Pet Valu Holdings Ltd

TSX:PET

Earnings Call Transcript 2024-Q1

[Operator]

Good morning, everyone. Thank you for standing by. Welcome to the Pet Valu's First Quarter 2024 Earnings Conference Call. My name is Carlin. [Operator Instructions].I would now like to turn the call over to James Allison, Investor Relations at Pet Valu. Please go ahead, Mr. Allison.

[James Allison, executive]

Good morning, and thank you for joining Pet Valu's call to discuss our first quarter 2024 results, which were released this morning and can be found on our website at investors.petvalu.com. With me on the call is Richard Maltsbarger, President and Chief Executive Officer; and Linda Drysdale, Chief Financial Officer. Before we begin, I would like to remind you that management may make forward-looking statements, which include guidance and underlying assumptions. Forward-looking statements are based on expectations that involve risks and uncertainties, which could cause actual results to differ materially from those expressed today. From a broader description of risks related to our business, please see our Q1 2024 MD&A, 2023 annual information form and other filings available on SEDAR+. I would also like to note that today's remarks will be accompanied by our earnings presentation, which can be viewed through our live webcast and is also available on our website. Now I'd like to turn the call over to Richard.

[Richard Maltsbarger, executive]

Thank you, James, and good morning, everyone. As usual, I'll begin by covering strategic and operational highlights from the quarter, along with some observations and key milestones for the balance of 2024 before handing it to Linda to review our financials and the reaffirmation of our 2024 guidance. For first quarter, the collective efforts of our teams and franchisee community helped deliver strong growth. System-wide sales and revenue grew 4%. Adjusted EBITDA increased 16% with expense leverage helping improve adjusted EBITDA margins by over 200 basis points and adjusted net income grew 10% despite absorbing a significant step-up in DC fixed cost. We believe the continued resilience of our system-wide sales and revenue is a direct result of our unique positioning within the Canadian pet industry. Our high-touch local specialty experience attracts discerning pet lovers who value quality, expertise and trust as much as prices. Our strength in needs-based consumables and services moderate the impact of continued softness in industry-wide and discretionary purchases. Our product breadth enables us to benefit from prevalent humanization and premiumization trends as well as deliver high-quality products for customers seeking the right balance of price and functionality. And our store exposure to suburban and rural markets helps mitigate the softness many retailers are experiencing in key urban markets. Additionally, in Q1, we benefited from the intentional delay of our targeted pricing investments as we chose to wait to see market adoption as a typical winter round of vendor price increases before activating our price changes in April and May. Behind our strong financial outcomes in Q1 is a continued balance of managing costs while progressing on key strategic initiatives supporting our long-term focuses to be the local and everywhere pet specialty retailer, deliver the best pet customer experience in Canada and fortify our strong retail and wholesale fundamentals. Let me walk through each of these. First, to be the local and everywhere pet specialty retailer. We opened 11 new stores, a record pace for us in the first quarter. In addition, we and our franchisees renovated, expanded or relocated another 7 locations as we continually work to keep our store fleet modern and consistent. Our network now consists of 794 locations. We will open our 800th store in the coming months and continue to target 40 to 50 new locations for the full year. Factoring in new stores and corporate resales, we increased our franchise store mix to 71% in Q1 compared to 70% last year, fueled by strong levels of interest from local entrepreneurs, keen to invest in our brand and retail experience. In addition to our brick-and-mortar presence, we continue to enhance our nationwide digital channel to round out our unmatched omnichannel offering. We are in the midst of our digital platform upgrade, which will go live in the coming weeks, unlocking greater flexibility, customization and speed, all of which will enhance our customers' digital experiences with our brand.All the while, we continue to grow our e-commerce sales, including our auto ship offering, showcasing the value our customers place on each element of our ecosystem. Our second key focus is delivering the best pet customer experience in Canada. Central to this is providing a compelling offering of premium products sought after by our devoted pet lovers. Super premium national food brands like ACANA, ORIJEN, and Big Country Raw continue to experience the strongest growth in our portfolio, continuing a multiyear trend underscored by enduring humanization and premiumization. Our merchants have curated another exciting spring assortment update, including dozens of new SKUs in food and treats. On the proprietary brand side, we refreshed our lineup of jump cat furniture in February. That launch and the great customer response to last fall's Jump toy launch are helping grow our hardlines proprietary brand penetration in the quarter. Our work continues to sequence to the end of the quarter with expanded protein options with the introduction of the Hill's Science Diet in our leading holistic food brand, Performatrin Ultra. And we have started regional rollouts of our performatrin Culinary Frozen raw and gently cooked products. We expect to have full nationwide availability by the end of the summer and are excited by the quick uptake given franchisee buy-in for this new line and the high levels of ACEs interest, which we have supported with updated training courses. These products offer increased