Pet Valu Holdings Ltd

TSX:PET

Earnings Call Analysis

Pet Valu's Resilient Q2 Performance Amid Economic Challenges

Pet Valu continues to thrive with a 3% growth in revenue and a 7% increase in adjusted EBITDA in Q2 2024, despite a tough economic environment. The company opened five new stores, reaching a total of 799 locations. Their focus on premium foods and long-term strategic initiatives, even as discretionary spending in urban centers like Vancouver and Toronto softens, positions them well for future growth. Pet Valu revised its 2024 revenue guidance to $1.08-$1.11 billion, with adjusted EBITDA expected between $243-$248 million, showcasing strong cost control and strategic investments.

Navigating a Challenging Economic Environment

In the face of a sluggish economic backdrop, the company demonstrated resilience with a 3% increase in system-wide sales to $354 million during the second quarter. This growth was bolstered by the addition of 41 new stores over the last year. However, they are witnessing challenges in certain discretionary categories, particularly in urban markets like Vancouver and Toronto, where demand has softened. This reflects broader trends where necessity-based products continue to perform well, while hardline categories face headwinds.

Profitability and Cost Management

Despite the macroeconomic challenges, net income for the quarter was $18 million, down from $24 million last year. Adjusted net income remained stable at $26 million, equivalent to $0.36 per share. Importantly, the company improved its adjusted EBITDA by 7% to $58 million, allowing for an EBITDA margin expansion of 80 basis points to nearly 22%. Effective cost control strategies have enabled the business to maintain solid profitability even as SG&A expenses decreased by 4%.

Operational Initiatives and Future Outlook

Looking ahead, the company has adjusted its revenue guidance for 2024 to between $1.08 billion and $1.11 billion, signaling a revenue growth range of 2% to 5%. This adjustment reflects a more cautious outlook driven by expected flat same-store sales and ongoing softness in discretionary spending. For adjusted EBITDA, a target of $243 million to $248 million has been set, growing faster than revenues due to continued cost controls. Furthermore, the expectation for adjusted net income per diluted share is between $1.50 and $1.55.

Growth Strategies in Focus

The company plans to continue its growth trajectory by opening 40 to 50 new stores in 2024, along with enhancing its e-commerce capabilities and expanding its wholesale shipments. Notably, there has been a strategic focus on growing the franchise model, now comprising 72% of total stores. Key product innovations, including the launch of the new Performatrin culinary line, are expected to resonate well with consumers seeking higher quality pet food options.

Supply Chain Investments and Cash Flow Generation

Despite the current demand challenges, the company remains committed to its supply chain transformation to improve operational efficiency. They anticipate net capital expenditures for 2024 to be around $50 million. By deferring certain automation projects until 2026, the company aims to optimize cash flow and target more impactful investments, aiming for free cash flow to surpass $100 million by 2025. In Q2, the company generated $8 million in free cash flow, significantly improving from last year's outflow.

Challenges in Consumer Trends

The company is closely monitoring changing consumer behavior, noting a shift towards necessity purchases and increased scrutiny in discretionary categories. The leadership conveyed confidence that long-term trends such as humanization and premiumization of pet products will ultimately support durable growth despite short-term challenges. With inflation pressures still impacting consumer spending, maintaining price and promotional strategies has become crucial.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, everyone. Thank you for standing by. Welcome to Pet Valu's Second Quarter 2020 Earnings Conference Call. My name is Kiki, and I will be coordinating today's call. [Operator Instructions] Please note that following the formal remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to James Allison, Investor Relations Head, Pet Valu. Please go ahead, Mr. Allison.

[James Allison, executive]

Good morning, and thank you for joining Pet Valu's call to discuss our second 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. For a broader description of risks related to our business, please see our Q2 2024 MD&A, 2023 Annual Information Form and other filings available on SEDAR Plus. Today's remarks will also be accompanied by an earnings presentation, which can be viewed through our live webcast and is also available on our website. Now I would like to turn the call over to Richard.

[Richard Maltsbarger, executive]

