Good morning, and welcome to the Petco First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Benjamin Thiele-Long, Chief ESG and Chief Communications Officer. Please go ahead.

Good morning, and thank you for joining Petco's First Quarter 2024 Earnings Conference Call. In addition to the earnings release, there is a presentation available to download on our website at ir.petco.com summarizing our results. On the call with me today are Mike Mohan, Petco's Interim Chief Executive Officer; and Brian LaRose, Petco's Chief Financial Officer. Before they begin, I'd like to remind everyone that on this call, we will make certain forward-looking statements, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from such statements. These risks and uncertainties include those set out in our earnings materials and SEC filings. In addition, on today's call, we will refer to certain non-GAAP financial measures. Reconciliations of these measures can be found in our earnings release, presentation and SEC filings. [Operator Instructions] With that, let me turn it over to Mike.

Good morning, everyone, and thank you for joining us today. I'd also like to take this opportunity to welcome Glenn Murphy as our Executive Chairman. With over 30 years of retail experience, we're delighted to have him join our Board. The entire leadership team will be working closely with him on the next stage of Petco's transformation. In Q1, we made meaningful progress against our strategy to reposition the business for sustainable and profitable growth. Although I've been a pet parent for many years and a member of Petco's Board for over 3 years, the last 60 days have provided me with even greater insight into what makes Petco a special place to both work and shop. We operate in an attractive category with a track record for consistent growth, and Petco remains an iconic and trusted brand for millions of pet parents. Our store partners bring in a palpable energy for change, and I'm grateful for the incredible work they do. It's their enthusiasm that shapes how our leadership team focus on both our mission and our potential as we look ahead. We need to address some big challenges by capitalizing on our strengths. Specifically, we must return to profitable growth and generate improved free cash flow, keeping an eye on the long-term opportunity to capture further market share in what remains a highly fragmented industry. In support of this, we've structured Petco's -- we have restructured Petco's executive leadership team. Consequently, we've simplified decision-making, aligned our focus on fewer and clearer priorities and empowered the organization to move with greater speed and agility. The leadership team's priorities to improve profitability are clear: return to retail fundamentals while executing on cost transformation and takeout. Retail fundamentals falls into the following distinct components. The first is store productivity. In our…

Thanks, Mike, and good morning, everyone. Building on Mike's comments about the quarter, the last 60 days have given us even greater clarity on the full potential of our business, and we've already begun activating against clear and significant opportunities to deliver on it. Specifically, we're committed to restoring profitability and balancing our assortment to reflect the needs of pet parents. And we're being forensic and disciplined with cost to ensure future revenue growth translates meaningfully to the bottom line. Ultimately, we expect these actions to return value to all shareholders. For the quarter, net revenue was $1.5 billion, a decrease of 2% year-over-year. Comparable sales were down 1%. In merchandise, consumables was flat year-over-year, reflecting the impact of lapping prior year inflation, coupled with the pricing actions we took in the third quarter. Our discretionary supplies and companion animal businesses experienced continued softness, down 7% year-over-year. Services and other, which includes services, wholesale and recently disposed noncore businesses delivered 4% revenue growth with services up 10%, driven by ongoing strength in our vet hospitals, mobile clinics and grooming services. Moving down the P&L. Gross profit was $579 million, down $26 million from prior year. Gross margin for the quarter was 37.8%, a decline of 101 basis points, primarily driven by mix. SG&A as a percentage of revenue increased from 37.1% to 38.9% year-over-year driven by severance expenses related to the management changes during the first quarter, increased depreciation, investments in store labor and a onetime expense related to the disposition of PupBox. Excluding severance-related charges and the onetime disposition expense, SG&A as a percentage of revenue was 38.2%. Q1 adjusted EBITDA was $75.6 million, down 32% with an adjusted EBITDA margin rate of 4.9%, down 219 basis points year-over-year. Adjusted EPS was negative $0.04 compared to $0.06 per share…

[Operator Instructions] The first question comes from Seth Basham with Wedbush Securities.

Congrats on the improving results. I would love to get some color first on the supplies business, which remains under pressure. As you look forward and project revenue into the second quarter, how do you think that business is going to perform? Do you see changes to demand levels? Do you see any changes to the competitive environment?

Seth, thanks for the question. We did see some slight improvement in the year-over-year decline in our supplies and companion animals business, but we know we have more work to do. The team has taken some decisive action to deliver on this. Overall, we remain confident in our assortment strategy and plans, our breadth of offerings and how we're serving our pet parents. And I think -- I want to be really, really clear for you, we're acting every day to improve profitability in the near term. My focus is to sequence the highest priority drivers that we have while not compromising on our value proposition or our relationship with our customers.

Understood. And as it relates to the gross margins, which were stronger than expected, could you provide some more color on the drivers there? As you look forward, how should we think about gross margins relative to SG&A in the second quarter?

