Petco Health and Wellness Company, Inc. (WOOF) Earnings Call Transcript & Summary

All right. Good morning, everyone, and welcome to day 3 of Baird's Global Consumer Technology and Services Conference. I'm Peter Benedict, senior retail analyst here at Baird, and very pleased to welcome the team from Petco to the conference. Following his arrival in 2018, CEO, Ron Coughlin, helped lead Petco through a comprehensive business transformation. And the results, thus far, have been pretty impressive. Fast forward to today, Petco has over 1,400 pet care centers, a vibrant omnichannel offering, a rapidly growing vet hospital network and around $5 billion in annual revenue, making them a uniquely positioned scale player in the North American pet supply services and health care industry. The company IPOed earlier this year. They delivered an impressive beat-and-raise a few weeks ago, and they reported their first quarter results, and we think they are well positioned for continued growth and market share in the years ahead. We're fortunate to have Ron here with us this morning. Along with Ron, we have SVP of Finance, Brian LaRose. Ron is going to open with some introductory comments, work through a few slides, and then we will pivot over to Q&A. If you have any questions you'd like me to weave into the conversation, please enter them into the portal. It will show up in my e-mail, and I'll do my best to work them into the conversation. So with that, I'll turn it over to you, Ron.

Thanks, Peter, and thanks for having us. We're thrilled to be here. I realize that some of you are newer to our story. So let me start with a few higher level comments, but I'll start with 3 words that really depict where we sit today. The first is proud. We're proud of what we've accomplished in terms of transforming this business. We're excited about the tailwinds from a category standpoint that, mathematically, will continue into the next decade. And we're confident in our ability to execute our strategy that is differentiated and that is gaining share. If we turn to the next thrilling page, we have included our safe harbor statement and non-GAAP reconciliations in the presentation that's posted to our website. So at your leisure, you guys can have fun with that. Next page. Every company has one of these, but we are truly trying to be a different kind of company, a company that makes an impact in the world around us. Our mission is about improving lives: pet lives, pet parent lives and lives of folks who work at Petco. So we save over 400,000 lives a year through the Petco Love foundation. We got rid of shock collars. We got rid of artificial ingredients. No other retailer has done that. And then just last month, we launched a breaking cancer diagnostic that allows earlier detection of cancer, which then leads to better likelihood of treatment. On the people who work at Petco front, we've had double-digit wage rate increases. We've given 7 COVID appreciation bonuses, parental leave, et cetera, et cetera. So we're very serious about delivering against this commitment, but at the same time, executing to the highest level. So next page. So from a business at a glance standpoint, what you see in the middle is, yes, we are a brand that is trusted. But we were a little bit of a dormant brand, and we've brought the brand back to life. If you look in the top left, 23.6 million active customers, just to give you a little feel. When we started the testing-the-waters process back, I think it was probably November, that number was 18 million. So you're seeing us pick up customers at a quite rapid rate. What we've done, though, is really brought our brick-and-mortar physical assets together with a world-class digital to have a quite unique ecosystem that I will talk about shortly. We have 27,000 partners that are engaged, that are knowledgeable, that give us a competitive advantage. And if you look on the bottom right-hand corner of the slide, what you see is whether you look at it on a 1-year basis or a 2-year basis, the business is performing strongly and is accelerating. Importantly, we were growing 6% before COVID. So we were accelerating already before COVID came. Underneath that, our traffic increases, our retention increases, our share increases. So underneath it are healthy dynamics that will drive continued growth. Next page. So we talk about the only company that has a full ecosystem. That's grounded in a customer insight, and that customer insight is that 50% of customers want a one-stop shop. Owning a pet can be confusing. I go here for food. I go there to get groomed. I go there for veterinary care. We're the only company that can bring it all together because we own vets, we joint venture vets, we have TeleVet, we have vet clinics. We have grooming, we have training. We have own brands, we have exclusives from vendors. We bring that to life in our pet care centers as well as in our now first-class digital offering. I'll direct you to the 11:00 on this slide, if you look at 11:00 there, it's an offer called Vital Care. Okay. Vital Care is the industry's first membership program. Think about Amazon Prime but for your entire life, and so we're focused on Vital Care. After Q1, we announced we were at 70,000 