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

Thank you for attending one of our last fireside chat of the conference. It's our pleasure to introduce you to Petco. Today, we have with us Joel Anderson, Chief Executive Officer. And we also have with us Sabrina Simmons, Chief Financial Officer. Thank you both for joining us today. We're excited to have you. You do have a lot going on.

Yes, we do.

I almost wonder if I have to be up here, like you could just launch into all your phases and initiatives. But obviously, this has been a big year of transformation for Petco so far. And you have this multiphased approach and focused on 3 stages. And the first one is the strengthening of the retail fundamentals. So I wondered if we could maybe just level set in terms of what you've been able to accomplish? How do you think you're positioned? And how soon and closer we are to the next phase?

Yes. Look, as you just alluded to, this transformation is very well grounded in specific phases. And we're well past Phase 1, but I think it's important to articulate Phase 1 for a second because that really led to the foundation of putting us in Phase 2. And so much of Phase 1 was just a combination of, one, identifying where the opportunities were as well as rebuilding the leadership team. And so we completed the rebuilding of the leadership team with Sabrina joining and a couple of others at the beginning of the year, end of February. But like any great strategy, it only works if you're also really good at execution. And so that's Phase 2. And so if I had to summarize Phase 2, it's really about executing and implementing. And so while we had a long runway last year of really identifying a lot of things, what I'm most excited about and most pleased about, and it's already showing up in our results, both Q1 and certainly in Q2, is a lot of improvement in EBITDA. And specifically, Phase 2 was really about improving the bottom line. And that's really where we've been focused, and that's where you've seen the movement. And it's also, though, been about improving the culture. I mean we've changed the culture from playing not to lose to playing to win. And that's the part that's been, as Sabrina said a number of times, it's become fun to save money and people are excited about it. And we celebrate that at Petco. And so we're reinventing the culture, and I'm really pleased with where we're at in Phase 2.

That's great. And then if we can maybe jump ahead to Phase 3, which I know is on the come. But maybe what you're most excited about, what you think will come to fruition first?

Well, what's important about Phase 3 is that it's equally as grounded in the strategy. And so while many of you are very interested in when we're going to get to Phase 3, we're also being very disciplined in our approach. And as I said, we're squarely in Phase 2, but we are starting to think about Phase 3 strategically. And our strategy on Phase 3 growth is centered around 4 pillars. And I'm happy to go into all 4 of those pillars, but I'd articulate them quickly. One is about amazing store experience. Like our partners are incredible. They love pets and fostering the fun of a great store experience is number one. Number two is merchandise differentiation. And I think we have an incredible opportunity to differentiate our product in our stores. Number three is services at scale. And while strategically, we've made many acquisitions and growing hospitals very fast, we have a big opportunity as part of our growth to take all our services to scale. Services are tough. They're hard to do. But in many ways, that's our moat. That's something we're really good at, and it's hard to replicate. And then finally, it's winning with omni. And so those are the 4 pillars that we are now looking at that will lead our growth that will start to show up in '26. But it's also important I mention to you that the approach we're taking is very much a test-and-learn approach. So there's not some big unveil coming, Kate. If you think about merchandise differentiation, as we change a department, we will test and learn, try it in 25 stores, make sure it works and then roll it out. So there's not this -- we're going to change the whole store and wait until next July. As each department gets corrected and fixed and we bring more opportunities to it, we'll start to roll those out, but it will be grounded in a lot of facts that prove this works before we make the inventory investment. And of course, you have to sell through what you currently have.

And maybe a good place to drill down with regards to the pillars and then the piece that I find most interesting is the services. It's a traffic driver. It's a reason to go to the store. Now omnichannel is part of it, too. But also from a competitive standpoint, I think it's a differentiator. So I wondered if you could maybe talk through just services, what -- maybe how you found services when you got there, where you think services can go? And how big of a deal do you think it is versus your competitors?

