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

Great. For our next fireside, I'm joined by Petco's Chief Customer Officer, Darren MacDonald. For anyone less familiar with the story, Petco was brought public out of private equity ownership in early 2021. They currently operate just over 1,400 pet care centers and are executing against the strategy to become a one-stop shop for pet parents. They're combining an omnichannel retail platform with pet services like grooming and vet. So Darren, thank you very much for joining us.

Thanks for having me.

So maybe to start us off, Chief Customer Officer is probably a role that some in the room are not as familiar with. So can you maybe just start by giving us an overview of what your role entails and I guess where you're focused today?

Sure. Yes. The role of the Chief Customer Officer is actually one that is much more broadly deployed in European markets. It's not as big here in the U.S. Essentially, what the role is, is how we talk to our customers in terms of acquisition, once they join the franchise, how do we communicate with them across channels. So online, off-line customer care. And then how do we build better economic model by keeping them in the franchise through things like loyalty and membership. And then ultimately, we want to enable all that with data -- so my role is essentially those things. I'm responsible for all things marketing, all things digital, all things product. I have the loyalty and membership business. responsible for enterprise analytics and data science and in our call centers. So it's just representative of those different functions.

Okay, great. And maybe to a good transition would be to pet category trends. So you guys reported not too long ago, first quarter comp sales grew 5.1%, but the team spoke to a more cautious consumer in the second half of the quarter, which prompted more prudent implied guidance for the remainder of the year. Can you expand on what it is you guys are seeing in the marketplace right now? Is it trade down? Is it less traffic, outsized weakness in more discretionary categories? Any color there would be helpful.

Yes. I mean, look, I'll actually go the opposite direction. I would just say we're pretty proud of $5.4 million revenue and 5.1% comp. I mean, if you look at overall retail, it's pretty tough out there. And for those of you that track a lot of categories are seeing negative comps, right? So the fact that people have to feed their animals, the fact that they have to bathe them the fact that they have to take them to a vet hospital I think, speaks to the solid foundation of this category is built on. So durably over time, we're seeing 1% animal growth, and we're seeing 4% of lift from things like AUR, so we feel very good about the overall category. I would say our services business is doing extremely well right now our consumable business is doing extremely well right now. Are we on the margin seeing some level of trade down? Yes, but at the same time, we're actually seeing lots of premiumization happening in the market. So the analogy that we always give is the dog use sleep outside, then it moved inside, then we do the fit of that and now sleeps in the bed with you. We are seeing growth in things like fresh and frozen. We're seeing growth in categories, our own brands. So yes, there are some challenges out there in the market, no surprise to anybody, but I think the brilliance of this category and why I love working in this category is that you have trade up through premiumization and through humanization of pets.

And that's actually a great segue into where I wanted to go next was, if you think about your strategy over the past couple of years, it's been carrying higher quality items going more premium. And as we think about the consumer environment, maybe getting a little bit tougher, you talked about ebbs and flows in terms of people trading down and others trading up. But I guess how are you thinking about your current offering versus what the consumer is doing. Are you well positioned for that?

Yes. I think we've got value for the customer no matter where they shop with us, everything from fresh and frozen, premium kibble to even down into the more kind of value segments, we think we have an offering for kind of all customers. Are we going to compete with the really low-end Kibble. No, it's actually just not part of our strategy, meaning the old Royse of Walmart. We don't want to compete in grow share in that market because it's not what we stand for. Our brand stands for health and wellness. And in fact, in 2019, we actually got out of a lot of those businesses deliberately. So the positioning for our company is slightly more premium, but at the same time, we feel like we've got a price point for any one day regardless of how they shop with us.

Right. And I think it's often misunderstood how difficult it is to trade your dog down to a different type of food.

It's -- honestly, it's just -- it's not a trade-off that customers are willing to make. In some cases, they might decide that they're going to go to the local bodega for breakfast rather than stopping at a Starbucks or something like that. They're not doing that with their animal. And I think that kind of speaks to the uniqueness of the category.

Great. And then I guess just supplies and companion animals. You talked about that was the one area of the business that is a little bit weaker right now. In the past, you've talked about that segment or discretionary overall on average over time in past cycles, it takes 5 to 6 quarters for that to kind of bottom out. It's been down between 7% and 10% on a net sales basis for 5 quarters now. I guess, do you think this cycle is maybe any different? And if so, why? Like what factors might contribute to that?

