Petco reported third-quarter 2023 earnings that fell short of expectations, with net revenue coming in at $1.49 billion, a slight year-over-year decrease. Despite the disappointing results, the company is taking swift action to improve its business performance, focusing on value offerings, pricing adjustments, supply chain efficiency, and labor optimization. Petco expects these upfront costs to yield profitability gains in 2024.
Key takeaways from the earnings call include:
- Petco reported growth in its services, merchandise, and digital channels. Gross profit for the quarter was $550 million, and adjusted EBITDA was $72.2 million.
- The company's liquidity remains strong, with $586 million in cash and credit facility availability. Petco has also made progress in reducing its debt, with a year-to-date reduction of $75 million.
- A significant goodwill impairment of $1.2 billion was recorded in Q3.
- The company updated its full-year guidance, maintaining revenue projections of $6.15 billion to $6.275 billion, adjusted EBITDA of approximately $400 million, and adjusted EPS of approximately $0.08.
- Petco plans to focus on operational changes to align with current consumer dynamics and generate further operating leverage and earnings growth.
- The company's merchandise strategy includes a shift towards value offerings while maintaining a focus on premium and super premium products.
- Petco is investing in its supply chain and labor models to generate cost savings and is focused on reducing capital expenditure in fiscal 2024 while optimizing its existing infrastructure.
- Executives discussed the deceleration in the company's top line and the factors contributing to it, including the abating inflation benefit from the second half of last year and a continued decline in discretionary business.
- The company aims to attract more customers by offering a range of products, including value brands, and hopes to increase basket size and attach rates.
Petco executives highlighted the growth of their grooming business and the potential of veterinary services for driving profit improvement. They addressed the company's inventory levels, stating that inventory was slightly higher due to the introduction of a new value assortment. However, they expressed satisfaction with inventory management and the team's efforts to align inventory with product velocity.
The company is also considering potential door closures as part of their cost-saving initiatives. Despite the lower margins of value brands, Petco sees them as a means to drive customer traffic and incremental profit. They believe they can benefit from existing customers consolidating their shopping with them and attracting new customers.
Petco remains focused on bringing more pets into their ecosystem and returning the business to long-term growth and profitability. The company's strategies for dollar profit growth include strengthening competitive positioning through pricing, expanding their assortment, and implementing cost actions in the second half of 2024 and into 2025.
InvestingPro Insights
Petco's recent earnings report has raised concerns among investors, as reflected in the real-time data and analysis from InvestingPro. The company's market capitalization stands at $801.59 million, indicating a scale of operations significant enough to merit investor attention. However, Petco's P/E Ratio is currently negative at -0.658, suggesting that the market is valuing future growth prospects cautiously, especially as the company has reported a decline in earnings per share.
InvestingPro Tips indicate that analysts have a bearish outlook on the company, with 8 analysts having revised their earnings downwards for the upcoming period. Additionally, Petco's stock has experienced a pronounced decline over the last week, with a 1 Week Price Total Return of -24.5%. This volatility is a critical consideration for investors, as the stock generally trades with high price volatility, a pattern that may continue in the near term.
Investors looking for more comprehensive insights can find additional tips on InvestingPro, which currently lists over 10 tips for Petco. These tips provide a deeper understanding of the company's financial health and market performance.
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Full transcript - Pet Acquisition LLC (WOOF) Q3 2023:
Operator: Good morning, and welcome to the Petco Third 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. And now, I'd like to turn the conference over to Benjamin Thiele-Long, Vice President of Corporate Communications. Benjamin, you may begin.
Benjamin Thiele-Long: Good morning, and thank you for joining Petco's third quarter 2023 earnings conference call. In addition to the earnings release, there is a presentation and infographic available to download on our website at ir.petco.com, summarizing our results. On the call with me today are Ron Coughlin, Petco's 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. With that, let me turn it over to Ron.
