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

[Audio Gap] through the hardline, broadline food retail analyst from UBS. It's great to see everybody. Welcome to our discussion with Petco. We're super, super excited to have Brian LaRose with us. Brian, it's 5 or 6 years at Petco.

Oh, gosh, for me. Just over 3.

Time flies. You're having fun.

These are dog years, Michael. By the way, I know I have some math placed in the house, so I would be remiss if I didn't say Happy Pi Day to everybody. I certainly celebrate it.

Yes. Wherever you are, well, it has been an eventful period for Petco. There is a lot for us to dig into. It's an interesting story with a ton of opportunity. So we are excited to hear about it.

And where I want to start is on some of the recent changes. Why did the Board decide to go with an interim CEO versus a permanent change? And give some of the thought process around why now is the right time to make a change.

Yes. I'll do my best to speak on behalf of the Board. I think the Board felt the sense of urgency to make a change. I don't think Mike or the Board is questioning our strategy. I think our strategy is sound. The great news about where we play is this remains an attractive market, and it's a fragmented market. If you look at our market share, pick a data point, it's mid-single-digits market share in $140-plus billion market. And the great news is if you take the top 6 or 7 players in the pet space, it's not even the majority of the market. So there's plenty of opportunity for us, and I think we have an advantaged strategy to go get it, but we haven't been executing well. And I think we have to own that and the Board felt that sense of urgency to go bring in somebody even on an interim basis, who has a little bit more operational discipline. And if you think about Mike's background, 36 years in retail, you can go look at what he did at Best Buy and the time he was there, and it's a great success story. He was a COO there. He comes in with a lot of intuition on things that we can actually change. And he will be somebody who makes some change and as a change agent, he's not coming in to be a caretaker for the seat, but he'll be very active even if it is interim.

And given that he has the interim role, what's he focused on in the near term?

Yes, improving profitability. I mean I think it's no secret. You can look at the numbers that our profitability has been down and even we guided yesterday to be down year-over-year. And so he sees a lot of opportunity for us to improve that. Some of that is cost-related. Some of that's quality of sales. Some of it is the way we execute in-store, everything from an assortment to the in-store experience.

And you talked a little bit about this on your call yesterday, but Mike mentioned that the Board has been deeply involved in the strategy, focusing a bit more on value-adding some brands while at the same time, continuing to move ahead with the service orientation and getting more share in the health care segment of the market. It might feel that this is still the right strategy. And are there going to be any changes given what's happening with the leadership?

Yes. I don't think there'll be large-scale changes in strategy. And the one thing I'll say is bringing the value assortment was important, but it wasn't student body right from student body left. We still have an advantage in the premium space, and we have great vendors, great partnerships in the premium space, and that's a business that continues to grow. We continue to do new and unique things with our vendors there. We have strong partnerships. So it's not about bringing in value at the expense. We got a question on the call yesterday about are you pulling premium brands out for this assortment. The answer is no. The answer is no. If you go look at our pet care centers, what we call our stores, those premium isles remain the same, and we continue to do great things with those partners. So there was a part of the market, a customer segment that we weren't addressing. So we brought those value brands in. I think that stays. I do think you'll see us refine and cultivate the assortment over time, just like we always do. We are still in the early cycles. There are pet parents that visit us 15 to 20 times a year. There are pet parents that visit us 2 to 4 times a year. We need to cycle through some of those return visits on the value brands, determine which SKUs are actually working, which ones are maybe lower velocity. And over time, we'll continue to refine that. But I will tell you that anything we bring into the assortment, whether it's value premium services or anything online, it has to be profitable. So we'll take a hard look at each component of the profitability.

And Brian isn't just the Chief Financial Officer of a pet supply company, he actually practices what he preaches. He's got 6 pets, including 2 tortoises.

2 tortoises, 2 cats, 2 dogs.

He is a customer.

They're -- officially, the step tortoises, but step tortoises nonetheless.

Okay, you still love them nonetheless.

