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

Good morning, everyone. My name is Oliver Wintermantel. I'm one of the broadlines and hardlines analyst here at Evercore ISI. And it's my pleasure to introduce Ron Coughlin, Chairman and Chief Executive Officer of Petco; Brian LaRose, Senior Vice President of Finance; and Kristy Moser, Vice President, Investor Relations. Thank you for being here today. And I know Kristy and Ron and Brian, you have some prepared remarks for us today. So take it away, please.

Thanks so much, Oli. We appreciate everyone joining us today, and thank you so much for hosting. Before we begin, I'd like to highlight that we've included a safe harbor statement and non-GAAP reconciliations in the presentation posted to the Events section of our Investor Relations website. Additionally, we're aware of the increased trading activity on our stock. Our management team is focused on driving the long-term strategy and continuing to enhance the fundamentals of our business, all while delivering on our mission to improve the lives of pets, pet parents and our own Petco partners. With that, let me turn it over to Ron.

Thanks, Kristy, and thanks all of you for joining us today. I'll start with 3 words. The first is proud. We're really proud of the transformation that we've engendered here. We're focused on purpose-driven performance. From a performance standpoint, we've driven 10 consecutive quarters of growth, and we are continuing to drive growth in the marketplace. And we have structurally transformed this business into a growth business. And from a purpose standpoint, we've had meaningful impact on pet lives. The second word is excited. We're excited at a dynamic category, and we're excited at the growth we're driving and the share we're gaining in that category. And the third word is confidence. We're confident in our strategy. It is unique and it contains structural advantages. And we're confident in the team that's executing against that strategy. We have brought in executives from places like Target, Walmart, Best Buy, PepsiCo, HP, and our strategy is working. So with that, let me get into a presentation that we'll quickly go through and then take your questions. So just about every company talks about their purpose, but there's not many companies that do it in the way we do it. It starts with the fact that we save 400,000 pet lives a year through our foundation. We make tangible impacts on cancer. And in fact, last quarter, we announced OncoK9, a new diagnostic tool for pet cancer that will diagnose cancer earlier, which increases the likelihood of that being treated successfully. At the same time, we look out for our Petco partners and enhance the lives of Petco partners. We gave them double-digit wage increases this past year. We've expanded parental leave to all employees. We had no parental program before, and we continue to enhance benefits across the board. So we are focused on improving a lot of pet lives, pet parent lives and the lives of the folks that work at Petco and making tangible impact on that. Next page. If you look at the business, we have a strong brand, but it had been a somewhat dormant brand. Over the last 3 years, we brought it back to life. We have 23.6 million customers, and over 80% of them are Petco Pals members, which means we have incredible data on those customers. We've significantly enhanced our digital experience and more and more that is interacting with our pet care centers, formerly known as stores. They're not called stores anymore because they are the salons for pets. They're the doctor's offices for pets, but they're also micro distribution centers, providing us with competitive advantages. Speaking of competitive advantage, our folks who get up every morning and go into our pet care center, provide tremendous advice and are so passionate about taking care of pets are also a competitive advantage. And what you see is our strategy is working, whether you look at it on a 1-year basis or you look at it on a 2-year basis. Our growth has been accelerating. Importantly, we were growing prior to -- 6% prior to COVID. We grew 4% in 2019. So this has been on a steady acceleration path. And if you look in the top left corner, we added 1.2 million customers last quarter, following 1 million customers the prior quarter and nearly 1 million customers the quarter before that. That acquisition of customers that we're retaining and who are spending more with us drives this growth into the future. Next page. So our -- the core of our differentiation is our strategy. Our strategy is rooted in customer insight. 50% of customers are looking for a one-stop shop. Today, you go for food in one place, you go get groomed in another, and you go get your veterinary care in another. We are the only company that brings that all together under one roof, all with either owned or joint-ventured assets. So we have hospitals, clinics that we bring into our pet care centers. We have grooming, we have training, we have owned brands. We get exclusive from vendors. We bring that to life in our pet care centers as well as in our digital offers. And more and more of those are coming together. As I said before, 83%, 83% of our e-commerce orders are fulfilled through our pet care centers. That means they are faster to the customer and lower costs than our online competitors. And then if you look at 11:00 on this sheet, Vital Care. Vital Care is the industry's first membership program, providing benefits across checkups, vaccinations, grooming and discounts on merchandise, $19 a month recurring revenue offer. We launched it in October. End of Q1, we talked about being at 70,000 customers or members. Today, we're at 80,000 customers. So that continues to grow at $19 a month per customer. Next page. So we talk about vet as being a pillar of our strategy. If you look all the way over to the left, the vet