Earnings Call: Q1 2022

Jun 10, 2021

Good day, and welcome to the Chewy First Quarter 2021 Earnings Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask Please note this event is being recorded. I would now like to turn the conference over to Robert LaFleur, Vice President, Investor Relations, please go ahead. Thank you for joining us on the call today to discuss our Q1 Joining me today on the call are Chewy CEO, Sumit Singh and CFO, Mario Marte. Our earnings release and letter to shareholders, which were filed with the A link to the webcast of today's conference call is also available on our site. On our call today, we will be making forward looking statements, including statements concerning Chewy's future prospects, financial results, business strategies, investments, Industry trends and our ability to successfully respond to business risks, including those related to the spread of COVID-nineteen, including any adverse impacts on our supply chain, workforce, fulfillment centers, other facilities, Such statements are considered forward looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those contemplated by our forward looking statements. Reported results should not be considered an indication of future performance. Also note that the forward looking statements on this call are based on For further information, please refer to the risk factors and other information in Chuy's 10 Q and 8 ks filed earlier today and in our other filings with the SEC. Also during this call, we will discuss certain non GAAP financial measures. Reconciliations of these non GAAP items to the most directly comparable GAAP financial measures are provided on our Investor Relations website and in our earnings release and letter to shareholders, which were filed with the SEC on Form 8 ks earlier today and in our 10 Q. These non GAAP measures are not intended as a substitute for GAAP results. Additionally, unless otherwise noted, Results discussed today refer to Q1 2021, and all comparisons are accordingly against the Q1 of 2020. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of this call will also be available on our IR website shortly. I'd now like to turn the call over to Sumit. Thanks, Bob, and thanks to all of you for joining us on the call. 2021 is already turning out to be an exciting and busy year for us at Chuy. Our business momentum and strong customer engagement continue and that gives us the confidence to Our full year 2021 guidance for net sales and adjusted EBITDA margin expansion. Along with our financial results, Today, I will share with you some exciting new launches that highlight our ongoing pace of innovation and further strengthen our customer value I will also share with you some of the headwinds we are facing and update you on the actions we are taking to protect customer experience and business continuity. After that, I will turn the call over to Mario to discuss our Q1 results in greater detail and share our updated guidance. Let's start with our Q1 results. Q1 net sales increased 32% to $2,140,000,000 Continued growth in our active customer base and strength in purchasing behavior drove our top line results. While we are pleased with our net sales in the quarter, Elevated out of stock levels were a persistent headwind throughout the quarter and reduced our Q1 net sales by an estimated $40,000,000 This is clearly a supply driven situation, which we expect to abate in the second half of this year as additional production capacity comes online. Efficiently adding new customers to our platform and then growing their share of wallet remains a key part of our growth strategy. Active customers increased by 4,700,000 or 31.6 percent to end the Q1 at 19,800,000 customers. New customer additions remained above pre pandemic levels and as anticipated moderated against the peak pandemic levels of this past year. Further, retention rates remain steady as the 2020 cohort matures into their 2nd year on our platform. Taking a broader view, over the past 2 years, we have increased our active customer base by 8,400,000 or 75%. The practical effect of this is that the weighted average tenure of our active customer base is just under 2 years. In other words, our average active customer is still squarely on the left side of their lifetime spending curve with us. For context, our customers historically spend over $400 with us in their 2nd year compared to approximately $700 in their 5th year and almost 900 in their 9th year. As such, we believe that we still have significant future share of wallet gains left to realize from a substantial component of customer base. 1st quarter net sales for active customer or NSPAC increased $31 or 8.7 percent to reach $3.88 a meaningful acceleration over our 2020 growth rate. In reviewing the purchase behavior of the Q1 customer cohort, We saw the same kind of positive engagement levels and basket size trends that we saw throughout 2020, which helped drive a 13% year over year increase in Q1 average spend per new customer. Top line momentum translated into improved margin performance. Q1 gross margin was 27.6 percent, reflecting a 4 20 basis point increase, approximately half of which is the result of our The remainder came from normalizing freight costs against the COVID related spike last year and the muted pricing and promotional environment. As we executed Q1 with rigor, we