Petco Health and Wellness Company, Inc.

Good day, ladies and gentlemen. Welcome to PECTO's fourth quarter fiscal 2020 earnings conference call. If at any time during today's conference you need assistance from an operator, please press star then zero. After today's presentation, there will be a question and answer session, and further instructions will be given at that time. Please also note today's event is being recorded. I would now like to turn the conference over to Christy Moser, Vice President and Investor Relations Officer. Christy, you may begin.

Thanks very much and welcome everybody to Petco's fourth quarter fiscal 2020 earnings conference call. We are webcasting live over the internet. To access the call on the internet, please log on to Petco's website at Petco.com and follow the links from there. In addition to the earnings release, there is also a presentation available to download summarizing our fourth quarter 2020 results. On the call today with me are Mr. Ron Coghlan, Petco's chairman and chief executive officer, and Mr. Mike Nuzzo, PECA's Chief Operating Officer and Chief Financial Officer. In a moment, Ron and Mike will walk you through PECA's recent financial and operating performance. Before we begin our remarks, I would like to remind you that in this call, we will be making forward-looking statements regarding our current beliefs, plans, and expectations, which are not guarantees of future performance and are subject to a number of risks and uncertainties and other factors that could cause results to differ materially from results and events contemplated by such forward-looking statements. These risks and uncertainties include those set forth in our earnings relief and our filings with the Securities and Exchange Commission. Those forward-looking statements are made only as of the date hereof and accept as required by law. We undertake no obligation to update or revise any of them, whether as a result of new information, future events, or otherwise. In addition, today's presentation contains references to non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and our filings with the Securities and Exchange Commission. During the question and answer portion of today's call, please limit yourself to one question and one follow-up. Now, let me turn it over to Ron. Ron?

