Petco Health and Wellness Company, Inc. (WOOF) Earnings Call Transcript & Summary

Great. Thank you, Christina. Good morning from the U.S. Good afternoon to those in Europe. Thanks for joining us today at the Citi Global Consumer Conference. I'm Steve Zaccone, Citi's hardlines retail analyst. We have the privilege of hosting Petco Health and Wellness this morning. I'm joined by the company's CEO, Ron Coughlin; and CFO, Brian LaRose; as well as VP of IR, Kristy Moser. I think Ron will run through a couple of slides to start. With that, I'll turn it over to Ron.

Thanks, Steve. We really appreciate you having us and for all of you for attending this session. We're going to spend a short amount of time on this presentation and then take questions. Please note, the materials are available on the Events section of our IR website. And within the presentation, you'll see the safe harbor, which is up there now. With that, let's change the page, and let me get into -- so at the macro, macro level, if you look at Petco, we are gaining share in a category that is explosive. The prediction is 8% growth for this year, 7% growth from a '21 to '25 standpoint. And once again, it's showing high economic resilience. Within that, we have a very unique offer. The offer, we uniquely have a full ecosystem offering, whether you're looking for veterinary care, whether you're looking for grooming, whether you're looking for training or merchandise. We are unique and 50% of customers say, that's where they're looking for a one-stop shop. Our merchandise is differentiated. We spent the last 3 years differentiating our merchandise. So that 70% isn't sold in other places. We have 1,449 pet care centers. These provide great experiences, but they're also now micro distribution centers. Over 80% of our e-commerce orders are fulfilled through our pet care centers. That means lower cost to the customer and faster to the customer. And that gives us competitive advantage. We have a rapidly scaling digital offering. Our 2-year growth rate is over 150%, which is in the rare air of the retail space. We're shifting to services. We're launching 70 vet hospitals in our pet care centers, formerly known as stores per year, and we're approaching 200 locations. Importantly, unique, unique, unique in our model is step and repeat. We put in a vet, we put in a JustFoodForDogs fresh food pantry, and we put in a Reddy store-in-store, and we come in and do a remodel. And that gives us a significant lift to not only creating the vet revenue, but a 4 to 5 point lift in center store. And that is a step and repeat all the way up to 900 locations that we will have for years to come and that is unique to our model. And it also provides a tremendous ROIC because we're getting greater throughput from our existing footprint. And then our recurring revenue programs are up 60%. Our customer growth within that is up 50%. So we have significant growth in recurring revenue, making us more predictable and stickier. If you click to the next page -- next click, we've been adding customers at a significant rate. In last quarter, our rate of customer add was nearly 3x that of our online competitor with over 800,000 customers added. And then if you look all on the right, this unique model against great category is driving fantastic results. Twelve consecutive quarters of growth, 6 consecutive quarters of double-digit growth. There were questions, as Steve can attest, will the pet industry be able to lap? Will Petco be able to lap once we got into double digits? And not only did we lap, we lapped with strength with -- in last quarter, we were one of the fastest-growing retailers with our Q3 announcement. Our digital is 159% on a 2-year basis. And as I said, we're on track for 197 vets by the end of the year with our Q4 on track. Our EPS was up -- EBITDA was up 25%, and we raised guidance for the last several quarters on both the top and bottom line. Next page. What's driving it? One of the key things that's driving it is an amazing management team. If you look at our business, we're $5 billion to $6 billion business, but yet we have marquee names in terms of the team that we've been able to bring in, whether it's Walmart, Jet, Best Buy, Target, Restoration Hardware, Gap, History. So it's blue chip. And then if you look at our Board, we've brought in the President of Best Buy, we've brought in the CFO of Gap. We just announced Nike's Head of Digital as a Board adviser yesterday. So we're tracking -- attracting the best talent in the world. And we're applying that talent against an amazing category. If you look here, we have $119 billion category. Importantly -- but there's a lot of focus on consumables, but if you look vet care is $35 billion of it, services like grooming and training is $10 billion of it. So there's a significant market that is well beyond just the traditional consumable business. And as I said, the growth projection has gone up. It was a 5% to 6% long-term growth projection and now it's a 7% growth projection moving forward. If you go to the next page. So I talked about a unique model. This is our ecosystem. 50% of pet parents say they want a one-stop shop. They go to 1 place for food, they go 1 place for grooming, they go 1 place for training and they want to bring that all together with somebody that they trust, and we uniquely can do that because we have our own vets. We have tele vets, we have vet clinics. We have grooming. We have training. We have strong own brands. We have exclusive high-end products like JustFoodForDogs that you can't get in other places. We bring that to life with our pet care centers. We bring that to life with our now first word of digital offer. And that ecosystem is unique and it's winning in the marketplace. If you look at 11:00 on this chart, it's a program called Vital Care. It's the industry's first membership program. For $19 a month, you get your checkups, vaccinations, grooming discounts, product discounts. Nobody else can pull this all together in terms of a holistic offering. I think at the last quarter, we announced over 150,000 members in Vital Care, and they are spending significantly more to factoids. Over 20% of the Vital Care customers were new to food with us. Over 30% of Vital Care customers were new to services with us. So in terms of capturing the share of wallet, it's been very, very powerful for us. If you go to the next page. I'll pass it over to Brian to hit on a couple of additional points.

