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

Great. Well, thanks, everyone, for being here on Day 2 of our Bank of America Consumer and Retail Technology Conference. I'm Liz Suzuki. I am the hardlines retail analyst here at BofA. And I am joined by Ron Coughlin of Petco this morning.

So thank you for coming. Sorry, Petco Health and Wellness Company. I should add the extra bit. So I mean, Petco is a household name, but the audience may be less familiar with some of the health and wellness initiatives that you've gotten into over the last couple of years. So can you just give us some background on Petco and everything you've been doing recently?

Absolutely. Well, first of all, thank you very much for having us. It's great to be here. And actually, this is my first in-person analyst meeting in years. So it's great to be here today. So I came to Petco about a little under 4 years ago from HP. I was running the PC division there. And it's just been an amazing, amazing journey. Our big bet from the beginning was on our ecosystem. If you go to talk to pet parents, 54% say that they're looking for a one-stop shop to take care of their pets. You go one place today for vet, one place today for grooming, one place to get -- today for food. And bringing that all together is something pet parents want. But we're the only company that could pull all that together, but it's complex to do so. And that's kind of what we've done is create that full ecosystem. So you look at vet, we have Televet, we have vet clinic, we have vet hospitals. We now have over 200 vet hospitals as we sit here today. We have grooming, we have training. We have owned brands. We have an omnichannel offering that gets leveraged every single day. And so that ecosystem, combined with our omnichannel, is what's giving us competitive advantages. And if you look at our numbers, what we said yesterday is we've done 7 consecutive quarters of double-digit growth. And we're 1 of 3 retailers out of the top 50 that's done 7 consecutive quarters of double-digit growth with margin expansion. So the strategy is working.

And so you talked about some of the services that you offer -- grooming, training, vet -- and that's still a relatively small portion of your revenue. But do you expect that mix from product to services to shift over time? And how is that incorporated into your outlook?

Yes. So if -- as I sit here today, our services business grew 22% last year. Our total business grew 18%. So we are mix shifting. And importantly, our services business is relatively the same as our total enterprise in terms of the EBITDA margin. There's P&L geography because cost of sales hits the gross margin line. But EBITDA, it is neutral to enterprise. So we like that growth. If you look at our current trajectory, in 2 to 3 years, it will be $1 billion business. So it is -- it has significance. The other way to do the math is we've said we're going to do 900 vet hospitals. And when I talk about vet hospitals, this isn't like a little closet like has been done in some of the initial drug chain. This is a full hospital with 3 rooms, x-rays, et cetera. If you go to 900 hospitals, which is what we said our end state would be, at $1.5 million per -- in terms of end-state revenue, you're over $1 billion on that part of our business alone. So it's scale. And then as you know, last week, we announced the acquisition of our joint venture partner for many of our hospitals. They helped get us started, but we started running our own hospitals and we liked that model. We like the throughput. It was a higher throughput. It was higher margin. So we acquired the other half of that. So now it's all under one banner, Vetco Total Care. It's all one operational playbook, We see pretty significant revenue and cost synergies on that play.

And so once you've rolled out those 900 vet hospitals that are in your plan, I mean, what do you think the mix looks like? How do you see the company looking in total in, say, 10 to 20 years' time?

Yes. I mean I go back to my original strategy, which is about the ecosystem. So if you play it out 10 years, when I say 2 to 3 years, it's $1 billion. Then 10 years, it's probably close to $3 billion of services revenues. And the nice thing about that is it's insulated from the Amazons of the world, the Walmarts of the world, the Chewys of the world. And if you look at vet in particular, that's a $30 billion TAM. Services overall is a $50 billion TAM. That $30 billion TAM of vet, 99% of it is hands-on pets. So there's lots of conversations about Televet. 99% of the $30 billion are hands-on pets. And it's really the centerpiece of the pet ecosystem. And one of the things that we're working on now is what we call the golden record. We'll talk more about this at our analyst meeting, where we're taking data that happens in the vet or any place else in the enterprise and moving it around. So think about you go into the vet, you get diagnosed with a skin issue. Then when we interact with you in the aisle, that partner in the aisle that you're considering food knows that pet has a skin issue and can choose the right product. And that's going to be really, really powerful for us.

