Q2 2022 Chewy Inc Earnings Call
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Ladies and gentlemen, please remain holding the conference will begin momentarily.
Please remain holding the conference will begin momentarily.
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Good afternoon. Thank you for attending today's chewy Q2 fiscal year 'twenty two earnings call. My name is Hannah and I'll be your moderator for today's call.
All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question. Please press star one on your telephone keypad.
I would now like to pass the conference over to our host Robert before Vice President of Investor Relations. Please go ahead.
Thank you for joining us on the call today to discuss our second quarter 2022 results. Joining me today are <unk> CEO Sumit Singh and CFO Mario Marty marks are.
Our earnings release and letter to shareholders, which were filed with the SEC earlier today have been posted to the Investor Relations section on our website investor Chewy Dot com.
On the call today, we will be making forward looking statements, including statements concerning <unk> future prospects financial results business strength investments industry trends and our ability to successfully respond to business risks, including those related to inflation and its effect on the economy and our industry.
Such statements are considered forward looking statements under the private 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.
Ported 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 section and other information and she was 10-Q and 8-K filed earlier today and in our other filings with the SEC, including our annual report on Form 10-K.
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.
non-GAAP measures are not intended as a substitute for GAAP results. Additionally.
Additionally, unless otherwise noted results discussed today refer to the second quarter of 2022, and all comparisons are accordingly against the second quarter of 2021.
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 to turn the call over to Sumit.
Thanks, Bob and thank you all for joining us on the call today.
We are proud of our Q2 performance and ability to deliver double digit top line growth and margin expansion during a period when accelerating inflation place incremental pressure on an already stressed consumer.
Across the pet category pricing escalated throughout the second quarter.
Consumers in the pet category responded to growing economic uncertainty by curtailing some of their purchase activity leading to industry wide declines in unit volume.
Even as consumers pulled back in select areas chewy outperformed broader industry trends on the strength of our market leadership in non discretionary recurring revenue categories like food and healthcare the product categories that are most important to pet parents.
Chewy grew Q2 net sales by 13% to $2 $43 billion, reflecting our ability to drive steady demand in non discretionary categories.
Demand that is anchored by the superior value proposition that we offer pet parents and the predictable nature of our auto ship program.
Collectively these categories represent more than 80% of our overall business, which provides us with distinct structural advantages in the current environment.
At the same time, we saw softer demand in the second quarter with discretionary products with longer replacement cycles, such as hard goods, which offset some of our positive momentum in food and healthcare.
Altogether chewy strengths and competitive advantages in the pet category were evident in Q2 as customer engagement metrics, such as auto ship and NASDAQ set New records at 73, 1% of net sales and $462 respectively.
Shifting to profitability Q2 gross margin was 28, 1% an improvement of 60 basis points, both year over year and sequentially.
This improvement was led by pricing, which continued to strengthen in the second quarter as the favorable delta between price and cost increases widened by approximately 100 basis points compared to last quarter.
Additionally, moderating fuel costs and our ongoing efforts to improve supply chain and logistics capabilities also contributed to the strong second quarter gross margin performance spin.
Specifically during the second quarter, we improved system wide inventory placement, which reduced average delivery distance improve delivery speed lowered costs and enhanced customer experience, which I will expand on shortly.
Q2, adjusted EBITDA was $83 $1 million and adjusted EBITDA margin was three 4% year over year increase of 230 basis points and a sequential improvement of 90 basis points, reflecting our gross margin expansion greater marketing efficiency and improved execution in several SG&A functions.
We will detail shortly.
Moving next to our customers we ended the quarter with $20 5 million active customers in line with the expectations, we shared on our last call.
Our Q2 net adds reflect gross customer additions that have come off their pandemic highs and the retention behavior of the large cohorts we acquired during the pandemic.
The number of gross customers that we added in Q2 2022 was mid single digit percentage points higher than the comparable pre pandemic cohort from Q2 2019, even that softer demand across discretionary categories put some pressure on customer acquisition.
Once we fully cycled the effects of elevated pandemic pet adoptions and the macro environment recovers, we believe the customer acquisition headwinds related to discretionary demand levels will abate.
Additionally, retention rates on the customers we acquired during the pandemic in 2020, and 2021 are still running low single digit percentage points lower than their comparable pre pandemic cohorts, which continues to affect total net adds due to the large size of these schools.
Having said this we are encouraged to observe that the complexion of the new cohorts that we have acquired so far in 2022 is more consistent with the long term retention profile of our pre pandemic world.
Notably we believe that the dynamics that are impacting both gross adds and retention are temporary in nature and it is important to remember that over the long term our business model produces incredibly sticky customers, which result in retention curves that stabilized after the first two years of a customer's relationship with chewy.
Now moving on from financials, let me update you on several innovation areas across Julie.
Let's start with supply chain logistics and transportation.
As I have shared on previous earnings calls, we have multiple initiatives underway to improve profitability and customer experience by improving inventory placement, reducing inbound and outbound freight costs and driving incremental fulfillment cost leverage through automation.
To this end, we successfully launched our third automated fulfillment center last month located in Reno, Nevada, the benefits from automation continued to expand across our network and our pace of realizing these benefits continue to accelerate.
