Earnings Call: Q3 2022

Nov 8, 2022

Good morning, everyone. We apologize for the delay, and thank you for standing by. Welcome to Pet Valu's third quarter 2022 earnings conference call. My name is Savannah, and I will be coordinating today's call. All lines have been placed on mute to prevent any background noise. Please note that following the formal remarks, there will be a question and answer session. If you would like to ask a question at that time, please press star one on your telephone keypad. If you are using a speakerphone, please lift the handset before pressing with any keys. We ask that you limit your time to one question plus one follow-up before cycling back into the queue. I would now like to turn the call over to James Allison, Investor Relations at Pet Valu. Please go ahead, Mr. Allison. Good morning, everyone. Thank you for joining Pet Valu's call to discuss our third quarter 2022 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 Jim Grady, 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 the business, please see our Q3 2022 MD&A and other filings available on SEDAR. I would also like to note that today's remarks will be accompanied by an earnings presentation for Q3 2022, which can be viewed live through our live webcast and also available on our website. Now, I'd like to turn the call over to Richard. Thank you, James, and good morning, everyone. I will begin today with an overview of our accomplishments in the third quarter, along with highlights and observations as we move into Q4. Jim will then provide a more detailed review of our financial results and updated guidance for the year before opening the call to take your questions. We are very pleased with our performance, as much of the success we had in the first half carried on through the third quarter. The Canadian pet industry continues to grow at a very healthy pace despite the macroeconomic backdrop, exhibiting its resiliency. On top of this, Pet Valu continues to gain market share as our flexible business model and focus on providing engaging retail experiences resonate with more and more pet parents across Canada. These strengths translated into robust financial results across both the top and bottom lines in the third quarter. Same-store sales grew 15% or over 47% on a three-year stack basis. Revenue increased 22%, adjusted EBITDA grew 12%, and adjusted net income per diluted share increased more than 10%. Our growth continues to be supported by execution on multiple strategic initiatives, which we group into three main pillars. First, expanding our store network. We opened 13 new stores in the quarter. This brings our total new store openings to 32 year to date. Well on our way to reaching this year's target. We ended the quarter with 729 stores across all ten provinces, 68% of which are operated by our franchise owners. I am pleased with the progress we've made in expanding our recently acquired Chico banner, which now consists of 80 stores across Quebec, making it amongst the largest pet chains in the province by store count. Second, driving our same-store sales, which increased 15% in the quarter. While we are seeing growth in the Canadian pet industry still meaningfully exceed its historical long-term run rate, our Q3 growth outpaced even that with consistent growth seen through the quarter. As we are no longer lapping pandemic operating restrictions, our robust same-store sales growth was supported by continued traffic and basket growth, more reflective of the balance seen in pre-pandemic periods. Performance across categories continues to remain relatively consistent, suggesting no sizable shifts in consumer behavior. We once again saw very strong high double-digit growth in our consumables offering, which represents almost 70% of our sales. In particular, the premium tiers, driven by the long-standing humanization trends driving the pet market. Growth rates in more discretionary categories, such as treats and toys, were firmly positive. The only notable softness was in some of our smaller categories, like bedding, crates, and small animal habitats, which is not surprising as we lap initial purchases for some of the 3 million new pets adopted over the last 2 years. Even when we dig into multi-year purchasing patterns from our most loyal customers, we are not seeing any meaningful trade-down behavior. We continue to see consistent same-store sales growth across store vintages, a key benefit from our thorough renovation and refresh program. We completed 4 renovations, expansions, or relocations in the quarter, bringing our total year to date to 20. On the digital front, sales originating online more than doubled, driven by our higher website traffic and stronger conversion rates. We continue to make enhancements to our online experience as customers grow more familiar with our platform. Late in the quarter, we launched our subscription service, AutoShip, across all regions outside of Quebec. With convenience top of mind, our subscription service offers customers the option of having their everyday essentials shipped to their home or ready for pickup at one of our stores. We are pleased with the initial uptake and are sharing the success of this program's launch with our communities through our partnership with the Lions Foundation of Canada Dog Guides. For every product added to an AutoShip subscription before December 