Chewy Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 30, 2023

There are 8 speakers on the call.

Operator

Afternoon. Thank you for attending today's Chewy Second Quarter FY 'twenty three Earnings Call. My name is Hannah, and I will 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. One, I would now like to pass the conference over to our host, Jin Xu, Head of Investor Relations.

Operator

You may go ahead.

Speaker 1

Thank you for joining us on the call today to discuss our Q2 2023 results. Joining me are Chewy's CEO, Sumit Singh and Interim CFO, Stacy Bowman. Our earnings release and letter to shareholders, which were filed with the SEC earlier today, has been posted to the Investor Relations section of our website, investor. Chewy.com. On our call today, we will be making forward looking statements, including statements concerning TUI's future prospects, financial results, strategies and investments, industry trends and our ability To successfully respond to business risks, such statements are considered forward looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks, uncertainties and other factors described in the section titled Risk Factors in our annual report on Form 10 ks and other subsequent quarterly reports, which could cause actual results to differ materially from those contemplated by our forward looking statements.

Speaker 1

Reported results should not be considered an indication of future performance. Also note that the forward looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward looking statements 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 our earnings release and letter to shareholders, which are filed with the SEC today. These non GAAP measures are not intended as a substitute for GAAP results.

Speaker 1

Additionally, unless otherwise noted, results discussed today refer to the Q2 of 2023, and all comparisons are accordingly against the Q2 of 2022. 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 Investor Relations website shortly. I'd now like to turn the call over to Sumit.

Speaker 2

Thanks, Jen, And thank you all for joining us on the call today. Before we begin, I want to introduce Stacy Bowman, our Chief Accounting Officer. As previously announced, CFO Mario Marte retired on July 28 and Stacy is serving as our interim CFO while we continue the search for a permanent CFO. She is a respected leader who has been with Chewy for more than 8 years and is deeply familiar with our finance organization, systems and processes. Welcome, Stacy.

Speaker 2

Now let's begin. Our Q2 carried on the positive trends we saw in our Q1 results, delivering mid teens growth exceeding guidance as well as robust profitability. In Q2, we reported $2,780,000,000 in net sales, up 14% and a 3% adjusted EBITDA margin. Consistent with our expectations, active customers were broadly flat on a sequential basis, while net sales per active customer or NESTAC Reached $530 reflecting a 15% increase. Net sales growth was underpinned by strong participation from our customers, Underscoring the ever increasing strength of the Chewy ecosystem.

Speaker 2

This momentum was evident across many of our focus areas, including autoship, where sales continue to grow at a faster pace than our top line, increasing their share of total net sales to 76% in the 2nd quarter. AutoShip remains a key differentiator of Chuy's business model, enabling high visibility and predictability driven by recurring revenue streams while engendering customer loyalty. Additionally, we are also successfully driving discovery of our Chewy Health platform. For example, cross category penetration into pharmacy now represents nearly 20% of our overall active customer base. Elsewhere across Chewy, our teams are continuously enhancing our CRM capability, improving targeting and supporting strong customer engagement.

Speaker 2

Moving down the P and L, we delivered another quarter of robust profitability. Gross margin of 28.3% Was broadly in line with expectations. As anticipated, promotional activity in the Q2 was higher than in the Q1. However, the promotional environment on the whole remains largely rational. Adjusted EBITDA margin came in at 3% for the quarter, Benefiting from our strong gross margin trends and fulfillment cost efficiencies offset by the impact of our exciting growth investments, including our Canada expansion, which remains on track for a Q3 launch.

Speaker 2

As we indicated during our Q1 earnings call, We continue to utilize our growing free cash flow to self fund a meaningful portion of these growth initiatives. Additionally, our automation efforts continue to be both a driver of margin improvement to date as well as a source of continued upside. 2 of our 4 automated facilities are still ramping and our 5th automated site is opening in early 2024. Combined, we expect them to provide additional operating efficiency in the future years. Before spending time on business initiatives, Let me share our perspective on consumer behavior in the pet industry and in particular how these trends may impact active customers and Nespac at Chewy.

Speaker 2

Coming out of the summer months, we are sensing a shift in consumer mindset towards being more discernible and at the same time with a higher willingness to consolidate their share of wallet to their trusted retailer of choice. This behavior is driven by a more fluid macro environment, including high levels of inflation, which have been passed through the industry over the past 18 months. Our dialogue with our suppliers Confirms that these trends are permeating throughout the pet industry. At Chewy, we are in many ways Insulated from these pressures given our high quality customer base, the mix of our consumables and healthcare businesses, Which drove nearly 85% of our net sales in Q2. Our powerful AutoShip subscription service, best in class healthcare experience and our overall promise of competitive prices, convenience and unparalleled customer service.

Speaker 2

Our loyal customers recognize these attributes as key differentiators and continue to demonstrate robust ordering behavior, which in turn continues to support our strong performance. Further to this point, we see significant potential to continue growing share of wallet With our existing customers, evidenced by our strong track record of sustainable Nestpack expansion. As you may recall, We have grown Nestpack from around $3.30 in the year preceding our IPO to $5.30 this quarter, up approximately 60% over that time. While we saw a modest benefit from price increases, efforts such as growing Chewy Health Ecosystem, Increasing uptake of our ownership program and our large customer base that spends more with us over time have driven the majority of our NASDAQ expansion. This underscores the sustainability of our track record as well as the ongoing potential to outperform the pet industry and deliver strong and profitable growth.

