progress in a number of key areas, over the last several years. I recognize, we have not been executing the way we need to, in a number of areas, to deliver on our full potential. Most critically, we have not adapted quickly enough, to recent changes in consumer preferences. First, we did not anticipate, the magnitude of the shift, to value in both our consumables, and discretionary business. And second, we did not expect customers, to pull back as quickly as they have, and for this duration, when spending on discretionary items. As a result, our in-store and omni-channel offering, was not appropriately aligned, with our customers’ needs.

This has led to two fundamental problems that, we need to address with speed. One, an erosion of market share as customers sought out alternatives, and two, a significant decline in profitability. Our work here, has already begun, with the reintroduction of value brands, in our consumable business, and adjusting our discretionary offering, to provide more balanced price points. But simply reintroducing these products into our assortment is not enough. This more balanced assortment, must be supported with stronger retail and online customer experiences, and more disciplined execution. This starts with effective marketing to both existing, and potential customers. It builds with strong in-store and online merchandising. It is further supported by the education of Petco partners, to ensure they can effectively sell our complete offering.

And finally, it needs to be supported, by effective supply chain management that delivers inventory profitability with high-end stocks across our store base, and efficient delivery to omni-channel customers. Going beyond these critical near-term actions, we have to engage pet parents more effectively. We are focused on executing against high-quality, top-of-funnel customer acquisition and long-term retention, so more customers benefit, from the full Petco offering. In doing so, we’ll double down on our efforts, to maximize the opportunity, to fully leverage the competitive advantages and opportunities, we have with our in-store and online customer experience. And we’ll act purposely, to connect with pet parents, to drive share gains, and grow margins through improved baskets, and a quality of sales in a meaningful, and substantial way.

Improving our customer experience, retail execution, and overall cost structure, will help us drive profit stabilization in the near-term, and growth in the medium and long-term. I plan to have us work against fewer, and more clearly stated priorities and outcomes, while keeping our teams energized, supported, and equipped to execute against achievable goals, and making progress, against promises we commit to for ourselves, our customers, and shareholders. Throughout my over 36-year career in retail, one truth has remained. This journey is never linear, but it must be built on a world-class retail experience. If our comprehensive ecosystem, is the engine that drives Petco’s success, then the trust and advocacy of our customers, vendors, and partners, is the fuel that powers it.

This principle, will sit at the heart of everything we do, beginning with our employee experience. This is an exceptional business that serves millions of pets every year. And I believe that, by focusing on our mission, while addressing the realities of the business’s performance with clear, consistent, and focused prioritization, we can unlock Petco’s full potential. Finally, on behalf of the Board and all of us at Petco, I want to thank Ron for his leadership over the last six years. Ron has overseen the evolution of Petco as a full service omni-channel retailer, and champion for pet health and wellness. We are grateful for his leadership, dedication, and passion for pet, people and our business. Thank you for your time. I’ll now pass it over to Brian to cover our financial performance.

Brian LaRose: Thanks, Mike. I’d like to start, by thanking our Petco partners, for their relentless efforts in 2023. While we experienced a challenging year, they continued to do everything they can, to deliver the very best, for pets and pet parents day in and day out. Turning to numbers, for the quarter, net revenue was $1.7 billion, an increase of 6% year-over-year, which includes an extra week in the fourth quarter. For the full year, net revenue was $6.3 billion, up 4% year-over-year, inclusive of the extra week, which contributed approximately $120 million in revenue in Q4 and for the full year. In Q4, comparable sales on a like-for-like fiscal basis, were down 1%, driven primarily by the absence of discretionary recovery, and lapping a more inflationary environment.

While we saw early gains in revenue, from the aggregate impact of our assortment actions, they were relatively small in magnitude for the quarter. For the full year, comp sales were up 2%. Unless otherwise specified, the results I’ll discuss, are on an as-reported basis, including the extra week in Q4. In the fourth quarter, our services team delivered 17% revenue growth, driven by ongoing strength in our vet hospitals, mobile clinics, and grooming services. In merchandise, consumables was up 9% year-over-year, reflecting the impact of lapping prior year inflation, coupled with the pricing actions, we took in the third quarter. Our discretionary supplies, and companion animals businesses, experienced continued softness down 1% year-over-year.