31st, we are donating CAD 20 worth of Performatrin dog food to the Dog Guides feeding program. We are also very pleased with the evolution of our loyalty program. With a broader assortment of products available through our frequent buyer programs, we are seeing continued growth in our membership base, who now account for almost three-quarters of our system-wide sales outside of Quebec. We continue to flex the capabilities of this program, leveraging purchase insights to deliver targeted promotions and provide our loyal customers with incremental value and help build their basket. For example, just this past quarter, we began tapping into the insights of some of our most loyal customers, providing an opportunity to speak with myself and some of our executive leadership to hear what these customers love about Pet Valu and, as importantly, what we can do better. In exchange for their time, participants were assigned VIP customer status and gifted a personalized assortment of Pet Valu products for pickup at their local stores. The final pillar of our growth strategy, enhancing our operating margin. We are continuing to make very purposeful, strategic investments to scale many aspects of our organization, not only to adapt to the exceptional growth we've captured over the past few years, but to position our business to drive continued expansion. Adjusted EBITDA margins were 23.3% as we made planned investments in people, wages, IT, supply chain, and proprietary brands, and cycled unfavorable FX rate comparisons year-over-year. As we look out over the balance of the year, we have raised our full-year guidance, which Jim will discuss in more detail shortly. We remain constructive on our outlook for the business. With key events like Black Friday and the holiday selling season still to come, much can change, and so we and our franchisees are focused on delivering excitement and value to devoted pet lovers across Canada. Importantly, we are making excellent progress on many of our initiatives, which align with our growth formula. On new store growth, we now expect to open 40-45 stores this year, representing as much as a 50% increase compared to new stores opened in 2021. Looking beyond this year, I'm very pleased with the state of our pipelines for 2023 and 2024, which continue to fill out nicely, both for our Pet Valu stores as well as for Chico. We look forward to sharing specific plans for 2023 when we report our Q4 results in March. As we've noted in the past, expect similar levels of new store openings per year. On same-store sales growth, we have raised our full-year target to factor in our strong growth in the third quarter. We expect industry growth to continue to normalize, supported by recent channel checks that suggest net adoptions have returned to pre-pandemic levels. As always, we plan to capture this growth as well as earn share when opportunities arise. We continue to see heightened levels of inflation, roughly in line with general CPI, and expect to see elevated levels through the remainder of the year based on conversations with key vendors and what we are seeing in freight and fuel rates as we brought our seasonal goods into inventory. As in recent quarters, we have intentionally not passed all inflation through to our retail and wholesale prices as we try to ease the burden on our franchisees and customers. As we gear up for the fall selling season, we are incredibly excited about our offering. Our decision to accelerate shipment and receipt of our seasonal goods has put us in an excellent position for our stores to be in stock ahead of key seasonal changeovers. Our assortment this year will feature a broader selection of proprietary branded hard goods across categories such as apparel, bedding, and toys. This, in addition to the strong growth we are seeing in our Performatrin freeze-dried raw products introduced in early Q2, showcases how we continue to enhance our proprietary brand offering to broaden the selection of good, better, and best options we can offer our customers when shopping for their pets. Also starting this fall is an exciting multi-year sponsorship agreement with the Vancouver Canucks. This represents our first sports sponsorship with a major sporting franchise and provides a unique opportunity to drive brand awareness of our regional banners, Bosley's, Tisol, and Total Pet in the BC market as our marketing team branches out to test some new and exciting engagement concepts. I'm excited to announce, starting this week, we will be launching our newest iteration of the Love Lives Here marketing campaign with a holiday-themed 360-degree campaign, including incremental investments in television and digital advertising to further increase awareness of the Pet Valu banners as we continue to enter new markets and neighborhoods through our store openings. Finally, enhancing our operating margins over the long term. As I mentioned earlier, we continue to make strategic investments in human capital and supply chain designed to scale the business and drive future growth. While we expect this to result in modest deleverage in the fourth quarter, it positions our business to capture operating margin expansion over the long term. With regards to our supply chain, we continue to add incremental capacity to support our strong volumes ahead of the opening of a larger GTA distribution center. This incremental