Yes. Thank you, Ron. Our focus on our long-term sustainable growth is powered by continued execution against our transformation, including one of the fastest vet build-outs and history, further enhancements of our digital advantages, expansion of our merchandise differentiation through powerful owned and exclusive brands and maximum leverage of our physical footprint and that execution is showing up in our results. In the most recent quarter, Ron touched on this, Petco delivered record results, with our sixth consecutive quarter of double-digit comp growth, comping a strong prior year with comp of 15%, generating a 32% comp growth on a 2-year stack. And our continued execution against our step and repeat growth initiatives like Vet Hospital, JustFoodForDogs, ready shop-in-shops and digital expansion give us a long runway for growth and share gain building on the strong results across each of our business areas in the quarter. Next page. Year-to-date, we've delivered growth. Revenue up 20% year-over-year, while our operating leverage drove even stronger adjusted EBITDA growth of 25%, reflecting the strength of our model and the nature of our growth, focused on productivity of existing boxes, even as we invested in future growth and in our people. And we drove robust free cash flow, up 18% versus prior year as we continue to enhance profitability and operational excellence in our businesses. Our net leverage ratio reduced by 60% to 2.6x year-over-year by the third quarter, driven by a reduction in net debt by 52% to $1.5 billion and increased adjusted EBITDA, positions us well to continue to drive growth and strong financial performance. In the upper end of the category where we're focused, we're serving the highest spending pet parents with relatively inelastic spend. We also have offerings for every customer. And while we continue to operate in a dynamic supply chain and labor environment, our teams continue to execute and we've shown that our model remains nimble. Our Services business provides us with an additional layer of insulation versus competitors that don't have owned services as part of their core model. Let's go to the next slide. Let me leave you with, Petco's exceptional team continuing to deliver strong purpose-driven performance combining stellar business results with tangible improvements in the lives of pets, pet parents and Petco partners. It's not an either/or thing at Petco, the decisions we make are best for pets and best for the business, whether it's saving 400,000 pet lives a year from youth in Asia, providing life-saving vaccinations to under-resourced communities or helping lead the way in early cancer detection, purpose-driven performance is in everything that we do. And with that, Ron and I would turn it over and take your questions.

Great. Thank you so much for the prepared remarks there. I think we can start off. And I think, Ron, I wanted to start off a little bit higher level because you've been public now for close to a year. And I was curious when you look at the business execution, what's really changed since coming public? Where have been some of the opportunities you've really exceeded plan because the numbers have really delivered, where are some of the bigger opportunities as you look at the business into next year?

