Q3 2020 Chewy Inc Earnings Call
[music].
Good day and welcome to the Chewy third quarter 2020 earnings Conference call.
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Please note that this event is being recorded I would now like to turn the conference over to Mr., Robert floor, Vice President of Investor Relations and capital markets. Please go ahead Sir.
Thank you for joining us on the call today to discuss our third quarter fiscal 2020 results. Joining me today are true E. C O Sumit Singh and CFO Mario <unk>, our earnings release and letter to shareholders, which were filed with the FCC on form 8-K earlier today have been posted to the Investor Relations section of our web site.
Investor Dot chewy Dot com a link to the webcast of today's conference call is also available on our site.
Our call today, we will be making forward looking statements, including statements concerning <unk> future prospects financial results business strategies industry trends and our ability to successfully respond to business risks, including those related to the spread of COVID-19, including any adverse impacts on our supply chain workforce.
From a centers other facilities customer service operations and future plants.
Such statements are considered forward looking statements on or the private Securities Litigation Reform Act on 90, 95 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those contemplated by our forward looking statements.
Good results should not be considered an indication on future performance also note that the forward looking statements on this call are based on information available to us as of todays date, we disclaim any obligation to update any forward looking statements, except as required by law for further information. Please refer to the risk factors and other information and she was.
10-Q, and 8-K filed earlier today and in our other filings with the FCC on.
Also during this call we will discuss certain non-GAAP financial measures reconciliations of these non-GAAP items to the most directly comparable GAAP financial measures are provided on our Investor Relations Web site in our earnings release and letter to shareholders, which are filed with the FCC on form 8-K earlier today and in our 10-Q.
These non-GAAP measures are not intended as a substitute for GAAP results fine.
Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of this call will also be available on our IR website. Shortly I'd now like turn the call over to summit.
Thanks, Bob.
Thanks to all of you well joining us on the call.
Our Q2 results reflect chuys relentless focus on execution on customer experience, coupled with the positive macro trends accelerated ecommerce migration and increased pet ownership debt.
Of course, that's came together you have to get to produce another quarter of strong net sales growth.
Volume on the back half of the quarter outperformed our expectations as traffic conversion or does Adam customer retention also went on from September into October that's customer shifted their shopping behavior. This year shopping earlier responding favorably to talk on additions in our assortment and innovative product and service launches such as person.
On the nation and gifting.
Coming into the third quarter, we expected and only take off to the holiday season, and the true team was prepared and ready to ship into high gear when it came.
This summer, we began optimizing our inventory and preparing our fulfillment centers knowing that the holiday Spike would add to the elevated demand that book that has been in place since March the teams responded and executed to plan.
Over the next few minutes I will discuss our Q3 results and share some insights as to how the quarter unfolded.
Well then use the balance on my remarks to talk to our exciting new health care launches and how those fit into the broader chewy story as we prepare to celebrate our 10th anniversary next year and carry our mission entered the second decade, Justin eagerly Unenthusiastically as we approached gets worse.
After that I looked on the call over to Mario to discuss our third quarter results and guidance in more details.
Q3, net sales increased 25% year over year to $1.78 billion, but on the ship net sales representing 69.2% on total net sales.
Yeah, I did 1.2 million net active customers in the quarter and in Q3, but 17.8 million active customers.
The net sales per active customers or that's pack was $363 an increase of 2.8% year over year when adjusting for the extra week in 2018.
We delivered Q3 gross margin of 25.5% 100 on 80 basis point increase year over year and consistent with our gross margin last quarter.
Promotional environment was muted throughout most of the quarter before picking up in mid October the only launch on the holiday season such.
Such promotional discounts were less off a gross margin headwind than forecasted shipping costs were also in line as we worked closely with great partners to uphold customer delivery experience.
Private label remained a strong contributor this quarter, but Q3 private label hardgoods penetration, reaching 16%.
Our seasonal businesses such as Halloween were also strong in the quarter and year, we improved our private label on merchandise mix by 20 points to over 70% showcasing the quality and appeal of our newly launched proprietary assortment.
This helped grow total Q3 hard good sales, including public policy and private label by more than 70% year over year.
Over the past few quarters. Our team has been hard that look to reported that our proprietary brand strategy by introducing compelling merchandise many had expanded price points, improving discoverability and delivering on overall tremendous value proposition for our customers. This strategy is creating a positive consistent and sustainable.
On to add on driving incremental profitability in our portfolio.
Moving on to Q3 adjusted EBITDA, we produced another positive quarter generating $5.5 million of adjusted EBITDA at a margin rate of 0.3% representing 280 basis points of improvement you know where your line.
Why gross margins were strong in the quarter several of the short term operating cost headwinds, we detailed on our last call materialize as anticipated and impacted our ability to translate our top line momentum into bottom line results as efficiently as we did in the first and the second quarters.