Thank you, James, and good morning, everyone. As we have often said, the Canadian pet industry has a strong track record of resilience throughout economic cycles. The industry's needs-based nature and long-term humanization and premiumization tailwinds have supported 3 decades of continuous growth. The middle of the industry's resilience is being tested in today's economic environment, and we are pleased to see that it continues to prevail. Looking at our Q2 results, same-store sales and our needs-based consumables and services categories, which account for over 80% of our sales continue to grow at a healthy pace, driving recurring trips and revenue. The few pockets of demand softness continue to be in more discretionary hardlines and specifically in the urban markets of Vancouver and the Greater Toronto area. Most importantly, for our long-term success, we continue to see the fastest growth in our premium foods, holistic kibble and culinary such as frozen raw, freeze-dried and gently cold recipes. These dynamics, together with our shelter channel checks give us confidence that key tenants underpinning the long-term resilience of our industry remain intact. We are the industry leader and have grown in line or faster than the market by tapping into multiple growth avenues such as new stores, e-commerce, customized loyalty, in-store services and exceptional merchandising. But we don't stop there. Perhaps one of our greatest actions is fostering a culture capable of delivering strong profitability through all phases of a demand cycle, and our Q2 performance was a prime example. While total same-store sales growth remained muted. We grew revenue 3% and increased adjusted EBITDA by 7%, allowing us to maintain and expand our healthy adjusted EBITDA margins to almost 22% and deliver another quarter of solid free cash flow. Importantly, it is our team's commitment to calibrating spending to today's demand environment, while also delivering our most critical strategic initiatives that position us for long-term profitable growth and elevated returns to shareholders once economic conditions begin to normalize. Let me cover some of these in the framework of our 4 focuses. Our first focus is to be Canada's local and everywhere pet specialty retailer. We opened 5 new stores in Q2, bringing us to 16 new stores year-to-date and 799 locations by quarter end. In early July, Leonard franchisees opened our 800th store, owned and operated by long-time franchisees, Kevin and Bernadet Clipperton and their daughter Cassandra Harvey in London, Ontario. This is their fourth store in the Greater London market, where they have grown with Pet Valu over the last decade. Their story is one shared with many of our franchisees, whose ongoing success is the culmination of years of experience and local involvement in over 370 communities across Canada. Our franchisees form the heart of our coast-to-coast network that is further cementing our leadership in omnichannel convenience. In addition to new stores, we renovated, expanded or relocated another 9 sites in the quarter and 16 year-to-date. Add to this more than a dozen smaller touch-ups that we've completed, and our real estate team is on pace to complete over 100 projects this year to keep our network modern and deliver consistent shopping environments. We continue to enhance the local element of our neighborhood stores through the expansion of our franchise community. Over 100% of our net store growth in Q2 and over the last few years has come through new and resold franchise stores. While in recent years, we have tapped into the strong demand from current franchisees looking for an additional store, so far this year, we've welcomed a higher proportion of new faces to our franchisee community and are excited to help grow their business alongside ours. On the digital front, we successfully transitioned our website over to a new platform mid-quarter, enabling greater adaptability and flexibility for back-end processes and launching several key customer-facing improvements like faster site speeds, broader access to assortment and the introduction of wish list to share with friends and family or for our rescue partners to create a list of products needed for local donations. The team has built a full roadmap of enhancements so that we continue to employ industry best practices and meet customer expectations for a smooth and seamless digital experience. Our second focus is delivering the best pet customer experience in Canada. Our merchants just completed our biannual assortment refreshing consumables, including hundreds of new items that tap into key long-term growth trends. Examples of these new and on-trend items include solution-based foods, diversified protein toppers and supplements. We also continue to adapt our offerings to meet growing humanization needs. For example, we recently introduced Asobu line insulated water bottles for dogs. These water bottles mimic high-quality human insulated water bottles and include a detachable bowl to make it easy to share water or snack while on the go. We continue to complement national brands like these with a growing portfolio of proprietary brands. In Q2, our proprietary brands entered some exciting product segments with the rollout of JUMP, retractable leases in April and entry-point litter accessories under our Essentials brand. Through these and other launches over the past year, we saw our hardlines proprietary brand penetration increase year-over-year for the second consecutive quarter. Perhaps the most exciting entry was a successful launch of Performatrin culinary, marking our first proprietary brand entry into the freezer. We have been pleased with the trial and repeat purchases we are seeing across this new portfolio with almost 100% uptake by franchisees in the first month and having shipped over 400,000 pounds in total of Performatrin culinary products since launch only a few short weeks ago. In fact, the adoption curve of our gently cooked recipes has accelerated faster than we had projected, quickly establishing performance and culinary as the #1 gently cooked brand within our network. We are excited to invest in this high-value on-trend food category, which has grown at a 30% CAGR over the last 3 years and whose customers visit our stores and spend twice as much on average. On the pricing front, the targeted pricing investments on key value items rolled out in April and May have successfully recalibrated our competitiveness against key peers. As I mentioned earlier, we continue to see good momentum in our needs-based consumables and services category. At the same time, softness in hardlines, especially PET, has persisted through the second quarter. It is here where we see some pockets of increased promotional activity and where customers are willing to defer or substitute as they search for ways to grapple with the increased cost of living. We have seen these trends before, and we expect them to be cyclical. This is why our teams remain vigilant, balancing discipline with targeted actions such as expanding our proprietary brand options often price 5% to 20% less than reference national brands. Another mechanism being increasingly utilized is our loyalty programs. We continue to add additional brands to our free bag program, including the recently launched Performatrin culinary and multiple small animal brands as we broaden the appeal to multi-pet households. Our journey to enhance personalized offers to our over 3 million active customers continues as we leverage our data to target a broader set of behaviors. And finally, our marketing team continues to expand the boundaries to traditional pet industry marketing. In the second quarter, we teamed up with Chatelaine Magazine to produce a first-of-its-kind integration, a special edition custom cat-themed food cover Catalan, celebrating the deep bond between Canadians and their feline companions. This collaboration is an opportunity to leverage the scale of Chatelaine audience of devoted pet lovers to drive awareness and amplify the reach of Pet Valu, showcase our product assortment, animal care expertise, share the story of one of our VIP customers, and shine a light on our Companions for Change program. And our third focus is to fortify strong retail and wholesale fundamentals to support long-term profitable growth. A critical element of this is the continued work on our supply chain. First, let's talk about our operations in the Greater Toronto area, servicing Ontario, Quebec and Atlantic Canada. We recently lapped the 1-year anniversary of the opening of our new 670,000 square foot DC in Brampton. Over the last year, our teams have ramped up bulk picking and similar to Q1, we saw the benefits of favorable variable costs as we leverage the incremental capacity together with advanced warehouse management systems. At the same time, we set up and tested our Goods to Picker automation, which went live in early July. Over the coming months, our teams will ramp up this capability while simultaneously winding down operations in our last legacy building in the GTA. All this progress at the GTA DC continues to enable our ability to better serve our Chico franchisees in Quebec by expanding our Chico wholesale shipment catalog. In the second quarter alone, we opened up 8 more brands for wholesale ordering by Chico franchisees. We are pleased with the continued uptake and are well on track to our goal of at least 50% penetration by Q4 2025. In Metro Vancouver, we're happy to announce just last week, we have now activated our new warehouse for bulk and piece picking. We are actively transitioning all inventory and staff and are on track to exit our legacy facilities by the end of the year. And we remain on track for our Calgary DC, where we intend to transition to a larger DC for bulk and piece picking activities in 2025. We are currently assessing potential sites with several viable options under consideration. We want to pause here and specifically note a change to our original supply chain transformation plan. In accordance with our capital allocation framework, we continuously assess our uses of cash to optimize returns. Given the current market environment and actions we have already taken to generate higher picking productivity, we enacted an opportunity to defer automation in our Metro Vancouver and Calgary DCs until 2026 or later, and we believe we can more efficiently leverage these investments. This provides the immediate benefit of freeing up cash flow for other higher return opportunities or returning it to our shareholders as we move into 2025. And our fourth and final focus, which is to enhance free cash flow and return on invested capital. In light of slower top line industry growth, I could not be prouder of our team's diligent focus on balancing growth, efficiency and investments to promote our long-term profitable growth mandate. Given all our actions, we continue to track towards delivering free cash flow inflection late in 2024 and our target of more than $100 million in free cash flow in 2025. Now I'll turn it over to Linda to walk through our Q2 financials in more detail before reviewing our updated 2024 guidance. Linda?