For example, based on the learnings from our first two automated FC launches, we expect that it will take Reno half as long to ramp up to its comparable performance benchmarks as it took for our first automated FC.
As we expand our network of automated FCS. These facilities are handling an increasingly larger share of our outbound shipment volume and they are doing so at progressively lower variable cost per package for.
For example, during the second quarter, nearly 25% of our outbound network volume shipped from our first two automated FCS at a variable cost per unit that was approximately 15% lower than our legacy network.
By this time next year are turned off or outbound volume is expected to shift from automated Fcs.
Based on these trends as we have shared with you in the past we are confident in our ability to realize the 40 to 60 basis points of targeted SG&A leverage over time from our three existing automated up seats.
We expect to benefit from further SG&A leverage as we open additional automated FCS in 2023 and beyond.
On the transportation front, we recently launched our second important routing facility. This one on the east coast with facilities on both coasts. We are now able to optimize freight distribution to rfps and reduced inbound freight costs on more than three quarters of our import volume.
Elsewhere in transportation should be afraid services or CFS also continued to grow in the second quarter.
As a reminder, CFS is our line haul initiative, where we operate a portion of our own middle mile Network. In Q2, we carried triple the volume that we did last quarter, which led to reduced cost and improved delivery performance.
Looking forward, we will keep adding capacity to this program throughout the remainder of the year.
Combined these automation and transportation initiatives are generating savings in cost per package and improvements and delivery performance and customer experience.
Next let's move on to Chewy helped and the progress we are making in our mission to make that healthcare more affordable and accessible and to improve the lives of pets and pet parents.
As a successful public launch of Careplus, our wellness and insurance programs after.
After a two stage soft launch in June we are now up and running in 31 states as of today, we had expectations to complete our nationwide rollout by the end of the year.
While it is still early days, we are pleased with the initial customer response to our bespoke insurance and Standalone wellness plans.
Innovations like care, plus that improve customer experience increase engagement and enhanced retention are the cornerstone of our customer strategy.
Our primary goal this year is to iterate and learn all we can about this new space from our customers and partners. So while careful us won't have a meaningful financial impact on 2022 over the longer term. We believe careplus will provide us an opportunity to help grow that historically underpenetrated pet insurance term and gain market share.
In our high margin business, and we look forward to sharing more with you on our reinsurance rollout in the quarters to come.
Next is practice up I am pleased to share that we now have over 1000 practices using the platform up from approximately 300 in March of this year.
As a reminder, with practice hub, we have designed a complete e-commerce solution for veterinarians that can be integrated with their existing practice management software or <unk>.
Primary app allows reps to easily create preapproved and manage both medications and diet prescriptions all in one place and then earn recurring revenue when customers place an order in clinic or purchase their items at home on chewy Dot com with chewy handling all inventory fulfillment shipping and customer service.
Sure Sir.
And finally I'd like to note an important and proud milestone for our corporate philanthropy program Chewy gives back at the end of July we reached a $100 billion Mark for pet food and essential supplies donated to over 9000 nonprofit animal welfare organizations that serve pets in need throughout the U S.
Over the past 10 years, we have donated 96 million meals and helped feed millions of rescue pets.
Before turning things over to Mario Let me conclude with the following.
The operating environment, including what we faced in the second quarter remains dynamic and evolving.
As pet parents pulled back in some areas the refocus their spending on categories centered on the health and wellbeing of their pets.
The strength and durability of our value proposition positioned TUI world to compete and take additional market share in this environment.
Looking ahead, we believe the same strengths, which include market leadership across recurring demand categories, such as food and healthcare and rapid innovation and service of customers will enable us to keep winning impact a category that has proven its durability throughout economic cycles.
As we continue to navigate the challenges and opportunities ahead of US our team remains focused on running the business towards incremental growth and profitability and on making decisions that deepen engagement and improved customer experience for millions of pets and pet parents.
To that end, we remain guided by our mission to be the most trusted and convenient destination for pet parents and partners everywhere.
With that I will now turn the call over tomorrow. Thank.
Thank you submit.
Second quarter net sales increased 12, 8% to $2 43 billion.
Non discretionary categories like consumables and healthcare were the primary driver of growth this quarter, representing 83% of our net sales.
While harvest sales declined year over year as consumers ration their dollar store staples and non discretionary items. It is worth noting that our hardgoods business today is up substantially from pre pandemic levels with net sales up nearly 70% compared to Q2 2019.
Looking forward, we believe that the current dynamics that we're observing in discretionary categories like hard goods is temporary in nature and the demand will improve as consumer sentiment recovers and pet household growth returns to historical levels.
Second quarter auto ship customer sales increased 17, 3% to $1 78 billion.
Outpacing net sales growth by 450 basis points.
As a percentage of total net sales second quarter auto ship customer sales reached an all time high of 73, 1%, increasing 280 basis points year over year, and 90 basis points sequentially.
Second quarter net sales per active customer or netback reached another record, increasing $58 or 14, 4% to $462.
Since the beginning of the pandemic in early 2020, our netback is increased by over $100 as we gain an ever growing share of our customers that spend.
We ended Q2 with 25 million active customers, an increase of two 1% year over year.
On a sequential basis active customers were effectively flat versus Q1 2022.
So we expected Q2 net active customer growth was muted as gross customer adds come down from the elevated levels. We saw in the pandemic and as we continue to work through the modestly lower retention rates over COVID-19 cohorts moves.
