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

Good day, everyone. I'm Steph Wissink, Senior Research Analyst and Managing Director from Jefferies consumer team. Thank you for joining us for our virtual pet care summit. And joining me on screen at this point is Petco, the senior leadership team, including Brian LaRose, the company's CFO; and Mike Nuzzo, the company's Chief Operating Officer and President of Petco Services. Thank you guys for joining me today.

Thank you. Thanks for having us Stephanie.

The first question we wanted to start with or maybe the first topic is really just to level set. There are going to be a number of folks that are watching this that are unfamiliar with Petco, particularly those investors from side the U.S. Talk a little bit about the business, the positioning of the business in the broader pet landscape, and then we'll dive into some trends thereafter.

Yes, sure. I mean would it be helpful, Stephanie, for me to walk through just a little bit of an intro with a few slides or...

I think that would be great. Yes, you've got those up. Yes.

Okay. Well, let me thank you again for inviting us today, and thanks for everybody for joining us. We're excited to be here, and I am excited to give you a brief overview of Petco, and then we'll dive into that Q&A. Before I begin, please note that we've included a safe harbor statement and non-GAAP reconciliations in the presentation posted to the Events section of our website. And with that, let me kind of dive right in. So we fundamentally believe that we have the best, most differentiated model in the pet category. We're focused holistically on pet health and wellness, delivering a full spectrum of premium products and services to meet the needs of pet parents across multiple channels that can't be matched in the industry. We have an end-to-end integrated multichannel experience that is grounded in customer insight, with 50% of customers looking for a one-stop shop part to life in first-class digital assets with a nationwide physical network. Petco has several distinct competitive advantages, things like a leading position in services, which drives traffic and center store lift. Our integrated multichannel ecosystem offers distinct competitive advantage that allow us to capture greater share of wallet, build greater loyalty and fuels our growth. Our breadth and depth of products and services provide us a singular view of the customer. It gives us a competitive advantage with a customer base that over-indexes in the highest quality-seeking and spending customer segments. We've built Petco into a proven brand winner with a complementary portfolio of owned and premium brands that differentiate our merchandise offering and provide a competitive moat. Our integrated multichannel ecosystem is a structural advantage with a nationwide footprint of almost 1,500 pet care centers and 27,000 partners. These pet care centers double as micro distribution centers, offering differentiated fulfillment capabilities such as BOPUS, curbside and same-day delivery, which are faster to the customer with lower cost to deliver helping drive 150% digital growth on a 2-year stack. We offer a full spectrum of services like grooming and training and veterinary care to meet all of our pets' needs. We have over 1,000 Vetco clinics with 155 full-service vet hospitals that deliver 4-wall adjusted EBITDA margin of 20% at maturity, plus a mid-single-digit center store lift. We also have best-in-class digital assets that are scaling. Our position is further strengthened by our significant growth in recurring revenue and loyalty, driving higher customer spend. We're driving significant growth in this recurring revenue segment with revenue customers up over 50% versus last year and revenue recurring customer revenue up over 60% versus last year. We also just announced that PupBox will offer a new lineup of boxes designed for the specific needs of the varying stages of dogs' life cycles in mind. This extension provides pet parents more convenient, easy ways to care for overall pet health and wellness while further strengthening our recurring revenue model. Also, we recently launched Vital Care, which is the industry's first whole health -- first comprehensive whole health membership program, and it is resonating with customers and driving share of wallet. For $19 a month that covers checkups, vaccines, grooming services and merchandise discounts. We're up to 100,000 customers today, with over 3x higher spend versus the average customer and 25% of them new to food, 36% of them new to services. The power of this ecosystem and continued investment in the marketing flywheel resulted in 1 million net new active customers and 11 quarters of comp growth, including 30% growth on a 2-year stack basis last quarter. Importantly, we expect these customers to be a source for sustainable growth going forward. Overall, our continued outperformance reflects the traction of transformation and stickiness of our differentiated model. And all that differentiated position is supported by an exceptional category that is large and growing. Research is calling for 2021 growth of 9% and 7% projected go-forward CAGR through 2025, driven by growth in both the pet population and increasing spend per pet. Looking ahead, the category strength plus traction within our strategy gave us the confidence to raise guidance again in Q2 on both the top and bottom line with 12% EBITDA margin flow through. With that, let me turn it over to Mike to dig in a little bit more on services.