Thanks, Christy, and good morning, everyone. Let me begin by saying that we could not be more pleased to be speaking with you for the first time since our IPO in January. We've been looking forward to sharing progress against our strategic priorities and how that translated to strong fourth quarter and full year results. We exited 2020 with momentum, delivering fourth quarter revenue growth of 16% above our expectations, a 17% comparable store sales or comp sales. 90% plus digital growth, almost a million new customers into the franchise, and 13% adjusted EBITDA growth. This contributed to an impressive 2020 performance overall, where we saw a full-year revenue growth of 11%, translating to 14% growth in adjusted EBITDA. And while the COVID environment has definitely provided a strong industry tailwind, looking forward, the millions of incremental new pets who entered homes in the past 12 months generates a predictable pet spend annuity for years to come. And coupled with premiumization and humanization trends and the stickiness of our multi-channel customer relationships, we see strong growth long into the future. Mike will dive deeper into our financial performance and provide guidance for 2021. But before we do that, I want to ground everyone on why Petco is such a special growth company. For those of you who are new to our story, we are the health and wellness company for pets and pet parents. Building off of a 55-year history of serving pets and the people who love them, over the last three years, Petco has transformed into a disruptive, fully integrated, and digitally-led provider of premium products, services, and veterinary care. Our investment thesis starts with a phenomenal category that is large and growing. And within this category, Petco has an exceptional integrated end-to-end ecosystem with the ability to reach customers when and how they choose. That is absolutely what pet parents want, as industry research suggests. 50% of customers are looking for a one-stop shop for all of their pet's needs and are customer-based over indexes in the highest quality seeking and highest spending pet parents. Our transformation has delivered nine consecutive quarters of growth. In particular, we had momentum going into 2020 with strong top-line performance. Our performance accelerated through the pandemic, and we're on an exciting growth trajectory even as COVID restrictions relax. The Petco multi-channel platform integrates our strong digital assets with our nationwide physical network. For example, we launched approximately 400 more shift-from-store locations and curbside pickup in a matter of weeks. This nimble approach enabled us to adapt to the environment in a way that would have just been impossible two years ago. At Petco, though, great results start first with great people. I could not be more proud of how our knowledgeable, passionate, and caring Petco partners have rallied together to do amazing things for pets, pet parents, and each other. Their health and safety remains our absolute number one priority, along with the customers and animals in our care. We've consistently met or been ahead of CDC safety guidelines. The protocols we've deployed in support, we've provided our partners as a result of an Impeccable Partner COVID infection rates that are around one-third of the national average despite everyday interaction with customers. Importantly, we have provided five COVID-related bonuses and established an employee emergency fund that has already provided support to over 1,300 partners and their families. We believe vaccinations are critical enablers to the fastest possible recovery, so last month we launched a $75 incentive program for each Petco partner, completing a COVID-19 vaccination regimen. For each partner vaccinated, we're also donating $25 to the Partner Assistance Fund. As we think about the road ahead, there are two critical factors that have us all very excited. First, the strength of our category today and forecasted into the future. Second, we are really just getting started monetizing our unique end-to-end pet health and wellness ecosystem. The pet category has proven once again how resilient it is to economic cycles and industry projections forecast accelerated growth for many years to come. That is powered by the seismic 3 million plus incremental new pets in 2020 and heightened adoption activity continuing into 2021. According to recent studies, the pet food and pet supplies categories are up mid-single digits and double digits, respectively, over the first few weeks of 2021. And while our list mirrors other COVID beneficiaries like masks, home improvement, and home goods, what makes us different is that once the garage is remodeled, you're not going to do that again for a decade. Conversely, once a cute puppy becomes part of your home, that will need to be fed. They'll need to be groomed and vaccinated for a decade or more. And importantly, the spend per pet has increased 4% annually for years, as pet owners increasingly embrace their pets as part of their family. Much like my dog, Yummy, who comes to work with me, eats salmon and sweet potatoes, and not only sleeps in bed with us, but is a bed hog at that. This combination of more pets and greater spend per pet has resulted in industry experts freezing their forecasts from historical levels around 4% to 5%, up to 6% to 7%. with higher growth projections in key areas like premium food, services, vet, and digital. The exact area is what we're focused in seeing accelerated growth. All in all, PET has historically been a great high-growth category that accelerated in 2020 from COVID tailwinds, and that creates an annuity for many years to come. We also believe that there is no company better positioned to both provide world-class health and wellness and capture a dominant share of wallets. from these new pet parents. While we compete with peers across each of our channels, from our perspective, no one has the end-to-end integrated multi-channel experience with the ecosystem that Petco provides pet parents, from nutrition to own vets, to vet clinics, to training and grooming, to our differentiated fulfillment options, and more. This results in tremendous stickiness. Our platform provides a singular view of the customer, giving us what we believe is a significant competitive advantage relative to our peers. Let me give you an example to make this more tangible. Only a few weeks ago, I received a reminder on my Petco app that Yummy was due for his vaccinations. I scheduled his appointment online and took him in. While I was there, I picked up a few new treats, picked up a toy, and scheduled a groom. Without an integrated ecosystem that enables one view of the customer, we never would have had all those touch points. A key component of our ecosystem is our best-in-class digital platform. which drove 100% plus digital revenue in 2020 and has steadily gained share. Thanks to strategic investments in recent years, our site speed is now as fast as any other player in the market. We were laggard two years ago. Our user experience is winning over customers, and our assortment and pricing are now competitive, all of which drives substantial improvement in conversion. We're also seeing compelling results from our recurring revenue offerings, repeat delivery, and pop box. which is our monthly subscription box program for puppies. They were up over 40% and 100% respectively for the year. Shifting next to recurring revenue is a strategic priority that is now tangibly impacting our business and we're continuing to make great progress. One of the things I'm most excited about is a structured manage created by our customer fulfillment. Our pet care centers now double as micro distribution centers and our footprint of physical locations have become a huge asset. At the onset of the pandemic, we launched curbside pickup. And over the holiday period, we launched same-day delivery, an offering that our digital pure play competitors just cannot offer. We believe this will further enhance our customer retention, with almost 40% of early adopters saying they prefer same-day delivery. Today, over 80% of our Petco.com orders are fulfilled from our pet care centers. enabling us to get the product to customers faster and at a lower cost on average than pure play online competitors. Also, by the end of the fourth quarter, our mobile app has been downloaded 3 million plus times and is driving merchandise sales and incremental services bookings. Our own brands and exclusive merchandise deepen our competitive moats and power our growth. Our team has demonstrated the ability to build brands and products that resonate with customers. In both Q4 and full year 2020, our own brands drove double-digit growth and are rapidly approaching 30% penetration, further fortifying our differentiation from our competitors. Our food brand, Whole Hearted, which we launched in 2016, is now a top three offering, while our premium and supplies brand, Ready, grew almost 90% with aggressive expansion plans ahead. Complementing our own brand offering, we also have exclusive partnerships for unique products. We're particularly excited about fresh food, which is projected to more than quadruple into a multi-billion dollar category over the next several years, according to industry forecasts. We're focused on becoming a market maker in fresh. In 2021, we're set to more than double our Just Food for Dogs distribution, while our recent launch of premium price human grade Honest Kitchen has broken all our previous initial sales records. Overall, our own brands and brands exclusive to Petco in specific markets represent over half our portfolio, not only enhancing our gross margin, but also creating competitive insulation. Petco's competitive insulation is furthered by services like our veterinary business, where we're creating a new paradigm in the industry, as well as grooming and training. We're rolling out full-service veterinary hospitals across the country, to address the growing need for affordable pet healthcare consistent with our mission to improve the lives of pets and their pet parents. By integrating these veterinary hospitals into existing pet care centers, we benefit from significant structural advantages, including lower cost of acquisition and additional basket opportunities compared to standalone veterinary care providers. This model enhances customer lifetime value and drives retention. Our vet hospital business is shifting into high gear as we open 20 additional hospitals in Q4, despite COVID related construction and permitting delays. This brings our year end total to 125 locations. Our hospital customer count is up strong double digits year over year. This performance comes with consistent nine out of 10 customer satisfaction scores. We are executing what we believe is the fastest vet build-out in history and are seeing a strong performance ramp ahead of our expectations. Long-term, we're targeting up to 900 vet hospitals and our pet care centers. This will have a tangible annual and long-term impact on our financials. In addition to our rapidly scaling vet hospital business, our mobile vaccination clinic business, Vetco, services over 800 pet care centers weekly and is seeing strong customer demand. We continue to expand to new markets like Reno, Anchorage, and Nashville, and have begun to pilot mobile clinic sites with other major retail partners. I visited a pilot location several weeks ago in Phoenix and am excited by the potential there. Needless to say, our vet offering stack is scaling into a major long-term growth engine for Petco. Turning now to grooming and training. COVID has had a tangible negative impact on our business. As we shuttered all group training classes, and implemented capacity restrictions at grooming salons. In spite of those restrictions, grooming began to rebound in the second half as we started to carefully reopen. In grooming and training, we expect to continue to take share in a fragmented market as we compete primarily with single-unit operators, and our digital marketing capabilities provide tangible advantages. Over 25% of grooming appointments are booked online or in our app. Our Spa Club loyalty program has over 200,000 customers. We successfully launched online training, which means my mom's new Maltese here in San Diego was trained virtually by our star trainer, Chloe, in New York City, 3,000 miles away. And lastly, we successfully applied digital media and search at the local level. All capabilities single unit operators typically lack. Due to the 2020 COVID-related closures, Grooming and training will likely have a positive lap dynamic from Q2 to Q4 of 2021 as we annualize stay-at-home restrictions. Bringing all the services business together despite COVID-related headwinds and health and safety requirements, we achieved revenue growth in 2020 and returned double-digit growth in the fourth quarter. And further powering our acceleration, We're leveraging our data analytics engine to drive new customer acquisition, build further momentum, and multi-channel purchase conversion. We have a base of over 20 million active customers, and that grew by nearly 1 million customers in each of the third and fourth quarters. So today, approximately 90% of those customers, well, they're PALS loyalty members, which gives us insight into what they buy, where they buy, and when they buy. One of the most robust databases of pet parents in the industry. We leverage this data across the entire organization from marketing to new products and services to how we operate our pet care centers. Importantly, we are very focused on having pet parents participate in more of our categories and channels. We call these multi-channel customers. And our analytics show that when a customer shops more of our categories and channels, their spend and our share of wallet increase exponentially. We drove double-digit growth in our multi-channel customer base last year. And given the spring, I'll use a baseball analogy. I think we're only in the third inning and see a scale revenue growth opportunity from customer acquisition and this multi-channel conversion effort. In support of these efforts, we're deploying enhanced CRM, digital marketing, analytics, and customer segmentation capabilities, with marketing ROIs double industry benchmarks as a result. These capabilities are driving our game-changing VitalCare membership program. It's the industry's first comprehensive membership program covering checkups, vaccinations, grooming services, and merchandise discounts. In essence, bringing our unique ecosystem to life. We launched in mid-October and already have more than 50,000 participants. VitalCare is providing better care for the pet and increased share of wallet for Petco. I will close by reinforcing both the importance we place on our North Star of purpose-driven performance and the significant progress we've made in the purpose area. We've made bold moves and demonstrated our commitment to improving the lives of pets, pet parents, and the partners that work at Petco. This year, like prior years with the Petco Foundation, we helped save roughly 400,000 animals from euthanasia. And since our inception, have helped find homes for more than 6.5 million animals. Ending pet euthanasia is an absolute mission for Petco. Two years ago, we made the choice to eliminate products with artificial ingredients. The only national retailer to do so, and that choice resonated with pet parents. It was an important step in our journey to differentiate ourselves as a pet health and wellness company. In October, we led the industry once again by removing electric shock collars, which cause stress and pain. from our shelves and increased our advocacy for and provided free introductory positive dog training classes. The response to this announcement was incredible. It generated more than 2.3 billion impressions and further established Petco as the true health and wellness company. Our purpose also includes improving the lives of Petco partners. As I mentioned earlier, we gave five COVID appreciation bonuses, and in 2020, our average wage rate increased by double digits, living up to our commitment that if the company does better, employees will do better. Similarly, we granted IPO shares to an extremely broad swath of employees, reinforcing that when the company wins, our partners win. We're also committed to sustainability and are making strong strides. We'll be laying out details about our sustainability progress, targets, and initiatives in the coming months. Pulling all that together, we've delivered strong results from a Q4 and full year 2020 standpoint, powered by a differentiated customer proposition, customer acquisition and engagement momentum, obsessive execution by the Petco partners, and a strong mission-based culture that drives us into the future with tailwinds from an accelerating industry. The scaling of our industry and power of our model is evident in our Q1 quarter-to-date revenue and customer acquisition momentum, which has given us added confidence for the year. We are beginning to lap the supercharged pantry loading from March 2020 and are pleased with what we're seeing. Petco has also strengthened beyond operational components. Our IPO and oversubscribed refinancing allowed us to lower debt and debt servicing obligations and provides more ability to invest for growth. In the near term, we would expect a lift in the recently passed stimulus as pet parents have increased spend on their beloved pets after receiving prior checks. And from a leadership standpoint, we've added terrific new board members, including Sabrina Simmons, former CFO of Gap, Mike Mohan, President and COO of Best Buy, and Mary Sullivan, Senior Managing Director and Chief Talent Officer of Canada Pension Plan Investment Board. These moves will further enable us to continue to pull away from the competition while doing everything in our power to improve lives. We look forward to keeping you updated on our progress. And with that, let me now turn it over to Mike Nuzzo, who, in addition to being our CFO, has done a terrific job leading our services business and supply chain as COO. Mike will walk you through the financial details on our fourth quarter and fiscal 2020. Thanks, Ron.