[Linda Drysdale, executive]

Thank you, Richard, and good morning, everyone. Overall, despite the tepid demand environment, I'm extremely proud of our team's ability to adapt to deliver solid profitability for our business in the second quarter. Let me start with an overview of our KPI. System-wide sales increased 3% to $354 million in the second quarter, driven by contributions from 41 new stores opened over the last 4 quarters, including 5 in Q2. We ended the quarter with 799 locations, 72% of which are franchised, up from 70% in Q2 last year as we continue to grow our franchise mix over time. Same-store sales were flat year-over-year with a 2.5% increase in average basket size, offset by a 2.4% decline in transactions. As Richard mentioned, we continue to see steady growth in necessity-based categories such as consumables and services, while hardlines and urban markets remain soft. Second quarter revenue increased 3% to $265 million, growing at a similar pace as our system-wide sales. Gross profit was $88 million, down 5% from last year. As a percentage of revenue, gross margin rate was 33.1% or 34.2%, excluding 110 basis points of cost related to our supply chain transformation. Excluding these costs from Q2 and the comparable period last year, gross margin decreased 190 basis points, primarily driven by higher fixed distribution and occupancy costs from the new GTA distribution center and higher wholesale merchandise sales due in part to our accelerated rollout of distribution to our Chico franchisees and higher discounts related to planned promotional activity. 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 4% compared to last year and 140 basis points favorable as a percentage of revenue. Our teams continue to tightly control noncritical projects and discretionary spending to drive consistent profitability, which in turn fuels future growth. Adjusted EBITDA increased 7% to $58 million. As a percentage of revenue, our adjusted EBITDA margin expanded 80 basis points, slightly better than expected due to our diligent cost control. Net income was $18 million compared to $24 million last year. Adjusted net income, which excludes items not indicative of our underlying performance was $26 million or $0.36 per diluted share, similar to last year. Now turning to the balance sheet. We ended Q1 with $24 million of cash on hand and total liquidity of over $150 million when including our revolver, which remains undrawn through the quarter. Total debt, net of deferred financing costs, was $285 million. Taking into account net lease obligations, our leverage ratio of 2.1x continues to provide us with financial flexibility. Inventories at the end of the second quarter were $134 million, up 2% compared to Q2 last year, similar to our growth in revenue. Our teams continue to leverage new tools and software to manage inventory at responsible levels even while transitioning to new buildings and activating new automation. We remain comfortable with the quality of our stock across our DCs, corporate stores and franchise networks, which in turn provides flexibility for our merchants to promote responsibly and encourage a stable trading environment. Net capital expenditures were $12 million in the quarter and are trending at $24 million year-to-date. Based on spend to date and adjustments to timing of certain supply chain transformation expenses, we now expect net capital expenditures for 2024 to be roughly $50 million. Free cash flow in the quarter was $8 million. On a year-to-date basis, we generated almost $31 million in free cash flow, well above the $4 million outflow last year at this time. We are pacing well to grow our free cash flow in 2024 on our way to exceeding $100 million in 2025. Now to our outlook for 2024. Our business continues to deliver on all the operational initiatives we mapped at the outset of the year. This includes the successful launch of Performatrin culinary, the replatforming of our transactional website, the activation of Goodsta Picker automation in our new GTA DC and as of last week, having activated our new Metro Vancouver distribution center. We are also pacing to open between 40 and 50 new stores this year while growing our wholesale shipments to TECO. At the same time, our merchant store teams and supply chain teams have done an excellent job navigating the evolving demand environment to protect share while preserving profitability. Simply put, we continue to control the controllables within our business. However, industry-wide sales growth has materialized slower than we had hoped in response to pullback in discretionary spending, predominantly in hardlines. Given performance year-to-date, what we're seeing so far in Q3 and subdued outlook from economists for the balance of the year, we are now anticipating a slower growth rate for the industry for 2024 overall. We continue to take steps to adjust our operations to the slower growth environment and have done much to curb the impact to our annual financials. Nonetheless, we have made adjustments to our full year targets. We now expect 2024 revenues between $1.08 billion and $1.11 billion, representing 2% to 5% growth over 2023 driven by contributions from new store openings, increased wholesale shipments to TECO and flat same-store sales growth. Based on Q3 trends seen to date, we anticipate year-over-year revenue growth to ease sequentially in the third quarter compared to our Q2 trend before improving in Q4 as we comp up against a relatively weak 2023 holiday season. For adjusted EBITDA, we now expect to deliver between $243 million and $248 million, growing faster than revenues as we leverage SG&A expenses through diligent cost controls. And finally, on adjusted net income per diluted share, we expect to reach between $1.50 and $1.55. Recall that this includes the absorption of approximately $20 million pretax or $0.20 per diluted share of incremental depreciation and interest expense associated with the new distribution centers in the GTA and Metro Vancouver. In summary, our financial position remains strong, providing the flexibility for our teams to make the right long-term investments to fuel growth, while we navigate the suppressed discretionary demand in the near term.