It's a great question. And quite honestly, Kate, when I was making the decision to make a change, services was one of the compelling reasons I got excited about Petco. On one hand, we've had grooming a long time. On the other hand, we made the right strategic decision to grow hospitals internally. So all our vet operations are Petco owned. And I think that gives us a really nice point of differentiation that our veterinarians are connected to our groomers who are connected to the center of store, and it's one big Petco ecosystem. And like you alluded to, services is something that not in my lifetime will you take online, right? You have to physically show up. And so to your point, it drives traffic. Having said all that, we've seen since looking under the covers, a big opportunity to optimize our services. And so if I look at vet, again, that's staged out how we're going to optimize it. And the first one is optimizing the existing fleet. So we went from 0 to 300 in a very short period of time. And now we have a fleet there that without having to spend a lot of capital, that's in the rearview mirror, it's been spent. We can really grow our hospital operations. We're improving the digital operations so that you can make appointments easier online. We're improving the number of days our hospitals are open. And that takes just training and developing more veterinarians, but doesn't take a lot of capital. So you're absolutely right. Services is a big point of differentiation for us. And even on the grooming side, despite having it for as long as we had, we found there was a lot of times you could go online and there wasn't a grooming appointment available. So we've optimized the software. We've standardized how many pets our groomers can see. We're getting better at utilizing our junior pet stylists to maybe do the washings so that our senior pet stylists can do the more difficult ones, which then, again, you can train a junior pet stylist much quicker and you open up more appointments. So we're really making that efficient. And then down the road, we'll start to look at opening more hospitals as an example.

That's great. Just speaking of competition, I know it's very fragmented, but you also have some very solid competitors in the space, both with mass and specialty. We talked about services as a differentiator. But just overall, how are you thinking about competition and what Petco's value proposition is amongst the competitive set?

Yes. It's a good question, right? And we do have a wide spectrum of competitors. And if anything, the pet space became too easy to grow during the COVID years, just you opened a door and sales happened. And so as you've gotten back to a more normalized growth rate, you got to be tighter and you got to be differentiated. And I think for many of the reasons I just articulated our growth strategy, all 4 of those pillars are points I believe we can be different than the competition. And even when I talked about omni, it's important I didn't say e-commerce. And our stores will play a really key role. And as we start to grow e-commerce again, same-day deliveries, 2-hour deliveries, buy online, pick up in store, even the fact of the mobile phone playing a very important role in making grooming appointments, making that appointments, checking your loyalty points. And so we really think of it as a digital operation that really enables the stores as well as serves the pure-play customer that wants an online delivery.

And speed has been actually something that we have heard across the board at this conference in terms of that is what the customer is looking for, obviously, value. But I think speed and convenience is right up there now with value based on what everybody is telling us. So how do you feel you are today with regards to the convenience and speed versus your competitors? And can you get better?

Yes. The good news about that is, well, a, we agree. It is an element the customer is looking for. But b, we can get faster without it having to be a huge capital outlay for us. So in addition to using our distribution centers for repeat delivery because that's a planned purchase. We know what date we owe them that shipment. It's much easier and efficient to use the distribution center. But for a customer that needs speed and want speed, those 1,400-ish stores we have out there are already kind of forward deployed inventory, and we're getting much better at using market fulfillment centers. And we're being very strategic about that as well. We are utilizing our lower volume stores as opposed to our higher volume stores. So not to disrupt the customer that's coming in foot traffic. And by the way, that also makes a lower volume store more efficient because you're sending more inventory in there to fulfill an online order. But I agree 100% that speed is a component that we are focused on and it will get better in '26.

Great. You mentioned 1,400 stores. I think you've closed some stores since you guys have been at the company. How do you think about your store count and your fleet? Is there any criteria that you're looking at to evaluate store performance today?

