Q2 2021 Chewy Inc Earnings Call
Pardon me, ladies and gentlemen, the chewy second quarter conference call will begin shortly so please continue to hold again, the chewy second quarter conference call will begin shortly so please continue to hold.
[music].
Good afternoon, and welcome to the Chewy second quarter 2021 earnings Conference call. All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero.
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Please note. This event is being recorded I.
I would now like to turn the conference over to Bob Lafleur, Vice President of Investor Relations. Please go ahead.
Thank you for joining us on the call today to discuss our second quarter 2021 results. Joining me today are <unk> CEO Sumit Singh and CFO Mario <unk>, our earnings release and letter to shareholders, which were filed with the SEC earlier today have been posted to the Investor Relations section of our website investor Dot chewy.
Dot com.
Our call today, we will be making forward looking statements, including statements concerning <unk> future prospects financial results business strategies investments industry trends and our ability to successfully respond to business risks, including those related to the spread of COVID-19, such statements are considered forward looking statements under the <unk>.
But securities Litigation Reform Act of 1095 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those contemplated by our forward looking statements.
Reported results should not be considered an indication of future performance also note that the forward looking statements on this call are based on information available to US as of today's 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 in <unk> 10-Q, and 8-K filed earlier today and in our other filings with the SEC.
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 website and in today's SEC filings. These non-GAAP measures are not intended as a substitute for GAAP results.
Additionally, unless otherwise noted results discussed today refer to second quarter 2021, and all comparisons are accordingly against the second quarter of 2020.
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.
Now like to turn the call over to submit.
Thanks, Bob and thanks to all of you for joining us on the call.
We have now crossed the halfway point of 2021 and our results once again demonstrate the strength of our business model and the incredible bond between pets and pet parents are business remains healthy customer engagement continues to grow and we are confident in our ability to build upon the strong results. We delivered last year, while navigating the uncertain <unk>.
Conditions due to the ever evolving COVID-19 pandemic.
Let's start with our second quarter results.
Q2, net sales rose, 27% to $2 $7.0 billion.
To gain an even greater appreciation of our topline momentum. We believe it is also insightful to look at our net sales growth on a two year stacked basis through this view Q2 2021 net sales grew at a two year CAGR of 37%.
We ended Q2 with $21.0 million customers a year over year increase of 21% or 29% on a two year CAGR.
Gross customer ads are running higher than pre pandemic levels, but below the record levels. We saw last year during the peak of the pandemic driven lockdowns.
In fact year to date, we have acquired approximately 20% more new customers than we did in the first half of 2019 prior to the pandemic our retention rates remained stable as well.
In addition to the number of customers, we add customer spending is equally as important to our growth equation second.
Second quarter net sales per active customer our netback increased 14% to $404. This is a meaningful acceleration over the growth we reported in the first quarter and the first time in the company's history that netback has surpassed $400.
We have increased share of wallet from every cohort we've added to our platform over the past 10 years and our long term revenue retention levels from each cohort remained well above 100%.
As a result, our base of recurring revenues grows over time as the revenue produced by each cohort stack on top of one another like the layers of the cake.
Revenue retention is above 100% each new cohorts contribution to net sales is completely incremental to the base.
This dynamic combined with our ability to consistently improve margins creates a powerful long term growth and profitability flywheel.
Returning to our second quarter results gross margin expanded 200 basis points to 27, 5%.
Driving 200 basis points of gross margin improvement in this difficult operating environment reflects our focused execution across multiple customer offerings and a strong and record purchase behaviors of our customers over time combined with the benefits of our scale.
The pricing and promotion environment remains stable throughout Q2, and we estimated that this benefited gross margins by approximately 50 basis points.
As was the case across much of the economy labor market challenges persisted throughout Q2, this impeded our ability to staff, our Fcs at desired levels and achieve optimal productivity aligned with the expectations. We shared with you on previous earnings calls, we increased our investments in wages benefits and hiring incentives across our fulfillment network.
Order to maintain customer experience and business continuity.
As a result of these increased investments Q2, SG&A leverage was minimum.
Marketing is an area, where the landscape evolve rapidly in Q2, the 80 basis point increase in advertising and marketing expenses as a percent of net sales in Q2 as a result of two main drivers. The first is a sharp recovery of input costs across advertising platforms. While this was expected to some degree the magnitude of inquiry.
In Q2 was unprecedented and second seeing early signs of benefits from our continuous learning approach, we invested dollars into the opening of new marketing channels, which we believe will drive incremental long term customer acquisition and build brand awareness.
Usually we see a couple of quarters lag between the initial investment in a new marketing channel and the realization of returns as those channels scale the.
Q2 gross margin gains that were driven by our strong operating performance more than offset the environmental challenges from higher FC labor costs and elevated marketing expenses and Q2, adjusted EBITDA margin expanded 20 basis points to one 1% and adjusted EBITDA increased 51% to $26.0 million.
Mario will provide more color to this line item.
Next I'm excited to share some of the many innovations we've been working on at Chewy. These initiatives are improving operational efficiency driving higher customer engagement and advancing sustainability.
Electively. We believe these efforts will unlock additional top line growth and support long term profitability.
Let me start by updating you on the latest developments across our fulfillment network.
We recently announced that our 14th fulfillment center and fourth automated FC will open near Nashville, Tennessee in the fall of 2020 to Nash.
Nashville, now joins Kansas City, and Reno, and the pipeline of FCS that we will open over the next 12 to 14 months.
Additional efficiency driving measures include technology, which custom mix boxes based on the size of the contents. This process is not only faster than Manuel pack and ship, but it also reduces the amount of corrugate and packaging materials used per order, which then reduces costs and it's better for the environment.
We're also refining our pick pack and ship processes to reduce the time spent configuring box content, which helps expedite how quickly packages leave rfc's.