His elevated costs were related to investments in labor and benefits as we ramped up our fulfillment centers on customer service sites to deliver a successful holiday amid increasingly constrained labor markets and residual income at 19 cost.
Additionally, as anticipated we saw marketing costs increased in Q3 normalizing from the hyper efficient run rates, we saw in Q1 and Q2.
Mario will provide more details on these components in just a moment.
We continue to be laser focused on executing against our commitment to pets and pet parents to deliver exceptional customer experiences by offering a broad assortment of brands and products with the convenience of E. Commerce that commitment extends to better health and wellness as part of our goal to make health care more affordable and access.
The book, we recently launched medication compounding and connect with a bet on proprietary Tele health platform.
These two in a weighted business. These are valuable additions to the growing health care business and represents our force service based offerings for pet parents, but.
But before I discuss these new businesses in greater detail I would like to share some insight into our pharmacy, Rx business, which anchors our broader healthcare strategy for.
For clarity when I refer to chewy pharmacy, I'm, referring to the business that we own and operate under our own licenses total pharmacy includes chewy pharmacy, plus the pharmacy that we operate that generate third party management <unk> book.
Pharmacy operations are expected to generate over $500 million on gross revenue this year, which we believe makes us the largest ecommerce pet pharmacy in the U.S. MACI.
Achieved this milestone just over two years after Robert launch is a remarkable achievement for which we as a team are proud.
We pharmacy on a reported basis is expected to generate over $350 million on net sales this year, which would equate to 5% of total net sales based on our current guidance.
Given the scale pharmacy is now contributing positively to the year over year expansion in Chuys total gross margins.
As we have noted on previous earnings calls, we believe that we are still in the early innings regarding our pharmacy business and we remain focused on growing just want to go in a disciplined manner.
Now, let me tell you a little bit more about our recent compounding and tele health launches that's.
Let's start with compounding on.
Well I think as a service offered to our pharmacy, where we customize medications to the specific needs on individual pets as some pets Hans take medications in their commercially available forms they may need to liquid instead of a tablet or a specialized dosage on formula.
To enable these requirements are licensed pharmacist use ingredients sourced from Ftn registered manufacturers do custom prepared medications in our labs do the specifications provided by the veterinarians.
Good day, we offer the service exclusively to pets and pet parents in the future we plan to extend the service to the value. So that's going on for a compounded medications directly to their in clinic patients.
In both these use cases, we seek to pioneer bar raising customer experiences across that billion dollar fragmented market. We are just as excited about our new Tele health service connect with a bat, which connects true pet parents directly to a contracted license veterinarian using our proprietary tally free arash platform very bad on circle.
Question on the Red line and discuss pet health concerns without diagnosing medical conditions are recommending treatments.
That they make referrals to local debt or emergency kinex, if needed, which drives customer traffic back into these veterinarian clinics or medical diagnosis and treatment.
We also on the service free of charge to auto ship customers from eight in two H.B.M. Eastern time Monday through Friday.
We launched the program in 35 States in October and starting today I'm happy to announce that we are rolling it out to another 12, which brings our total coverage up to 47 states from.
<unk> utilization rates today are encouraging as is the customer feedback we are receiving from.
With a bat is clearly a forced off its kind service. We are still in early days and I have a lot more low at the same time you have taken an important force step towards building a tele health platform that can evolve and expand over time as our culture of innovation advances the technology platform and as the regulatory environments modernized to meet the needs of.
Todays patients and providers.
2020 has been an unbelievably busy year, so far and I'm proud of the way every member of the chewy team across our fulfillment centers customer service side on corporate offices had stepped up to meet both the challenge and the opportunity.
Not only do we continued to optimize our day to day operations. We are always looking for ways to enhance customer assortment service and experience as we welcome a record number of new customers and offer current customers, a safe and reliable way to capital debt pets, the bond between pets and their pet parents has never been stronger and we look.
Well would do a robust holiday season, and close to the year I will now turn the call over to Mario who will provide the details on our third quarter results and financial outlook there.
Thank you Sumit third quarter, net sales reached $1.78 billion, increasing $552.2 million or 44.9% year over year.
In absolute dollar terms third quarter growth Mark the biggest increase we have reported in the company's history.
Yesterday net sales are up 46% on accelerated customer growth and solid increases in per customer spending.
Q3 sales from auto ship customers total $1.23 billion, representing 69.2 per cent of total net sales for the quarter.
Customer acquisition rate remains healthy and continues to run a book Prefund demick levels. In Q3, we added 1.2 million net active customers and ended the quarter with 17.8 million active customers.
To date, we have about a 5.1 million active customers an increase of nearly 40%.
Well continue to monitor and be pleased with the purchasing behavior of our 2020 customer cohorts. The first and second quarter cohorts remain engaged and the initial engagement levels of the Q3 cohort is consistent with it appears from earlier on the year.