Yes. If you look at it at a macro level, we are significantly, significantly above our IPO model. You remember the -- testing the waters in the IPO in those engagements, and we are tangibly above that model. And it really is across the business. Our consumable business is significantly healthier than we expected it to be, and we talked about that on Q3. That is a really good thing for our business because it's very sticky. It's the foundation of the pet industry. The products we've brought in, whether it is Honest Kitchen, whether it's expansion to WholehEarted and the expansion of JustFoodForDogs has really worked. The second thing is our services, a year ago, they were cut back because of some of the COVID restrictions, they have bounced back and performed ahead of our expectations. There's lots of conversations about labor. I will tell you we've never had more rumors, and we've never had more trainers. And so we're seeing a lot of success on our Services business. But the transformational part is the vet business. And our own vet model is performing ahead of our expectations, and I will tell you in my 3.5 years, the most significant thing that's happened is the unlock of the own vet and now knowing how to do the own vet model and having success with that model is working for us. Own brands, continue to drive double digits and that gives us insulation. And a great example is Reddy. And Steve, I know you're in Soho, we opened our first -- I should say, the New York Soho, not the London Soho. And we opened our first Reddy flagship store, and it's doing very well. But it symbolizes the fact that we are really making the world's first fashion brand in pet. So across the business, we're doing well, and that's why we delivered a 17% comp, and we have strong momentum -- 17% on the bottom line, 15% on the top line. We have strong momentum.

Great. Great. Maybe if we drill down on the near term, I think you referenced our continued momentum in November, what do you think is driving the prolonged strength in the pet retail business? What gives you confidence this elevated level of demand is something that's sustainable?

Yes. When we first started the process of the IPO, there was questions. Is there going to be a kind of was there a pull forward of pets? And we saw that pets in household continues to grow ahead of normative year. So we continue to see more pets going into homes at a heightened level, number one. Number two, we now know that the majority of pets were adopted by Gen Zs and millennials. They spend more. They're more likely to treat their pets as human, and therefore, they're more likely to get fresh food. They're more likely to get premium kibble. They're more likely to get a puffer vest at our Reddy shop. And so we're seeing upward pressure on spend per pet, complementing continued heightened pets going into homes, and that's good for the category.

Got it. Got it. Maybe we could talk a little bit about pricing? Can you talk about like your efforts thus far to take pricing up? Is there opportunity to take some more pricing increases in the fourth quarter into next year? Just tell us what you're seeing from some of your vendors? And maybe how do you expect the kind of the customer to react? What have you seen thus far? And what do you expect to see in the future?

Yes, I can take that one, Steve. I'd tell you that our pricing strategy has been executed methodically, and we have been passing increases from manufacturers along. The good news is the pet category is fairly inelastic. And in aggregate, we have not seen an impact to unit decline where we have taken price. Now we executed our pricing increases primarily in Q3 and saw a partial benefit. We expect that to be fully realized in Q4, and that's reflected in the guidance that we gave. We're confident in our ability to continue to pass along pricing to customers. And in this demand environment, the market remains fairly rational. I want to talk about promotions for a second. Promotions. Revenue from promotions continue to be down year-over-year. So in a rational pricing environment and our ability to control pricing, we feel pretty good.

Got it. Got it. Okay. Very helpful.

And by the way, Steve, the only thing I'd add is, you're not going to see supply catch-up with demand before the -- probably the mid-2022. So this pricing environment will remain. And our model is advantaged in this type of supply situation because we can redirect customers, number one. And number two, we're less reliant on repeat delivery. And if you look at that, you're breaking that purchase cycle when you can't provide the product that was supposed to show up on the customers' doorstop. So we believe our model is advantaged in a tight market and also advantaged in a market where you have to take pricing because of our higher-end customers.

Are there certain areas where supply is more challenging than others? I know the industry has talked about what can food, when can dogs would being an issue, but just maybe where are the biggest challenges in the reference of mid-2022 for kind of normalized inventory? Where is there opportunity for improvement right now?