Yes. Look, I think this one is different. I mean, you have the War in Ukraine, you've got banking crisis, you've got a bunch of things that have popped up recently that like I think anybody tells you explicitly they know exactly how this cycle is going to work relative to previous ones is probably not telling all of the truth. In our case, we feel actually pretty good about the overall performance of the business. We talked about consumables continuing to drive the business. our vet business is working exactly like we'd like it to. Our grooming business is doing, I think, took last quarter as much share as it ever has. So we're doing lots of things really, really well. Our back half guide doesn't anticipate any meaningful recovery on the supply side of the business to be explicit. Our overlap is going to get easier. So when you think about kind of the back half of the year, we're going to see strength in the majority of the business in the areas that are slightly more discretionary, the comps are just going to get easier.

Excellent. And as we think about that kind of weakness in the consumer, not just in supplies and companion animals or this category, but like broadly across the market, I think a topic that investors are very fixated on is pricing. So I guess to start, do you anticipate that consumer prices have to be rolled back to any degree across pet, whether that be consumables or discretionary?

Yes, our CFO talks about disinflation versus deflation. You might see some level of that. But I would also offer that I think relative to this category, we have seen this durable premiumization that exists and people are moving into fresh and frozen. That business is on fire right now. It's growing as fast as it ever has. So people are moving into more premium products quarter after quarter. And when you layer in all the good work that we're doing around our membership programs and things like that, we feel very, very positive about the business.

And I guess as a second derivative to pricing, your suppliers are also seeing their input costs come down. Are you getting better terms on what you're purchasing? Or is there an opportunity to push back on those vendors to get better prices now that you guys know they're purchasing for less?

I'm responsible for a good deal of our merchandising business. So my -- coming from a Walmart background, I think the answer to that question is always yes. That said, we've done a pretty good job where input costs have gone up. We've been able to pass it on to the customer in ways that we don't think is harming them nor is it harming our balance sheet. And most of that really went in, in kind of 2021 and less so in '22 and even less this year. So at this point, my sentiment is that what we're seeing in terms of price inflation is more than offset -- sorry, any price deflation that might happen is more than offset with us just moving customers up and trading them up to more premium products.

Okay. I did want to spend a little bit of time talking about your customer base as well. So I was looking at some data in the past couple of weeks here, and it looks like you've gained an impressive amount of share with millennials and Gen Z. Can you just talk a little bit about your customer acquisition strategy and why you think you're resonating with that consumer?

Yes. If you think about -- people are starting families later and later in live now. And if you walk around New York City for 10 years, you see lots of younger generation walking their animals around, and in some cases, taking them out to bars and things like that. The reality is that, that generation sort of sees pets even increasingly so as a member of the family. And for our part, we think that we have an offering that meets the needs specifically of that customer. And in large part, it has to do with how we think about what our ecosystem looks like. If you -- our business is based off of a couple of key principles. And one of them is that customers want one-stop shopping. And so we think about how we go to market as being this largest segment, which is customers that are looking for both online and off-line shopping. They want to go to one location. And so we offer a very easy way for them to shop with us. I think our value proposition of being health and wellness-focused is resonating with customers, we are increasingly getting smarter about how we target different customer segments, millennials and Gen Zs being one of them. So I think we're getting a lot smarter about how we do customer acquisition, how we drive retention programs for things like Vital Care, repeat delivery. Just to sort of give you a little bit of color around that. I mean our Vital Care business, we're introducing 1/3 of new customers are moving into consumable categories. So they never -- new Vital Care members are going in to consumables and into that. So we think that the value prop that we're offering to that customer is actually just resonating very, very strongly to them.

And you kind of alluded to this, but that Gen Z and millennial consumer, I guess, kind of embraces the humanization of pets. I mean, are you seeing that, that cohort is purchasing or engaging with the company differently than some of the others? I would assume they're more tech-enabled, are they using the app with some more engagement?

For sure. For sure. Yes. I mean they are more used to things like subscription programs. So like I said, our repeat delivery business, we think resonates very, very strongly with them. We think that our Vital Care offering resonates really strong with them. And that's showing up in the numbers, by the way. I mean if you look at our membership program and our programs where people are in recurring revenue programs eclipsed $1 billion in our last quarter. It continues to grow. So we're -- year-on-year basis, it's up 50%, just to give you some sort of quantification of that. So it's sticking with customers for sure, that easy shopping. They're getting into other things like the app you mentioned, which is driving higher retention as well because it's easy you can manage the whole health of your animal. We help you to set reminders and care reminders and things that you need to do to be a better pet parent. So yes, it's absolutely landing with them.