Collectively once these three automated facilities and efficiency measures are fully ramped we expect that increased fulfillment productivity will produce 40 to 60 basis points of incremental SG&A operating leverage and reduce our future exposure to labor market volatility.
We are also deploying new software across our network to improve productivity reduce per unit fulfillment costs and positively impact sustainability for.
For example in the second quarter, we launched proprietary machine learning driven software, which streamlines order routing and allocation across our growing FC network to optimize shipment volume customer promise and cost to fulfill.
At our current scale the fully realized benefits from this proprietary software are expected to be between 30% and 50 basis points of margin improvement.
Once fully ramped across our FC network, we expect these initiatives to contribute a combined 70 to 110 basis points of incremental adjusted EBITDA margin.
Moreover, these efforts have become increasingly relevant as labor markets remain challenged transportation networks become capacity constrained and inflationary pressures on freight costs begin to rise.
Moving on to truly help we continue to think big and in a way it rapidly to serve our growing base of customers and a veterinarian partners.
First we are very excited to launch a marketplace, where veterinarians directly on <unk> dot com to help them grow clinic revenues and improve experience for pet parents.
This revolutionary free service enables veterinarians to choose items to list on <unk> Dot com set prices create preapproved prescriptions and earn revenue when customers place an order in clinic or purchased from them why actually.
Moreover, the service allows millions of chewy customers to purchase pet medications directly from their veterinarian, while shopping on <unk> dot com with fast free shipping directly from our nationwide network of fulfillment centers.
What is even more exciting is that the backend prescription management capability of this platform is powered by our pet scriptures product, which is currently in use at more than 8000 clinics across the country.
Collectively we are branding this innovative new platform as practice hub.
Through which we are offering veterinarians are complete e-commerce solution for their customers practice.
Practice hub leverages, the benefits of our quick and reliable delivery unparalleled customer care and convenient auto ship subscription service, we look forward to sharing more details with you in our future earnings calls.
We are pleased to announce that our third chewy pharmacy will open later this year. This new facility located in Pittsburgh, Pennsylvania will provide fulfillment services for pet medications and special dietary food, providing chewy health customers in the northeast and mid Atlantic with even faster delivery of pet prescriptions and other health and wellness products.
Last but not least we continue to be pleased with the ramp of our compounding pharmacy service since its launch last fall. It is still early days, but the results. Thus far are confirming our investment pieces.
Compounding net sales increased by almost 50% sequentially between Q1, and Q2 on increased order volume and larger basket sizes and auto ship penetration increased over 250 basis points over the same period.
More importantly, compounding is attracting new customers to chewy health with 65% of new compounding customers, either being new to chewy entirely or existing chewy customers, who are first time healthcare consumers.
Services like compounding, which at the present moment are available only to our end customers show, how chewy is uniquely positioned to assist pet parents, who need customized solutions in an otherwise limited marketplace.
Here at Chewy, we are pleased with and proud of our progress and the pet healthcare space.
With every innovation that improves customer or VAT experience, we progress one step closer to fulfilling our mission to make pet healthcare more affordable and accessible for every pet parent in the country and we are doing so by keeping veterinarians at the center of the equation.
Further each new product or service that we launched to benefit our customers. Our vet partners further positions us as the only player in the pet industry, who is building out a full pet healthcare ecosystem that effectively services, both pet parents and veterinarians.
In doing so we are positioning ourselves to assume market leadership in the $35 billion Tam.
Our pet health and wellness offerings from Chewy health include OTC medicines, veterinary diet pharmacy, compounding medication telehealth pet ascription and now practice hub, a unique and innovative marketplace that provides the VAT community a complete e-commerce solution that leverages all of the strengths of chewy Dot com.
More importantly, we are just getting started in addition to what we have shared today, we are working on multiple new initiatives across chewy health and we look forward to sharing these with you in the not too distant future.
Let's exit these innovation updates with a brief check in on our newest launch fresh prepared foods.
Our expansion in the fresh and prepared food space continues as planned.
The launch is still in early days and we are refining the product and service offerings based on customer feedback keeping food safety and customer experience top of mind.
Here are a few data points to apprise you of the ramp we can now successfully shipped product in custom design sustainable packaging to customers across 25 states covering 56% of the U S population.
Overall customer feedback is positive and we continue to fine tune, our product and service offering based on this feedback freshly prepared auto ship sales as a percent of net sales are already approaching 50%.
With fresh and prepared foods, we intend to deliver a customer experience that will rival how pet parents shop today by offering them, a broad selection, great prices and the unparalleled convenience and customer service that are <unk> hallmark.
I will conclude my remarks by reiterating my confidence in our second half outlook. Despite the uncertainty of the current operating environment, we continue to execute our business plan with rigor and enthusiasm.
Our fundamental growth drivers expanding our customer base, increasing share of wallet and building out our highly profitable verticals remain intact.
We continued to drive year over year improvements in key metrics like net sales gross margin adjusted EBITDA margin net pack and free cash flow and.
And finally amidst all the ongoing uncertainty the chewy team remains as relentless and customer obsessed as ever delivering new and exciting experiences to our pet parents and delivering top and bottom line growth for our shareholders with that I will now turn the call over to Mario.
Thank you Sumit.
I am happy to share our results at the execution of our long term growth strategy continues to bear fruit.
Beginning with our topline results second quarter net sales were $2 $7.0 billion.
Representing 26, 8% growth on a.
Two year stack basis, Q2, 2021 sales were $1 billion higher than the second quarter of 2019.
Out of stock levels remain elevated in the second quarter, but they improved modestly versus the first quarter, resulting in a smaller drag on net sales in Q2.
This is a result of supply chain conditions, improving in some areas as certain vendors reduce backlogs. However, other areas like wet dog food are still being affected by industry wide production capacity limitations.
Second quarter auto ship customer sales increased 33% to 151 billion.