faced labor shortages in our fulfillment centers or FCs, similar to those being faced by many companies nationwide. To offset these headwinds, we did a few things concurrently. We invested in higher wages and short term incentives, which to some degree helped overcome FC staffing constraints. We also implemented other operating cost disciplines. For example, we developed algorithms which enabled real time improvements in inventory receipt and order allocation, leading to increased density in pick and pack across our Feet network. We introduced part time shifts to better optimize interval level labor forecasting and provide more flexibility options to our team members. These activities help keep operating expenses in check And this operating discipline, when combined with our strong gross margin performance, drove meaningful improvements in flow through as Q1 adjusted EBITDA came in at $77,400,000 and adjusted EBITDA margin increased 3 40 basis points to 3.6%. In addition to the strong financial results, I am also tremendously proud of the broader transformations underway at Chewy. In 2018, we were mostly a provider of food and treats. Today, just 3 years later, we are delivering a multi dimensional customer experience that has never been stronger. With that in mind, I'd now like to spend a few minutes sharing some of the many things that are going on inside Chewy today. We are excited about these because they represent continued progress in our effort to improve experience for our pet parents and partners and drive higher engagement with them. Additionally, they position us well to capture the large and growing opportunity in front of us. First, we continue to make meaningful strides in upgrading our technology stack and architecture. In Q1 2021, we relaunched the chewy.com homepage and other stops in the shopping funnel at single page application. This enhancement allows us to offer a more targeted and customized shopping experience to our customers, which we are already starting to take advantage of. Once fully implemented across our website, these features will unlock hyper local and enhanced personalized recommendations that will improve the shopping experience and through their revenue enhancing functionality support our efforts to increase customer share of wallet. We are also excited to Our entry into the fresh and prepared pet food space with new selections from the segment's leading brand Freshpet and our premium proprietary brand, Tylie. That are available today. To date, we have already developed and patented new sustainable packaging that allows us to preserve product quality throughout the customer delivery process. We are currently in beta mode and will soon launch our initial distribution in 3 geographies, covering approximately 60% of Chuy's customer base. And we intend to grow both our fresh catalog and expand geographic distribution as we scale this business. We are enthusiastic about the fresh and prepared foods categories and the opportunity to serve new customers and expand assortment choices For our existing ones, with this launch Fresh Joints Connect with Yvette and our compounding pharmacy on the growing list of recently launched offerings that expand our TAM. Over the past few years, we have expanded our pet health and wellness offerings to include a wide Compounding and Telehealth. Collectively, we now call this still expanding effort Chewy Health, which consumers and veterinarians are starting to recognize as a brand that delivers innovative solutions designed to improve the health of every pet and empower those who care for them. We continue to gain traction with our recently launched innovations Connect with A Vet, Compounding Pharmacy and Prescriptions, which is our proprietary prescription management system for veterinarians. Recently, we enabled the video chat functionality for our proprietary telehealth solution and expanded its reach. Connect with Yvette is now available via text For video chat, 7 days a week until 11 pm East Coast Time, 3 65 days a year, which provides important coverage on nights, Weekends and holidays when care is often difficult to find. These upgrades have significantly improved customer experience and are driving higher customer adoption of this service. Net promoter scores for Connect with A Vet remain strong and over 85% of customers who rated the service in Q1 gave us perfect ten out of 10 scores. Our compounding pharmacy business continues to expand. We now publish 1800 compounding SKUs Servicing dogs, cats and as of April, horses. We also achieved a major milestone recently by earning our PCAP accreditation, which is a gold standard for quality and safety compliance in the compounding industry. As planned, our entrance into compounding is improving customer to pet health and wellness services and growing our customer base. Approximately 2 thirds of our compounding customers are new to Chewy Health, including over 20% that are new to Chewy overall. As anticipated, compounding is also emerging as a strong recurring revenue driver with over 60% of outbound shipments already going through AutoShip. And on prescriptions, I am pleased to share that close to 7,000 clinics This helps to reduce friction, improve veterinarian efficiency, reduce in clinic costs and enhance customer experience for both the veterinarian and the patient. We will share