Thanks for the question, Seth. I'll just say we're focused on driving bottom line improvement, and we expect sequential dollar improvement on bottom line profitability as the year progresses, steady progress throughout the year. We're looking at initiatives to drive both gross profit improvement and SG&A efficiency. And as I laid out in the prepared remarks, we're on track with our cost transformation and believe there's opportunity to both augment and accelerate progress there. I will tell you, specific to Q1, you did see some modest improvement in the discretionary categories and the team also did a good job across supply chain driving efficiencies.

The next question comes from Kaumil Gajrawala with Jefferies.

A lot going on, and it all makes kind of good logical sense. But can you maybe just help us out with prioritization or how you balance each of these items? For example, effectiveness of marketing, when does that come around versus the assortment versus the productivity? If you could just kind of maybe just work us up through what the time line looks like because, obviously, doing all at once is difficult. So maybe just if we can get a better sense of prioritization, that would be helpful.

No, great. Thank you for the question. I would start with that we are focused on fewer and clearer priorities and we're taking decisive action to improve our profitability while we enhance our customer experience. And everyone in the organization, both at the store and leadership level has rallied around our reset plan. From an overall standpoint, our #1 focus is improving our profitability. The biggest area to improve our profitability is in merchandising, and that's why we have our focus in that area, is followed by improvement in our services profitability and a renewed focus on reviewing our SG&A spending. That's how I would line up our priorities. Brian, would you add anything?

Yes. I'd just say, Seth -- I mean, excuse me, Kaumil, we gave a couple of examples of things we're doing to prioritize the disposition of PupBox, the pausing some of the internal upgrades to systems as well as the deferment of the Summit. Those are just a couple of examples of things where the team is united and working towards the same objectives, which is making sure we have fewer priorities, clearer priorities and those that add the most value to the enterprise.

Okay. Great. And then in the context of all the things you're doing, it doesn't sound like optimizing the network or closing stores is part of the plan? Is that just my maybe just misreading that? Or is that something you're also evaluating?

I would tell you, Kaumil, that we are dynamic in the way that we look at our real estate portfolio. We have a very comprehensive process to make sure that we understand the demographics of any market that we enter and the competitive dynamics as well as our own position in the markets that we may exit. So it's a rolling portfolio. I would say that there are not any large-scale changes planned at this time.

The next question comes from Steven Zaccone with Citi.

I wanted to understand the category performance outlook for the second quarter? How should we think about consumables versus some of the more discretionary categories? And then along those same lines, you mentioned returning to sustainable growth. The macro is a challenging thing to predict. But from a company-specific aspect, what do you think really needs to happen here to drive that sustainable growth going forward?

Thanks, Steve. I'll start here on the category outlook embedded in our guide of the $1.525 billion revenue. We know we have work to do in our assortment, and that's why merchandising excellence. And the work we're doing there is at the top of our list. We have an opportunity to improve the quality of our sales to better support our pet parents' needs. And our focus is on improving profitability, both within the mix that we sell and then every part of the mix. Brian?

I would just add, Steve, we haven't baked in any significant recovery in the discretionary category to our guide consistent with the way we came into the year. Services remained strong in the first quarter, up 10%. Consumables was roughly flat, which is partly due to the overlapping dynamics relative to inflation. So everything that we think about from those categories going forward is baked into the $1.525 billion guide for the second quarter.

The next question comes from Anna Andreeva with Needham & Company.

Good to see you guys making progress. A couple of questions from us. With Glenn's appointment as Chairman of the Board, just any of the initiatives to keep looking at that you can share? And would he be considered for the permanent CEO position with the company? That's my first one. And then we have a follow-up.

Great. Thanks, Anna. I've spent a lot of time with Glenn over the last few weeks, and he'll be of great value to me and the team, given the experience in retail turnarounds. We remain committed to our strategy and executing on it. And our top focus is improving our profitability. The search for the permanent CEO is ongoing, and we'll provide any updates as soon as we have additional information for you.

Okay. Fair enough. And just as a follow-up on that, can you update us on some of the economics there? Should we think that most of the base is now EBITDA profitable? And are you still seeing that mid-single-digit lift to the center of the store from that, that you used to talk about?

Thanks, Anna. There's been no change in our long-term economics in terms of the vet model. And our plans for the year have not changed since we guided coming into the year, 5 to 10 vets for the year, which are baked into our CapEx guide. I will tell you what we're focused on is that we just brought in some additional expertise into the vet business. We have a new leader of that business with significant experience in that space. And we're focused on improving both the vet experience within our hospitals as well as the improved customer value proposition. We're also looking for ways to improve the profitability through greater utilization.

The next question comes from Oliver Wintermantel with Evercore ISI.

I had a question regarding, first of all, the transactions versus ticket or AUR. If you could give us some updates on how that trended through the quarter and how you think about it for the rest of the year.