TAM is $35 billion. We are focused on vet hospitals, we're focused on vet clinics. Yes, we also have a TeleVet offer. TeleVet is $100 million or less than $100 million of that $35 billion business. So we're focused on the largest part of the business, but we have offers across TeleVet, mobile clinics and full-service hospitals. We're currently at 137 hospitals, headed to 900 hospitals. You can see all the way to the right, the return is strong. And importantly, when we come in and we put a vet hospital, we're seeing a 4- to 6-point lift in our center store merchandise sales. Let me repeat that, we put in a hospital, not only do we get the hospital revenues and the financial dynamics you see on the right, but we get a 4- to 6-point lift in center store sales. So it's good and even better. And I should add that our customer acquisition in our veterinary business is best-in-class because of the traffic we organically have coming through our pet care centers. Next page. So I talked about 83% of e-commerce orders being fulfilled through our pet care center. This generates a structural advantage. We have curbside, we have BOPUS, we also ship from store. 67% of our e-commerce orders are recurring revenue. Let me repeat that because there's been some misinformation, 67% of our e-commerce orders are recurring revenue, repeat delivery orders, which means they're sticky. And it also means it is predictable revenues. And then if you look all the way to the right, I talked about the fact that when we fulfill through our pet care centers, we are faster to the customer and lower cost. So on a 2-day shipping versus our online competitors, what you see is they probably have a little bit of an advantage because of increased scale through that fulfillment option. But if you look at next-day delivery through our pet care centers where we do ship from store, we have a significant cost advantage. And then same-day delivery, very, very difficult for them to compete with and particularly on fresh food, where same-day delivery is going to be particularly appealing from a customer standpoint. And if you're shipping fresh food from a DC, it's very difficult to generate margin as you have significant cardboard, significant cooling, not to mention, obviously, the FedEx or UPS costs there. So we have structural advantage through our fulfillment or pet care centers. It used to be -- I used to get this question, "Are your pet care centers a dinosaur?" It's actually the exact opposite. They're providing tangible structural advantage for us. Next page. So if we talk about the pet category, it's a story of being a great category that just became an exceptional category. 11 million new pets in 2020, with continued acceleration in pets coming into homes in 2021. Importantly, it's not all just new pet homes. It's second, third, fourth and even fifth and sixth pets in homes. So forecasters have taken their long-term growth CAGR up to 8%. They've taken 2021 projection up to 8%. And within that market, we have proven and consistently gained share. The other dynamic beyond number of pets is spend per pet. And we now know that the majority of pets adopted in 2020 were actually Gen Zers or millennials. Well, why is that significant? It's significant because Gen Zers and millennials spend more than prior generations on pets. So that will put upward pressure on spend per pet, which has historically been an increase of 4% per year. Next page. So if you look at the financials that we put up last quarter, we did a beat and raise. Let me repeat that, we did a beat and raise, 27% revenue growth; margin expansion; 45% adjusted EBITDA, EPS, plus $0.24; and net debt, we improved our debt position to 2.9x, which had been a question. So we feel comfortable that we've made progress there as well. So strong financial performance across the board, ahead of -- as I said, beat and raise. Next page. So this will be my last slide. If you look at our story in aggregate, we have a phenomenal category projected to grow 8%. And once again, it has proven it is a category with high economic resilience. Whether times are good or bad, people are taking great care of their pet and now taking even better care of their pet. We're the only player with this fully integrated ecosystem. Of our merchandise, 50% of our merchandise can't be found in other places so we're insulated from some of the commoditization pressures that other competitors have. Nobody has the amount of business that we have in owned brands and exclusive brands combined. Our pet care centers, formerly known as stores, are now providing us strategic structural advantage as well as more and more becoming services centers. We have a digital platform that is more profitable and growing faster than our online competitor, and we have 129% 2-year revenue growth on a 2-year stack. We're mix shifting to services with a 63% year-on-year revenue growth. And I should add that our services have a positive overlap dynamic as some of the COVID lockdowns impacted services a year ago. So there's a positive lap dynamic on our services business. And then our customer dynamic, which is what puts the biggest smile on my face. We added 1.2 million customers. We have 23.6 million. We increased our recurring revenue customer base by 50%. We increased recurring revenues programs by 60% in Q1. And we have strong growth in multichannel, meaning they don't just buy online. They buy online, and they buy in brick-and-mortar, they buy food plus they buy grooming. So we have strong growth and strong headroom in those areas. All of that delivers momentum in our business. 10% -- or sorry, 10 quarters of comp growth that's only accelerating. Our top line growth translated to strong bottom line growth in Q1, and we have strong category growth, which has provided us with the foundation to raise our guidance for the full year. With that, I think we'll shift to questions.