<unk> expense in basket size reorder rate and auto ship sign up all remain favorable reflecting the continued success of our assortment and merchandising strategies.
Net sales per active customer or net spec increased to $363 in the third quarter $7 or two per cent higher versus the second quarter and 2.8% higher year over year. When adjusting Q3 2019 net back to exclude the benefit from the extra week in the fourth quarter of 2018.
A reminder, net sales per active customer reflects trailing four quarter net sales divided by the number of active customers. So the end of the quarter.
This is the last quarter, we will have to adjusted for the extra week in Q4 2018 in our year over year comps.
I should note on the quarter over quarter increase it's a reversal from recent quarters would mess back remained relatively flat. This is what we would expect that the mechanics of the net speculation begin to more fully reflect the positive revenue impact on the large customer cohorts that we acquired earlier this year and that's our pace of quarterly active customer assets moderates from its peak locked down.
Yes.
Moving to the income statement third quarter gross margin was 25.5 percentage a year over year increase of 180 basis points as we again surpassed the low end of our long term target range.
In the third quarter, we benefited from strong execution as hard goods private label and health care collectively contributed 110 of the 180 basis points of year over year gross margin expansion Q3 operating expenses, which include SGN day in advertising and marketing were $486.9 million or 27.3% on net sales scaling.
280 basis points year over year.
That's your day, which includes all fulfillment customer service credit card processing fees, corporate DNA corporate payroll and share based compensation total $352.3 million in the third quarter or 19.8% on net sales.
It's improved a 120 basis points year over year, which on a fully loaded basis against scaled versus 29 team as our share based compensation declined versus our prior periods on great factors affecting third quarter restaurant expenses include the launch of two fulfillment centers investments on bonuses on other incentives for fulfillment and customer service team members.
And absorption Oh, some residual costs related to kogan on team.
Q3, advertising and marketing was $134.6 million or 7.6% on net sales scaling 100, or 50 basis points year over year, that's pretty good on our Q2 call in September as the economy reopen in Q3 organic acquisition rates as a percentage of total acquisitions begins to normalize after running at elevated levels through the first.
2020.
Likewise, the stronger economy and increased political advertising around the election helped drive a search and digital advertising during Q3, which led to channel input costs rising from the depressed rates, we saw in Q1 and Q true.
In response, we adjusted our acquisition marketing efforts Accordingly, and continue to acquire customers smartly, while still delivering year over year marketing efficiencies and progressing towards our long term target of 6% to 7% when net sales.
On a quarter net loss was $32.8 million and net margin improved 460 basis points year over year to negative 1.8%.
Third quarter net income excluding share based compensation on $25.1 million was negative $7.8 million.
Net margin excluding share based compensation improved 280 basis points to make it a 0.4%.
Total adjusted EBITDA was $5.5 million, an adjusted EBITDA margin improved 280 basis points year over year to 0.3% again exceeding breakeven.
While gross margins were solid this quarter, the operating cost headwinds that we face and that's DNA and marketing that I detailed earlier affected our ability to convert growth profit into adjusted EBITDA as efficiently as we did the first two quarters of the year in our view several of these headwinds are not systemic and simply reflects short term issues related to.
New FC ramp up and residual costs related to Koban on tape.
Turning out to free cash flow third quarter free cash flow was posted a $32.9 million, reflecting $63.4 million and positive cash flow from operating activities and $30.5 million of capital expenditures.
Instead of operating cash in Q3 was primarily a function of the strong sales momentum we saw in the latter half of the quarter.
Capital investments continue to refocus on capacity built into cash outlays for our new automated fulfillment Center, an article, Pennsylvania, and our New limited catalog fulfillment center in Kansas City, Missouri.
Finished the quarter with over half a billion dollars of cash on the balance sheet, which.
Which is a function of the $154 million from started the quarter with combined with a $318 million. We raised through our September follow on offering and the $33 million on free cash flow, we generated during the quarter.
This level of liquidity gives us tremendous flexibility.
First to support our growth and second it gives us the ability to evaluate internal and external opportunities to expand our addressable market now.
Now to guidance based on strong early quarter results on accelerator customer demand spending we are increasing our guidance range is as follows.
Fourth quarter net sales to between $1.94 billion and $1.96 billion, representing year over year growth of 43% to 45% full year 2020, net sales to between $7.04 billion and $7.06 billion representing year over year growth of 45 to 46 per se.
And reflecting over $2.2 billion of incremental net sales added in 2020, we now expect to be profitable on a full year adjusted EBITDA basis, we are increasing our full year 2020, adjusted EBITDA margin guidance range to between 0.20, 0.4%, while some potential cost headwinds from Maine lease mostly were.
Like short term impacts directly related to cove, it or its temporary effects on areas like labor and logistics.