Yes, they're 18, they live to be 70. We keep -- we have 5 kids combined, and we keep asking which kids are going to inherit them because they live to be 70 or 80. And so far, no takers.

And they move very slowly. They do. With all that being said, what is going on with the pet category? If you look at all the different players in the space, it's been an unusual time for the pet category. This is a market that has -- you could set your clock to for a long period of time given the humanization of pets and how important pets have become as members of our family. Why has that category become so much more challenged in the last several quarters?

It's a great question. I think if you go back pre-pandemic, and you said it best right there, for 30 years, this is a category that grew mid-single digits, and you could probably pick any 5 years. You could go into those 30 years and you could pick 5 and it's probably mid-single digits. So through any cycle, that's how it grew. Pandemic was obviously elevated. You had much larger pet adoption. You had much larger weight towards the discretionary categories. And as we think about the pet life cycle, spend per pet continues to increase throughout pet's life. However, in the early years, you have a heavier weight towards discretionary. If you're -- we'll use dog as an example. With your crate training, you need a crate, you need a bed, you need all these things that you get one time. I would say I think the market itself probably overestimated or underestimated how much that pet boom contributed to the pet growth in the years of 2020 through early 2022. So there's still some normalization of that pet, the pet market. And I think that will continue throughout this year. That said, I think, long term, it's still a market that's projected to grow. I mean Mike cited the number yesterday, a couple of hundred billion dollars. That's what we see in the future for market. I think it will return. I think humanization is not going away. I'll use fresh as an example. I can't recall if you follow Freshpet, but they -- fresh market today is $1 billion, $1.5 billion, and they project that to grow to $5 billion in the next 3 to 4 years. We believe that that's a solid indication of the premiumization of pets. We think that's a space we have an advantage in terms of the way we can actually get product to customers. So I think we're in a transitionary year in pet, but I do believe the category returns to the kind of 30-year profile that we saw pre-pandemic.

Brody last, is there any sort of indication? He's a finicky eater. So this fresh trend is going to continue to drive the category for a while.

Yes. Shut up, Brody.

And with that being said, if you had to use the perennial baseball analogy where -- and if we assume that it is some pull forward of demand or normalization of these purchase cycles. Are we in the middle of the innings, the later innings? It's been hard because you were using a historic frame of reference previously to say these cycles typically last 4 or 5 quarters. Now with new evidence, new information, it seems like it's extending out a little longer, but it's in part because the category has gone through an extraordinary period. So is it right to think that it's maybe twice as long as it has been in the past?

Yes. I mean we didn't get that right. I think we have to own where we haven't gotten something right. We thought the discretionary pullback was going to be that 5 to 6 quarters, but we've demonstrated otherwise. So I -- specific to that category, I'd hate to put a number on it. What I would tell you, when I -- there's lots of predictions about the pet category this year, and that it will be below historical growth rates, but returning to historical growth rates kind of in '25. So I'd say you're probably in the seventh-inning stretch type of situation.

Got you. Another popular topic of discussion around your stock has been on market share. While we have seen a slowdown in all the players who serve the pet category, Petco has seen a little bit of a deeper slowdown than others. How do you think about what's happened from Petco's market share perspective? What has been influencing the ins and outs of those share changes?

Yes. Let me start with the good. Our services business has been exceptional. So everything from that through grooming and within that hospitals and mobile clinics. So we continue to outpace the market there. So we've actually gained share in the services space, which remains fairly fragmented. So that business has done well. I think when it comes to broader market share, we underestimated the gravitation to value we just did. And so we have lost share. And I think it's something we said we'd address in the call yesterday. Part of that's assortment, part of that is execution. The good news for us is we have tremendous partners in our stores. So we -- again, we call our stores pet care centers, and our employees or partners, and they're tremendous. They have a ton of knowledge, and we need to do a better job of equipping them with the tools to actually educate customers on what we have to make sure that customers have a choice when they come into the stores and then we give them the ability to actually cultivate what that customer is looking for. And so we'll get better at that. But I think part of it's assortment, part of it is execution, and we're going to get after it.