Good morning, everyone. Building on the strong business momentum that Ron discussed, I am pleased to share with you how this momentum is translating into strong financial and operational results. I'll start with the fiscal year 2020. Full year 2020, revenue grew 11% from 2019 to $4.9 billion, with total comp sales up 11%, consisting of digital up over 100%, services and vet up modestly despite COVID headwinds, and brick and mortar merchandise up mid-single digits, reflecting robust trends discussed previously. Both transactions and average basket trends were strongly positive for the year. As Ron mentioned, our digital business continues to benefit from repeat delivery, which by the end of the year represented almost 45% of total digital revenue, and from local pet care center-based fulfillment, including buy online and pick up in store, curbside, ship-from-store, and same-day delivery, which collectively represented approximately 80% of fulfilled digital orders. Own Brands delivered a teen's growth rate for the year. Our services and vet businesses continued to benefit from momentum in grooming, as well as the scaling of vet hospitals. In spite of a challenging environment from COVID restrictions, In 2020, as we added 44 new full-service vet hospitals within pet care centers, ending the year with 125 hospitals. From a performance standpoint, our hospitals are expected to reach full revenue and EBITDA maturity at five years after launch. Notably, our hospitals completing their third year of operations are ahead of model, generating over $1 million in revenue and over $200,000 in four-wall EBITDA in year three, while our 2019 and 2020 cohorts are scaling meaningfully faster than model as we gain more vet service share within our target markets. In addition to these impressive hospital trends, the rest of store lift from our pet care center transformation remains strong, with vet locations delivering results that exceeded the rest of chain sales growth rate by mid-single digits in 2020. Full-year gross profit increased $200 million, or 11%, in line with revenue growth to $2.1 billion. Gross profit as a percentage of revenue was 42.8% compared to 43% in 2019. Excluding certain COVID-related impacts within our services channel and distribution centers, 2020 gross margin rate would have been up modestly from 2019. SG&A expenses were $1.9 billion, up $135 million or 8% from prior year, inclusive of non-recurring COVID-related expenses. SG&A as a percentage of sales was 38.9%, an improvement of 120 basis points versus prior year, reflecting expense leverage on sales growth and our cost management efforts. Adjusted EBITDA was $484 million, an increase of 14% from prior year, outpacing 11% revenue and gross profit growth. Adjusted EPS, which also excludes IPO-related debt extinguishment costs, improved by 33 cents to 28 cents based on 211 million weighted average fully diluted shares for full year 2020, as well as a normalized effective tax rate of 26%, which excludes unusual one-time tax impacts, including the IPO transaction and the 2020 CARES Act. Turning to the fourth quarter of 2020, revenue grew 16% to $1.3 billion, and comparable sales were up 17% and 20% on a two-year basis, demonstrating acceleration in the second half of the year. This revenue performance was driven by 92% growth in digital, 13% growth in services and vet, and 10% growth in brick-and-mortar merchandise, reflecting the strength of our multi-channel platform. Fourth quarter gross profit increased 71 million, or 14%, to 569 million from Q4 2019. Gross profit as a percentage of revenue was in line with our plan at 42.6% compared to 43.3% in Q4 2019. Much of the gross profit rate difference was driven by COVID-related costs as well as the anniversary of a Q4 2019 actuarial true-up. The balance of the difference was from a modest channel mix impact, partially offset by gross margin rate improvements within key areas of the business. SG&A expenses were $502 million, up $65 million, or 15% from Q4 2019, inclusive of non-recurring COVID and IPO-related expenses. SG&A as a percentage of revenue was 37.5% compared to 38.1% in Q4 2019, driven by expense leverage and cost management, even as we made incremental strategic investments in the safety of our partners and customers, capturing new customers with added digital media and performance-based bonuses for our team members. Adjusted EBITDA was $149 million, an increase of 13% from Q4 2019. Adjusted EPS was 17 cents based on 216 million weighted average fully diluted shares and applying our 26% normalized effective tax rate among other adjustments outlined in our GAAP EPS to adjusted EPS reconciliation. Turning to our pet care center base, we ended Q4 with 1,454 pet care centers. down 23 locations from a year ago. In the quarter, we added one new location and closed 15. We also added 20 additional vet hospitals within pet care centers and ended 2020 with 125 locations. We also ended the year with 96 pet care centers in Mexico, operated by our successful joint venture with Grupo Gigante, where we had double digit comp growth in 2020. For 2021, we expect the US pet care center count to remain roughly flat to year-end 2020, but we expect to transform 70 pet care centers by adding full-service vet hospitals and other revenue-driving enhancements. We will also plan to add over 10 pet care centers in Mexico. Looking at our balance sheet, we continue to have strong liquidity at the end of the year of $499 million inclusive of $111 million cash and cash equivalents and $388 million of availability on our revolving credit facility. On the cash flow side, we began the fiscal year with $149 million in cash and cash equivalents and generated $269 million in cash from operations. We invested $160 million in capital allocation focused on IT infrastructure and innovation the strategic transformation of our pet care centers with the addition of vet hospitals, Just Food for Dogs pantries, and ready shops, and other corporate and supply chain capabilities. All that said, free cash flow generation for the year was $109 million. Moving to our leverage position, we recently took action to strengthen our balance sheet. First, in January, we successfully closed our initial public offerings which yielded net proceeds of approximately $939 million after deducting underwriting discounts and commissions. We used these proceeds and other funds to pay down debt, ending the year with net debt of just under $1.5 billion, a net leverage ratio of 3.2 times. Second, after the fiscal year ended, we successfully completed a refinancing of our loan facility with borrowings under a new term loan facility with a principal balance of $1.7 billion maturing in 2028. Our refinancing enabled us to take advantage of low borrowing costs and actively manage our near and medium-term maturity profile. When coupled with the deleveraging from our IPO and related recapitalization, we lowered our annual interest expense by over $100 million and our required principal payments by over $8 million annually. enhancing our ability to invest for growth while maintaining financial flexibility. Building on our strong 2020 performance, we are confident in our ability to drive continued growth in 2021. Our initial outlook and guidance for 2021 is as follows. Total revenue in the range of $5.25 to $5.35 billion. Adjusted EBITDA in the range of $520 to $530 million. and adjusted EPS in the range of 63 cents to 66 cents based on approximately 90 million of interest expense, an effective tax rate of 26%, and a weighted average fully diluted share count of approximately 266 million. Our 2021 revenue guidance reflects the continued strength of our business. Similar to other consumer and retail companies, we have a higher sales growth compare in the second half of 2021. However, unlike most businesses that benefited from COVID stay-at-home dynamic, the increase in pet ownership will generate meaningful, ongoing industry sales growth tailwinds that we are well-positioned to capture. We believe that the recent approved federal stimulus bill and the anticipated broad-based economic recovery should also be beneficial to us. And finally, as we stressed in our IPO process, we have a substantial multi-year growth runway across all parts of our business, complemented by exciting emerging capabilities. As we sit here today, we feel very good about both pet care market trends and the execution of our ecosystem strategy as our momentum has continued into Q1 of 2021. With that, I'll turn the call back over to Ron for some closing comments.