value and choice for full nutrition recipes alongside our leading national brands. Additionally, the 7 gently cooked recipes now enable us to offer choice to customers who may not want to feed raw but are looking for wholesome human-grade options similar to fresh options seen in other channels by using the freezer to extend shelf life. Our loyalty membership continues to grow and benefit from last year's expansion of brands eligible for our free bag program. We are increasingly leveraging multiple years of historical data from our almost 3 million active members to enhance the excitement and efficacy of our personalized promotions. We are programmatically tailoring both the timing and specificity of offers to customers along different pet ownership and product journeys. A great example is a guided set of personalized offers for all customers who have tried Performatrin for the first time during one of last fall sales for the 4-day sale we did during March. This allows us to extend the value customers are seeing in this brand without the need for as many ongoing mass promotions. We also recently ramped up our VIP Plus program following a very successful pilot last year, empowering our store managers and franchisees to curate and present customized gift boxes to thousands of unsuspecting loyal pet value customers this year, to thrill and thank them for their continued trust in us. In marketing, our teams continued their 360-degree approach, curating content for both brand building and sales driving media. Just last month, we launched our latest series of brand spots related to our multiyear ‘Love Lives Here' campaign. The campaign showcases the connection and relationship between our ACEs devoted pet lovers and their pets while adding an irreverent spirit tied to our corporate belief that there are moments upon in every day, and we will look for and celebrate them. We also launched an exciting collaboration with RE/MAX, developing a free digital guide filled with tips for devoted pet lovers to help ease pets through the move and transition into their new home, together with a limited time welcome home co-branded get box. Not only does this showcase the depth of our ACEs expertise, but it also provides potential for further customer acquisition, introducing ourselves to pet parents moving into our local markets. I'd also like to take a moment to congratulate our marketing team who are recently recognized for their innovative work in last year's casting call contest for our Companions for change calendar. Up against entries from around the world, our contest on platinum status at the 2024 Armas creative awards competition, which is one of the oldest and largest creative competitions in the world. From a pricing perspective, as I mentioned earlier, we have just kicked off the targeted pricing investments I highlighted on our Q4 call to enhance our competitiveness on key value items. As a reminder, this investment is very selective across hundreds of our more than 9,000 active items and is in line with continuing to set a tone for rational promotional activity over the coming months and quarters for the industry. We expect this to apply a bit of pressure on Q2 gross margin rates, but expect to earn these dollars back over the coming quarters as we retain and attract nutrients and basket-building items. And our third focus is to fortify strong retail and wholesale fundamentals to support long-term profitable growth. We continue to advance our supply chain transformation as planned and on budget. In the GTA, we continue to refine our bulk picking processes to leverage the incremental capacity and advanced management software, which delivered incremental productivity in the quarter, implementation and testing of our automation for piece-pick operations and our GTA DC continues as expected, and we are on track to go live at the end of Q2, after which time we will wind down operations of our last legacy DC in the GTA. In Vancouver, fit-up work continues in our new 350,000 square foot DC. Interior walls are going up, cabling is being installed and racking construction is underway. The team remains on track to transition into the new facility in Q3 and exit our legacy facility and 3PL in Vancouver before the end of the year. And finally, in Calgary, we will soon kick off our site search with plans to address that market in 2025 and 2026. Based on the progress to date, we are starting to unlock the key benefits from our supply chain transformation. First, it is enabling us to cost effectively continue our network expansion across Canada as we build towards our 1,200 store long-term target. Second, it is enabling greater service levels to our franchisees through greater capacity to service our Quebec-based Chico locations, greater assortment availability for owners to localize their stores and improvements in our extended aisle options online. And third, it will provide significant productivity gains as we activate piece pick automation and further enhance our warehouse, transportation and labor management systems. To this end, we were excited to achieve a significant step-up in our wholesale shipments to Chico in the first quarter through expanded access to our proprietary brand portfolio and the addition of more national brand vendors in the quarter, we are on path to our target for 50% or more run rate shipments to Chico by Q4 2025. And from a store training perspective, we reached a key milestone in Q1, having launched more than 30 training courses with full bilingual capability for use by Chico and Pet Value franchisees and ACEs who prefer to learn in French. These first 3 focuses work together to deliver the fourth, which is to enhance free cash flow and return on invested capital. As expected, we have started to leverage our working capital and continue to expect our free cash flow to improve substantially in latter 2024 and exceed $100 million in 2025. And -- now I'd like to hand over to Linda to share our financial highlights and guidance. Linda?