Or a 37, 6% CAGR over the last two years.
Second quarter also customer sales as a percentage of net sales increased 200 basis points to 73%.
This improvement in auto ship penetration rate reflects the maturation of the 2020 customer cohort and auto ship's growing value proposition Act.
Active customers were $21.0 million at the end of Q2, an increase of 21, 1% year over year.
As a reminder, net customer ads are a function of new customers added in the period and the retention of customers acquired in prior periods.
As Sumit mentioned year to date gross customer ads are running 20% above the comparable pre pandemic period in 2019 and retention rates are stable.
To better demonstrate the dynamics of new customer adds and retention as it relates to net active customer adds we have included a supplemental section on this topic in our shareholder letter this quarter.
Second quarter net sales per active customer or netback increased $48 for 13, 5% to $404. This.
This was a $16 sequential increase over Q1 on an absolute dollar basis, both the year over year and sequential in the spec increases were the largest in the company's history.
We expect that <unk> growth will remain strong for the balance of the year as the 2020 cohort continues to mature and we expand our customer offerings.
Moving down the income statement second quarter gross margin increased 200 basis points to 27, 5%.
Delivering 200 basis points of gross margin expansion in the current environment is a strong testament to our ability to scale, our operations increase share of wallet and build a strong recurring revenue base by delivering best in class customer service to each and every pet parent.
Second quarter operating expenses, which include SG&A and advertising and marketing were $615.0 million or 28, 3% of net sales compared to 27, 4% in the second quarter 2020.
The increase reflects the incremental investments we made in both SG&A to overcome the current demand and supply imbalance and labor markets and in marketing.
I will expand on both of these areas next SG&A, which includes all fulfillment and customer service costs credit card processing fees corporate overhead and share based compensation totaled $444.0 million in the second quarter or 23% of net sales compared to 22% in the second.
Quarter of 2020.
SG&A, excluding share based compensation totaled $413.0 million in the second quarter of 2021 or 19, 1% of net sales an increase of 110 basis points.
This increase reflects the incremental $30 million, we invested in wages higher incentives and recruiting in the second quarter.
Not only was it budgeted spend in line with the Q2 expectations, we outlined on our last earnings call, but it is also approximately twice as much as we spent on these items in the first quarter.
Without this $30 million of additional labor expenses second quarter SG&A, excluding share based compensation would have scaled 30 basis points year over year to 17, 7% of net sales.
Said differently the permanent leverage in SG&A that we have delivered and expect to deliver in the future is being offset by temporary macro factors that are driving incremental costs.
This demonstrates our ability to fund needed FC capacity and still leverage operating expenses, we believe that the investments we are making in our team members automation and technology will drive higher engagement retention and productivity, enabling us to effectively scale SG&A over the long term.
Second quarter advertising and marketing was $172 million or 8% of net sales, an 80 basis point increase versus second quarter of 2020.
While we expected an increase in this line item is AD rates have been in an upward trend since bottoming out in early 2020 and organic customer growth rates have returned to pre pandemic levels. The rate of increase we saw in Q2 was unprecedented.
Even for the seasonally strong quarter.
As we enter the third quarter auto rates have moderated somewhat but still remain above Q1 levels.
It is worth noting that even with these two factors at play when we take a two year view marketing spend in the second quarter scale to 160 basis points, while at the same time, we acquired more customers in the second quarter of this year than we did in second quarter 2019.
But this reflects the efficacy of our marketing spend which primarily focuses on acquiring and then developing customers to produce higher levels of profitable sales that increase the longer they stay with us.
As a result marketing scales as we grow.
This combined with improvements in gross margin drives our LTV to CAC ratio overtime.
Second quarter net loss was $23.0 million, improving $17.0 million versus the second quarter of 2020, and net margin improved 110 basis points to a negative <unk>, 8%.
Adjusted EBITDA was $26.0 million, improving $15.0 million versus the second quarter of 2020, and adjusted EBITDA margin improved 20 basis points to one 1%.
As we have previously shared we expect to make gradual and incremental improvement in profitability on an annual basis, while retaining the flexibility to make short term investments in a given quarter for the long term benefit of the company and our shareholders.
Moving on to free cash flow second quarter free cash flow was $63 million.
Reflecting $86.0 million in positive cash flow from operating activities and $32.0 million of capital expenditures.
The positive operating cash in Q2 was primarily a function of favorable working capital only partially offset by growth in our inventory levels as we work to protect our supply chain.
Capital investments included additions to our fulfillment network, including cash outlays for our new FCS in Pennsylvania in Kansas City, as well as ongoing it projects.
We finished the quarter with $725 million of cash and cash equivalents on the balance sheet and no debt.
In addition, we recently Upsized, our ABL facility to $500 million.
This facility remains Undrawn and combined with our cash on hand provides us over $3.0 billion in available liquidity.
That concludes my second quarter recap, so now, let's discuss our third quarter and full year guidance.
Environmental cross currency continued to make precision forecasting difficult.
Macro conditions seem to be improving as vaccination levels increase although the delta variant that's clouding the picture it.
At the same time supply chain and labor market challenges remain and no one really knows how long or to what extent these might prevail Bill Theres philosophy bullish about as a trend towards increased pet ownership.
For pet spending and category shift towards online all remain positive.
Consumers may have started redirecting some of their discretionary spending back to areas like travel or dining out but on the whole spending on the family pet isn't really discretionary.
While there may be a few less indulgences on treats and toys as we return to the office and some consumers might cross shop more as they venture out and about we don't believe that is going to alter the long term trajectory of the pet categories ongoing shift towards greater online penetration.
In fact, julie's growing product and service offerings compelling value proposition and unparalleled customer service have positioned us well to capitalize on the industry's expected growth and to keep gaining market share as sales continue to migrate online.