I will conclude by saying that our third quarter results demonstrate the appeal and resilience of the value proposition, we offer pet parents and our ability to grow and scale the business profitable we remain optimistic about our future and look forward to wrapping up a successful 2020 and building on this momentum in 2021 per which we plan to provide you more details on our next earning.
That's cool with that I'll turn the call over to the operator operator.
Thank you we will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone. If you are using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then two please limit yourself to one question and one follow up if you have further questions you may re.
Enter the question queue at this time, we'll pause momentarily to assemble our roster.
And our first question will come from Steph Wissink with Jefferies. Please go ahead.
Thank you good afternoon, everyone and some that congratulations on your business week recognition.
Our cash and actually two full day, if we could just start with some of the private label penetration you're seeing good success, there, but maybe give us a pathway to what you think that penetration rate could be over the course of the next 12 to 24 months and.
And then how does that influence the way you're thinking about gross margin advancement over that same timeframe. Thank you.
Hi stuff. Thank you.
Private label is a strategic vector for us, it's a three little bit over a three year old business and we have been ramping assortment on private label, both across our consumables on hard goods portfolio.
While we haven't broken out the specific size of private label or it can be informed to be between somewhere around the mid to high single digit percentage of net sales and we aspire to grow private label to become between 15 and 30% on net sales or.
The comment that we shared today on the call was particularly giving private label penetration for our hard goods portfolio that has now reached 16% overall hard good sales in hard goods, where we believe product lines on commoditized and customer loyalty isn't index to a particular brand. We believe we can.
Reach north of 30 somewhere around 40, 45, perhaps even 50% penetration for private label goods pork.
It can do you have on that there's obviously you know we are we will keep the contacts off our customers is loyalty towards their brands and our strategic nature of relationship with our suppliers in mind as we grow the private label portfolio there overall.
Overall, as we get to range between 15, and 30% over time for all private label business. We expect this business to generate 800 to 1000 basis points higher gross profit than our base business from.
From the progress that we're making we're pleased with it not only have value added assortment within private label effectively doubling assortment over the last 18 month period. We have also increased price points as we've added new assortment across newer subcategories and higher price point products that are driving tremendous engagement and tremendous.
Response from customers, particularly given the quality of these products remain a four 4.24 0.4 star rated products at a minimum.
Thank you.
True.
And our next question will come from Cory Carpenter with JP Morgan. Please go ahead.
Our sales are accelerating in October on it seemed like you called you called out early holiday holiday demand, but hoping you could expand a bit more on some of the dynamics you saw on that money and then also higher thinking about the can channel I pull forward of demand.
Maybe typically wouldn't come later and then as a second question just curious over the past month or so what type of impact do you see any from the second wave virus on consumer demand or any evidence of pantry loading. Thank you.
Hey, Corey this is a bit I'll take it.
Two part question I'll on sort of them collectively because we believed there they're connected on related.
Let's start with you know when we provided Q3 guidance in early September we share that sales pace coming into the third quarter was strong.
We saw as anticipated trends start to accelerate on October as the holiday season kicked off earlier this year on that.
The momentum built through November and has carried through black Friday on cyber week with those two days being the highest day is a highest net sales day in the company's history.
We have examined the drivers off this momentum across traffic and conversion patterns we.
We don't believe that this is a simple pull forward or a covert induced second day of phenomena.
In fact, we believe that the demand that we're seeing is primarily organic on structural in nature.
So let me sort of expand on that a little bit. It first of all that we haven't found evidence within our internal day data suggest the same type of corporate induced customer purchase behaviors as we observed in spring.
For example, we aren't seeing a material variance in metrics such as units per order or disruption or change in order frequency to suggest any kind of panic buying a you know that we saw on kind of March April time frames or the early onset of the pandemic.
As we look to the balance of the Q4 you know so we we remain optimistic that these demand trends will continue.
On.
Underneath of the organic volume you know when we when we analyze the data here, we're seeing a couple of things force. We are retaining a larger portion of our cohorts overall customer retention for our active customer base is up more than 600 basis points year to date, which also by the way.
Helps address the question that we've all been wondering about to the to the true the onset of this year as to are we going to be able to retain the cohort of customers that we are acquiring during depend on it and we believe that sort of hits on that.
Second you know, we're attracting larger newer cohorts and we're seeing higher engagement from these active customers.
Especially whatever garnering or larger share of wallet from new customers new cohort earlier in their lifecycle. So for example, if you use Q2 of this year cohort as an example, this cohort plus 50% larger than the Q2 2019 cohort Andy.
And the initial net sales per active customer or share of wallet for this cohort just Q2 2020 cohort was 10% higher than the two <unk> Q2 2019 core.
So when you put it altogether, it's sorta nets out to be we're attracting more new customers, we're keeping more of our established customers and more and more off are on these customers are building larger and more profitable buckets already on.
That's sort of the summary of what we're seeing right now in terms of them on patterns.
Yeah, it's very helpful.