All right. Ron, thanks very much for the presentation. And I think for the people that saw you first time, it shows how excited you are about the company and about the category. So thank you very much.

So let's start with the question that we are asking many of our companies that are participating in our summit this year. So consumer behavior has changed during the pandemic. And Ron, which of those consumer behavior changes do you think are the most sticky going forward?

Yes. So let me go back to the customer dynamics that I talked about. We had a lot of the new pets being adopted by Gen Zers and millennials. That means they spend more. That means that the pets, instead of being in the backyard, instead of just being in the houses, pets are in the beds with their pet parents. And so if they're wearing a puffer vest, so is their boxer walking next them, wearing a puffer vest -- a ready puffer vest. If they're having fish and sweet potatoes, guess what, their pet is having fish and sweet potatoes, which is what my dog, Yummy, has every single night. So there's a dynamic of premiumization happening. The other thing that happened with COVID is the bonding of pets. I'm a firm believer that pets were a big reason why emotionally, America was able to get through this COVID pandemic dynamic. And so they are having them groomed more often. They're taking better care of them from a veterinary standpoint. So there's more care being given to pet. So you have kind of premiumization and better care, which translates actually for us into more services. The last thing I would say is this trend towards sticky recurring revenue relationships, which we believe we're best positioned to go capture because we are the only company that has the holistic offer. But I'll pass it to Brian. Anything I missed in that answer?

No. I think -- well, I'd say the multichannel component is huge. So when you talk about consumer behavior specific to this sector, Oli, we're seeing that trend accelerate. So 50% of customers are looking for a one-stop shop. We're the only company positioned to be able to satisfy customer needs across a true omnichannel experience, and within that omnichannel experience, to be able to get product to customers when they want, how they want. So the capabilities we have through our digital fulfillment across BOPUS, same-day ship from store, ship from DC are meaningful and intangible. So I think we're meeting that customer need head-on.

Got it. And maybe related to that, you guys IPO-ed more recently. You guys are relatively new to Petco. But when you hear customers talk about Petco today, what is different from when you joined the company, what people are talking about Petco?