Yes, I'll start, and Brian, you can complement. So food, clearly, you have proteins that have been somewhat challenged. You have things like barley that didn't have a great crop. So there's challenges across the board. But that said, let me start by saying, because we have services, we're less exposed. Because we're more own brand-centric, we're less exposed. Because we're able to redirect purchases, we have less impact, which is why we're putting up the numbers that we're putting up with a 15% growth. That said, cans has been probably the weakest part of the category. But again, we're able to redirect that. So if someone comes in and says, "I like a Royal Canin product for digestion," and we don't have it, we can redirect them to the Hills product and they trust our people in the aisle. So we've been pretty successful in not losing customers based on supply. And then on the supply side of things, we've been -- because we're more owned brand, we've been able to get kind of prioritized in the line. And then on the high end of our food line, I was with a president of one of the big food companies a couple of weeks ago or several weeks ago. And he said, listen, we're providing you and 2 others at 100%, the rest are getting at 50%. So we believe we're getting advantage supply because in those high-end products, we are the big kahuna for many of these vendors.

Yes. The last thing I'd add to, Ron touched on this, Steve, is that, our pet care center partners are a strategic advantage. So Ron mentioned the ability for them to redirect customers to where we may not have product available. And by the way, in those instances where we may not have that product available, the same would be true for others. That gives us an advantage, not only against online pure players, but against mass, where you may have a pet aisle next to an aisle that has nothing to do with pet, whether it be automotive, household or otherwise. So specialty of our pet care partners is a true advantage in an environment like this.

Great. Great. Maybe we could shift back to the pet dynamics of that because Ron, you talked about some trends there? But it comes up a lot with the investment community. We've seen this big adoption in text the last 2 years, like how does the spending look for pet as you get into maybe year 2, year 3, if you could address that? I think you also referenced cat adoption has been very strong this year, which is an interesting data point. But I guess like my question is more broadly, like if we do see a slowdown in pet adoption next year, would the business be susceptible to some decline, like how do you think about those trends impacting your business?

Yes. So let's start with time memorial then we'll -- time -- for the last decade, pet has been a 1% to 2% growth in number of pets in households and a 4% growth in spend per pet. That has survived economic downturns, et cetera, et cetera. There are upward trends pressuring that upward right now. The fact that millennials and Gen Zers are putting off child rearing is putting upward pressure on that. The reappreciation for nesting is putting upward pressure on pets in homes. So we're seeing continued heightened levels, continued backlogs at breeders, et cetera, on new pets and households. Spend per pet, as I said earlier, Gen-Zers and millennials have higher spend per pet. That shows up in marching up to organic foods, marching up to products where you know the sourcing, for example, they're backward integrated into the fisheries, they're backward integrated into the farmers in $80 a bag or all the way up to fresh food, and you're seeing fresh go from a $1 billion category to a $4 billion category in the next 3 years. So you're seeing upward pressure on spend per pet, which is why the forecasters were saying the category is predicted to go 7% going forward. And we believe we're really well-positioned to capture that because where the trends are going, we are well positioned. We moved our premium mix 10 points since I've been at Petco 3.5 years. We are #1 in fresh food, which is kind of the highest end of the category, and we're establishing kind of the high end of the supplies category with Reddy. And actually, 1 other point on your question, this question of spend per pet per year, it's even basically until near end of life. So year 1, year 2, the amount -- the dollar spend are even. It really doesn't change until near end of life when you have higher vet and medical bills. There is a difference of year 1 to year 2 and what gets spent. Year 1 is more supply centric, you get the trade, et cetera; year 2, the pet puts on 20, 30, 40 pounds and is more consumable-centric and then that flat line. But that generated some of our mix pressure in Q2, Q3 as we went from year 1 pet to year 2 pet.

Got it. Very helpful. Very helpful. Maybe if we think about market share and like the general TAM opportunity for the business, you have a lot of initiatives at play with growing services, right, that, like even e-com is small relative to some of the bigger pure plays out there. How are you focused on driving market share in this industry because you do compete with some pretty big players? Just maybe talk about what are the bigger -- what's the biggest focus there to kind of drive market share and really the big opportunities for TAM growth in the business?