[Linda Drysdale, executive]

Thank you, Richard, and good morning, everyone. Before beginning, I'd like to say thank you and congratulate our teams for their efforts in delivering solid Q1 results, especially given the tepid demand environment. Let me walk through some of the highlights. First quarter system-wide sales increased 4% to $353 million, supported by 43 new stores over the last 4 quarters, including 11 in Q1 as well as organic growth across our stores and digital channels. We ended the quarter with 794 locations, 71% of which are franchised, up from 70% in Q1 last year as we purposefully grow our franchise mix over time. Same-store sales grew 1%, driven by continued growth in average basket. Same-store transactions declined by 2% as we continue to annualize the impact of bag size trade-up seen in 2023 and are seeing fewer trips from customers not on our loyalty program. That said, we continue to see strength with our growing active loyalty members who account for over 80% of our system-wide sales. First quarter revenue increased 4% to $261 million, growing in line with our system-wide sales. Gross profit was $87 million, flat to last year. As a percentage of revenue, gross margin rate was 33.5%. Excluding 90 basis points of duplicate or onetime costs related to our supply chain transformation, gross margin rate was 34.4%, down 40 basis points from last year, primarily driven by higher fixed distribution and occupancy costs from the new GTA distribution center. Higher wholesale merchandise sales due in part to our accelerated rollout of distribution to our Chico franchisees and partially offset by lower inbound freight costs. Selling, general and administrative expenses in the first quarter were $54 million. Excluding costs not indicative of business performance, our SG&A expenses were approximately $48 million, down 3% compared to last year and 140 basis points favorable as a percentage of revenue. I'm proud of the rigor, our corporate and store teams continue to apply to managing our discretionary expenses and realize savings as we adapt to the evolving demand environment. Adjusted EBITDA was $57 million, up 16% from last year and 220 basis points higher as a percentage of revenue, driven primarily from the SG&A expense leverage I just mentioned. Net income was $18 million compared to $19 million last year. Adjusted net income, which excludes items not indicative of our underlying performance was $25 million or $0.35 per diluted share, up 10% and 9%, respectively, from last year.Now turning to the balance sheet. We ended Q1 with $41 million of cash on hand, up slightly from year-end due to the timing of certain payments. Total debt net of deferred financing cost was $289 million. Considering net lease obligations, our leverage ratio now sits at 2.1x. Our inventory balance at the end of the first quarter was $130 million, down 7% from the end of Q1 last year, which was a great outcome given we grew revenue 4%. I want to congratulate our procurement replenishment and supply chain teams for their exceptional work closely managing our stock, all while navigating the complexities of our nationwide supply chain transformation. We are beginning to leverage the combined benefits of our demand and replenishment systems working with our enhanced warehouse management systems, providing improved visibility on items specific terms, allowing us to better manage inventory levels across our DCs, corporate stores and franchise network. Net capital expenditures were $11 million in the first quarter, continuing our investment in our supply chain transformation. Free cash flow in the quarter was $23 million compared to an outflow of $17 million last year as we benefited from lower income taxes paid, improved working capital as well as improved profits. Moving on to our outlook. We are reaffirming our 2024 guidance. We have delivered a solid start to the year with strong adjusted EBITDA and adjusted EPS growth rates in the first quarter, yet we still have much of the year ahead of us. While our expectations for the full year remain unchanged, we wish to share a few notable items for the second quarter. We are excited about several key strategic initiatives planned to launch in the quarter, such as the launch of our performance on culinary currently underway, the activation of goods to picker automation within our new GTA in June and the go-live launch of our upgraded digital platform in the coming weeks. Each of these initiatives will have specific start-up costs to consider in the quarter, and we also have completed our targeted pricing changes on key value items in April and May. Given all of this and our trends to date, we expect Q2 same-store sales growth to be similar to our Q1 performance and expect Q2 adjusted EBITDA margin to be similar to last year before improving in the back half. 2024 is undoubtedly another exciting chapter for our business as we reach key milestones designed to fuel our growth for many years ahead. Even while we make the necessary adaptations for the current environment. Each of our teams have a clear view of our long-term goals and how we'll achieve them.

[Richard Maltsbarger, executive]

Just before we turn to questions, I'd like to build further on what Linda just said. Across the near term, we continue to see excellent growth in our strong food, treat and other consumables business and in our services business, led by our in-store self-serve dog washes. We have seen great results, strengthening our share of wallet with loyal monthly customers. Throughout, we maintain a close eye on costs even as we maintain a clear focus and determination to deliver the critical initiatives that position us for industry leadership, like our culinary supply chain and digital launches this quarter. I'm so proud of the collaboration teamwork in grid, our ACEs, franchisees and leaders continue to show every day in our mission to be Canada's preferred pet retailer and the sheer enjoyment we have in helping to make memorable moments for millions of devoted pet lovers every month. Thank you again to everyone in our business for your hard work. With that, we are now happy to take your questions.