Our next question will come from Mark Mahaney with RBC capital markets. Please go ahead.
Thanks, I guess I'll, just ask two specific pinedale questions or the or were there specific drag factors on gross margin is another up nicely year over year. There was nice revenue growth sequentially, but the gross margin was the same is that where the build out of the new fulfillment center costs kind of came in and and limited the sequential gross margin.
Expansion and then secondly, you talked about this rising from a competitiveness for <unk> online AD spend do you feel like what you're on what you are where you ended the quarter is that back to kind of par or based on your historical experience do you think you're still <unk> would you expect to get back to par would you expect oh advertising costs.
Advertising tends to continue to rise so just put that to put that in context, where are you now versus where you think you normally would run the business. Thanks a lot.
Hey, Mark this summit I'll take them.
Sure from a gross margin point of view, we saw we saw a drag in two places right. One on a wasn't natural drag as we came into the holiday season. There is obviously you know a higher degree of promote stability, but definitely on the holiday season arrived on earlier in October on a year on where your comprehensive basis, the promotional environment was relatively low.
You did but on an absolute basis, we obviously did see promotions kick in so that's kind of what number two when you look at when you look at our supply chain you know our supply chain healthy from an in stock level point of view, but the placement on inventory right is as you all could be could be suboptimal in places.
As we are still adjusting.
Balancing out value chains, as we worked closely with our suppliers to get product into the warehouses. So from that standpoint, and you know there's still a little bit off an effect on us either shipping products over a longer zones. We generally shows up and freight costs that generally the drag on gross margin. So that's sort of the first part of the question.
Well overall must be sad, I mean, 180 basis points improvement year over year.
You know and the fact that our newer strategic pillars are driving positive incremental gross margin into the portfolio is something to per tremendously proud off and satisfied with.
Moving on to marketing marketing you know as expected it.
As we came out of Q2, when we talk to you in September we said hey, marketing costs are starting to rise because inputs are starting to rise as the economy opens up as more advertisers come in on the demand supply ratio offsets to be able to raise kinda bid cost and the market environment. What we saw was essentially exactly that happen on the back on.
We also saw opportunities, where we could efficiently spending money on acquired customers, which our team continued to do.
Older all due to the shifting in holiday, we observed a pull forward trend in new customers that were acquired kind of free cyber period, starting from late October into mid November.
And that growth was built on strong shopper demand on reflected across the digital network on the television side. Obviously you know this is pre bought inventory given you know everybody anticipated sort of up on the political campaigning advertisement spend.
So Dan we pulled in our spend a little bit to the left and spend money efficiently. We you know or on marketing cost as you know and as you've seen on the piano continues to trend below from a year, where your point of view its obviously higher than the hyper efficient periods that we saw in the early onset on a pandemic and yes, we do believe that marketing costs will continue to be pressured.
As we execute a the rest of Q4, perhaps even into next year.
And Mark if I can add one more thing because I think what you're referring to a couple of points on gross margin.
One is Oh, you know obviously, we've stated that we did increase gross margin on an 80 basis points year over year, but if you're looking at quarter over quarter, you're right. There were 25 per cent in both quarters, though if you look at the mix of sales in the second quarter versus the third quarter.
You see that in the third quarter, we had an increase on a percentage of sales that went to consumables and we've talked about the relative margin performance on different different components.
Components of revenue.
So when you go from a 69.4% rather 68.2% of sales being consumables in the second quarter and debt increased over 69%. It is those from mix between the sales are the components.
Components of net revenue a debt.
That would have an impact on gross margin.
Okay.
Thank you. Thank you for the clarification. Thank you Maria Thank you something.
Thanks Mark.
Our next question will come from Brian Fitzgerald with Wells Fargo. Please go ahead.
Hi, Thanks, guys and then from a congrats also.
Could you guys talk to the opportunity to monetize connect with that referrals to local that's is that I'm really monetize today what is the monetization mechanism. There seems like there's a lot of new Panda parents from this is that way to drive auto ship for the on initiated and then similar topic on on connect with.
Does that can you talk about how you're growing awareness of this offering with your current orders from customers. You know, it's very early but do you have any sense of how how much awareness you have been able to drive already and maybe how you think about how that can help drive auto ship retention and last point the path.
Two.
Availability that service in all 50 states. Thanks.
Hey, Brian thing.
Thank you, let's start with the availability so as of this morning.
On the services available across 47 off the 50 states. So we've rapidly expanded it from the 35 up four or five weeks ago to the 47 as of this morning. So as of this morning is available close to cost across our base of ownership customers.
Which we're happy and proud off.
Number two of course, you know us starting the opportunity with auto ship customers is strategic in my mind as what we expect to do there is to observe we believe this will help both fuel acquisition into the auto ship program or stronger acquisition and also help with retention auto ship members.