Moving to profitability second quarter gross margin expanded 60 basis points, both year over year and sequentially to 28, 1%.
As sumit detail in his remarks growth in pricing during the quarter exceeded escalating cost inflation our.
Gross margin performance also continues to reflect the progress we are making in our supply chain and logistics initiatives.
As we move into Q3, we expect a positive price cost Delta that we saw in Q2 narrow a sum cost catch up to the price increases that we saw in the second quarter, providing less of a gross margin tailwind in the back half of the year.
Continuing on to Opex, SG&A, which includes all fulfillment and customer service costs credit card processing fees corporate overhead and share based compensation totaled $517 million in the second quarter or 21, 3% of net sales compared to 23% in the second quarter of 2021.
John .
Excluding share based compensation SG&A totaled $477 2 million or 19, 6% of net sales an increase of 50 basis points versus the second quarter of 2021 and flat on a sequential basis.
Let me elaborate on the modest year over year deleverage of SG&A, excluding share based compensation.
First larger basket sizes and improvements in fulfillment center productivity fueled by our deliberate strategy to invest in automation collectively drove 80 basis points of positive SG&A leverage in the second quarter.
Offsetting the improvement in variable fulfillment cost productivity, our two items, the first which contributed to approximately 20 basis points of year over year deleveraging reflects higher fixed costs associated with the ramp up of the facilities. We have opened in the past year, including a new pharmacy in Pennsylvania, and our new automated FC in Reno, Nevada.
Second are the upfront investments, we began making in the second half of 2021 and personnel and technology to support our growth and profitability initiatives in areas like healthcare fresh and premium supply chain and transportation.
This contributed approximately 110 basis points of year over year deleveraging.
Consistent with what we have shared in the past we expect these investments to begin scaling as we exit 2022.
Second quarter advertising and marketing expense was $144 2 million or five 9% of net sales a 210 basis point decline over the second quarter of 2021.
This year over year improvement is a function of both the spike and AD costs, we saw in the second quarter of last year.
And the moderating consumer demand, particularly in hard goods that we have observed in the second quarter of this year.
Looking forward, we expect advertising and marketing to remain in the range of 5% to 7% of net sales as we continue to be ROI, driven and focus on the long term value contribution of new and existing customers.
Wrapping up the income statement second quarter net income was $22 $3 million a year over year increase of $39 million.
Net margin expanded 170 basis points, 0.9%.
Second quarter, adjusted EBITDA increased $59 8 million.
Versus Q2, 2021% to $83 $1 million.
Our adjusted EBITDA margin expanded 230 basis points to three 4%.
Sequentially, we added $22 $5 million of our Q1 results and expanded adjusted EBITDA margin by 90 basis points building. Upon this year's gross margin expansion and our discipline around opex.
Moving on to free cash flow second quarter free cash flow was near breakeven and $1 million, reflecting $49 $2 million in cash flow from operating activities and $48 2 million of capital expenditures.
Capital investments were primarily comprised of investments in our new automated FC in Reno and ongoing technology projects.
We finished the quarter with $607 million of cash and cash equivalents on the balance sheet between cash on hand, and availability on our ABL, our liquidity stands at $1 1 billion.
That concludes my second quarter recap. So now let me cover our third quarter and full year 2022 guidance.
For the reasons that we have articulated throughout this call. We believe that we will continue to see differences in demand patterns between discretionary and non discretionary categories throughout the balance of the year.
As such we are revising our full year top line expectations.
At the same time, we are raising our profitability outlook for the year.
And that's always our current guidance reflects the balance of the opportunities and risks we see today.
We expect third quarter net sales to be between $2, 44, and $2 $46 billion, representing year over year growth, 10% to 11%.
We now expect full year 2022, net sales to be between nine nine and $10 billion, representing year over year growth of 11% to 12% or one to $1 $1 billion in absolute dollar growth over 2021.
We are raising our outlook for full year 2022, adjusted EBITDA margin to 175% to 2% up from our prior range of breakeven to 1%.
As you update your models here are a few housekeeping items to keep in mind.
We expect net active customer growth to remain muted for the balance of the year given the impact of softer than anticipated non discretionary demand on customer acquisition and the ongoing impact of lower retention for our Covid cohorts.
We now expect full year 2022 gross margin to expand approximately 30 to 50 basis points from our full year 2021 gross margin of 26, 7%.
That said our run rate gross margin for the second half of the year is likely to be lower than the first half as product cost increases catch up to the last round of map increases and we move through the normal increase in promotional activity that we see during the holiday season.
While mindful of the economic backdrop, we continued to make investments and margin expanding growth initiatives to further improve customer experience.
At the same time, we continued to strengthen our core operations and we are already seeing the tangible bottom line result for many of these efforts returns that are expected to multiply in the years to come.
As we navigate through the current environment, we remain as confident as ever in our ability to drive sustainable profitable growth and further our leadership in the pet category.
With that I'll turn the call over to the operator for questions.
Okay.
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I will pause here briefly of questions are registered.
The first question is from the line of Stephanie Wissink with Jefferies. Please proceed.
Hi, This is corey on for Steph. Thanks for taking our questions I wanted to ask about retention is still running low single digits below pre pandemic levels.