And so with all of these services come skilled labor and the need for it. And we've been hearing a lot about shortages of skilled labor in nursing and tech. So how are you building a pipeline of talent that can ultimately fill these 900 vet hospitals?

Yes. So I'll start by saying that's part of the reason we're so excited about the acquisition. 800 veterinary professionals, about doubling our veterinary professional coming over into the Petco family. The vet hiring is largely through referral. Sure, you're doing recruiting, but referral is a big part of it. And our referrals are up 40% year-on-year, number one. Number two, our time to fill in our own hospitals is significantly ahead of category benchmark. So we're already filling. There's this theory out there that people don't want -- the vets don't want to work for larger enterprises like us. We actually saw a rush to safety during COVID because we were more dependable. There are some vets who don't want to, but the majority of vets would like to. And I'll give you an amazing, amazing statistics. We have a 94% satisfaction of our vet and vet techs who are working for us. That is the highest in our entire enterprise, higher than the people in the store, higher than people in our headquarters. 94% satisfaction of those folks. So it's a tight market, but we're able to compete. And we've done a lot of work on our employee value proposition. So we offer stock. Almost no other companies offer stock. We offer autonomous medicine. We don't tell you what medicine to run. The roll-ups push down medicine because they go do deals with pharma. So they'll get some money from pharma and then they'll push that pharma down. We don't do that. We offer autonomous medicine. We offer flexible hours. And the reason we can offer flexible hours is because any place we put a vet hospital, guess what happens to our center store. We get a 4- to 5-point lift on merchandise in our center store. And our customer acquisition is lower than any other vet hospital because we have traffic coming into that location. So our economics are quite unique, and we can turn that into employee value proposition, value that's working for us.

And that 4% to 5% lift, that's even with taking away square footage for merchandise, right? Or is that on a per square foot basis?

You're actually taking the note that [ Christy was telling me ] I didn't cover, which is absolutely true. So when we put a vet hospital, then we pull out 2,500 of merchandise -- 2,500 square feet of merchandise. So you think your merch would go down because you're pulling out 2,500 square feet. And our merch actually goes up 4 to 5 points when we put a vet hospital in. And that's the other advantage of bringing those JVs into our house. We had a great relationship. They were called Thrive, but they were run by Pathway. It's a joint venture, but they operationally had control of it. Our ability to cross-sell out of those hospitals was much less than our ability to cross-sell out of our owned hospitals, one. Two, they had their own membership program. Now they'll be driving our membership program, Vital Care. And just a plug for Vital Care, it is, in many ways, the manifestation of our ecosystem strategy. Vital Care, when we get a -- Vital Care is $19 a month for checkups, grooming discounts, food and supplies discounts. And when we get a Vital Care customer, 20% of them are new to food with us, 30% are new to services with us, 3x more spend for those customers. So it is very much the future of the company.

And then how does the online business interconnect with the pet care centers? And given that one of your competitors actually spun out their online business, I mean, how does that approach differ from omnichannel approach that you've taken?

Yes. I wasn't in the boardroom, for most folks who know, it felt like financial engineering to most. If I look at the world today, COVID accelerated everything we've been talking about in terms of omnichannel. It absolutely accelerated everything we've been talking about for the last decade on omnichannel. I talked about a concept called Retail 3.0. Retail 3.0 is great brick-and-mortar, great digital coming together for one experience with customers being able to choose based upon that moment, which they want to choose, coupled with the physical retail fulfillment as a micro distribution center, which I'll come back to. And then you add on services on top of that. And to me, that's Retail 3.0. And we think we're a leader on Retail 3.0. And we think it's the future, as evidenced by the fact that Amazon themselves are getting into retail. What's unique about our execution are 2 things. 80% of our e-commerce orders or over is being fulfilled through our pet care centers, whether that's ship from store, whether that's curbside, whether that is same-day delivery. 91% of the time when customers are offered same-day delivery or BOPUS, they choose it. 91% of the time, and that's something that our online-only competitors just can't offer. So we like our model a lot.