Vital Care customers. As of today, we're at 80,000 Vital Care members. Those members are spending 2.5x more on food. So think about -- or on products. So think about that as a recurring revenue sticky program. Now a couple more double clicks into our recurring revenue. Our recurring revenue customers are up over 50% year-on-year. Recurring revenue customers up over 50% year-over-year. Our recurring revenue is up over 60%. And in Q1, 2/3 of our e-commerce revenue is recurring revenue. So 2/3 of our e-commerce is recurring revenue, just as a little flavor of how serious and how much progress we're making on recurring revenue. Next page. Let's talk about the category. So what you see here is there's a lot of focus on food and even on merchandise more broadly. Yes, food or consumables is a big part of it. But there's a much broader part, which is vet care and the services as well. So vet care is $32 billion, the majority of which is actually vets' hands on pet. So whether those are vet hospitals, vet clinics, et cetera. So if you look at this, you see a category that accelerated. It was a 6% growth category. Now it got projected up to 7% and 8% into the future from a CAGR standpoint. Underneath that are more pets. There were 11 million new pets in 2020. I call that the furry annuity because they're going to need to be fed, they're going to need to be groomed, they're going to need to be -- veterinary care for years to come. It's not like a Peloton. It's not like a garage you do once. This is an annuity for the category and for our business. The other tailwind on the category is the majority of pets were adopted by Gen [ Zers ] and millennials. They spend more than prior generations. So historically, there have been a 4% spend per pet increase. We see upward pressure on that number as well, which is why you see the category growth CAGR go from 7% to 8%. The other dynamic that's happening is there's more larger breeds. Larger breeds means larger bowls. Larger breeds means higher supplies cost. And nobody is better positioned to capture this category growth than Petco. All right. Next page. So what you see here is the delivery for Q1, and we're very proud of the numbers we put up, a 27% top line growth number; margin, up 32 basis points; EBITDA, 46%; EPS, up $0.24; and net debt to adjusted EBITDA, 62%, down to 2.9%. And that was a conversation we had on the roadshow in terms of debt levels. And with our offering, we were able to get that down on post IPO. So we feel very good about the progress and the delivery from a financial standpoint. Next page. So this is the last page, and then we'll get into some of your questions. So when we look at our business, it starts with just a category that has always been strong, that has absolutely accelerated. And once again, it's proven that it has high economic resilience. Secondly, we're the only company with this full ecosystem. And that's what pet parents say they want, 50% say they want that. So we have merchandise. 80% of our merchandise, you can't get other places, so owned and exclusive brands. We have these pet care centers, otherwise known as stores. Once upon a time, people were asking me, "Are they dinosaurs?" It ends up its exact opposite. 83% of our e-commerce orders get fulfilled through our pet care centers. That means they are lower cost and faster to the customer than DC-shipped product. We have a rapidly scaling digital platform that's now first world, 129% growth on a 2-year basis, a mix shift to services that the competitors just don't have, with 63% Q1 growth from a year-on-year basis. And they're active customers. We picked up 1.2 million customers in Q1 on the back of 1 million customers in the prior quarter and nearly 1 million customers the quarter before that. That gives us momentum as our retention of our COVID customers looks like our prior customers. All those elements add up to 10 consecutive quarters of growth, comp growth accelerating. Q1 top line, very strong. And as we sit here in Q2, we are very happy with our comp, and we're very happy that it is able to lap stronger comps a year ago, the further we go into Q2. And so we're very happy with what we're seeing in Q2, even when we start seeing stronger comps. And this gives us confidence in raising the guidance, which we did in our Q1 earnings call. And with that, I think we'll go to questions.

Okay. Terrific. Thanks, Ron. There was a lot there and -- but a great overview of what really is a transformed business at Petco. I think maybe I'll just follow up right out of the gate on that last comment there. And like most of our companies, you guys are starting to face deep year-over-year comparisons. I mean you comped maybe 10%, I think, last year in the second quarter, and then you were kind of mid-, upper teens across the back half of the year. So it sounds like you're pleased right now. Your guidance clearly implies that you believe you can comp to comp. What gives you that confidence? Obviously, what you're seeing right now probably reinforces it. But just maybe walk us through what gives you the confidence in your belief that you can drive positive comps as we look out over the next several quarters?

Yes. Let me start, Brian, and then you can add on?

Yes.