more about our ongoing work in this space in our Q2 call in September. Chewy Health is the only brand Our mission within Chewy Health is to make pet healthcare more affordable and accessible by developing value added services and products that keep pet parents and veterinarians at the center of the equation. We are just getting started and will keep you updated on our progress. The same spirit that animates our request to make pet healthcare more affordable and accessible also drives our charitable efforts through a program we called Chewy Gives Back. Chewy Gives Back operates under a mission to make the world a better place for pets and the communities that serve them. To this end, last year, we made approximately $35,000,000 of in kind donations to shelter and rescues, providing them with the critical supplies they needed to perform their important work on the front lines. Additionally, I am excited to share with you that last week we launched Our nationwide pet adoption services that enables millions of Chewy customers and not yet Chewy customers to discover and adopt a pet directly through Chewy's website. As with everything we do, we believe that customers will find this new service to be an engaging and bar raising experience. Over 1,000 shelters and rescues have already signed up and the list continues to grow rapidly. The launch is supported with full WishList integration, which enables shelter and rescues to lift There are needed supplies on chewy.com for customers to conveniently discover, donate and have them shipped directly to the shelter. Our launch of the pet adoption service and features such as Wishlist again shows how our innovation with customers continues to extend to our partners and service community and is in complete harmony with our mission of being the most trusted and convenient destination for pet parents and partners everywhere. Now before I wrap up, let's quickly visit growth across our fulfillment center networks. As our top line momentum continues, We are investing in our distribution network to stay ahead of the growth curve and enhance customer experience. At the end of Q1, we opened our 12th And or items that ship in their original containers. I'm also pleased to share the news that we are expanding the capacity of our Phoenix, Arizona and also that we will open our 3rd automated FC and 13th FC overall in Reno, Nevada next year. This new facility along with the Phoenix expansion will further reduce ship times, improve customer experience and help reduce costs. I will end my comments by reiterating my optimistic outlook for the balance of 2021. We continue to execute against our growth roadmap by expanding our customer base, increasing share of wallet, growing our TAM expanding verticals and launching new ones. While supply chain and labor market conditions remain challenging, we are successfully managing through these headwinds and still driving significant year over year improvements in gross margin, Adjusted EBITDA and free cash flow. I am incredibly proud of the determination and focus of our teams and their ability to accelerate our pace of innovation, while consistently delivering strong top line and bottom line results for our shareholders. With that, I will turn the call over to Mario. Thank you, Sumit. We continue to execute on our long term strategy and momentum remains healthy. 1st quarter net sales were $2,140,000,000 representing 31.7 percent growth. 1st quarter auto ship customer sales increased 34.4 percent to $1,480,000,000 and auto ship sales as a percentage of net sales increased 140 basis points to 69.3%, which approaches the high watermark we reached in the Q4 of 2019. These results reflect the maturation of the 2020 customer cohort and the growing appeal of the auto ship program's benefits, which include complementary access to our 1st in the industry telehealth offering Connect with A Vet. AutoShip is a powerful tool for reinforcing the customer value Proposition and strengthening loyalty bonds with pet parents. Net sales proactive customer or nest pack Increased $31 or 8.7 percent to reach $3.88 in the 1st quarter. Compared to the Q4 Nespac increased $16 sequentially and marks the largest absolute single quarter Nespac increase in the company's history. Improved discoverability and merchandising, growth in our newest verticals and more spending from the 2020 customer cohort are the primary drivers behind the acceleration in Nesteck growth. Moving down the income statement. 1st quarter gross margin was 27.6%, an increase of 4 20 basis points. As Sumit mentioned, approximately half of the increase came from structural business improvements And the remainder reflects normalized freight and logistics costs compared to the elevated investments we made during the peak of the pandemic last year to protect customer experience and the muted price competition and promotional activity that we saw in the Q1 of this year. 1st quarter operating expenses, which include SG and A and advertising and marketing, were $550,700,000 or 25.8 SG and A, which includes all fulfillment and customer service costs, Credit card processing fees, corporate overhead and share based compensation totaled $406,200,000 in 1st quarter or 19 percent of net sales, scaling 70 basis points. SG and A, excluding share based Compensation totaled $381,400,000 in the Q1 of 2021 or 17.9% of