Speaker 2

Now, while we're more insulated than some others, we are not fully exempt from the pressures currently facing the pet industry. That household formation remains relatively muted and as I mentioned above, the consumer mindset continues to be pressured. These factors taken together make the current environment a challenging period to forecast consumer behavior. Taking this into consideration, We continue to see potential for returning to net adds growth during the second half of this year. But in light of recent trends, we are now expecting a wider range of potential outcomes.

Speaker 2

While the industry wide trends I just described make it challenging to forecast net adds, these dynamics are not specific to Chewy And we believe we are well positioned to drive improved active customer trends as macro factors and consumer behavior patterns normalize. Now, I would like to provide an update on some of our strategic initiatives. Our upcoming expansion into the Canadian market remains on track for Q3 of this year. Canada represents a large and fast growing pet category and our teams are hard at work finalizing selection, ensuring the same convenient delivery experience and high bar service That our U. S.

Speaker 2

Customers enjoy. We look forward to sharing our progress over the quarters to come. In Sponsored Ads, One of our prospective margin accretive growth vectors, we are executing against a compelling roadmap and remain on track to ramp the program throughout the second half of the year and into 2024. We remain encouraged by the opportunity ahead and we'll continue to update you on progress as we scale the business. Lastly, I am excited to announce that we intend to host our 1st Investor Day later this year.

Speaker 2

Chewy has come a long way since our 2019 IPO, Having nearly tripled our net sales to north of $10,000,000,000 expanded gross margin by 800 basis points and adjusted EBITDA margin by nearly 1,000 basis points. Yet, we are just getting started and believe that we still have considerable runway with clear potential to outperform the broader pet industry and drive both strong growth as well as significant margin expansion. We look forward to sharing a deep dive on our highly integrated pet ecosystem, unveiling our exciting roadmap ahead and recalibrating our long term financial expectations to reflect the upside we see in the Chewy platform. In closing, I am particularly proud of our strong results and the high levels of customer engagement that we achieved in Q2. We operate in a secular growth category with demonstrated consumer resiliency and Q2 once again showcased the strength and durability of our platform.

Speaker 2

With that, I will turn the call over to Stacy.

Speaker 1

Thanks, Sumit. I look forward to engaging with many of you in this new role. In the Q2, net sales grew 14.3 percent or $347,000,000 to $2,780,000,000 Non discretionary consumables and healthcare categories continued to meaningfully contribute to growth in the quarter, collectively representing approximately 85 percent of 2nd quarter net sales. Auto ship customer sales were $2,100,000,000 Up 18.1 percent and continue to outpace aggregate top line growth by almost 400 basis points. AutoShip customer sales now represent 75.5 percent of total net sales.

Speaker 1

Active customers remained broadly flat on a sequential basis and finished Q2 at 20,400,000. However, our primary measure of customer engagement, NESPAK, grew 14.7 percent to $5.30 Notably, both NESPAK and AutoShip customer sales yet again reached new record highs. As we move down the P and L, please note that my discussion of financials, where applicable, refers to metrics excluding share based compensation expense and related taxes as well as certain other adjustments disclosed in our SEC filings where relevant. The same applies to my discussion of guidance and financial outlook. Gross margin reached 28.3 percent in Q2, which reflects a 20 basis point expansion, broadly consistent with our expectations for the quarter.

Speaker 1

Continuing on to OpEx. SG and A, excluding share based compensation and related taxes, Totaled $550,900,000 or 19.8 percent of net sales, deleveraging 20 basis points compared to the Q2 of 2022. This temporary increase was largely driven by corporate payroll increases related to our growth initiatives, Such as sponsored ads and our expansion into Canada, ahead of realizing the associated expected net sales growth. The SG and A deleveraging was partially mitigated by continued fulfillment cost efficiencies supported by our automation initiative. Q2 advertising and marketing expense was $185,500,000 or 6.7 percent of net sales, consistent with our expectation of 6% to 7% of net sales.

Speaker 1

2nd quarter adjusted net income was $63,300,000 an increase of 1,200,000 2nd quarter adjusted EBITDA reached $86,900,000 UP 3,800,000 implying an adjusted EBITDA margin of 3.1%. 2nd quarter free cash flow was $101,100,000 reflecting $158,800,000 in net cash provided by operating activities and $57,600,000 in capital expenditures. Capital expenditures were primarily comprised of automated fulfillment center investments and ongoing technology projects. As a reminder, we regularly see fluctuations in CapEx intensity from quarter to quarter. Following below average CapEx intensity in the Q1, CapEx spending increased in the 2nd quarter.

Speaker 1

Overall, we expect 2023 capital expenditures to remain in the range of 1.5 To 2% of net sales. We finished Q2 with $905,400,000 in cash and cash equivalents And marketable securities, nearly $300,000,000 higher than the balance at this time last year, and we remain debt free. At the end of Q2, between cash on hand, marketable securities and availability on our ABL, our liquidity stood at $1,700,000,000 That concludes my 2nd quarter recap. So now, Let me cover our Q3 and full year 2023 guidance. As always, our guidance reflects A balanced view that incorporates the strength of our business model and customer engagement, along with the latest views on the evolving economic outlook.