And it's useful to point out that Justin, who runs the stores and Mike spent some time together at Best Buy, because they have a comfortable...

Yes, we have a little bit of a Best Buy policy. So Justin was at Best Buy; Amy College, our Chief Merchant was at Best Buy. They know Mike well. I've spent time with Mike as a member of the Board and again, he's got -- I'm going to date myself, but some of you may remember the movie, The Matrix, right? And as those digits come down, some people see ones and zeros and other people could see through, I think that's how I think about Mike in retail. When he walks into a store, he can see things. He can kind of see through the matrix. And I think what he talked about yesterday, some of the things he sees, observations of three and a half decades of being in retail and knowing what we need to do better.

Is there an example, a tangible example of execution that you could point to help illustrate where the opportunity lies? Is it stocking shelves, cleanliness and orderliness, what -- how do you think about that?

More customer-facing time using our partners in the stores and assets. I think we've done a good job in some of the other areas. In stocks throughout the pandemic, we're bouncy for everybody. We brought in somebody who manages inventory for us, our in-stocks have been up tangibly year-over-year. So we're in good shape there. I think it's again about making sure that our partners have enough customer-facing time to do the education that they're good at.

And give us a sense of the profile of a customer who comes to Petco -- and does that -- how does it differ? Or how is it typical of the average pet supplies customer?

Well, we have different profiles, different avatars, if you will.

We've got time.

Yes. Okay. I think if you start at the top, the top decile of our customers are very, very well educated. And they come to Petco because they can get everything in one shop. So they typically have Vital Care Premier. They typically have very frequent grooming visits. They typically participate in our grooming and food perks programs. So they're very knowledgeable about the ecosystem. So those customers have a multiple -- we've talked about Vital Care Premier customers doing -- having about 3x the spend of a typical customer. So if you look at our net spend per average customer, call it, $250-ish is if you do the math, that means that customer is spending $750 to $1,000 a year with us. So those customers are very, very knowledgeable. And I think that does filter down through the second, third, fourth deciles of customers where they come to us because we do have an assortment that is unique. Yes, there's some overlap with our competitors, but we also have exclusive products. We have -- we're the only pet specialty retail player where you can actually get your pet into a vet clinic or a vet hospital groomed, trained and have a loyalty program that encapsulates the whole thing. And then, Michael, we have -- like any retailer, we have transactional customers who are coming in, one and done, and we need to make sure that we're servicing them with the same level of sort of grace and knowledge that we do the top decile.

And as you reflect on what's happened over the last year or so, are there observations that you have about where there's been some softness from a socioeconomic perspective from your customer base?

For sure. The discretionary categories have been pressured. And as you said earlier, we originally called this a 5- to 6-quarter event and it's taken longer. There are -- and when we talk about discretionary, the way we categorize it, call it, roughly 40% of our business, it's really made up of 2 things. There's the supplies business and there's a companion animal business. So companion animals are -- starting with live animals like tortoises, like ferrets, like fish and all the associated accessories with that. And then supplies would be collars and leashes and crates and beds and squeaky toys. Within each category, you have things that are discretionary binary, 1, 0 type of decision-making purchases and things that are less. So within companion animals, for example, I'll use my tortoises, they need rays from a heat lamp or 75-watt heat lamp. When that lamp goes out, I have to get a new one or else, I want...

So have maintenance

So I have maintenance, right? They don't need a half log for their enclosure, it's on a need-based decision. That's a discretionary purchase. Same thing in supplies. If you're collar frays or you're leash frays, you're going to get a new one, do you have to buy a squeaky toy? No, you don't. And I think as consumer wallets have been pressured, services remain strong. Food has remained strong. Components of supplies in companion animal are doing okay. But those truly discretionary categories are weaker, and it's been more pronounced than we thought.

And would you say that's probably more so coming from your lower to more moderate-income consumers versus...

I think it's pretty much across the board, more -- probably more pressure there, but for the most part, it's pretty much across the board. And we do think it will revert, and we just -- we're not going to call when that is.