Despite the elevated opacity of the current operating environment, we remain confident in our ability to deliver another year of strong topline growth and adjusted EBITDA margin expansion.
With that we are reiterating our full year top and bottom line outlook as follows we expect third quarter net sales to be between $2, two zero and 222 billion representing.
Representing 23% to 25% year over year growth.
We expect our full year 2021, net sales to be between $107.0 billion.
Representing 25% to 26% year over year growth.
And finally, we expect our full year 2021, adjusted EBITDA margin to expand between 200 basis points.
As you update your models. Please keep the following in mind.
We still expect to add more new customers. This year than we did in 2019, but not as many as we did during the pandemic last year.
Normal attrition rates for a cohort as large as 2020 creates a meaningful headwind I guess net active customer ASP this year.
We expect this to be a one year phenomenon and the delta between gross and net adds is anticipated to normalize next year.
As I mentioned, we added a supplemental section on this topic to our shareholder letter this quarter. So please check that out for more details on the mechanics and map behind net active customer outs.
Additionally, if the current labor shortages persist they may lead to delays in orders, leaving Rfc's similar to what we saw in the second quarter of last year as demand surged and shipments lagged.
This could affect reported net sales because we do not book the revenue from an order until the chips.
To be clear the simply affects the timing of when sales are recognized as reported revenue shifts from one quarter into the next any.
Any potential inter quarter revenue facing is not incorporated into our current guidance and improvements in the labor market could reduce or fully mitigate any risk.
As we continue to execute against our strategic plan of increasing scale growing share of wallet and expanding our product and service offerings, we remain focused on operational discipline and on driving meaningful margin expansion.
Our 2021 guidance reflects net sales growth of 25% or better and adjusted EBITDA that is approximately two times, what we generated last year.
We are delivering incremental profitability at the same time, we are making meaningful investments in the infrastructure that will support our growth as evidenced by the fact that we will nearly double our fulfillment footprint in two years in short we are bullish about <unk> future.
And with that I'll turn the call over to the operator.
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.
Our first question today comes from Steph Wissink with Jefferies.
Thank you good afternoon, everyone and we have two questions. One is more of a tactical question just on your comments on the wet food still being limited if you could just talk a little bit about what you think that might have been.
And as an impact to Q2 sales.
And then.
Maybe if you could talk a little bit about the net pack. It seems like it's coming in much stronger than we would have expected even at this point in your maturation to talk a little bit about how youre thinking about NAV Pac contribution I think you mentioned balanced across net adds in net pack.
How are you thinking about net pack over the back half of the year and then maybe as we think about 2022. Thank you.
Hi, Steph.
I'll take the first one Mario will take the second one.
Estimate the impact to be lower than Q1, and in the range of 25% to $30 million for vertical production.
Hey, Steph this is Mario so I'll take the second part so netback youre right the strengthened netback.
A meaningful in fact, if you look at the $404 that we reported in the second quarter and you look back sequentially in year over year.
Fastest growth we've seen in dollar terms for that metric.
But let me let me sort of go in and give you color around whats happening around netback. So if we start with that.
Cohort that joined us in the first half of 2020 and Thats been a topic of conversation.
The past, we now have at least one full year of data for that cohort.
Those customers now have a netback in the following 12 months four quarters since joining of over $400.
That's higher than cohorts in 2019, and the first year following their acquisition.
So what it tells US is that the hypothesis, we had that not only were those customers.
We're going to spend more upfront, but other spend was going going forward would be higher holds.
Think about it in terms of the netback curves that we've shown share with you in the past.
We believe that curve has shifted upwards for that for that cohort. So thats very positive right.
We also had a hypothesis that we share those with you last year.
The 2020 cohort to a develop LTV profiles that were as good if not better than predecessor cohorts and so far that's also proving out to be the case.
Now if we think about customer behavior more broadly the average spend per new customer in the in the second quarter.
<unk> was higher than last year, so that the average spend per new customer in the quarter continues to rise year over year, and we've seen that trend in the last few quarters.
Auto ship sign up rates remain strong and they are running higher than last year and the average basket size remain above pre pandemic levels in.
And the sales mix within our basket size.
<unk> the gross margin expansion, so all of those metrics and all of those factors are helping in that in the various line items.
Moreover, I think if you go back longer trend customer behavior again going back to what we shared with you in the past remember that customer spend more the longer they stay with us they stay with us.
And those trends have repeated themselves year after year after year since our launch and to give you. An example of that every cohort that we acquired in 2015 and prior to 2015 has a netback in the last 12 months of over $800.
So again, all the trends all the metrics that we're seeing are still pointing in the right direction.
Very helpful. Thank you.
Our next question comes from Mark Mahaney with Evercore ISI.
Okay. Thanks, Let me ask a couple. Please first is you talked about leaning more into some leaning into some new marketing channels, but I don't think you describe what those were any color on those.
Hey, Mark this is some of that no we haven't provided color.
On those mark.
On the basis of our sensitivity in.
Information that we're still kind of experimenting and don't want to release publicly at this point.
Okay understood and then let me switch.
These elevated costs youre seeing in labor and marketing there is no particular reason why you have visibility and wind into Windows would change.
As you think about it to the extent to which they are temporary or permanent.
I don't think there's a way to answer that but do you have a strong point of view as to whether those elevated costs in both of those areas are things that are they permanent or is it after three or four quarters, though should abate any opinion on that.
When you say both areas, you mean labor and which one is the secondary and Mark you talked about rising AD costs I think the market price per AD or okay. Let me, let me provide color on boat. So on labor no. We don't have perfect visibility. What we are is we're triangulating data across markets markets, where we have fulfillment centers and the forecast and our forecast.
And the film that we are getting as a result of that both in terms of short term and long term fill rates and we've triangulated data to understand the impact of where the pandemic or the fed benefits have retained versus where they have expired and the correlation to what labor inflow or increase the pro.
