Item 1. Business
Item 1. Business .
Our Company
We are a beloved brand in the U.S. pet care industry with more than 55 years of service to pets and the people who love and care for them. Since our founding in 1965, we have been developing new standards in pet care, delivering comprehensive wellness solutions through our products and services, and creating communities that deepen the pet and pet-parent bond. Over the last three years, we have transformed the business from a successful traditional retailer to a disruptive, fully-integrated, digital-focused provider of pet health and wellness offerings. We revamped our leadership team and invested over $375 million to build out leading capabilities across e-commerce and digital, owned brands, data analytics, and a full suite of on-site services including veterinary care.
Our go-to-market strategy is powered by a multi-channel platform that integrates our digital presence with our nationwide physical network. Our e-commerce site and personalized mobile app serve as a hub for pet parents to manage their pets’ health, wellness, and merchandise needs, while enabling them to shop wherever, whenever, and however they want. By leveraging our extensive physical network consisting of approximately 1,454 pet care centers located within three miles of 53% of our customers, we are able to offer our comprehensive product and service offering in a localized manner with a meaningful last-mile advantage over our competition. Through our connected platform, we serve our customers in a differentiated manner by offering the convenience of ship-from-store, buy online and pick up in store (“BOPUS”), curbside pick-up, and same day delivery. Multi-channel customers, who spend between 3x to 7x more with us compared to single-channel customers, increased by double-digits in 2020.
Through our multi-channel platform, we provide a comprehensive offering of differentiated products and services that fulfill all the health and wellness needs of pet parents and their pets. Our product offering leverages our owned brand portfolio and partnerships with premium third-party brands to deliver high quality food that avoids artificial ingredients, complemented by a wide variety of premium pet care supplies. We augment this product offering with a broad suite of professional services, including grooming as well as in-store and online training. Our service offering is further enhanced by a rapidly expanding, affordable veterinary service platform, which includes full-service veterinary hospitals, Vetco clinics, and tele-veterinarian services. In addition, we are increasingly linking our offerings with subscription programs such as membership and pet health insurance that create deeper engagement with our customers and with our Pals Rewards loyalty program members specifically, which members accounted for approximately 80% of transactions in fiscal 2020. At the end of 2020, we launched our Vital Care membership program, the industry’s first broad-scale, comprehensive membership program covering items including vaccinations, grooming services, and merchandise discounts. In addition to providing differentiated products and services, our over 23,000 knowledgeable, passionate partners provide important high-quality advice to our customers in our pet care centers.
Industry Dynamics
The U.S. pet care industry serves more than 72 million households with pets and represented a total addressable market of $97 billion in 2020. Since 2008, the industry has grown at a 5% compound annual growth rate (“CAGR”), driven by steady, predictable growth in the underlying pet population coupled with strong tailwinds associated with pet humanization. Due to the essential, consumable nature of pet care, the industry has demonstrated resilience across economic cycles, as evidenced by the strong industry performance, growing at a CAGR of 6% during the Great Recession from 2008 to 2010.
In addition, as a result of the COVID-19 pandemic, the industry has experienced a significant increase in demand that is expected to be a tailwind for years to come. In 2020, U.S. households welcomed over 3 million incremental new pets and drove continued heightened adoption activity. According to Packaged Facts, the number of households with pets in the United States increased by approximately 4% in 2020, creating an estimated $4 billion in incremental annual demand for pet care products. Given the long-term, recurring demand for pet care products and services, which is expected to continue to grow in response to the pet humanization trend, this step function increase in the pet population represents a meaningful acceleration in total industry growth from 5% historically to 7% through 2024, according to Packaged Facts and company internal estimates. With respect to our business, we are strategically focused on growing our presence in three of the fastest-growing areas of the market: services; e-commerce; and veterinary care, which are projected to grow at 11%, 14%, and 9% CAGRs, respectively, from 2020 to 2024. As pet care demand continues to grow, we believe we are well-positioned to capture an outsized portion of the growing market as a fully-integrated, comprehensive pet care provider in the industry.