Thanks, Brian. The pet health and services space is a $50 billion total addressable market in the United States. It's one of the fastest-growing parts of the pet industry. And it is a very important part of our ecosystem approach. It gives us the ability to grow our share of wallet. It drives additional trips to our pet care centers, what we used to call stores, today pet care centers, and it increases our basket. And so overall, it is an important linchpin in our position as a leader in pet health and wellness. We have been growing and scaling in the pet health and services space. In 2018, we completely invested and turned around our grooming business. Today, we're gaining share in a very strong growth category, and we've got plenty of headroom for growth. We've also been able to recruit and drive our grooming staffing numbers to the highest level that we've had in the history of our business. In training, last year, we pivoted and added to our training offerings online training services that have been scaling very quickly. And our vet stack is really like no other in the space. We offer full-service vet hospitals, as Brian referenced. And we have grown our mobile wellness clinics that we have at our pet care centers on a weekly basis to over 1,000 locations each week. This is a $35 billion total addressable market, and we are growing and having a distinct advantage in the space with our digital tools and offerings like TeleVet. Overall, this is a space that is highly fragmented and has local players in the space where our sophisticated approach to marketing, technology, data analytics and HR give us a massive advantage. And at the end of the day, across all of our services businesses, it's about being the employer of choice and having a great partnership with our groomers, our trainers and our vets as we drive the business forward. Let me double-click into the vet space. We have 2 major growth vectors as we mentioned. We have an expanding wellness vet clinic program that we do in our pet care centers each week. We've recently grown that offering from 800 locations to over 1,000 locations each week. And this service offers to customers affordable vaccinations, well check visits, Rx sales and more. In 2017, we started to open full-service vet hospitals in our pet care centers, providing everything from checkups, to surgeries, to diagnostics, lab work, emergency care, and we have quickly expanded to over 155 locations today. With the success of our full-service vet hospitals, we are expanding and embarking on the largest vet build-out in history. We are on our way to 900 locations, and we're gaining momentum. Our model and experience to date shows that these hospitals are scaling to roughly $1.5 million of mature revenue and driving a 20% 4-wall EBITDA margin within our pet care centers. And when we put a hospital in our pet care center, although we're dedicating 1,500 to 2,000 square feet of existing space to put the hospital, we have actually seen a lift in the rest of the store sales, mid-single-digit achieved in year 1 and another point to 2 achieved in year 2 and year 3. So this strategy equates to an overall massive productivity enhancement for our chain. We intend to open roughly 70 hospitals a year, and as I mentioned, grow to 900 across the chain, which gives us a $2 million productivity lift in each of our pet care centers where we put a vet hospital. Beyond hospitals, we're also focused on prescription drugs, which comprise $8 billion of total addressable market and prescription food, which is $3 billion in total addressable market. We've historically been underdeveloped in this space, and we have a significant opportunity to just leverage the synergies that we have by cross-selling from our vet services into prescription. And we see significant momentum online in Rx. And so it's a space that we feel like we can have a big opportunity for growth in 2022 and beyond. Now I'll turn it back over to Brian to close. Brian, you're on mute.

Excellent. Thank you, Mike. That makes it better. Just a few more comments from me. So Petco is a purpose-driven company, and purpose is part of our DNA. We're on a mission to improve lives, improving the lives of pets, pet parents and our partners in the communities we serve informs every decision we make. It's not an either/or thing at Petco, the decisions we make that are best for pets are also the best for the business. Our unwavering commitment and actions over the history of the company make a tangible impact, taking a leading position on pet nutrition, health and ethics. We've saved over 200,000 pets from euthanasia just in the first half of this year alone. We have reunited hundreds of pets through Petco Love Lost and through our Petco Love partnership with Merck, we've enabled 1 million pet vaccinations. To close, I'll just tell you that a 30% 2-year comp with strength across each of our areas of focus is a testament to the strength of the team and unique health and wellness ecosystem that sets Petco apart. Customer acquisition engine has been in high gear, strengthening loyalty, gaining share in focus areas and delivering differentiated offering of premium products and services. And we remain strategically positioned to drive top line and adjusted EBITDA growth, including margin expansion over time through strategic initiatives. And make no mistake, our leadership team is executing. Our partners are executing, and that's showing up in our strong results. We're confident that the execution of our strategy will sustain momentum, creating value for shareholders. And with that, let's move to Q&A.