[Operator]

[Operator Instructions]. Our first question comes from Martin Landry from Stifel...

[Martin Landry, analyst]

My question is on your traffic patterns. Your traffic was down for the second consecutive quarter. And I know in the past, you've talked about customers buying larger format to stretch their dollars. But are you also seeing some of your loyalty members maybe trading down and shopping elsewhere in more value-oriented channels? I'm just trying to understand a little bit if traffic being down is a concern to you guys and when you expect traffic to return to positive levels?

[Richard Maltsbarger, executive]

Martin, this is Richard. I'll start off and then I think Linda will probably have something here to add within this. So -- as we had signaled when we provided our Q4 results in March, we did see muted same-store growth in the first quarter, mainly due to those lower transactions. We believe this is a combination of the consumer trade up to larger food bag size as you noted and we've mentioned in recent quarters, which is driving slightly lower frequency on necessity-based trips along with fewer transactions from the minority of our customers that are not in our loyalty program. So as I said in my prepared remarks, we've done really well growing share of wallet with our loyal monthly customers, but have seen that minority of our set, the less than 20% that's now not on the program. For obvious reasons, we don't have complete visibility into this non-loyalty subset, but sales trends together with anecdotal evidence suggests this related to sharper industry-wide pullback and discretionary spend and inside of our loyalty program and outside a retraction in the Specialty Pet Business. So fish, reptiles, small mammals, which was a trend in place prior to COVID. And 4 years now post-COVID, we've returned to that long-run trend of declining sales in the small minority of our business. This directly impacts transactions because it impacts weekly visits related to aquatic, a and feeder businesses like crickets that generally generate weekly trips. The silver lining in all this is that we are seeing really encouraging trends within our loyalty members, which, as a reminder, do capture over 80% of our sales and are the customers most aligned with our long-term value proposition, balancing great products, expert in store service and competitive prices.

[Linda Drysdale, executive]

Martin, I'll just add, we did reaffirm our full year guidance this morning, which includes the same-store sales range of 2% to 5%. The low end of that range would likely be driven by Suppress transactions similar to what we've seen during prior sessions, while the high end would be supported by a return to positive transaction growth -- we've taken into consideration both scenarios in constructing our plan and expect to see transaction growth improve in the back half as we come up against a softer second half in 2023 and a relatively weak 2023 crisis...

[Martin Landry, analyst]

Okay. And just a follow-up to that, Linda. In the last earnings call, you mentioned that you expected same-store sales, the cadence this year to be even when you look at it on a 2-year stack basis. Is that still the expectation?

[Linda Drysdale, executive]

Yes. So we -- so as I just said, we look -- we're looking at the whole year for 2% to 5%. We have continued to see suppressed demand similar to prior recessions so far year-to-date, resulting in slightly softer same-store sales growth expectations for the second quarter. We continue to be optimistic that trends will improve in the back half, especially as we begin to lap that second -- that softer second half we saw in 2023 event...

[Martin Landry, analyst]

Okay. That's helpful. Thank you.

[Operator]

Our next question comes from Mike Van Aelst from TD Securities.

[Michael Van Aelst, analyst]

Could you comment on the hardline growth versus the consumable growth in this quarter?

[Richard Maltsbarger, executive]

Certainly, Michael, I'll take that. Really, when we look at it, as I noted in my prepared remarks, our consumables business, those necessity-based trips and our services business, primarily driven by our in-store self-serve dog wash, continue to outcomp the company average. The patterns of what we saw for hard lines to Q1 were similar to how we exited Q4.

[Michael Van Aelst, analyst]

Okay. So I think in Q4, if I remember correctly, you were down kind of mid-teens or something like that on the hard lines. Is that fair?

[Richard Maltsbarger, executive]

That was the estimate, I believe you and a few others provided, we actually don't break down our comps by categories in specificity.

[Michael Van Aelst, analyst]

Okay. All right. And then just a follow-up on your corporate store count growth. We're kind of expecting to see most of our growth come from franchise openings. But in this quarter, specifically, your corporate stores were up 6%, your franchisees were up 5%. I'm wondering, is this a timing issue? Or is there any sign that franchisees are having a harder time gaining financing or anything along those lines?

[Richard Maltsbarger, executive]

No, Mike, it's completely timing. If you go back to the end of last year, we actually ended the year 3 corporate stores fewer than we started the year. Part of that was, as I noted in last quarter's call and -- sorry, and I noted in November, we would have a few stores slipped into the beginning part of this year because we wanted to open after the anchors. Those all just happened to be corporate stores. So if you look at it year-to-date, we're essentially just a few stores up over our normal long run rate of 225 corporate stores.