So Petco was a company of 27,000 passionate partners who showed up every single day to do best thing for pets. And that's the strength, and that's part of the magic sauce of the company. But in many ways, we -- there were 2 dynamics that were holding us back. One was we were kind of, "Let me help you with that big bag of dog food into your cart" company. And secondly, we were a little bit, 5 or 6 years ago, maybe this Internet thing is not going to happen. And so we were -- a laggard on our digital offering. I have -- I came from tech. I was President of HP's PC division. So I know tech pretty well. I've never seen a tech build-out the way that it's happened at Petco in the last 4 years. And it started before me in fairness. Whether it is buy online, pick up in store, whether it is ship from store, whether it is in app that now has over 3 million downloads, whether it is curbside, whether it is same day, whether it was going from the slowest website to now either the fastest or equal to the fastest, whether it's closing kind of SKU and pricing capability gaps, we now scrape multiple times a day just like the world-class e-commerce businesses. We have shifted our digital capabilities massively. We've brought in people from places like Amazon, places like Jet.com, et cetera. And the results speak for themselves with 129%, 2-year stack comp. So we were growing before COVID, roughly 30%. And obviously, that accelerated during COVID, and we're pleased with what we've seen in Q1 and Q2. So that's shift #1. We're now a digital company that now linkages into the pet care center. From a pet care center standpoint, we've completely transformed. We brought in leadership from places like Target, places like Best Buy. And we taught our folks that it's okay to sell. And I don't mean sell in terms of selling not the wrong stuff. It's okay to sell better food. It's okay to sell better products because you're doing the right thing for pet. And our tenet has been when we do the right thing for the pet, the right thing for the company will follow. So we're taking better care of customers from a merchandise standpoint. And then the last thing I would say is being a true health and wellness company. So we completely reconstituted our grooming business. We had a negative 7 grooming business. Now we've been a double-digit growth grooming business and providing a better experience where we have satisfaction scores above 9 there. And then bringing in vets into our pet care centers transforms perception. So long answer to your question is number one -- whoops, wrong finger. We're now a health and wellness company, and we're hearing that played back to us that they're leading. We're the first ones that got rid of artificial ingredients and still the only ones who got rid of artificial ingredients. We're the only ones who got rid of shock collars. So we're the ones that are looking out for pets and customers are noticing.

Got it. And I think that's a good transition to talk a little bit about the numbers here. And you mentioned in your presentation that Petco added about 1.2 million net new customers in the first quarter alone. And I think you said that it was about 1 million in the quarters before that, and spend per pet was up 5%. So where's the strength coming from? And how do you plan to keep those new customers that you gained during the pandemic?

Brian, you want to...

Yes. I would say, first of all, Oli, it starts with the type of customers we're acquiring and how we're getting them on. I'll start with digital. We have made significant investments in our digital capabilities over the past couple of years. We've leaned into that business from an infrastructure and innovation standpoint. And make no mistake about it, that engine is a customer acquisition machine. So we're acquiring lots of customers across the ecosystem. The investments in digital are paying off. The customers we're acquiring are not only good in terms of numbers. The type of customers that we're acquiring is meaningful. So we -- for the third quarter in a row, we grew multichannel customers double digits in the first quarter. So it's the third quarter in a row that we did that. Those customers spend 3 to 7x more, they have significantly higher retention rates, their loyalty scores are significantly higher. So the type of customers gives us a natural hedge against those retention levels over the -- and that includes the 3 million that we've acquired over the last 3 quarters. So that's kind of -- a key component of it is just the type of customers that we're acquiring. We also -- going back to some of the things Ron talked about, the different company that we are. The vet build-out is meaningful. We're attracting customers 2 ways through those vets. We're getting new vet-only customers coming -- switching from their current vet providers. Also, the customers that we have who are in our vet practice are giving our same-store sales a lift of mid-single digits. So those vet customers are scaling across those channels. So it's beyond the net new that we've acquired. It's the existing customers scaling across the different channels through vet, through our digital fulfillment capabilities. As we bring customers in through digital, we give them different options in terms of how and where they get their products so we can meet them where they want their product, how they want their product, when they want their product. So it's a number of different things. I don't know if -- Ron, if you'd add anything to that.

That's good.

And so maybe the next question is maybe a leading question into your growth initiatives that you have. But maybe before that, maybe can you comment on the traction that you're getting with recurring revenues because that's a word that comes up within the pet industry a lot, right? And so the traction that you get with that? And how do you want to grow that or keep that going?

