Q3 2022 Chewy Inc Earnings Call
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Attention to all participants please hold the conference call will begin shortly and then all participants. Please hold the conference call will begin shortly.
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Good evening everyone.
And thank you for joining <unk> third quarter fiscal year 2022 earnings call. My name is daunting and I'm. Your operator for today's call all lines will be media during the presentation portion of today's call when an opportunity for questions and answers at the end.
If you would like to ask a question star one on your telephone keypad I would now like to Paas conference over to our host Mr. Robert Lafleur, Vice President of Investor Relations, Sir the floor is now yours.
Thank you for joining us on the call today to discuss our third quarter 2022 results. Joining me today are chewy, 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.
On our call today, we will be making forward looking statements, including statements concerning <unk> future prospects natural results business strategies 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.
Reported results should not be considered an indication of future performance.
So 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, 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. These non-GAAP measures are not intended as a substitute for GAAP results.
Additionally, unless otherwise noted results discussed today refer to the third quarter of 2022, and all comparisons are accordingly against the third 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 submit.
Thanks, Bob and thank you all for joining us on the call today.
Building on the momentum we reported in the second quarter should we use Q3 results showed accelerating double digit topline growth a sequential increase in active customers sustained gross margin expansion and solid free cash flow generation.
We experienced strong demand throughout the third quarter, especially across our non discretionary categories, which provided a solid foundation for our growth.
The resilience of the underlying demand in these categories, coupled with our ability to grow customer share of wallet again enabled chewy to outperform broader industry trends and take incremental market share.
Q3, net sales were $2 five $3 billion.
Your increase of 14, 5% and a sequential acceleration from the 12, 8% growth in the second quarter.
Our topline results were anchored by the predictable nature of our auto ship customer sales, which grew nearly 19% to 73, 3% of net sales and by rising customer engagement as measured by net sales per active customer or less pack, which grew nearly 14% to $477.
Digging a little deeper into our Q3 net sales non discretionary categories like core food and healthcare collectively made up over 83% of our net sales and were the primary growth drivers, reflecting healthy unit demand and improved in stock levels.
Within discretionary categories hard goods showed relative improvement in Q3 with sales declining 5% year over year, which is a 400 basis point improvement versus the second quarter year over year performance.
We remain confident that hard good sales will return to their growth path as the economic environment improves taking a longer term view over the last three years, our third quarter had good sales are up 70% gross profit has nearly doubled and gross margin has expanded by over 400 basis points.
Shifting to overall company profitability Q3, gross margin expanded 200 basis points year over year to 28, 4%, which is a new quarterly high.
Our gross margin performance this quarter reflects the favorable comps from Q3 last year, the continuation of strong pricing trends without any noticeable impact on demand and the incremental benefits, we realized from our ongoing supply chain and logistics transformation.
Q3, adjusted EBITDA was $74 million and adjusted EBITDA margin was two 8% an increase of $64 million and 250 basis points respectively.
The primary drivers of adjusted EBITDA growth were higher gross margins and accelerated scaling of SG&A results that showcase our ability to get big fast and get fit fast as we simultaneously drive topline growth and expand margins.
Moving onto customers, we ended Q3 with $20 5 million active customers.
Gross customer additions accelerated 6% sequentially and are up 9% compared to Q3 2019.
Consistent with recent quarters customer retention rates remained stable as we continue to work through the initial attrition phases of a pandemic era cohorts.
In the third quarter as consumers shifted their focus away from summertime pursuits like travel towards the upcoming holiday season, we saw opportunities to increase our level of marketing investment compared to recent quarters.
While AD supply remains tight we found Ottawa positive opportunities consistent with our philosophy to maximize LTV payback and we invested accordingly.
Now let me update you on some of our latest innovations as we continue to build out the chewy health ecosystem expand into new and exciting high margin verticals and make meaningful strides in our supply chain transformation.
Starting with Chewy healthcare, we recently announced the expansion of care plus our exclusive suite of insurance and wellness offerings with plans provided by lemonade.
Combining the products from lemonade and companion under the care plus banner enables us to diversify our product offerings across the full spectrum of price points and coverage options in order to meet the needs of a wider range of pet parents.
We are targeting a nationwide launch of our lemonade offerings beginning in spring 2023.
We remain bullish on the pet insurance space, and our ability to drive customer acquisition and deepen customer engagement.
Elsewhere <unk> help we recently launched Wildblue other forest private brand in the pet wellness category why Paul is a line of supplements featuring products from multi vitamins to hit and joined supplements.
The nonprescription pet health and wellness category has an estimated 2020 to cap off our $2 $4 billion and given the increased consumer focus on wellness and the ongoing trend towards pet Humanization. We believe this launch gives us another opportunity to strengthen our connection with customers and to drive top and bottom line results.
<unk>.
Moving to new lines of growth with <unk>.
Recently launched the beta version of our sponsored ads program. Several months ahead up should do.
Sponsored ads are dedicated product placements on <unk> dot com that promote specific products from select vendors.
These ads our suppliers can seamlessly advertise two hour 20 plus million active customers.
We believe sponsored ads will enable us to scale contextual advertisements, which in turn should deliver highly relevant products to customers and high margin revenue to our business.
The full launch is on track for 2023.