And how much is competition played into the situation? Is it -- it's always been a competitive category with some strong players. But has the competitive landscape evolved in a way in the last couple of years than it's had more of an impact?

Certainly, you've had a little bit more from some of the larger retailers in the space as they've gotten trip consolidation benefit in human food that has transcended over to the pet food space. But I would say, all in all, it's just -- the spend competitive remains competitive. As I said earlier, the good news is it remains fragmented, and there's a lot of opportunity for us. So one of the disciplines that Mike is bringing in to the team is, we compete against everybody and nobody. There's a lot of market to go get. And our job is to focus on what we control, how we go get our fair share of that market, and that means we compete against everyone and no one.

One of the debates or questions that come up often is how does Petco store base compare to some of its pet specialty competitors. I think the perception is it's been a little bit more urban-focused. I don't know if that perception is right or not. So a, can you give us a flavor for that? And b, what's the right number of stores for Petco over the long term? And is there any repositioning that needs to be taken place given where the portfolio stands today?

Yes. Good question. So yes, we have more density in some of the more urban areas, but we do have pet care centers nationwide, and we have a partnership in Mexico, a 50-50 joint venture, where we have over 100 stores, over 120 or 130 stores in Mexico. So within the U.S., we're north of 1,400 stores. We did -- about 18 to 24 months ago, we did a pretty significant reduction in the number of stores in the quarter. We brought down stores about 20 or 30 in a quarter. Those were mostly unprofitable. So we get a scrub of unprofitable stores that we actually did some trimming. Most of our stores today, unless they are -- this is going to sound like a strange term, sort of strategically unprofitable or profitable. Those strategically unprofitable stores or things like you're in a highly dense urban area with a higher rent expense, where you still make money, but maybe not as much. And strategically, you don't want to walk away from that part of the market. But those are nascent and small. So I think roughly, you're looking at a flattish type of store count for now.

That store in SoHo is beautiful.

Yes. Yes. No, the Union Square store is great, too. I mean that's our kind of our flagship store. So if you haven't had a chance to check that out where you're in the city, please do.

And presumably, this is a competitive advantage for Petco because the core pet supplies customer is omni in nature, who wants to be able to interact with the retailer in multiple ways. So how important is that to some of the decisions that are being made around the store portfolio?

Very important. I think we look at each store uniquely. And we -- and by store, we determine is it a good vet market. So is it a market we want to put a hospital in or can it actually sustain with vet clinic? So we haven't talked a lot about that, and we should. The vet mobile clinic business is tremendous. This is mobile vans that actually show up in pet care centers once or twice a week. We hit about 1,200 locations on a weekly basis. And these are like 7-minute appointments where you come in and you get your vaccination. And in this market, it has played very, very well. And the vet team has done an exceptional job scaling it. So that -- we determine which location can have a hospital, which one is better suited for mobile only. Secondly, we determine whether that store can or should be a node, a supply chain node for shipping from store. So it's 4 ways we get product to customers. First and foremost, and the one we like the best is BOPUS, buy online, pick up in-store. You order something you're paying for the logistics, Michael, you're driving to the store, so we like that the best. Secondly, we have a great partnership with DoorDash, where we can get product to you same day. And that particularly plays well. I mentioned fresh frozen earlier in terms of how that's going to scale. The packaging where either -- packaging in the DoorDash cooled envelope to get fresh product or frozen product to a customer is about 1/10 of what it would cost to ship from a DC. So that's an advantage for us. But then these little nodes we have are shipped from store. So you want to have for fulfillment purposes and customer choice, the ability to get product out. And so you might have an urban area where in the back room, we have the ability to pull somebody out and actually package up a number of products to ship out to customers via UPS and then last, it's kind of shipped from D.C. So ultimately, we -- I think there are things that we've done well. And one of those is actually getting things to customers how and when they want it in very different ways.

Yes. This category has seen a pretty significant increase in online penetration over the last decade. Petco more recently has been really playing well in that trend. Where do you see the penetration now? And how do you see that playing out over the next few years from an online perspective?