Yes. And that's an important point. If you look at the size of the market, it's over $100 billion category, and we're a $5 billion business. So we have lots of headroom to gain share, and we've been gaining share. And one of the things we said on earnings was that our rate of consumables share gain doubled, and that's really good for our business, though it did create some gross margin pressure. It starts with our core, core, core strategy. At the end of the day, our differentiation is, we will be the only one-stop shop for pet parents. 50% of pet parents say they want that, and we're the only ones that can do that. Walmart can't do that, Chewy can't do that. The only one who had it was PetSmart, but they spun out their vet business. So we're the only one with a one-stop shop across that ecosystem I talked about. The second thing is what the pandemic proved to us is the advantages in our omnichannel offer, right? Over 29% want to shop omnichannel. And those are the customers within the digital world that we can attract first. And what we did in the pandemic was we tripled the number of ship-from-store locations. We launched curbside. We launched same day. And so what happens now is 80% of our e-commerce orders get fulfilled via our pet care centers, faster to the customer, lower cost. And here and now, we're much less exposed to the FedEx and UPS cost increases that our competition is. So we have advantages in our core proposition of one-stop shop, we have advantages in omnichannel. And then the last thing I would say is 70% of our portfolio -- our merchandise portfolio is unique or not broadly distributed, so that gives us insulation and differentiation as well. And then on top of that, you look at the vet business, our ability to consolidate within the vet business with the fastest vet build-out in history is quite remarkable. As I said, we're going to put 70 a year. We're approaching 200. We have headroom to 900 vets. This is our step and repeat model that we think is so powerful.

Got it. Got it. Maybe if we drill down on 2 of those. If we start with the e-com side, I know you had very strong growth last year. More broadly this year, the growth has kind of continued. Maybe talk about what is the focus there going forward? Is it continuing to leverage the omnichannel capabilities? How big do you think the penetration of e-com can be over time? And maybe just how do we think about profitability of that business relative to the overall company average?

Yes. So we have had phenomenal digital growth. We went back and retooled our platform. We addressed pricing gaps. We addressed SKU gaps to get an even playing field. And then we started leveraging our strengths with the pet care center leverage. And the model is working, as you said, 159% on a 2-year stack. The only 2 companies in retail that we see that are ahead of that would be Target and Tractor Supply. So we're in kind of rare air in terms of that 2-year stack. 90% of customers when they're offered same-day or BOPUS are choosing it. So it shows you the customer wants that and our competition can't do that. So if I sum it up, we're growing faster than our e-commerce competition. We're more profitable than our e-commerce competition. And now we're gaining customers at a faster clip than them. And with that, I'll pass it over to Brian in terms of the profitability.

Yes. Yes, Steve. So let me start with we are profitable in our digital business. And over the last 3 years, we've expanded gross margin by several hundred basis points. As Ron mentioned, we leverage our PCCs. So from an adjusted EBITDA margin standpoint, there's leverage there. And that doesn't happen by accident, there's close collaboration between Darren MacDonald who runs our digital business and Justin Tichy who runs PCCs. If you look over the last 5, 6 quarters, we've on average have between 80 and -- low 80s and high 80s percent fulfillment through our PCCs. So there's a very dynamic labor model that we leverage within the PCCs. Justin has done a great job at reducing tasks within the PCCs to pivot more hours toward customer-facing time to enable digital growth as well as the foot traffic within brick-and-mortar. And I would say also within digital, we continue to see opportunity to expand margins. So the continued increases in basket size from core initiatives, but also through the expansion of things like Klarna and Petco Pay. We also see an improvement in order level economics, monetization of vendor dollars through our Petco AdWorks. And then within the launch of our new DC. So we've talked over the last couple of quarters about investments in our DC capability, that's not simply to fulfill overall demand in brick-and-mortar, but also to leverage cost for fulfillment of e-com orders. So improved freight lane cost, auto store improvement, cost per pick. You talked about how big can it get? We haven't given a specific long-term penetration target, but we continue to take share, and we expect the category to grow in the low 20s going forward.