net sales, an increase of 80 basis points. This reflects the additional investments we made in wages and benefits for our fulfillment and customer service team that we outlined on our last earnings call, as well as the impact of the higher recruiting and hiring incentives that have been necessary to address persistent labor shortages. Absent the incremental wage benefit and recruiting costs related to the current disruptions in the labor market, our SG and A expense, excluding share based compensation, Would have been flat year over year as a percentage of net sales. Launching 4 new FCs in 12 months while keeping SG and A flat as a percentage of net sales, Aside from incremental expenses related to current labor markets, demonstrates our ability to fund incremental investments by efficiently leveraging operating expenses across the network. 1st quarter advertising and marketing was $144,400,000 or 6.8 percent of net sales, a 30 basis point increase versus Q1 2020. We expect that this line to increase year over year Adjusted EBITDA reached a new high this quarter, totaling $77,400,000 improving $73,900,000 versus the Q1 of 2020, For a net sales to adjusted EBITDA flow through of 10.5%, excluding the estimated $20,000,000 negative impact that COVID-nineteen had on freight costs in the Q1 of 2020. Adjusted EBITDA margin improved 3.40 basis points to 3.6%. In Q1, we also delivered our 2nd quarter of positive net income, reaching $38,700,000 Improving $86,600,000 versus the Q1 of 2020. Our net margin was 1.8%, a 4 80 basis point Improvements. As we have shared in the past, we expect our expanding and profitable repeat business, coupled with the benefits of scale to drive increasing profitability over the long term. Moving on to free cash flow. 1st quarter free cash flow was 59,500,000 reflecting $98,400,000 of positive cash flow from operating activities and $38,900,000 of capital expenditures. Deposit of operating cash in Q1 was primarily a function of Q1 profitability and favorable working capital, which mostly reflects A temporary reduction in inventory levels due to the ongoing supply chain situation. Capital investments include ongoing additions to our fulfillment network, including cash outlays for our recently opened limited catalog facility in Pennsylvania and our 2nd automated fulfillment center in Kansas City. We finished the quarter with $638,000,000 of cash and cash equivalents on the balance sheet, which is our highest ever level of cash on That concludes my Q1 recap. So now let's discuss our Q2 and full year guidance. We are raising our full year top line and profitability outlook. But before I discuss the details, I'd like to spend a few moments on how we formulated this guidance. As Sumeet mentioned at the beginning Call. 2021 continues to be a busy and exciting year for us. Our strategy remains intact, demand remains strong, and we remain bullish about our Our ability to maintain pace of execution. At the same time, as we prepare and ramp our network to handle the current and future momentum in We are not immune to the labor shortages currently being faced across the country. Even with the $60,000,000 of enhanced wages and benefits that we committed to last quarter, Labor markets remain constrained and it remains difficult to attract workers. In an attempt to fill job vacancies, companies across the U. S. Continue to invest in Higher wages and benefits. As these conditions persist, we may choose to commit an additional $30,000,000 to recruiting and hiring incentives over the next two quarters. Although we expect these types of expenses to be temporary in nature, that ultimately depends on how labor markets respond to the end of extended unemployment benefits in September. While these higher costs may put near term pressure $1,000,000,000 representing 26% to 28% year over year growth. We are raising our full year 2021 net sales guidance to between As you update your models for 2021, please keep the following in mind. First, elevated out of stock levels are Stronger headwind this year than they were in 2020, and we have not yet seen signs of this abating. While macro conditions are clearly improving on the pandemic front as vaccination levels increase, predicting how exactly consumers will behave post pandemic is not yet fully clear. What is clear to us is that our compelling value proposition and the predictable and recurring nature of nearly 70% of our business provides us real and tangible advantages in today's marketplace. 2nd, as you saw in the Q1, our advertising and marketing spend remain This year should look more like they did in 2019 prior to the pandemic, which reflects the normal retention patterns we expect to See from the 2020 cohort as it moves from its first to its second year. PetSpac is expected to accelerate in 2021 As we annualize the 2020 cohort and as the many initiatives that we have launched over the past 2 years continue to expand customer share of wallet. 