And then, I guess, more broadly across cohorts, income cohorts, generational cohorts, I mean you guys are executing against the strategy to become the one-stop shop for pet owners. So I guess, do you look at data when a customer just shops in store versus shops in store, plus uses grooming, plus uses vet services or maybe uses the app? And I guess do you have any data to suggest that as consumers become more entrenched in the ecosystem, their loyalty goes up by a good amount?

100%. Yes, 100%. I mean again, just to go back to Vital Care, which we've announced 575,000, 580,000 customers in the last quarter. I mean that business is going to run rate $100 million. And that just makes it easier for people to shop across all of our ecosystem. It's -- they get benefits from you spend $20 a month, you get $15 back to spend with us straight away. You get benefits for the vet, you get benefits for grooming, you get benefits to shop with us. And so that behavior, both cross category as well as cross channel is generating higher LTVs, Vital Care on its own, people really post are spending 3.5x what they did before for lookalikes. So we know that, that is generating greater utilization. The app, for instance, when you start to use the app and we set the hooks with you on that, the spend is going up 2x right? And so we have all these programs that we can put people into that helps them to engage with our full ecosystem, again, cross-category, cross channel that is driving significant uptake in utilization of our business. So you take repeat delivery again, the retention rates are significantly higher if we get you into that program. But the benefit is that we're actually not losing the revenue, we're not losing the margin that you're already shopping through inside of a pet care center. So our strategy is very much about how do we enable greater utilization across these channels because it's just a more valuable customer for us.

And I feel like this is kind of your -- like in your role, your bread and butter is leveraging data and insights. And I imagine there's a ton of data that you guys collect between point of sale and transactions on the app and online. So I guess in my experience, anyway, I feel like there's a difference between data collection and being good at that and then taking those insights and turning it into action to either innovate or market. So can you talk a little bit about where you guys think you are in that curve?

Yes. I mean, I love that question. The first piece of the question is around the data collection. When I showed up at the company 4 years ago, we did not have a data science function to speak of. Practically speaking, we did not have anywhere close to the people that we have in-house now, which are data engineering, PhDs, people who are running pricing analysis, doing inventory management. We just didn't have the muscle, if I'm being really honest, I think we've built the muscle. We have a very, very high-quality data science team now, and now I believe that we're very much in early innings of doing something. To your question is like -- so one thing to sort of know what the problem is. It's another thing to say, like, how do you activate against that. So the ways that we are activating against that are smarter, more targeted marketing. So we're getting better at customer acquisition while we are lowering our cost of acquisition. We're getting better at driving retention programs because we know the things that are driving greater retention. And then if you think about really the -- what I am probably most excited about is this journey that we're on for personalization. See if you have a dog, there's no reason for me to show you cat and bird on the homepage. So how do I -- it's true, right? So how do I personalize that experience for you, but do it in a way that we think is industry leading, meaning if you're unlike our competition, you're shopping with us, but you're also in our vets. You're also doing grooming with us. And so we have this like amazing amalgamation of data that we can then turn around to you and publish personalized experiences to you no matter where you are within our ecosystem. And that, I think, is actually a pretty significant differentiation from the rest of our competition. And one that I'm super excited is generating higher revenue per customer. Even the small stuff on recommendation engine and widgets and things like that are driving up basket. So we're doing all the right things. And I think we're very much in the early innings of what that's going to look like.

Well, I think that's been a pretty underappreciated part of the story is the M&A, just like how much data you guys have. And if you are in the early innings of actually turning that into actionable insights, then I think that's actually a big piece.

And just a final point on this, it's showing up right now with our NSPAC. Our net spend per active customer is growing right now because we are doing all those fundamentals of turning that data into insight and into action that's helping us to drive up spend per customer.

Great. I did want to switch gears a little bit and jump over to vet. So not necessarily new, but definitely a big focus for you guys, a growth area to the story. You have a vet presence in 90% of stores at this point, and you've guided to opening an additional 50 to 55 vet hospitals in 2023. So I guess as you've been rolling out these stores and have gotten to the point where you've anniversaried some and you've recognized the lift in the store, I guess, what is the biggest learning from the rollout?