Speaker 1

We expect Q3 net sales to be between $2,740,000,000 $2,760,000,000 representing year over year growth of approximately 8% to 9%. We are reiterating our full year 2023 net sales outlook of $11,150,000,000 to $11,350,000,000 representing growth of approximately 10% to 12% compared to full year 2022. We are also reiterating our full year 2023 adjusted EBITDA margin outlook of approximately 3%. As you update your models, also note that we expect our free cash flow for full year 2023 To be approximately 2.5 times the free cash flow we generated in full year 2022. Before we open the call to questions, I'd like to reiterate that our strong second quarter earnings reflect the resilience of our operating model in an evolving macro environment.

Speaker 1

We believe that Chewy is exceptionally well equipped to navigate the road ahead and deliver strong performance as our execution is grounded in our operating philosophy of driving sustainable, profitable growth. And with that, I'll turn the call over to the operator for questions.

Operator

Certainly. We will pause here briefly as questions are registered. Our first question is from the line of Doug Anmuth with JPMorgan. You may proceed.

Speaker 3

Thanks so much for taking the questions. Sumit, if you could talk more about the wider range of Outcomes for active customers in the back half. Curious how much is hard goods driven acquisition of factors here even though it's not a big Piece of your business. And if my math is right, the 4Q guidance range is around 5% to 12%, which feels pretty wide. Just hoping you can help us understand what's happening at both of those extremes.

Speaker 3

Thanks.

Speaker 2

Okay. Doug, just to clarify the guidance range you're talking about is revenue guidance range or somehow customer guidance range?

Speaker 3

Revenue Yes, the implied revenue guidance range for 4Q.

Speaker 2

Okay. That's not so just to address that head on, that's not how wide We're estimating the range of outcomes on net adds to be a bit wider. We clearly communicated that we expect Growth in the back half of the year. And while that's certainly possible, we're sort of modeling a couple of different types of scenarios. But on the back of that, I want to reiterate the guidance that Provided which we actually feel pretty good about given the strength that we're seeing from Odring customers and the engagement from those customers on our platform.

Speaker 2

Now let me go back and kind of give you the color on why we're projecting a wider outcome or wider range on the net adds or active adds kind of conversation that we've been having the last couple of quarters. So essentially what's happening is I'll provide a short version, happy to dive into the details here. So consistent with What we've previously communicated, large COVID cohorts that were a headwind to net adds during the first half of the year, Yes. We continue to expect this impact to diminish in the second half now that we've reached the 2 year mark for a majority of these cohorts. At the same time, coming out of Q2, what we've seen is a slightly more discernible customer.

Speaker 2

And it really started in July for us much more than it did in May June. And so we just haven't had enough time for this to play through. We're projecting what we're seeing right now forward. And what it is, For the more recently acquired or newer cohorts of customers whose behavior is proving difficult to forecast given kind of The pressures that they're under given the high inflation, we just have to we believe we have to work harder or we will have to work harder to earn their trust Simply because they are more distracted by the current macro pressure and they haven't yet had the cycles to experience the Chewy magic. So we know that we have to execute even more sharply to deliver value to the cohorts of customers that are seeking value in the near term, Such that we are winning with them as much as we win with the customers that are already loyal to choose.

Speaker 2

So it's really kind of a tale of 2 cities. The loyal cohorts stay loyal, and they're consolidating their share of wallet with us, so that is driving the netback expansion. And then this recent kind of July trend that we're slightly seeing Projected into August so far is what's causing us to say, hey, maybe we should widen the aperture here and play through a range of sensitivities. Yes. But on the back half, we're pretty confident about delivering or holding our guidance, which by the way is going to be a share winning position in the back half of the year.

Speaker 3

And if I could just follow-up on NSPAC, can you just Help us parse out what's happening kind of 2Q and 3Q between inflation and like for like pricing?

Speaker 2

Yes, sure. So pricing is going to impact in 2 different ways and Stacy can also provide some color if he wants to hear. But essentially on pricing, what you're going to see is the back half, the cost increases that came through in 2H of 22, right. We benefited from them in the first half of twenty twenty three. So going into the back half, our growth is driven as a combination.

Speaker 2

The revenue composition Is weighted volume and price and not over weighted towards price. On NEST PAC, as we've decomposed our NEST PAC or deconstruct Ernesto, what we can confidently state is that inflation over the past years has provided a modest benefit. So greater than kind of 2 thirds to north of 70% of the benefit that we're seeing in the nest pack growth It's organically cohort development plus ordership development plus health development etcetera, etcetera. So it's all accretive. And obviously Q4, we expect a little more transactional given kind of the holiday season and the ASP compressions that generally take place in a time like that.

Speaker 2

So it's a bit more transactional than Q3.

Speaker 3

Great. Thank you, Sumit.

Speaker 2

Sure.

Operator

Thank you, Mr. Anmuth. Our next question is from Eric Sheridan with Goldman Sachs. You may proceed.