Yes. Several elements. And Sabrina, if you want to weigh in as Sabrina sits in our real estate committee meeting every week. But first and foremost, we look at the financial performance of the store, bottom line profitability, labor rates, things like that. The second thing we look at is the market. Is this a node we want to be in, but maybe it's just in the wrong location. So we look at that. And then we look at the overall trajectory and health of our store fleet. And so we're fortunate enough that we're in a situation that over half of our stores come up for lease renewal in the next few years. So that, Kate, really gives us a lot of flexibility that we can outward project where we need to be. Having said all that, the health of our stores is in pretty good shape where we have really looked at that. The EBITDA continues to improve. And as we alluded to, we closed 25 last year. We expect to close about that this year, then it will start to moderate next year. And I think as you get into '27, actually start to see growth. I don't know, Sabrina.

Yes. The only thing I'd add to that, all of that's right on, is there's a really nice opportunity that we have in store productivity. So we have a nice sized fleet nationwide. I think it's an advantage these days to be an omni player. Most pure-play e-com want to establish some brick-and-mortar. We have that differentiator in the services. So as over the last few years, as our gross margin came down, so did the performance in our stores. So building back as we are focused on gross margin expansion, focused on the 4-wall profitability of our boxes, we're just looking at square footage improve. So we've even seen that in the first half. So we're just at the very beginning, again, without having to spend a whole lot of capital of just reaping the benefits of increased profitability within those 4 walls as we improve our merchandise, as we improve how we operate around our pricing architecture, promotions, all of that to improve our margins.

And this might be too soon to ask, but just given that you do have 50% of your store base up for renewal in the next few years, does that give you an opportunity to maybe reassess the size of the store or think about a different way to approach the store?

Yes. We've actually already looked at the size of the store. Our average store is about 13,000 square feet. That's the optimal model. And we feel really good about the size of our store. It -- as Sabrina said, we still have opportunity to improve sales per square foot, and there's a lot of initiatives that are all about that. But that feels good and that does represent an overwhelming majority of our stores.

Sabrina, I know you've worked very hard on the cost side of things. And one of the areas that I think you've been focused on is moving towards more impactful targeted promotions and any kind of opportunity as a result of that. How have you been able to balance the promotional activity and maybe what the customer has been used to versus this new more targeted strategy?

Yes. I mean, first of all, we always start with a customer lens. And we know to play in retail effectively these days, you have to be very value conscientious. You have to offer value, play on the holidays, do promotion. So what we've been doing is not trying to take away any of that promotional cadence, but more responsibly execute it. So what was happening before in our stores purposefully and probably some inadvertently before the management team came in was we were allowing customers to use a lot of stacking. So they could take a coupon on a markdown on an extra 20 and you deteriorate margin quite quickly that way. And I don't actually think most customers even expected to be able to do all of that stacking. So we're still offering the promotion, but we're getting much more careful and disciplined about how we're operationalizing that so that we're preventing all of that stacking. And we're also just looking overall at depth because, again, we got a little eager about chasing sales, and there wasn't enough balance on the profitability side. And so now we have a really talented team who's working on inventory planning, merchandise planning, managing our margin appropriately so that each promo we do, we have an opportunity to look at depth of promo and perhaps get the same lift without having to go so deep.

And then another area that I know you've been focused on is just average unit cost or just your cost. Could you maybe update us on how the conversations have been with suppliers and what you've been able to accomplish there?

No, not take it.

Okay. So yes, we started that at the very end of 2024. What we have found broadly speaking about the company is, again, a lot of -- this is why we talk a lot about retail fundamentals because there's a lot of low-hanging fruit and basics that we have found we can just do a better job executing to that reaps a lot of return. And I would say merch and non-merch procurement were both areas of opportunity where we really weren't using the weight of our size at $6 billion in sales to be assertively negotiating with our vendors. We always want to create win-wins. But we really weren't negotiating as hard as we could to affect that win-win balance with them. So we've done that much more effectively beginning last winter, and we're in the midst of doing that again as we're preparing in the summer to have discussions around 2026. So that has reaped a lot of benefit for us as well. And I'd say, again, on the non-merch side, we put in a whole team now. We didn't have really a professional procurement team that was focused just on looking at negotiating deals on the IT side, on the freight side, having good discipline around RFPing everything to make sure we were getting the best pricing always. So all of that now has been put in place and it's starting to reap the benefits you're seeing in our financial statements.