Yes. You put a smile on my face asking that question because it is a significant, significant focus for us. So let's start with the offer that's been in the market. It was critical for us to have a competitive repeat delivery offer given our online competitor. We have closed the competitive gap on that. Our satisfaction is equal, if not exceeding, to competitors on that. 2/3 of our e-commerce business is recurring revenue. Very similar to our online competitor. Our recurring revenue business overall is growing -- grew 60% in Q1. So we are shifting customers into a recurring revenue program. So that's kind of a me versus competition. The pull-away move is Vital Care. Vital Care is exactly what customers want, and it's a manifestation of our strategy, which is complete care for your pet for $19 monthly fee. And the fact that we're accelerating at the rate we are speaks to the strength of the offer. And as I said, we went from 70,000 at the end of Q1 to already at 80,000 sitting -- 80,000-plus sitting here in Q2. So we're very pleased with that. Beyond that, we're just getting started in insurance offers, and we're closing the gap versus the leader in pet insurance. That is a scale market. We have PupBox that has been growing like a weed, and many of you might be familiar with the competitor in the adult box. And obviously, that's an interesting adjacency. So we're very pleased with our recurring revenue. And our recurring revenue customer base, which is how we're looking at things more and more now, was up 50% last quarter, which just speaks to the strength of our future.

Got it. And so yes, maybe shift a little bit to multichannel, one of your growth initiatives that you're talking about. So for online penetration, I know you don't give the exact number. We think it's probably in the low teens percentage, but it's an Evercore ISI estimate and -- which I think is still below the industry average, right? So how do you believe you can -- well, first of all, do you think you can grab market share in e-commerce going forward? And if yes, how do you plan to do that?

Yes. So I'll start and then Brian can add in and give some dynamics around the multichannel customers. So in this instance, it doesn't matter what I think. It matters what we're doing. We're gaining e-commerce share. We've been steadily gaining e-commerce share, and it's because we have -- for 2 reasons. All the upgrades that I talked about created a better experience and better assets to capture it. And then secondly, we have structural advantages, right? We're faster to the customer for lower cost. That is a structural advantage versus online players. And then one of the dynamics we haven't hit on yet is the pet industry still has regional pet specialty players with between 10 to 100 to 300 stores. Those players have underdeveloped e-commerce. So we've seen a shift from those players into our franchise. One of them went out of business in January or December, called Pet Valu. We picked up a bunch of their customers. So there's continued consolidation with regional pet specialty players that we take advantage of. So if you segment out the digital business, we estimate 39% of customers are omnichannel customers. They want to shop in both a digital and a pet care or a store, and 29% are digital only. For the 39% that are omnichannel, we're the best offer. We have the best offer. It's integrated the best across digital and pet care centers, and that is working. For digital only, if you're a digital-only customer and you want same day, guess what, you got to come to us. If you're a digital-only customer and you want to do BOPUS, guess what, you have to come to us. If you're digital-only customers and you have to -- you want to do curbside, guess what, you have to come to us. So we have advantages in the digital-only as well. But maybe Brian will build on the...

Yes. Yes, I'll add a couple of things. I mentioned retention early, Oli. Retention rates for multichannel customers versus single-channel customers are about 25% higher. And for us, our retention rates within digital are up about 46% year-over-year. So we're actually seeing that retention accelerate across multichannel and within digital. A couple of quick examples of sort of how we've tackled this. If you go back to the onset of the pandemic, we launched curbside. You go to the back half of 2020, we launched same-day delivery. Our early customer suggest that 40% of early adopters prefer same-day delivery. 83% of our fulfillment is through the pet care centers, not through the DCs. The ability to offer customers choice, whether they want to go to the store and pick it up through BOPUS, whether they want to ship from store in a day or 2, whether they want same-day delivery, is a strategic advantage for us. Same day is a strategic advantage for us versus a pure online competitor, something that they can't offer, something that's only going to separate even more as fresh continues to scale. Within fresh, we have a competitive advantage to deliver fresh same day, both from a customer standpoint and a cost standpoint. And so going forward, we're going to continue to lean into our digital capabilities in terms of investment. We're going to scale out our vet capabilities. That's not only a services play. That is a multichannel play. Make no mistake, vet is not just a services play. The lift that we're getting in our stores is real, it's meaningful, and that's part of the strategy around scaling vet, is to scale beyond services and get that stickiness across multichannel.

Okay. And we have about 5 minutes left. So I just want to -- one more question on multichannel, and then I want to shift to what you just mentioned on vet because I think that's important to your story. But the multichannel initiatives, and I think you gave some statistics about what a single-line customer spends versus multichannel, I think that's important to talk about. Maybe just a couple of minutes on that, how important that is.