capacity is an investment designed to maintain strong service levels to our stores and our direct-to-customer shipments as we bridge to the new DC. Construction of the facility is progressing well, and we remain on track for an initial transition starting in mid-2023. As I conclude my remarks, I can't thank our people enough for the passion and commitment you bring to Pet Valu every day. You are what makes us Canada's preferred pet retailer by providing the products, care, and most importantly, the memorable moments that strengthen our bond with our devoted pet lovers. With that, I'll pass it over to you, Jim. Thank you, Richard, and good morning, everyone. I will start by reviewing our third quarter financial performance, followed by an update to our full year outlook. Q3 performance exceeded our expectations as we were happy to see the top-line momentum in the beginning of the quarter continue through the full quarter. As a reminder, Q3 2022 performance includes a full quarter impact from the acquisition of Chico, which was completed in Q1. As a result, Chico impacts year-over-year growth rates across many metrics, except for same-store sales growth, which excludes the impact of Chico. Third quarter system-wide sales increased 28% to CAD 332 million. Excluding Chico, system-wide sales grew 18%, driven predominantly by strong same-store sales growth of 14.7%, with same-store transactions up 8% and an average spend per transaction increase of 7%. We opened 13 new stores in the quarter and 44 over the last 12 months, ending Q3 with 729 locations, 68% of which are franchised. Turning to our company performance, third quarter revenue was CAD 245 million, an increase of 22%. Excluding Chico, revenue growth was similar to system-wide sales growth. Gross profit was CAD 94 million. As a percentage of revenue, gross margin rate was 38.2%, down 80 basis points from 39% last year. This decrease was driven by lower product margins as we decided to not pass along all vendor and freight cost increases through to our retail and wholesale pricing to ease the inflation burden on our customers and franchisees. In addition, margin was negatively impacted by a weaker Canadian dollar on foreign source product. These factors were partially offset by a CAD 1.8 million duty recovery associated to COVID relief measures, as well as the positive impact of Chico. Selling general and administrative expenses in the third quarter were CAD 50 million. Excluding IT transformation costs, share-based compensation, and other non-operating items, our SG&A expenses were approximately CAD 46 million, an increase of 28%, primarily attributable to purposeful investments in headcount and wages to support long-term growth, higher software and advertising fees, and increased travel and meeting expenses, such as a return to our annual in-person store manager and franchisee conference and trade show, which had been on hold since the beginning of the pandemic. Adjusted EBITDA increased 12% to CAD 57 million, representing 23.3% of revenue. While we guided to pressure on adjusted EBITDA margin, the 190 basis points decline in Q3 was better than we had expected. Net income increased 11% to CAD 27 million. Excluding items not indicative of our underlying performance, adjusted net income was CAD 31 million, also up 11% from last year, driven by growth in adjusted EBITDA, partially offset by higher interest expense due to rising rates. Adjusted net income per share was CAD 0.43, up 10% from last year. Now turning to the balance sheet. Our liquidity position continues to strengthen as we ended the quarter with CAD 48 million of cash on hand, plus access to our full CAD 130 million revolver, which remained undrawn through the quarter. Total debt, net of deferred financing costs, ended the quarter at CAD 340 million. Taking into account leases, our leverage ratio continues to decline, ending the quarter at 1.8 times. We invested in additional inventory during the quarter, with corporate inventory at the end of the quarter of CAD 136 million, up 54% from a year ago. The primary investments are for better in-stock levels and improved fill rates to our stores on our core assortment compared to more constrained levels last year, especially in longer lead time hard line categories that faced chronic global supply chain challenges over the past few years. As noted last quarter, we also received seasonal goods earlier this year as we gear up for a busy holiday season. Recall, much of our seasonal goods had been pre-ordered by our franchisees given the demand expected during the holiday season, most of which shipped to stores during October and early November. Of course, cost inflation related to vendor price increases and higher freight is also contributing. We are seeing the continued support of our strong growth through these inventory investments and believe we have the right quantity and quality of inventory in our DCs and stores as we head into the fourth quarter. Our inventory turn rates remain relatively stable at roughly 4 times. Free cash flow in the third quarter was CAD 20 million, down from last year, primarily due to the timing of inventory purchases. Now, I will provide an update to our full year outlook. Based on our strong third quarter and performance to date in Q4, we have raised our full year expectations for 2022. We now expect full year revenue between CAD 