2021 is off to a great start. We grew 1st quarter net sales by 32% and our growing scale and operating discipline Adjusted EBITDA guidance, we are reiterating our bullish view on Chuy's market position and how we see the balance of 2021 playing out. And with that, I'll turn the call over to the operator. Operator? We will now begin the question and answer At this time, we will pause momentarily to assemble our roster. Our first question will come from Mark Mahaney with Evercore. The out of stock issue, it sounds like, Mario, that's continuing. Can you just talk about your level of confidence that that will abate in the back And what you can do to help that abate, I don't know if that's completely out of your hands or not. And then I want to ask about this, The statement about new customer acquisitions remain above pre pandemic levels. The net adds in this April quarter were actually below the net adds you had in the Q1 of 2019. Does that mean that you have got elevated churn just related to all the new customers you brought on during the COVID year or am I I just want to get back to this issue of whether your net customer adds can this year be like they were in 2019. Thank you. Mark, good evening. This is Sumit. I will take the first question, Mario will take the second one. On out of stocks, We believe, as we've indicated in the Q4 earnings call, wet canned food capacity constraints or production capacity Constraints was where we started and primarily remained there. Any other out of stock that we're facing, we're actually able to fairly mitigate given our extensive size of the catalog And given the substitutability within the discretionary categories such as hard goods or supplies, The primarily the area that out of stock issues are being felt on industry wide, this is not a Chewy thing, this is an industry wide Issue is consumables. So healthcare is also not as deeply impacted with this. And while we don't have perfect visibility, obviously, there's Perfect data coming in. What we have heard and why we have confidence from our strategic suppliers and vendors and partners is that Incremental investment is going in and incremental capacity is being unlocked and should be available in the back half of this The rate of improvement is the one that is a little bit unclear right now and which is why we've consistently starting from Q4 said that this is a headwind We will continue to monitor. But yes, we do expect it to abate back half of this year. Mark, and I'll answer The second part of your question, first, you're right, we added 600,000 net active customers in the Q1, ended at 19,800,000 active customers in Q1. And that was right in line with our expectations for the quarter and what we've mentioned over the last couple of earnings calls. So I'll break it down into retention and then gross customer adds. I know you know the dynamics of this for everybody else to higher than traditional e commerce platform, and then any attrition that we see happens year 1 into year 2. And the customers that stay with us after 2 years remain with us for a very long time. So then let's talk about the Q1 'twenty cohort because that's really what's going to drive Some of the year over year impact here. First, retention rate for that cohort It's higher than the average retention rate over the last couple of years. But even with a higher retention, that cohort was so large The normal attrition we saw created a headwind to net customer adds this quarter. Then if we look at the customer new customer adds this Last quarter and Q1 'twenty one, that was not only higher than pre pandemic, but it was also higher than what we expected for this year, Just 18 months ago, so dial it back 18 months, what we projected this far out into Q1 'twenty one, our pace of new adds was Higher than then and higher than pre pandemic. So we're still acquiring customers at a very fast clip. So if you think of it another way, We don't believe that any of the demand we saw in 2020 was pulled forward from future years, still adding a lot of growth, new customers. And then finally, take it from a revenue perspective, we expect the 2020 cohort to generate more revenue This year than they did last year. And in fact, when we look at all the mature cohorts, so 2011 through 2018, let's say, They produce more revenue in 2020 than they did in their 1st full year on our platform. So we would expect the same thing for our 2020 cohort coming into 2020 Great. That clears it up. Thank you, Mario. Thank you, Sumit. Thanks, Mark. Our next question will come from Nat Schindler with Bank of America. Please go ahead. Yes. Hi, guys. I'm actually wondering about some more of your longer term plans on growth in international Expansion and what conditions and what areas would you look to go to and how you would enter Markets, particularly Europe, where similar size than the U. S. Hi, Nat. This is Sumit. I will take that question. Our plans, first of all, are squarely centered on achieving our mission statement to be the most trusted convenient destination for pet And obviously, we've gone back and now added the word partners there because we believe we are effectively servicing and should service communities and pets that Have not been serviced in a high quality manner in our opinion in the past. So given that we have focused on the United States And we believe there is a ton of online growth that is being driven and will continue to be driven in the United States. And we fully plan to capitalize on that growth Our investments across the multidimensional experience that we talked about in the earnings script, food, treats, personalized accessories, healthcare and Services. International, the last word of our mission statement is to be present everywhere. We believe pet parents