Ron Coughlin: Thanks, Benjamin, and thank you, everyone, for taking the time to join us today. To start, I'd like to express my utmost appreciation to all our Petco partners across the country. Their dedication makes Petco the special place that it is, and this quarter the team worked especially hard to deliver the very best for pets. In Q3, results were below our expectations, and we're taking swift and decisive action to improve the performance of our business by broadening our appeal with customers and tightly managing costs and capital. This work is already underway and is the top priority for the entire Petco team. This includes progress against the targeted $150 million in run rate savings by the end of fiscal 2025, which we outlined last quarter. We remain on track to deliver $40 million in year one. Over the past years, we've seen significant changes that have impacted consumer spending. While we saw a surge in pet adoption during the pandemic period, coupled with stimulus that facilitated discretionary spending, the current economic environment means many consumers are increasingly discerning in their spending and actively seeking out more value. As a result, it's clear we must adapt our business to meet the needs of consumers in this environment. Consequently, we've launched an operational reset to improve the performance of our business, which is well underway and consists of four key pillars. The first and most significant is our focus on delivering value. We brought in the category's largest nationally available value brands in food and treats for both dog and cat. These brands include Friskies, Pedigree, Purina 1, Beneful, Temptations, and Milkbone among others. These will complement our best-in-class premium in fresh frozen food, treats, and toppers, allowing us to cycle out slower-moving brands and skews and focus on the highest-velocity skews. Food is a primary driver of where and how pet parents shop, with over 70% of households buying at least one of the food brands that we're now bringing into our portfolio, and equating to approximately $12 billion in category sales for dog and cat annually. Supported by powerful and targeted marketing, we expect these brands will bring more customers through our doors, increasing traffic, and delivering incremental sales through services and supplies attached. While we remain committed to being a leader in the still rapidly growing premium, super premium, and fresh frozen categories, this is about choice. Bringing as many pets as possible into our health and wellness ecosystem. Whether chosen because of price sensitivity, brand preference, a picky eater, or a combination of these, we believe in the current environment it's important that no pet is excluded. Simply put, we can't improve the health of a pet whose pet parent doesn't walk through our doors or shop with us digitally. Our team has acted fast. These brands are already on shelves, having been set in the first few weeks of November. This is in addition to Fancy Feast, where we began expanding our assortment in Q2. I'm grateful to our vendor partners for their collaboration, and I'm exceptionally proud of the speed and agility with which our merchandising, supply chain, and pet care center teams were able to get these products in distribution centers and on shelf. This move has already proved acquisitive to our customer base. In the first month since introduction, a significant number of Fancy Fees customers were new or lapsed food customers with Petco. Moreover, they demonstrated significantly higher attach rates when compared to other cat food customers, including litter and supplies purchases, vet visits, and vital care premier signups. I personally worked in multiple stores over the last month, helping our teams put these valued products on shelves, and meeting many customers who are now purchasing products like Fancy Feast, Friskies, or Purina 1 at Petco instead of a grocer or mass outlet. Importantly, while the upfront costs and investment in labor and logistics to get these products on shelves has impacted near-term profitability, we fully expect to realize profitability gains in 2024 as we build loyalty and basket with these incremental customers. The second pillar is about honing our pricing. We have seen progress with targeted pricing actions to address competitive gaps in key traffic driving brands. In Q3, we adjusted pricing on several hundred SKUs with a tangible uplift in sales. We will continue to use both pricing and promotional cadence surgically at key moments, including through the holidays, with a focus on driving traffic, customers, units, and revenue growth. In aggregate, these actions contributed to Petco returning to customer growth in Q3, with approximately 60,000 net adds in the quarter, and year-over-year Nest Pac growth. These changes will enable even greater top-of-funnel acquisition, loyalty, basket, and share of wallet, as we bring customers deeper into our ecosystem through memberships, services, data-driven personalization, and the attentive expertise of our partners in the aisle. Third, we're focused on driving efficiency in our supply chain. While we expect the bulk of our supply chain savings to take effect in fiscal 2024 and 2025, some of the early actions we have taken are already showing favorable results, including year-over-year improvements in distribution costs per unit. And in labor, the fourth and final pillar of operational reset, we've completed the previously announced adjustment to our corporate and field leadership headcount by 25% and are working hard to ensure we leverage synergies between teams and optimize our labor model. Inside the PCCs, we made target investments in our people and further enhanced processes. These actions positively impacted store