938 million and CAD 947 million, supported by stronger same-store sales growth of 15.5%-16.5%, up from a prior range of 13%-15%. We have also increased our range of new store openings to 40-45 for the year. Consistent with our prior comments, we continue to expect year-over-year growth rates in revenue to be lower in the second half of the year compared to the growth rates in the first half, as we are now lapping a more normalized operating environment. As implied by our guidance, Q4 revenue growth is expected to remain in double-digit territory. We have raised our expectations for adjusted EBITDA to between CAD 212 million and CAD 214 million, up from a prior range of CAD 203 million-CAD 207 million. This increase balances our solid Q3 performance and momentum heading into Q4 against our intentional investments and uncertainties tied to the current macroeconomic environment, such as rising FX headwinds due to the recent depreciation in the Canadian dollar. On adjusted net income per diluted share, we now expect to reach a range of CAD 1.56-CAD 1.58. This factors in our higher expectations on adjusted EBITDA together with rising interest rates, an effective tax rate between 26.5% and 27%, and a fully diluted share count of 72 million. We expect to incur approximately CAD 8 million of information technology transformation expenses, as well as CAD 6 million in share-based compensation, both of which are excluded from the calculation of our adjusted figures. Finally, for net capital expenditures, we continue to expect to spend between CAD 35 million and CAD 40 million as we fund new store growth, ongoing renovations across our store fleet, as well as payments on equipment and initial leasehold improvements for our new distribution center in the GTA. As we begin to turn to 2023, please note that we plan to provide our financial outlook for next year when we report our Q4 results in early March. We continue to map out our supply chain plans for the GTA as well as Western Canada to leverage our scale and enhance our competitive advantage. As such, we are in the early stages of building our net CapEx budget for 2023 and believe our spend will be similar to this year. To summarize, we are very pleased with how the business performed in the third quarter, which is due to the continued efforts of our people, from our franchise owners to our ACEs, as well as across our supply chain and corporate teams. The team is focused on delivering an excellent fall and holiday offering, which we believe will round out a very successful year. With that, we would now like to open the call up to your questions. Operator? As a reminder, that is star one if you would like to ask a question. Our first question will come from Mark Petrie with CIBC. Please go ahead. Yeah, thanks. Good morning. I guess maybe first, you know, what are you guys seeing with regards to consumer behavior, both in terms of traffic and the types of visits? I think you've talked about sort of the evolution as we've, you know, moved away from pandemic-affected behaviors, sort of changing the nature of the visits. What's the ramp-up in services? And then also, you know, any comments about how the sales of your discretionary items are selling, you know, both in consumables like, you know, like treats as well as in hard goods? Thanks. Good morning, Mark. It's Richard. Thanks for the question. Just before I respond, I wanna apologize again to everyone for the delay this morning due to the technical difficulties that will be addressed. With that, Mark, to your question, as I noted in our prepared remarks, I'll just highlight a couple of things and then dive a little deeper for you. Again, we're continuing to see relatively consistent performance across all categories. Very strong growth in our consumables, particularly premium food tiers, but we're also firmly positive in the discretionary categories like treats and toys. The only real softness we saw was a few smaller categories like bedding, crates, small animal habitats, which we know is attributable to the reduction in total net adoptions that we saw from the 3 million adoptions in the two prior years. We aren't seeing anything in the way of trade downs. We really dove into this through our loyalty data, looking at multiple year patterns where the data is. Again, our loyalty program, over 2 million customers, about 75% of our sales, no meaningful shifts. The only minor change, Mark, that we saw is some of our customers have moved up from small or medium bags or smaller cans to larger sized food bags and cans of the same brands, which do typically offer slightly better cost per pound economics. Otherwise, we really haven't seen any shifts to date. With key events still coming up like Black Friday or holiday selling season still to come, and a possible more uncertain macroeconomic backdrop, we still know much can change. We can lean into our proprietary brands that are often priced at a 5%-20% discount, as well as into our loyalty programs if the need arises. Again, we haven't seen any meaningful trade-down behaviors. Our services continue to grow. Our dog washes are up over the volumes that we had in 2019. The traffic continues to normalize the patterns that we saw in pre-pandemic times. Overall, Mark, we really dug into this question in preparation for today's call, and other than the small minority of customers trading up