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Our Transformation
Over the past three years we have invested over $375 million to support our innovation and business transformation strategies to become the health and wellness company for pets and pet parents with the capabilities to serve customers when and how they choose to shop. These investments include: digital and e-commerce integration and expansion; data analytical capabilities; veterinary services; marketing and advertising; and our owned brands. Our transformation actions were focused on the following major initiatives and investments:
Assembled a Next Generation Leadership Team to Drive Transformation . Two years ago, we hired Ron Coughlin, who previously ran HP’s $33 billion Personal Systems business as Division President and, prior to that, had a successful career in senior executive roles at PepsiCo and experience with businesses in transition. As Chief Executive Officer, he made multiple senior management hires and changes, adding digital and technology, consumer-packaged goods, marketing, and best-in-class retail experience to the leadership team. These executives bring experience from leading companies, including Best Buy, Walmart, Jet.com, Target, Bank of America, Williams Sonoma, and HP, among others. This highly qualified leadership team has implemented significant operational and cultural change to our business, including a substantial acceleration of our digital capabilities, optimizing the effectiveness of pet care center partners through training, enhanced analytic tools and communication, step changed marketing and customer engagement return on investment, launching a veterinary hospital network, and supporting the scaling of our pet health and wellness offerings.
Built Leading E-Commerce and Digital Capabilities that Leverage our Physical Network . With pet parents increasingly engaging online, we aggressively invested to create a superior e-commerce and app experience to succeed in the market, improving the speed, navigation, personalization, and services access of our website and app. We focused on optimizing site merchandising, market-based pricing, convenient order delivery within two days, and digital sales conversion rate to successfully attract and retain customers, all of which have experienced noticeable growth since the fourth quarter of 2019. We launched a repeat delivery service, which has the highest-rated customer satisfaction in the industry, and provides a revenue stream that increased 13% in fiscal 2019 and 43% in fiscal 2020. To further differentiate and create scale advantages, we leveraged our physical network to roll out key capabilities, including ship-from-store, which grew to over 720 enabled locations as of January 30, 2021, BOPUS, which grew over 225% during fiscal 2020, curbside pick-up, and same day delivery that allow us to meet our customers anywhere they want to shop and provide a significant last-mile fulfilment advantage versus our competition, driven by our distributed inventory and proximity to customers. These efforts have resulted in total e-commerce sales growth of 33% in fiscal 2019 and 103% in fiscal 2020.
Reinvented Grooming and Training, and Launched a Full-Service Veterinary Hospital Network . Pet services represent the most personalized, sticky, high-touch part of the market, which is critical as we focus on acquiring and retaining high-value customers. In grooming, we invested in digital integration, marketing, staff compensation, and other operational improvements, which have resulted in the acquisition of new customers and an increase in groomer retention. In training, we have led with innovation, and in fiscal 2020 we launched online training classes that can be conducted at home. In fiscal 2017, we embarked on one of the fastest veterinary hospital build-outs in the industry and today offer full-service veterinary care at 125 pet care centers, driving both incremental service and merchandise sales, and unlocking the prescription food addressable market. As a result of this reinvention, we have grown our services sales at a CAGR of 8% between fiscal 2018 and fiscal 2020.
Created a Highly Differentiated Owned and Exclusive Product Offering . We offer a highly differentiated owned and exclusive product assortment that engenders strong customer loyalty. We focused on three core product differentiating capabilities: nutritional expertise, exclusive partnerships, and a leading owned brand platform. As a testament to our commitment to pet health and wellness, in May 2019 we made the decision to pivot away from dog and cat food and treats that contain artificial ingredients making us the only major national retailer in the industry to take a stand against artificial ingredients in dog and cat food. We utilized a best brands strategy to form new partnerships with some of the most highly regarded premium food brands in the industry, such as Just Food For Dogs.
In 2019, we leveraged our established owned brand platform and capabilities to launch Reddy, a fashion-driven supplies brand, to complement WholeHearted, our premium food brand. We have grown our owned brand sales at a CAGR of 13% between fiscal 2018 and fiscal 2020, and during fiscal 2020, our owned brands generated sales of $1.2 billion, or approximately 27% of total product sales. The combination of our differentiated food and supplies strategy, including owned and exclusive brands, has enabled us to offer a premium product offering, many of which are not available via online or mass competitors.