It will -- I mean, I don't want to put a number on it, but online will continue to grow faster than brick-and-mortar. I mean I think that's what the industry projections indicate and that's what we see. So you want to make sure that you're capable and compete in that market. And so for us, that's why those choiceful ways to actually get product to customers matter and why we think our stores remain an asset to get product to customers.

It will grow faster than the market, but probably not at the same rate that it has for -- and is it in part because the profile of the customer who's now coming in, getting into their pet formation years, household formation years that -- where there would be a pet adoption is just a little bit more digitally native because typically, when you have a pet, you have a little bit more space, you might be living in the suburbs and so Petco is going to be very convenient.

Very much. And then also, it depends on where that pet parent is in the life cycle. If you're a new pet parent, it doesn't matter how old you are, it's very helpful to walk in and have a conversation with a pet care center partner who's knowledgeable about what you need. What you need, what products are good and whether that's talking to our -- one of our GMs or talking to if you happen to be in a hospital that as a vet, that vet can actually give you a lot of knowledge about after the check-up what food might be best for the type of breed that you have. So I think the early parts of a life cycle is really important to actually have time with somebody and we believe there's an advantage to, we call it, hands-on pet. If you're online only, you don't have a lot of hands-on pet. So -- and there's an attractiveness to that.

Yes, for sure. I want to pivot a little bit to some of the strategies that have been implemented over the last several quarters. First, on some of the food additions, which it has sparked some debate. And the reason why it's sparked debate is because Petco had made this pivot several years ago to more natural ingredients, more premium products. And now with the addition of some more widely distributed products, does it create the potential confusion for the customer? And what is hoping to be achieved by the addition of these products?

Yes. I think it creates confusion if we don't do a good enough job creating awareness and making sure that customers know that we don't just sell those products. We sell a full suite of products. One of the things that we did before we made this decision is we have just out of 300-bed hospitals. And if you think about each one has 2 DBMs on average, so call it, 600. And then you have the vet clinics, where we have a couple of thousand to 99 vets. One of the things we did is actually talk to some of our top vets in the company about the decision to actually bring in a wider assortment. And their analysis was pretty simple. The most important thing for a pet is to get vet. It's just to get vet. So make sure you have enough choice so that people can actually feed their pets. And yes, we still believe that there are more premium versions of food, and we will continue to sell that. And as I said earlier, we have great, great partnerships there and great vendors. But having a choice. And I think, ultimately, over time, what you want to do is make sure that you have enough knowledge and awareness with customers so that they know what those choices are.

And how does this play out? What I think you -- Petco has mentioned that 70% of pet consumers purchased one of the products that have been rolled out. So is the thought process, perhaps one of these customers was going somewhere?

Absolutely.

So can you give us a little bit more...

Absolutely. I'd say there's 3 components to those customers. And I'll go in order of the easier customers to sort of get back. The first are customers who were coming to us for everything, so they were coming to us for grooming that premium products, services across the board. Maybe their dog happened to like one of the treats or food items that are in the value assortment that we didn't sell. So they're going somewhere else for that.

Like a Purina or [indiscernible]. Can you finally just give a talk about this?

Yes, I'll speak of. So now they're still with us and their basket increases because they can now add that product and not have to go somewhere else. And we're seeing very early success with those customers. Second tranche would be remarketed customers. So those, we have a lot of knowledge. We have a very good data analytics team who can farm data for us and understand who are the customers who've left us in the past 6, 12, 18 months.

Can you remind your customer counts have been 22 million, 23 million, 24 million?

Over 25 million. And we did grow customers last quarter, which is a good indicator. This is starting to gain traction, but you want to go get those customers back to third and the more difficult one is actually brand new customers. And then this is kind of what Mike was touching on yesterday and better awareness from our marketing efforts. And it's nothing that the marketing team hasn't done an exceptional job pushing, but it's just a little bit different focus. One of the other things that we talked about yesterday was prioritization. I think we've been criticized or at least questioned for doing too many things. And Mike will simplify that. I think when you simplify that, that has a ripple effect into different functional components of the business, including marketing. Marketing team can only do so much if they have to market to making a number up 75 priorities. If you actually get them a little bit more focused on where it drives the most value, it doesn't necessarily mean you spend more. It just means you spend differently and you get a better return.