Which is obviously both of them are incremental to the portfolio and driving topline and bottom line to the portfolio over time as you pointed out the opportunity. This is these are early innings and <unk> as.
As we develop the product we will obviously seek opportunities to embedded or offer it to our our entire base of customers and there. We have it you know several ideas in the way that we can monetize this product over time, but.
But so far we're focused on ownership <unk> auto ship customers on learning how to service does does does there did I Miss a part of your question I don't believe so no I I think you got it all thanks guys.
Thanks.
Our next question will come from Lorne Schenker with Morgan Stanley. Please go ahead.
Great. Thanks for taking the question its line up a little bit on on an earlier question thinking about marketing spending into next year. Obviously, you know I think we're hearing about yeah, CPC is largely going to be higher next year, but from a you know.
Sort of retention new buyers perspective is there anything that you think you need to invest in from that perspective or is it really going to be sort of continued new customer growth and you know to to that effect. How should we think about new customer growth next year and given the really strong growth that you've seen this year.
Sure Hi, Lauren will stay away from speculating on numbers for for next year, we'll talk to you more about 2021 on our Q4 call, but I will generally on sort of the question first of all no. We do not expect to spend incremental dollars on retention in fact, as we have seen or as we have shared on this earnings.
Call customer retention year to date is up more than 600 basis points, including debt. Obviously includes the cohort of customers that we acquired this year, who continue to engage with us in a positive manner bid higher it always driven by SP in mix not actually driven by higher U.P.O., therefore, not indicating any kind of pandemic buying.
Behavior there.
Number two you know we expect to continue to broaden or open up more marketing channels as we step out from 2020 to 21. So you should expect us to broaden our range our reach our frequency.
Overall, we are a strong direct response performance <unk> performance marketing engine and you should expect us to be to hold ourselves a disciplined on accountable and the way that we spend money on acquired customers last but not least I will remind the audience that you know we've enhanced the value proposition off products.
On services that we bring to chewy customers and in that way, we've actually not only are we seeing customers spend more early on we believe the overall potential on net customer spend an LTV is greater therefore generating higher LTV to CAC ratio is which has been on north star as we think.
On marketing and we will continue to do so as we move from this year into next.
Great. Thank you.
Our next question will come from Seth Basham with Wedbush Securities. Please go ahead.
Thanks, a lot and good afternoon, my questions around south per active customer.
You saw that metric increased by it slowed a little bit sequentially in terms of year over year growth on.
Is there anything to think about as it relates to that metric here.
Yeah, Hi, Seth this is Mario so are you referring to net back on so the mechanics on net spike if you remember.
Is that we take all the revenue in the last four quarters and divide by the active customers on the another quarter or.
So where are you starting to see the sequential increase is the positive revenue impact on the large customer cohorts that we acquired earlier. This year. So now we're seeing that the debt that number move up again.
You would expect that we would expect that net spec should contribute to improve over the balance of the year and into next year.
The revenue from those cohorts continues to be realized.
For the full trailing four quarters on having acquired the <unk>.
The cohort itself.
I think what you have to do for the last few years, you still have to adjust for the extra week in the fourth quarter of 2018, if we do that day and our net back it's up almost 3%.
And and you can see how many new active customers, we got it on the quarter, which obviously has a temporary drag on that number from.
Moving on.
Understood. Thank you.
Our next question will come from Oliver Wintermantel with Evercore ISI. Please go ahead.
Yeah, Hi, Thanks, I just had a question regarding to the cost headwinds that you mentioned and in Q3 and and I think in your prepared remarks, you said they should shift into Q4.
And then maybe into next year as well, while overall use that they should be not permanent in nature, but you mentioned labor line, just sticks as well as covance. So.
So maybe a little bit more information flow of Ah well, what do you expect in Q4 and what part of these cost headwind should should fall off in next year.
Yeah, certainly hit on the as far you I'll answer that one so you've heard us say that unlike the on like the first quarter covert to not having a material impact on gross margin in the third quarter.
But we did see an impact and as you day, we had approximately $8 million of expenses that were either directly or indirectly related to covert and the third quarter, which is about in line with what we shared with you for first quarter and second quarter, We said 11 million on the first quarter.
And rather 11 million in the second quarter 10 million on the first quarter.
For the fourth quarter, we do expect somewhere between 15 million and $20 million of incremental what's your name.
And again directly or indirectly related to covance.
And that's partially due to higher wages and benefits for our fulfillment center team members.
But we do believe these are temporary in nature.
On Oh, a lot a lot a couple of things.
You know as you know we're also ramping up two from <unk> two fulfillment centers, along the way that that kind of go into that I see on a number and then you know we've just talked about marketing where on a input costs are increasing on its a bit of a bit of an open playing field on marketing. So Dara you know, we we will continue to remain disciplined and also.
Opportunistic so that depending up on how the market behaves our team can respond to court to respond accordingly to to drive both yield as well as a net customer adds to the portfolio.