the larger sizes of the same product and the same brands, we've really seen no meaningful shift in behavior. Okay, great. I appreciate all that. I guess just one quick follow-up on that topic, specific to what you're calling out on, you know, bedding and crates. Is that slowdown different in Q3 versus Q2? You know, and how is that sort of trending in Q3 or in Q4? Excuse me. It is a little different than it was in Q2, primarily because last year we saw our highest adoption volumes in Q3 and into the beginning of Q4, because you still had the pandemic adoption surge going on, as well as you were beginning to get into normal seasonal patterns of holiday adoptions. Yeah. Okay. Fair. Second question, I mean, obviously, there's been some consolidation in the pet food supplier market, and I'm sure it's too early to have any view on what that will mean specifically. What's your view on the likelihood that this could lead to a change in thinking when it comes to distribution strategy or selling channels? Mark, you've already said it in the body of the question. You know, it's still too early to speculate on anything related to that. All I can say is that we have really great strategic supplier relationships across the entire industry. Long run focuses on pet specialty retail across many of these players. You know, we're looking forward to what we continue to do to grow with these companies. Okay, fair. Maybe I'll just actually squeak in another one. This is maybe also too early, but what's the take-up on AutoShip like, and how's that breaking down between delivery and pickup in-store? Are you able to track, you know, are those consumers already pet shoppers? Were they already sort of like Pet Valu online shoppers, or what can you tell us about, you know, who's taking up on that offer? It really is too early to speculate, having just launched it, 7 or 8 weeks ago. We are happy with what we're beginning to see in terms of the initial uptake. We did offer, again, both delivery to home as well as the opportunity to sign up for an in-store subscription for pickup, and we've seen both types of offers be taken up by our customers. As an additional incentive, right, we're also tying this into our broader community relationship by tying, right, any item going into an AutoShip subscription before December 31, we're providing a CAD 20 Performatrin food donation to the Lions Foundation of Canada Dog Guides as an additional incentive for our customers. It's still too early to tell, Mark, but we are seeing both types of subscriptions be taken up, and we're pleased with what we've seen to date. That's great. Appreciate all the comments, and all the best. Thank you. Our next question will come from Irene Nattel with RBC Capital Markets. Please go ahead. Thanks, and good morning, everyone. Just to be very clear, on the net adoptions, you're seeing absolutely no change relative to pre-pandemic in terms of percentages or numbers? Numbers, really, Irene, right? Okay. Which means as percentages, they're even lower than pre-pandemic. Right environment. As pure numbers of net adoptions both in and out of shelters, the numbers themselves are pretty similar. That, of course, is on a much larger adoptive base. Right. Absolutely. Understood. Thank you for that clarification. Second question, if I might. You said that you haven't passed through all of your cost increases to, you know, to. Sorry, all of your cost increase. Missing words this morning. Is it your intention to continue to do that, or do you think that, in the upcoming quarters, you will start to pass through a little bit more cost? Hi, Irene, it's Jim. Hey Good morning. Look, as we've said, you know, we have a great track record of being able to pass it along, and we've said that we will always be selective and look at the market, and decide what is the right amount to pass along and when. We made a decision now this quarter, that it was the right decision to absorb some of those increases to support both our customers on the franchise side as well as our devoted pet lovers in the stores. What we'll do in the future, you know, we'll take it as we see the environment at that time. We believe, you know, we believe we have the ability to pass it along as we have historically, but we'll take it as a decision at that point, look at the market, look at how the environment is, and yeah. We saw an opportunity to support our customers, both franchisees and in the stores, and we took advantage of that. That's great. Thank you. That leads me to my next question, which is what are you seeing in the marketplace, both in terms of, let's say, consumer behavior through some of the mass channels and as well competitive intensity in both the specialty, but also sort of more through mass? Irene, this is Richard. Going a little bit back to what we said with Mark, let's start first with the consumer behavior. We're not seeing any change in the behavior. We, like you, can see the headlines from other retail and other consumer categories and understand that there are shifts in behaviors going across the different industries. From a competitive intensity perspective, we continue to see another quarter in third quarter of really low promotional intensity, much lower than average. With Black Friday coming up, we do believe that we are going to lean in a bit more into Black Friday, but again, in a very rational