It starts with the category dynamic that I talked about, right? 11 million pets last year, continued accelerated pet adoptions this year. You see 65% of 18 to 34-year-olds saying they plan on adopting a pet in the next 5 years. So strength in the category with spend per pet increasing and upward momentum on that number. We are gaining share, and we're gaining customers. So we gained share across the entire business, and we gained share where we're focused: premium food, training, veterinary, digital. So we see strength there. And then from a customer standpoint, as I said, a million customers in -- nearly a million customers in Q3, nearly a million customers in Q4 and then another 1.2 million customers in Q1 gives us a lot of confidence and gives us momentum as our spend per customer is up. And then the last thing I would say is, sitting here, what we're seeing in Q2 as we are now in higher year ago comps, we're feeling very confident. Anything I missed, Brian?

No. I'd add just that when Ron talks about the customers, we entered Q1 with momentum in our customer base and then added incrementally on top of that. And then when Ron talks about the 11 million new pets in 2020 and coined the phrase of furry annuity, it's not just a cute name for the way we think about it, it's a real economic model. So there are real economics behind that annuity that give us that confidence. And I just -- I'd reinforce what he said about where we are in Q2. We're pleased with what we see in Q2, even as we lap stronger year ago comps. All those customers that we acquired are from the strength of our offering. So we've acquired those customers across digital. We're expanding our capacity in grooming and training. Brick-and-mortar, you saw a strong return in Q1. And then just overall, the sector remains strong. We see continued tailwinds in the industry.

Yes. Listen, that's great to hear. And I think the new customer stats, I mean that's probably the single best indication that Petco is back in the game, right? I mean if this pandemic had hit 4 or 5 years ago, we probably wouldn't be seeing 1 million new customers a quarter accrue to the platform. So you mentioned the Gen Zs and the millennials coming on and how their spend per pet maybe is going to be higher. Maybe dig down into that a little deeper. Is that because they're spending more holistically on all the categories? Is it they're more apt to buy premium or fresh? Or what do you think drives that higher spend across that emerging demographic?

Yes. So one of the macro trends in the pet industry is about humanization, and that humanization trend shows up even more strongly in Gen Zs and millennials. So yes, they're more likely to buy fresh. We love the fresh category. It's going to go from about $750 million today to about $3 billion by 2025, 2026. We plan on being leaders in it. We're a leader today in it with just food for dogs as our Tier 1 offer, but we also have fresh pet and other offers as well. They also buy premium supplies. One of the things we did in the last 2 years is we launched the brand Reddy. So if a millennial is walking down the street with their boxer with a puffer vest on, guess what their boxer has? A puffer vest walking along with it -- with them with their Reddy. And we actually -- the Reddy is flying off the shelf. So there's premiumization, there's humanization trends that are happening there. They're more likely to get veterinary care. So the whole range of services is happening. And there's been many documentation of putting off child rearing. And in many ways, the furry friend is the delayed child rearing, and they get all that love and care.

Yes. No, it's interesting. We're just still at the early stages of these generations kind of entering their -- whether it's household formation years or pet adoption years. So it's certainly a dynamic that's got a lot of legs. You mentioned...

The spend is 1.8x than prior generation. So it's a big deal.

No, that's exciting. You mentioned repeat shop rates look similar. Maybe talk about that a little bit more and what your retention plan -- what your plans are for retention and keeping these customers as we go out over the next few years.

Yes. So our retention -- one of the things we were afraid of was you get all these new customers, and then they would go do something else, right? They were kind of -- COVID changed everything, and they ended up with us or they're forced to us and then we'd lose them, and that's not what happened. Our retention rates are very similar to pre-COVID retention rates, if not going up. So we're very happy with what we're seeing from a retention standpoint. That speaks to the strength of our offer. We did a lot of work. We replatformed our website. We continue to enhance our app, which has over 3 million active users there. So we've done a lot of work on our offer first. We've done a lot of work on our analytics and CRM. The truth is 18 months ago, we didn't have an analytics group. We've built an analytics group with world-class analytics. We've built a CRM organization that's best-in-class as well. So how we're doing those things has changed. But we've really gotten focused on recurring revenue and subscription programs. So my favorite is Vital Care from a recurring revenue standpoint. I talked about 80,000. We only launched it in October. So we are very, very pleased and ahead of our plans. When you bring in a Vital Care customer, 20% of them were new to food and over 30% were new to services. So it's the very definition of a share of wallet builder for us. We also have repeat delivery. I talked about the fact that our e-commerce -- of our e-commerce revenue, 65% is recurring revenue, repeat delivery. So we're strong there. But we also now have subscription programs. So if you're getting groomed, after a certain amount of grooms, you get a free groom. With food, we have a food club now that gets that loyalty on the food. So we're driving these subscription programs that are sticky as well. We also have PupBox. Think about that as the puppy version of BarkBox. And we have insurance offerings that are scaling as well. So a lot of focus on recurring revenue, which drives stickiness. But also for investors, drives predictability.