And last but not least we continue to make excellent progress transforming our supply chain and logistics operations and developing world class capabilities across our organization.
More importantly, these efforts produced meaningful operational and financial benefits throughout the company in Q3.
First our automated FC network is handling an increasingly larger portion of our outbound shipping volume at progressively lower variable cost per order.
In Q3, we shipped nearly 30% of our volume through our automated FC network up from 10% in Q3 last year.
Second our inventory rebalancing efforts through enhanced software and planning capabilities have improved in stock levels across our network, which has lowered costs by reducing average shipping distances by 25% compared to last year and enhanced customer experience by reducing click to delivery times and improving order accuracy.
These efforts have been complemented by our middle reminded initiative, which also cut average shipping distance and reduces cost.
Finally, our two new important routing facilities are on pace to handle 90% of our import volume by the end of 2022, which further enhances our ability to optimize inventory distribution across our network and reduce inbound freight costs.
Collectively the supply chain and logistics efforts have allowed us to mitigate freight costs began leveraging our SG&A expenses a quarter ahead of schedule and improve customer experience on multiple fronts.
Let me conclude with the following.
The operating environment remains dynamic and evolving what hasnt changed is how much pet parents value the enduring companion chip off their pets and it is this emotional bond that sustains the pet category through all phases of the economic cycle.
He is a compelling value proposition backed by low prices personalized service and delivery convenience across a broad selection of products continues to resonate with our customers.
This enables us to build the long term trust that in our view allows us to outgrow our competitors and take market share.
Concurrently and unequivocally our team's relentless focus on execution and operational excellence allows us to take this growing market share and transform it into incrementally higher profitability and growing free cash flow.
Before I turn the call over to Mario I would like to share an important development with you all.
After nearly eight years at chewy Mario has decided to retire from the company now it's too soon to plan his retirement party or order the proverbial gold watch, although those things there'll be appropriate sometime next year.
As of today, we have no specific date in mind for Mario's departure, and our intent right now is simply to inform you of our transition plans.
We have begun a search for top tier internal or external candidates for this important and strategic position.
In the meantime, it's business as usual and we are grateful to have Mario services for as long as necessary to find and ramp a worthy successor.
Please understand that this is not a matter about which we will provide regular updates and we don't plan to comment about this until we have a successor in place.
With that I will turn the call over to Mario.
Mario.
Thank you Sumit I appreciate the kind words and I'm looking forward to a little R&R. When the time comes but until then it is business as usual now let's talk about our third quarter results.
Net sales increased 14, 5% or $320 million to $2 five 3 billion.
Growth was led by our non discretionary consumables and healthcare categories, which collectively represented over 83% of our Q3 net sales driving our third quarter net sales growth was an 18, 8% increase in auto ship customer sales, which reached a new high of <unk> 73, 3% of net sales a 13, 8% increase in <unk>.
<unk> also a new high for the company and an active customer base of just over $25 million, increasing approximately 30000 versus the second quarter and 100000 versus last year.
Moving to profitability, our third quarter gross margin expanded 200 basis points year over year to 28, 4%.
Approximately 100 basis points of the year over year improvement as a result of favorable comps against Q3 last year, when global supply chain disruptions and product cost inflation adversely affected our gross margin.
The balance came from continuation of the strong pricing trends that emerged last quarter and greater efficiency in outbound shipping costs, which resulted from bigger basket sizes and the favorable progress we've made in our supply chain and logistics initiatives.
Continuing onto Opex.
SG&A, which includes all fulfillment and customer service costs credit card processing fees corporate overhead and share based compensation totaled $543 $5 million in the third quarter or 21, 5% of net sales compared to 21, 1% in the third quarter of 2021.
Excluding share based compensation SG&A totaled $497 4 million or 19, 6% of net sales.
This is an improvement of 60 basis points compared to the third quarter of 2021, and it was flat on a sequential basis.
As we shared previously we expect that to begin leveraging SG&A expenses, excluding share based comp as we exited 2022 and we are pleased to be a quarter ahead of schedule in delivering on this expectation.
I will now take a moment to elaborate on how our efforts to leverage these costs are paying off.
First greater efficiency and variable fulfillment costs provided 120 basis points of leverage in the quarter led by ongoing improvements in fulfillment center productivity from our expanding network of automated Fcs.
As Sumit shared in his remarks, nearly 30% of our Q3 volume shipped from automated Fcs compared to 10% last year.
This helped drive down variable fulfillment cost per order, which provided about half of the Q3 year over year cost leverage in this area with the remainder coming from an increase in average order size.
We also gained an initial 20 basis points of SG&A leverage as the incremental volume shipped through our automated FCS absorbed more of the incremental fixed carry cost of those facilities.
In addition to these gains corporate overhead scale by 40 basis points year over year as a result of our disciplined management of G&A spend and tight cost controls.
At the same time that we're scaling our base costs, we continue to invest in the future.
This includes the upfront investments, we began making in the second half of 2021, and the personnel and technology needed to support the growth and profitability initiatives that we have detailed for you on this in prior calls.
This contributed approximately 90 basis points of deleveraging in Q3, which was a 20 basis point sequential improvement from the deleveraging that we saw in the second quarter.
As a reminder, while the growth driving investments, we make show up in our SG&A expenses today, the benefits will be realized over time through incremental top line growth and gross margin expansion.