You break down the components of the retention headwind, maybe how much is from out of stocks, how much might be tied to pet owners shifting back to brick and mortar.
How much might be tied to issues that you can potentially solve for the coming quarters.
What's the outlook for retention getting back to pre pandemic levels. Thanks.
Hey, Cory the Hudson.
We arent breaking it down into those specific components, but I can tell you that supply chain is continuing to improve and so we don't really see that as a headwind.
The retention trends of the attrition trends are starting to stabilize as we've come out of Q1.
As we've come out of Q2.
So we believe this is normal recycling off our normal cycling of consumers as the economy opens up.
Against the incremental headwind of inflation and the macroeconomic factors that we're cycling through now.
A large portion of those consumers that were acquired were also.
Discretionary customers.
Which as we can as you can tell from the script and from what's going on in the marketplace.
Is impacted and continue to do so as we move through the year.
So when we look at you know at the Bu level consumers that are interacting with the non discretionary categories, including in these cohorts that represent high LTV type customers are in fact getting better in terms of retention. So thats, the plus and the minus that we're seeing in the overall stability in this particular this particular metric.
If you notice the numbers for Q2 is essentially all driven by our.
Gross ads.
Delta as we move between Q1 and Q2 sequentially. Our gross adds between Q1 and Q2 are down.
As you know as a historical trend. So this quarter is much more related to that even even when our gross adds are running ahead of pre pandemic levels as the script alluded to by mid single digits. There is still a little bit of a of a union young that's playing through right now I hope that helps.
And Corey this is Mario let me add to one thing the some insight in terms of the the.
The mix of customers when they first.
Joining the platform and the first purchase.
The effect of the more favorable mix, we're seeing in the last couple of quarters as more customers purchase.
Consumables or healthcare products in their first their first order with us.
You would you would start to see that one year out that retention there counted as an active customer for the next year, we start to see that affecting or the the positive effect of that more than one year out.
That's really helpful. Thank you.
For my follow up I wanted to ask about just the impact from out of stocks in the quarter.
How are you thinking about the impact of out of stocks in the back half and then when you expect in stock rates to recover at this point.
We're seeing our what we've anticipated and forecasted in our Q1 call, which is supply chains are getting better at the rate that we expected. We do expect to come out of this year materially improved from the way that we entered the year, but really in terms of crew stabilization. I think 2023 is a better you have to look to.
Got it. Thank you. Thank you.
Thank you thanks Corey.
The next question is from the line of Brian Fitzgerald with Wells Fargo. Please proceed.
Thanks, guys.
Improved inventory placement wondering if there is ongoing runway there for further improvement and you've noted that it would take some other supply chain initiatives.
Pass important routing kind of multiple quarters play out. So just wondering if theres similar dynamics, there and maybe kind of the classic what inning are we in in terms of inventory in place improved inventory question and then second question related to <unk>.
Government centers is the learnings from the automated fulfillment centers and you expecting Marino to take happens longer ramp from your first of automated Amazon has kind of intimated to us.
Makes about you know you get to a two thirds level of capacity and then you have enough things running through the warehouses and fulfillment centers, where you can really start to.
Hone your optimization wondering is there a similar dynamic.
Hey, we have to build the saying we have to put the optimization, yes, we learned how to optimize and automate better but we also have to get to kind of a critical mass of volume flowing through them to affect our optimization.
Thanks.
Hey, Brian Nice to hear from you.
Under let me kind of gross margins in in broadly because I think of.
The context is important to be able to answer the question that you asked so when you compare year over year. In addition to strengthened pricing this quarter.
Our steady and continued growth across higher profitable businesses like healthcare and auto ship is contributing to year over year gross margin increase.
In addition to that as you noted our continued work and success with the logistics and supply chain initiatives is helping offset.
Some of the 100 to 150 basis points higher freight and fuel costs that we had outlined for you in the Q1 call.
And in May.
During the first half now to answer your question during the first half we believe that efforts that are helping improve inventory placement and other.
Experience initiatives, we believe have now mitigated roughly one third of that headwind.
And so that's sort of the impact at this point, we're continuing to observe how Q2 plays through there was obviously some controllable elements in terms of you know how.
How we execute against these initiatives and Theres also some natural.
Glide paths across how inventory positions approve improve across the supply chain and how fuel positions moderate as we move through the year. So it's a little bit hard to forecast. So I think I'll keep my comments too.
The first time, we've actually already seen or we've mitigated roughly a third of that 100 to 150 basis point impact.
In terms of your second question.
You want to take a moment yeah EMEA.
EMEA and one more thing to what <unk> said and you know and where we are in the inning I think it's your question, Brian If you think about the <unk>.
Proximately, one third of the of the headwind that we said we mitigated so far this year, we have said in the past that by the end of next year, we expect to have mitigated most of the headwind.
So that gives you an indication of the ending if thats, what youre looking for so theres more to come on that and yes.
We are pleased with the progress that we're making.
And we believe its a its optimal and the teams are doing a really nice job executing behind these initiatives.
In terms of your automation question.
Look I think the you know our ramps are.
In the in the <unk> network before we'd launched automation, we've gotten to the point, where we can rapidly ramp up a fulfillment center, but then within a matter of quarters.