[Operator]

Our next question comes from Irene Nattel from RBC.

[Irene Nattel, analyst]

Just going back to sort of the question about consumer behavior. The 20% of consumers that are not loyalty customers, what have you been able to find out about why they're not loyalty customers? And is there any way to convert them?

[Richard Maltsbarger, executive]

So Irene, we have been doing a pretty good job and around converting over time. If you go back, remember to pre-IPO times before we digitized our loyalty program, our penetration rate was sub-50%. And so within the last 3-plus years, we've grown that from less than 50% to now over 80%. A lot of the last few customers that we have are relative to what we call casual customers. And it's just a matter of conversion. And then there's a natural rate across all of Canadian retail. In fact, my experience across retail around the world of some portion of consumers who are just simply not interested in joining loyalty programs or providing their information.

[Irene Nattel, analyst]

Understood. And then just going back to hard lines versus services versus animal nutrition, where are you seeing the greatest stickiness? Where are you seeing sort of the greatest pockets of weakness? And what initiatives do you have in place to support and correct?

[Richard Maltsbarger, executive]

Certainly. If I could, I don't pull this up just a little bit, Irene, from that and then layer in your question within that. So what we're generally seeing across consumer demand is really playing out similar to what we discussed in the recent quarters. So again, over 80% of our system-wide sales are composed of those needs-based consumables and services. As I noted earlier, and I'll reiterate demand for these categories, again, needs based consumables like the animal nutrition that you quoted as well as services led primarily by our in-store self-serve dog washes are outpacing the overall company average, which tells us our devoted pet lovers continue to deeply value the product expertise and convenience, we and our franchisees offer through our stores and digital channels. We are seeing growth primarily in our premium offerings, which continue to outpace fueled by humanization trends. At the same time, we are seeing good results for customers seeking value with our less premium food tiers, especially through our own proprietary brand, Performatrin naturals and Performatrin branded treat. We do continue to analyze consumer trade up to largest food bag sizes, a behavior that really picked up speed in Q1 of last year and continues to pressure transaction frequency for needs-based trips. So this, together with overall pressure on consumer wallet is softening demand for discretionary items, and we still won't fully analyze that until later in the year. And then as I just shared, just to reiterate, again, while a small minority of our sales, the specialty pet segment, specifically areas around fish, reptiles and small mammals, has significantly softened post-COVID and really returned to pre-pandemic normal. We saw a temporary and general uplift in these particular categories in the first year or 2, a go with many of these pets, unfortunately, have relatively short lifespan, and we're not necessarily seeing replacement rates on the small mammals and some of the rep tiles in the fish. So this contributes to a pullback in transactions, primarily because we're seeing fewer weekly purchases of aquatic pay or crickets. So overall, I think that gives you a good complexion across the different categories and where we're seeing it. In terms of your follow question on what are we doing to lean in. We're absolutely continuing to focus on those things for which we believe we have strength to be able to compete for customers in the industry around our premium food tiers, the introduction of performer culinary, we'll be able to layer into that and be able to provide for us really an incremental step-up in our ability to compete in what is a very fast-growing category, not only in frozen, but also, of course, now in fresh. So our gently cooked really is an opportunity to provide a fresh style product, but in the freezer, which more than doubles the shelf life over what you see in a refrigerated product and perhaps other channels. And then I do have one exciting update like shares since I got a chance to talk about overall consumer demand. We're once again seeing our proprietary brand penetration and hardlines expand. So this is one of the key upside opportunities we highlighted during our IPO, and I'm excited to see it become a reality. This is a culmination of effort over the last several years of our merchandising and our proprietary brand teams working together to source, develop and market an expanded offering across multiple hardline categories like toys and apparel and then this quarter's update on Jump Cat furniture. So overall, I think that will give you a feel for the characteristics of our core customers, our strengths and need-based products and services and the functional breadth of the offering, is actually helping to build the resilience that we're seeing with our core monthly loyal customers and those most aligned to our value proposition. And then we're carefully and selectively deciding where to go after incremental share or incremental opportunities for customers that may lay outside of our loyalty program...

[Irene Nattel, analyst]

That was a great comprehensive answer, Richard.

[Richard Maltsbarger, executive]

Well, thanks. We put a lot of time, Irene, and so what's going on with the consumer in the market right now. We just want to make sure that we are completely aligned with our core focused customer even as we go through this economic cycle

[Operator]

Our next question comes from Mark Petrie from CIBC.