[Richard Maltsbarger, executive]

Thanks, Linda. In closing, I want to once again thank all our people and franchisee owners for their unwavering dedication to practice safety, compassion, expertise and efficiency, especially in today's uncertain economy. In equal measure, I am humbled to see devoted pet lovers step up to help those in greater need than themselves. In June, we held our annual Pet Appreciation month and hit a new record raising $2.2 million in product and cash donations for over 400 local pet rescues, shelters and charities across Canada. The compassion of Canadians and in particular, devoted pet lovers, never ceases to amaze. It's our service to these deeply compassionate devoted pet lovers, our commitment to the long-term support of our franchise owners and our team's hard work to balance cost management with investing in key strategic initiatives that have led this business to deliver over 60% revenue and adjusted EBITDA growth over the past 3 years. Even as we navigate the current market environment, we will hold true to these fundamentals that have helped create this company's 48 years of success. With that, we are now happy to take your questions.

[Operator]

[Operator Instructions] The first question comes from Mark Petrie from CIBC.

[Mark Petrie, analyst]

Just first on the top line, thanks for all the comments so far. But hoping you can provide a little bit of color on 2 things. One, your views on market share. It sounds like you believe the slower sales growth is industry driven, but any comments there, specifically on market share would be helpful. And then also, how are your new stores performing or the stores opened in the last 12 months? Are those ramping as you would have seen historically?

[Richard Maltsbarger, executive]

First, on market share, based on third-party analysis that we have as well as our tracking of what's going on in the marketplace, all indications are is that we continue to see pretty similar share with no significant differences across the industry year-to-date. So that would give us indication that, yes, this is an industry thing, slightly different complexion. We're very strong in consumables, especially premium and culinary and other products that drive regular weekly and monthly visits and were a bit weaker in hard lines, more discretionary categories where we do see a bit of shift in that market as others are somewhat irrationally promoting those categories and chasing after sales sometimes to unprofitable means. So the complexion of the year might be a bit different, but the overall share, no significant shifts in our year-to-date tracking. On new store performance, our new stores over the past year that we've opened continue to meet our expectations are well within line. We actually look at this every 6 months in detail, not only for last year's new stores, but for all stores within their first 4 years of activity and all of those continue to track, which gives us confidence that we are making the right long-term 10-plus year decision that we are making to continue to open, whether times are great, our times are a little more constrained. So we continue to adjust our expectations given the market, but the stores are continuing to meet or exceed our hurdle rates.

[Mark Petrie, analyst]

And if I could just follow up on the promotional piece specifically. Could you just delve into that a bit more? How is that investment being deployed? What sort of consumers and behavior are you targeting? And you commented that there's increased activity from your competitors, specifically in hard lines, but you also called out some investments that you're making on the consumables side. So any color there would be helpful.

[Richard Maltsbarger, executive]

Certainly. So let me talk first with what we're doing that's the more and most pertinent to this conversation. We are continuing to lean in primarily through our loyalty program. While we do run our normal flyer-based programs every month, and within which we are highlighting things like deals under $20, deals under $10. These aren't necessarily items that are for sale per se. They're not even necessarily at promotional prices. They may still be at the same everyday value that we've taken, especially with the roughly 1,000 or so price changes that we took during April and May. So in many cases, we're promoting the core elements of value that we provide to the market every day. When it comes to our loyalty program, we're leaning a little heavier into marketing and promotion to those customers that we know have the highest lifetime value, specifically those that purchase our premium kibble and our culinary products. Our culinary, especially for dog, continues to do very well with greater than 30% CAGR for the past 3-plus years, including year-to-date into this year for our business. So we're continuing to lean into those categories that drive the weekly and monthly sales. And then we are doing some sparing promotions into hardlines and other less shopped categories. That alternatively, though, to answer the second part of your question is where we continue to see greater promotional intensity primarily from regional players, 1 or 2 promotions out of national players, but really some odd behavior from some of our regional competitors who seem to be much more invested in going deeper on discounting for those noncore items.

[Operator]

The next question is from Irene Nattel from RBC.