Going back to the demand environment and everything that's happened during COVID, I mean, there have been some major swings. Obviously, in the last 2 years, with services being constrained by COVID and then -- but then some benefits like the pet boom that's taken place, so a lot of increase in adoption rates. So what are these industry-wide changes do you think are transitory versus what's going to be more permanent?

Yes. So if you look at -- go back to my comment that COVID accelerated the omnichannel move, if you look at our company, we added 1,407 same-day delivery locations in 2 months. We added 493 ship-from-store locations in 2 weeks. We added 1,427 curbside pickup locations in 2 weeks in the heat of COVID. That speed, first of all, we didn't think we could do things that fast. We would have deliberated on those things for 9 months to 2 years. We would have piloted, et cetera. So the ability to move fast and to adjust and do a winning strategy, I think, was new. And all of those capabilities, we're not pulling out. Actually, they accelerated all the omnichannel stuff that I've been talking about and the real realization was that it provides competitive advantage. The other area would be -- look at services bookings. Now over half of our service bookings are done on our app, which is just incredible in terms of automation and customer access to our service offerings. And then we launched virtual training in the middle of COVID. And the trainers loved it. My mom's Maltese sitting in San Diego got trained by our all-star trainer who's sitting in Union Square. And so that capability is stuff that we didn't have. We probably would have tested forever. And we did and it worked, and it changed our business forever.

Has the retention rate on those virtual services remained high, even as things reopened?

It only goes further. Now as the reopening happened, one of the things we saw was a shift back to brick-and-mortar. We got all these presentations how people are permanently going to go to online, and it was the opposite. We got a shift to -- back to brick-and-mortar. But it wasn't a -- what's the word, it wasn't a unidimensional brick-and-mortar. People are now very much shopping in an omnichannel fashion. And so companies that can fulfill all those needs are the winners in my view.

And have the in-person services kind of gone back to normal at this point? Or do you think there's still some room for recovery there?

So we did 22% growth on our services. But if you look at it in the heat or the peak of Omicron, we did back off a bit in terms of grooming density. We did back off a bit on group training. So there's a little bit of a favorable overlap. It's nothing like what we saw in '20 in terms of some of the limitations that we imposed or regulatory imposed.

And then some of the steps that you've taken to really adapt to this rapidly changing environment, I mean, what do you think were some of the biggest lessons that were learned? You mentioned that you did have to like make a lot of changes really quickly that you otherwise would have tested. I mean do you think that this has proven that going forward, when you want to make a change, you can do it pretty quickly?

Without a doubt. I mean I've been in business 30 years, and I wouldn't have thought we could move this fast. And I think we all learned the 80-20 rule is true, right? You're going to -- if you have smart people, you're going to get it pretty much -- pretty right and you can adjust. So I think that that is a legacy of COVID for all businesses, quite frankly. The other thing that was very powerful for us is the bonding that happen across the company. We have some -- we use Facebook's Workplace as a communication tool. And it really is a community. And out of kind of the street level folks came this concept Petco Strong, everyone was wearing Petco Strong T-shirt, Petco Strong hats. And everyone came together because we were all trying to keep each other safe. They knew the company was trying to keep them safe. They knew the company was doing the right thing. We gave them I think it was up to 7 COVID appreciation bonuses. And it really created this community of -- we're trying to keep everyone safe, but we're also trying to make sure that pet parents can take care of their pets in one of the most challenging times in America when it was at its peak.

So I guess we get the question a lot about how much of the growth has been sustainable, and what -- where we could see some give back, I guess so -- and particularly around some of the benefit around stimulus, just increased the wallet of the average customer. So what are the demographics of your average customer? And then what does your internal data tell you about how much of a benefit stimulus and other government programs might have been?

Yes. So let me just ladder up and then I'll go down. So on how much is it sustainable, we added millions of new customers in the last year alone, millions, up to 24.1 million customers that we have data on. Our customer adds last quarter were 800,000, prior quarters were between that and 1 million. We've done -- our customer adds are more than 2x our online competitor. And our customers are spending more. So that, at a fundamental, fundamental level says our growth is sustainable. In terms of -- so what was the second part of your question?