[Mark Petrie, analyst]

So netting all this out on the sales trends and not to belabor it, and thanks for all those comments, which they are very helpful. But I guess, a flat sequential sort of same-store sales growth for Q2 would imply a deceleration in the 2-year stack. And it sounds like this is a reflection of sort of continued trends and then maybe a slight deceleration in the Specialty Pet Area. Is that a fair summarization?

[Richard Maltsbarger, executive]

I'd say that is a fair summarization Mark.

[Mark Petrie, analyst]

Yes. Okay. All right. And I'm not sure how you would want to talk about this exactly. But when you're making these price investments and step-up in promo activity in Q2, is that more geared towards traffic or basket size, would you say?

[Richard Maltsbarger, executive]

So Mark, I'd say it's actually a balance. If you look at the actions that we'll take within our core consumables space, that is absolutely tied to traffic and assuring that we maintain our competitiveness across those core anchoring purchases that go into the basket. And then we are taking the opportunity through a combination of some targeted and selective price decreases in our lines, but also through our expansion of our proprietary brands such as the Jump Toy Line we launched last year to be able to offer incremental value to the basket. So on one side, yes, we will look at some of the national brand products that we have within hardlines and ensure that we got a crisper tight and competitive price on those. But another great example is the ball launcher that we launched last year would jump, which is an everyday value to the national brand of a pretty substantial amount, well within that 5% to 20% lower price point that we target that not only delivers value on the day they buy the ball launcher but also delivers value every day because the balls that we sell to go with our ball launcher generally sell at about a 20% price discount to the national brand. So Mark, it is a mix. Yes, price points related to consumables to ensure we maintain our competitiveness and our indexing against our key competitors in the market, but also some things to be able to build the basket over time.

[Mark Petrie, analyst]

Yes. Understood. Okay. And then on the gross margin, obviously, you heard the comments with regards to the deferral on those price investments, but hoping you could just elaborate on what you're seeing more broadly in the sort of competitive environment -- and then your expectations for gross margin on the whole for the year, I assume those are unchanged because this is really just a timing thing, but if you could just confirm that, that would be great.

[Richard Maltsbarger, executive]

Yes. I'll let Linda just give you a quick update on sort of our expectations for the year, and then I'll circle back and answer the broader question around what we're seeing competitively.

[Linda Drysdale, executive]

Yes. So as you know, this year, we're absorbing the $20 million step-up in occupancy and equipment costs associated with our new GTA and Vanover DCs. So most of this cost is captured in our cost of sales, which impacts our gross margins. The step-up in costs will impact margins over the next 2 years as we onboard more modern DCs in the GTA, Vancouver and Calgary and activate the automation within each of those. So while we aren't giving specific guidance to the level of margin over the near term, we do expect to remain below our long-term target of 35% to 36%. And for the next few years and then gradually return back to that target as we grow.

[Richard Maltsbarger, executive]

And so Mark, I think within that environment, there are a few things, again, coming at us competitively that are also impacting that. I'll say promotional activity across the industry remains heightened, specifically amongst regional players. So our merchandising and marketing and loyalty teams continue to do an excellent job managing through it, working to drive excitement while balancing long-term gross margin expectations. As you know, we are not a high-low player like some in our industry. Instead, we find creative ways to deliver everyday value through multiple levers beyond price, things like product introductions, high-tech service personalized offers. We are implementing these selective targeted price investments on key value items to maintain our long-run competitiveness. We think this balance is working. Our third-party market share analysis in the quarter would lead us to believe that the trends we are seeing and discretionary and otherwise are industry-wide and that we're at least, if not slightly growing share, primarily through our strengths in the necessity-based products, especially with loyal monthly customers. So similar to the response that I provided back to Irene's question, right, we are maintaining our LaserEye focus on those core customers that are long-term value and deliver great lifetime value to us and ensuring that even while Canadian consumers adapt their discretionary spending as they weather higher interest rates and heightened levels of inflation, that our team makes sure that we focus on delivering incremental value. making sure we leverage our loyalty program, the proprietary brands, I noted in hardlines and other actions that we're taking across key items to ensure that even as the industry goes through this more competitive period, we maintain or slightly grow our share.

[Mark Petrie, analyst]

That's very helpful.

[Operator]

Our next question comes from Michael from Barclays.

[Michael Vu, analyst]

This is Michael Vu on for Adrian, -- so I just wanted to touch a little bit on the market share comments. Based on your presentations, obviously, they're a little bit scaled from 2023, but I was just curious about the 18% of market share and what are the different initiatives that you're taking to combat new entrants as well as to maintain this market share? Are there any strategic initiatives to gain share as a competitive landscape grows?