It's just a if I may the 15 to 20 million incremental yesterday.
Compared to the 8 million cobot costs or was that a total number.
The total number.
Got it thanks very much.
Our next question will come from Aaron Wright with Credit Suisse. Please go ahead.
Great. Thanks.
On the how much do you think you are taking share from other players per se.
Veterinary profit.
More broadly on the.
Yes, it'll be on large.
Approach over time are down the road you see the opportunity to bolster your EBIT.
More rapidly through your acquisition or just potentially highly synergistic on pharmacy file.
Opportunity for you or will this be.
Organic EPS.
Hi, Ryan I'll take the question.
So first of all day.
Yeah. The first question on on share we let's start from the top line. So we view healthcare as a 35 billion dollar market and off that 35 billion approximately 7 billion a in our research is Rx medication, which is growing at 10%.
Taylor.
And we believe you know if you do that math, then were roughly 7% of the overall total available market share.
In that category, 70% or higher is still on dividend of at an area on channel E. Commerce in our in our opinion is approximately between one to 1.3 billion for total Rx medication, which gives US a segment share off somewhere between somewhere on 40, 45%.
So that's a force part off that off that question.
With the market growing at 10% into that channel you know owning over 70% I mean I'd. These dynamics the category in our opinion has multiple has room for multiple simultaneous winners.
And our job is to ensure that chewy is one of them.
In terms of you know our strategy in terms of the growth. We're clearly focused on organic growth at this point and as that strategy evolves. You know we are force focused on making sure that we have value added services and products both for our customers end up at an area on space, where we can keep the veterinarians and their center on the equation as.
He go make health care more affordable and accessible on that will be our primary focus over the next nine to 12 to 15 months as we grow the category and and and the space overall.
Okay. That's helpful and just as a related question on the Treehouse free how do the economics work with the veterinary referral partners can you maybe quantify what didn't turn partner with you.
On the prescription management side.
Well the feed material near term.
These exclusive relationships with the profit day, how does that actually for sure.
Sure. So so far so far that's farther on new exclusive relationships. The referrals are essentially we are providing a service to the customer and in identifying the type of that an area that might be suited to be able to appropriately diagnose Oh, you know the medical condition.
On board the level of urgency with which the the deep.
The diagnoses might be required in that way you know chewy partner veterinarians are redirecting customers to either you know neighborhood veterinarians are the customers is on veterinarian orphan emergency clinics.
Wendy if he if you've gone through the experience. What you will find is that we provide a full diagnosis summary on a full summary of the conversation.
And you know some specific notes for the for the for the veterinarian in clinic to take a look at that can actually so in this way what we are essentially doing is driving.
What we call the high quality traffic into the veterinarians office, where the opportunity for conversion.
Or offering that service or treatment.
Receptiveness on for that for the customer is the greatest and the highest so that's that's one way to think about it the other way that that we're thinking about it which we're excited about is when you think if we believe that services like these can help solve challenges like compliance and also grow Tam for the health care space.
Yes, which is obviously a vested interest on a joint commission that the veterinarians have how well, we we believe that and I've shared this data point earlier on this call. We believe that you know turned off pet parents in the U.S. either do not take their pets to assets or don't do so routinely.
And the barriers to doing so in our opinion is either the cost on that care.
You know the it'd be about barriers on friction in the process itself or just lack of awareness around preventative health care in the minds of the pet parents and so you know by offering on by bringing tree our services like Tele connect like connect with a bet. We can offer this service to that type of pet parent from the convenience.
Their home and essentially on their trust to be able to educate them and therefore drive that traffic into the veterinarian clinics and in doing so both increased compliance as well as open up the entire Tam for that particular customer segment, that's not touched or not fully fully fully on leased on opportunity from.
From a veterinarian site standpoint, so those are two different ways of thinking about it.
That makes a lot of sense. Thanks.
Again, if you have a question. Please press Star then one our next question will come from Rick Patel with Needham and company. Please go ahead.
Thank you and good afternoon earlier, you touched on how newer cohorts you're spending more earlier on compare to prior cohorts I believe that historically your revenue per active customer has been in the 150 to 200 ballpark.
The year, one on if that if that if this hasn't backed ticked higher do you see upside to and back in the out years at <unk> as well where does this mean that lifetime value is consistent but the ability to catch your revenues earlier on has improved.
Rick I think this is mark I think I understand your question, so, but let me let me I think on the answer to that question is both not only are we capturing more revenue earlier, which impacts LTV to CAC and therefore, we would expect that the behavior to continue going forward.
Continuing to improve LTV to CAC versus prior cohorts.
But the <unk> an uptick in the first year revenue per active customer.
Good could be a good indicator of future.
Future year netback per active netback also being higher than prior customer gorge up but that doesn't just happen right. We've been doing that actively by expanding the catalog expanding the category. The fact that two years ago. We did not have a pharmacy that meant that a customer could spend potentially seven $800 with us on the price.