And we the playbook the launch and the ramp really efficiently in the <unk> sites that are fully automated networks, obviously theres a lot more there's a bigger and steeper learning curve that we've gone through and so from that point of view you know Reno ramping up in half. The time is impressive given that we've only launched two of these so far.
In terms of the volume density that we need yes. The concept broadly is the same which is as volume flows through you know you see greater utilization and therefore greater levels of productivity come through as well whether the numbers are two thirds or not I think it's a little bit different in the world, where we're pushing stable volume and we have predictability in terms of the auto ship.
That provides us the base load to be able to forecast better labor plan better eliminated kind of special cause variability as we move through our network and then deliver those orders effectively including with high utilization on trucks.
That's a little bit of a structural advantage that we believe the network has.
And that throws off the leverage that we're talking about here.
That helps.
Yeah very helpful. Thanks, very clear thanks.
Thanks, Brian .
Thank you.
The next question comes from the line of Mark Mahaney with Evercore. Please proceed.
This is Jan for Mark Mahaney. Thanks, guys for the question. So I want to kind of circle back on the Covid cohort.
For an explanation of how just like why it's that it's inherently it's gotten some are higher.
Turn than prior cohorts, but is there any other kind of factors that we should think about about this cohort in terms of.
Like auto ship penetration in terms of the trajectory of <unk> growth.
If you can just talk about anything else that we should look out for.
And also the second question is the I kind of talked about the benefits of pricing can you just like a stand on two lease pricing tree strategy for the pricing pass through.
Oh to pass for majority of the price cost Inflations and how has that impacted this quarter's acquisition and retention. Thanks.
Yeah, I'll take the first one and some it'll take the second one this is Mario so in terms of.
The Covid cohorts look the good news here is that we solve the.
One year rate decline by low to single digit low single digits as we said before.
And that has stabilized.
For the last several quarters, so so from that end.
Good development on the Covid cohorts.
Why.
<unk> seen changes or differences between dose cohorts and pre pandemic rewards. The answer is initially they build a bigger basket they order more they spend more.
When we look at their <unk> behaviour overtime I.
I can tell you we look at this on a regular basis and.
There is.
No meaningful difference between those cohorts in previous cohorts.
So the netback curves look very similar overtime.
You may have slightly fewer customers of course, as we've said, but the customers that stay with us or spending more so from a netback curve. If you do the math there they will look very similar.
In terms of the auto ship behavior nothing nothing there to note.
So I will kind of leave it in those two points that I mentioned.
In terms of your question on pricing.
The pricing dynamics that we saw in Q2 was as follows first of all to hit the question directly yes, we're pleased with the ability.
Our ability to manage through the inflation and effectively portfolio price just very similarly to how we were playing Q Q1, what we saw in Q2 was product cost inflation accelerated in Q2 as Q2 progressed.
To like what the broader economy also saw.
In this case the costs were known increases they were anticipated increases in in that anticipation.
These cost increases.
Yeah.
<unk> and us in many places we preemptively price demand and the result was escalating strengthen pricing that outpaced cost inside of the quarter, which is why you heard us make that comment.
Our team executed sharply in a timely manner and broadly speaking we observed strong industrywide discipline around these pricing slopes.
It is important to call out that our competitive positioning within the industry actually improved.
During the quarter as we outpaced the industry in terms of growing units sold and net revenues.
Our Q2 sales growth was driven year over year by increases in both unit volume and pricing growth, whereas when you followed the industry wide volumes.
The unit sold actually declined so pricing contributed to more than 100% of the sales growth in the industry. So hopefully that provides you a bit of a perspective on how kind of replayed through pricing and how generally pricing impacted.
The volumes in the industry.
Alright, Thank you guys.
Thank you.
The next question is from the line of Doug Anmuth with Jpmorgan. Please proceed.
Thanks for taking the questions.
First I just wanted to follow up on pricing just trying to understand the drivers here.
In terms of whether prices went up more on inflation more opportunistic increases or better math adherence and then secondly, just trying to understand your view on the ability to continue to drive net tax IR going forward and kind of into 'twenty, three particularly active customer growth.
Remains impacted by inflation and some of the pressure on discretionary products.
Sure. So the following happened on pricing.
Inflation that had to pass through as we've talked about in Q1, we were expecting that inflation to come through starting the months of June entering July and that is consistent with what we saw on top of that we continue to take a portfolio of pricing approach, where there was a portion of our catalog where we actually took price there was a portion where we held price.
Two price cost ratios.
And there was a portion where we did not pass at the entire cost through given the elasticity of demand impact.
What we found.
On a net basis was given the anticipation of cost increases, we preemptively and industry wide. There was preemptive pricing increases, which helped provide some tailwind and price to cost Delta.
That has flowed through into the strength of the gross margin. So the map compliance is actually.
Behavior that the industry demonstrate which helped keep pricing discipline sharp as the quarter moved through so hopefully the cause and effect is sort of more clear there.
In terms of.
Question on netback growth.
This is an area we remain excited about our you know given the fact that our health businesses are continuing to strengthen.
You know some of them very in very early stages, such as compounding such as insurance such as practice hub that are seeing or connect with a VAT. The telehealth service that are seeing.
You know very strong customer response and engagement.
Kind of put behind them at the same time existing businesses, such as pharmacy continued to deliver strong double digit increases on a year over year basis.