[Richard Maltsbarger, executive]

Absolutely, Michael. And look, we're very proud of the share that we were able to hold in 2023 given the shifting market environment. Really, to your question, the key initiatives that Linda covered, I'll reiterate as these are market share taking activities for us. So starting first with Performance & Culinary. -- again, frozen raw and the overall culinary space, including gently cooked and shelf stable through the high-graded or freeze-dried is the fastest-growing category within that specialty. Our ability to layer in our Performer trend brand into that creates incremental value price points for the customer and we gently cooked expands us into a growing segment of fresh, so not quite raw, but human-grade ingredient, which believes in our case, gives us a chance to take share in an area that we hadn't yet introduced into our mix. The upgrade of our digital platform coming at the end of the quarter allows us to improve our overall customer performance. We did note in our prepared remarks speed, and speed of use of the site as well as our ability to more quickly customize and adapt the site to changing consumer patterns is going to give us an opportunity to continue to put our best front porch face forward for the customer. So even though the vast majority of our customers shop in our stores, the omnichannel use of our site is critical as both our in-store and online customers benefit from that work. And then, of course, what we're doing in our supply chain. So we are being able to expand to our Chico franchisee. It's not just the possibility and the reality of the step-up we're seeing in revenue generation through wholesale is also expanding their access to award-winning and leading products -- we more than doubled the availability of proprietary brand products to Chico in the quarter now that they're able to order directly out of our GTA warehouse. That gives them access to all these same great benefits on the hardlines price points that I noted earlier, are now available to our Chico franchisees, allowing them to also compete within today's environment. So overall, we're quite excited that the steps that we've taken and the strategic alignment that we have long term still aligns up with what drives value within this market. So thanks, Michael. I love that question because I got the brag about all the great work that my team is doing.

[Michael Vu, analyst]

Yes, of course. I appreciate all the color there. And as a follow-up, just touching upon the e-commerce part of the business. Can you talk a little bit about any of the online competitors? Like, for example, Amazon, they have the -- okay, I'll subscribe and save on Amazon -- and just repeat shipments. Have you seen any behavioral changes of core customers who are choosing to say, do that?

[Richard Maltsbarger, executive]

We haven't seen anything outside of our expectations for any of the online competitors. That particular offer that you noted has been available for the better part of a decade across both regional players in Canada as well as Amazon and other players. And so we're not seeing a significant shift in consumer behavior related to any of the more recent entrants or any of the other activity that's been in the market. It really is more tied to this overall pullback in discretionary demand.

[Michael Vu, analyst]

Understood. Thank you. Appreciate it.

[Operator]

Our next question comes from Chris Murray from ATB Capital Markets.

[Chris Murray, analyst]

Maybe talk -- turning back a little bit to free cash flow. And I know, Richard, you talked about kind of the path to $100 million in 2025. But can you just talk a little bit after Q1, which was a pretty positive number. How should we be thinking about the cadence of free cash flow as we move through the quarters. Is there something that we may need to see or think about in terms of adding inventory as the DCs get more up and running or something to deal with the e-commerce. So any thoughts around some of the levers through the balance of the year? And then, Richard, if you want to take just a couple of seconds maybe, what has to happen in your mind to be able to hit that $100 million in 2025?

[Richard Maltsbarger, executive]

Chris, thanks for the question, and I'm going to completely defer all of the responses to this to Linda. So I'm going to hand over to her

[Linda Drysdale, executive]

Yes. Chris, yes, we are really pleased with our financial position at the end of Q1. The higher cash balance that we had and free cash flow was mainly a result of timing. Our primary focus in the immediate term remains on reinvesting our capital back into our business through the store growth and renovations as well as through initiatives like our supply chain transformation. Our supply chain investments can be a bit lumpy depending on the timing of certain elements like our automation equipment. But together with the other capital projects, we remain on target to meet our CapEx budget for the year. With respect to 2025, we are on a great track record of robust free cash flow conversion. So as we move throughout the year, we will expect to the demands on working capital reviews as you've seen. And in 2025, we plan for CapEx and the onetime cost to ease as we near the completion of our supply chain transformation. So together with these factors, that should enable us to enhance our free cash flow profile to that $100 million that you mentioned for 2025.

[Chris Murray, analyst]

Okay. And I guess what I'm trying to understand a little bit is on the working capital draw. As you noted, I think there was a -- an improvement in working capital at the same time an increase in sales. Is that more just a timing thing and we should expect that to normalize into Q2 and through the balance of the year? Or is that something that you think you can hold on to?

[Linda Drysdale, executive]

Yes. We expect for the full year to be able to continue to see those improvements in the working capital. So like I said, we may have a little bit of lumpiness. But overall, for the full year, we will see -- we are expecting to see improvements there.