are more the same than different. We also believe that our brand and our capability is extensible outside the United States. That being said, focus has been important to us. We've been focused on the U. S. And we've said international plans are roughly between 1 5 years and that's set at the point of IPO, we had said that and that's still that statement remains true. When we do explore international, we would explore it, keep our options open and explore every possibility. And in terms of what specific country we would enter and how we would do it is a matter of working through how customers behave, how markets are, how do you do marketing, supply And infrastructure, availability, customer behavior, all of that and we'll work backward from that to be able to figure out what markets we enter. But rest assured, we're going to be We're going to be diligent and we're going to be disciplined about the investments in our approach internationally. Great. Thank you. Our next question will come from Erin Wright with Credit Suisse. Please go ahead. Great. Thanks. Can you speak to the traction you're seeing across the pharmacy business? Is the stickiness across that business playing out according to plan as we lap Some of the COVID dynamics from last year, some of that going back to the vet clinic. And you mentioned you're working with 7,000 vet clinics now. What sort of share do you have in terms of the placenta scripts that you're that at those clinics that are getting filled through Chewy? Sure. Hi, Arren. We believe a couple of things to be true. First of all, our data indicates that retention into Our pharmacy and other healthcare verticals remain strong. AutoShip subscription rates into these verticals remain stronger than the core business, which is a net positive. And our work with veterinarians and connecting customers into veterinarians continues to earn us Trust and credibility in the space. A recently conducted independent research driven by Mark suggested that 86% of the veterinarian Would be open and favorable to working with Chewy. These are encouraging data points to us. And the Descriptions, as I mentioned, is present in 7,000 clinics. I'll refrain from the number of scripts that you lost, But what I will mention is 7,000 is roughly equivalent to 30% of the veterinarian clinic penetration in the U. S. At this point, which is something that we're tremendously proud of. Okay. Great. And Eric, let me add one more thing. So to point you back to our 10 Q, because you'll see that The other segment of our revenue, which includes all proprietary brands, pharmacy, other and specialty, notice the speed of growth for that That part of the revenue, it's growing twice as fast as the overall business. So that should give you an indication of how we think about these newest verticals. Okay, great. And one just quick follow-up. Just on the incremental spending associated with hiring and incentives of 30,000,000 That's not or is that embedded in your guidance at this point or is that an incremental expense? It is fully embedded in our guidance. Okay, great. Thanks. Our next question will come from Brian Fitzgerald with Wells Fargo. Please go ahead. Thanks, guys. We want to ask about the entry into the fresh market. Could you maybe provide us with some context around the opportunity, the current size of fresh Pet food market, maybe what happens with consumable spend as you move from traditional to fresh, what the margin uplift is there. And then maybe really quickly on the adoption service. It sounds like you stood that up pretty rapidly. You've already done a really nice job there, Integrating with shelters, we know it's early on, but what's the opportunity to build awareness there? And then are you investing behind that? And any Early learnings with kind of the attach rates and what those cohorts look like and maybe how the adoption Cohorts maybe differ from traditional cohorts. Okay. Hi, Brian. Nice to hear from you. There's a lot in there, so let's try to unpack them At least 2 distinct areas, fresh and packaged foods and then shelter adoptions. Fresh and packaged foods, we believe we've always Understood and believe that humanization and premiumization of pet is very real. And our customers, As customers become more aware, given our ability to educate them and given their natural ability to Engage with their pets, categories such as fresh and prepared foods is an attractive opportunity for us to get into and service customers in a high quality Another motivation for us is the fact that this is a category that requires education. And there are barriers to adoption if the customer isn't engaged or educated. And we believe that with the high customer Care model that we bring to the pet industry as well as our focus on personalized care and experience building, we believe we can effectively educate And therefore drive customer adoption in the category. In terms of the size, there's not perfect data available. The market right now is likely between $600,000,000 to $1,000,000,000 in size. Growth rates also are hard to predict because again, it's not An easy category to drive adoption into, and we believe that, we can do an effective job in connecting customers with high quality products To be able to drive that adoption. And you'll see us focus on that. Of course, any business new business that we launch Requires