retention, improving over 800 basis points year-over-year, and allowing us to up-level our overall talent and deliver better engagement with our customers. As we reposition our business to better serve pet parents, we remain focused on executing our core long-term strategy: expansion of services, merchandise differentiation, and seamless omnichannel delivery. In services, we deliver double-digit growth. Our veterinary services teams are driving both revenue and customer growth. We now have a total of 282 full-service veterinary hospitals and are averaging 1,481 veterinary clinics a week. Without a doubt, our veterinary offerings strengthen our hands-on pet capabilities in a way none of our competitors can match. Stores with hospitals continue to drive mid-single-digit center store uplift and our outgrowing rest of chain. In merchandise, In addition to strong continued demand in premium, fresh frozen supplements, pest, farm and feed, and Rx all showed sustained growth as they continue to resonate with pet parents who gravitate to our health and wellness offerings. In Omnichannel, we saw revenue growth across our digital channels, including growth in BOPUS, while also leveraging reduced shipping costs in same-day delivery. And our membership offerings continue to be both a value driver for pet parents and an indispensable tool to drive loyalty and share a wallet. Vital Care Premier members, now totaling 672,000 remain our most engaged and valuable customers. They continue to visit more and spend triple what non-members spend and are fully immersed in the full benefits that our unique ecosystem offers in a way no other pet care membership program does. As I close, I'd like to reiterate my thanks to our Petco partners. Over the last few weeks, they've worked extra hard to prepare our business for the holidays and have dedicated additional effort to delivering against the operational changes that I've outlined today. Above all, we continue to believe that our unique ecosystem means no one can take better care of pets than we can. And we are absolutely focused on executing our operational reset with urgency. Thank you for your time. And with that, let me pass it over to Brian.
Brian LaRose: Thanks, Ron. I too would like to extend my thanks to our Petco partners for their enduring commitment to doing the best for pets. Over the last few weeks, I've seen, firsthand, their dedication come to life by executing against our strategic objectives, and I'm humbled by their approach to doing everything they can to ensure every pet is fed, loved, and cared for. Turning to numbers, for the quarter net revenue was $1.49 billion, a slight decrease of 50 basis points year-over-year. Comparable sales were flat, primarily a result of the ongoing pressure on discretionary spending and the increase in value seeking seen in the quarter. Within the business, the hard work of our services team delivered 14% growth, driven by ongoing strength in our vet hospitals, mobile clinics, and grooming services. In merchandise, consumables were up 2% year-over-year, while our discretionary supplies and companion animal businesses experienced continued softness, down 9% year-over-year. Moving down the P&L, gross profit was $550 million, down from $597 million in the prior year. Gross margin for the quarter was 36.8%. To reiterate what Ron said in his remarks, the impact of gross profit and gross margin in the quarter was primarily due to the continued softness in discretionary spending, coupled with the investment we made in bringing additional brands into our consumables assortment. These upfront costs were necessary to act with the agility needed to get these products on shelves in a timely manner. And while they cause a lag on profitability in the short term, we expect this expanded assortment to be margin dollar accretive in 2024. In Q3, SG&A as a percentage of revenue increase from 36.6% to 37.5% year-over-year as a result of investments made in store labor, as well as depreciation and stock-based compensation. Q3 adjusted EBITDA was $72.2 million, down 40%, with an adjusted EBITDA margin rate of 4.8%, down 318 basis points year-over-year. Q3 adjusted EPS was negative $0.05 compared to $0.11 per share in the prior year. As we look at the balance sheet, our liquidity remains strong, with $586 million, inclusive of $140 million in cash and cash equivalents and $446 million of availability on our revolving credit facility. Additionally, we continue to make progress on our plan of accelerated debt paydown. This quarter we paid down $15 million in principal, bringing our total year-to-date debt pay down to $75 million. As a reminder, we also maintain callers on roughly two-thirds of our debt, which has protected and will continue to protect meaningful portions of our debt from potential interest rate [raising] (ph). Our year-to-date CapEx of $177 million was down 17% year-over-year as a result of our continued optimization of cash flow, balancing short-term cash flow management with long-term investment. Before turning to outlook and guidance, it's important to note that we recorded a goodwill impairment of $1.2 billion in Q3 associated with goodwill recorded in 2015, well before our IPO in 2021. The charge is non-cash and made in accordance with the accounting rules governing the evaluation of goodwill. Looking ahead, as Ron outlined, while we remain focused on the long-term drivers of growth and differentiation, the balance of this year and early 2024 will focus on making operational changes necessary to align our business to the current consumer dynamics. In terms of guidance for the balance of 2023, given the results of our fiscal third quarter and the current consumer dynamics, we are updating our full-year guidance to the following. Revenue of $6.15 billion to $6.275 