Third quarter advertising and marketing expense was $177 1 million or 7% of net sales a 20 basis point increase over the third quarter of 2021, and 110 basis points sequential increase compared to the second quarter of 2022.
As we have said before our marketing investments are ROI, driven and may fluctuate from quarter to quarter, depending on market conditions.
In Q3, we saw the opportunity to make incremental investments across a full spectrum of marketing channels and we lean into those opportunities to maximize long term gains in terms of active customers and topline growth.
Overall, our marketing spend remained within the 5% to 7% of net sales range that we articulated on our last call.
Wrapping up the income statement third quarter net income was $2 $3 million a year over year increase of $34 6 million.
Margin expanded 160 basis points to <unk>, 1%.
Third quarter, adjusted EBITDA increased to $74 million and our adjusted EBITDA margin expanded 250 basis points to 8%, which we believe clearly demonstrates the operating leverage that we are unlocking as we realize the benefits of higher gross margin and accelerate the scaling of SG&A expenses.
Moving on to free cash flow third quarter free cash flow was $69 $8 million, reflecting $117 $4 million in cash flow from operating activities and $47 $6 million of capital expenditures.
Capital investments were primarily comprised of investments in our automated FC in Reno and ongoing technology projects.
We finished the quarter with $675 million in cash and cash equivalents and marketable securities, which is $68 million higher than our cash and cash equivalents balance at the end of last quarter.
This quarter, you will notice on our balance sheet includes $297 million of marketable Securities Star.
Starting in Q3, we took advantage of rising short term interest rates to redeploy excess cash from overnight deposits into highly liquid commercial paper in short term treasury bills.
At the end of Q3, we remain debt free and between cash on hand, marketable securities and our availability on our ABL. Our liquidity currently stands at over $1 1 billion.
That concludes my third quarter recap. So now let me cover our fourth quarter and full year 2022 guidance.
As 2022 winds down the resilience of consumer spending in the pet category continues and <unk> value proposition remains as compelling as ever.
Current outlook for the balance of 2022 assumes no material change from current trends in the macro environment.
We are increasing our full year 2022 guidance to incorporate our Q3 results and a tighter range of expectations for Q4.
We're also raising our full year adjusted EBITDA guidance to reflect our gross margin and leverage on SG&A as reported through the third quarter.
We expect fourth quarter net sales to be between $2 63, and $2 65 billion representing year over year growth of approximately 10% to 11%.
We are raising our full year 2022, net sales outlook to a range of 10, two to 10 4 billion.
Representing year over year growth of approximately 13% and over $1 1 billion in absolute dollar growth compared to 2021.
We're also raising our full year 2022, adjusted EBITDA margin outlook to a range of two three to two 4% up from our prior range of 175% to 2% as you update your models here are a few housekeeping items to keep in mind.
We now expect full year 2022 gross margin to expand by approximately 90 to 100 basis points from our full year 2021 gross margin of 26, 7%.
While we expect Q4 gross margin to improve year over year. It is likely to come in somewhat below Q3, due to seasonal factors like higher promotional activity and fewer opportunities to achieve freight and shipping efficiencies amid higher holiday volumes and peak season surcharges.
In terms of Capex year to date Capex is running at two 3% of net sales.
As we articulated on prior calls the higher Capex. This year reflects a pull forward of payments on our next round of FC projects given longer project lead times.
We now expect full year 2022, Capex will come in slightly below our previous expectation of two 5% of net sales as some anticipated spending shifts into 2023.
We now expect to generate approximately $50 million to $100 million of positive free cash flow in 2022, given our revised profitability and capex outlook.
Q3 results demonstrate <unk> ability to expand margins and grow profitability in the current macro environment.
This is a direct result of our sustained track record of making targeted investments in areas that enhance customer experience grow our top line expand margins and improve free cash flow.
We believe our unwavering customer centricity combined with our sharp operational execution will enable us to continue extending our industry leading position in pet.
And with that I'll turn the call over to the operator for questions.
Thank you Sir.
We'll now begin the question and answer session of today's call.
I would like to ask the question again star one on your telephone keypad. If for any reason you would like to remove that question into starting again to ask a question that is star one and as a reminder, if you're using a speakerphone. Please pick up your handset or asking your question. We would also like to ask the participants to limit themselves to one question and one follow up question.
Our first question comes from the line of one Doug Anmuth with Jpmorgan.
Sir.
Sure. Thank you.
Thank you for taking my questions.
Thanks to just I guess first on the <unk> revenue you should talk about.
Deceleration versus <unk>.
If theres anything in particular, driving that or anything that youre seeing in terms of trends quarter to date or during the holidays and then.
The accelerated scaling SG&A expenses.
Where do you think youre seeing the biggest gains across warehouses and automation and just overall logistics. Thank you.
Hey, Doug it's Marty I'll start off with the Q4 guidance, so as you've heard us say before our guidance doesn't anticipate.
It takes into consideration all of the data that we have as of right now when we looked at the fourth quarter.
Considering the fact that hard goods into make a it seems to be a bigger piece of the <unk>.
Sales usually in the fourth quarter.
Seasonally Q4 tends to show a little more heavily.
Heavily towards hard goods given the holidays.
While we saw some demand firming up in the between Q2 and Q3 generally speaking demand for that category remains relatively.