Thanks, Oliver. I'd say we're not going to break that out for you specifically. I would tell you, though, that basket was stronger than traffic, and that's been consistent with what we've been seeing.

Got it. And the other one, I think, Brian, you said you're expecting free cash flow to be positive this year. If you could maybe talk about how you get there, what the moving parts are.

Thanks, Oliver. I'll start with Q1. Although Q1 was negative $41 million, it was down negative $24 million last year in Q1. It is typically historically a negative free cash flow quarter for us given some of the seasonality of the rolling balance sheet items. The knobs for us, Oliver, are quite frankly, to continue to focus on profitability of the company, improving the profitability trajectory of the company, and we expect steady progress on that as the year progresses. The second variable, I would say, is continued execution against our CapEx guide. We were down 47% in spend in year one from last year, and that's on track with the $140 million we guided for the year. And the third thing is we have opportunities in inventory. Although the team has done a good job of managing inventory, we do have an additional opportunity to continue to rationalize our inventory management and focus on higher velocity SKUs.

[Operator Instructions] The next question comes from Steven Forbes with Guggenheim.

This is Rene Marin on for Steve Forbes. Given relatively stability within the product gross margin profile quarter-over-quarter, can you help us better understand where we are in terms of bottoming? And what drivers of the business is working through to improve overall profitability within product sales?

Thanks for the question. I would just tell you, we're focused on driving bottom line profitability. What you saw in the first quarter, as I mentioned earlier, was some modest improvement in the discretionary category, coupled with the team's execution against some of the supply chain efficiencies that we saw in the first quarter. Looking forward, though, we have opportunity across our merchandising strategy to continue to look for opportunities within cost of sales.

Got it. And then as a follow-up, can you help us further break down the 4% growth in services and other revenue between vet training and grooming? I know you mentioned the 10% in the prepared remarks between vet and services, just so that we can get a better understanding of the underlying trends.

Yes, I'm not going to get into that level of detail for you. Services was strong at 10%, and that was driven by grooming, that was driven by our Vetco mobile business and continued maturation of our vet hospitals underneath. So all three of those reported strong results.

The next question comes from Justin Kleber with Baird.

My first one is just on the consumables business. I understand the disinflation trend. But any color on how units are trending? Are you seeing any improvement just based on the assortment efforts? And then how are you thinking about like-for-like pricing on consumables across the balance of the year? Do you see any risk of deflation? Or is pricing simply flattening out here?

Yes. Thanks, Justin. I'll start here. I think I would just go with that our comprehensive assortment and breadth of offerings makes Petco the preferred destination for millions of pet parents. And we've introduced different products over the course of time to make sure we can have a solution for every pet parent and their needs. I think on a pricing standpoint and thinking about disinflation, the customer continues to be choiceful. But again, back to our whole offering that gives them great products and solutions at the right price points, it gives us the ability to solve all of their needs. We're committed to meeting the customer wherever they are with whatever they need, and we continue to overindex in premium and super premium in our fresh and frozen assortments.

Okay. So you don't see any risk that vendors will take prices lower to stimulate volume?

The question is a good one. We're always working with our vendors to drive profitable outcomes for both of us on assortments, promotions and demand generation marketing campaigns. With our comprehensive assortment, we have the ability to meet our customers with whatever product solutions they're looking for.

The next question comes from Greg Badishkanian with Wolfe Research.

This is Scott Stringer on for Greg. I wanted to just ask some more macro questions. The topic of discussion last quarter was market share. Can you provide an update on how market share trended in 1Q? And if you could break that out by value versus premium merchandise, that would be helpful.

Thanks, Scott. I'm not going to give you the level of detail you're looking for, but I'm just going to start with, our #1 priority is to improve our profitability, and we have the entire organization rallied around these objectives. Focusing on offering our customers, our pet parents, the products they need and giving them an exceptional shopping experience while also addressing our cost structure is our #1 focus. And these actions will strengthen our competitive positioning.

Got it. That's fair enough. Maybe just one follow-up on inflation. How is that trending? How is that impacting gross margins today?

I think the biggest thing to call out there would be relative to the growth in consumables. You saw consumables roughly flat for the quarter. The primary driver of that was the year-over-year lapping dynamics of inflation. That said, I think the team did a good job managing overall gross margin for the quarter.

The next question comes from Michael Lasser with UBS.

In your response to the last question, suggested that right now, Petco is prioritizing profitability over market share. So, a, is that right? And b, when is it realistic for outsiders to expect that Petco's market share stabilizes, especially with stepped-up efforts from mass merchants and predominantly online-only retailers to aggressively target the category?

Thanks, Michael. Our top priority is improving our profitability, and that gives us the basis for us to be more than competitive in a very fragmented marketplace. Our unique end-to-end offering and our millions of pet parents who love our brand get a chance to experience things that we can do that other online-only or mass players cannot do, and we're going to remain focused on that.

Thank you for your time and for your questions. That concludes today's earnings call. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.