billion, which is unchanged. Adjusted EBITDA of approximately $400 million and adjusted EPS of approximately $0.08, each reflective of the year-to-date results and expectations for the fourth quarter. And $215 million to $225 million of capital expenditures, which is unchanged. Assumptions in the guidance include interest expense of $145 million to $155 million, which is unchanged, and $268 million weighted average fully diluted shares, down from $269 million. Also, as a reminder, fiscal 2023 is a 53 week year with an incremental week of operations. When thinking about our 2023 guidance and laying the foundations for next year, the actions we are taking now and will continue to take in the coming months are focused on generating further operating leverage and earnings growth going forward. Specifically, while we did see upfront costs associated with the addition of value brands, we fully expect to see a healthy return associated with those brands in 2024. We will continue to seek out opportunities to enhance our supply chain and labor models to generate additional compound savings. We are on track to deliver against our projections of $40 million in cost benefits in the first year from the planned $150 million in run rate savings outlined in our Q2 call. We will continue to be prudent and surgical with capital allocation. Specifically, while we remain focused on evolving our business as needed, we have planned for reduced capital expenditure in fiscal 2024, while optimizing our existing infrastructure. To close, I want to reinforce Ron's remarks that we're fully focused on navigating the current economic environment and controlling our controllables as a top priority for the entire Petco team, so that we quickly return to sustained growth and profitability. Thank you for your time. And with that, we'll be happy to take your questions.
Operator: Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions] And today's first question comes from Oliver Wintermantel with Evercore ISI.
Oliver Wintermantel: Yes, thanks. I had a question regarding the merchandise strategy. It sounds to us that this is a big shift in focus. During the IPO you always mentioned that the premiumization and premium food, is this -- do you consider that a long-term shift in merchandise strategy or is that just adjusting for the current environment? And then second, what are the impacts on revenues and especially on margins? I think Brian, you said you expect gross profit dollars accretive in 2024, but if you could maybe talk a little about the margin impact. Thank you.
Ron Coughlin: Thanks for the question, Oli. So you're right. We have talked a lot about premium and super premium. And if you look at the past decade plus, and if you look at the future decade plus, the dominant macro trend is about premiumization and humanization, which is why we believe we have the best portfolio in the industry against those trends, whether that be fresh frozen offerings, whether that be limited distribution offerings like Orijen, Acana, Taste of the Wild, we continue to drive against that. That has been the largest deliverer of revenue growth and profit growth in the category. That said, in this economic environment, we're supplementing that strategy with value offerings. And we're bringing in some of the largest brands in the entire pet food and pet treat industry. And the whole idea is to meet customer demand. I was in a store in Charleston, South Carolina and I met a customer who was buying Friskies and what I found out was, she was buying wholeheartedly from us, our own brand, but she was going someplace else for Friskies. So we have customers that are looking for these products and when we provide them, they are pleased that we're meeting that customer need. This is about incremental footsteps into our stores. We're seeing a similar basket from these customers. We brought in an expanded assortment of Fancy Feast in Q3, and we're seeing a similar basket to our overall food customer. That means they're buying more supplies, they're signing up for Vital Care Premier, and they're also actually signing up for vet visits. So it's good for our ecosystem. And from our mission standpoint, we can't make a pet healthier if that pet parent doesn't walk through our door, if that pet parent doesn't visit our digital assets. But to sum it all up, this is about supplementing our strategy and it will drive gross margin dollars. I'll let Brian elaborate.
Brian LaRose: Yes. Thanks, Oliver. The margin rates on these products are lower than the average food margin of the rest of our chain. However, as Ron said, they will drive incremental dollars to the company. It's about getting more [bats] (ph), it's about getting more customers into the ecosystem, it's about driving incremental profit dollars to the company across both food, supplies and services.
Operator: Thank you. And the next question comes from Peter Benedict with Baird.
Peter Benedict: Hey, guys. Thanks for taking question. First one, just around the CapEx view on next year coming down a bit, can you give us a sense for maybe the maintenance CapEx of the business, and then also what the plan is for the hospitals and the rollouts there? What kind of assumptions are you embedding for that next year? That's my first question.
Brian LaRose: Thanks for the question, Peter. We're being prudent with the level of investment that we're making just in light of the current environment. We continue to prioritize cash generation, debt reduction, and continued investment in long-term strategic growth initiatives. In terms of the specifics around whether it be maintenance CapEx or other strategic initiatives, you can expect to hear more of those details at our year end results. But I'll turn it over to Ron to talk a little bit more about vet.