Yes. No, for sure, for sure. Let's pivot over to the vet hospital story because that's one of the most compelling, I think, value unlocks that is kind of in front of Petco. It sparks a lot of conversations for us with investors, and it really broadens the appeal of the story. It's not just your traditional retail folks that we talk to, it's people who focus on health care, frankly, that has become -- the stock is on the radar screen. So maybe talk about how your strategy in the hospital is differentiated in the market. We always get questions about the ability to source that, so that goes back years. But just maybe talk about the [ recruitment ] that you have and really just what this vet rollout can do for Petco.

Sure. So I'll hit the first 2. And then, Brian, maybe you can talk about the financial impact.

Yes.

So a vet business starts with vets. And anybody who spends any time in the vet business knows that vet sourcing is tight and retention, obviously. So our time to fill is ahead of industry benchmarks and is improving. Our retention is ahead of industry benchmarks and is improving. So at the end of the day, the numbers are there and what we're doing. So why is that? We believe we have a great proposition. First thing is when you go out and survey vets, there's some vets who say, "I don't want to be a part of a big corp," but there's a large part of vets that say "I wanted to be part of something larger and I want to have a safe environment." Particularly COVID, there was a rush to safety. And the fact that we are a larger organization helped us in that people felt safe as you had 1 and 2 vet operators either closing or being on hold. So that was one. Second, as we worked a lot on our proposition, we have flexible hours. So whether you want to work full time, whether you want to work part time, whether you want to work in our Vetco clinics at only on weekends, given that a lot of these people are parenting age, that flexibility is very, very important. Over half, roughly 60% to 70% of that are female, so that flexibility is very important. We've leveraged stock. We're giving the vets stock, which is quite unique in what we're doing. And we allow them to practice autonomous medicine. One of the things that's happened is these consolidators [ come in ] and have done 2 things. One is they're dictating how they practice. And second, because they're paying a lot for these practices, they're driving quotas. Well, if you know anything about vets, they want to take care of pets. And they don't -- they're not the quota driving, driving numbers today type people. So we're providing a friendlier environment on multiple levels, and it's working as evidenced by our time to fill. Brian, do you want to talk about the financial impact?

Yes, let me start with capital. So Peter, when we think about our capital, investing in the vet rollout is right at the top of the list. So investing in the business as a bucket is at the top. And within that, certainly, the vet rollout is one of the key priorities there. And when we look at the economics, we look at it on a stand-alone basis. So we call it 4-wall EBITDA. So when we evaluate the ROI on any individual hospital and we identify these sites well in advance, line them up in a funnel environment, just like you would a sales funnel or opportunities, we lock them in. And then we look at the ROI on a stand-alone basis, which does not include the store lift that we get whenever we put one of these vets in. So we get about a mid-single-digit lift to the store. That's an adder to the economics. We evaluate the economics on a stand-alone basis. It's about a 2- to 3-year payback on each hospital depending on the environment. We are seeing as we roll more of these out that the hospitals that we have been rolling out more recently are ahead of plan. They're ahead of those early cohorts. If you think about the impact that we -- that has on our -- sort of on our economics, we're -- we exited Q1 at 137 hospitals. We got 70 lined up for this year. We are still early days. So some of the hospitals that we launched in the last couple of years are starting to get to full maturity. And when they get there, that's real value for the business. The last piece I'd say, Peter, is this unlocks other elements of the TAM for us. So whenever we put in a vet, that's going to open up opportunities in prescription, insurance. And those combined are about $11 billion TAM. So there's more opportunity as we put vets in the hospitals beyond the store lift for us to penetrate other parts of the market. So it's really attractive.

Yes. No. So sorry, go ahead, Ron...

I'd just add 2 things. One is our CAC is better than anyone in the industry because we have traffic, right? As soon as we open up a vet in a hospital, a vet hospital in one of our pet care centers, we're attracting customers because of the traffic coming into that pet care center. So our CAC is going to be lower than anybody. Our basket is going to be higher because we have other sales when they come in to get their veterinary care, and that allows us to drive our affordable vet care strategy. The other thing is, if you look at the $32 billion I talked about from a vet industry standpoint, where we're playing, the vet hospitals, the vet clinics is the vast majority of that. There's been lots of conversations of TeleVet. We're in the TeleVet, [ nice ] business. They are nice businesses, but they're between $15 million or $100 million of the $32 billion. We're playing where the real meat of the market is.