Okay. That's helpful. That's helpful. Maybe then if we shift to the vet side, I still think this is an underappreciated growth opportunity for the business. But maybe just talk about some of the success you've had in openings thus far. What are some of the challenges on that side of the business? We often kind of read the news about that labor being expensive and kind of hard to get. So just kind of give us an update there. And then over time, I'm curious when do you think this business will be large enough that you could break it out in terms of revenue and maybe an EBITDA separate kind of line item?

Yes. I'll let Brian take the last part of your question. We love the vet business. It is -- this move -- you're exactly right, Steve. This move is the single most transformational part of our model. It really enables this step and repeat concept that is so powerful for us. It's a $35 billion market. The majority of that market is hands on pet. So I know there's a fascination with TeleVet, which we have as well, but that's a $100 million business. We're talking a $35 billion market. And it also drives add-on like Rx that is quite powerful for us. So as I said, we're executing the fastest vet buildout. We're 173, we'll be roughly 200 by the end of the year. We also have Vetco clinics. And this is a business that I didn't pay a lot of attention to when I came here, but I now realize just how powerful it is. We have 1,100 locations where we knew Vetco clinics, checkups, vaccinations on weekends and sometimes 3 or 4 days a week. Where we don't have a hospital, we do a clinic, and again, they prescribe, et cetera. What's important there is it also gives us over 1,000 vets, 1,300 vets that are part of our ecosystem that we either can convert to full time or that we can tap into for filling shifts that gives us advantages. As I said earlier, we love our own model, and we love the financials. So the economics: we're getting about $1.5 million of additional revenue in existing box annually at a 20% adjusted EBITDA margin. We also see a mid-single-digit lift in center store. So imagine this, we take out roughly 2,500 square foot of merchandise, we put in a vet and our merchandise lifts by mid-single digit. The model is just wonderful. And in terms of return on capital, there's not much of a better story than that. We're getting higher value customers because of the vet customers, which is great. Shifting to labor, that has been the limitor in the vet industry. We've done a lot of work on our value proposition. First, we allow that to practice medicine as they see fit. We don't dictate medicine. A lot of the consolidators dictate medicine because they go to the of the world, they go get money from them, and then they tell the vets what they have to prescribe as part of those types of deals. We don't -- while we negotiate hard with vendors, we don't tell that's how to practice medicine, number one. Number two, we give flexible hours. Why can we do flexible hours? Because we have more financial flexibility in our model because we have a lower CAC, because of the traffic and because we get the center store lift. So we have flexibility in hours. They can do full time, they can do part time, they can do clinics as well. So we have flexible hours. We offer stock to our vets as well, which is relatively unique. And we also allow them to be part of something larger in terms of our pet locations. And then they buy into our model, right? We save 400,000 pet lives a year. Not many people can say that through our Petco Foundation. So our time to fill is better than industry standards. Our retention is better than industry standards. That said, it's a tight market, which is why we are committing to 70 at this point. If we find upside, we will. We have begun in Q2 doing small tuck-in acquisitions at 1 or 2 vet practices a quarter and ingesting them into our pet care centers, and we like the financial model. And you don't see the big aggregators in the 1 to 2 vet practice space. So the prices haven't been as elevated as the multiunit space. Brian, I don't know if you have anything to add?

Yes, 2 things to add. On the acquisition piece, Steve, I'd just tell you that in those instances, as Ron said, they're one-offs. When we see those opportunities, that's an accelerant to the model. So it's those instances where we feel like we are quicker to market, quicker to scale than if we built out the hospital itself, but it still fits within the owned hospital model. You asked a question about at what point does this business get big enough where you might break it out? Size has nothing to do with not breaking it out in more detail, it has to do with how we manage the business. So when we talk about being the only true omni-channel company in the business, that's how we manage the business. So there are certainly goals by business. Our services team has goals, our digital team has goals, each leader has goals, but we manage the business from a customer end standpoint. What is the customer looking for? How do we enable that across all of our channels? So how we manage the business is sort of how we disclose information. But make no mistake, we have goals within each business to make sure that we're driving toward our mid- and long-term plans.