Speaker 4

Okay. Thank you so much for taking the question. Maybe when we come back to the ads business potential both to the end of this year And into the next fiscal year, maybe you can refresh us on some of the key learnings you've had from debating and working with partners on the ads business rollout? And how should we be thinking about the elements of ad coverage or advertiser response or things that you're trying to line up ahead of that

Speaker 2

Two cities also. The demand on the platform is far exceeding the supply that we have right now opened up to our suppliers, which is obviously a point that proves kind of the conviction behind the product as well as the quality of the product that the team is launching. The guardrail on opening up Supply is limited to make sure that we're making sure that the organic experience that customers have come to enjoy, right, doesn't get overrun by sort of the We just want to make sure we're very thoughtful in opening up that supply. So the plan has always been to ramp this up into Edge and we're on track for that. In fact, The original forecast that we had kind of coming into perspective, as the program scales, we were sort of thinking of this as 1%, 1.5% of opportunity that we are now kind of squarely thinking in the 1% to 3% range and will widen our aperture as the program kind of takes hold per So the response rate is there.

Speaker 2

The teams are appropriately focused. Customer experience forms the right type of bar to make sure That our quality and go to market execution is high. ROIs that our vendors are seeing or at least the participating suppliers are seeing are high, particularly as you deal with the subscription nature of our business and therefore the ROI is appropriately converted into an LTV basis rather than a one time transaction that most ad platforms I'm just going to run-in the market per se, which we have always been aware of and that we believe is the strength of the Chewy platform and will allow our suppliers to kind of build their brand in an even more compelling manner.

Speaker 4

Great. Thanks for the color.

Speaker 2

Sure.

Operator

Thank you, Mr. Sheridan. Our next question is from the line of Steven Zaccone with Citi. You may proceed.

Speaker 5

Great. Good afternoon. Thanks for taking my question. Stacy, congrats on the new role. Sumit, I was hoping you could elaborate a little bit more On the commentary about the consumer changing out of the summer months, are you seeing more trade down?

Speaker 5

Are you seeing smaller baskets from these customers? I guess, like what makes you concerned it's a new trend versus just a 2 month period at the end of the summer? And when you say you need to work harder with these new customers, Does that mean more promotional at the start? Should we assume this has some gross margin implications?

Speaker 2

Sure, sure, sure. Yes. So it's a great question. So are we seeing concerning trends? Not really, not yet.

Speaker 2

So what do I mean by saying we're observing the consumer become a bit more For the first time in July, we really noticed a shift out of kind of wet food more towards dry food. And that generally is an indication of more value seeking behavior. We're also seeing kind of treats Pull back a little bit, they've gained traction in Q1 coming out of 2022 and they've pulled back slightly in Q2, particularly coming out of July, right? It's not material yet to come out and actually raise any alarm bells and we're not because we believe we're fairly insulated. So let me give you kind of color on what's happening.

Speaker 2

And I think to really get gain the color, we've sort of like broadened the aperture and gain some context here. So from 2020 to 2022, the storyline was all about dealing with the pandemic. So coming out of last year, Right. 2022 became the year of recovery. Supply chain stabilized, but costs rose dramatically through this period and have been passed on to the consumer by way of unprecedented high prices.

Speaker 2

And these inflationary pressures are now showing up industry wide and also in pet. Now recall that pet household formation was already muted, right? That hasn't changed through 2022 and continues through the first half of twenty twenty three. In addition to that, this behavior that I am kind of calling out here, it indicates that the consumers Being more value conscious at this point. And that makes sense.

Speaker 2

I mean to think that in times like these, the consumer preferences towards value over convenience makes sense. But the winning combination is offering them both value and convenience and we believe that for a majority of the consumers we do that. We offer both value and convenience. And therefore, we believe we're somewhat insulated from the full impact of these current times given the strength in the business model. Now for recently acquired customers, right, their behavior is hard to predict, Right.

Speaker 2

Their order purchase frequency might be slightly off. Usually when we see customers come back in 4 weeks, that might be 5 weeks, etcetera. So we believe that we have to be extra sharp and the CRM capabilities that we've deployed, that we developed kind of towards the latter half of last year into this year, Right. Those are going to be much more sharply deployed towards the back half of the year. So in terms of promos, we are not going to lead the market As we never do, right?

Speaker 2

We're price followers. We're not price leaders in that way. But we stand ready to respond. Internally, we're going to find ways to self fund, Right. Creative ways to pass on the value to the customer.

Speaker 2

And that doesn't have to be kind of promo led per se, it could be other tactics as well. We also have a series of kind of roadmap where that we are taking into account in H2 as well as next year That will formulate our strategy to both acquire net new customers as well as improve retention of the recently acquired cohort. I can continue, but hopefully that makes up quite a bit of the color.

Speaker 5

No, that was very helpful, Dita. I appreciate all that color. I guess just to have a brief follow-up then. Do you think the overall industry gets more promotional as we get into the back half of the year? Because I'm curious, as the 2 months Of activity of what you've seen, has your peer set gotten more promotional?

Speaker 2

We do expect that. So if you recall, we've been transparent about our expectation of greater promotionality in 20 about our expectation of greater promotionality in 2023 from our Q1 call itself. And both Q1 and Q2, we saw higher promotional activity relative to the pandemic years, but the promotional activity so far has been lower than our As we move out from first half into second half, we've continued to bake in an incremental promo spend because our expectation is that promotions are going to be higher in the back half So like I said, we're not looking to lead the market, but we stand ready to respond to make sure that customer experience and demand are both protected.

Speaker 5

Okay. Thanks for all the detail. Best of luck in the back half.

Speaker 2

Thank you.