<unk> to us on an index basis. So what we have seen so far mark is that the states, where pandemic or the fed benefits of expired have provided us somewhere between a 25% to 35%.
Improvement in labor fill rates and but the data is not.
It's empirical data and we're triangulating across a couple of different sources.
But we are tracking it closely we don't have full confidence on how the situation might evolve, but we are waiting for labor markets too.
Kind of reveal themselves in terms of data points a bit stronger over the next couple of weeks.
So that we can move into Q3.
In the in the appropriate manner for now we're maintaining the level of investments that we've committed to make sure that there is business continuity and customer experience preservation in terms of managing our shipments.
Coming to marketing marketing is an area, where the landscape evolved rapidly in Q2 and.
A part of this was expected in terms of AD cost recovering in participation rates improving from all players online and retail.
The rate of course, as Mario mentioned was unprecedented and I'll give you a little bit of color. There here in the next one minute and then.
And so what we really saw was overall shopper demand in the online in pet category in Q2 was flat to slightly down on a year over year basis and before it started picking up again towards the latter part of July and that uptick is actually continued into August.
Amidst flat to declining industrial level pet traffic chewy as traffic in Q2, approximately increased or was up approximately 20 percentage point premium to the overall industry and that indicates both a healthy inflow of customers and also indicate that we're actually gaining share as the year plays out.
The online segment softness in Q2, we also saw a directly correlated with May and June which were the months, where aquarius for travel restaurants local retailers were at 12 months high which makes sense because customers are venturing out pre delta evolution.
So to counter this traffic decrease in online and at the same time to incent consumers to revert to their pre pandemic store shopping behavior, both retailers and E. Tailers spent marketing dollars vigorously on paid channels and participated across Q2 promotional events.
As a result of this behavior, we saw pricing inputs increase across the board. So just as a reference Google CPC has climbed 51% year to date and pet supplies category and Facebooks average prices increased 47% year over year and in pad, we actually estimate cpm's increased over 80% year to year on year in these months.
These have been the highest year over year increases that we've observed in the space.
I will exit by saying this.
As we've alluded to before I mean, we don't really have a have a.
We don't really spend to a predefined marketing budget instead, we let the returns and the LTV to CAC ratios guide our payback philosophies all in all we believe we spend.
Incremental 50 basis points or $11 million higher than our internal forecast that could be attributed to these rising AD costs now as we step out of Q2 into Q3 AD costs have moderated. So they are running below Q2, Q2 highs and theyre running above Q1 level at this point, so that's sort of the sentiment as we move into Q2.
Thanks, and sorry, one last quick question. Thanks, a ton for that page Slide 17 page 17, I appreciate the simple math behind that.
In your.
A press release in the <unk>.
Our holder letter you talk about retention rates being consistent that's the same thing as saying that the churn rates are relatively consistent youre using the same terminology there yes, yes.
Okay. Okay.
Thank you very much.
Yes.
Our next question comes from Doug Anmuth with J P. Morgan.
Thanks for taking my questions I have two first just on customer additions would you still expect 2021 to return to pre COVID-19 or 2019 type of levels, which would suggest bigger sequential pick up in the back half or is the composition of how you get to that revenue.
We have customers somewhat below that and then just a higher netback that youre seeing.
Then secondly, if you can talk a little bit about QE practice hub for vets curious on your view of how that opens up the <unk>.
Vessel market for prescriptions any early feedback you can provide from vet partners and just what you've learned from the 8000 clinics that you've been working with on the back end so far thanks.
Hey, Doug I'll take the first part of the question and Insulet will address your second part, but when you think about the active customer adds this year.
And this is why we included a couple.
Supplemental in the shareholder letter so show you the math behind it.
I would expect the impact of the very large I would say record sized cohort in 2022 still.
Moderate are masked the number of ads we have this year.
Said more plainly.
I would expect our net active adds this year to continue to pace at a lower rate than we saw in 2019 now that is a one year phenomenon. So by next year by 2022, we expect the Theres, a very large cohort and the attrition that happens naturally in absolute terms too.
To work itself through.
Sure.
So the cycle, let's call it that.
On the flip side when you have this netback that is growing very quickly.
So that means that the customers that we are retaining and the customers. We are acquiring are spending more and more on the platform. That's a very good time. So not only have we acquired and are retaining a very large number of customers in fact, adding more gross adds this year than we did in 2019.
Those customers are spending more and more with us over time.
So this is a very good dynamics that that lead to expanding growing topline that lead to expanding gross margin because repeat orders are more profitable than the first orders.
And also at <unk>.
Lead to more efficiencies in the supply chain and therefore, expanding bottom line as well. So those are good inputs in terms of netback and active customer adds.
Okay, that's very clear.
Doug I will take the practice hub. So this one we're very excited about.
If you recall in previous earnings calls I've shared that our research indicates a third of pet parents do not take their pet to the VAT or don't do so at a record frequency. So compliance is constrained or compressed in the industry that actually holds back Tam secondly, as this allows us to work with veterinarians.
More closely as direct partners right and we've always.
We've always been clear about the fact that we're building an ecosystem, where the pet the VAT and the pet parent are all very much in the center of the equation and chewy becomes an enabler to improve experience and complete the journey. So practice hub essentially allows us to accomplish both.
It offers veterinarians because veterinarians offers a directly listed on <unk> Dot com. The VAT has got access to 20 plus million chewy customers and they also get the benefit and did not only access to our powerful auto ship program, but they get the benefit on the earning revenue on all repeat auto ship orders.
Incentivize is improvement in compliance and working with a partner like us that actually understands customers and can build on those relationships from an education and awareness and driving repeat traffic point of view and so it just with our with this type of a proposition. It just creates a lucrative flywheel for the veterinary.
And to be able to effectively participate and it opens up both the marketplace for not only the VAT or the Tam for the veterinarian to participate but also consumers in the way that we will improve compliance.