[Irene Nattel, analyst]

If we could just continue the discussion, please around consumer behavior and what you're seeing in response and maybe what you're seeing now and how that plays into, I guess, the trim in guidance?

[Richard Maltsbarger, executive]

I'm sorry, Irene, you cut out twice during asking that question. All I heard was the word consumer behavior and now. If you could possibly repeat that.

[Irene Nattel, analyst]

Sorry about that. What I was saying is you trended your guidance. If you could talk about how you had thought the back half of the year was going to evolve versus what you're seeing today? And I guess, your outlook if this new spending behavior is the new norm versus just a temporary blip?

[Richard Maltsbarger, executive]

Certainly. Let me talk about the consumer behavior to give a little more specifics around the change in our back half outlook and what we're thinking there. So on the consumer, quite frankly, many of the trends we've heard us discuss in the last quarters are still happening throughout the second quarter. And while I covered a lot of this in prepared remarks, I'll just quickly summarize some of the key points again. Look, the momentum for us is in our consumables and services. About 80% of our system-wide sales, very solid comp sales. Again, this is where we're putting our primary focus because this is what ties most specifically to long-term customer value with the devoted pet lovers that are at the core of our business. It shows that we remain the retailer of choice for those core customers and their most critical trips. We continue to see positive humanization effects. Our premium boots like culinary, as I quoted earlier, continue to outgrow our other food tiers. But there are pockets of value-seeking behavior. Specifically, we continue to see really strong performance out of Performatrin Naturals, one of our proprietary brands. As I also noted that while we see declines in our discretionary hard lines, especially PET, you'll also note on the call that I highlighted the strength we're seeing because we have introduced incremental proprietary brand products into those hardline categories. So we are seeking to provide long-term value to the customer about 5% to 20% lower price points compared to reference national brands. In the near term, that puts a bit of suppression on same-store sales as we lower the prices for customers to enter those categories. But long term gives us the advantage of having those customers now become focused on using our brand. And then finally, we do continue to see most of the pullback acutely in the metro areas, primarily Metro Vancouver, Greater Toronto area and a bit to a lesser extent, but also in Montreal. These also are typically where the consumers, of course, have higher debt levels and are a little more susceptible to the higher interest rate environments as housing costs continue to increase across Canada. So every day, we continue to look for ways to continue to operate and introduce value to customers, not always through promotions as much as any other also through permanent price reductions like we did in April, May or introducing of our proprietary brands. Light performance in culinary, which not only is an exciting launch that provided over 400,000 pounds of product already shipped across the country but did so also at a price comparison reduction to the reference national brand. So overall, pretty similar to patterns we've seen in the past. I think that is the lead-in to Linda. It's the fact that those patterns haven't changed that are setting up some of our change. So Linda?

[Linda Drysdale, executive]

We contemplated a variety of scenarios revising our 2024 guidance. Each demand cycle is different. The discretionary pullback we're seeing today is different from cycles we've experienced in the past. And what I mean by that is industry growth year-to-date and expectations for the balance of the year are materially slower than we'd expected, mainly driven by the macroeconomic backdrop. We have seen inflation slow across many key categories, which is a good thing for all of our customers over the long term, but it does have an impact on our reported same-store sales growth. And as a result, we now expect same-store sales growth for the year to be roughly flat, similar to our trends through the first half of the year. And as I said during my prepared remarks, we expect growth to be lower in Q3 before improving in Q4 as we come up against a relatively weak Christmas season in 2023.

[Irene Nattel, analyst]

If we were to assume that there are no further changes to consumer spending and not going forward, what we're seeing today in consumer behavior will be sustained, what further changes would be required or would further changes be required in order to drive same-store sales, notwithstanding this environment?

[Richard Maltsbarger, executive]

So we believe the changes that we've undertaken are the right changes in this environment, realizing that in the short term, there are some impacts most specifically in the hardlines categories. We also understand with overall macro demand being pulled back. It's going to be those categories. While the depth of the pullback and the length of the pullback is different from the prior recessions that we've seen within this century, the behavior of consumers pulling back that but continuing to invest in food and better for their pet quality products hasn't really changed. So it gives us good understanding of what's going on. It also gives us good confidence that over the long term, we would expect to return to more industry norms. The underlying humanization and premiumization hasn't changed. It's simply what people are doing to economize in the near term.

[Operator]

The next question is from Martin Landry from Stifel.

[Martin Landry, analyst]

Very large price increases that have been put through by the food manufacturers in the last years. And I'm wondering if you're starting to see some price deflation from vendors on the food side.

[Richard Maltsbarger, executive]

Let me pull us back up a little bit level to overall inflation, and then I'll get more specifically to your question around what we're seeing from vendors. So look, first and foremost, we're pleased to see that overall inflation across the industry has decelerated from the heightened levels that we were experiencing in the past few years. It's good for all participants, especially our customers. Having said that, there is a near-term impact to our same-store sales growth. We're seeing a slightly different number than what you'd see in overall published CPI figures. While they're a good indicator, remember, they do include all price movements and promotional intensity across the entire spectrum of pet food and other supplies. So while industry inflation has decelerated, our internal inflation is not quite as low because, again, we have relatively lower promotions, and we're seeing higher growth across our premium-oriented products. What we're seeing from our vendors would indicate to us that we are seeing alignment of vendor cost increases slowing, I wouldn't necessarily go so far as saying that we're seeing a deceleration or deflation within our vendors. Our vendors are continuing to bring forward cost increases. So while the pace and the magnitude of the cost decreases are not what we were seeing over the past 2 or 3 years, don't mistake that as our vendors are coming to us asking for us. We continue to have to negotiate staunchly with our vendors as they continue to bring forward cost increases because while maybe ingredient costs have come down, minimum wage and other costs across Canada that are also input into production have not slowed at the same pace.