Soft compared to non discretionary demand and things like consumables and healthcare.
And it's not that those headwinds produced by not softer discretionary demand to slightly to keep net sales growth rates.
What we saw for example in Q3.
Also recall that last year Q4, we got a bit of a boost from the omicron search in December and January .
So that's the impact of higher comps last year regarding omicron.
No that'll set the midpoint of the fourth quarter guidance is still.
Jesse over $250 million increase year over year.
And in the quarter is off to a good start and if you look at the full year you see that our guidance now for for full year 2022 is about.
About 13% growth over $1 $1 billion growth in dollar terms year over year and.
More than doubling the revenue over the last three years.
Eight of the system. It I'll take the second part of the question you.
You said, what's contributing to accelerated SG&A you also said logistics I'll take both logistics initiatives are rolling up to gross margin, but I'll explain as I kind of go through on the SG&A scaling. Its a couple of things that are in play here one the benefits that we're getting from automation, which we rolled out a couple of years ago are really starting to come through now.
So if you've heard me talk about kind of a physics and others in the past, where I've said theres a lot of Connecticut, the potential energy conserved in the system, which once we start unlocking turns into Connecticut energy and Thats kind of what you're seeing flow through so basically the two fulfillment centers that we launched last year are fully ramped we pushed you know nearly a third of our volume.
Just a little under 30% of our volume through that network. We know the third one is still ramping and we realized half of our 120 basis points of leverage through the accelerated ramp up of the fulfillment centers. The ramp is also helped by the fact that our inventory positioning is improving both as a result of our work and as a result of improved in stock levels and so when you do that you actually create density.
The fulfillment centers that allows you to be more productive and the labor situations being fairly stable. So when you put all of that together it allows us to leverage our network in a manner that we essentially planned it or built it to begin with.
So that's the fulfillment center portion underneath of that we're also getting operating leverage as a result of higher basket sizes and as incremental volume flows through.
That's the 20 basis point that Mario talked about today.
And then third of course, the G&A component that is built in strong Opex management.
Strong controls on a you know kind of spending head count.
Travel relocation anything basically that you need to run the company in a disciplined manner.
<unk> is all over that so that always contributing to SG&A on the freight and logistics initiatives that are basically three that we've talked about one of our work with inventory and positioning allows us to better position inventory, we've gotten inventory and lower zones that allows us to ship.
Sure distances that allows us to to essentially be more efficient with our shipping costs.
Number two we're also improving package density that allows us to improve carbonization per order that allows us to extract that benefit number three the middle mile initiative is contributing again it helps us consolidate orders and deeper inject into carrier networks and then for the work with our import routing centers allows us to move inventory more effectively.
Lee that hits, the inbound freight side, which also rose up to a gross margin. So as a result of these four youre seeing us leverage kind of.
The cost on the freight side.
In the previous comments were about it relative to the SG&A side.
Great. Thank you both I appreciate that.
Sure.
Thank you for your question Sir.
Our next line of question comes from the line of one Mark Mahaney with Evercore, Sir the floor is now yours.
Okay. Thank you.
Let me try to.
Two questions first sponsored AD.
Revenue opportunity have you sized the Tam before and just talk about that.
Which kind of advertisers you would expect this green onto the platform.
And then in terms of the net active customers. This growth you had this quarter after two quarters of decline and I know, there's a factor here, which is kind of moving beyond kind of the COVID-19 cohort a little bit.
Should be interpretation b that you've now kind of at the end of that tunnel and are you back.
I'm kind of more normalized churn levels across the customer base in the <unk>.
Gross ads.
You know kind of stay high that we should now expect consistently ongoing growth in net active customers.
Hey, Mark I'll take the first one Mario will take the second one so on sponsored ads since it just launched and it's still in beta we haven't fully kind of shared the financial benefits. The way, we would think about it as we compare ourselves to other companies that run single category sponsored ads in single category. So I think that would become a <unk>.
And then we would also consider the power off the auto ship program that allows us to build repeat purchases and loyalty into brands that allows us a kind of a <unk>, which is just different and more powerful than we've seen in the industry. So you put those two together are the type of products, then kind of lends itself to consumables healthcare.
But all products were you.
And we've seen basically great response from partners from that standpoint, right now so we're prioritizing those too.
Hey, Martin on your second question about active customer growth.
In the third quarter you saw that.
We did increase the active customer count by about 30000.
And up about 100000 year over year that was in line with our expectations.
The increase really is the result of.
A small uptick in the number of gross customer adds in the quarter and a small reduction in the number of churn customers.
As to your coins, we continue to lap the very large COVID-19 era of cohorts that we acquired in 2020 one.
Obviously, we don't guide to active customers, because we don't guide to NASDAQ, but that said our expectations for active customer growth.
Going into the fourth quarter remained generally consistent with what we said on prior calls and that's all reflected in the guidance, we provided for sales and the like.
Okay. Thank you Simon Thank you Mario and Mario Congratulations on the eight years of great success in execution. So wishing you all the best.
Thank you Mark.
Thank you for your question Sir.
Our next line of question comes from the line of one <unk> with Needham <unk> Company Ma'am the floor is now yours.
Great. Thank you so much good afternoon, guys and congrats on great results.
Two quick questions from us.