Alex and being being a consumables are hard goods, but they couldn't buy their medicine Ah well they can do that today.
Our hard goods catalog itself was much smaller two years ago and EPS, we can do to expand not only the product selection, but also the price point that means that the customer now has an opportunity to buy their food and there a dog bed khatri et cetera from us. We've we've expanded the product selection of non dog non cat pets at home.
So again the customer may have had to split their purchases with us in another channel. Another can consolidate all their spend on our on a on chewy dot com. So therefore, the answer is the <unk> not only can we capture more of the revenue early earlier, but also the LTV to CAC to those for those customers should improve not only was higher.
Revenue, but also more profitable orders for each of the four that for those customers.
Very helpful. Thank you.
Our next question will come from Peter Keith with Piper Sandler. Please go ahead.
Hi, Thanks, Good afternoon, maybe use that as a quick follow up to Richs question on D. cohorts spending you have had this impressive 150% increase in in cohorts spend from year, one to year. Two historically, so maybe with a higher starting point year. One do you still see that type of increase.
For all these customers moving into next year or do you think maybe that growth moderate somewhat.
Yeah. Peter this is Mario so the court spend increasing from your one through you are to.
Look at without speaking to 2021, because we are we will do that on the fourth quarter call.
Nothing that we're seeing from the customer. So we acquired this year would have us believe that they're going to behave any different.
Then prior year customers.
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So I think that's the short answer without me getting into 2021 or any guidance discussion.
Okay, that's fair enough and if I can ask a maybe a simplistic big picture follow up.
So impressive numbers that you're giving out on that the higher retention rate this year.
I think there are some views out there that maybe are your churn rate would actually be higher retention will be lower because you acquired a lot of customers when brick and mortar stores were closed.
So simplistically could you just maybe give us an overview of why you think the retention rates. This year in particular are trending so much stronger.
Hey, Peter This is a testament I'll take that as well.
Well I think it goes back to the to the entire value proposition I mean vs. First of all we seek to deliver a a a high bar a credible experience from the get go and we aim to repeat that but every interaction that a pet parent has been on us. So much so that you know.
We build relationships not acquire me or transactions and you know in some way the relationships that we acquire fuels long term loyalty and evangelism towards the brand and that has a lot of value in a category like Pat where where customers reported themselves as parents, it's on a motive.
Category underneath of that when you layer on the deep core tenets Sophie commerce on offering competitive pricing broad assortment and really reliable and convenient delivery services and you complement that wed see you know an expanded portfolio of products and so.
Service is it allows us to inch closer every month every quarter to our mission statement of being the most trusted convenient destination for pet parents everywhere and we believe that it's reflected in the numbers that were sharing today, including retention type statistics or spend per cohort.
Statistics that weve shared or numbers that you share on the call today, both up more than 600 basis points on the retention bases and cohorts a in on on a year over year basis spending 10% higher in quarter.
As I kind of shared earlier on the call you.
You should expect us to continue to operate in a highly disciplined on high customer experience high bar manner.
Okay very helpful. Thank you.
Our next question will come from Deepak mothers on him with Barclays. Please go ahead.
Hey, guys. Thanks for taking the question. So the first one on the auto show you had the well let's start on discount on auto ship program at around 40% for a few months now what are the benefits you're seeing from this change and how do you think about the ROI at these levels also is the ownership penetration currently the same on line.
Our recent cohorts maybe on a monthly basis, you know because of the pandemic there's been some fluctuation there. So just curious on how that's adoption has been thank you.
Sure.
I'll take the second one I will take the first one on the auto ship penetration is same or better on on customer cohorts that we are acquiring.
Yeah that I think you're on that your first part of your question was about the discount and then the you know I think the simple answer is you are right. The ODESZA penetration is increasing or its higher at this higher level, but then the other side is what does it cost to us right and the cost is minimal until that.
You have the benefit of having more sign up red range higher sign up rate net of any cancellations or.
On a lower cost, which then leads to an improved LTV to CAC Oh from these customers and the book you know. These are these are trends you and you know seasonal promotions that we do a we're not seeking to disrupt the value proposition into program driven by deep discounting or any sort sword. These are season.
No holiday driven promotions or where we are particularly sensitive and data driven in understanding what our gross customer adds would be an auto ship and also understanding the cancellation rate you know post event. Therefore, arriving at net adds that we that formed the basis off day.
The payback calculation given how low you know on given that we understand how long the customers are going to stay with us what their spending patterns are going to be and how we can develop them from one category into purchasing multiple categories over time.
That's how we think about it.
Got it no that's very helpful. Thanks, guys true.
True.
This concludes our question and answer session I would like to turn the conference back over to submit Singh for any closing remarks. Please go ahead Sir.
Thank you everybody have a good night.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Yeah.
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