Ron Coughlin: Yes, on vet, it's a key differentiator for us. We continue to see the mid-single digit lift in this center store. The stores with vets are outgrowing the stores without. We have 282 now, we'll be adding more hospitals in Q4. In terms of 2024, as we navigate the current environment, it's all about balance. So all about balance of driving throughput from existing, investing in more clinics, because the clinic business is doing very well, and then overall cash flow management. So we'll have more details on that at the -- in our Q4 earnings.
Peter Benedict: Okay, that's fair enough. And then I guess the next would just be around any way you may size the upfront cost. You guys have occurred here to load the new value brands into the store in 3Q and 4Q. Just curious kind of how material that has been? And then the supply chain efficiency actions that you alluded to, maybe a little more color as to what exactly you're doing there to take those distribution costs down and just kind of the timing of all that? Thank you so much.
Brian LaRose: Thanks, Peter. Let me break it down actually into three different components in terms of the overall profit change in the guidance. The largest driver of the change has been the shift of customers to more value-seeking process -- products and the associated promotional and pricing environment related to those products. That's happened a bit faster than we anticipated and that represents a little over a third of sort of the impact. Second is the continued softness in discretionary spend. That's about a third of the impact. The balance of that are increased costs, which includes the increased investments associated with getting these products onto shelves. And there are three tiers of that. There's logistics, there's store labor, which was the primary driver of the SG&A year-over-year, and the third piece was advertising. So this is about making the right investments to get the products on shelves. It happened faster than we anticipated, at a larger scale than we expected. And then the advertising is an awareness building campaign to make sure that we get the right customers through the door.
Ron Coughlin: Yes, I would just build on Brian's comment. When we spoke in Q3, we did not have line of sight to getting all these brands at the accelerated timing that we were able to get them in the quantities that we got them, which, obviously, is a positive, given the adjustment that we wanted to make. The broader comment I'd make is, we understand that EBITDA was below expectations. We recognize the importance of meeting our commitments. While there are market dynamics, there are things we can do better. And we're attacking those and focus on driving improved execution. And that's the operational reset that we talk about today. But we take these commitments very seriously.
Operator: Thank you. And the next question comes from Simeon Gutman with Morgan Stanley (NYSE:MS).
Simeon Gutman: Hey, good morning or -- good morning, everyone. My first question, it's on the top line. If we look at the deceleration we've seen this year and maybe even in part of last year, can you separate what you're seeing in terms of reversion or how much of the slowdown is explained by discretionary reversion, a move to value for the category and then can you separate that out from the wallet share with your core customer?
Brian LaRose: Yes. Thanks, Simeon. First the implied guidance for Q4 is low single digits, which we believe is appropriate, given what we're currently seeing. That does include the extra week. In terms of some of the drivers, we are lapping pricing from the second half of last year. So the inflation benefit that we, like others saw in the first half of the year is beginning to abate in the second half. So that is a driver. Secondarily, if you look at the discretionary business, it has continued to stay at kind of a minus 9% clip that we reported this quarter. And that's off of a compare that was a bit easier. So arguably that's a larger impact than last quarter on the top line.
Simeon Gutman: And then one quick follow-up. Can you share with us if you look back several years, maybe five years ago, before you moved upstream with product, what percentage of either the consumables business or the overall business did value brands represent?
Ron Coughlin: Yes, we'd have to get back to you on that. What I can tell you is, the value brands have grown significantly in the last two years, which is why we're making the move. If you look at Super Premium, Fresh Frozen, as I said, they were the predominant drivers of growth in the category. Basically, since the second half of 2022 into 2023, we've seen strong double digit growth in the value brand. So they have scaled significantly from where they were back then. But we can follow up with you on that, Simeon.
Operator: Thank you. [Operator Instructions] And the next question comes from Steven Zaccone with Citigroup.
Steven Zaccone: Hi, good morning. Thanks very much for taking my question. Ron, I wanted to get your assessment if something's changed in the overall pet industry. Premiumization has been a good category, but now you're doing this pretty significant shift to focus on value. Do you think this is something that's going to be a multi-year trend where maybe the consumer is going to have more of a high-low approach to the category? Thank you.