investment. The investment on a CapEx side, all of the investments is already baked in into our guidance as well as the 1.5% to 2 And CapEx spend that we modeled in our P and L. And We would expect the business to be to scale as we drive scale into the business. And right now, the impact of margins or any dilution is really immaterial And negligible. So that's on fresh and packaged foods. On pet adoption services, again, yes, very proud to work across The shelter community to bring this to life, it is our way of giving back to the community and connecting pet Parents who are likely Chewy customers and those who are not yet Chewy customers to bring Chewy top of mind consideration when their Journey begins. Over 55% to 60% of the pets in the U. S. Are adopted via shelters and rescues. And this is our way of connecting the 2 communities to be able to serve a greater purpose and to build brand awareness And consideration towards Chewy, which then drives again future loyalty and engenders repeat visits to our platform. So We'll continue to enhance our work in this space and come back and share more as the program grows. Awesome. Thanks, Sumit. Our next question will come from Steph Wissink with Jefferies. Please go ahead. Thank you. Good afternoon, everyone. Mara, these might be best suited for you, but Smith, please jump in. I want to talk a little bit about gross margin advancement because it is running I'm curious if you can talk a little bit about what opportunities still exist To further enhance the margin, whether that's through mix or leverage. And then, Mario, a question for you on cash. I mean, the cash flow in the quarter was outstanding. I know that some of that was a benefit of working capital, but how should we think about cash flow for the year? And how should we also think about your cash priorities, therefore, as the cash Thank you. Hi, Steph. All great questions. I will take the first one on gross margins. Mario will take the second one on cash. Gross Margins, I would like to point you back to the roadmap that I have often shared on these calls, in our 3 buckets of gross margin improvement, Acquiring Customers and Growing Share of Wallet Bucket 1, growing investing in Improved discoverability, merchandising and growing our sub penetrated newer verticals, proprietary healthcare, etcetera, And then connecting the destination with services. Yes, we believe we are making incremental And encouraging progress in our gross margin. We are now net of the pricing muted environments. We believe we are sitting at right about 26%, which is slightly above the low end of the long range guide. And we believe there is a ton of headroom in front of us to be able to go achieve the long term guide of And perhaps even surpass that as we continue to build behind gross margin. We still have Less than 1 third of Chewy customers today are exposed to proprietary brands. Less than a 5th of our customers today are exposed to healthcare. And so there's a lot of opportunity and headroom as we develop that customer base to become full funnel shoppers with us and increase their basket sizes. At the same time, you've seen us expand our addressable market by launching newer categories such as fresh and packaged foods that we're describing today. And at the same time, we're starting to uptick our focus on services with compounding and telehealth, which have great potential for us in the future. So net net, I want to give you the confidence that there's a lot of innovation that is going on inside The company, we're very disciplined and we're focused on rapidly improving customer engagement so that we can achieve the high end of our gross margin targets as we've laid out. And then when we're ready to discuss any updates in the future, we will talk about that on future calls. Hey, Aaron, this is Mario. So I'll answer the second part of the question in terms of cash. So you have seen us over the year be able to grow very rapidly Without consuming any cash, in this year, if you look at the guidance we provided for net sales and for adjusted EBITDA margin, You would see at the high end, we would produce over $200,000,000 of adjusted EBITDA. So I'll let you draw a conclusion on what that means for free Cash flow, since we don't explicitly guide to that, but obviously those are 2 good components to what we expect for cash generation this year. I will say 2 other things about cash. One is, you're right, we benefited To a degree from working capital, the fact that we drew down some of the inventory in the Q1, certainly that's not That would otherwise not have been our intention given that that was more of a result of high out of stock and disruptions in the supply chain. So you would expect us to build the inventory back up throughout the year to make sure that we can serve our customers. Then you look at the cash we have available to us. And you're right, we ended the quarter with the highest cash level we've had in our history. We also ended the quarter with a facility of $300,000,000 That's untapped. So roughly $1,000,000,000 of dry powder. That gives us both strength in the balance sheet and So flexibility going forward for things like incremental investments in technology, automation, potentially M and A, and growing new verticals and expanding our TAM. So it's good to have the flexibility and I think we're in the right place