No, no, terrific. You're also doing some other things in the stores in addition to the vet, Just Food for Dogs. Ron, you kind of alluded to that earlier, the Reddy shops. Maybe just talk a little bit more about what you're doing to invest in the stores beyond the vet to make those pet care centers vibrant and attractive to consumers.

Yes. It is so exciting. As I said earlier, it used to -- when I first started, people would come into my office and say, "Aren't the stores a dinosaur? Aren't you going to shut them down?" We did some pruning of unprofitable locations, but there's a reason they're not stores anymore, they're pet care centers. Because when you go there, they are the salon for pets. They are the doctor's office for pets. And they are where you get advice on health and wellness, similar to if you went to a CVS or you went to a Whole Foods. So these are vibrant locations. But at the same time, one of the most exciting things is they become microdistribution centers. So I talked about the fact that 83% of our e-commerce orders get fulfilled through our pet care centers. So think about that as ship from store, think about that as BOPUS and curbside and think about that as same-day delivery. All are faster to the customer and lower cost than DC-shipped product. So they give us a strategic advantage versus online competitors. That is meaningful, which is why we're gaining digital share right now. And a great example of this is our recently announced fresh. Right? When we ship fresh from a pet care center, it is a fraction of the cost if you're -- versus shipping fresh from a DC. Think about fresh from a DC, you have the box, you have the cooling units and then you're putting the fresh food in there and then you're shipping it via UPS or via Fedex. When I get my fresh food, Just Food for Dogs brought to my house, it's in a paper bag. That's the only packaging that's there. And it's in the back of a DoorDasher, which -- our cost is the same if it was a tennis ball. So we have significant advantages and time to customer and -- off of our pet care center. I should say when we do the vet, add the Reddy and add the Just Food for Dog pantry or run or in some cases, kitchen, we see a significant, significant uplift in box. So it is tangible. Anything I missed, Brian?

No, I think you got it.

No, that's great. And I guess we maybe have 2 minutes left here. So Brian, it's probably longer than a 2-minute conversation. But EBITDA margins, slight expansion is, I guess, the base underlying theme. Maybe just toggle us a little bit gross margin versus your expense, where you see some leverage and what you're doing to kind of drive that modest expansion.

Yes. I think as you touched on, Peter, the guidance that we gave reflected leverage in EBITDA, and that's with investing back into the business. So Q1 was a great example for us. So we saw good leverage across our labor model. So our total store expenses, we saw leverage on the SG&A line as a percentage of sales while doubling down in some areas. So we saw opportunity to lean into the business, particularly in advertising and investments in our workforce. So through our sixth appreciation bonus that we made in Q1, increases in wage rates, double-digit year-over-year, and again, advertising. So those were investments we made on top of the results that we delivered in Q1. And as we look forward, we continue to look for ways to lean into the business more while delivering that leverage. I'd say some of the areas in terms of margin expansion, Peter, for us to focus on, premium and owned brands, and that's going to go across PCCs as well as digital as well as higher AOV from targeted customer engagement. Ron touched on our advantage in terms of fulfillment through our PCCs with digital. That's a large advantage for us from a customer standpoint. It's also an advantage from an economic standpoint. The more we can direct customers and guide them toward BOPUS, that's super attractive for us. The asset at site, petco.com, is becoming a very valuable asset that we're beginning to monetize. More specifically, I'd say that if you look in the services business, we talk a lot about vet. Grooming and training is a great business. That business was impacted last year quite considerably, not just on the top line, but on gross margin, just based on utilization of labor. That labor sits in cost of sales. So it's a very different P&L construct than when we look at the other businesses. So as we get further into this fiscal year and utilization continues to grow, that's going to be a margin benefit for us year-over-year. And then we touched on vets, as those hospitals get to further maturity, that's a lever for us as well. So there's lots of levers, but I'd go back to we'll continue to look for ways to lean into the business to reinvest while looking for EBITDA expansion.

No, that's terrific. That's great. Well, listen, it looks like we're out of time, but great conversation. Ron, Brian, thanks so much for your time. Thanks, everyone, for tuning in. We will have a breakout session here. So if you want to join that, you're more than welcome. But thanks again to Petco, and I hope everyone joins the last day of the Baird conference. Thank you.

Thank you, Peter. Appreciate it.

Thank you, Peter.