About the demographics of the average customer.

Yes, we have the highest-spending pet parents in the category. That means they tend to be inelastic. And one of the dynamics of the pet boom is Gen Zers and millennials adopted more of the pets. Gen Zers and millennials are leading the humanization trend. So they spend more. So we see it continuing. I like a quote that Kristin Peck from Zoetis had: there's more pets spending -- pet parents are spending more time with them and they're spending more on them. And that's the true dynamic right now.

So I guess there's been some concern among investors also just -- and it's been visible in the markets about the potential for the next recession on the horizon. So how has demand for pet supplies and service held up in prior recessions? And what -- do you see any risk that your customer could shift from best to better or to good in that environment?

To quote Bill Murray, the pet industry has tended to be a recession buster. And if you look at the Great Recession, the pet industry was pretty much undented in terms of the dynamic there. People, especially our customer, is the highest spending customer. And they're relatively inelastic to these things. If I'm feeding Fluffy ORIJEN at $80 a bag, I'm not really changing that. And particularly if you're a cat -- if anyone's a cat parent here, you don't really change your cat food because it's very difficult and they're very finicky. So we don't see much impact from a recessionary standpoint. That said, it's my job to make sure we're ready for any dynamics. So we have offers from fresh frozen at the highest price points, high-end kibble to mid-range kibble with our WholeHearted brand to make sure we have offerings for every wallet above the lowest kind of old Roy-type level where we don't meet for that customer. At the same time, Vital Care provides value, right, $200 to $300 of value for a typical customer. You might say, well, how can you afford to do that? And it's all share of wallet play, I talked about, 20% new to food, 30% new to services. So we're getting more share of wallet that allows us to fund the value for the customer.

And then with inflation top of mind for a lot of investors and customers, how have rising product costs impacted your top line? And then how are rising costs to you like transportation and freight and wages impacting your margin?

Yes. So actually bridging between the 2 questions, there has been a premiumization trend for a decade in the pet industry. And that's unabated. It's actually today, even in more uncertain economic times and geopolitical times, the premiumization trend continues to higher-end food, more human-like food. That's not going to stop. There have been prices passed on by our vendors. We've been able to pass those through. At the same time, like I said earlier, we offer a range of products, but we're not seeing a down trade right now. We're actually -- we're seeing continued premiumization. Our fresh frozen with JustFoodForDogs continues to be a rocket ship. We're going to add 300 new locations. So we're not seeing that, but we've been able to pass through any pricing that we've received. From other costs, yes, we've seen increases. We've been able to offset them, which is why we have margin expansion. And we've had a positive spread from revenue to EBITDA. The fuel thing is obviously top of mind for everybody right now. So we will do our best to offset that. We also -- one of the things we haven't talked as much about is we've been very effective at taking about $20 million to $30 million of cost out of the business. In some instances, we invest that back in areas like marketing, where we love the return. In some instances, we drop it to the bottom line to get that positive spread. We have current in-flight initiatives targeting that same $20 million, $30 million in 2022. That can cushion things like oil prices. The last thing I'd say on the topic is, if you look at a gas inflationary environment, that plays to our model because the micro distribution, people picking up their own food in a BOPUS-type environment versus paying for that last mile through the UPSes or the FedExes, it's going to hurt online players more than it's going to hurt us.

That makes sense. So are there particular categories where you're finding it's easier to pass along those price increases versus others, like where the demand is more elastic? Or do you just kind of take a portfolio approach of being able to raise prices in some places and not so much others and remain competitive in some areas?

So our strategy starts with the fact that 70% of our portfolio is either owned, exclusive, or [ map ] controlled. So our exposure to some of these pricing dynamics from a competitive standpoint is less than anybody in the category. Our key competitors in online and pet specialty have much more exposure to commodity-type products. In general, there hasn't been a big difference between food and supplies because we tend to play in the higher-end own brand of supplies. That said, at the commodity end, a tennis ball is a tennis ball is a tennis ball. That's where you're going to have more pricing pressure, but that's again why we try to curate our portfolio away from those. And you'll see us continue to do more of it, as evidenced by Reddy. If folks haven't seen the Reddy store in SoHo, it's right across Louis Vuitton and it's a high-end supplies brand.