Moving down to P&L, Q4 gross profit was $606 million, down from $627 million in the prior year. Gross margin for the quarter, was 36.2%, a decline of 350 basis points, driven by our investment in bringing value brands, into our consumables assortment, and ongoing discretionary headwinds. In Q4, we also took a $21 million inventory write-down charge, as a direct one-time response, to our assortment actions that were taken in connection with our operational reset, with approximately 60% of the charge, related to lower velocity supply SKUs, and 40%, related to consumable SKUs that, will no longer be part of the assortment. This charge, was a necessary step, to optimize our SKU footprint – and our reset is now completed, and we believe we are in a good place, with inventory.

Ex-inventory reset gross margins would have been 37.5%. In terms of the new brands, although it is still early days, we are pleased to say that we are seeing positive momentum, in both transactions and basket, leading to a small, but positive net impact on revenue, from our assortment and pricing changes. This has translated to positive customer net ads in the fourth quarter, suggesting early momentum from our reset. In Q4, SG&A as a percentage of revenue, increased from 34.8% to 36.2% year-over-year, as a result of ongoing investments made in store labor, as well as increased depreciation. Q4 adjusted EBITDA, was $105.3 million, down 33%, with an adjusted EBITDA margin rate of 6.3%, down 370 basis points, year-over-year. Q4 adjusted EPS was $0.02, compared to $0.20 per share, in the prior year.

Turning to the balance sheet, our liquidity remains strong, with $572 million inclusive of $125 million in cash and cash equivalents, and $447 million of availability on our revolving credit facility. As a reminder, we also maintain callers, on roughly two-thirds of our debt, which have helped mitigate the impact of rising rates this year. Our Q4 CapEx of $49 million is down 26%, year-over-year. I’ll now turn, to our 2024 outlook. Given the change in leadership, we are not providing full year guidance, at this time. Instead, we are providing revenue, adjusted EBITDA, and adjusted EPS guidance, for fiscal Q1 only. For the first quarter, should current demand conditions persist, we would expect revenue, of approximately $1.5 billion, adjusted EBITDA of approximately $70 million, and adjusted EPS of approximately negative $0.06.

For 2024, which as a reminder, will be a 52-week year, the environment remains uncertain, and as a result, we are taking a prudent approach, to our plans for the year. From a full year perspective, we 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. Approximately $140 million of capital expenditures, including the build-out of approximately five to 10 vet locations. In the meantime, our mobile clinics business, continues to perform ahead of our expectations, and we’re confident that the demand there, will help support vet economics. To provide some additional color regarding assumptions for the full year, we are currently not expecting a substantive change, to the underlying demand environment, including discretionary.

With respect to profitability, there are a number of actions that, are being contemplated, as part of the leadership transition. We will communicate as those plans are finalized. We do expect stabilization of profitability, as the year progresses. Although we are seeing early traction from implementing our assortment and pricing actions, we believe the scaled revenue, and profit benefits, will take time to phase in, increasing throughout the year. We remain on track to achieve $40 million in cost benefits, in year one from the cost opportunities we identified, as part of the planned 150 million in run rate savings, by year end 2025. That said, the cost benefits will be partially offset, by additional investments into store labor, to ensure that we deliver a differentiated, hands-on customer experience in our stores, as well as mitigation against gross margin.

On capital allocation, we remain focused on our balance sheet, as we navigate this environment, leading to a deceleration in our pace of that build out, and a balanced approach, between investments and cash flow. To close, our focal points this year, are disciplined execution, operating in a more efficient manner with a focus on expenses, stabilizing margins, and cash. Thank you for your time. And with that, we’ll be happy to take your questions.

Operator: [Operator Instructions] The first question comes from Steven Forbes with Guggenheim. Please go ahead.

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Q&A Session

Steven Forbes: Good morning. Mike, Brian, I wanted to focus on capital expenditures, the guide for the full year, maybe a two-part question. Of the $140 million, can you break it down between maintenance and strategic CapEx. You mentioned five to 10 vet hospitals, but just how are you thinking about the broader, sort of strategic initiatives here? And then, although you’re not providing full year guidance, was the $140 million a result, of sort of planning the business, to a neutral free cash flow state, or any sort of comments on, where you sort of, are bridging free cash flow for the year?