Thanks, Mike. My closing point is the same one that I made on our IPO Roadshow when I asked how to think about Petco. Beyond being a mission-based, strong growth company with a terrific management team, yes, I encourage you to think about us as a high-performing retail company. We're also a digital and omni-channel innovator whose e-commerce business doubled in the last year. At the same time, we're a veterinary care and services provider whose vet footprint increased by over 50% in the last year. We are confident that the continued execution of our strategy will drive momentum across our business as reflected in our 2021 guidance, and will enable us to continue to create long-term value for shareholders. On behalf of our more than 26,000 passionate partners, I could not be more proud of our incredible performance in 2020, and we are just getting started. The hashtag PetcoStrong is something that organically became our rallying cry this year, and I see us becoming Petco stronger every single day. We're excited about the future and appreciate you being a part of our journey. With that, Mike and I will now take your questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on a touch-tone phone. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Today's first question comes from Kate McShane with Goldman Sachs. Please go ahead.

Hi, good morning. Thanks for taking my question. My question centered around gross margins. It was nice to see that you were able to offset some of the pressure from the mix piece, which I know includes digital and services. So I wondered if you could maybe talk through that a little bit more, how much that mix impacted have on gross margins in Q4, and how should we think about the gross margins in the context of the guide for 2021?

Thanks, Kate. Appreciate it. Let me be clear. Our FY20 and fourth quarter gross margins were in line with our expectations. We will continue to drive gross margin rate improvement in each area of our business, as well as drive into high profit areas like own brands that offset that mix shift Ron Papsdorf, To digital so from a longer term standpoint, you know any gross margin rate erosion is going to be modest and moderating over time i'll let Mike double click into that though.

Mike Wilberg , The Capacity Collective, yeah thanks ron thanks for the question Kate. Mike Wilberg , The Capacity Collective, yeah I would start by emphasizing that our gross margin rate for 2020 would have exceeded 2019 gross margin rate, excluding the covert related impacts, as we mentioned in our prepared remarks. In Q4, the major impact was the lapping of an actuarial true-up from 2019, and we also had COVID-related impacts. Channel mix was modest, but what we are seeing is gross margin rate improvement in major areas of our business. And the other really positive thing is that we are seeing substantial opportunity for continued rate improvement. We've talked about the delivery optimization that we're doing in e-commerce. The productivity enhancement in services with the scaling of vets and the increased productivity around our grooming business, for example, own brands is a huge help to our gross margin rate. So we don't guide to gross margin rate. It's embedded within our guidance. We feel very good about our ability to manage this aspect of our business.

