Pet Center Comercio e Participações S A : 1Q23 Results Conference Call Transcript

PETZ

1Q23 EARNINGS RESULTS VIDECONFERENCE EDITED

TRANSCRIPT

MAY 5th, 2023

Sergio Zimerman (CEO):

Good morning, everyone. It's a pleasure to share with you our presentation of the First Quarter of 2023. Before we actually start the presentation, I just wanted to say a few words about our understanding of the macro scenario. On the demand side, we see a stabilization of the movement that we had seen in 2022. So demand is stabilizing with clear signals of recovery happening in some categories of discretionary products.

As you will see later on, one of the highlights of this recovery movement is happening in dog collars, where we have a significant share of our private label. The results of the first quarter show how successful the implementation of what we announced in the last call has been, which was a search for a balance in profitability, growth and innovation.

I'm going to try to explain this through a metaphor. Let's imagine we are on a ship and conditions in the sea are quite adverse. It's raining, the sea is with a turmoil and when we talk about balance, understand this concept of acceleration or deceleration as a relative concept that takes into account the acceleration of market share gain or the decrease in the speed in which we gain market share. But at no point we consider not gaining market share. It's important to clarify that because of some conversations we have been having, this is what balance means to us.

For 21 years or more than 80 quarters in a row, we have been gaining market share and we do not want to interrupt this sequence anytime soon. So for us, gaining market share is essential. However, gaining market share can be gaining a little bit of market share or more market share and that's when the external scenario comes in. And in our understanding, we believe that the acceleration in the gain of market share should not be so intense, so we can focus on our profitability.

But we are always going to work for this balance. A gain in profitability is also conditioned to increasing our market share. And this is the key message for us when we think about the future and when we think about the speed of expansion for this company.

Another important thing that I would like to share with all of you today is some big topics that are affecting the economy as a whole. And perhaps we should detail how these big topics impact Petz specifically, so this tax discussion on tax benefits, et cetera, et cetera. What is the impact that has on Petz?

Zero, pretty much no impact, simply because of the fact that we don't receive any tax benefit that is of significant importance. So this tax benefit discussion is not at all related to our company. It's something that we have already discussed in the past, the discussion with withdrawal risk ("risco sacado"). We don't work with that. Another discussion that is quite strong is the discussion on interest rate. That is quite high and here we have a much more indirect participation and why do I say that?

Well, the situation today is zero net debt, a little bit above, a little bit below, but it's almost like we have no net debt. So this scenario of high interest rates today has a very limited impact in our debt scenario. We don't sell in credit, so this interest rate scenario does not necessarily

impact our sales. Of course, high interest rates have an impact in the economy as a whole and in the purchasing power of consumers as a whole. So -- and for indirect reasons, it affects not only Petz, but the segment as a whole.

Another specificity that is important to mention, so we can contextualize is something that I have been saying since the moment of the IPO. It has to do with how resilient the pet segment is. And resilient doesn't mean immunity, but it means that we are an industry that is a little bit more protected from this adverse scenario. So the industry has still a healthy growth forecast for this year for the industry as a whole. And Petz, by this industry, is going to continue to gain market share, like I said in the beginning. So the combination of these two elements is what I called a double resilience factor that Petz has.

And still going over the macro scenario, we have the DIFAL (default?) element, which pretty much didn't affect us. So, when we are talking about results and I apologize because I'm deviating the conversation, but it's important to cover these big topics related both to the results and to the economy. So it's clear for all investors to understand what are the elements that have an effect on us and what are the big elements that do not affect us.

And some of these have pretty much no impact on our company. I also need to mention one important thing about the deceleration of the inflation rate. In the past months, we have seen the lowest level of internal accumulated inflation. So we are talking specifically about the pet inflation. So we see a deceleration in the inflation rate in a continuous space, and naturally, this is what is going to help us recover the discretionary categories of products.

Just to give you more context on the history of the company, Petz is turning 21 years this year, so we have divided this history into three main moments. The first one, in August in 2002, when the company was founded, the company had all the characteristics of a company that is starting from scratch, opening its first store and that had all the natural characteristics of a business that is just starting. The communication was much more informal, processes didn't have a lot of structure, much more feeling than science, much more general skills than specialist skills, and we carried on like that until 2013, so we have 27 stores, BRL200 million in revenue and receive investments from the Warburg Pincus Fund, which led us to the second part of our story that went from 2014 to 2022, which is the moment when we became more professional as a company. We brought quite intense levels of governance to prepare for our IPO.