That's great. I wanted to make sure I asked a question on the merchandising. It's kind of -- it can go 2 ways or 2 kind of big questions. Before you guys arrived at the company, the company had been more premium focused and didn't have many value brands. But I think once things started to kind of normalize after COVID, there was a realization that more had to be offered. And so there were more value brands introduced. So when we just think about the nondiscretionary or just the consumables piece, is there a lot of work to do there? Are you happy with the good, better, best and how things are positioned?

Well, look, as Sabrina just alluded to on pricing and AUC and all that, we've got a lot of work to do there. But as it relates to strategically how I think about it, I came out of a business that was largely discretionary. And my prior business was largely consumable, Walmart, right? We're blessed at Petco that we've got both, and they operate very differently. I think of the consumables business as our traffic driver. It's a reason to come to Petco all the time. And so where we've been really focused on that, like if you're going to be successful in consumables, you've got to be in stock all the time. And certainly, it's very national brands, so you've got to be sharp -- price sharped, right? And so a lot of our efforts on consumables has been about improving our in-stocks, and we've made incredible progress there. As I think about the discretionary side, having spent 10 years in it, the opportunity with that is basket, right? So consumables is going to bring them into Petco and the discretionary provides us the opportunity to drive basket. And so I think we have an opportunity to not treat that side of the business so much in a set it and forget it mentality, and it needs to be one that changes much more frequently, surprise and delighted. I'm coming in from my bag of dog food and like that is a really cute color, and it's got my dog's name on it. And so there's a personalization element to it. There's a trend right, newness element of it. And so we're really working on both sides of it. Combined together, it will help drive more consumers into the store and drive a bigger basket.

That's where I was going to go with my second question on the discretionary side because Michael, the former Chief Merchant at Five Below is your Chief Merchant now. And we know he has great ideas. And so I wondered when we could maybe start -- it sounds like you're going to do a lot of test and learn, but when we could start to see more of that infiltrate into the stores.

I'm big in understanding what somebody's superpower is and Michael's true superpower is sourcing and product development. And so as he's gotten on board, joined right around the same time as Sabrina, he has already had a trip overseas, understands our brands, our private label brands. And not too surprising, he and I are aligned on the ability to use discretionary to really drive surprise and delight and drive newness and drive trend. I think there's a license element to it that obviously exists on the human side, and I think it exists on our side as well. As I alluded to at the very beginning, Kate, this isn't going to be a big unveil. We're working on many categories. We'll start testing them later in the year, won't show up in real sales until next year, but -- because we want to get it right. And it's the same way I used to do it at Five Below, like you got to test it, right? Like this -- we are not going to bet the [ farm ]. I can't go to Sabrina and say, I need $100 million in inventory to go do this without having the facts to back it up. But it's a real opportunity for us to really drive a new assortment throughout our whole supply side. And on our last call, I alluded to one example and share that with you. We brought in human, right, T-shirts and coffee mugs and sweatshirts and because the pet parent loves to show off who their pet is and snarky things for pets and bring that to life. So that's just one example of many to come.

That's great. We are asking 5 questions of every company who meets with us on stage. A lot we've touched on already. But this is more -- less about Petco, more just about your expectation for the consumer and the health of the consumer. Just what do you think the consumer will look like or what the environment will look like in the second half versus what you've seen in the first half?

I obviously have to look at it a little bit through the lens of Petco. But I think of the broader lens, they've been surprisingly Uber resilient, right? And I think about in our lens, Sabrina alluded to getting rid of double stacking. And so you would think despite pulling back on some of that, you look at our second quarter results on sales versus first quarter on a 2-year stack, we actually had 100 basis point sequential improvement. And so that, to me, big picture allude to the consumers remain resilient as we've tightened. Look, we all know tariffs are coming. In the pet space, it's not near as meaningful as it is in some of the other categories, but there will be a halo impact on it. So I think we're cautiously optimistic. Look, I've been in the fourth quarter world. I mean, Five Below was very much fourth quarter and my Toys "R" Us days, the consumer is not going to pull back in the fourth quarter. I think that's a given. They'll buy for holiday. I'm a little concerned about the amount of consumer debt rising. And so I think that will be interesting to watch as we get into '26. But I think the back half of the year looks like it will maintain the consistency we've seen.