Okay. Great. That's helpful. Maybe we can shift to margins in the last about 10 minutes we have left? Third quarter, right, we had some recent pressure on the gross margin line. I guess, Brian, maybe this is directed a little bit more towards you, but just how do we think about how much of the pressure is transitory in nature, maybe versus what can kind of continue into next year? And then how do you -- what levers do you have to maybe play defense on the gross margin line?

Yes. Let me kind of tick through those, Steve. Let me start with -- from a dollar standpoint, we grew gross margin dollars by $53 million year-over-year and within each business. So we grew margin in services, we grew margin in digital and we grew margin in consumables year-over-year. Now all that said -- and I'll also add, going back to our operating leverage, we grew revenue 20% for the full year, adjusted EBITDA of 25%. So full bottom line faster than revenue growth. Now within gross margin in the third quarter, there were 3 dynamics at play. The first one, which is the largest one, greater than 1/3 was the mix shift to consumables. So we've touched on this in our prepared remarks and before, but the category mix shift year 1 to year 2 in terms of the pet adoption cycle in consumables is a shift from supplies to consumables year 1 to year 2. Doesn't mean a decrease in overall spend, annual increase in spend per pet of 4%, but a shift in the category dynamics from supplies to consumables. Now consumables were strong as a category, Petco was even stronger. So we had 21% growth versus a category of sort of low-teens. That was driven by our nutrition program, continued customer acquisition, premium, super premium, fresh with higher AOB and repeat delivery growth. Now those acquired customers have a greater LTV with strong double digits higher than a supplies customer. So that 21% consumables growth doesn't mean suppliers didn't grow. If you look at supplies and CA combined, they grew 6% in Q3, but that was off of a very strong year before with that year 1 dynamic. So on a 2-year stack, supplies in CA grew 34%. So if you look sort of beyond Q1, which benefited from sort of stimulus weighting towards supplies, those growth rates between consumables and supplies in CA will start to converge. So that's point one. The second one is a shift toward our services and digital businesses, which have lower gross margins, but let me call out services explicitly. So remember that labor and services sits in cost of sales. So it's a P&L geography issue. And if you look at outside of vet core services, adjusted EBITDA is roughly neutral to company average. And within vet, we're in the scaling portion of our business, so we're currently disproportionately dilutive to that year 1 to year 3 vet build-out. If you look at the 5-year model for vet, our 5-year model is $1.5 million of revenue and 20% 4-wall EBITDA for each vet. We're in year 3, end of year 3. So you're starting to see those vets get to the maturity point where they're feeding the front end of that. The funnel margins are improving, but we're not quite at that maturity cycle of the vet, which we expect to be as we continue to scale this business. So we do expect a continued mix shift to services and digital. So we talk about things being transitory, I talked about consumables converging back to a growth rate. Services in digital is fundamentally going to grow faster than the brick-and-mortar part of the business, at least that's what the projections are. But we have levers across our businesses to drive margin increases, and I'll come back to those. The third one, the third element, which is the smallest element, is supply chain cost, and that one is transitory. So we have done a good job managing supply chain dollars and pushing through pricing. We -- there are some inefficiencies and some pressures in the model, receiving and shipping constraints, et cetera, but we expect those costs to abate or be baked into pricing. It is an elastic category. And those supply chain pressures are incorporated into our guidance going forward where we talked about directional gross margin guidance Q3 to Q4. I would tell you from sitting on top of all that, we do have opportunities to help offset that gross margin decline. I mentioned consumables, over time, that will start to converge back. We expect to continue to expand premium and own brand offerings, enhancing our services pricing. This is an area that we've taken some action and continue to look at. Realizing the economics of our vet business, I talked about us being in the early stage of that maturity cycle as that gets too closer to maturity, that drives gross margin and profitability improvement. We do think there's an opportunity to expand AOB, targeted customer engagement of PCCs and digital. And then when it comes to supply chain, optimizing our digital fulfillment cost and our overall fulfillment costs through continued investments in supply chain. So if you look at our -- translating that to capital, 2 of those areas I touched on are our largest capital investments. So if I look at capital, we've got, of course, IT infrastructure and innovation, but unique to us, that build out within capital and then we continue to invest in supply chain as we continue to see the demand environment remains strong, and we look for opportunities to continue to drive down costs.

