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

Great. Welcome everyone to 25th Annual Needham Growth Conference. My name is Anna Andreeva, and I cover consumer e-commerce for the firm. And next up, we have management team from Petco health and services. From the company, we have Brian LaRose, who is the CFO. Welcome, Brian.

Hey, Anna. Thanks for having me.

Okay. Absolutely. We are rated by -- on Petco. We really like the resilient nature of the pet space, and we think the company has done a really great job of growing top line via consumables and also services, especially health care and vet. And we think the stock is pretty attractively priced.

So let's kick this off. So Brian, I guess, first off, just starting with the big picture. It's been kind of a tale of 2 cities in '22. Your performance in consumables that has been very strong, growing double digits, e-com up in a double-digit range as well and underperformance in hard goods and companion animal and hard goods seems like it's an industry issue overall. But maybe talk about how that has compared to your expectations as we went through the year? And any green shoots that you're seeing in the hard goods category?

Yes. Thanks for the question. And again, thanks for having me. Let me take a step back and say, I think if you went back a year ago, I'm not sure in any industry that anybody could have predicted we'd be where we are today in terms of the overall market. So they're sort of unprecedented times. Now the good news in that is where you started on that we've continued to grow. Petco is a growth company. We're going to continue to be a growth company. You said it was a tale of sort of 2 companies here. Consumables has been really strong, very resilient, growing double digits all year. We actually -- I'd be remiss if I didn't mention services. I think Jason would be upset with me so services has also been very resilient. So services would be grooming, training as well as vet. That was up 14% in the third quarter, up 38% on a 2-year stack. So we've had a lot of resiliency in services as well. The hard goods category or what we call supplies and companion animal, the more discretionary category, it's about 40%-ish of our business. And that's been down about 9% for the year. We've gone back and looked at prior economic cycles in terms of how these categories typically behave through the great financial crisis and prior downturns. And they behave somewhat similar. You have a consumer pullback in certain categories. Overall, the company has been growing, and we would fully expect those categories to come back as the economy improves.

Okay. Within hard goods, if you were to slice and dice a bit further, how are the non-new pet formation categories doing within that? I would think within hard goods, anything related to health care has been more resilient. And with that, what are you seeing in terms of pet ownership? I know it's really difficult to get the accurate stats on those haven't been super reliable. Just curious if there's any color there.

Yes. Let me start with because also in the prior question, you talked about green shoots. We -- one of the things that we did last quarter, we launched a Supplies Perks program. So think of that as kind of the old school punch card program where you buy more products, you get one for free. We launched Supplies Perk off of the basis of success we saw in grooming and nutrition perks, where for every bag of dog food, you buy, you get the 10th one free. So as we looked at the discretionary categories, while we've looked at the prior economic cycle data, we're not passengers on the bus here. We continue to take action to stimulate the category. Supplies Perk was one of the things that we put in place to try and stimulate growth there. In terms of the overall pet adoption cycle in the category, kind of going back to what I said earlier, this is a resilient category. It was resilient before the pandemic. It was resilient through the pandemic and has been resilient since. So it's a category that over the last 30 years has had a mid-single-digit CAGR through all economic cycles, obviously grew a little faster during COVID, but we've continued to see the category grow this year. Now pet ownership is up this year. Relinquishments are down from pre-pandemic levels. Overall, that's good news. That means there's more pets in the ecosystem. That means there's more pet parents spending time with their pets and that means there's more pet parents spending money on their pets. So the category remains strong and continues to grow.

Okay. Good. That's great. Any -- just a follow-up on my previous question. Any non-new pet formation categories within the supplies category that you could call out?

Yes. You mentioned health care products under our own brands name, our Well & Good products continue to perform well, the discretionary or hard goods category isn't sort of a one size fits all. So you have items that are truly discretionary in nature, whether that be toys or things of that nature. But you also have pockets of that category that are less discretionary where you take collars or leashes, if I have -- if my pet grows out of a collar, I'm going to get a new one, if I have a leash that's fraying, I'm going to get a new one. So you have pockets of the category that have been more resilient than others.

Okay. That's perfect. You mentioned own brands and my household, we are a fan of your Good & Well brand. So that's great. And I know exclusives as well as owned brands are a big differentiator of the Petco model. Just curious if you could remind us about the penetration there. How has growth trended so far in '22, and those are more profitable categories for Petco, just any additional color on profitability?