The biggest learning is how to manage such a fast-growing segment, to be honest. There are growing pains that come with doing that. I think the good news is that we've gotten through that learning. And then we feel very good about where we're at. Just as a reminder, our hospital network is around 250, 100 of them came through M&A. Those are our oldest cohorts, which are a few years old at this point. And then we've been kind of stamping these things out and learning how to do them better and better and better. The beauty of this business is it is on a stand-alone basis, kind of at the precipice of starting to be accretive to our overall business. So if you just sort of think about the 50 that we're going to do in the back half of this year, that will put us at close to 300. If you stopped doing any more vets, which we are not going to stop doing, those businesses as they mature are going to generate $1.5 million PER. So that's a $450 million business that will throw up $90 million in EBITDA. So that's if you did no more, and we anticipate taking this number up to close to 900 vets. So we think that not only the vets themselves, but the benefit that they generate through center store because they're driving more traffic, they're helping us to acquire 20% of our customers are new through the that channel. And then you put in the 1,300, 1,400 clinics that we're doing through our Vetco Network, doing vaccination clinics and things like that. I think we're servicing this market, I think, in a way that is in my view, kind of unique and unparalleled. And then again, as I mentioned, the fact that these hospitals are now maturing to the point where they're starting to become or will become meaningfully accretive to the overall business is very exciting.

And when you add a vet to a new location, presumably you're going to get a portion of customers who get a pet for the first time. But the customers who already had pets in theory already have a vet that they're working with already. So I guess how difficult is it to get consumers to switch over to your services? And maybe like what has the biggest friction point to date been?

Well, I mentioned one of the key insights, which is 50% of customers are looking for one-stop shopping. The other key insight that drives our business is that 90% of pet parents want to do better by their pet, but only 50% know-how. And so as we think about building our overall business, we want to show up for the customers in all the areas that they need to manage their animals welfare but also educate them on how to do that. And so you think about the vet side of the business, that's a really great opportunity for us to engage with the customer and help them to sort of drive utilization of our overall business. So we're -- like I said, we're very excited about what's happened with the vet side of things. And communicating the value of moving over to us is demonstrated through actions. It's not something that we talk about. It's something that we show you. So if you go into our app, for instance, we're sending you care reminders. We tell you when you're out of dental shoes. We tell you when your next vet appointment is due when you're up for a vaccination. So we're driving the engagement of things like that through operating with the overall ecosystem. So we can, in some ways, kind of pull people out of their existing behavior with other vets and pull them into our ecosystem because of the ways that we're communicating that value.

Got it. And I guess, with how competitive that space is, it's even that much more impressive that you added 375 vets to Petco, to the Petco ecosystem last quarter, which is up 60% year-over-year. What is driving that? How have you been able to attract that many vets?

Yes. I mean it's an area that we feel like we're really standing out in because of the value that we provide to the bets. They get stock. They have flexible working hours. They have access to diagnostic equipment that they might not have otherwise. We think that in some cases, you could say, well, why would a vet want to go work for a larger chain. In reality, there's a ton of benefits that come from it. And it's showing up precisely in that data where we're having -- I would say, I don't know this to be true, but probably the most success in the market and requiring new vets. New hospitals are being rolled out. They understand how this fits within the broader ecosystem, and it's working. The strategy is working.

Excellent. To jump around a little bit, we'll go over to e-commerce. So over the past few years, Petco has invested to improve digital capabilities and better compete online. Any color you could share in terms of what percent of sales are currently online? How much is buy online, pick up in store? And how you think that progresses over time?

Yes. We don't break out exactly what percentage -- the penetration of e-commerce businesses, but I'll just tell you, it's in the mid-teens. We are very excited about the digital platform. Again, if you segment how customers shop, the largest segments are people who want to shop both online and in-store. And we think that the digital channel enables greater behavior across both of them. If you look at the customers who utilize things like buy online, pick up in store, and same-day delivery. When we make that available to a customer, they're choosing it 90% of the time, 90% of the time, they're saying, "I want to use buy online, pick up in store or same-day delivery." And those are capabilities that we think are pretty unique in the market. The largest players online only can't offer those things, either of those things. Even Amazon with its tremendous scale can't offer because of their distribution center model can't offer things like same-day delivery from a distribution center. You have to have pet care centers or stores in market, we have almost 1,500 of them where we can enable things like same-day delivery. So there are capabilities that just don't exist. Our buy online, pickup in store business, grew faster than our overall business last year. It's working. It's working very, very well. We think it's a good experience for our customers. They can leverage the app. We know when they're driving it up. We can do curbside delivery with them. It's a very profitable transaction for us. So while we don't break it out, I can tell you, it's working extremely well. And the other piece of that, I'll just say is our repeat delivery business, too. I talked about overall membership and recurring revenue programs. I mean that business is doing extremely well and again, growing faster than our overall online revenue and customers see the value and just being able to kind of set it and forget it. And the great part, by the way, you talk about omnichannel shopping is it's not draining revenue and margin out of the pet care center. So it's accretive. It's actually driving up their spend and earning more wallet share with that customer.