Thank you.

Thanks, Kate.

And our next question today comes from Steven Zicone with Citigroup. Please go ahead.

Great, thanks. Good morning and congrats on the nice start to being a public company. Ron, when you look back on 2020, how much of the strength in the business was driven by the pandemic lifting demand versus the general transformation in the business that was already underway?

Thanks, Steve, and thanks for the well wishes for quarter number one. So if you break it down, in many ways, we were just perfectly positioned for COVID. The transformation that we engineered, we were already accelerating coming into COVID. So we were growing 6% coming into COVID with plans to accelerate from there. As COVID changed behaviors, we had been in the process of turning our pet care centers into micro distribution centers already. So we immediately tripled the amount of ship-from-store locations. We launched curbside and then later launched same-day delivery. All of these positioned us very well to capture the COVID opportunity. Now, I know there's lots of conversations about stay-at-home beneficiaries versus companies that are going to surge with the reopening. I would tell you that we're a bit of a unicorn between the two. Yeah, we got a benefit from COVID, but that benefit brought with it 3 million incremental new pets in 2020 and we see elevated pet adoptions and we see waiting lines with breeders and we see our live animal sales at an elevated level in the first half of 21. So that provides an annuity. If you look at a home gym, you're only going to do that once every five or 10 years. But once you have that new furry friend in your house, they're going to be fed, they're going to be groomed, they're going to need to be vaccinated. So that provides an annuity that gives us a bridge from the COVID beneficiary to the reopening beneficiary. So we bridge into both. We also have parts of our business that were hampered in COVID that are going to have positive lab dynamics. And grooming and training would be a perfect example. You know, out of abundance of caution, we stopped group training. We reduced our throughput and footfall in our grooming salons. And those went negative for the first two quarters after the COVID. We got back to growth, and we got back to double-digit growth in Q4. But those are going to have a positive overlap dynamic as we head into the second half. And then when you look at, you know, total spend per pet, you know, it is for the last seven or eight years has been up 4% as humanization and premiumization increases. So we see that continuing into the second half. So we're both a COVID beneficiary, but we're also a reopening beneficiary. And all the work we did in the leading up to COVID positioned us perfectly. Thanks for the question, Steve.

Yeah, that's great. Thank you for the detail. Just a quick follow-up. Question on the e-com business. So you have very strong growth this year, but there's still a pretty sizable sales volume gap versus the industry's largest e-com pure play. What do you view as your key competitive advantages online to narrow that gap over time? And thanks very much.

Yeah. So let me start by saying we doubled our e-com business in 2020. So obviously, we're very happy with that. We've steadily gained share from a digital standpoint, so we're happy about that. Where I would depict our e-commerce business is into three buckets. We historically, prior to those three buckets, had been overly promotionally oriented. We had an antiquated infrastructure and a promotion orientation. So phase one was getting the basics right, getting the fundamentals. We rebuilt the IT infrastructure underneath our digital business, and within 18 months, we launched repeat delivery. We launched our app. We launched buy online, pick up in store, et cetera. So we redid our IT infrastructure. Then we closed gaps in areas like SKUs versus competition. We closed gaps in areas like pricing where we wanted to. We were the slowest site in the industry. Now we're either the fastest or as fast as anybody else. So we got our fundamentals right. And guess what happened? We did that. Our conversion grew by double digits. And then stage three, which is the really exciting stage, is where we generate competitive advantage. And that really became clear to us in COVID. As we launched Focus, as we expanded, or Curbside, as we expanded our ship from stores, but really, really when we launched same day delivery. Same day delivery is now 30% of our orders. And the way to think about all of those offers is We get to the customer faster, so you have higher customer satisfaction at lower cost than pure online players who are shipping from DCs. And the best example of this is a big bag of dog food. So a big bag of dog food from a DC, 40-pound bag, is going to get a UPS or FedEx charge based upon the weight going across zones to that customer. Instead, that big bag of dog food gets picked from one of our pet care centers, formerly known as stores, goes in the back of a DoorDash trunk, which costs us the same as if it was a tennis ball, and gets to that customer the same day, again, lower cost. So we believe we have structural advantages that will allow us, at minimum, to play our game and to continue to gain share, but we think it's competitive advantages versus the online players that the dedicated player would have very difficult time competing against. Thanks very much.

Thank you. Our next question today comes from Michael Lasser with UBS.

Please go ahead.

Mr. Lasser, is this the operator or is it unmuted perhaps?

It was. I'm sorry. Good morning. Thanks a lot for taking my question. Two quick questions. First, if you look back at 2020, how was the overall promotional environment and how did that contribute to your gross margin dynamics, especially in the fourth quarter? And second, what is your expectation for the contribution from inflation in 2021 in light of the sharp rises in commodity input costs for pet food? Thank you very much.

So I'll front this and then Mike will tell this one. Thanks for the question. The good news is the promotional activity was severely backed off in 2020, which allowed us to, you know, do some of the margin offsets. Digital is a great example where expanded margins within our digital business. So promotional activity has been down. We don't see that more promotional pressure as we navigate into 2021. The other thing I would say is over half of our merchandise portfolio isn't sold at other places. So we have less promotional pressure than just about all of our competitors because we have much stronger mix in own brands and much stronger mix in exclusives. We don't have that same promotional or commoditized pressure on our business. Where we really see pricing and promotions going is is on the back of the analytics build out that we did in the last year. We've spent time building a data infrastructure. We brought in analytics experts. We created a cross enterprise analytics group with some phenomenal analytics talent from outside. And now we're getting hyper-targeted at the individual customer level on what motivates them. And one of the examples right now is customers that we think would be prone to buy online, pick up in store. In that instance, they're doing the shipping for us. So we'll promote them into buy online, pick up in store. We see them turning into almost repeat delivery customers. So the long-term value of that customer is high. So we promote them into buy online, pick up in store, and then we increase our long-term value and obviously exponentially expand our margin as just one example. But I'll let Mike expand.