Yes. I can't probably get into the profitability as much as you would like, but I would tell you they are accretive to our model. Very important part of our model is owned brands, and we see a long trajectory of growth for it to continue to increase penetration, coupled with our premium assortment across different vendors. So if you take owned brands in total, obviously, we have brands like Reddy and WholeHearted, which have continued to grow very, very well for us. You couple that with exclusive relationships in products like backcountry, new partnerships with companies like Stella & Chewy's and you have an overall premium assortment of category that has positioned us very, very well in the overall market. And against competition, about 60% of our assortment is exclusives or owned brands, not available at mass. So it allows us to position ourselves against a certain demographic in the category that is advantageous to us.

Are you seeing any trade down within any of the parts of your portfolio, either towards your owned brands or from more premium brands to more of a price -- a mass price point?

No. In aggregate, we haven't seen that. And if you think about -- let me talk about food, for example, the consumables category growing double digits. The fact that we're still overweight in a premium assortment suggest that there could not be a mass trade down within that category otherwise, we wouldn't have shown up to double-digit growth in consumables. So what we have done is, I think, WholeHearted, our owned brands, gives us a great opportunity to position ourselves against those customers who are maybe more value conscious for a premium product. So we've come up with new bundles in WholeHearted to -- for those customers who are looking for that value entry price point. We've also continued to lean into our Perks program. So there's an inherent benefit whenever you participate in nutrition parks, you get that 10th bag of dog food free. When you sign up for Vital Care, the benefits that you get from Vital Care across nutrition, services as well as that allows you to get greater benefit as a customer.

Okay. As you talk about the premium trend, which has been the case across the industry for a few years now, you can't be -- you would be amiss not to mention the fresh and frozen. That's a pretty exciting TAM, has been growing really nicely. Maybe talk about that. What kind of education do you think is still necessary for the consumer to really see acceleration, like bigger acceleration in that area?

It's a great question, and you're right, Anna. When we look at the market, it's, call it, somewhere $800 billion , $900 billion worth of market today. We think it grows to $4 billion or $5 billion over the next 3 years. There are different data points out there in the size of the market, but it's large and growing and growing very fast. We believe enough in the market, we made a significant CapEx investment this year to make sure that we had freezers available in over 1,000 locations within our pet care centers to be able to provide fresh and frozen products. So we believe we have an advantage as this market continues to grow in terms of the way we fulfill. So fresh and frozen is a difficult economic model to ship direct from DC and mass. We have -- roughly 80% of our e-comm orders are fulfilled through our pet care centers, through buy online, pick up in store, same-day delivery and ship from store that allows us to get the fresh product to a customer faster at better economics for us. So there continues to be sort of an advantage for us from a fulfillment standpoint. And then one other question in there that I missed.

I guess general education of the customer.

Yes. General education. So we continue to lean into our marketing efforts around Fresh Frozen. Our partnerships with our vendors are core to that. We obviously have a good relationship with Just Food for Dogs, with Freshpet with other vendors within the fresh space. So we continue to partner with them to educate. And I also think there's a natural humanization trend that follows what you saw in premium kibble where you just continue to see customers migrate. There's an overall wellness umbrella that fresh fits into. And I think as you look at the demographics of new pet ownership, we're over-indexed in certain areas like in Gen Z and millennials, where 66% of Gen Z and millennial customers want to do what's best for their pets. They spend more on their pets. They are more invested in the overall humanization and wellness of their pets. So fresh fits under the umbrella of that education as well.

Okay. That's actually a perfect segue into my next question. As you think about the spend per pet, so we talked about 1 component, right, the number of pets, which is growing slightly more modestly, right this year, but it sounds like still growing slightly. Spend per pet, just given the demo that you just described, and the propensity to spend on services, especially. Talk about what inning are we in, in terms of the growth there? And what is Petco doing specifically to accelerate that further?

Yes, it's a great question. Let me take a step back first and think about historically. Historically, when I talked earlier about the resiliency of the category being kind of mid-single digits growth. If you break that apart, traditionally, it's been kind of 1% pet growth, 4% spend per pet. We talked in our last Analyst Day about longer term, the category growing from a 5% category to a 6%, 7% category, driven by an increase in spend per pet. That spend per pet will come from the increasing humanization of pets and the fact that people are looking for the overall wellness of their pets, investing more in premium food inclusive of fresh; expansion into grooming services and making sure that you're getting regular wellness checkups as well as Rx and insurance. Now how do you bundle all that together? One of the things that we've done to one of our major investments to scale spend per pet across our own ecosystem is Vital Care. So it is the most comprehensive offering for a pet parent in the industry. So for a $20 fee per month, you get rewards back to the tune of $15. You get pre-vet visits within our 4-wall vets. You get discounts on nutrition. You get discounts on grooming. All in, what that allows from a customer standpoint is about $200 a year of savings from a customer standpoint. For us, a Vital Care customer spends about 60% more than an analogous non-Vital Care customer and as 3.5x higher LTV. So perhaps the biggest vehicle we have to drive spend per pet across our ecosystem is Vital Care. We're up to 400,000 members today and growing nicely.