And then your second part of the question was.
The exposure.
Today, we're working across several independent clinics and also a very well known nationally recognized.
Uh huh.
Group, who have so far being on boarded and theyre, helping us perfect the product.
Which is presently available on a curated and on an invite only basis, but as the year plays out we are rapidly looking forward to working across the 8000 clinics.
Our 8000 veterinarian practitioners that we have a partnership with who are already using prescriptions. So excited about what's to come next.
And what's the timing for when you think this will be kind of fully open to all bets.
Yes, so we.
We will have more to share dug in Q3, but we are actively actively working with our partners and we believe we will be fully ramped over the next couple of quarters here.
Okay, great. Thank you.
Our next question comes from Brian Fitzgerald with Wells Fargo.
Thanks, guys I wanted to follow up on Doug's question, and its and the mechanics of the the practice of marketplace. It sounds like it could evolve into a lead gen.
That form for VAT, eventually and zoom and I think you mentioned a couple of days ago on CNBC evolve you said look where the telenet is acting as a triage and we're at a point right now where.
That's R b.
Being outpaced their capacity as being a place outpaced by demand and so it almost acts like a triage situation.
Is is this a situation where you could eventually parlay this into a paid.
<unk> product for VAT, that's helping them get leads that that's helping them manage in triage things and making them more kind of productive to getting the type of work that they need to do versus kind of shorten out stuff that that really didn't demand visit.
Brian Yes in short we have a big bold vision for what we can do in practice hub as we continue to develop and improve the product we're starting out with the concept of a curated marketplace and backed by the power of prescriptions.
But your intuition and the way that we're thinking big.
There are many that yes, there are many ways that we're thinking about expanding the product and the service in the future.
And then if I could ask a quick question did you have a rough figure for what percentage of the pharma business through the healthcare business is really akin to subscriptions like like.
Anti parasitic calls.
Heartworm pills show up every so often you have to keep giving them to the pet.
Our ultrashape subscribers.
Is equal or better in the pharma space is that sort of where you are.
What you were asking or did I misinterpret to your question yes.
Yes, no. That's helpful. I was just I wasn't sure what percentage of the Tam.
Anti parasitic holes makeup.
About $35 billion I see between between Hot and Preventatives. It makes up 80% of the total of $12 billion Tam that exists between OTC and pharma medication today.
Okay. Thanks, Okay, so extreme pain medication and such makes up roughly 15% to 20% of pharma.
Very helpful. Thank you.
Our next question comes from Seth Basham with Wedbush Securities.
It's a lot and good afternoon. My question is on your gross add commentary you talked about being up 20% year to date versus 2019, what's your expectation for the full year 2021 versus 2019.
Yes. This is Marty I'll take this one so look we know we don't guide to two active customer adds in the year I think the best way to think about the pacing is that.
It will.
The effect of the cohorts that we acquired last year Youll see that continue to have it.
And impact a masking of the gross adds were adding this year.
So but from a from a breaking down gross ads and activity.
In 2000.22021 of this.
We don't do that.
Okay Fair enough and then secondly, as it relates to the customers acquired in this second quarter.
Type LTV do you expect all of those customers versus the questions.
Here in the last year given the.
Record high cap, what I think what you got.
As we're incurring this quarter.
I'll start again, and some it may add something to it.
LTV to CAC you have to think about it in both terms so yes.
The potentially there were some input costs that were higher in the second quarter, and therefore, leading to a higher CAC potentially in the second quarter.
But the margin is amongst the highest we've ever recorded a 27, 5%.
They are also spending more upfront so they've joined the platform and immediately started spending more and the dollars are producing at or higher.
A higher margin level.
So there is.
An indication that the LTV to CAC should be.
So I would say that the.
Customer of today, and the way that they are exposed to expanding and broad choices and offerings from us.
Which we have credibly expanded over the last three years.
LTV expands by several $100.
On an annual basis.
Haven't yet put a number to it and it's hard because we're still graduating customers through different offerings that we have developed and some of these offerings are early stages that we're actually maturing into.
But when you look at it from a maturity point of view there are several hundred dollars a LTV to be added up top which actually provides us a nice cushion at the expanding contribution margin to be able to tolerate CAC and to be able to participate very effectively.
The marketing environment, whether it be the marketing environment of today or the future as we continue to acquire more customers and add them to our platform.
Got it very helpful. Thank you.
Our next question comes from Lauren <unk> with Morgan Stanley.
Hi, This is Nathan feather on for Lorraine.
Can you just talk through a little bit more some of the puts and takes on gross margin expansion in the quarter and where do you think that kind of ended up without the short term impacts in terms of discounting.
Thank you.
Sure so.
Mario alluded to gross margin expansion and we provided the details in the script not much more to provide their customers continue to robustly engage across the verticals that we've built out.
We continue to see our work and improving discovery search.
Graduating customers into buying more cross category as well as higher margin verticals.
Come to fruition.
Combined with the benefits of our scale.
And how we're driving the gross margin improvements and we saw we estimated a 50 basis point.
Uplift.
Or a 50 basis point addition to gross margin.
As a result of the muted pricing environment or promotional environment that we're seeing currently.
Nathan I would add that back to the point that <unk> made in the opening remarks.
But we are implemented technology, what we call the Rs II, our order routing system that we estimate could lead to another 30 to 50 basis points of gross margin expansion. So there are puts and takes to gross margin expansion.
We see the results in the second quarter.
There is there.
There are some initiatives that were in place that should expand them and.
And also if you look at the mix of sales consumer versus hard goods and other there is opportunity to continue to move some of those sales to some of the more profitable.
Mix in the future.
Okay, great. Thank you.
And then on top of that on the marketing side did you see any shift in channels within the quarter in terms of where your marketing outside of the introduction of some of those new channels and was there any potential impact from <unk> in the quarter. Thank you.