Ron Coughlin: Thanks for the question, Steve. So first, from a -- if you look at the past decade plus, and if you look at projections going forward, there continues to be a projection of premiumization, humanization. Underneath that is the dynamic of more millennials and Gen Z’s adopting pets. And they spend more and they are more inclined towards premiumization, humanization. And you've seen some of the announcements on Fresh Frozen that reflect that, right? So we continue to see that. And on the food side of the business, we see a bifurcation. We continue to see strong growth on Fresh Frozen. We continue to see solid growth on super premium. What has really accelerated is value. Between those two is where the pinches come in the category, coupled with the discretionary spend that's impacted supplies and companion animal. But that bifurcation is real. We continue to believe and projections continue to show that Fresh Frozen, super premium will grow, which is why we have our portfolio, why we brought in products like [Ali] (ph). But there's a short term impact of the value seeking that we're responding to. And again, it is all about not only selling those products for customers that want those products, but it's also about driving them into our ecosystem, getting the supplies, getting the services, getting the vital care premier signups, and which has a financial benefit in terms of gross profit dollars, speed to growth for us. But it also has a benefit for the pets, because in an unassisted environment that pet's not going to get healthier. In our environment that pet is going to be healthier.
Steven Zaccone: Okay. And then the thought I had is more for Brian. Could you talk about the cash flow outlook for this year and then into next year, because you had the commentary about CapEx? And along those same lines, if you think about the building blocks to see EBITDA margin rate improve over time, could you walk through the biggest factors, because now you're implementing this area -- this assortment that's a little bit more value and it's a little bit lower margin. So do you really just see the discretionary side of the business to get better, to see even that margin rate improve? Thanks very much.
Brian LaRose: First on cash flow, Steve, let me comment on the quarter itself. Year-to-date, we are at roughly the same free cash flow as last year, even though earnings are down the way they are. And I think the team's done an exceptional job managing working capital. [Fables] (ph) has been a big driver for us of working capital improvement. And I think on inventory, although we're up slightly year-over-year, that team has just done a remarkable job. In stocks are up year-over-year, inventory turns are up year-over-year. So in terms of overall cashflow year-to-date, I'm pleased with where we are given the working capital management, not going to get into specific guidance on Q4 and in terms of 2024, we'll come back with that on the Q4 call. As for the building blocks of EBITDA, first of all, it's all about customers and baskets. I mean, that is the primary driver. The expansion of the assortment that we announced just now is about getting more footsteps through the door, building basket with those customers, and getting them across the ecosystem. The second component of that would be cost. We talked about $150 million cost takeout. The first leg of that, the first $40 million we talked about in year one, is primarily OpEx and associated partially with the actions that we announced last quarter around headcount reduction. The next leg, when we get into second half 2024 and to 2025 and exit run rate, it has more to do with cost of sales across supply chain and the merchandise overall bucket of cost of sales. So I put those two in that order. Customers in baskets first, cost second.
Operator: Thank you. And the next question comes from Michael Lasser with UBS.
Michael Lasser: Hi. It’s Michael Lasser from UBS. Thank you so much for taking my question. What is the competitive response you're expecting, not only from the price investments that you've been making, but now the addition of the widely distributed brands? How do you prevent this from becoming a race to the bottom?
Ron Coughlin: Thanks for the question, Michael. So first, a lot of these products, actually all these products are controlled by [MAP] (ph) and the vendors. These are large scale vendors like the Nestle's of the world, the Mars of the world. These are large scale vendors who have a vested interest in making sure that their prices are managed in the market via MAP tools. So, there are controls in place in terms of that. Again, this is about driving more footsteps. I talked about the customer in South Carolina. There was another customer that I met in Northern California, and she was buying Fancy Feast, and I asked her if she bought that from us before? And the answer was, no, she didn't know we had it. She was buying it previously at a mass. She was buying litter from us. So there's a lot of customers for whom they are looking for these products from us, whether it's our existing products, our existing customers or new customers that we have a better proximity to. I've met another customer who was buying it from another pet specialty player. So there is demand out there. We're hearing it from customers directly. If you look at our assortment, we can marry the premium brands that we have either exclusively or in limited distribution with these value-based brands. And again, in many instances, you have finicky cats who only eat one brand or only one flavor, and we're now expanding to those brands, and it's a matter of meeting those needs. 50%, 50% of our services customers don't buy food from us. And a lot of instances is because they have a cat who has a certain product or they're more value conscious. I met a customer who had eight dogs and they needed to have an affordable product and they serve pedigree, but they loved our Groomers. Right? And so now we have at-bats with those customers and then those at-bats lead to us being able to attach. So that's more where we're focused on it. We will have aggressive marketing, but it's really about our differentiation as a one-stop shop that now includes these value brands.