[Martin Landry, analyst]

And I just had a question on your distribution center. You've anniversaried, it's already been a year now since you've opened your GTA distribution center. Could you update us on the benefits you expect to realize from a cost side with that new distribution center and the timing?

[Richard Maltsbarger, executive]

Yes, certainly. So as you heard a bit in the prepared remarks, we have already begun to see incremental productivity from the GTA, greater than we were actually expecting in the first 6 to 9 months. of ramp-up, which has been quite positive. And we just went live in the first week of July with the auto store automation. So we're looking forward to having that ramp up to full productivity as we move through the back half of this year and into the beginning part of next year. The biggest benefit to date, of course, in addition to that leverage that we're beginning to see is the expansion of wholesale shipment to Chico, which is well on track to our 50% of all shipments to Chico run rate by Q4 of 2025 and helping to contribute to our revenue growth despite some of the sales softness. And then, of course, we would not have been able to continue our new store growth trajectory as we not increase the capacity that's coming from that GTA. So on all fronts, we like what we're seeing. I will turn to Linda again just to flesh out a little bit more on the ability of the productivity increases we're seeing elsewhere to help change some of our investments in the overall DC automation. Linda?

[Linda Drysdale, executive]

Yes, sure. As Richard shared in the prepared remarks, we are constantly recessing our capital allocation in accordance with our framework to ensure we're investing in the right combination of projects that drive long-term growth and higher term on investments for our business. And as such, we did decide to delay the automation for Calgary and Vancouver. And that is in part because in addition to the supply chain transformation currently underway, our supply chain team is focused on improving the baseline productivity of our existing DCs through process improvements, and they've been really successful in improving productivity by double digits. So combining this higher productivity with the capital cost and slower growth environment, it provided us an opportunity to defer the implementation of that automation into Vancouver and Calgary DC until 2026 for later without impacting our ability to serve our stores and direct-to-home consumers. So this decision unlocks additional cash flow in the near term to put towards higher return alternatives and it could include potentially returning cash to shareholders given our current valuation.

[Operator]

The next question is from Michael Van Aelst from TD Securities.

[Michael Van Aelst, analyst]

You covered a lot, so I have a few smaller questions instead of one bigger question. But first, on the promotion of the price investments that you made in April or May, I think you mentioned about 1,000 SKUs. It sounds a little bit more than than what I was understanding in prior quarter. Is this still restricted or limited to mostly items that are newer in the pet adoption phases?

[Richard Maltsbarger, executive]

No, Mike. It was never restricted to items that were more specific to earlier in a pet adoption basis. While some of those items are absolutely included, many of these items were in core consumable foods that wanted to make sure that we maintained. We've been really excited about the fact that just those changes we made in April and May have been able to recalibrate our competitive across a wide range of targeted items and categories. But to your note, we continue to monitor this. So we continue to make everyday price changes to ensure that we maintain the same price competitiveness to all of our competitors across all different types of categories as a normal course.

[Michael Van Aelst, analyst]

So what would have been your average price investment across those SKUs?

[Richard Maltsbarger, executive]

Michael, I'm not going to divulge that. I don't want to give that away to my competitors or specifically which items we gave it a way to. The key thing I would tell you is I'll reiterate what we've provided in the past, which is for our core products, our target pricing strategy within 5%, plus or minus of our key competitors, most of the pricing actions that we took were specific to ensuring that we maintain that price competitive. And there were gaps that were larger than that going into the year that we felt that we need to adjust to keep back to our overall pricing strategy.

[Michael Van Aelst, analyst]

But you're able to maintain your gross margin at a pretty reasonable level. So were you able to offset elsewhere?

[Richard Maltsbarger, executive]

We were able to offset primarily through the incremental productivity in our DC that we've already achieved in the GTA. As I noted to Martin's question, we have been pleased with the incremental work that our teams have already taken in the first year of the GTA to find incremental productivity than what we actually immediately.

[Michael Van Aelst, analyst]

And then just the last question was on your depreciation and interest outlook. And when I look at the difference between your EBITDA guidance changes and your EPS guidance changes, it seems like the numbers below the EBITDA line went up a couple of million dollars. Is that accurate? And what would account for that?

[Richard Maltsbarger, executive]

So Mike, I'll take that real quick. Yes, you did note it. We might have thought Michael else might ask this question. So you did note the difference. What I would say is, look, when we constructed our original guidance, we made assumptions on the timing of several actions, which are historically subject to minor shifts in timing. This includes new store openings, escalations at lease renewals, corporate resale dates. As a result, we are expecting our depreciation to be slightly higher than we originally budgeted, which will result in a slightly different impact, as you noted on the bridge from adjusted EBITDA to adjusted EPS. So part of this and most of this, Michael, is just timing on some of those shifts.

[Operator]

Next question is from Vishal Shreedhar from National Bank.

[Vishal Shreedhar, analyst]

Just on the mix of consumables still seeing growth. Even if you assume modest growth in consumables, it's just the discretionary 20% of the business is declining mid to high single digits. Is that a fair comment that I'm making based on the comments you provided earlier?