Operator

Thank you, Mr. Zaccone. Our next question is from the line of Anna Andreeva with Needham. You may proceed.

Speaker 1

Great. Thank you so much. Good afternoon, guys. Just to follow-up on the previous question, just any color on how we should think about the gross margin for the Q3, just given your comments on potentially higher promos for the industry as we approach the back half. And then secondly, just as a follow-up, you had talked about 50 to 75 basis points from Canada Investments this year.

Speaker 1

What was the amount in the Q2? And should we think about the balance more or less evenly split in the back half? Sure. Hi, Anna. This is Stacy.

Speaker 1

I'll take, the first question on gross margin. So, as you know, we don't typically give formal guidance around gross margin, But we do note it is typical to see some fluctuations from quarter to quarter, but we feel good about This quarter and expect gross margin to remain around the 28% level for the balance of the year. Longer term, We're excited because we believe there is still meaningful room left for gross margin expansion. So for example, as Sumit mentioned earlier, we continue to grow and obtain market share in High margin verticals like Chewy Health, and we also are investing in and scaling new initiatives such as sponsored ads that are margin accretive. And

Speaker 2

on the second question, the EBITDA guidance essentially It implies and consumes the level of investment that we are going to make. So they started we started ramping investments into Canada and other verticals such as sponsored ads, etcetera, in Q2. And we will see those continue to ramp up through the back half of the year, which is baked into the guidance. Also, if you recall, we mentioned on our Q1 call, we're going to ramp up new fulfillment centers that launched in the middle of the year, And we should expect some short term dilution as a result of that. And then finally, the incremental promo or promotional environment that we are Talking about is also baked in.

Speaker 2

So that kind of formulates the way that guidance is built for on a profit basis for the back half.

Speaker 1

All right. Thank you so much,

Speaker 2

guys. Sure.

Operator

Thank you, Ms. Andreebo. Our next question is from Dylan Carden with William Blair. You may proceed.

Speaker 6

Thank you very much. Sumit, I'm just trying to reconcile the idea of a wider range of outcomes Now, I anticipate for net customer adds, albeit still positive and keeping the guidance for the year. I'm just Curious me what levers or optionality you might be envisioning in doing that?

Speaker 2

How we plan on exceeding our own expectations, Dylan? Is that basically the question?

Speaker 1

Well, it just seems like

Speaker 6

there's some incremental caution on the net customer as in the back half And then keeping the guidance as it is and for where you said the 3rd quarter is trying to understand just reconcile those 2 ideas that seem to be at all.

Speaker 2

Got it. Okay. The strength that we're seeing, the balance is essentially drawn, Dylan, from the strength that we're seeing in open So, pocket sizes are holding up pretty good. Ownership penetration rates are holding up steady. Assets and orderships are holding up steady.

Speaker 2

And so our ordering frequency was higher for existing customers. And so it's this notion of during times like these, Customers look to consolidate their share of wallet instead of continuing to perhaps cross shop even a little bit that they do as part of their normal day to day. And so we believe that trend will continue through the back half of the year. Secondly, we provided a bit of a data point here today Stating the penetration that we are driving into our verticals such as TUI Health, particularly prescription food and medication, That continues through the back half of the year as well. And 3, our mobile app continues to gain traction, the percentage of orders that went through the app And the AOE benefit that we see for customers that are more engaged is also going to build in a little bit in the back half per se.

Speaker 2

So all of that essentially holds us right now. It gives us the confidence that we can deliver the backup In the way that we are. On the customer side, it's more recent, right? It's these recent cohorts that have been a little more deal seeking and value conscious. And so we're watching this one really carefully to understand what kind of Cohort behaviors are being demonstrated.

Speaker 2

Are the repeat order rates like we expect and want them to be? Is there ASP compression in basket sizes as this Forward kind of ramps up, etcetera, etcetera. So, primarily, we're going to deploy a series of tactics to make sure that we are Protecting ourselves as well as serving both value and convenience. So overall, we feel good playing out from here.

Speaker 6

Got it. And kind of sneak one in just about automation. Any way to kind of quantify or Gail, the impact that you're seeing already from automation and kind of where you are in the utilization of those facilities, I think you've given that historically.

Speaker 2

Yes. So if you recall, we've launched 4. We're on track to open our 5th one next year. Of the 4 that have launched, 2 are ramped And 2 are ramping. And for every fulfillment center that we ramp, you should expect roughly 20 to 30 basis points of leverage that we will provide.

Speaker 2

Of the remaining 10 fulfillment centers, we have left room And are actively starting to retrofit with other ideas that will serve to provide leverage in the future for us. We're actually excited to share our road map of the future at the Investor Day that we announced today in the back half of this year. So we're always on track on the supply transformation side.

Speaker 6

Great. Thank you very much.

Operator

Thank you, Mr. Carden. Our next question is from Mark Mahaney with Evercore. You may proceed.

Speaker 3

I wanted to ask a question on the Canada launch and on sponsored ads. On the Canada launch, could you give us a sense of the timing of that during the quarter? And if it's successful, should we start seeing that in net adds already in the September quarter? Or is it a late quarter launch? And so if it's successful, it would only show up in Q4.

Speaker 3

And I know you're I know we're talking starting from nothing. So I get that it would be a small contribution, but just trying to understand the timing. And then on sponsored ads, are you doing this all internally organically or are you working with 3rd party retail media networks To start growing that. Thank you.