Brian, Mike, very helpful. I want to start out with some of the comments from your recent earnings report. You talked about it, and you actually just mentioned it in your remarks, continued momentum in the business into the early part of the third quarter. Talk a little bit about how that shapes your outlook for the back half? And then as you think about the biggest opportunities, maybe it's by category or by service proposition, over the next couple of years, what should we be watching for as key drivers of the growth?

Yes. I can start on that one. So let me first start about sort of what's been driving the growth this year and what gives us confidence in that back half. I'd say, Stephanie, that it's a number of things. 4 -- 5 things. First, I think a lot of the stuff that I talked about, our offering is resonating with customers, and we're gaining share. Pet parents are engaging with us all the way across our ecosystem. Pet adoptions continue to be strong, and we've added millions of net new customers. Second, when we talk about being a brand builder in premium and super premium, it is a differentiated position for us. And those products drive some of the highest AOV in the industry, particularly in an area like Fresh, where we're #1 in pet specialty. I'd say third, what Mike touched on, the fastest pet build-out in history. So this is a big deal for us. 155 vet hospitals, on our way to 900. We are just 3 years into this. And what we're seeing so far is the more we -- the more hospitals we build, the better we get at it. And this is scaling and giving us added revenue and those hospitals are starting to get towards that maturity level. Number four is recurring revenue. So I mentioned that the recurring revenue is up 60% year-over-year. And I would have to touch on the category. The category remains strong. And look, there were a lot of questions about whether this was kind of a 1-year phenomenon last year. We don't see that. The category is projected to grow this year at 9%. You look forward 5 years, it's a 7% CAGR. And that's based upon sort of run rate pet spend with a little bit of a bump. We see the category remaining strong. All these pets that get add -- 11 million pets got added last year, 11 million pets off of a base of normally somewhere in the 3, 4, 5 million range, historically, 11 million pets. Those pets are going to have to be cared for, fed, groomed, have vet services all the way through their end of life. So that is an annuity for us. We've kind of jokingly called it a furry annuity, but it's serious. So those are kind of some of the things that are fueling that growth. If you look forward in terms of categories, one of the things we talked about in Q2 and Q1 is going one double-click underneath sort of that merchandise level. I mentioned those 11 million pets last year. In a pet life cycle, you see year 1 where there's sort of an over pivot towards supplies. You need to get a dog bed, a crate, et cetera. As that pet grows, it's not that, that spending goes away, but the pet grows, you suddenly start to need more consumables. And we're seeing that dynamic play out. It actually played out exactly as we anticipated. Last year was a huge year for supplies. This year, we still had very strong growth. Q2 is an example on supplies. If you look at supplies and companion animal growth combined, that was high single digits. Consumables was more than double that, which was what you would expect in that life cycle. So I'd say in the back half, you'd -- we'd expect that trend to continue, where consumables growth is sort of outpacing supplies in particular. But look, we're well positioned. The category is growing, and we're taking share.

I think this is really an important distinction because clearly, we have pet retail in mass, in grocery and specialty in vets. And you've really created a unique curated assortment. So I also want to give you a chance, Brian, or Mike if you want to jump in here too, to just refresh everyone on the statistics around what percentage of your business is unique to you. And as you think about that premium and ultra premium, the pipeline of innovation and newness that you're seeing, whether it's in fresh food or raw or other attributes that you think can complement your curated assortment to continue to give you that merchandise edge? Just talk really briefly about that component.