You've been migrating away from a heavily promotional environment in 2019 and 2020, so I can't say that we were meaningfully less promotional in 2020 related to 2019. I believe, as Ron was saying, that we don't really feel like we would have to be more promotional in 2021 for the very reasons that Ron was talking about. As far as input costs, we have not seen a broad-based substantial increase in input-related costs. historically, as you know, Michael, this has been a business where if there have been increases in input costs, they've been able to be incorporated into the pricing structure for us. But as of right now, we feel pretty good about how we're positioned from a pricing standpoint, how we're positioned from a manufacturing input pricing structure.

Awesome. Thank you so much, Inga Vuck.

Thank you.

Our next question today comes from Seth Sigmund with Credit Suisse. Please go ahead.

Hey, everybody. Thanks for taking the question, and congrats on all the progress. So you're exiting 2020 with significantly more customers than you started, and I'm just wondering, can you discuss the repeat behavior a little bit more? How have you been able to retain these customers to date? And I guess just given the recurring nature of your business, presumably that would support some higher level of baseline growth into 21? I'm just curious, how do you think about that?

How does that factor into your outlook? Thank you. Thanks, Seth, and great question. So yes, we captured nearly a million customers in Q3. We captured nearly a million customers in Q4. The Q3 number was competitive with our biggest online competitor. who has been historically good at that. So we feel really good about those two numbers. So then the question becomes what you just said, which is, what do we do with these customers? We have been actively shifting more of our customer base and more of our revenue base into recurring revenue customers, which makes it much more predictable and quite frankly, much less promotional. So whether it is repeat delivery, whether it is pup box, which is our monthly box for new puppies, which is an on-ramp to our business. Whether it's our insurance offer, whether it is our membership vital care offer, we are shifting mix to recurring revenue. And recurring revenue had a significant impact on our comp, both in Q3 and in Q4. Specific to repeat delivery, what we see is Um, we see higher satisfaction scores from our repeat delivery. We see significant growth in our repeat delivery. Um, concurrent with that though, one of the interesting things that's happening is we have a lot of customers that behave as if they are recurring revenue. These are programs like spa club, um, and, uh, focus customers that come every two or three weeks and pick up the same product. So more and more of our revenue is becoming recurring type revenue, either explicitly or implicitly. The other thing I would say is that our LTVs are going up and our retention is going up on our customer base. The customers that we acquired during the COVID years we're higher retention and more profitable customers than prior years. So we feel really good about these nearly a million customers picked up in Q3 and Q4 and what we're doing with them.

Okay, that's great. Very helpful. If I could just follow up on the guidance. So you're guiding sales towards the high end of the long-term algorithm that you've talked about. I guess you're guiding to EBITDA growth slightly above that. I realize the long-term outlook doesn't really embed a lot of EBITDA margin expansion, given some of the puts and takes you've talked about, but is there anything specifically that holds back the margin expansion in FY21, maybe an assumption for continued COVID costs or anything else that you would flag? Seth, I wouldn't call it anything in particular. I would emphasize, and we feel really good about the fact that in 2020, even with COVID expenses, we expanded our EBITDA margin by 20 basis points. So our guidance would imply a continued growth in the EBITDA margin. And as we have shown in the past, our ability to manage our cost structure, our ability to do that while smartly investing in the business, I think gives us a lot of confidence that we can continue to expand EBITDA margins into 2021. Thanks very much. Thanks, Seth.

Our next question today comes from Liz Kazuki with Bank of America. Please go ahead.

Great. Thank you. Are you seeing any meaningful changes in markets that are reopening, particularly on the services side? And do you also expect online penetration to come down as markets reopen, or have consumers become so accustomed to buying online that that acceleration in the online shift is now more likely to be permanent?

I'll do the second part of that, and then I'll pass it over to Mike to do the services reopening. We definitely have a change of behavior, particularly in older consumers. We're seeing all of a sudden they are comfortable buying, purchasing online, and their digital savviness has gone up, forced by the stay-at-home orders. At the same time, increasingly, we're not thinking about our customers as either or. 39% of customers, according to our studies, are omnichannel customers. And those are our sweet spot, right? They want to do some activities online, but they also want to come into the pet care centers to get groomed, to get trained, to get advice from our amazing pet care center partners. So we see more and more omnichannel behavior And actually, I'll give you two dynamics. First is as our digital business has surged 100% in 2020, it is driving PetCare Center traffic and growth, number one. The second thing I will tell you is we really dialed up as we over-delivered through the second half of 2020, we dialed up our performance marketing to aggressively acquire customers on the digital side of our house. What we found as we dialed up our marketing on the targeted against the digital side of our business, our traffic on a basket grew in our pet care centers. So this is really one end-to-end ecosystem, omni-channel ecosystem that is quite powerful. And we believe it's unique because we're the only one that as part of that owns our own vet network, and I'll pass it on to Mike to elaborate on services.

Yeah, Liz, I would say, and I'm really proud about this, our services business, our rebound has been broad-based, so it hasn't been market-specific. It's been significant, so much quicker than I think we may have even anticipated, and I think one of the big drivers is What Ron was talking about, this link with digital and services has become very, very powerful for us. So we talk about the 25% of appointments that are now booked online for grooming. The spa club program is all app-based. The rollout of online training, which we did in literally three weeks within COVID that we're now servicing Ron's mom's pet That, coupled with Vetco, our mobile vaccinations, where we pivoted to an online scheduling system, all of these digital linkages have helped to accelerate the business, have it rebound faster, and have given us a lot of momentum as we get into the first part of the year. And just, I'm really, really excited about it.

The last thing I'd say, Liz, on that is, Our traffic and basket are up in our pet care centers. So we didn't have this massive shift to digital, and our pet care centers aren't growing. Our pet care centers are growing. Traffic is up and basket are up in our pet care centers, and that continues to this day.

Perfect.

Thank you.

Thank you.

And our next question today comes from John Heinbottel with Guggenheim Partners. Please go ahead.

Hey, guys. Maybe talk to... what you think your current share is with the most lucrative customer segments that you have and where you think that might be able to go to. And then how many, where did you finish the year with multi-channel customers? How many did you add in the fourth quarter?