Speaker 2

Sure. On sponsored ads, we are doing most of this internally, Mark. So that's the Short version of that answer. On Canada, we are expecting launch imminently and it starts ramping really in Q4. So the impact would likely start we will start feeling the impact in Q4, but we haven't built in any materiality in our forecast for this year.

Speaker 2

Okay. Thank you, Sumit. Sure.

Operator

Thank you, Mr. Mahaney. Our next question is from Brian Fitzgerald with Wells Fargo. Please proceed.

Speaker 7

Thanks guys. A couple of follow ups. The cross category pharma penetration 20%, where do you think that can get to at Maturity and is that accelerating? And then follow-up on the NEST PAC hitting 5:30. Can you opine a little bit on what's going on with household spend and how much of that you think you can Eventually capture as you continue to add different products and different SKUs and services.

Speaker 2

Sure. Hey, Brian. On the gross category for Rx, You know, in one of our top priorities inside the company is one where we believe every active Chewy customer should also be a Chewy pharmacy customer. So there's a lot of headroom here for us and we are excited about that. And yes, on a year over year basis, it is accelerating or has accelerated and all positive here.

Speaker 2

NESTAC Household spend can be captured. We believe we are for our loyal customers, we're likely capturing a majority of their And in the Food and Health segment today, supplements was an opportunity for us 2 years ago, but we closed that gap pretty credibly last year, Which has actually also contributed to the NASDAQ expansion for us. So on these merged classes that constitute food, toppers, Health, whether it's diet or prescription medication or OTC Or supplements. We believe we are actively consolidating and gaining share. And that truly is kind of where the consumer's mindset Today, because if you recall, what's happened is consumer allocated $100 towards pet.

Speaker 2

In the past, it used to be $80 on consumables and held $20 on hardgoods. That $20 hardgood that's essentially shifted out of there and most of that is now being spent on consumables and health and it will remain so up until the macro recovers in our opinion. Long term, we're actually the fact that The spend continues to move from offline to online. I believe We will emerge as a stronger company in the future given both our base, the level of investments that we've made through the pandemic and the execution quality that the team continues to demonstrate. So overall, we're much we're bullish about the future.

Speaker 2

We all collectively have to endure just a short term macro as it plays through. Thank you, Sumit. Appreciate it.

Operator

Thank you, Mr. Fitzgerald. Our next question is from Lauren Schenck with Morgan Stanley. You may proceed.

Speaker 5

Hey, everyone. It's Nathan Feather on for Lauren. I just want to dig in a little bit more in the Truly Health roadmap. What gets you from the encouraging 20% cost category penetration today to the goal of 100%? And from the pharmacy side, how much of that is SKU expansion versus getting more customers to discover and adopt the protocol.

Speaker 5

Thank you.

Speaker 2

Yes. So it's primarily it's a great Our primary challenge is discoverability of this platform and essentially winning customer trust. If you notice or if you recall, I may have mentioned this data point, A third of the customers today in the United States don't visit their pets at a recurring frequency or don't consume medication at the recurring frequency. And so we have an opportunity to not only expand the current TAM that we see in this particular space, we also have the opportunity By driving essentially by driving incremental compliance. And that has truly been the power of how we go to market with customers on the back of our ordership platform.

Speaker 2

Yes. So our ownership eligibility for pharmacy is at par or even higher than our consumables businesses And we are rapidly innovating to make sure that customer, sign up any kind of friction around customer experience, whether it's sign up or whether it's discovery or whether it's Sort of checkout is being addressed actively by the team. Overall, our NPS on this platform continues to remain high And we're pretty proud to serve a large base of customers. So this is less about adding SKUs, it's much more about just making sure that there is awareness as well as discoverability.

Operator

Our next question is from Trevor Young with Barclays. You may proceed.

Speaker 3

Great. Thanks for the questions. First on a category basis, it looks like hard goods returned to growth in the quarter. Was that kind of consistent with your expectations? And do you expect that cadence To improve from here or does that more discerning customer and tougher compares make it likely that growth stays a bit more challenged?

Speaker 3

And then any update on the insurance initiative with Drew Panion and Lemonade? I think that's now available nationwide. Just any initial comments on uptake there relative

Speaker 1

Hi, Trevor. This is Stacy. So I'll take the hardgoods question first. So historically, we always do have some seasonality in our hardgoods sales with a small pullback So that also combined with the value seeking behavior that Sumit spoke about shown by the consumer recently contributed to some softness in hardgood growth for this quarter. Our expectations for the rest of the year have not really changed.

Speaker 2

On hardware, it's also easier comps. If you notice last Q2 was a negative High single digit, low double digit decline and so you're comping a much softer year from last year. On insurance, we are Super excited about having 2 best in class providers on our platform, Tropanian and Lemonade. As expected, what it has done is it's Opened up, the range of plans and choices across various different price points and coverages to a wider range of our customers. And as you would expect, what that has translated to is the rate of policy sign up has gone up proportionately because you open up Assortment, it drives to incremental revenue pretty on a pretty direct correlation basis.