Yes. Let me hit the assortment and Fresh, in particular, and then maybe Mike can talk a little bit about what that means from a services standpoint. So over 50% of our assortment is either own brands or exclusive to Petco. And that is a differentiator for us, particularly when during the environment we are in right now where demand is sort of outstripping supply in certain areas, it's not to say that there haven't been sort of pockets of challenges for us in the supply area. But when you have an assortment that's over-pivoted towards unique to Petco, it does give us a bit of an advantage. The other thing when I closed a little bit talking about purpose and said purpose is part of our DNA, we mean it. If you go back 3 years ago Mike, keeping it honest, 3 years ago we made the decision to remove artificial ingredients from our shelves. Now at the time we did that, we had some products on our shelves that were #1, #2, #3 in terms of shelf space. So that was a bold move, but it was something we believed in because we believed it was in the best interest of pets. And when I said we make decisions that are not either/or, we make decisions that are in the best interest for pets, but they're also good business decisions, and that's exactly what happened when we did that. So that assortment gives us an advantage in 2 ways. It first of all, lines up with our mission statement, and we do believe that we have the best assortment available in terms of the overall health and well being for pets, 50% or more of our assortment is unique to us. We talk about the area for Fresh. We have Just Food for Dogs is a great example. That's exclusive to us outside of the Bay Area, where there is a preexisting relationship. Just Food for Dogs for us, whenever we put Just Food for Dogs pantry into a store, we not only see increased traffic from those customers but increased basket. When we put that into a store, it's typically by the end of the first year, #1, #2 in terms of the overall sales of that store. When you talk about where Fresh is going, that market today is depending on which estimate you look at, close to $1 billion growing to $4 billion over time. We think we have a competitive advantage there, not just from our assortment standpoint, but how we deliver that product. It is difficult to have an economically viable model shipping Fresh direct to customers from a DC. 86% of our digital orders in total, so not just Fresh, in total are fulfilled through our pet care centers through either BOPUS same-day delivery or shipped from store. When we do that, you see an enormous amount of packaging, you get that product to the customer faster, or -- and overall, it's cheaper than shipping it from the DC and that becomes more of a differentiator when you start to evolve into Fresh. And then, of course, in services, the differentiation is around our vet build-out, which Mike, maybe you can dive in here and talk about vet a little bit.

Yes. I think -- well, maybe before I touch on that, I think, Brian, your discussion around the innovation in food is so significant to the story. I think that on the merchandising side, I think sometimes what gets overlooked is how innovative we've been in supplies. So Stephanie, you remember me from my Abercrombie days, but I think that I like to talk about how we have become so fashion forward and that's where the customer is going. If we think about the number of millennials getting pets as their first child, and the investment that they make not just in the pets' wellbeing, the look and the fashion element of that pet. And so brands like Reddy, which is our contemporary supply brand. It covers everything from dog beds to leashes and collars, really resonates with this customer and gives us a distinct advantage in a space that has historically been more commoditized. So I think that alone is a nice add to our merchandise distinction. On the services side, Brian's right. I think one of the things that we are really positioning around is ultimate convenience, high-quality, affordable care for the customer. And that spans the services propositions. So the idea that over 30% of our grooming appointments today are done online. And most of those are being done on our phones, right? So just the fact that you can go on to the Petco app, you've got everything for your pet and you can sign up for your grooming appointment. That's a real advantage that we have that a local groomer in the marketplace will not have. We have a loyalty program called Grooming Perks. So as you do more grooms on your app, you can see additional rewards that you can earn by being a more loyal grooming customer with us. So that kind of distinction around our services business is important. And then on the vet side, it's very much the same. The fact that you've got the convenience of having a vet at our pet care center. You've got the digital component to it. You've got a loyalty component to it that integrates in something like Vital Care. So as we engage customers around Vital Care, it's a very holistic approach to getting everything you need, including that services component. So I think that convenience, that digital connection is really important in the services space, and I think we're making a lot of progress in it.