Where we are where we continue to both acquired demonstrates strong retention and demonstrates strong.
Growth in spend from an active customer point of view, so the mix of customers buying multiple categories, but increases.
As you kind of take a take or what they call like this into impact.
We would expect much more of this to happen as we move through into Q3, our insurance Rollouts.
Complete throughout the throughout our nationwide and the economy kind of gets back on track.
That's kind of how we're seeing 23.
Thank you. Thank you.
Okay.
Thank you.
The next question is from the line of Laurence.
Morgan Stanley . Please proceed.
Thank you.
And also the program for the company.
I'll follow up off called home or sort of a closed loop model.
Bobby our margins overall.
<unk> grown comfortable equal.
Hong Kong.
If approved in Colombia.
A couple of loans and on the call I'll call phone calls, so I'm, a little bit more growth in the back half.
Well, what I'm, calling a possible manner.
But over the long haul.
Hi, Lauren I'll take the first one Mario will take the second one no. There is no change in long term strategy of <unk>.
Continuing to gain incremental market share on the back of growth that we believe we can achieve entertained and continue to drive in the industry.
We're seeing right now is an incredible disciplined execution from the team and where we're finding pockets of.
Oh, where we're finding the opportunity to benefit and taken margin, we're absolutely not giving up those opportunities whether it's in sharper pricing or whether its executing sharply onto our in opex control in SG&A type initiatives as you've heard us articulate.
Also super proud of the initiatives that are running through the company that improve experience and lower cost structure.
Which in our opinion is structural and can be sustained moving forward.
<unk> speaking, we remain steadfast on our mission of being the most trusted convenient destination.
For pet parents and partners.
So not coming off of the growth story there.
Alright, Lauren on the active customers you know as you know we don't guide to active customers as we don't guide to netback, but.
Obviously that said based on the current trends and.
We expect net adds to remain muted for the balance of the year I think that that's the keyword there that we've said several times now.
The adjustment to our outlook on the top line is one of the factors or that is tied into our expectations and active customer.
Growth through the balance of the year.
So think about it that way.
Thank you.
Thank you.
The next question is from the line of Ana <unk> with Needham. Please proceed.
Yeah.
Great. Thanks, so much good afternoon, guys and thanks for taking our question.
We have two quick ones I'd just follow up on the guidance. So is the lower sales expectation entirely on the hard goods category and what's being implied for the back half of this category as part of the updated guide and secondly, just bigger picture you had mentioned units were down for the industry in the second quarter.
Just what do you see that it's growing this year.
And on hard goods. So yes. So the first part of your question. The short answer is yes, given the elevated inflation that has pass through Q2, and the ongoing macro trends, including lower interest towards new household formation.
We believe that we're taking an appropriately more conservative view on consumer spending across discretionary categories, such as hard goods moving forward for the balance of the year and that is what you see reflected in our guidance. So that was the first part of your question can I wasn't listening to tremendous.
And to kind of expand on that and so for the as you said primary factor being hard goods.
Do keep in mind, 80% of our sales are in consumables and healthcare and.
Those two categories continue to grow we're taking market share.
For us they're also more predictable given their recurring nature. So for US those are very good indicators of how we think about revenue going forward.
20% that is hard goods.
Does discretionary in nature, and we're seeing that across the industry and for that part of the business. We continue to use our best judgment and the best data available to forecast demand.
And based on what we saw in the first half of the year and how we expect inflation will continue.
Biasing customer spending towards food and healthcare, where we excel.
Wait from hard goods again this are data points that we used to think about our second half or just our revenue projections going forward.
To meet commitments to the point earlier too that we expect the growth in pet households to remain below piece from the last few years before return to trend.
That's evidenced in the data that we have available and so we believe that that's borne out by the data that's available.
Out there now.
All that to say, we still expect double digit growth in the second half of the year.
And what we're seeing coming into the third quarter.
It's encouraging to our to.
So the numbers we've seen.
Can you repeat your second question about marketing units.
Okay.
The second question was about just the growth in the pet space and I think you're largely answered that.
That will be taking share, but I guess do you still expect the units to be down in the back half.
We expect discretionary to continue to remain pressured if you see.
You know unit demand in pet food.
Pet food unit demand industry wide declined 1% compared to discretionary which actually declined roughly 8%. So there's a big delta there and we expect.
Food and health to continue to recover and strengthened as the back half unfolds and discretionary to likely continue to remain pressured yes.
Okay understood I appreciate that.
Jonathan.
Thank you.
The next question is from the line of Dylan Carden William Blair. Please proceed.
Yeah.
Thanks, a lot excuse me.
So I was just hoping to be kind of crystal clear and sorry, if I missed it as to when you lap in your view kind of the Covid disruption because I know, there's some sort of nuance to the particularly the net add metric and around kind of the trailing nature of it.
And then sort of related question that mid single digit underlying gross add growth.
Is that kind of the foreseeable future in this new world, where there's maybe been some pull forward in adoption.
Just trying to get a sense as far as expectations when we totally clear through some of the noise in your view at least on that item.
Yeah, I'll start with the second one and Mario will likely jump in for the first one in terms of like gross adds there is definitely a base hit driven by the current macro because.
Because we believe that.