Speaker 2

So while that's a really positive data point, this vertical Sales requires a ton of education and awareness. And we're seeing our metrics head in the positive direction, our Quote to conversion rates or call to quote rate and quote to conversion rates are all improving. As you would expect, our customer care team is actually becoming a pretty powerful source of educating customers about insurance and therefore So driving on a high cost basis, providing the information and driving the conversion. This was always our hypothesis to start Because you don't really buy insurance online, you buy it via kind of these assisted channels. And we have one of the best assisted channels out there.

Speaker 2

So overall, we're super excited about what's to come. I must kind of note on you that this is a bit of a longer arc vertical given that the consideration cycle for customers Is longer. So we're not we're going to be appropriately patient and play this game over the long term. Thank you.

Operator

Thank you, Mr. Young. Our next question is from Seth Basham with Wedbush. You may proceed.

Speaker 5

Thanks a lot and good afternoon. Sumit, I was wondering if you could provide some color on gross adds relative to 2019 like you did in recent quarters and then also provide some color on CAC trends either year over year or sequentially?

Speaker 2

So gross adds continue to run higher than 2019. We're not entirely dissatisfied by the pace of our gross adds. We believe the team is Yes, the categories that are muted are of course causing a pullback On gross adds, I think Doug mentioned whether it's like the contribution of hard goods is weighing in on customer acquisition. It absolutely is. But on the balance, we're not totally Satisfied by the pace of gross adds.

Speaker 2

Net muted Chewy is Slightly softer than pre pandemic, but reactivations are much stronger than pre pandemic. So if you combine those 2, the overall output is that gross adds are stronger than 2019. And then color on CAC, not much has changed from what I believe I shared last time, which is The CAC has increased over the last couple of years, at least through the as we've come out of the pandemic because then you were picking up Everybody was declaring intent and you were picking up customers quite economically. But Candidly, the when viewed from the lens of LTV to CAC, LTV has also continued to go up. So our ratios have actually very nicely maintained and on an ROI standpoint, we're spending where we believe we should be spending from a marginal point of view.

Speaker 2

The reason CAC continues to go up right now and will remain high up until the macro recovers in my opinion is, a, there's a shallower pool of customers Declaring intent. So clearly the competition for the same customer is higher and that drives up the bid rate. And then B, recall that social used to be a pretty active channel A few years ago and the loss of targeting has actually led to a loss of yield that drives up CAC in the social channels. So it's a combination of those 2, but LTV is going up appropriately.

Speaker 5

That's helpful. And just as a follow-up, is LTV going up appropriately for the most recent Cohorts are customers too? And if not, if that LTV to CAC ratio is weakening for the most recent cohorts, are you going to adjust where you're Spending to find new customers.

Speaker 2

We always do actually. So cumulative contribution profit is what we go after and we're always trying to Find that tangential point where this tips over to the fact where to the point where the campaign actually becomes negative returning. So far, the team has been very diligent. And we've actually experimented with trying to spend money to pick up discretionary customers and it's just not a high ROI effort So we're not really going after that because we would rather maintain the quality that drives the repeat purchase. Otherwise, you never really get out of the spiral of And spending money to keep that customer per se.

Speaker 2

And so we are our engines, our performance marketing teams appropriately adjust To find the best customer, the best return across the best channel, and that is done On a daily, weekly, monthly basis, not on a quarterly basis. We're fairly responsive.

Speaker 6

Thank you.

Operator

Thank you, Mr. Basham. Our next question is from Lee Horowitz with Deutsche Bank. You may proceed.

Speaker 4

Great. Thanks for taking the questions too, if I could. When you think about the consistently challenged pet household growth environment, do you think that you need pet household growth to Turn more meaningfully positive in order to return Chewy back to more meaningful meaningfully positive user growth in the medium term. And then maybe digging in again to these recently acquired cohorts in the platform and some of the caution you were seeing amongst these users, can you talk a bit more specifically on what you maybe are seeing from these cohorts in terms of repeat purchase rate, auto ship penetration, basket size, relative to the core. Anything that these users are flagging to you that's raising this degree of modest caution That leads

Speaker 6

you to believe maybe this is easier

Speaker 4

to have structurally higher churn than your existing base. Thanks so much.

Speaker 2

Sure, sure. On the first question of do we need them to turn more meaningfully positive, well, there's certainly a factor. Household penetration is a factor and that it is an important input into the model. But it's not the it's not what we are solely dependent on. In fact, For we our teams are progressing multiple features across chewy.com, which we And this is all kind of in the back half, which will continue some of this will continue into next year per se.

Speaker 2

Yes. Our team is progressing multiple features across tui.com, which we expect where we will expect to credibly reduce friction And lower conversion barriers in areas of, for example, account creation and improve both sign up rates as well as customer retention, So some of these specific examples might be in areas of account creation, payments, our content platform, our CRM mechanisms, Or we've talked about which I will discuss more in detail at our next earnings call. We're super excited to talk to you about Chewy loyalty, which we're progressing for an early 2024 launch. So we're not sitting idle waiting for the macro to recover, Right. It's just this notion of what cannot be cured has to be endured.

Speaker 2

So we're going to endure that. And at the same time, everything that is controllable On our side, which is improving experience and opening up net avenues to acquire and retain customers, we are absolutely focused on that. And then your second question was with the more recent cohorts, what are you seeing on repeat order frequency? We're seeing their repeat order frequency that essentially what I was mentioning earlier. Authorship penetration actually is fairly intact.