So I guess, on supply constraints sort of dovetailing on to the inflation topic, there have been some constraints in certain categories. But has Petco experienced any material issues? And do you think that it's getting better or worse at this point? And from a competitive standpoint, is it any different for Petco than it is for your competitors?

Yes. There's not one single of our vendors that said, I think there's going to be 11 million new pets in 2020. Just nobody had that in their plans. That's the reality. And then there was heightened pet adoptions in '21 and into '22. So there was just more pets and compounded by some of the meat processing type stuff that people have heard and barley had a bit. So there was tightness. Our team has navigated incredibly, incredibly well. For us to put up an 18% growth for the year in that environment was astounding, 14% on the quarter was just astounding. One of the things that our model affords us from the brick-and-mortar side is if someone comes in and says, I want a urinary tract product for my cat, Royal Canin, we don't have it. We can redirect them into Hill's. People trust our partners in the aisle. If you're purely digital, you lose that sale because they're going to find somebody who has it. And we have some of those dynamics on our digital business, but we have less exposure to that. So we've been able to navigate it quite well. But there's been categories, particularly wet cat has been challenging for the entire category. And we have really good relationships with vendors. It was the first thing I told my merchant team is we're going to have the best relationships with vendors. I was a vendor for 30 years. And so I don't think we're adversely supplied. And if you look at the -- what I talked about, 70% owned and exclusive, we're the big kahuna on those products. So I don't think anybody is getting better supply on that. Maybe some of the commodity stuff, but I don't mind mix shifting out of that.

Yes. Got you. So when you do have those out of stocks, you're generally able to get the customer into an alternative product. And is that usually pretty specific? Are those shortages specific to certain brands or SKUs or in the whole categories like wet cat, you're seeing that? And what are the alternatives you can even offer in that case?

Yes. I mean the only -- the good news is vendors come in and out. So you generally have something that you can recommend. There hasn't been a situation where you don't have an alternative to recommend, in general. But wet cat is the only category that was our category dynamic. Other than that, there has been different folks. But this is also why we choose the vendors that we do and why we have the developed own brands that we do. WholeHearted is roughly 10% of our mix now. We're able to control the supply there. So we feel like we've done well in a tight environment, and the numbers suggest the same.

Great. And I had a question that was actually e-mailed to me that I want to make sure I have time to ask. So there was -- you had mentioned on yesterday's earnings call that cat adoption trends are particularly strong. And so the question was about how we should think about the economics of a cat customer versus a dog customer?

Yes. So let me be clear because I wouldn't want to be completely -- I haven't seen '22 in cat. That was a '21 was up in cat. I haven't seen a new number for '22. So cat has a comparable LTV. They have a longer life. So they are lower in any given year, comparable on an LTV basis to dogs.

Got it. That makes sense.

And by the way, we're under shared. So we see that as an opportunity for us. And actually at the Analyst Day, Amy will talk about efforts against cat. We finally have a merchant who is a cat parent. So we're honing our efforts there.

Great. Well, so I want to make sure there's some time for questions from the audience. So if you have a question, please feel free to raise your hand and someone will come around with the mic. All right. Then I've got more. Well, you do have an Analyst Day coming up, and I'm sure we'll talk about this a bit there, too. But what are the opportunities now that we're in a more theoretically normalized environment, having kind of reopened and things theoretically going back to normal? What does that mean for your business? What are you most excited about in that environment?