So Q2 first of all if you recall Q1, we'd set a couple of things. We had said hey, we expect Q2 to remain pressured on the protect staff really two broad things one consumer budget, continuing to get Russia and away from discretionary, but much more so into travel and so forth and so on.
Number two increasing inflation was a bit of a bogey that we said we need to watch.
See how much more inflation gets pass through in Q2, and what is the impact of discretionary on that relative to Q1 double digit inflation in pet cost got passed through to consumers in Q2, and the impact is very evident in discretionary. So when you compare that data point. When you look at categories that are that are weakening as we've come out of Q2 both.
Interest in new pet.
And interest in hard goods continues to trend down for example searches for hard goods are down 24% searches for pet are also down roughly 2022% levels.
So just for Golden Retriever puppies are down 45% coming out of Q2. So there is a there is a distinct kind of correlation there and the gross adds.
<unk> that the industry is right now picking up.
Given the kind of the causality of the factors that I've actually talked about the encouraging part is that both of these factors are temporary and as the pressures abate or the economy reset so the macro debate, we do expect to.
We do expect that this headwind will actually mitigate.
So hopefully that provides you.
Greater color in terms of gross adds.
You want to try to deliver alpha when we expect to lap the COVID-19 disruption. So we'll go back to the way we've explained our customer retention over time most of the attrition that happens for a COVID-19 for a cohort period no matter when we acquire them happen year, one into year, two and why is that as it goes in the first year that they join the plot.
They're counted as active customers the entire time, even if they don't return to make a purchase.
So we see the first effect one year out after their first purchase.
There is also another step year to two year three because they may have come back throughout the throughout the first year and they are getting counted through till the second year.
One year from there.
<unk> purchased let's call it that way.
So if you think about the 2020 cohort and by the way after after two years with us they tend to stay with us very very long time, and we can go back cohort after cohort year after year and see the same pattern overtime. So.
So if you think about the 2020 cohort.
It would have been the first cohort cohort.
Those customers are now.
The last two years with us the first year of 2022nd year 'twenty 'twenty. One so now we're starting to see sort of a.
This is what we're saying there is stabilizing the retention stabilizing overtime.
<unk> 2021.
We're in the middle of the second year.
Counted all last year. They are in the middle of the second year. So we're going to see that there is stability and we're starting to see some some signals from there as well.
As we get into out of this year and into 2023.
All that to say and I would add that one of the positive developments over the last couple of quarters is that the customers that are joining the platform. Their initial purchase order tends to be in categories.
<unk> historically been more sticky for us.
<unk> healthcare.
So you would so I would expect without giving you sort of a specific guidance that their retention.
Overtime would be potentially better than what we've seen in the last couple of years.
Very good.
All right. Thanks, guys.
Thank you Don.
Thank you.
The next question is from the line of Eric Sheridan Goldman Sachs. Please proceed.
Thanks, so much for taking the questions maybe two if I can.
On the competitive intensity side are you seeing anything different that you have to respond to from the mix of online or offline competitors that you have given both the pandemic normalization team as well as sort of the macro volatility you're calling out on the call that'd be question number one and then question two on the gross margin side it seems what you're.
You're implying is that there are some headwinds to gross margin or some puts and takes to gross margin in the second half of the year that we should keep in mind.
Can you just frame up again some of those puts and takes and how should we be thinking about gross margin against your longer term goals from the exit velocity you expect to see this fiscal year. Thanks, so much.
Hey, Eric this threat I'll take the first one Mario will take the second one on the the short answer is no. We arent seeing any increased intensity neither come through in terms of short term transactional promo or demand driving levers in the marketplace.
Nor are we really seeing the pace of innovation.
Or working backwards from customer innovation actually pick up so in the second area, which we continue to actually put a lot of pride in ourselves we have lots of good initiatives running inside the company that.
That improved experience and strengthen the overall value proposition for TUI.
So not not much to actually share there, but we're not seeing intensity pick up.
And Eric I would add to that that if you think about our growth versus the industry, we're growing faster than the industry.
Our growth versus general e-commerce growth in the U S. In second quarter. It was we grew twice as fast as the general ecommerce so you're seeing us both take share and also outperform overall e-commerce in the quarter. So so think about it that way in relation to our how.
How do we think about competitive.
Actions in the quarter.
In terms of on the gross margins. So there are a couple of factors there one is.
And in Q2, we did see a favorable gap between map increases and product cost inflation.
Ill cover that in my prepared remarks, and that boosted second quarter gross margins in the second half we do expect some of that gap to remain positive, but start to narrow I think cost catch up with the price increases. This is more about timing of when the vendors implemented map increases.
And they gets implemented ahead of increasing costs in order to have more of a.
Potential.
Hum.
Of keeping the map increase in place.
Second.
The promotional activity, which normally picks up around the second half of the year.
Primarily around holidays and that we know we do not expect margins to be impacted there and finally, we expect sales mix away from hard goods in the second half as consumers continue to prioritize food and healthcare.
Purchases, which again is where we are and that's over 80% of our sales.
Eric are you still there.
Are we still there operator.
Yes, it seems like Eric has gone on mute or disconnected. So thank you Eric.
The next question is from the line of Deepak <unk> with Wolfe Research. Please proceed.