environment. However, we will monitor all of our competitive behavior within the marketplace. Should there be a shift in what has been a low promotional environment, we do have contingent plans in place to lean in. That's great. Thank you. Just finally, one last question. With the sponsorship of the Canucks and some other stuff that you're doing, just wondering if we should expect a step up in marketing expenses, SG&A? No. No, at this time, Irene, it's not a step up or an increase. It's more reallocation as we continue to hone in and modify both our top and bottom of the funnel investments to have the right mix between awareness in the new markets that we're entering into and then the bottom of the funnel investments and continuing to convert that traffic. That is outstanding. Thank you so much. Thank you. Our next question will come from Vishal Shreedhar with National Bank. Please go ahead. Hi. Thanks for taking my questions. I was hoping you could comment on the impact of rising rates on your business. In particular, thoughts on COGS and how we should think about the lease impact. Hey, Vishal. It's Jim. Good to hear from you. I missed the back end of the question. I'm sorry. Rising rates and Yeah. Rising rates on the impact of COGS and leases. Yeah. Really, as we've said, we are seeing the impact of inflation throughout the P&L, on the inputs as well as leases in new stores, et cetera. We have, as we just talked about, you know, passed on a lot of that to our customers, and we have a long track record of doing so. We decided this quarter not to on the vendor input costs. On the other side of the P&L, we've been able to manage it, specifically on stores and leases. On our new stores, we are seeing increased build costs, et cetera, but the economics, given the top line growth, continue to improve. What I would say, you know, just real simple summary is we're definitely seeing it, we're managing through it, but with the fantastic growth of the market and our top line growth, we've been able to handle it. Yeah. Okay. With the leases in particular, how does that work? On the corporate stores, you get a higher. Is it passed on immediately, or is there a lag? Like, how do the actual increases in rental costs work associated with rates? How should we think about that? Yeah. With the franchisees, do they incur it? Do you pass it on to them, or do you absorb that? Yeah. Two different aspects, of course. On corporate stores, obviously, you know, we absorb it in our P&L. It's part of our overall cost structure. For the franchisees, remember, we are on the head lease, so the franchisees pay the greater of base rent. If that goes up, then, you know, they pay that. We have percentage rent, so they pay the greater of. Depending on which one they're in, the P&L is impacted accordingly. I see. Okay. Just switching gears here, you know, some of your, I'll call them broad peers, not necessarily in your industry, have started speculating about the possibility of inflation, call it deflation, call it you know several months out into 2023. Wondering if that's an analysis that you're starting to review now. Do you see that as a possibility? If so, how does your business perform in periods of deflation when some of these heightened costs start lapping? Yeah. I'm not really gonna speculate on whether, you know, inflation is gonna come down or go to deflation or whatever. I'm not an economist, but you can imagine we're watching it very closely and planning it. What I would say is, you know, this quarter, we benefited from strong transaction growth. Historically, our comps have been, you know, the majority has been driven by transactions. That's what we're really looking to drive. That's what we can, you know, influence and we'll continue to do that in the future. Then if there's deflation, we will react accordingly. We're looking to continue to drive traffic into the stores. To be sure, the only thing to add to that is historically, pricing within the pet food market is relatively sticky, and does not fluctuate up and down as much as you may see in other food-related categories. Understood. I appreciate the color. Thank you. Our next question will come from Martin Landry with Stifel. Please go ahead. Hi. Good morning, guys. I wanted to dig a little bit into your full year guidance, you know, especially for same store sales growth. You know, if we look at what your full year guidance suggests for Q4, it looks like you're calling or expecting a same store sales growth of 6%-8%. And that would be a bit of a deceleration from Q3. I'm just trying to better understand the dynamic at play here. Is it a function of just lapping strong inflation? Yeah. Hey, Martin. It's Jim. You know, we're coming. We've always said that the second half would be lower than the first half, right? As we lapped you know, lockdowns in the first half of the year, and we're moving into this normal operating environment. Then, of course, we have the macroeconomic backdrop with that. Yeah, we've always been saying that we are gonna turn to a normal growth rate within the industry, and our plan is to grow at the rate of the industry and take market share when available. I think what you're seeing in our guidance is really that coming to fruition. We're very pleased with the way the business has been performing. We've seen good momentum continue. You know, we're basically following