Michael Lasser: That's super helpful Ron. If I could ask one more quick follow-up. Is the decision to add value brands due to your perception that you're losing market share? And if that's the case, who are you losing market share to?
Ron Coughlin: It's about customers, right? A business like ours is going to be successful when we listen to our customers. And whether that be customers migrating to channels where they can get these products or even our own customers looking for these products from a value pinch or seeing these services customers aren't buying food from us. It's about customers and bringing more customers through our doors. If you have double digit growth in the value products, that means customers are looking for those products. And we want to participate in that growth, not only from a share standpoint as you cite, but also to build our baskets and do the attach.
Operator: Thank you. And the next question comes from Steven Forbes with Guggenheim Securities.
Steven Forbes: Good morning, Ron and Brian. Given the new category level disclosure on gross margin or cost of sales, we went through the pressures right on the product side, but I think the services margin expanded pretty significantly year-over-year. So I was wondering if you could maybe expand on the drivers of that improvement within that segment?
Brian LaRose: A couple of things, Steve. Thanks for the question. First of all, the vet model. So if you think about the vet model, we've talked about this historically that as you invest in that model, the first year of those hospitals being open is traditionally a loss. And as you start to mature those hospitals, you start to get to break even and then positive in the end of the second year or into the third year. We have 282 hospitals and if I go back and think about how many of those have been added in the last two years, it's roughly a couple of hundred, 175. So you've got a weighted average life of a hospital that's maybe two, two and a half years. As those mature, that's going to drive profit improvement. Secondly, the grooming business. The grooming business has been such a strong business for us and a huge driver of the 14% services growth year-over-year. That team continues to do an exceptional job driving productivity. It's something that our customers remain sticky about, so the grooming business strength coupled with the vet maturity, and just some good cost actions and basket building opportunities that the team has integrated.
Steven Forbes: Thank you for that. And then maybe just a quick modeling question. The 53rd week, as we think about appropriately sort of modeling that next year, can you give a little more color on the sales, EBIT and EPS impact?
Brian LaRose: Probably no better, Steve, than if you take the implied guide for Q4 and assume that there's an extra week in there and do that math you're going to get close. It's not entirely linear, but it's close enough.
Operator: Thank you. [Operator Instructions] And the next question comes from Anna Andreeva with Needham & Company.
Anna Andreeva: Great, thanks so much. Good morning, guys. Two quick ones from us. So inventory's up 1 exiting the quarter. The trend had been down in the first half. Can you just talk about the comfort level with the amount of carryover within that? And how are you buying inventories for 2024, considering also the addition of the value type of offering? And then secondly, just looking out as you focus on operational savings, you have over 1,400 pet centers and have only closed a handful in the last couple of years. So is a real estate analysis with potential additional door closures part of what you guys are looking at?
Brian LaRose: Let me start with inventory, Anna. Thanks for the question. The team's done a really good job with inventory. Yes, inventory was up slightly year-over-year at the end of this quarter. As we brought in the new value assortment, we did see that bump as we got products into our DCs and from our DCs out to our pet care centers. That product came in faster and at larger scale than we anticipated, but we're happy with where inventory ended for the quarter, especially since in stocks are up year-over-year, inventory turns are up year-over-year. That said, we continue to take the opportunity with this reset to further evaluate the composition of both our consumables and supplies inventory to focus on aligning that inventory where we can drive the right velocity. That will improve reducing SKUs in certain areas that are lower in velocity. So we're early in the reset. I do expect inventory on a year-over-year basis at the end of the fourth quarter to be up, but we are doing that tactically and eyes wide open as we continue to build out the value assortment.
Ron Coughlin: Hey, Anna, it's Ron. I would just add to Brian's commentary. When we brought in the value brands, obviously, there was a significant lift in terms of the reset. But part of that activity was either taking out brands or reducing SKUs within brands that were slower moving. So this was not a total add. We took out a lot of SKUs. We took out some brands that were slower moving as part of this process, which should make our shelves more productive.