Our marketing mix is dynamic and we spend relative to the returns that we're getting so we don't have a pre defined budget for a predefined channel.
Sure.
<unk> go to market strategy.
It's a bit of a hard question to answer because.
Depending upon the dynamic nature and the volatility that we saw in Q2, we reacted accordingly.
And then what was the second part of your question.
Did you see any impact from the Apple App store change or the Apple fee changes.
Yes, no we have been actively working to sort of mitigate that from the beginning and the way that our architecture is both so we didn't see a material impact on that so far.
Great. Thank you.
Our next question comes from Peter Keith with Piper Sandler.
Hey, Thanks, good afternoon.
Maybe follow up on the gross margin it looks like Youre seeing continued healthy mix shift so with all of the new engagement with pet health.
In the past, you've you've talked about health.
<unk> running about 500 to 800 basis points above your core business. When we think about like practice hub and compounding rolling in and presumably growing very quickly does that gross margin lift change in any way for better for worse.
Sure So system hotel ticket so.
We have said at scale, we expect healthcare to be 300 to 800 basis points higher gross margin than the base business.
And we are on we're on track to.
To deliver that and you can see some of that starting to come through in the gross margin uplift that we've continued to deliver on a year over year basis, and then from from here on out.
As I have said in the past we have many initiatives that we're working on to complete the roadmap that builds out towards our long term guide of 25% to 28%.
And so far we reserve the right to update that guidance because there's so much more interesting stuff for us to work on and reinvest reinvest dollars and where we see the the long term return taking place. So in terms of building out our roadmap, we still have a full non non healthcare we have we have healthcare to build out that we're starting to.
Open up more and be more candid with here and starting to share with all of you we still have non healthcare.
So this is to build out and we still have a lot of work to do in connecting the dots to be able to engage the customer holistically across these three or four verticals that connect the pet lifecycle and at the same time, we're thinking.
Boldly about not just end consumers in this space, but also about the community that services pet which is also embedded in our mission statement of being the destination for pet parents, but also partners.
And a few of the examples that you've seen us bring to life. So far are compounding.
Vacations, which are today, a b to C.
Offering.
And now.
With our telehealth, where we're working with veterinarians collectively and now with practice hub that we've actually opened up to veterinarians. So you should continue to expect us to.
In a way robustly and at pace and keep you apprised of gross margin expansion in the future.
Okay very helpful.
Separately I was.
I'm wondering if you could address.
The growth for small animal and a dog and cat gets a lot of attention, but we've been hearing rumblings out there that it's actually small animal adoption that remains white hot.
Im wondering if youre seeing that in your business and maybe is it too small to matter or any quantification of sort of the Dx dog and cat business as a percent of sales would be helpful.
Yeah.
Sure.
Long term trend is correct.
Are all in the United States, we believe somewhere between 70% of pets are small pets and they are growing at slightly higher rate than large pads. So it definitely makes sense.
As a lot of Gen Gen y and Z and millennials adopt pets and.
At least pre pandemic city living and dwelling was a much more continuing to become a popular option.
And when you look at the density of space in the pet type that might be.
More suitable.
Give a little bit of a tailwind to the small pet data point, but it's not materially shifting or has shifted to the point, where we need to update our planning assumptions or educate customers a different way so far.
Okay. Thanks, very much good luck. Thank.
Thank you.
Our next question comes from Chris, particularly <unk> with Exane BNP Paribas.
Hey, Thanks for taking the question.
So it was helpful to see the ulcerative curves I wanted to drill a little bit deeper.
I think your overall consolidated attrition rates just naturally benefits from cohort maturation just overall customers.
Just naturally blends down at least historically anyway.
If you look at your two attrition rates in 'twenty, one versus 2019.
Where the attrition rates better in 'twenty, one to 19, if you can comment that'd be helpful.
Okay.
Chris This is Mario I'll take it.
The attrition rate no matter, how we look at it and we do look at it from the very many different angles has remained there will remain within historical levels. It doesn't matter. If we're looking at the 2020 cohort or we're looking at the 2018 or 2015.
The <unk> curve.
And the high levels of retention.
Over time for those for those customer cohorts.
Almost regardless of the size of the cohort remained steady so.
I think there's a bed.
The way to answer that.
Yes, okay.
That's helpful and then wanted to check in on the fresh pet offering.
With your own private label product and then.
With such tight.
It's on their products now can you give us a sense for like what the early you gave us some growth rates, which was nice to see but it gave us a sense are you finding your own customers are migrating up from kind of wet food and dry food into this where you conquesting.
New customers from other channels with this initiatives.
Lastly, there is like a perception in the market.
This might be lower contribution margin just given the elevated shipping cost again with this like whats your experience been so far from a contribution margin perspective is it similar to other consumables at a similar price point or has it been dilutive to smart. Thank you.
Sure. So for the first part of the question, it's still a very new business and we're ramping it up with limited assortment, so far and so the customer base isn't large enough to have an interesting conversation. So far it is ramping very quickly and so far we are seeing both.
A lot of customers migrating so existing jewelry customers.
Migrating either fully migrating are actually using these as a copper, which I believe I will use again.
And my second and the second part of your question. We're also seeing a lot of net new customers being acquired directly into the into the vertical itself. So it's supporting the investment hypotheses of existing and new customer acquisition channels and.
And then to answer the second part of your question, Yes. It has.
From a shipping point of view, Okay shipping suppliers when you utilize the dry ice or cold chain, Yes, you have a little bit of a higher burden on the shipping supplies costs, but at the same time, we're very good at about at building baskets with consumers and being able to drive repeat purchases using our auto ship program that allows us to.
Planned better forecast better.
And control all inputs that drive operational efficiency and a much much more efficient manner.
So on the on the whole at scale, we expect this business to be contribution profit positive and accretive to the base business.