exactly what we said in past quarters, that we think it's a normalization and this guidance reflects that. Martin, just, Okay. In your opening remarks. Sorry, go ahead. I was gonna say just a little more color. Just remember last Q4 when we shared with you results there, we felt that we had a fantastic outcome, most especially in our hard lines and seasonal categories, where we felt that we were in a competitively advantaged state, having been able to bring our products in. While we also brought our seasonal products in much earlier in inventory this year, we do believe that was more commonplace across the industry, and that it will be a more competitive environment in Q4 this year, most especially in the early days of seasonal and holiday selling here in November than what we saw last year. We're just reflecting that we're gonna have to fight a little harder for it, this year than we did last year. Okay. Understood. That's helpful. Jim, just wanna talk about your balance sheet a little bit. You know, your leverage is going down, and your business is generating strong cash flows. I was wondering what's the optimal leverage that financial leverage you wanna maintain on a go-forward basis? Yeah, we really haven't set a target on what that leverage ratio should be or a targeted leverage ratio. As we've been saying, you know, our priority is to invest in the business. That's what we're doing, investing in new stores, remodels. As we've talked about, we'll give a lot more details on in March, you know, we have a supply chain transformation in front of us. We've talked a little bit about moving to a new warehouse in the GTA, and that building is in construction now. We have a lot of cost in the build-out on that. That'll come some in fourth quarter, some in the first half of next year. As we begin to talk about, we need to make similar investments, probably not in the same magnitude, but in Calgary and Vancouver. Our focus is really on the investments in the business first. We still need to make some investments in Chico as we integrate that in and concentrate on driving our private brand business there and growing the wholesale business. When we come out in March with guidance, we'll give a little bit more color on where we're going. Right now the priority is to invest in the business and we'll give a little bit more color on debt levels in the future. That's what we're focused on now. Okay. That's helpful. Maybe last question. You're talking about, you know, not seeing any trade downs. I was wondering, you know, given inflation, you know, it probably an optimal time to look at converting some of your customers to your private label brand. I was wondering, have you increased promotional activity to push your private label brands recently? Martin, what I would say is we haven't increased promotional activity. As Jim noted, we chose not to pass along all of the cost inflation that we were seeing, in particular to products that were quite supportive of our franchisees and our devoted pet lovers. While that applied across all types of products and all types of categories, there was a specific focus for us in our proprietary brands when we made those decisions. Okay. Perfect. Thank you. That's it for me. Thank you, Martin. As a reminder, that is star one if you would like to ask a question. Our next question will come from Adrienne Yih with Barclays. Please go ahead. Great. Thanks so much. Congratulations on another just putting the quarters together. Clearly the defensive nature of your category is coming through. Richard, I guess actually it's either Richard or Jim. It's really on inventory. I know that you're with 68% franchise, you're acting more like their wholesale partner. I guess the question is: how come we're seeing sort of the increase sort of later, right? At the end of this October period, I would imagine that a lot of that is gonna get drawn down, right, over Black Friday, the next two months. How should we think about that inventory number, you know, as we end the fourth quarter? The follow-on to that is there a difference? Do you allocate your inventory differently for the 68% that are your franchise partners versus your own retail stores, or is all of that inventory fungible? Thank you. Yeah. Hey, Adrienne, good to hear from you too. Yeah. On inventory, there's a few things going on, right? I would begin by just reminding you that, yes, we are a wholesaler to our franchisees, and we're a big wholesaler to them. We provide about 90% of the products they sell in their stores, they purchase from us. Our wholesale business- Yeah As you know, is a big piece of it. We're really dealing with three things on inventory, and it's very purposeful. Obviously, inflation is playing a role in the dollar value of the inventory, so you're seeing that. But what we have done is make investments in core assortments, right? We have seen over the years, as everybody else has, chronic shortages due to supply chain challenges that have lasted. Last year, we got that inventory in. We got inventory in just in time, and we saw it as a competitive advantage. What we have decided to do is to continue to hold elevated inventory in those categories. You know, things that are very bread-and-butter categories like containment, cat trees, aquariums, grooming tools, shampoos. That's helping us achieve our highest fill rates to our franchisees. Very