On higher pricing I know you have more of a portfolio approach towards managing that just any initial thoughts on how we should think about your price versus unit relationship into 'twenty, three and as you start lapping the price increases implemented this year and then secondly on advertising.
That's related in the last couple of quarters can you talk about what's implied for advertising for the fourth quarter and should we think that 5% to 7% range is still the right level for the business as we look out thank you.
Hi, I know this is a summit I'll start and as Mario has to add anything you will jump in here. So first of all pricing and unit growth contributed about equally to sales in Q3.
We grew pricing, but we also grew units meaningfully as we move through Q3 and.
In terms of lapping next year so one.
Obviously this year, we've seen increasingly.
Elevated pricing as we move from Q1 through Q3, and so the first half of year. They are still positive favorable comps to be lapped. So that's one number two we are expecting incremental costs as we've shared in the previous calls.
<unk> incremental cost and therefore.
More inflation to be pass through into the industry as we enter 2023. So we believe that our you know.
That's how the pricing environment, but it looked like as we get out of Q4 into the first half of 2023, and then of course.
Similar manner of ever growing units.
Which is actually structurally different than how industry growth occurred in Q3, and Q3 industrial growth occurred primarily on tobacco price, but at chewy grew units and price, we expect to do that in Q3, and <unk> 23 as well.
And as to your second part of your question on marketing spend.
We would expect Q4 marketing as a percent of net sales to be similar to Q3 and for the year to be in that 6% to 7% range, given where we are year to date.
Thank you for your question.
Okay.
Our next line of questions comes from the line of one Brian Fitzgerald with Wells Fargo.
Your line is now open.
Thanks, guys to 30% of volume handled by the automated Fcs.
Any update or how should we frame up the cost savings that you realized from that and then.
As you ramp FC automate automation and efficiency and then you drive these logistics improvements across the network.
Drives a better user experience right.
And so have you seen anything in terms of positive impacts on engagement order frequency mess pack as a direct result of what youre doing to the network.
Hey, Brian .
So the.
Improvement in how do we think about potential there. So I think you were asking a cost question, we've seen favorability to the tune of somewhere between 18 and 20%. So the volume fulfilled out of the <unk> network was roughly 18% to 20% cheaper than the volume that we fulfilled from our first one legacy <unk> network.
And two we're still ramping volume into the third fulfillment center. So there is incremental volume leverage that we expect to gain.
We're still continuing to scale our costs. So there's incremental productivity improvement that we would expect from our network. So all positive story there.
In terms of the impact that we've seen.
We have I mean, we've seen an acceleration both and it's reflected in the gross adds number. It's also reflected in the reactivation number as we've improved both our inventory positioning and as we've improved.
<unk>. This is not this is not an exact science so getting down to specific numbers is a little bit hard, but you can clearly see it in the way that our network plays out in a REIT and our auto ship rates boards.
Well, it's kind of a net and gross work out there so yes.
And Brian if I can add one more thing here.
You look at where we are today, we have you saw the numbers we recounted our we reported in terms of the benefit we're seeing in SG&A from these three FCS and and as a reminder, arena just open the more or less at the end of second quarter. So we're still ramping.
So there's a there's three <unk> one of which is ramping out of 13.
Over the next year or.
A year 18 months, we're going to see a couple more <unk> open up that are also automated. So these are layers of profitability as we said before.
As we get more and more of our volume through these automated facilities overtime right.
And if you add these up like Reno has.
Several basis points of improvement to give and it ramps. The next too we sized it at 30% to 50 basis points. We also said there is 20 to 30 basis points of FTE utilization capacity, which is operating leverage suddenly got released.
So when you when you add that.
Kind of improvement along with the fact that we continue to push more volume unexpected lower cost.
We're we're we're we're satisfied with the journey so far there's more to come.
Awesome.
Mario Thank you.
Thanks, Brian Thank you Brent.
Thank you for your question Sir.
Our next line of questions comes from the line of Juan and Corey Grady with Jefferies. Your line is now open.
Hi, Thanks for taking my questions I wanted to follow up on the pricing you are talking about in 2023 can you say more about what youre hearing from brands and commodity costs and additional pricing and what you're expecting in terms of the magnitude of pricing next year.
On hard goods, so as we come off the Covid adoption cycle and so to think about a potential recession. In 2023, how are you thinking about a recovery in that segment and what are the leading indicators you would look at to gauge.
Covering hardgood demand thanks.
Sure sure sure so pricing conversation, that's early to define or to put a range on the magnitude. So perhaps we could discuss that on the next earnings call. When we have a little more clarity when we meet in March we are expecting.
Pricing to start rolling through in the Q1 timeframe.
So this will actually become more clear as we kind of wrap up the year and get into next year.
So far we're not hearing of multiple rounds of increases, but then again.
We get more information, we will definitely pass that on if you look at 2022, we've had four rounds of cost increases over the last 15 months starting from Q3 of 2021.
Through Q3 of 2022, we don't expect a multiple rounds of cost increases coming but theres certainly.
Incremental cost that needs to pass through the system first half of next year.
Your second question on hard goods.
<unk> that are that are driving the hard goods lag essentially are a couple here. One is it's tied directly to the consumer's mindset, the inflationary might the inflation pressures and consumer mindset to pull back spending from discretionary categories number two is.