Brian LaRose: And I'm sorry, Anna, the second part of your question?
Anna Andreeva: The real estate portfolio is...
Brian LaRose: Oh, the real estate, yes. So we actually -- if I go back and look, I would characterize it as more than a handful down. If you go back, not Q4 last year, but Q4 coming out of the year before that, I think we closed 30 some odd pet care centers in the fourth quarter alone. We're at 1400 plus, but if I go back three years ago, that number was 50, 75 lower. So it's more than a handful of stores. We always look at our real estate portfolio. I would tell you, I think that team has done a good job managing both costs and making sure that we are in the right locations with the right profit profile. We have gone through the process of making sure if we have an unprofitable store that we have the right plan for that. And that's a big part of what you've seen in the reduction of pet care centers over the last couple of years [indiscernible].
Operator: Thank you. And the next question comes from Seth Basham with Wedbush Securities.
Seth Basham: Thanks a lot, and good morning. My question is on gross margin. Given the dynamics of adding these value-oriented foods, I assume the expectation is that, your gross margin is going to continue to decline in 2024, even with the fact that some of the pressure recently is related to the transition. First of all, can you confirm that assumption?
Brian LaRose: I'm not going to get into 2024 guidance, Seth, but thanks for the question. The value brands, as I mentioned, have a -- on a product-for-product basis have a lower margin rate than the rest of our food -- our enterprise food products. However, this is about driving customers through the door and driving incremental profit dollars. It's about getting more at bat. It's about getting customers across the ecosystem. We're taking some pretty bold actions and we believe those actions will help drive that dollar profit growth over time, whether it's strengthening our competitive positioning with pricing as we talked about last quarter, whether it's the expanded assortment and the basket associated with that we talked about this quarter, and then the third leg would be the cost actions that we're taking which are primarily on the cost of sales line and we'll kick in on that line mostly in the second half 2024 and into 2025.
Ron Coughlin: And again, I would just reinforce. What we're seeing and what we've seen historically is the basket for these value brands is roughly the same as the rest of our food portfolio, which means actually that the supplies and services are larger as a percent of that customer's basket.
Seth Basham: That's helpful. And I assume that price competition in value brands is more intense than the premium brands. When you look forward, do you see increasing competition in this macroeconomic environment and who's driving that? Is it Walmart (NYSE:WMT), Petsmart, Amazon (NASDAQ:AMZN), Chewy?
Ron Coughlin: We see this as incremental for us. Yes, these are mass distributed brands, but we see it as incremental for us. And I would break it down into two buckets. There are existing customers who buy products from us, whether that be litter, whether that be they get groomed with us, whether that be dog food, and go other places to get these value brands for other pets, because there are multiple pets, multiple species types products. We even have companion animal customers that buy companion animal products from us and then go other places for these products. So the first bucket is our existing products who can consolidate their shopping and we've seen multiple instances and been communicated multiple instances of that. The second, are new customers that we can bring through our doors. And if you look at Q3, when we expanded the distribution of Fancy Feast, I would say a tangible portion, a tangible portion of those Fancy Feast customers were new to Petco. So we see this as incremental for us. Is it more of a price centric subcategory? Yes, it is. But it's incremental for us and then we're able to add the basket on top of it. And the fact that they're signing up for Vital Care Premier tells me that they're actually planning on being a pretty dedicated customers, because otherwise they wouldn't be signing up for a monthly fee on top of it. So -- and again, these are MAP managed products by the vendors. That doesn't mean it's a perfect pricing environment, but it is a controlled pricing environment.
Operator: Thank you. And this concludes the question-and-answer session. I would like to turn the call to Ron Coughlin for any closing comments.
Ron Coughlin: Well, thank you everyone for your questions today. As we close, I would like to reiterate that we're fully focused on controlling our controllables and delivering against the plan that we shared today. We continue to believe that no one can take better care of pets than we can. And these operational changes are laser focused on bringing as many pets as possible into our 360 degree pet care ecosystem and returning our business to long-term growth and profitability. Thank you for your time and have a happy holiday.
Benjamin Thiele-Long: That concludes Petco's third quarter 2023 earnings conference call. Thank you everyone.
Operator: Thank you. And as mentioned, the conference has now concluded. Thank you for attending today's presentation and you may now disconnect your lines.
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