[Richard Maltsbarger, executive]

So Vishal, as you know, we don't really get into very specific performance by category. But what I would indicate to you is, yes, services and consumables ranking higher than the company average, it clearly would indicate that the trends that we have seen to date within the hardlines, specifically and specialty pet secondarily to that, continue to be materially lower than the company average.

[Vishal Shreedhar, analyst]

Is Q4 the time that we should really expect to see that anniversary? I know that trend started midway last year, but it seems from your comments, you're thinking Q4 would get an anniversary point for that. Is that a fair comment?

[Richard Maltsbarger, executive]

I wouldn't classify it, Vishal, as an anniversary point. I would indicate that we had a relatively weak Q4 Christmas period last year in comparison to what we normally see in terms of hardlines and other category lifts. Look, people gift for their pets; betting apparel, holiday sweaters, even the ogre holiday sweaters we put out for dogs and cats, toys, et cetera, are typically what we see some incremental lift on. We just simply didn't see that lift last year during the holiday period. So we are still expecting some of that lift this year, albeit given the reduction in our overall guidance outlook, you'll note that we're not expecting that lift to be quite as much as we were at the beginning of the year.

[Vishal Shreedhar, analyst]

And just one quick one here. Given the changes in the timing of the supply chain revitalization initiatives, could you help us understand when the efficiencies will start eclipsing and when we hit that transition point, is that still an early 2025 story or how should we think about it?

[Linda Drysdale, executive]

As you know, this year, we're absorbing $20 million step-up in occupancy and equipment costs with our new GTA adventure obviously, and most of this is captured in our cost of sales, which impacts our gross margin. Starting in Q3, we will start appreciating our equipment in the GTA as it comes in use, and we'll incur other transitions we opened the Vancouver DC. So we expect gross margins in the back half to be lower than in the first half. And then we continue to see a step up next year as we lap those transition costs that we had this year. So we expect that inflection to happen towards the back half of 2025. And I'll just remind you that we do see also the free cash flow. We want to make sure that we point that up as we get through these major significant investments in our supply chain, so we also expect to see that inflection in the back half of this year.

[Operator]

The next question is from Adrienne Yih from Barclays.

[Adrienne Yih-Tennant, analyst]

What I was saying, it's nice to see the flexibility in the model. Richard, I wanted to know the industry growth as you had said, is materially slower than you had expected. What is the forecast that you're using or we're using as you entered the year in 2024, how is that different, and was it what was the industry growing in 2023? So I'll start there.

[Richard Maltsbarger, executive]

Certainly. So if you look over the past few years, let me start. Long term, it's about 6% so roughly mid-single-digit CAGR over a 30-year period, leading up to and including the pandemic era, it was a 9-plus percent CAGR. So we fully expected it to come back down to no more than industry average, if not lower. As we went into the year, that's what drove our original same-store sales guidance. The forecast we are using primarily the top 5 banks across Canada, their overall economic forecast for Canada and personal consumption throughout the year as well as other forecasts that are more specific to PET. All indications are that overall GDP expectation in Canada is lower. So while we're not economists, we read closely what the economists across Canada indicate. And then we understand how we need to adjust our spending and our expectations of market around that. overall economists perspective on the back half of Canada has come down pretty accretively from where it was in January and our outlook helps to reflect that.

[Adrienne Yih-Tennant, analyst]

When we think about the release of the full rollout of Performatrin, the culinary frozen and gently cooked, what percent of sales is the expectation? Ultimately, where are you in that road map? And then when we think about where are you getting new customers coming in from that who are trading down or trading into you? Or are you seeing a trade up from current customers? So just trying to figure out how much growth there is in that in terms of the active customer base.

[Richard Maltsbarger, executive]

Yes, certainly. So the overall culinary segment, which would include frozen, raw, gently cooked, and freeze dry, it's typically across specialty anywhere from 3% to 10% of overall sales of the store. We're well within that range today, even before we launched Performatrin culinary into the market. As we launch Performatrin culinary in the market, what we're primarily seeing is actually continued trade up into this. So one of the critical parts of this launch is gently cooked. So while frozen raw is great, and we continue to see strong growth in our frozen raw segment, and we do provide value compared to the leading national brand in frozen raw. Gently cooked is a game changer for us in the introduction. So gently cooked while frozen and giving us up to or more than a year of shelf life, puts us squarely into the fresh pet feeding market that we had not been in prior. So gently cooked allows us to introduce a fresh type product to customers, which is a growing category across Canada. But since it's in the freezer, it provides a shelf-stable more than 1 year as compared to many of the fresh options on the market only at weeks of shelf stable because they're refrigerated. And so that for us is the most exciting part, an already fast-growing category with freeze-dried and frozen now has the potential to become even faster growth as people are looking at us now as an option that they didn't or if they like the feed fresh.

[Adrienne Yih-Tennant, analyst]

And what is the margin profile on that category relative to where they're trading from upfront?

[Richard Maltsbarger, executive]

So I would indicate the margin profiles are still pretty similar. It's a consumable product and so margin profiles are still pretty similar. The great advantage for us, the culinary is now we also have an incremental margin associated with we do get higher wholesale and retail margins out of our own proprietary brands.

[Adrienne Yih-Tennant, analyst]

And then which leads me to my question, where is proprietary label brand penetration today?