Brian LaRose: Thanks for the question, Steve. Let me start with the announcement today. We’re taking a disciplined approach, to capital allocation. Your question specifically on how the $140 million breaks down. That is the full year guide that approximately $140 million. I’ll just tell you that, you get kind of triple digit-ish and north of that, when you talk about maintenance. And that’s inclusive of IT infrastructure, some of the maintenance that, you have in the store front, whether that be HVACs, or replacement of aquarium tanks, et cetera. Beyond that 5 to 10 vet builds, you know what that math is. It’s $600,000 per bed, another $600,000, $700,000 for the center store build-out. There are some other projects that we have.

We’ve been very mindful about balancing the investments this year, against what we’re trying to do on cash flow. I’m not going to get to a specific cash flow guide for you. But what I will tell you, is that’s a function of three knobs: earnings, working capital and CapEx. We’ve talked about CapEx. The most powerful of those three is earnings, Steve, and our focus is on bending the profitability curve, of this company and improving profitability.

Steven Forbes: And then just a quick follow-up. I don’t know if we can maybe focus on the fourth quarter supplies, trends, or sort of what’s implied, by the first quarter sales guidance, for supplies. But any way, to help better understand, like whether we’re seeing any path to stability, or any stabilization in supplies trends? Or how that business today compares to, I don’t know if you want to baseline it back to 2019? Just is there any path, to sort of stability in the underlying supplies trends, now that you’ve reintroduced value brands, and reengineered the assortment?

Brian LaRose: Yes. Let me kind of help you with the revenue, Steve. So, we reported down 1%. That’s with the extra week in there. We didn’t break that $120 million extra revenue, by subcategory. But if you do the math, you get to about the same decline rate, as we’ve had the last couple of quarters in supplies and CA combined. So from a growth rate standpoint, there hasn’t been stabilization. We’ve taken significant action on the cost side, on the assortment side in terms of pricing. So, we’re confident, we have the right actions in place. We felt that it was most prudent, to plan our year as if there, is no meaningful change in the demand environment, at the holistic level, but specifically to that category.

Operator: The next question comes from Kate McShane with Goldman Sachs. Please go ahead.

Mark Jordan: Good morning. This is Mark Jordan on for Kate McShane. Thinking about the change in leadership that was announced today, can you help us better understand, what the Board might be looking for in new leadership?

Mike Mohan: Hi, Mark, Mike here. Thanks for the question. I appreciate it. Right now, we are really focused on improving our urgency, and driving operational performance and profitability, and really operating at a world-class retail level. So from a Board standpoint, we’re doing a comprehensive search, and we’re looking for skills in that realm, to help drive our business forward.

Brian LaRose: Let me just add, Mike probably won’t say this, but he’s coming in with 36 years of retail experience, with a reputation for operational excellence. So, this is somebody who can come in and actually make meaningful change.

Mark Jordan: Perfect. And just one follow-up, if I could. Does this change anything, with regard to the near-term strategy that was communicated, maybe going more down market, with the value brand; still committed to that?

Mike Mohan: Yes. Mark, we’re an iconic brand and advantaged ecosystem. And if you look at, how we think about our customer offerings, and the reintroduction of value brands, it’s just one part of our story of making sure, we have the assortment that makes sense for our customers. We have work to do, though, to make sure our customers, and our partners truly understand, what we offer and make sure that, they can navigate that entire assortment, but it fits well within our current strategy.

Brian LaRose: Yes. And I would just add to you. Whether it pertains to the reset, or just adding more broadly to our portfolio, anytime we bring new offerings into our portfolio, job one is to make sure that those offerings, are what the customer wants, and that we’re selling what they want, where they want it, how they want it at the right price. Over time, we need to make sure we continue, to cultivate that assortment, so that everything we bring in is — it contributes profitably to the enterprise.

Operator: The next question comes from Peter Benedict with Baird. Please go ahead.

Peter Benedict: Hi, good morning. Good morning, guys. First question is just around, some of the near-term opportunities, to impact the business. Mike, I think you mentioned supply chain management. I’m just curious maybe any more detail there, what you guys can do on that front? And related to that, kind of on the customer experience side, is that a suggestion that you’re going, to be putting more labor back into the stores? Or I’m just kind of curious at the store level, what you envisioned on that front?