I'll hit it quickly because I do think it's important to get to vet. So our multichannel customers, first of all, definition, when we say multichannel, it's either you purchase in brick-and-mortar and online or you're multi-category, meaning food plus grooming or food plus training or veterinary. So those -- that's the definition. It's been up double digit 3 quarters in a row and -- number one. And number two, we're approaching -- we're getting close to 4 million customers. But out of the, what, I think we showed 23.6 million in the beginning, we still have lots of headroom. So we're proving we can move it. We're proving that it increased -- that there's an exponential value out of those customers, but we have tons of headroom.

Perfect. And then yes, shifting to vet in the remaining time. Maybe you can talk a little bit about your growth strategy here in vet clinics, how many you open up per year, how many you have, what the goal is. But then also, you've done that now for a couple of years, opening vet clinics. So what have been the learnings and, maybe for Brian, maybe the financials of the four-wall EBITDA lift and the rest of the store lift, if you may?

Yes. I'll start and then Brian can -- so this is one of 2 transformational moves. The first one was digital. The second is vet. As we said, we're up to 137. We're ahead of our financial models. We like the volume coming through the vet. We like the center store lift. We have best-in-class CAC because of the existing customer base when we bring these in. And we are delivering against our mission because we have affordable vet care, and 70% of pets don't get the care that they need. So this is a win-win. We're focused on vet hospitals, but we also expanded our vet clinics where we do checkups, vaccinations, et cetera, on weekends to fill in where we don't have hospitals. Nobody else has that. One of the key pieces of that is that means we have thousands of vets that are signing up for these clinics every weekend. That means it's a feeder system for our vet hospitals, and getting veterinarians has been the issue for expansion of vet. Hospital businesses, we'll do the fastest vet hospital build-out in history. We're in the middle of the fastest vet hospital build-out in history. And our time to fill with vets is ahead of benchmarks. Our retention is ahead of benchmarks, and both metrics are getting better. And I'll pass it on to Brian on the financials.

Yes. Let me hit the financials quickly for you, Oli. So when we invest in a vet, it's roughly $0.5 million in terms of an investment and then -- and that's at the onset. We get to breakeven at about year 2, year 3. That's kind of the initial model. That's how we've modeled it, and we've kind of held that. And then it becomes accretive kind of year 3 and on. Now what I'll say to that, though, is that's the way we design the model. The ROI is very compelling along that model. But as we continue to scale vet, more of the recent cohorts that we're launching are ahead of that model. So one of the -- you asked about learnings, one of the learnings is we're getting better at it. So initially, more of our hospitals were through a JV model. We were new to the industry. From a learning standpoint, that was the right way to go. This year, the 70 that we'll do will be more owned than through the JV model, and that will be the model going forward. We believe that the joint venture still gives us leverage and the ability to scale. But the four-wall EBITDA model, and Ron showed it as we walked through the slide, $1.5 million at maturity with a 20% four-wall EBITDA is what these hospitals are. We're early. We're only a few years into this so we don't even have an abundance of our hospitals at full maturity. We're going to continue to lean in. We're going to continue to build out. Some of those early hospitals are reaching full maturity, and the ones that we're launching more recently are ahead of the models.

Very good. It looks like we have about 1 minute left. So maybe Ron, I hand it over to you for some closing remarks, if you have any.

Yes. We really appreciate you engaging with us. And for those of you who are holders, we appreciate your confidence in us. As I started, we've transformed this business into a growth business, grounded in the fundamentals, the fundamentals of a differentiated strategy with structural advantages, grounded in world-class people delivering results every single day and grounded in a mission. It will be very hard to find a company that is doing what we're doing. It's quite unique where we have a major impact on the world around us. We save 400,000 pet lives a year through our foundation, something that makes us all very proud. We are taking care of our folks, double-digit wage increases, COVID appreciation bonuses, things like parental leave in terms of enhanced benefits. But at the same time, we are striving to execute at the top of corporate America. And our results say that we're on our way to being that type of executional company. We take it very seriously. We take our -- your investments in us very seriously, and we are appreciative of them.

Thank you very much.

Thank you, Oli.