Refresh cycles on hard goods are typically longer. So for example, if you. If you if you recall the last two years every bed in America pretty much got a let's say a bad refresh.
Every new puppy go to create et cetera, and so you know these refresh cycles are generally 12 to 15 months long and they don't get is refreshed as quickly refreshed as toys would break for example, so there's a little bit of that that we have to lap laps as we played a bit kind of kind of the time scale here and the third one is a pet household formation when you look.
At at options under Languishment, or basically flat to very slightly down from a year over year perspective.
So as metal household formation returns to normalcy, which again is tied back to the inflationary environment. As these inputs correct themselves, we expect hard goods growth to return to normal.
Thank you.
Sure.
Thank you for your question Sir.
Our next final question comes from the line of <unk> Lee Horowitz with Deutsche Bank. Your line is now open.
Great. Thanks for the question maybe another one on NASDAQ.
The quarter can you help us unpack a bit how much of the NASDAQ what you saw in the quarter was from share of wallet gains versus just general inflationary pass through and the pricing environment and then I know we will have this conversation next quarter again, but just at a high level. When you think about the path forward for NASDAQ growth next year, you'll have some pricing pass through but you obviously copied.
That's a big inflationary year and don't necessarily have say 'twenty two cohort that's going to be at that call. It rapid faces NAV Pac growth next year or so so at a high level.
How are you thinking about the inputs for Nasdaq.
Next year. Thanks, so much.
This is Mario so I'll take that one.
I can go on for a while and just on this answer but let.
Let me preface it with a couple of things as we mentioned in the prepared remarks.
Netback did reached another all time high in the third quarter at $477.
You take that number back to Q1 2020 with 34% increase over the last couple of years.
So significant increase in green of share of wallet there.
The other thing is from a from a spending perspective. If you were if you're just comparing to customers that have been with us for a long time versus more of a more recent customers.
The customers we added during the last couple of years.
They are displaying similar spending patterns to customers, we acquired prior to the pandemic.
And where that simply means is that they spend more of the longer they stay with us.
Seen that four four for several years in fact, we've seen them back to the first cohort as we projected out to today.
First of all were back in 2011 to today.
Also consider that our current netback is as I said about 104 hundred $77.
And if you look at our oldest cohorts are 11, 12 13, they're spending about a thousand dollars a year with us.
Add that to the fact that 60% of customers today.
Today have been with us for three years or less so think about what that means theres a long curve that takes you from first year about 150 to $200 to about $1000 and on average today, our cohort as our cohorts are fairly young.
On a weighted basis and the average netback of 477.
So there's a tremendous amount of upside potential.
How much more share of wallet, we can gain over time from those customers.
Of course, we help drive <unk> growth by adding new product categories like health care.
We expanded our catalog now we have over 100000 products in our catalog.
And we also make it easier to for customers to discover product and drive more cross category shopping. So all of these things that we're doing to continue to gain that share of wallet.
But but.
But again, if you look back over over the years cohort after cohort.
Have these nice long curves they stay they spend more with us the longer they stay with us.
So Matt anything you want out there.
Yeah, I think Mario Mario hit it I mean, if you.
Look at the business unit level, we have several growth vectors that are still growing to deliver scale and contribute to positive <unk> development. I mean, if you look at healthcare that is a rapidly developing $40 billion Tam.
And less than 15%, 20% of our customers are active customers.
And when you look at private label, there is an opportunity to ramp that up we just launched fresh and prepared category, which is the high netback driver in themselves are.
Premium and specialty businesses have plenty of runway in front of them on top of this our b to C and b to B services, such as telehealth or connect with Evert compounding practice hub shelters pet insurance, they all remain in nascent stages and early stages.
And then on top of that new initiatives, such as sponsored ads.
Et cetera all.
These are all early kind of vectors that we believe can really compound.
The value proposition that we deliver and captures kind of full lifecycle output also customers engagement with our platform. So we're super bullish about this.
Very helpful. Thanks, so much.
Sure.
Thank you for your question Sir.
Our next line of questions comes from the line of one Steve Forbes with Guggenheim.
Your line is now open.
It was really more Kazan foresee Forbes I just a quick question on automated F. C. C. You mentioned, 30% of the volume is shipped from automated any color you can give us on what that might look like a maturity and any color you can give on.
Additional investments either in Reno or additional facilities into 2023. Thank you.
So in terms of additional investments we've talked about launching two new fulfillment centers, which will launch.
In the next 12 to 15 months. So one will definitely hit 23, one might have towards the end of 'twenty three perhaps early 'twenty four but in the next 12 to 15 months. We've shared with you two more fulsome centered launches in both of them are automated in terms of volume entitlement of course, you know the.
By the nature of the fact that we would have at that point 15 fulfillment centers and five of the 15 would be automated.
Linearly, we would say 30% of the volume, but we're already there. So we can tell is that we're identifying the region as much as possible to be able to ship or place. These fulfillment centers closer to customers and then picked them up with as much volume as possible. If you recall in one of the previous scripts. We've said we expect fixed.
Output per crude throughput per square foot to improved 25%.
Is the efficiency that these buildings are giving us at overall, 30% improvement in kind of full CPU or full full cost per unit.
Measure and so you know our.
Our goal will be to push as much volume as possible.