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Implemented a Performance Culture Led by Data Analytics . Our differentiated singular view of the customer across products, services, and channels, in combination with insights from our Pals Rewards loyalty database, provides access to a robust wealth of data. We implemented new capabilities to leverage these data to inform strategic and tactical decision-making across our organization, and ultimately drive higher customer engagement and lifetime value. We created a singular view of our customer to drive everything from marketing decisions and innovation of new products and services to how we operate our pet care centers. In our pet care centers, we have pushed data down to our pet care center General Managers and field leadership teams through advanced sales reporting to enhance decision-making. We developed a user-friendly, action-focused dashboard (HUB), which enables our managers to track performance across multiple dimensions, identify opportunities, and execute strategies to drive incremental sales. We also simplified the key metrics that we utilize to track performance and aligned incentives against those metrics by rolling out a revamped incentive structure across our field organization.
For more information regarding our transformative investments, please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Innovation and Transformation.”
Our Comprehensive Offering
Product Offering
We offer a comprehensive product offering consisting of over 58,000 products across pet food, supplies, and companion animals available through our physical and online channels. In fiscal 2020, 51% of our product sales comprised non-discretionary consumable products, such as food and supplements, which feature high purchase frequency over the life of a pet and sticky characteristics due to a strong desire for pet parents to avoid switching food brands. In addition, in fiscal 2020, we generated 27% of our product sales from owned brands—such as WholeHearted, Reddy, and Well & Good. This represents a much higher percentage of our merchandise mix compared to our online competitors, helps the Petco ecosystem attract and retain customers, and also offers us an enhanced margin profile.
Service Offering
We offer a fully-integrated comprehensive service offering that includes professional grooming, training and veterinary services. Unlike some other consumer purchases, the services we offer for pet parents are essential, recurring, and high frequency in nature. In addition to acting as a profitable driver of new customer acquisition, our service platform helps retain customers, drive physical visit frequency and digital engagement, and build long-term loyalty. During fiscal 2020, our services represented approximately 8.2% of sales.
Multi-Channel Platform
We have developed a data-driven go-to-market platform consisting of robust digital capabilities and a strategic physical network of pet care centers woven together by a singular view of the customer.
Digital Capabilities
Our digital capabilities have created a seamless multi-channel experience for our customers who, after downloading the app, spend increasingly more with us as they take advantage of more features offered on our digital platforms.
With repeat delivery, BOPUS, same day delivery, and curbside pick-up capabilities, we have transformed our vast network of pet care centers to double as micro distribution centers, allowing guests to receive products more quickly and conveniently than pet-oriented online-only competitors who offer no option for same day shipping. These capabilities seamlessly link our digital presence with our physical network, which positions us to more effectively serve our customers.
Physical Network
We operate approximately 1,454 pet care centers across the United States and Puerto Rico. Our Petco locations average approximately 13,000 square feet and typically carry 10,000 core SKUs, with nearly all offering grooming and training services, 1,030 offering Vetco clinics, and 125 offering full-service veterinary hospitals. We also operate 96 locations in Mexico through our joint venture with Grupo Gigante.
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Marketing and Advertising
Over the last two years, we have completely overhauled our marketing and media strategy as we established ourselves as a true health and wellness company. The rebirth began with the announcement of Petco’s commitment to eliminate food and treats with artificial ingredients, followed by the removal of human-operated or bark-activated shock collars from our shelves and increased advocacy for, and provision of, free introductory positive dog training classes. We then built a world-class performance marketing capability that has meaningfully accelerated our e-Commerce business growth and positively impacted pet care center sales. This focused investment translated into an over $70 million increase in advertising spend in fiscal 2020 compared to fiscal 2019, and overall advertising expenses, net of cooperative advertising reimbursements, of $168.4 million in fiscal 2020.