Okay. That was very thorough. Great. Ron, do you have any comment there [indiscernible]?

No. The only thing I would say on top of that, when you go past the gross margin line, ever since I've come in here, we've been good at picking out about $20 million to $30 million of cost a year, right? I used to run the HPPC business, 3% margin business. I know how to take out costs. And we've been taking out $20 million to $30 million a year, and there's no reason why that won't continue. And we have specific initiatives already launched for 2022 in terms of cost out. I know there's questions on ability to continue to get leverage. There's leverage in our model inherently. Every piece of the business will expand gross margins. But beyond that, we know how to take out costs, we have been taking out costs, we have plans to take out cost on a continual basis, and those aren't revenue-generating costs, those are kind of back-end costs.

Perfect. Maybe then just like to finalize on the model, I guess, from a bottom line perspective, you've exceeded kind of the targets of a mid-single-digit to high single-digit top line growth rate for the business. EBITDA has kind of been growing faster than that or towards the higher end. Are there -- do you think some of these near-term challenges with the higher transportation costs and the mix of the business, like could alter your ability to hit those targets going forward?

Yes, I'd say in the near term, Steve, any of the supply chain things we talked about are baked into our guidance. We have been driving operating leverage. I'm going to go back to the fact, 20% year-over-year revenue growth, 25% operating leverage. And that is not by pulling back on investments in the business. Ron and I, in partnership continue to lean in, in areas where we like the ROI. So marketing is a great example of that. As we see opportunity to acquire customers, whether that be in consumables, digital, vet, across the omnichannel, when we like the ROI on that marketing investment, we'll continue to lean back in. So yes, we want to drive operating leverage. We also want to continue to invest back into the business, whether it be in marketing, in our people, in our infrastructure to continue to drive that growth long term. As he mentioned, we've got programs in place to take out $20 million to $30 million a year in cost, to be able to free up capacity to go invest in the business and drive bottom line expansion. And I'd say we're also just holistically focused on driving productivity per square foot through vet hospitals, ready shop-in-shop, all the step and repeat functions that we've talked about.

Got it. Got it. Then Brian, I noticed that you did purchase shares yesterday. So anything to take away from that?

Yes, I'd tell you, I have a lot of confidence in the category and this management team. I think we're uniquely positioned in the market. We had 11 million pets last year. I'm bullish about the long-term opportunity in the category. And I think if we look at our model, we are differentiated. We're the only true player in the market with a multichannel, omnichannel presence. I think it's showing up in our results, 30% 2-year comp. It doesn't happen by accident. If you look at the larger retail sector, it's one of the highest comp rates of anybody out there for Q3. And I think our team is world-class, and we continue to execute. So I feel good.

Got it. Got it. Ron, any recommendations for the Labradoodle this year for holiday. Any gifts that you have given to Yummy that you can maybe tell everybody on the line?

Well, I'll tell you, I'm actually going to buy and wear it to my Board meeting tomorrow, the ugly -- smashing ugly sweater. So -- but actually, I already got Yummy the Santa pickle and he loves the Santa pickle. So those are my 2 recommendations for everybody.

All right. Great. I'll have to bring that from the Labradoodle. Okay. I think that's time now. So thank you to the team for joining us. Thank you, everybody, for dialing in. Hopefully, next year, we can do this in person, but best of wishes for the holiday season, everybody.

Look forward to it. Thank you for spending time with us. We appreciate it.

Thank you.

Take care, guys.