[Richard Maltsbarger, executive]

So as we entered the year in our AIF, you would see 26% overall enterprise penetration. That, of course, at one time was 30, but then we bought Chico and so we're still ramping up penetration and helpfully. But we have relatively flat consumables penetration. But as we noted on the call in our prepared remarks, we had our second straight quarter of increased hardlines penetration as we continue to lean into providing value to customers in those segments.

[Adrienne Yih-Tennant, analyst]

And then my final question, Linda, for the ramp and the inflections on both the free cash flow and the margin that was helpful. But where are we in capacity utilization and how should we think about the postponement of the automation to impact margins in 2024 and 2025? Well, I guess, largely in 2025 if you're pushing the automation to '26.

[Linda Drysdale, executive]

It has a small impact, but not significant enough to note material change from what we've suggested in the past. So I talked about the step-up in depreciation and interest this year. And next year, we'd say that's going to be roughly half of what we had this year, and that hasn't changed dramatically.

[Richard Maltsbarger, executive]

I think the key on just utilization well within our path, well within our plan. Really, ultimately, this comes down to a productivity conversation, just the great work of our supply chain team to find more productivity out of our regular traditional picking path processes, just really allow us to postpone the fixed cost investment into automation. So it actually helps our near-term utilization of the space because we're not adding incremental capacity beyond what we need today.

[Operator]

The next question is from Chris Murray from ATB Capital Markets.

[Chris Murray, analyst]

Maybe turning back to some of the enhancements in the new digital platform. A couple of questions around this. One, I was wondering if it gives you an opportunity to tap into a loyalty program either in a different way or a more advanced way. And then just looking at what we're seeing in terms of the transaction velocity, is there anything that we should be thinking about that you now have the ability to maybe tune or improve with the new platform?

[Richard Maltsbarger, executive]

Absolutely, as things we continue to improve now. That was really the core of why we did this. We've now been able to take a little more of the control into our hands. We're no longer reliant for our front-end development on an overall monolithic third-party provider. We can now actually adapt more quickly using our own prods and our own development capabilities, which really has excited us because there are certain things within our business like wish list. I'll just highlight that, as I said on the call. People think about whistles things like wedding registries. But in our business, wish lists are really important to our rescues because our rescues like to make sure that their donors and our stores know exactly what it is that they need within their business. Tapping into loyalty program, absolutely. The 2 teams both report in to the same executive leader and are already looking at how we can incrementally lean in to more automated, more trigger based, more very specific behavioral base, including things that we were not previously able to do in terms of retargeting and other activities, leveraging activity on the web back to activity within our loyalty program. So overall, quite excited, really proud about the team delivering it on budget, on time, being able to create the development capacity to go at a higher velocity of future customer enhancements. And right away, Chris, I thought even in the first month, the site is already faster. The checkout is already smoother and we're already seeing benefits.

[Chris Murray, analyst]

And then just maybe cleaning up some of the cash flow comment and maybe the moving around of some of the development. I think, Linda, you mentioned previously you thought probably the baseline $25 million in CapEx, plus maybe$5 million to $10 million in additional development for 2025 in terms of CapEx. If there's any updates to the CapEx rollout plan over the next couple of years with shifting around some of the development? Any updates there would be appreciated.

[Linda Drysdale, executive]

Yes. We mentioned the $5 million decrease from our original outlook this year. And so that's a change minor that's being pushed out. But otherwise, there's not a significant change in the rollout plans or impact on long-term capital, especially with respect to the supply chain.

[Richard Maltsbarger, executive]

I want to add, this is what we shared in the past. And that's why Linda aired it. We had already indicated that the capital for next year will go down and then the capital for the year after that would decline further. This helped to continue to support that path. So really the biggest immediate change is the $5 million reduction that Linda just covered in guidance for this year.

[Chris Murray, analyst]

But we shouldn't be thinking this $5 million just gets tacked into $26 million or $25 million or something like that.

[Richard Maltsbarger, executive]

Not at this point, no.

[Operator]

The next question is from Ty Collin from Eight Capital.

[Ty Collin, analyst]

I just wanted to circle back on the pricing discussion from earlier. Could you maybe touch on where your competitors or where the market has moved on pricing since you made those investments in April, May? Are you still sitting within your plus/minus 5% range? Are you expecting that you might need to do a little more catch up later this year as the backdrop continues to be challenging.

[Richard Maltsbarger, executive]

So Ty, I would indicate that right now, we're well within our competitiveness range, and we have not, through our ongoing monitoring. And again, just reiterate, we monitor key competitors every other week, smaller competitors, at least once a month. We are not necessarily seeing any movement further from where people were. If you'll remember, we postponed our original price reductions to watch the market for an incremental month or so back in late February and March as we've begun to see some competitors bring prices up. So that allowed us to recalibrate our decrease. That has helped contribute to us containing the impact to gross margin as we move through the year. The one thing I would say that is different from what we originally expected at the beginning of the year was the increased and continued level of promotional activity from certain competitors. So while we are really responsible and focused on where we promote. We do expect that we'll have to have slightly higher promotions than what we originally expected. But again, nothing outside of the responsible focused approach that we take and primarily through our loyalty program to the specific customers that make the most value to our company

[Operator]

This is the end of Q&A session. And I'd like to hand over to Richard for closing remarks.

[Richard Maltsbarger, executive]

So thank you once again for your investment of time, investment of money and interest in our overall company. We appreciate the support. We look forward to talking to you again with our Q3 results in early November.

[Operator]

This concludes today's conference call. You may now disconnect your lines. Thank you very much.