Got you. Okay. That's helpful. Thank you for your time.
Our next question comes from Justin Kleber with Baird.
Thank you everyone. Good afternoon, just wanted to follow up on the active customer add questions can you give us a sense how those gross customer adds flowed across the quarters in 2020.
Are they meaningfully different than the net adds that you reported just trying to understand if you have already cycled over the peak period of gross adds and how that might influence the pace of net adds.
We look to the back half of this year.
Hey, Justin it's Mario.
<unk>.
<unk> gross adds last year, where even throughout the throughout the year almost.
Almost the.
At the same number of gross adds in Q1 versus Q4 Q3, Q2, So you won't find any discernible pattern there.
Okay. Thanks for that and then just lastly, as it relates to your outlook. What are you guys assuming from a promotional perspective in your guidance are you embedding.
A gradual return to a more normalized promo environment, particularly as we head into <unk> and the holidays.
So far.
This is actually directly correlated to the various supply chain and out of stock issues and overall freight conditions improve and so so far we are continuing to assume a stable and relatively muted promotional environment as we move into the back half of the year.
Okay, and if I could just sneak one more in.
Just wanted to ask about new pet parents in the maturation of.
They're spending, particularly how how it evolved in year two as you cycle. Some of those initial purchases associated with the new Pat thinking things like a <unk> or a category. If you look at spending on an annualized basis those new pet parents can they grow in year two in terms of overall spend or do you see them take a bit of a step back.
No.
Whether on a customer basis per customer basis or on a cohort basis.
Revenue retention improves year over year, and unlike a traditional retailer retailer by revenue dipped from year one into year, two we see a steady predictable increase from year one into year, two we provided the shapes.
Back in the S. One document in 2019.
But when you look at it for eight years of cohorts very predictable for SER 150 to 200, the secondary jumps to $53.0 and memorials recent comments today, we are actually seeing consumer spend higher earlier. So no. We don't see a compression. If you are buying full baskets for US, yes, generally hard goods purchases are discretionary.
Larry in the buying cycle is a little bit longer so.
But on our consumables basis, where we're able to forecast.
Pete purchases and frequency of pretty accurately.
On a net basis spend actually increases from year one into year two.
Yes, Okay. Thank you guys appreciate the color sure.
And our final question today comes from Steven Forbes with Guggenheim.
Okay.
Good evening estimate I wanted to follow up on Chewy Health you mentioned in the release that veterinarians can now earn revenue when a customer places an order.
Was curious if you could provide any context around how this revenue share compares to other options that may have today.
And or whether you think the improved value proposition.
Now neutralized isn't selman preference, enabling the customer to truly drive the decision process as we think about the potential for market share gains into the future.
Other offering is very competitive and we believe that it should allow the veterinarians to be.
Divest control a part of that equation and the way that they're priced products with us.
<unk>.
We might charge, a small fulfillment fee and that fulfillment fee.
Is lower than what we currently see in the marketplace. So from that standpoint, we believe this should be accretive.
And the VAT should be very happy with the equation that or the overall equation when.
When they engage with chewy and our customers in a holistic manner.
And then I'm sorry, I did not follow the second part of your question. So would you please repeat that for me.
I think you answered I was just curious whether you think the offering right that you're putting forth here really neutralizes the summit preference among them.
Enabling your customers right.
Drive the decision process and we you know breakfast hub, yes, sure sorry, yes practice others is we believe so it's a completely different it's completely different than any other product or service in the marketplace. Currently first the service sits on <unk> dot com, but 20 million active customers, who now have immediate access to buy from their VAT secondly.
<unk> owns the entire customer experience, we shipped for free over $49, we don't charge them for life.
Lifesaving items like insulin, which currently are being charged you could you could expect to pay a 30 plus dollars on a single order of it services that are available out there right now we ship fast. It gets you in one to two days relative to the current delivery experience of somewhere between four and six days the way that we've benchmarked. It and then chewy customer care team is accessible to you which is available 24 seven.
<unk>.
On top of us delivering tremendous value proposition on a P&L basis as well as <unk>.
Customer base. So when you when you when you say neutralize I actually believe that this is a.
Really compelling superior product.
And in industrial defining industrial disruptive product that we're bringing to life here.
We're very proud of it.
Super Helpful. And then just a quick one for Mario if I may just regarding the software enhancements that.
You discussed in the prepared remarks, and any timeframe behind the recognition of the benefits that were mentioned.
And are there any incremental scaling benefits that we should be considering.
For the for the software. It's one is fully deployed and fully ramp at this node specific time on that I can provide you on that but it's something that we've begun to rollout through the network.
And then your second part of the question was about additional scaling benefit continued mix of sales shifting from.
And to the higher margin verticals that we've talked about.
The simple math of increasing our repeat order base, because repeat orders tend to be more profitable than in the first order.
So and then scale alone.
Provide us additional benefits over time in the supply chain efficiencies, so theres a theres a few tailwind there.
What we find very encouraging and.
Is the fact that we continue to improve customer engagement and develop our customers and achieved the combined with the benefits of our scale, we continue to deliver incremental gross margin.
Which is tremendous because.
The work that we're doing there is structural.
And.
The customer centric and P&L centric at the same time.
<unk>.
When you slowed this down presently there are macro environments that are hopefully temporary in nature that are holding back kind of the flow through that goes from the gross margin all the way down to the EBITDA line and even even with the current constrains, we've delivered roughly $300 million on a stacked basis over the last two years.
Into the P&L and on a year over year basis, we will deliver two extra EBITDA this year relative to last year.
So the scale and the efficiency and the work that we're doing with customers.
We believe we are on the right path and the strategy is intact.
Thank you.
This concludes our question and answer session I would like to turn the call back over to Sumit Singh for any closing remarks. Thank.
Thank you very much stay safe have a great evening.
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