Human Capital
Our Partners
Our Petco partners are our most significant assets, critical to the delivery of our transformation and our continued progress. Our pet care center partners offer a level of customer engagement and content that is differentiated in retail and based on a true passion for pets. As of January 30, 2021, we had a total count of approximately 27,081 employees. Our partners are primarily employed on an at-will basis and are compensated through base salary and incentive programs.
We strive to make Petco a diverse and inclusive workplace and to provide opportunities for our partners to grow and develop in their careers. We offer competitive compensation and benefits programs, as well as a range of health and wellness offerings, and a partner resource group platform to enable partners to build connections among themselves and their communities.
Health and Safety
The health, safety, and overall well-being of our partners is our top priority. Since the onset of the COVID-19 pandemic, we have been focused on protecting and supporting our partners, as well as the people and pets in our pet care centers and the communities we serve. We have awarded more than $26 million in additional COVID-19 related payment and appreciation bonuses for our partners. In addition, the Petco Partner Assistance Fund has provided approximately $1.3 million in financial support to more than 1,300 Petco partners who suffered a hardship related to COVID-19. We have also provided additional days of paid time off to all partners to support those directly affected by COVID-19 for reasons such as: partner infections; self-quarantines; living with or caring for someone at high risk or related dependent care challenges; and wellness days. Once vaccines became available, we announced that all partners who provide confirmation of vaccination will receive a one-time $75 payment, and we will make a $25 donation to the Petco Partner Assistance Fund . We also support scheduling flexibility for vaccination appointments.
Throughout the pandemic, we have taken proactive, precautionary steps to ensure we continue to meet or exceed local, state, and federal regulations as well as recommended health and safety guidelines from the CDC. This includes social distancing, rigorous cleaning and sanitizing protocols, requiring facial coverings for both our partners and customers shopping in our pet care centers, health screening and temperature checks before shifts, and providing ample sanitizer, masks, gloves, acrylic barriers, and more across all Petco locations.
Compensation and Benefits
We provide competitive compensation and benefits programs to help meet the needs of our partners and their families. In addition to base cash compensation, we offer our partners a mix of annual bonuses, restricted stock units, various incentive plans, an Employee Stock Purchase Plan, a 401(k) Plan, healthcare and insurance benefits, health savings and flexible spending accounts, paid time off, family leave, and a range of employee assistance programs. Partners experienced no increase in their 2020 and 2021 healthcare benefit premiums. In addition, we offer a range of webinars, trainings, and subscriptions to support our partners’ total wellbeing.
Talent Development
We invest significant resources to attract, develop, and retain top talent. Over the past two years, we streamlined methods for setting executional priorities, provided comprehensive sales training, and developed store-level sales marketing capabilities. In fiscal 2020, we are proud to have promoted over 2,750 partners into growth opportunities.
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Partner Communities
We believe that building and supporting connections between our employees and our communities creates a more fulfilling and enjoyable workplace experience. We have continued to expand our Partner Resource Groups and our Diversity, Inclusion and Belonging programs to encourage partners to bring their “whole selves” to work .
Distribution Network
We operate five primary and three regional distribution centers located in various parts of the United States that handle almost all distribution for our company. Our ship-from-store, BOPUS, and curbside programs enhance our distribution network, allowing us to more quickly and cost effectively serve our customers. During fiscal 2020, over 80% of digital orders (including BOPUS, same day delivery and ship-from-store) were fulfilled by pet care centers, which has allowed us to deliver product more quickly and cost-effectively than we otherwise could by using traditional distribution center fulfillment.
Any relationships we have with third-party logistics providers are governed by non-exclusive agreements that do not obligate us to minimum volume or fees, and such agreements may be terminated by either party on 90 days’ prior written notice.