Speaker 2

Their basket sizes are slightly lower because they're more value seeking. So obviously there's an ASP compression that is taking place there. Their attach rates are slightly lower, so the units per order metric is where you will see that impact, which ultimately goes back and kind of talks to the basket size also. Repeat order frequency, they need a little more nudge relative to our kind of loyal customer bases. So we're just we're watching right now.

Speaker 2

And that's we've essentially baked that in into the guidance and we're baking that in into the active customer ad forecast as well.

Speaker 4

Very helpful. Thank you.

Speaker 2

Sure.

Operator

Thank you, Mr. Horowitz. Our next question is from Stephen Forbes with Guggenheim. You may proceed.

Speaker 7

Good evening Sumit, Stacy. Just two quick follow ups, 1 on ownership and 1 on pharmacy. So first on ownership, Sumit, can you comment On how the average number of net ownership orders by customers in some of your more mature cohorts are trending Relative to plan. And then on pharmacy, can you also talk about like how the customer journey for pharmacy customers has evolved over the years Such as time to trial, usage statistics, auto ship adoption and maybe most importantly churn rates, right, among Those customers that try and convert into pharmacy earlier in their life cycle.

Speaker 2

Sure. I may not be able to satisfy your full curiosity relative to some of the metrics that you're asking, but I'll build your intuition Generally in stating that, you know, Autoship continues to be more powerful in the way that it is Accreting value for customers and passing that value on to customers. We've done that by, a, making sure that the assortment under auto We've also done that by making sure that barriers to either auto ship conversion or auto ship retention, whether they may be payments related or whether they may The attach related have continued to be lowered. Our improvement in segmentation and targeting ability does allow us to speak with customers a little more meaningfully And that will only get better in the future. And then from a cohort development point of view, we've invested Across our kind of discoverability and attach engines to make sure that customers not only discover complementary attached products, But are essentially attaching through them in a meaningful manner.

Speaker 2

So all of this is essentially leading to the incremental AutoShip sales that you're looking at. You know, Autorship, the beauty of Autorship is, it is a very flexible program and customers trust That they won't they both trust the flexibility and they have come to trust the reliability that we put behind Autoship. And so it's a high value program from that point of view, not only from a pricing point of view, but also from an overall experience point of view. On the Rx side, this is we believe we have the best healthcare experience That e commerce can offer or that customers can find in the Best of kind of retailers out there per se. So our metrics on pharmacy, our adoption AutoShip adoption is Even higher in pharmacy than it is in some of our other March classes.

Speaker 2

Our churn rate is lower given how high a bar we have. And at the same time, we always have opportunity that we're working on to make sure that we get even better with products like these. So Overall, we're excited about this vertical.

Speaker 6

Thank you.

Operator

Thank you, Mr. Forbes. Our last question is from the line of Rick Patel with Raymond James. You may proceed.

Speaker 4

Thank you. Good afternoon, everyone. Can you talk about what you're seeing in terms of spending by cohort For those customers that are not new to Chewy, so I appreciate that ends back is growing. But just as we think about how much customers are spending Further along in their life cycle, I'm curious if you're seeing changes in that trend line.

Speaker 2

Yes, we are. We absolutely are. In fact, our Like our more recent cohorts are slightly, as we've kind of mentioned on this call, they require a little more nudging. But the NESTAC development curves through our older cohort, if you look at the 3 main factors of NESTAC development, right, cohort maturity Lead the way, right, followed by kind of the other 2, which is a combination of AutoShip plus Health and other merch classes kind of mixing it per se. So without kind of talking to specific numbers, hopefully that's enough intuition building.

Speaker 2

If not, Happy to take a double click.

Speaker 4

Great. And can you also talk about your go to market strategy Canada, how are new customers going to learn about Chewy and how are they going to experience the brand and anything to think about In terms of marketing spend over the next couple of quarters as you ramp in Toronto?

Speaker 2

Yes, sure. So this is we're very excited about this. We are going to I think the punch line here is that we will Our aspiration is to show up in Canada as a Canadian brand, not as an American brand that And so essentially what you should hear in that statement is, we will we are going to try and understand the customer, their needs, their wants, Their desires, their behaviors and then model the offering in a manner that appeals to them in the best possible manner. That by the way is also the most efficient way to market Customers and the most efficient and a way of keeping our costs, you know, minimalized per se. We're going to be much more, you know, focused on delivering the experience through kind of trusted proven mechanisms that we have here in the United States.

Speaker 2

Those we do believe carry over pretty nicely. I was in the Canadian market with the rest of the senior leadership team a few weeks ago, sort of walking the stores and the All the way from our fulfillment side to the delivery side to the end market and we're excited. There's going to be a ton to learn here. We're going to try and self fund a bunch of this and at the same time whether investments required, we'll be upfront and candid about them. Overall, we're looking for high quality growth, not dilutive growth here.

Speaker 2

Thank you. All the best. Thank you.

Operator

Thank you, Mr. Patel. That is all the time we have for questions. I will now turn the call over to Sameet for any closing remarks.

Speaker 2

Thank you very much. Just want to welcome Stacy again, and wish everybody a nice evening. Thank you.

Speaker 1

Thanks, everyone.

Operator

That concludes today's Chewy Second Quarter Fiscal Year 2023 Earnings Call. Thank you for your

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Earnings Conference Call
Chewy Q2 2024
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