Yeah. So from a share standpoint, we're gaining share everywhere where we're focused. So super premium food, including fresh, fresh food, training, grooming, veterinary, digital. We're gaining share everywhere we're focused. Now, talking about the customer, we have the highest value customers, or we over-index in the highest value customers in the category. They're really the health-focused pet parents and the quality seekers. And The majority of our portfolio or our customer base is in this highest customer segment, and they spend over 40% more than your average pet parent. So we enjoy that customer as we bring in new customers, they gravitate towards that higher end spend and quality seeking. And part of it is because we have this unique end-to-end ecosystem. If you go talk to customers, 50% of customers say they want a one-stop shop partner for the care of their pet. We are the only ones who have that. Nobody else has from own vets to training to grooming to the highest nutrition foods to supplies. Our leading pet specialty competitor spun out their vet, as you know. So we're the only ones who have that. So we feel really good about our over indexing and our acquisition of the highest value customers in the pet space. In terms of multichannel, we have steadily increased our multichannel growth. So when we first started the conversations, I think, in testing the water, we were single digit growth. We went up to double digit growth at the beginning of the roadshow. And then in Q4, we're in the 20s in terms of multichannel growth. Now, importantly, multichannel customers spend between two and three times more than our single-channel customers. So they spend more as we drive them into more channels, like a food-only customer into adding grooming, a food and grooming customer into vet. They spend more. So it's great for our business. The headroom story of this is we only have 3.5 million customers. that are multi-channel out of our 20 million plus customers. So we have a lot of headroom in that.

Thank you.

And our next question today comes from Peter Benedict with Baird. Please go ahead.

Hi, guys. Good morning. I guess the two questions.

First, just can you maybe expand on your earlier comments around the fresh food category? Maybe give us a sense for what the size is today. I think you said it was going to quadruple. We're just trying to understand, frame those numbers, and how are you positioning Petco to, you know, take advantage of that and thinking about, you know, the opportunity for just food for dog? That's my first question.

Yeah, so, you know, pet isn't a phenomenal category for syndicated data. The data that we see from industry experts says that the pet category is roughly about, I'm sorry, the fresh category is roughly about $650 million. today, going up to $2 billion by 2024. It is a major focus of ours. We feel like we have the best offering with Just Food for Dogs, and we will be doubling our footprint of Just Food for Dogs in 2021. We plan on being a market maker in this space. It's the highest ring in our pet care centers or on our digital sales from a food standpoint. The second thing that it does for us is it has twice the trip frequency and all the associated add-on baskets that happen with that trip frequency. So we are big fans of fresh from a doing the right thing for pets. And we're big fans of fresh in terms of what it does for our business.

Okay. That's great. Thanks for that, Ron. And then, you know, we get a lot of questions about, um, Peter Haslund, Pecos ability to source qualified vets so just can you maybe update us on how your recruitment packages is kind of resonating the marketplace and they've got aggressive goals here in terms of adding. Peter Haslund, But just kind of any update on you know your success and how you go to market and attracting vets for your hospitals. Peter Haslund, If you're good morning, you know i'm really close to this, so I I could tell you i'm really excited about our progress on that the fact that we. opened 44 hospitals during the COVID year, and we have built this recruiting engine. That doesn't just happen. We've made a substantial amount of progress. I would tell you that our time to fill is better than the market. Our retention is much better than the market. And I really think it's because we've invested in field support and recruiting talent and compensation and benefits, and really tried to shape a very positive vet culture that emphasizes autonomy and Petco's mission is a huge help as well. In addition, as you know, we have the mobile vaccination clinic business, which gives us access to over 2,000 1099 vets, and it becomes a great sourcing engine for the full-time vets that we can bring into our ecosystem of hospitals. So I can tell you, I'm on the phone with vets. I'm usually the closer in the recruiting process. And what I'm hearing more and more from them is that we're this great combination of a bigger company with resources and support combined with a culture that feels like a really great family business. We're seeing a lot of good progress, and as we said, 70 next year or this year in 2021, and we're on a really good runway of growth.

That's great. Thanks for that. I guess if I could sneak just one more in here.

I know it's still early here, but the vital care effort initiative, just can you talk about the enrollment trends there, what you're seeing, and how you expect that to maybe scale as you go forward? Thanks.

Yeah, I am so excited about Vital Care. So we launched it in October, and we now have over 50,000 members in Vital Care. And what's beautiful about Vital Care is that we are increasing share of wallet. So if you look at what's happening, roughly 19% of our Vital Care customers are new to food. and 30% plus are new to services. So we're getting share a lot, which was the intent. From a strategic standpoint, really what it does is it brings our whole unique ecosystem to life for customers. So you get the checkup, you get the vaccination, you get grooming, you get discounts on food. So it's really powerful for us. It's growing. you will see us continue to evolve the offer as we learn in the market, and you'll see us continue to dial up the marketing and the customer acquisition. So we're very much getting started, but it is the future, a key future pillar of our business.

Okay. Thanks so much, guys. Good luck.

Thank you. Thanks, Peter.

Our next question comes from Zach Statham with Wells Fargo. Please go ahead.

Hey, good morning. Can we talk about the performance of your vet hospitals? You mentioned nearly all cohorts are ahead of your model, and I'm curious if you could talk a little more about the contribution to traffic and comps. And then as you think about the annual step up from 40 to 45 vet hospitals to 70 plus, how should we think about the gradual comp and EBITDA lift in 2021 and how that builds in 2022 and beyond?

That's a great, great question. Yeah, I would say that the health of the overall vet business is really strong. And as you indicated, we provided some information on some of our older cohorts and some of our newer cohorts. But I could say each cohort is showing a beat model on both revenue and EBITDA. And we're seeing some acceleration in Q1, which is fantastic. What is driving that is our customer counts are up. The number of surgeries done at hospitals is ramping nicely. These are two really big contributors to the maturity of the vet hospital. As far as the contribution to the comp, as we have talked about where we put our vet hospitals, where we do the transformation of our pet care centers, We're seeing a lift, and we've consistently seen a lift of mid-single digits in those pet care centers. So the combination of the vet business scaling, we talked about that in the context of the overall services business contributing on our long-term algorithm a couple points of comp. And then you add to that the incremental benefit from the transformation of the pet care center that includes the addition of the vet hospital, adding some additional comp points within the overall ecosystem of the business. So it becomes a very powerful engine for contributing to the overall growth of the company.