And as we think about the e-commerce industry and pet, I mean e-commerce penetration is already very high relative to other sectors of retail and given the recurring nature of the industry, presumably people have subscription set up already. So you guys are building out this technology and capabilities right now. I guess, what gives you guys the right to win? I mean, you talked about same day and -- but maybe it's the DoorDash partnership or anything you could expand on there?

Yes. I mean with the recurring revenue programs, certainly, when you think about repeat delivery, I mean if somebody -- the fastest way to get your product is not actually same-day shipping, it's buy online, pick up in store. And so we can enable people to pick up their product if they're in a recurring revenue program, sort of however they want to get it. We can ship it to you kind of via Pony Express, if we want to. We can ship it to you a same-day delivery. You can come in and buy online, pick up in store. The fact that we have a broad assortment, the fact that we provide a discount to customers to engage in that program with us and the fact that we offer flexible delivery options as the big driver behind why customers are deciding to choose and move off of other subscription-like programs. So yes, a very exciting area of the business for us.

Got it. And then in terms of profitability online, you guys don't break out exactly what margins look like. But at the Investor Day going back a little bit, you had talked about a 500 basis point opportunity to expand those digital margins. So any color you could share on progress against that to date and then the opportunity moving forward? Where the biggest buckets are?

Yes. I'm happy to report that we're ahead of what our internal plans were in terms of profitability improvement. And if you look on an EBITDA rate, we are at or above the enterprise level of profitability for digital. So we are doing great, great work there. The big buckets would be improvements in mix, improvements in fulfillment, lowering our variable cost of fulfillment. And then our ad network, which we're very, very excited about. And it's very in vogue now, but I have to tell you, we started this ahead of the rest of the category, and the value that our vendors are getting out of this is fantastic. It's allowing them to introduce new products. It's allowing them to show up, and in some cases, trump their competitors. And the way that we've built this out actually is quite unique, and it's offering significant profitability improvements for us. So all of that kind of goes into the profitability improvements.

Fantastic. We're coming up on time. I want to squeeze a couple more in Petco AdWorks. So advertising is an initiative that a lot of retailers have leaned into, I think Walmart kind of opened up investors' eyes to how lucrative that business can be. Can you talk about where you are? I think you're a little bit earlier on at this point, but where you are and kind of how you see that evolving over time?

Yes. I actually helped build the Walmart one, which has done, I think $2.4 billion, $2.6 billion, something $2.7 billion, yes. So I was there and helped to build that business. And as I said, we actually got out ahead of the pet market in terms of building this out. What's very exciting and very unique about our ad network is this. If you think about, again, largest segment of customers who want to shop omnichannel you show an ad to somebody online, most online-only competition would be able to generate a connection between I saw an ad and somebody made a purchase. The problem is if they end up going into a physical retail location, most retailers had to track that. We actually have the ability to do that because we have such high penetration of our Vital Care program. So we know when somebody is online, we know when somebody's purchasing in store, and we can report back to the vendor and say, "Hey, we showed an ad to somebody online. They actually ended up purchasing it inside of store." That is the golden goose. That is what we think differentiates us from the rest of the ad works that exist out in the world because there's a drain that happens from customers who end up going into physical location. Walmart has shown a lot of success in doing this because we have close to 1,500 pet care centers. We're able to capture that revenue and report it back to the vendors, and the vendors are continuing to invest in this category for us. So again, back to overall profitability, it's working for the vendors really, really well, and it's also really working for us. So it's a super exciting and material initiative for us.

Great. We have about 30 seconds left. Within your role of Chief Customer Officer, if we look out 12 to 18 months, obviously, the macro is going to do what the macro is going to do, but what are you most excited about?

Look, this category is really good. I mean, coming from a place like Walmart where you sell a TV to somebody every 5, 6, 7 years, we're seeing people every week, every month. You're seeing premiumization in the category. There are tons of initiatives in this business that are super exciting for us. Recurring membership is growing really, really fast. You've got premiumization happening. You have fresh and frozen growing. Our services business is ripping right now. Our vet business is growing at a very, very good clip and is about to tip into I think sort of meaningful growth or contribution. So I mean, I can't say that there's any single thing that I'm super excited about. It's a passion-led category and it's manifesting itself in a very kind of healthy business for us.

That's great. This has been super helpful. Darren, thank you so much for joining us.

Yeah. Thanks Steve. Appreciate it.