I'm going to say what you would expect me to say, and then I'll take another bit. I love our model, right? We are the only one who has the fully integrated owned ecosystem, period. And 54% of pet parents say that's what they want. So I just want to execute on that model, make it more robust, as evidenced by the fact that we made the acquisition on the JV vet partners. So that's number one. Number two, we have $40 billion of incremental TAM we're going after, right? We're early days in that $30 billion TAM, actually $50 billion. We have $11 billion of Rx. And if you recall, our talk track on Rx, when we did the IPO, we said it's an opportunity that we're not after yet. Then in Q2, I said we're replatforming to Vetsource. In Q3, I said we're starting to see growth. And in Q4, I said 66% growth. So it's not a concept anymore we're going after, and we have a right to succeed in that space. Insurance, similarly, relatively big TAM for us to go after. So we have significant new TAMs. And then there might be a special plus that gives you nice surprise at Analyst Day that you'll hear about.

Well, we look forward to that. And just so people know if they are not as familiar with the constraints around prescription from some of -- that some of your competitors can't offer. And what does the advantage of the vet hospitals do in terms of your ability to sell prescription?

Yes. So we are able to now have a closed ecosystem because we have all these vets writing prescriptions. So whether it's our vet hospitals, like I said, we're over 200 today and on our way to 900. So you'll have all those vets writing prescriptions, getting closed fulfillment through Petco. Now they don't have to come to Petco. But obviously, we would drive them towards a Petco for that closed fulfillment. The other thing that I haven't talked about, I mentioned at the beginning but haven't really double-clicked on is our vet clinic business. So we run vet clinics in 1,300 locations today. We're probably in 1,200 locations today. And we have 1,100 vets that we engage for those shifts. And so they write prescriptions as well, number one. Number two, it provides us with a feeder system of vets for our vet hospitals. You might have a vet that decides they're going to go out on maternity, but maybe they work on weekends. And then the child now is going to first grade, I can go back to work and they can come back into our ecosystem. That -- those vet clinics allow us to have flexibility and allows us to drive that value proposition of flexible work hours for us. But back to your point, it's a closed ecosystem of writing prescriptions that feed our Rx business. And then we can get them on repeat delivery of Rx. Like my guy, he has a pain killer he takes twice a day, right? It's a pain to have to go to the vet to go get that. Now I have it on a repeat delivery order.

Great. And I'll just -- actually, I'll open it up to the audience one more time, but I still have a couple of more, so --. Anyone else have a question? Great. Okay. Well, so since you've been openly talking about Yummy's progress, I always like following everything that's going on. I mean it seems like you're very passionate about this industry, and yet only came to the company 4 years ago. When you first came in, what was -- as a pet parent yourself, like what was the most noticeable things to you that needed to be changed or could be improved upon with the business?

I would say 2, we had phenomenal people and a lot of the strategy was there, but the company could not be successful because operationally, it didn't know how to be successful. And so you had one side of the company going one direction, one side of the company going another direction. If you went to our pet care center and you asked a store manager, how is your ORIJEN sales? They didn't have the data. If you ask them, how is your grooming business? They didn't have the data because the data was kept up in San Diego. So we pushed the data down. My head of stores, Justin, 5 key metrics that everybody got measured against. We put them in the break rooms, we stack ranked them. And so -- and then every month, we would do a business guide of what they're supposed to execute on. Every week, we have a reminder of what the weekly focus is. So we operationalize the company. We have one set of data. We look at it every Monday morning as a leadership team. That was -- none of those operational norms that you would expect were there. So that would be number one. The second thing, which we haven't talked as much about is it is the most passionate, committed group of people I've ever met. The secret sauce are the people and their passion for pets. And when we got rid of artificial ingredients, I found that out because we unlocked that passion. But when I stack ranked benefits and compensation when I first came in, we were 25 out of 26. And I've been on a mission, with my Board full support, to get that to the right place. And we've done double-digit wage increases pretty much every year. We've been here -- I've been here. We're up over $17 average as we speak. I picked up every benefit cost increase that's come to the company, having passed those through to employees. We've given bonuses to every employee. When I came in, bonuses were just for kind of the management team. So we've done a lot of work to make sure that we're doing the right thing for the folks who work at Petco. And we have this adage that as the company does better, our people are going to do better. We're not 100% where we need to be, but we've made tremendous progress.

Great. All right. One last opportunity for the audience. Otherwise, we'll wrap up. All right. Thank you so much. Really appreciate it.

Thank you. Appreciate it.