And you mentioned -- you referred to this a little bit. It's been about 4 months since you completed the rollout. What has been your early observations? And how do you think it's going to play out from here?

Yes, Early indications are good. I think -- again, I'll go back to our partners did a great job. I mean they got this product out really, really fast. And quite honestly, we didn't have it optimized which is why we had to do some inventory stuff in the fourth quarter because we needed to make sure that the footprint was optimized and that we had the right assortment to actually get these value brands in. But I think the execution of getting the product out has been tremendous. I think the early indicators of recapture of some of the basket for customers that we had has been really good. I do think, over time, we'll continue again to refine this. We'll look at repeat visits, what SKUs are working, which make sure that every product we sell ultimately has a profitability contribution to the company.

Got you. And on the discretionary side, what changes are being made in order to drive a better outcome there?

Yes, better cost in certain products, lower entry price points. I think when we talk about value assortment, it's not just food. We missed the part of the market on OPP on certain products and not having a great price right for somebody who's entering not having a bad price right. And it was nothing the team did wrong. We just -- we didn't execute that part of the market well enough. If you go back to 2021, '22, parts of '20, there was a category growing in some quarters 30%. So why do you need an entry-level bad when you're growing that much? And so we miscalled that. And so we've reintroduced some entry-level price points in those categories, we've gotten better cost. Our merchant team has done a good job at actually cultivating the assortment. I will tell you that, Michael, we've talked about the need for a macro recovery in that part of the market. We got to go look for other ways to actually get cost out of the ecosystem and not wait for a recovery. So we control a bit more than, I think, we've indicated.

Got you. I want to pivot to the Healthcare segment. It's been a really interesting element of the story for some time. So, a, just as a grounding for this conversation, there's been rapid growth in veterinary services, health care for pets. One of the questions I got that I didn't have an answer for is are consumers spending more on health care for their pet, is it an element of humanization?

It is. Yes, for sure. I mean you think about, again, the way this has evolved over the past 2 or 3 decades, these are family members. And then you talked about Brody like he's a son. And so that's...

He's a piece of work, Brian.

Yes, no, I get it. But that's the way people feel. And I think you want what's for, you want what's best for your pet, whether it be a cat, dog, tortoise, fish, whatever, you want what's best for them. I think you'll continue to see that evolve in areas like fresh food, in areas like Rx food, in areas like Rx in general, vet visits. The vet market is a high-growth market, very fragmented. And that's why we put a lot of investment in it because we think having that customer who is a frequent visitor to our vet hospitals and/or our vet clinics is somebody who is going to go across the entire ecosystem.

Got you. And Petco has been on this journey to roll out vet clinics at its pet care centers. Give the audience a sense for what these pet care centers look like, what the growth trajectory here is and importantly, what distinguishes pet's care -- a Petco veterinary clinic from the average veterinary clinic in the market.