Okay. Our second question is on pricing. And you just mentioned tariffs really isn't necessarily anything huge in the pet space necessarily. But to the extent that maybe you've had to raise prices here and there because of tariffs or whatever else, have you seen an elasticity response as a result?

Yes. And Sabrina, feel free to jump in here, too. Like for us, pricing is a little different because we started looking at our pricing last year long before we knew tariffs were coming. And so we've taken price up. And in some cases, we've taken price down. But it was more about us fixing our model than it was being driven by tariff. I think of promo stacking as a pricing mechanism that we had to pull against. And so we don't have a huge tariff headwind coming. But at the same time, we know we have to be competitive, and we watch it every day. Sabrina's team has done a great job putting more guardrails around that, and maybe you want to talk about.

No, I think that's right. We've been using all of our AUR levers, including pricing since the beginning of 2025, and we monitor it closely. So again, in our sector, we're not faced with the same headwinds as some other sectors. And yet there's a meaningful change in the tariff. So we're aware of that. But we'll be monitoring the competition mostly. We want to stay competitive, again, customer-first lens. We'll also be watching any unit changes. But most of our changes have been in play, both up and down for the first half already. So we feel like we're managing through it fine.

Okay. Our third question is on inventory. Can you discuss your expectation for inventory growth into the second half?

Yes. This is an area that, I've been quite pleased that how quickly the teams rallied and responded very responsibly. It's one of the silver linings of tariffs, honestly, because we really quickly started to look at SKU rationalization. It first started with, do we really need to import all this, on the private label side. But it forced us then to really get a head start on we have a lot of inventory that's not as productive as we want it to be, and we should really start rationalizing this. And so the team did a fantastic job. We delivered at the end of the first half year inventory down 9.5% on sales down 2%. So it's a great spread negative. We always want to keep a relationship to that. We expect to keep a healthy relationship with inventory below sales in the second half. And I think that's one of your best protections in a potentially volatile macro is being really, really well managed on inventory. So it's a strength for us.

Our fourth question is on non-tariff-related margin drivers. So freight, wages and materials, how do you think that will look into '26, better, same or worse?

Yes. I mean here, too, this is where when I mentioned how we brought in a professional procurement team, and they went to work on looking at all of these different areas of non-merch. One of the areas that we focus on most because of the dollars are big, are freight and supply chain. So we went and did really major RFPs with a lot of our providers. We feel like we're in a really good position with medium-term contracts that keep our pricing very well controlled. It's one of the things that has helped us leverage so much as well in 2025, and that will continue into 2026. So all of the -- and that's just part of the margin profile. Of course, we're going to continue to use all of the other levers as well. But we feel very well positioned and confident in where we stand there.

Great. And then our fifth question is about the competitive landscape and consolidation. Do you think market share consolidation will speed up, slow down or be the same in 2026?

Yes. Look, I think I look at it over a longer lens. And if you go back to pre-COVID, there was a consistent consolidation that kind of disappeared during COVID time. And we've seen that return in '23 and '24. So I wouldn't say it's an acceleration. I think it's more of what we've seen recently and more consistent with what we saw before COVID. And I think that's what's beautiful about retail if you got the stomach for it, right? You've got to keep reinventing yourself. You've got to have a point of differentiate and you got to stay relevant. And it's one of the things I'm excited about Petco and why I came because I think the brand is still relevant. And Sabrina and I have been working along with the rest of the team to just fix some retail fundamentals, but relevancy is key, and those brands that got complacent during COVID because sales were just happening are probably the ones that are struggling the most. But it's not so much that it's an acceleration as much as if you look back further, this is kind of how retail works.

Yes. Well, thank you so much for joining us today. So it's great. Appreciate the time.

Thank you.