Okay. Yes, Vital Care is definitely pretty unique in the industry. And I know as you rolled out that sign-up capability at the registers this fall, you really saw a pretty nice acceleration there. Maybe talk about what are some of the other ways to really monetize and advertise this program?

Yes. Good question. So there are a couple of things we did for Vital Care this year. So the first thing was we actually rolled out Vital Care for cats. Initially, it was a dog only product. We then had a partnership with Rover, and we enhanced the Pals Rewards associated with the program. We then right before we did the POS, sign-up, launched Vital Care for companion animals. So a different price point, different economics, but same value proposition, and we saw a lift from that. But the big unlock was sign up at point of sale. So before that, we were scaling nicely where you actually had to enable sign up through the app even if you were in store. Having that at point of sale, gives us a quicker transition for the customer. And it also leverages what's one of the best assets we have in the company with our pet care center partners, our employees in store. Highly educated employees, very good at making sure that our customers understand what's available to them, so to have them with that tool set at register is a big unlock for us.

Okay. That's great. Just taking a step back. Maybe talk about what you're seeing with the competitive set. You and your other publicly traded competitor in the space. I've talked about a very rational environment across this ecosystem and really for some time. Maybe talk about what are you seeing from that regard? And how would you categorize your performance year-to-date versus some of the others in the industry?

Yes. Let me start with -- maybe for those of you who are less familiar, we compete against, obviously, pet specialty retailers in brick-and-mortar. We compete against online-only players, and we compete against what is a fragmented overall vet market. So we have competition across different pockets of our business. That said, there's not a single company who has the end-to-end ecosystem that we offer where you have -- that's inside of our stores, augmented by Vetco mobile vaccination clinics. We have grooming capabilities, training capabilities, brick-and-mortar with fulfillment for e-comm orders at 80% of the e-com orders that come in. When we look at our competitive set, we're uniquely positioned to have all of those offerings. For some of our competition, you can't actually do some of the things that we do. You can't have hands on pet unless you have a vet. You can't actually administer an x-ray, if you don't have that capability in store. You can't do dog training in person if you don't have that capability in store. So we're leveraging our physical footprint and augmenting that with the services and digital capabilities around it. I think if you look at what's happened in the industry, you've continued to see where we started inclusive of us, very strong growth in services, very strong growth in the food categories, a category that continues to grow through this economic cycle and mass and then you have some pockets that we believe will return.

You had mentioned vet, and that's definitely one of the areas that we're especially excited about. You will end the year with, I think, about 250. You've talked about 900 locations over time. Talk about how you approach the thinking about opening your own versus being acquisitive. Any update how the Thrive acquisition and integration is progressing? And as you look out and the vet locations mature, any additional color that you can provide about that customer and what you're seeing to the center store as a...

Sure. Yes. Vet is so core to our growth strategy. It has been and it will be. We started investing in this business about 4 years ago. We initially started with a joint venture partnership where it's 50-50 owned. We then started opening our own vet hospitals about 3 years ago, started to scale those owned vet hospitals, and we like that model a lot better for us in terms of the overall economics. For those of you less familiar with that vet model, typically, when we put in a vet, you have about, call it, $600,000 capital investment for the vet itself. The 4-wall vet economics are where you're sort of loss-making in year 1, getting to positive in year 3 with a long-term EBITDA that is well above company average at 20%. As we've continued to scale vets, we've continued to see ourselves positioned well against that model. Now we measure that return on capital investment on the 4-wall economics itself. But apart from that, the center store of whenever we put in a vet, we get a center store lift of kind of mid-single digits in year 1. We've revalidated that. So Anna mentioned that we end the year at 250 vets. We've gone through the work to look at all of our cohorts on a month-by-month, year-by-year basis. And does that center store lift hold now that we're 200-plus vets in? And the good news is it does. So the model itself is super attractive to us in terms of how it ties together the ecosystem as well as what it means for 4-wall vet economics and overall company return. It also gives us a nice on-ramp for customer acquisition. So we've continued to acquire customers at the enterprise level that is a great on-ramp for that, and it's a great on-ramp into vet for customers who walk through our doors in brick-and-mortar. In terms of acquisitions, we've typically done kind of onesie, twosie acquisitions of vet practices. Most of our vets continue to be organic vet adds where we build them out ourselves. When we do acquire a stand-alone vet, they would move into our center store, either day 1 or in short proximity. We might do that in a market where we just find a vet that fits well in our ecosystem, and we find the opportunity to bring them in. So mostly builds a highly attractive model and something that we remain committed to.