We believe, we did an IPO in a very mature level when it comes to professionalism and governance levels in the company. And in this more mature stage, we also did our M&As. And we consider that this second cycle ended in 2022.

In 2023, we are starting a third cycle, which is now understanding that our company today is no longer that company from 2013 when we received our first investment fund, that's when we had our first network, our first chain of bricks and mortar stores. Today we have a huge share of digital sales, companies that were acquired and are being integrated and with this perspective of creating an ecosystem that is going to make sense for consumers, and with this view, that growth comes together, hand in hand with balance. So now we have this clear focus on profitability and cash generation at the same time, and this is the third cycle that we are starting in 2023.

Here we could say that despite the fact that we see sometimes mixed signals, we are very optimistic about 2023 because, like I just said, we see some indication of changes. And probably, this is going to be much more evident in the second half of the year when these signals are going

to be intense. But just the fact that we are already realizing signals that precede a stronger recovery, that's already a pretty good reason to be optimistic.

We started to detect these signals in the end of the fourth quarter. They are being confirmed now in the first quarter, and we hope to see this trajectory continuing. Like all of you know, retail doesn't move on big leaps, there is no button that you can push and what was bad turns good and what was good turns bad. Retail works based on trends, so we are very much paying attention to all these trends and we try to work ahead, so we can correct the trends when they are not moving in the direction that we want them to, and at the same time, so we can notice with a privileged amount of anticipated time, the positive trends on the business. And here, I can say that we are detecting signals that are not so representative in terms of figures, but that probably by staying in the same trajectory will bring a year of 2023 and 2024 for significant recovery.

It's important to remember that 2020-2021 were years that were very much favored by the pandemic. 2022, which was the year of the storm, and now 2023, we start to see the signals that now we have a balance, it's not that abnormal level of demand that we had that we had during the pandemic, but it's not the same conditions we had in 2022. It's a much more balanced business scenario that we see in 2023.

Like I said in the beginning, this level of discipline is evident in our results. We've managed innovation and growth in order to preserve our profitability with a slight gain there. And it's also important to mention that in order to reach all those goals, we are investing heavily in having a cohesive management. Many topics are related to different departments and areas. So now in 2023, our focus is to have different departments focusing on the same thing with similar commercial efforts so our actions are more effective. And this is where data science has been collaborating immensely

So, we are bringing different skills, different areas together with the support of data science. And I can say that even though we spend a lot with technology, we are just starting to reap the results of those investments. So, we have invested a lot in preparing ourselves for this moment, so we would have the possibility to track consumer behavior and understand how they behave and how they choose. And now we start to see the benefits of being able to have that visibility.

Now, focusing on today's meeting, we are going to cover these three topics, the level of profitability for Petz standalone, capturing synergies in the process of integration of the acquired companies, and the generation of cash and more effective capital structure.

So, when we talk about raising the levels of profitability for Petz standalone, a few moments ago, I mentioned this combination of different areas and departments that we work strongly together, so we can make very precise adjustments on what needs to be changed. So we test, we measure, we do control groups, we know exactly what we are going to lose in terms of sales when we apply a certain change. We are able to track this loss of sales, for example, when we change something on the pickup from store, when we remove the discount from the pickup from store, if you look at the isolated piece of data from that, you see, pickup from store is going down. It's natural, if you remove the discount, it's going to go down.

But the data science that I mentioned before is so important because it allows us to track where these customers went to. So part of those customers migrate to the ship from store modality, other part of those customers, they go shopping in our bricks and mortar stores. So they just go to the store and buy their products there, and part of these customers we lose. And that's when

we use all our science behind the contribution margin. We use science to understand the additional costs that we would have from these changes. And what are the advantages for removing that discount in the first place? And how much contribution margin you have lost from the customers that went away and how much the customers that actually go to the stores will generate in terms of margins.

So we look at them, go deep into the details and we can clearly understand if value is being generated or not and we are generating value. But science doesn't stop there because you can have that visibility based on the average or the mean data. But that's not enough. We look at the average but we look at the dispersion that we see.

So we see this level of dispersion per city, per state and that's when we do the second movement. So this tracking is so precise that it was enough for us to understand that, for example, in the city of Sao Paulo, we should remove the service fee from the pickup from store only in the city of Sao Paulo. This is how deep we go into the understanding of data. We saw that in the city of Sao Paulo's value was not being added, but it was something specific for this modality in this location.