Thanks, Mike. That's helpful. You talked a couple times about the impact of COVID-related bonuses and expenses on the P&L this year. Curious if you could break out the impact for us in 2020 in terms of basis points. And as you think about the 2021 model, can you talk us through which costs are recurring and what won't recur and any other offsets on the operating expense lines?

Yeah, good question. For 2020... our total COVID expenses were around $45 million. About three quarters of that would be in SG&A and about a quarter of it would be in our gross margin. For Q4, I think it was around $8 million. So obviously a big impact to us on the financials that we absorbed and still grew EBITDA, which is really good. As far as 2021, I can tell you that the increased sanitation and PTO, we've incorporated these in just running the business. And so we feel really good about those expenses embedded within our cost structure. We also have planned compensation investments that match up with our field bonuses that we gave during the year in 2020. So we feel like we're largely covered from a cost structure standpoint. You can't predict COVID. It's been relatively unpredictable, but as far as what we know, we feel like we're really good from a overall cost structure standpoint and what we've given you in the guidance related to that. Got it. Really appreciate the color. Thanks for the time.

Thanks, Zach.

Our next question today comes from Seth Basham with Red Bush Securities. Please go ahead.

Thanks a lot, and good morning. My first question is around your customer base. If you could give us the year-end customer counts, that would be helpful. And related to that, what are you seeing in terms of the spend per customer on average? How is that trended through the year 2020 on a quarterly basis?

Yeah, we're really pleased with what we're seeing from a customer dynamics standpoint. As I said, we picked up nearly a million customers in Q3, nearly a million customers in Q4. And we're acquiring customers as we speak in Q1. Our momentum has continued. So we feel really good about our ability to acquire customers. Our customer acquisition cost is either the lowest or one of the lowest in the industry, whether that be in digital, or we have great customer acquisition leverage in areas like that, that a mom and pop operator just can't compete with. So we have turned into a customer acquisition machine. And we have a virtuous cycle. As we invest, we acquire new customers. That's driving our top line dropping, and we're able to invest back to acquire more. Concurrent with that, our LTVs continue to build. Our retention rates continue to build. And as I said earlier, the customers that we bring in and the customers that we over-index with are the highest value customers in the category with over 40% higher spend than your average pet customers. So we feel really good about where we are from a customer standpoint, both in acquisition as well as the monetization. And I should say our customer satisfaction is up in every part of our business.

Got it. Thank you. And then separately as a follow-up, just thinking about your commentary around promoting into BOPIS, you know, 25% off orders over $50, you're essentially giving away any fulfillment cost advantage you have versus the online peers. And that's depressing your gross margin versus in-store sales, of course. How loyal are these customers? Do they stick after the promotion period wanes?

Yeah, good question, Seth. This is what I was talking about earlier in terms of getting smarter from an analytics standpoint. So first of all, we're not doing kind of mass everybody promotions. So we're targeting those promotions of the customers that we think that makes financial sense for us, number one. Number two, you know, I'm 54 years old, soon to be 55 years old. And one of the things that our digital leader had to teach me and get me up to speed is to change my mindset from profit today to an LTV orientation. And so when we shift these customers into a more profitable way of buying from us, the LTV is higher. So yeah, we will short-term trade, do some trade off on that promotion, but long-term that is LTV good for our business. And that's a sophistication that we're bringing to our business that we didn't use to have. We used to just do across the board discounts to incent purchases. Now we're driving people into the offers that have higher margin and have higher LTV. And that's a precision that we're bringing to our business.

Thank you. And our final question today comes from Oliver Wintermantle with Evercore ISI.

Yeah, thank you. And congratulations on a successful IPO. It's good to have you guys back as a public company. I have two quick questions. One is traffic versus ticket. If you could maybe comment on that, how that trended in the fourth quarter, but then also in 2020 as a whole. And then the second question is about labor costs. Average hourly wages are going up. So we just wanted to see how you guys model that going forward and what kind of a headwind that would be for you guys. Thank you.

Devin Kinyon- yeah, so I will take the second part of that and then i'll let Mike elaborate on that as well, in terms of Labor costs and then, as well as. Devin Kinyon- The average ticket but average ticket everything is going in the right direction, as I said, traffic and basket are going the right direction, but i'll let Mike elaborate. One of our commitments to the partners at Petco was as the company does better, you will do better. We take it very, very seriously. That took on a different flavor in 2020 as we had partners that were looking out for pets and pet parents in the middle of a pandemic and putting themselves at risk. So two things happened during this COVID year. The first thing is We wanted to make sure that they were compensated for being in a challenging environment. And we did five COVID appreciation bonuses. And I put that up against anybody, any retailer, anybody else who had employees on the front lines in terms of taking care of our people. And that served them well and helped our bond. The second thing that happened though is we had a terrific year as evidenced by these results. And so we increased wages. as we went through the year to compensate them, because we don't only think it's a short-term lift to our business. We fundamentally believe that there is a long-term lift to our business based upon having three, four, five million incremental new pets added into our mix that provides an annuity for our business. So as Mike said, we had EBITDA leverage in our P&L So we had cost leverage in our P&Ls. We were able to offset that, but I'll let Mike expand.

Yeah, I would just say that the comp growth that we saw in Q2, Q3, and Q4 was very similarly driven by growth in average ticket and growth in transactions. So we've seen both of those key stats grow significantly grow well and contribute to the overall comp of the business. And we're seeing the traffic, especially around our services business, as that has rebounded. That has obviously helped drive total traffic growth to the total enterprise. But on both stats, we've seen really strong performance.

On both sides of our business too, digital and pet care centers. And then from a labor cost standpoint, in terms of within the P&O?

Yeah, we have, as I think I mentioned, we have, we've built within our budgets and what's reflected in our guidance is continued investment in our labor model.

So it's within guidance.

Good luck. This concludes the question and answer session. I'd like to turn it back over to Christy Moser for final remarks.

Thank you, Rocco. That concludes Petco's fourth quarter 2020 earnings conference call. Investor relations will be available after the call if you have any follow-up questions.

Thank you. Thank you very much.

And ladies and gentlemen, this concludes today's conference call. Thank you all for attending today's presentation. You may now disconnect.