important for us to be in stock to support the franchisee business. Then second, or third, rather, we purchased our seasonal goods earlier. We brought them in as we touched on just in the nick of time last year, but we brought them in even sooner this year. We believe that is gonna be a competitive advantage now, and we're seeing it. Looking forward, we are going to continue to hold a high level of inventory. You know, it's the growth of our inventory is gonna be elevated. Is it gonna come down from where it is now to the end of the year? Yeah, I would say exactly what you described. There will be some natural drawdown of it, but we're looking to continue to hold more than what you'd see normally. We're totally fine with the quality and the quantity of the inventory we have, and in fact, our turns are roughly at the same level as history. From a dollar perspective, you'll see it high. On the allocation question, no, there's really no difference in the inventory. We service as wholesaler to the franchisees just as we service our corporate stores, so there's no allocation if you were to go into a DC. It's one inventory that we'd sell to the corporate stores and the franchise stores. Okay, that makes total sense. Yeah, we always say that the wholesale, if there's one job you should be good at, it's when the retailer says when and how much, you should say, "Yes." We totally- Absolutely. That goes back to what I said on why we're making these investments into our supply chain. You know, we believe it's our opportunity to leverage our strength right now. Adrienne, just greater color, right? We really did have a lot of success across our inventory and replenishment team. Finally getting back to normal would probably be the best way I would put it during Q3 on some of these chronic, challenged categories that we've been really struggling through the past two or three years of the pandemic. Yeah. You're just a consistent replenishment category. It's not like people are buying stuff up front. You're just constantly replenishing them throughout the entire year. That's been the case. Correct. Exactly. Correct. Especially where we lean heavier into these hard goods categories that really never expire, right? Cat trees. Yeah crates. These are just things that we need to be in stock for as the wholesaler. Okay. A couple of housekeeping items just on that point number one, Jim. You said inflation was roughly in line with CPI, so I'm assuming that's sort of high single, low double digit. How much of that are you not passing through? Either you can do it in basis point impact year to date, or you can do it in percentage, however you kind of wanna address that. Yeah. Adrienne, we're not gonna quantify exactly. Okay What we're not passing on. You know, what I would say is, I'm kind of repeating myself, but we did it to Yeah to support our customers on both sides. Sure franchisees, and we did it in a way that encouraged, you know, behavior, as you can imagine. Yeah. We've had strong pre-books for our holiday season, so we didn't look at it as dinners. Yeah. Yeah. Yeah. Okay, perfect. This is another, you know, very small housekeeping question. What is the amount of product that is foreign sourced? Yeah. About 30% is non-Canadian dollar sourced, so predominantly in U.S. dollars. 30% is U.S. dollar sourced, is the way to look at it. Okay, perfect. That's all I have for now. Thank you so much. Thank you. We have a follow-up from Irene Nattel with RBC Capital Markets. Please go ahead. Thanks. Just a quick follow-up to the whole inventory discussion. Perhaps I missed it, but I could've sworn I heard you say that an important level of that inventory has since been shipped through to franchisees. Did I hear that correctly? That's right. You know, holiday inventory, I mean, we have what we call pre-book. Before we buy it, the franchisees place an order as well. We in turn. That sizes the order we place to our vendors. A lot of the inventory we're holding was pre-ordered and has been shipped in October and early November. We That's great. We brought it in early, right? To ensure store supply, and when we brought it in, it was already committed, if you will. Not sold, but committed to be sold to our franchisees, and now it's shipped in the fourth quarter. That's great. Just to make sure that everybody's on the same page, we should expect you to run with higher inventories in order to support franchisee sell-through to consumers, but there is a seasonal element heading into Q4. There is a seasonal element, but what's happening is, you know, two things. We're ensuring that we're in stock on those things that Richard discussed, that we absolutely must be in stock on. We're hiring higher level there. The natural decline that you would expect to see due to seasonal is not gonna happen the same way. There will be a normal decline. I mean, a decline due to seasonal. Yeah. Okay. That is great. Thank you so much. That will conclude today's question and answer session. At this time, I'd like to turn the call back over to Richard Maltsbarger for closing remarks. Once again, thank you everybody for your interest in Pet Valu and for joining us on today's call, and we look forward to talking to you again in March, when we report out Q4 results. Have a great day. This will conclude today's conference. Thank you for your participation, and you may now disconnect.