The constraint there is ultimately locating inventory.
And of course, the corresponding to normal demand demand demand distribution that exists in the country. So more to come as we continue to scale. This.
Thank you for your question Sir.
Okay.
Our next line of questions comes from the line of one Eric Sheridan with Goldman Sachs.
Your line is now open.
Thanks, so much for taking the questions maybe a two quarter if I can.
What you've seen historically is there any way to frame or quantify what you're embedding in the forward guidance for promotional activity or competitive intensity in the in.
And the next quarter over the holiday period versus what you've seen historically and then is there any sense that you might see a different bend to competition in the industry given some of the inflation dynamics in consumer wallet dynamics out there broadly thanks, so much for the color.
Compared to Q3, the promotional environment is elevated in Q4.
This is a normal seasonal pattern, we see every year heading into the holidays, but within context of Q4 itself. We believe the promotional environment remains rational and more or less in line with what we've seen in previous holiday periods and looking forward. We don't expect the levels of promotions will intensify beyond the current levels.
What we're seeing.
On your on your second question.
We arent.
Do we expect competitors to act differently given inflation.
<unk>.
The fact that the industry, primarily on the consumables and healthcare side is mapped a I think it allows you know a tremendous level of pricing discipline in the market and secondly supply chain haven't yet fully recovered so in stock positions are suddenly improving but they're not back.
Two normal to be able to expect hyperactivity and then third when you look at hard goods sales that are generally the elastic category currently there isn't much elasticity to be driven given the consumer's mindset.
Plus the inventory there.
It doesn't like when you look at the contribution from from a contribution point of view it makes up about 15% of our overall sales. So we're a little more insured there.
Spend point of view.
Okay.
Yeah.
Thank you for your question Sir.
Our next line of question comes from the line of Juan mainland Carden William Blair.
Your line is now open.
Thanks, a lot yeah, just curious if you guys could disaggregate it provide any detail on the other revenue line item I know, there's a couple of moving parts there.
I think youre seeing trade down or any benefit more broadly over the last several quarters.
Private label space and any update on.
The partnerships with vets are practice hub.
Sort of how pharmaceuticals are trending.
Thanks.
Okay.
Hey, Dillon this is Mario I'll take the first part of that so as you know we don't disaggregate. The other other line item other revenue item, but in there. We include not only our pharmacy, but also our private all of our prototype proprietary brand sales.
Specialty, meaning anything that is non Dod non cat type of product, meaning other peptides.
As you would expect and you saw in the in the hardware. So I'll give you a context rather than specific numbers, but as you saw in hard goods.
Though there was an improvement quarter over quarter in terms of decline.
A lot of our sales in the private brand space, we're going to be hard goods. So just like we saw a third party or national brands hard goods declined year over year, you would have.
As expected something similar on the on the private line side of things.
Our healthcare offerings are a pharmacy.
Especially continues to perform really well and two.
To grow.
Faster than the rest of the business, so I'll say that.
And then we have not seen trade downs I think that was part of your question yes.
Your second part of your question was on the practice I'll update our ret initiatives look we're pleased with the updated practice hub.
Scale is up 30% quarter over quarter from the last time, we met you. So we continue to deepen our presence our engagement and our penetration.
With the vets.
And in a positively oriented manner.
Connect with the vet continues to scale well, we're pleased with insurance, we're very early in insurance. So these are generally arcs that.
Certainly beyond the one year Mark these other verticals that we think off in terms of three year increments.
Just as we did pharmacy, when we launched it back in 2000 and middle of 2018 19 timeframe.
So, but overall, we're pleased with the way that we're building out the healthcare ecosystem and we're bullish about our place in this in this Tim.
Thanks, a lot guys.
Yes.
Thank you for your question Sir.
Our next line of questions comes from the line of one Justin <unk> with Baird.
Your line is now open.
Hey, good evening. Thanks, guys, just a follow up to the question on promotions. If we look at gross margin you're going to end. This year about four points above 19 can you help us understand how much margin is benefited over these past three years from this more.
<unk> promotional backdrop, just so we can assess.
What a normalization in the environment could mean, if it does happen for gross margins in 'twenty three and beyond.
It's immaterial.
Due to the gross margin progress that we are showing.
Any context to add more things.
That's exactly right I think it's the minimum and I would say where you see the gross margin improvement over time is everything we've talked about is getting into our expanding our higher margin categories healthcare hard goods. It is the embedded business getting bigger gaining the scale. It is a gain sharing the benefits accrue.
Ross, our entire vendor supply an inbound and outbound.
It is all of those.
Drivers, there, but not promotional environment doesn't really affect that number.
Materially here.
Okay, I guess and why the big step down implied in <unk> on gross margin.
There is always a promotional holiday.
I guess it sounds like Theres not a year over year change in promotions that you are anticipating this holiday.
So it's not been a big benefit I guess I'm trying to understand why the step down in margin here in <unk> relative to the.
The 28, 4% and <unk>.
Oh sequentially I mean margins of course Q4 is the seasonal period. So you would expect increased promotional activity and we're seeing that we've seen improved increased promotional activity as we move sequentially into Q3 into Q4 on an annual basis, we will be stronger this quarter relative to last quarter relative to the same quarter last year.