It's a full-service hospital with the absence of 24/7 Specialty Care. I'll give you an example of my older dog. My older dog has arthritis and a couple of slipped discs in her back. She's 12. She's a Jersey dog. She was in Hurricane Sandy 12 years ago, and we adopted it from a shelter in San Diego because the shelters here were overrun and we named her Sandy. And so she's got some deteriorating health issues. I got her diagnosed at our vet hospital with arthritis. I got her diagnosed with the slipped disc. I had imaging done on her back. I got medicine for her. Where it stopped was she needed an MRI, I got referred to a specialty hospital. So it's everything all the way up to certain select specialty care or urgent care on a 24/7 basis. That distinguishes us from vaccination clinic or even our own mobile vet clinics, which are vaccination only. So it's a full-service hospital with qualified vets who we've done a good job recruiting into our ecosystem. The way the model works is you go into an existing pet care center and you carve out a couple of thousand square feet. You put in a hospital, and that is a hospital that has 2, 3 waiting rooms as well as a full hospital in the back with the necessary equipment. You have typically 2 veterinarians in those hospitals along with the support staff. You put in about, call it, $600,000 of CapEx for the vet and another $600,000, $700,000 for the center store build-out. And we evaluate the ROI on those separately. So within that $600,000 vet, we typically lose money in the first year. It's a volume-based business with a little bit higher level of fixed cost because you're talking about labor. Once you've cleared that hurdle, you get to kind of break even in year 2, positive in year 3, approaching 20% profitability or EBITDA in year 5. The center store piece of that, we get a lift. So we get about a mid-single-digit center store lift in the first year, a compounded 3 in year 2 and a 1 in year 3. And that's held true. We just -- we went back and took a look month by month, quarter by quarter, cohort by cohort across all of our -- just out of 300 hospitals and that center store lift holds. So it's a model differentiator because there aren't a lot of pet specialty retailers building out full-service hospitals in their ecosystem. It's a good ROI for us. And so we believe it's a very attractive model.

And what's the growth path from here and do some of the other dynamics in the business potentially disrupt the strategy of continuing to roll out these locations?

Yes, we'll have a lower growth in builds for this year. We said yesterday, we'll do 5 to 10 and that's down from, call it, 50-plus in the prior couple of years. And we made that decision choicefully to balance our investments against cash flow. So if you think about free cash flow, you're all smart, you bought some models, you know how simple it is. It's working capital, CapEx and earnings. We did a good job on working capital last year. If you look at the free -- the cash flow statement we printed yesterday for the year, over $100 million in working capital roughly for the year. So we did a good job there. Earnings on a year-over-year basis pressured in the first quarter that we guided yesterday. So you have to take a hard look at CapEx, and we pulled our CapEx investment down for next year to $140 million from, call it, $225 million this year. And we did that because we're focused on growing profitability and generating cash flow.

And speaking of profitability, can Petco get back to margins that it was achieving prior to the pandemic and what needs to happen in order for that outcome to be achieved?

Yes. I think, I don't want to put a number on it, but we can certainly meaningfully improve from where we are today. And I think a couple of things need to happen. And I won't start with macro because I think, you can't just wait on that. For us, it has to be making sure our assortment is right, and our assortment is not just food. It's food, supplies and services and making sure that everything that we offer customers is actually profitable to the enterprise and good for the customer. And I think there's some fine-tuning to do there. We got to get after cost. We talked about $150 million cost exit in 2025 run rate. We need to do more. We need to do more, and we need to get better at it. We need to do it faster. And I think we teed some things up yesterday with not a lot of detail. And as we get detailed, we'll kind of -- we'll talk to you all about that. So that needs to happen. And then I think you will see a reversion to normal pet growth over time. And I don't know, as I said earlier, that, that happens in 2024, but it will. It's an industry that 3 decades of growth is a pretty hard fact to say that this is a pretty attractive market.

And how do you think about cost inflation for 2024 versus retail inflation, meaning how much retail price across the category?

We've started to see the lapping dynamic of pricing last year, not just us but others where you've seen growth rates come down notably in food or consumables because we're lapping the inflationary dynamic of last year. So you haven't seen pricing to the degree we saw in prior years. And we'll just kind of see how that plays out.

And on the cost side?

On the cost side, it's been fairly stable. Yes, fairly stable.

And then you mentioned the $150 million of savings, where is Petco in the journey? You mentioned that there could be some upside to that number. Presumably, the next layer is a little more delicate to achieve than the initial savings.