So we're talking about the acceleration of capturing the synergies. We have Zee.Now with a very advanced moment. Inside the second quarter, we are going to conclude 100% of Zee.Now being inside the Petz environment. So Zee.Now will become a brand for B2C sales, but fully being operated inside the Petz environment, also from the fiscal perspective inside the Petz environment with all the gains in synergy that that is going to generate.

So, we are pretty advanced, and again, we expect to see the conclusion of this process in the second quarter. And this is specifically important when we remember that the Zee.Now profitability now will become -- or it shows a good trend to have exactly the same margin we have for the pet digital business. When we think about products, we launched the Slim Line, which is that Chinese piece of equipment that we brought to Brazil and that started operation in the mid of the first quarter. It is already manufacturing the Zee.Dog Pad, so we no longer import them from China. This is a reality that started in the end of the first quarter, in the beginning of the second quarter.

And definitely that is going to generate synergies, especially in the second quarter, I mean more intensively in the second half of the year. It's going to be a very important gain for us. Zee.Dog Kitchen continues to be assessed, but we still see an increase in sales, which is essential for us, but especially the level of satisfaction that customers are demonstrating. Because for us, this is the most important thing for us, happy customers with Zee.Dog Kitchen and increase in sales.

Of course, everything is still being analyzed internally. We're still analyzing how profitable this business is as a whole. We know how to do the math, and we will determine how feasible this business will be in terms of scale and the type of product, and this is why business is still being assessed.

An important forecast for the slim pad in the United States, remembering that in the U.S. market 5% of the sales of pads are from the regular pads which was offered in Brazil and Slim representing 95% of the American market. And now we have launched the Slim brand for the U.S. market. We are still on the early steps, but we are highly anticipating the results from the second quarter to see if we can actually penetrate this product category inside the U.S. market.

Talking about products still, with collars, we have Zee.Dog positioned as the best brand. We have launched a better category with the Petz brand, and now we have the Spike brand in the good level. So we have three pricing structures. Better is the 100 reference, and the best is 60% above the better reference and Spike is 40% below. And this is so significant and so important that this category, which is, collars is one of the discretionary categories that already showed clear signs of recovery. It's already growing in-line with the overall growth of the company, which is excellent news because for a few quarters, we hadn't seen growth or growth levels that we're way below the average growth.

And this is a category that is completely ruled by our own brands. We have 67% of share of our private labels when it comes to dog collars in general, which makes this category very profitable. There are some other items to be discussed here, especially the Zee.Dog franchise model. We are still assessing the system. Again, we are very cautious. We don't like to come up with a power point to sell something, if we still need to assess growth possibilities, but we have eight franchisees already. We are assessing their performance.

We are redoing the math with all of them. And if everything is validated in the end, we will accelerate this franchise project.

And this is an optionality that hadn't been mapped initially, but that will become quite interesting as an additional avenue for expansion. This assessment is going to take place in the second quarter, so most likely in the third quarter, we will have an idea already if we can accelerate this franchisee project for Zee.Dog or not.

Now, on the third big block of topics we're going to discuss today, it's important to remember the difference that exists when it comes to cash generation today. Aline, will give you more details on this, but we move from a negative cash generation of minus BRL60 million from the first quarter of 2022 to BRL30 million of positive cash generation in the first quarter. Talking about operational, so what happens? Much more discipline in imports, much more discipline in the generation of inventory and in the replenishment of stores and the full cycle.

So, we are going to continue in this search for better efficiency in logistics as a whole. It's also important to highlight that we raised BRL200 million. We still have a very comfortable cash situation. We are slightly cash positive - net cash positive. And the most important thing, luckily the fact that we don't have no type of hurry to raise these funds allowed us to raise funds at lower rates than at the time of the Americana's case. So certainly, this is one of those rare cases in which the fact that we were not in a state of urgency for finding these resources, even with the situations not being so favorable in the market, we were able to allow at lower rates that we had announced before.

Working capital wise, it's important to mention our improvement in the inventory levels and also our tax efficiency with the new DC in Hidrolandia-GO helping us recover the tax credits we had in Sao Paulo. Now, I would like to hand the floor to Aline Penna and I will come back to the Q&A session. Thank you very much.

Aline Penna (CFO):

Good morning, everyone. I'll talk about the financial highlights for the Petz Group in the first quarter of 2023. Just one comment. We are going to talk more about the Petz Group, why is that. Well, since our integration is quite advanced now, it's going to become more difficult to separate the EBITDA performance of the acquired companies and those numbers for Petz.