[Richard Maltsbarger, executive]

Yes. I would just reiterate the lumpiness comment that we -- again, we are activating our piece pick automation during this quarter. We're transitioning into Vancouver during Q3, both from a CapEx spend, a onetime start-up cost spend as well as potentially duplicate inventory spend. We still have some steps to take between now and the latter part of '24 before we feel comfortable that we're on that ascending path to free cash flow.

[Chris Murray, analyst]

All right. That's awesome. And then, Richard, just a question for you. You made the comment that the gross margins could be under pressure for a couple of years, but I'm also hearing you also talk a lot about your own brands. and new products getting introduced. Is there certain -- is there things in your product portfolio on your house brands? Do you think that you're missing or other areas you think you can expand? And is there any mix impact you think you -- that you can come up with that could help move those margins back into a more normal cadence or either just getting them in there or just getting them in there faster.

[Richard Maltsbarger, executive]

So Chris, what I'll share with you is something that we've shared since the IPO, but as you're relatively newer to the name than others, I'll reiterate something I was sharing a couple of years ago, with our growth being net 100% franchise, there is a natural mix impact to our gross margin rate every year as more of our business becomes wholesale. So we are actually leveraging our proprietary brand penetration growth and any productivity in the future that we pick up in the supply chain as a natural offset to what would otherwise be dozens to 30-plus basis points of impact every year simply from our mix to franchisee. So think about it this way, it's really leaning into proprietary brands. It's something we plan to do. And it is an offset to what otherwise would be naturally declining margin rate every year.

[Operator]

[Operator Instructions] Our next question comes from Michael Glen from Raymond James.

[Michael Glen, analyst]

Richard, just hoping that you can give some commentary surrounding any changes you're seeing in the performance of your new stores. Are you seeing any change in the payback period for the -- for those stores or any change in traffic patterns at those stores?

[Richard Maltsbarger, executive]

Michael, good question. And no, we're not. We look at this semiannually. So at least twice a year, we go back and review our original estimation that we approved at our real estate committee oftentimes anywhere from 9 to 12 months prior to us actually getting the store open. And we review not just first year store performance, but actually the first 4 years of store performance for every new store, again, twice a year. We're quite comfortable with what we've seen. Of course, as you can probably imagine, some stores opened a few years ago have had outstanding performance. against our expectations. And if you go back to our AIF, we provide a pretty good breakdown of unit level economics that both include what we've seen in terms of inflation of construction cost and the inflation of inventory but also a very similar and slightly outpaced increase in first year and maturity sales that allows for our paybacks of both corporate and franchise stores to still be quite similar to what we saw prior to the pandemic.

[Michael Glen, analyst]

Okay. And then on the $40 million to $50 million for the year, can you just provide an update on when those stores are expected to open as we progress through each quarter? And then is there any real estate type risk associated with those as is some developments maybe not going forward?

[Richard Maltsbarger, executive]

Yes. So Michael, I'll give you an indication, generally, we're a little more back half heavy in terms of our openings. We did note that 11% was a record for us in Q1. A little bit of that was the few that moved over from Q4, but also our real estate team has worked very hard over the past several years to try to better balance out both our openings and our renovation activity throughout the quarters. There isn't a specific cadence. I wouldn't want to give you a specific cadence by quarter. There's just too many other factors that could move a store 1 or 2 months forward or back just depending upon permitting construction timelines, real estate availability, et cetera. I would indicate that we don't see a lot of real estate risk for our openings this year. As has been quoted a few times in the Global Mail and from a few other sources, there are landlords that are pulling back on some of their shovel-ready products. We are closely looking at our 25 to 26 pipelines. -- in identifying what pivots and other things we can do to be able to continue to maintain this pace of 40 to 50. Really, our 40 to 50 is driven by our quality control pace. Roughly 80 to 100 real estate projects a year is a great number for us. So last year was a great example. We did 42 new openings last year -- sorry, 39 new openings last year as well as 40 renovation projects, a significant scale. And then about 10 to 20 smaller projects slightly touches adds of dog watches, et cetera. We generally work to maintain that 100 project pace. So if for some reason we were to see a pullback in new stores, we would fill that in with incremental renovations and other activities to ensure that we're constantly providing that 100-plus projects a year to ensure that we're keeping our fleet up to date.

[Operator]

Okay. We currently have no further questions. I will hand back over to Richard for any closing remarks.

[Richard Maltsbarger, executive]

As always, thank you to everybody for your interest in pet value. We appreciate the ongoing interest and the questions and look forward to speaking with all of you again in August on our next call. Thank you...

[Operator]

This concludes today's call. Thank you for joining. You may now disconnect your lines.