Vendor and Veterinarian Arrangements
We purchase merchandise from over 700 vendors. In fiscal 2020, our top vendors represented approximately 5% of annual sales, and no single vendor accounted for more than 5% of our sales. In addition, we only sell the products we carry directly to consumers and primarily purchase our products directly from our vendors rather than through third-party distributors. As such, we do not rely on third-party distributors to conduct our business. We onboard our vendors using a standardized process to confirm their adherence to our standards, policies, and procedures, including those relating to legal compliance, standard payment terms, and product quality. These relationships are typically governed by our standard vendor terms and conditions, under which we submit purchase orders to our vendors specifying the types, quantities, and agreed prices for merchandise that we intend to purchase from them. These agreements do not typically have minimum order requirements or exclusivity obligations for either party. Our terms and conditions do not have a set term but allow us to terminate the relationship for convenience at any time upon written notice to the vendor. Our vendors may terminate the relationship on 90-days’ written notice but are obligated to perform any purchase order accepted prior to such notice.
Our full-service veterinary hospitals are either operated by us or by third-party veterinary services partners with whom we have long-term contractual relationships. In the hospitals that are operated by our third-party veterinary services partners, we generally provide facilities, equipment, and customer relations management support, while the veterinary services partners provide staffing and run the day-to-day operations of the hospital. The veterinary service partners pay us a royalty based on hospital sales and a license fee to use our space and equipment. Either party can terminate the contractual relationship upon 180-days’ written notice or, as applicable, upon a breach of the contract by us or a violation of the standard operating procedures by the veterinary service partner. Our Vetco clinics are staffed by Vetco personnel, some of whom are independent contractor veterinarians.
Petco Foundation
At the Petco Foundation, a separately incorporated 501(c)(3) nonprofit organization supported both by contributions from us and contributions from our customers and community partners, we believe that every animal deserves to live its best life. Since 1999, the Petco Foundation has invested more than $290 million in lifesaving animal welfare work to make that happen. With our more than 4,000 animal welfare partners, we inspire and empower communities to make a difference by investing in adoption and medical care programs, spay/neuter services, pet cancer research, service and therapy animals, and numerous other lifesaving initiatives. Through the Think Adoption First program, the Petco Foundation partners with our pet care centers and animal welfare organizations across the country to increase pet adoptions. To date, we have helped more than 6.5 million pets find their new loving families.
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Our Trademarks and Other Intellectual Property
We believe that our rights in our intellectual property, including trademarks and domain names, as well as contractual provisions and restrictions on access to our proprietary technology, are important to our marketing efforts to develop brand recognition and differentiate our brand from our competitors. We own a number of trademarks that have been registered, or for which registration applications are pending, in the United States and certain foreign jurisdictions. These trademarks include Bond & Co., Good 2 Go, Good Lovin’, Harmony, Imagitarium, Leaps & Bounds, Pals Rewards, Petco, PetCoach, PupBox, Reddy, Ruff & Mews, So Phresh, Vetco, Well & Good, WholeHearted, and You & Me. The current registrations of these trademarks are effective for varying periods of time and may be renewed periodically, provided that we, as the registered owner, or our licensees where applicable, comply with all applicable renewal requirements including, where necessary, the continued use of the trademarks in connection with similar goods. We expect to pursue additional trademark registrations to the extent we believe they would be beneficial and cost-effective.
In addition to trademark protection, we own numerous domain names, including www.petco.com. We also enter into, and rely on, confidentiality and proprietary rights agreements with our employees, consultants, contractors and business partners to protect our trade secrets, proprietary technology, and other confidential information. We further control the use of our proprietary technology and intellectual property through provisions in both our customer terms of use on our website and in our vendor terms and conditions.
Government Regulation
We are subject to a broad range of federal, state, local, and foreign laws and regulations intended to protect public health, natural resources, and the environment. Our operations, including our owned brand manufacturing outsourcing partners, are subject to regulation by the Occupational Safety and Health Administration (“OSHA”), the U.S. Food and Drug Administration (the “FDA”), the U.S. Department of Agriculture (the “USDA”), the Drug Enforcement Administration (the “DEA”), and by various other federal, state, local, and foreign authorities regarding the processing, packaging, storage, distribution, advertising, labeling, and import of our products, including food safety standards. Please read “Risk Factors—Risks Related to Our Business—Our operations are subject to extensive governmental regulation, and we may incur material liabilities under, or costs in order to comply with, existing or future laws and regulation. Our failure to comply with such laws and regulations may result in enforcements, recalls, and other adverse actions that could disrupt our operations and adversely affect our financial results.”