Great Hey, guys. Thanks for taking the questions just a couple ones, but are you seeing any capacity of kind of trade downs or some sort of like you know.
Our basket of adjustments in the consumable category currently due to the broad inflationary trends and then set.
Second question more broadening can you give us some sense of the magnitude of inflation during <unk> either as a maybe a percentage of skus that have seen price markups and how should we think about the path for that in a second half. Thanks. So much.
Yes, Hey, Deepa, it's Marty I'll take that.
Second part of the question on so I'll cover the first part but in terms of the catalog is not much different from what we saw in the first quarter. When we look at the entirety of the catalog we've seen.
Half of the catalog with a price increase year over year.
So pricing and the other half is either flat or lower.
Year over year. So we when we look at pricing, we don't look at just sort of.
Monolithic approach about.
Price increases, it's very surgical was very SKU by SKU brand by brand.
That gives you an idea of how do we think how the catalog has developed in terms of pricing over the last year.
And notably we did not see any or we're not seeing trade down coming in and coming out of Q2. So it's very similar to what we saw in Q1.
Which was also we did not see trade down for Q1.
Okay.
Got it okay. Thank you so much.
Okay.
Thank you. Thank you. The next question is from the line of Justin <unk> with Baird. Please proceed.
Yeah, Hey, everyone. Thanks for taking the question just a couple of follow ups.
First on the NASDAQ.
Can you size the impact of pricing or I guess like for like SKU inflation on that 14 four.
4% growth then I think you mentioned double digit inflation.
Pass through across the industry. It doesn't sound like that's a good proxy for the.
The contribution that Youre seeing and as Pat I, just wanted to confirm that.
Yeah, I'll take I'll.
I'll answer this question just on so.
Look we don't break down how much of it as a unit versus asps or anything like that but but as you can see and in our 10-Q consumables and healthcare.
The main drivers of our net sales growth in the second quarter.
A lot of that is going to be mass priced and theres map compliant in that part of the business.
If we if you look at the imports I don't know we don't report those explicitly out but we had we had orders order volume increase for us year over year.
Each quarter was also bigger in terms of both units and dollars, so bigger baskets and more orders.
And we continue to gain incremental share of wallet across our customer base. So as adult all those components together that.
That are driving the netback expansion for us.
Okay very helpful. Thanks for that Mario just one other follow up kind of bigger picture question. You mentioned the demand for hard goods do you think will improve as pet household growth returns to historical levels, just any thoughts on the timeline of that return.
Debate across a lot of retail categories around how much demand or consumption was pulled forward during the pandemic. So just curious if you have a view on that from our pet acquisition perspective.
This is maybe a multiyear hangover or digestion period, just in terms of our pet acquisition.
Okay.
Yeah.
So I think it depends categorically.
If the macro factors abate you should actually see normal spending resume on categories that are more recurring within hard goods such as toys.
Or carriers that actually support travel et cetera come back to normal in line with the macro recovery. Then there are you know.
Categories that are impacted by household formations such as new.
<unk> adoption is driving to higher credit purchases, which I would also actually correlate back to the macro improving and finally, there are refreshed longer refresh cycle categories such as beds.
Which we believe will actually remain muted.
For for a bit while longer given the refresh cycle that's been through over the last two years, where every household likely bought multiple beds et cetera.
I'm, obviously speculating a bit and I don't have a crystal ball over here, but that's generally in line with how we forecast and what we would.
Predict are trending to work.
Got it makes sense. Thank you both.
Sure.
Thank you. Thank you. The next question is from the line of Chris Although layer.
<unk> with BNP. Please proceed.
Good enough I'll take it.
Yes.
Can you talk about.
A couple of things I guess, one when it gets sent some private label penetration both of the consumables and hard goods as inflation has crept up have you seen any increased adoption at least private little brands and could you quantify that if so.
When I read the 10-Q and it sounds like you.
Quoted mix as a tailwind on gross margin.
Surprising given the weakness in discretionary could you just elaborate more on what's driving that favorable mix.
Sure. So in private brands no we haven't seen a dramatic uptick in private branded adoption, our private brands adoption.
The reason for that is on a weighted basis hard goods formed.
But from a mix contribution point of view hard goods forms the majority of our mix and as you can tell hard goods mix was actually down.
And within hard goods.
We've seen some.
Trade trade towards private brands and toys, given Frisco is a really strong brand, but broadly speaking.
The purchase cycle isn't isn't actually favorable now.
In terms of your second question.
Could you repeat that please.
Yes, I was just looking at the 10-Q at sites that one of the drivers of Cogs was that you're seeing favorable changes in our mix of sales, but given the discretionary sales are down just trying to understand what drove the favorable mix.
Fair enough, but if you look at the other category that was for our healthcare sales are and that grew the fastest of all three categories. So the change in mix. Some of it went to consumables, but a fair amount of that also went to a.
A more profitable category, which is the healthcare or strengthen healthcare offset the decline in hard goods.
Got it okay. That's helpful. Thank you.
Okay.
Thank you.
That concludes our question and answer session I will now hand, the call over to Sumit Singh for closing remarks.
Thank you all have a good evening and royalty around soon.
That concludes todays <unk> Q2 fiscal year 'twenty two earnings call. Thank you for your participation. Please enjoy your day and you may now connect.
Disconnect your line.
Okay.
Okay.