So between that and the peak surcharges are happening during the holidays and as expected we would have seen that in the third quarter, we would see it more in the fourth quarter. So there.
Got it different drivers there exactly no I think maybe you or the.
The other part of your question you didn't ask I'll answer it anyway. So if you look at what we're looking at for the full year. We came into this year expecting to be basically we said quote broadly in line, we expect to be more or less flat year over year.
On a full year basis, and now we are guiding to a 90 to 100 basis point improvement in gross margins. So we're seeing certainly a lift there as we go through the year.
Got it and then just an unrelated question you mentioned price another round of cost increases and therefore price increases need to be pushed through the system. If we eventually enter a period of deflation as input cost decline how do you guys think about.
The ability to sustain all of its pricing thats been taken here over the past few years, particularly in the consumables category.
Yeah, we think pricing will sustain because most of the pricing is getting translated our applied in the industry through map pricing and map prices are generally sticky.
So you see less variability and therefore more stability at the same time. So we expect these to be sticky.
Okay.
Alright got it thank you both basketball and the holidays.
Thank you.
Thank you for your question Sir.
Our next line of questions comes from the line of one Chris Baltic Larry from BNP Paribas. Your line is now open.
Hey, guys. Thanks, taking the question.
You made a small bolt on acquisition of Petabyte technologies in.
In November can you talk more about what capabilities. This gives you and how this fits into your broader ambitions in the health and healthcare space.
Yeah sure so Panama.
Petabyte.
Relatively small acquisition of a cloud based provider of technology solutions for the vet sector.
We completed in November .
We're excited to welcome to petabyte team into the <unk> family and we see opportunities significant opportunities associating associated with adding petabytes technology to a broader portfolio of healthcare service offerings.
And you know today, there is not much more to comment because we're it's early stages and work has just begun but we look forward to sharing more with you in the quarters to come.
Yes, okay. Thanks.
And then.
I guess the next question is can you just talk more about.
I guess the basket the basket sizes, what Youre seeing there are you seeing like your basket size has grown it sounds like discretionary is under pressure. So it's like you're adding more discretionary what's trying to dig her basket sizes are people trading.
And the bigger package sizes in order to save more money per unit. These completion or is this just.
Are you finding more ways to attach like healthcare products and stuff like that that's what's driving it.
It's a combination of it's a combination of pricing strength and our complementary growth on the healthcare side.
Come up with a several different complementary products to add to the simple consumables and supplies purchase so as attach rates for you know highly discretionary categories such as toys.
Perhaps as near term impacted right the attach for pharma drugs.
Yeah.
Yes.
Other products such as insurance.
Telehealth these are all additive.
The basket size auto ships have higher basket sizes than non auto ship orders in an ownership percentage continue to increase so that's a contributor improving basket sizes as well.
As all in place.
Okay. Thank you.
Sure.
Yeah.
Thank you for your question Sir.
Our next line of questions comes from the line of Juan.
Yes.
Fashion.
Your line is now open Sir.
Thanks, a lot and good afternoon. My question is on customer acquisition costs, you noted that gross customer adds increased 6% sequentially.
Advertising and marketing expense increased 23% sequentially. So your Tac was up sharply did your LTV expectations on Paas mutations change that much from last quarter to this quarter to maintain our life extensions and new customers.
Hey, Seth this is Mike I'll start off and maybe somebody can cover something the customer. He said that our gross adds were up 6% quarter on quarter. So expand on that what I'm trying to make sure that I answer your question correctly.
I believe that you said.
Script and in the shareholders letter.
And yes. The gross adds that is both new <unk>, new customers and customer reactivation. So it is a combination of both.
And Ah lapsing coming back and also gross adds I wouldn't try to tie the two directly together we got into this question.
Similar before on the active customer count increase and comparing that to our investments in marketing.
But I would say is you have to sort of disconnected too.
They're not it shouldn't be.
It'd be connected though I said this is the system that we are continuing to see netback growth LTV growth. So when you look at Q3, there were multiple areas that the spend actually went in.
On top of the increased.
CPC or increased AD costs that we see in Q3, which you typically do coming out of a lull in Q2 as you gain.
As everybody tries to gain kind of mind share of the consumer.
In the current environment, where the consumer pool remains shallows. So <unk> have continued to increase but beyond that we saw opportunities to invest in three different areas.
Where we did versus customer development focused on increasing engagement and expanding <unk>. So that was part of our investment number two reactivating previously turned customers and in Q3, we saw a double digit year over year increase.
Customer reactivation, and then three theres always some experimentation and testing that we're doing with new channels that are designed to drive broader reach and awareness of the TUI brand.
Positioning that right in front of the holiday season, as we gain more traction with customers is just a prudent thing to do so all in all where we are.
And the way that we spent the money we kept it within the 5% to 7% range that we've talked about before and we were satisfied with the outcome here.
Got it okay. So your Tac was up sequentially, but in line with expectations to maintain ROI on the customer and <unk> acquired in this quarter relative to last.
That's right yes.
Thank you.
Thank you for your question Sir.
I would now like to pass the call back to Mr. Sumit Singh for any closing remarks.
Thank you all for joining us happy holidays, and a happy new year.
Yes.
And with that we will conclude todays <unk> third quarter fiscal year 2022 earnings call.
Thank you for your participation you may now disconnect your lines.
Yeah.