The FDA regulates animal feed, including pet food, under the Federal Food, Drug, and Cosmetic Act, (the “FFDCA”), and its implementing regulations. Although pet foods are not required to obtain premarket approval from the FDA, the FFDCA requires that all animal foods are safe for consumption, produced under sanitary conditions, contain no harmful substances, and are truthfully labelled. Most states also require that pet foods distributed in the state be registered or licensed with the appropriate state regulatory agency. In addition, most facilities that manufacture, process, pack, or hold foods, including pet foods, must register with the FDA and renew their registration every two years, and are subject to periodic FDA inspection. This includes most foreign, as well as domestic facilities. Registration must occur before the facility begins its pet food manufacturing, processing, packing, or holding operations.
The labeling of pet foods is regulated by both the FDA and some state regulatory authorities. FDA regulations require proper identification of the product, a net quantity statement, a statement of the name and place of business of the manufacturer or distributor, and proper listing of all the ingredients in order of predominance by weight. Most states also enforce their own labeling regulations, many of which are based on model definitions and guidelines developed by the Association of American Feed Control Officials (the “AAFCO”). The AAFCO is a voluntary, non-governmental membership association of local, state, and federal agencies that are charged with regulation of the sale and distribution of animal feed, including pet foods. The degree of oversight of the implementation of these regulations varies by state, but typically includes a state review and approval of each product label as a condition of sale in that state.
The FDA also regulates the inclusion of specific claims in pet food labeling. For example, pet food products that are labeled or marketed with claims that may suggest that they are intended to treat or prevent disease in pets would potentially meet the statutory definitions of both a food and a drug. The FDA has issued guidance regarding products that provide nutrients in support of an animal’s daily nutrient needs but which are also labeled as being
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intended for use to diagnose, cure, mitigate, treat, or prevent disease, thereby meeting the statutory definitions of both a food and a drug.
Under Section 423 of the FFDCA, the FDA may require the recall of an animal feed product if there is a reasonable probability that the product is adulterated or misbranded and the use of or exposure to the product will cause serious adverse health consequences or death. In addition, pet food manufacturers may voluntarily recall or withdraw their products from the market.
Certain states have laws, rules, and regulations that require that veterinary medical practices be either wholly owned or majority owned by licensed veterinarians and that corporations that are not wholly owned or majority owned by licensed veterinarians refrain from providing, or holding themselves out as providers of, veterinary medical care, or directly employing or otherwise exercising control over veterinarians providing such care. In these states and jurisdictions, we provide management and other administrative services to veterinary practices rather than owning such practices or directly employing the veterinarians providing medical care. Although we believe that we have structured our operations to comply with our understanding of the veterinary medicine laws of each state and jurisdiction in which we operate, interpretive legal precedent and regulatory guidance varies by jurisdiction and is often sparse and not fully developed.
In addition, all of the states in which we operate impose various registration permit and/or licensing requirements. To fulfill these requirements, we have registered each of our facilities with appropriate governmental agencies and, where required, have appointed a licensed veterinarian to act on behalf of each facility. All veterinarians practicing in our animal wellness centers are required to maintain valid state licenses to practice and veterinarians practicing in our full-service hospitals are required to maintain valid licenses with the DEA. We are also required to comply with state laws governing the dispensing of prescription pet medications by our veterinarians. Additionally, our pet insurance plans must be registered with certain state departments of insurance and comply with their requirements.
Available Information
Our website address is www.petco.com , and our investor relations website is ir.petco.com . We promptly make available on our investor relations website, free of charge, the reports that we file or furnish with the SEC, corporate governance information (including our Code of Business Conduct and Ethics) and select press releases. We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements and amendments to reports filed or furnished pursuant to Sections 13(a), 14, and 15(d) of the Exchange Act. The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements and other information regarding Petco and other issuers that file electronically with the SEC.