I think there's just things. A lot of that needs to come from the cost of sales line, and I'll give a couple of examples. Mike mentioned supply chain yesterday, and there's kind of 2 components of that. There are some things that our team has gotten a lot better at in terms of take an area like split shipments. Split shipments is a killer for a company and not good for the customer. So you come in, you order 2 things, and it comes on different days. You're the customer, you're not happy. As a CFO, I'm terrified because you don't want to actually pay double logistics on that cost. So we've done a good job reducing split shipments and I think we have more opportunity there. Longer term in supply chain, I think there are some things that will probably take a little bit of CapEx investment to go get, and that would be increasing the automation that we have, taking a look at where our nodes are. So I think those are the type of areas that are more strategically and foundationally meaningful for the company in terms of cost savings.

And as the outsiders, what benchmark or barometer should we be looking at to gauge the inflection in profitability? Is it as simple as we need an improvement in our discretionary sales to drive that outcome?

No, I think we -- that would help, that would certainly help. But again, I think we control more of that. And I think all the areas we talked about, supply chain assortment, execution, some OpEx in areas where we think we can actually still do some fine-tuning, we control all of that. So we have to go execute better against those cost envelopes. And then yes, certainly, a recovery would help, but we can't bank on it.

And you mentioned $100 million of working capital benefit last year, is there still more room to go from members?

Some. But I think the most powerful generation for us for free cash flow generation is earnings.

Got you. Can you give us a sense for the leverage situation, how you think about the balance sheet, how does that unfold from here? And how does the debt maturity outlook influence some of the decision-making?

Yes. So our term loan expires in 2028. So we have multiple years left on that. We have a $0.5 billion revolver, which -- in which we've not ended a quarter in that revolver. So our liquidity is good. We ended last quarter with $572 million worth of liquidity, a combination of access to the revolver as well as cash on hand. We remain focused on debt for sure, and we'll continue to look for opportunities to pay that down, but we haven't given the kind of commitment number for this year, but it remains a top priority. We did protect about 2/3 of our debt with a series of collars, so cap in a floor that we've been in the money on. Part of the reason, you saw the interest rate guide yesterday, and part of the stabilization there was the fact that we have protected ourselves against interest rate rises. As interest rates fall, will we benefit, absolutely. But I think the good news is with the protection we have in place with the hedges, stable or increasing rates are not impactful to us.

And what is the optimal capital structure? What is the leverage ratio for Petco?

Yes. I -- we haven't given an updated target for that. I would just tell you that it's a priority to reduce the overall outstanding debt we have.

Got you. Petco's got a lot of opportunities in front of it, some change afoot. As you look out, what are the most significant risks that you see on the horizon from Petco being able to reach its potential?

We control it, I think. The biggest risk for us is not executing against the playbook that we have. I do think that our strategy remains solid. I don't think there's another player out there who has the ecosystem that we have. I don't think there's another player out there that has the passion of partners, employees in the store that we have. I spent a lot of time in the field talking to our partners, they're tremendous. I think it gives us lower attrition and higher retention rates in our field than, I think, broader retail. So for us, it's all about how do we make sure that we're executing against the strategy that we have in the most efficient way, and we need to improve.

Yesterday, you gave guidance for the first quarter, not for the full year. So what was the thought process behind being a little bit more narrow term in focus? And as part of that, what do you need to see in order to regain the confidence or the conviction to provide a little bit more of an outlook for the market?

Yes, I'd say 2 things. Number one, we had a CEO transition yesterday. So Mike coming on board, yes, he's been a Board member, but as of 5:00 yesterday morning, he had been on the job 5 hours.

I think Kudos to Mike for jumping in.

Yes, yes, the joys of being a West Coast company. So he -- we wanted to give him some time. He has observations about things that we can do differently and better. But guiding for the quarter, I think it was the right call yesterday, given he just came on board that morning. And secondly, we're not -- we know how important it is to deliver against our commitments. And we, last year, unfortunately, needed to adjust our guide. And we felt that it was best to just guide one quarter at a time for now.

And so this is kind of for now. And once the business is heading in the other direction, perhaps, we'll get back to you.

Yes, we'll see that. Yes.

Well, Brian, I thank you so much. I want to -- on behalf of the audience, please join me in thanking Brian, and we really appreciate your insights and time.

Thank you all.