And I think as I listen to you guys, you're using words like curation, destination. There's a component here around being a true full-service solution for a pet parent. And I want to take that 1 step further, which is, Mike, you talked a little bit about the vet opportunity, but help us connect the digital and the physical a bit, not only through the loyalty app, but just as you think about the spectrum of opportunity for Petco broadly under that umbrella of destination? How do you think about investments over the course of the next few years in your digital business relative to your physical business? And then as a COO perspective, kind of supplying into that and creating the utility that you need across your key assets, whether that's labor, inventory, marketing dollars, et cetera. Talk a little bit about how that all functions as an omni -- true omnichannel solution.

Yes. So I think that when we talk about omni, I think retailers have been talking about omni for years. And I think that we've all gotten to a place where now it's just table stakes to be able to go on your phone or go online, place an order and pick up your product at the store or have somebody send it to you. And we've come a long way very quickly in the digital space, connecting the physical store with the digital engagement for a first product. So today, we are taking the lead in BOPUS. We're taking a lead in same-day delivery, which we rolled out last year, which significantly helped us compared to online pure-play companies, especially during the time when you got to Christmas, and it was really, really busy and you had shipping cutoffs. And so we feel like we're executing around the merchandise side of connecting the digital part of the business and the physical part of the business in a really, really important way. On the services side, I think there's just so much connectivity that we are driving in the business. And again, it all comes down to customers seeing us as the one-stop shop. And that engagement can be walking into our pet care center and engaging with our great pet care partners. And we do a lot of business just through that engagement and the cross-sell that happens there. Increasingly, it can be customers downloading the app and engaging on the app and investing in propositions like Vital Care or our multiple loyalty programs. So I think that when we talk about investments in the business, we'll continue to drive those kind of connectivity points. And we really think that we're just getting started. We think there's a ton of headroom around leveraging the customer engagement digitally and turning that into a sale, whether it's digital, whether it's in the pet care center, whether it's through the services element of the business. We really feel like that is just a great opportunity for us to continue to invest. You take an opportunity like Rx. Rx, both in food and in prescriptions. We're really just getting started in leveraging this ability for us to have a customer, for example, visit us in our wellness clinics and then reaching out to that customer 3 months later for capturing a refill prescription that we may have given them to start at our clinic. So there's just so much opportunity in pet. It's such a big space. It's so multifaceted that we just have a great opportunity to take a growing customer base and continue to link them and engage them on different levels.

That's great. I know we're running up on time, but I want to spend 60 seconds on PupBox, because this announcement when it hit was really intriguing. It ties back to your recurring revenue strategy. But maybe give us the 1 or 2 quick highlights on the importance of expanding that to all life stages versus just the early stages.

Yes. I think it's pretty simple from our standpoint. We saw an opportunity to scale the business beyond the early stage. And we think given our differentiated assortment that you touched on, Stephanie, it gave us sort of a great opportunity to combine what we have from a unique standpoint with an opportunity to make sure that we meet pet parents and pet needs across the entire life cycle. So I think the model itself has been proven out in the market. We liked what we saw with PupBox itself and saw no reason why we wouldn't want to scale it and give pet parents the opportunity to have a nice, easy solution with high-quality products across all stages. So it -- and to your point of recurring revenue, it just adds to that, it adds to our recurring revenue base. The stickier we can get in terms of our business model is better.

Okay. Last question. This one is for each of you, but you're going to fill in the blank. As a Petco executive over the next 12 to 24 months, I am most excited about, Brian, you first, then Mike, you get final word.

Our opportunity.

Gosh, I think I was going to say that, too. I think just what we can mean for a pet parent.

Eloquently said. And Mike, thanks for the shout out to teen retail, right? Once a teen retail participant always a teen retail participant.

No, you gave me credit for saying words like curate, but let's not forget, he also said fashion forward.

Indeed, indeed and it's now in the transcript, so.

I can take it. I just can take it.

It is always wonderful to speak with you both. And I wanted to just make sure, on behalf of the IR team at Petco, the presentation that you just saw earlier in this time together is on the IR website. So if you'd like to review it, you can go back and take a peek at it there. Thank you, everyone, for joining us today, and please stay safe, be well, and have a great day.