Okay. It's been an incredibly tight labor supply type of an industry, yet Petco has done a very good job, I think, attracting and retaining. Maybe talk about that, if you're seeing any improvement from the specifically labor standpoint. And just curious what other challenges or conversely opportunities surprises to the upside, have you seen with the rollout?

Yes. So I think the recruiting market is largely unchanged. It's a competitive market to recruit vets in. We've done really well against that last quarter, we brought in more vets than we ever had in any quarter. So it was a highly positive quarter for us in terms of vet recruiting. We attack it in multiple fronts. First of all, from an overall compensation standpoint, we're able to offer wages, bonus and equity, something that a lot of the larger fragmented players in the market can't offer. Secondly, our value proposition more is centered around what we can give from a lifestyle of a vet. If you think about the vet professional, they get into this business to actually practice medicine, we allow them the opportunity to do that. So to come into our 4 walls in a brand-new facility with the equipment provided, the staffing provided, the ordering system provided, the relationship with the general manager that allows them access to customers walking through the doors; and to do so, where you allow them to practice autonomous medicine is a very different pitch than some of the other players in the market. So it remains competitive, but I think our recruiting team has done a really, really good job in terms of when you say surprises or maybe newness. I think going back to part of your prior question, the Thrive acquisition has been good for us. We retained almost all of the vet professionals above our model in terms of retention of professionals coming over from Thrive. There were 800 vet professionals inclusive of vet tech staff, et cetera, within Thrive. We had a retention target for that acquisition. We exceeded that target. That validates our value proposition in terms of the vet space and the vet profession. It also gives us a nice on-ramp in terms of referrals. The last thing I'd say is, in addition to our own vets, we have these mobile vaccination clinics where we hit about 1,200 of our locations last quarter, and there's about 1,100 professionals -- 1,099 professionals within that ecosystem, gives us access to bring vets in to either fill in shifts or perhaps have an on-ramp to become a full-time professional with us. So I think our overall ecosystem for vet is strategically important and performing very well.

How does -- I personally think Vetco is a really interesting opportunity for the company. How does that tie in overall with the vet initiative? I know you've said it hasn't been as much crossover necessarily in terms of selling. But I would imagine it brings in new customer.

Absolutely. Yes, absolutely. It brings in new customers into our ecosystem. We make sure that we cross-sell and cross-market. We know for Vetco-only customers. And I think as you see this thing scale over time, it's not necessarily binary where it's either a Vetco owned facility or a Vetco clinic. We will deploy the Vetco mobile clinic wherever we think we're getting the best return. And as I mentioned, last quarter, that meant 1,200 locations actually had visits from a Vetco mobile clinic, so highly scalable.

Okay. All right. Terrific. Moving on to some of the KPIs. Petco discloses the net adds, and that has been pretty strong for the company for a number of quarters now. Maybe talk about where do you think that consumer is coming from. We've done our work on the independent channel and the mass and grocery. And I think those are still donating share. Just curious on your thoughts there.

Yes, I think it's coming from all sorts of different sources. If you think about the fact that 60% of our assortment isn't available in mass channels, the fact that we have vets inside of our 4 walls. We offer grooming and training services. So we have hands-on pet in many different means. It's highly attractive and overlaps well with a demographic who is looking for the best overall wellness for their pet. I mentioned earlier, we're higher indexed towards millennials and Gen Z-ers. That has been a nice part of that customer acquisition on ramp for us because those are customers who are looking to spend end-to-end in one-stop shop. How we position in the market? We've done a lot of work around this, too. You have -- if you think about where customers want to shop, 29% of customers want to shop online only, 32% of customers want to shop in store, 39% of customers want to shop omni. We hit all of those different buckets.

Okay. One of the metrics you provide, revenues per active customer, and we've talked about that, that has seen some decline. Talk about that and specifically what is the company doing to improve that metric?