in terms of cash. Thank you. Our next question will come from Doug Anmuth with JP Again, please go ahead. Great. Thanks for taking the questions. First, just on Profitability, I know you've raised the margin expansion obviously for the full year outlook. Just in thinking about the $60,000,000 potentially in the back half. Is that essentially the reason for not seeing more flow through on a Full year basis or is there something else or additional that we should be thinking about just on the EBITDA for 'twenty one? And then secondly, just on private label, I think you said about a third of customers are exposed there. Just curious if you can help Frame that in terms of where you are as perhaps a percentage of net sales and I think in relation to perhaps your ambitions that you've maybe mentioned in the past toward 15% to 30% over time. Thanks. Sure. Hi, Doug. This is Sumit. I'll take the second one. Mario will take the first one. So starting with Private Brands, What I mean by that is, of the nearly 20,000,000 customers that we now have on Chewy, a third of them Have either acquired or bought private label from us or our proprietary brands from us. So 2 thirds of them haven't yet shopped proprietary brands. And our efforts in improvement in search and discoverability and newer launches or assortment will continue to Provide us that exposure. We're actually we're pleased with the progress that we are making. As you might recall from Previously shared fact, we've improved we've doubled the overall number of assortment on the Roughly 35,000 new SKUs added over the last 2.5 years. And about a A 4th of them have gone squarely towards building out proprietary and more so hard goods. And in hard goods, we gained 500 basis points Share on a year over year basis reaching 18% penetration, therefore bringing us closer to that goal of 15% to 30% that we're talking about. We We believe in hardgoods we should be able to reach 40%, 45% penetration of net sales in proprietary and the balance coming from consumables That makes up the 15% between 15% 30% ranges that we've talked about. Gross margin for Proprietary is favorable to the core business, which is reflected in the overall Margin improvement that we're reflecting in our P and L or in the results and you should continue to expect us to Build assortment and expose more customers to buy more proprietary. Hey, Doug. And I'll take the first part of the question. So let me first start off with Q1 to sort of level set us. But In the Q1, we added $500,000,000 year over year. We increased gross margin and we had discipline in the expense line. So we reported, as you saw, a record adjusted EBITDA of $77,000,000 And if you think about what that means versus full year 2020, Our EBITDA in the Q1 was higher than all of last year if you adjust out the one time tax benefit in Q4 2020. Now for the full year, you saw us guide to an adjusted EBITDA margin increase of 80 to 100 basis points, which if you combine that with the sales projection that we provided, would mean tripling the EBITDA in the full year. And if you take that and you adjust the for the wages and benefits that we've called out explicitly in our Q4 and then our Q1 You get to about a 9% to 11% flow through for the full year, very much in line with what we saw in the Q1. So think about it in those terms, Doug, and I think you'll get to about the same conclusion. Okay, great. Thank you both. Thank you. Our next question will come from Seth Basham with Wedbush Securities. Please go ahead. Thanks a lot and good afternoon. My question is around advertising. How do we think about advertising as a percentage of sales this year? I I think you were commenting previously around 7% to 8%. You did better than that in the Q1. Do you expect to move to that range and have the opportunity to Grow your gross adds even more aggressively. Hi, Seth. This is Sumit. We believe Advertising and marketing will likely be in line with levels that we saw in 2020, right about the 7% range, plus And the plus and minus driven by efficiencies if we pick up like we did 20 basis points in Q1, so we came in at 6.8 And the pluses driven by if we see more opportunity in the marketplace to pick up new customers or if input costs Become further degraded. In terms of overall Q1 levels, we're actually quite Please, it's in line with our expectations. We've been continuing to scale marketing from 11% levels in 2018 to 7.2% coming out of 2020, albeit given some advantage due to the pandemic organic demand. And On a year over year basis, we still incrementally spend $35,000,000 higher on the $500,000,000 of net sales that we added. So overall, I believe we're Is to ensure that we're not leaving customers on the table. Relative to 2019, Are you expecting customer acquisition costs in 2021 to be higher? It's a very good question. If you recall the Q4 discussion that we had, it is hard to yet predict where marketing might end up this Peter? We've had a lot of platform changes that have come through across several advertisers. We've also it is Yet unclear to really predict how customers might behave as the country opens up. So we're still a bit of an evolving situation, But our guidance takes that into account. And therefore, I'm guiding or I'm providing my perspective that we should be flattish to 2020 levels on net Thank you. Our next question will come from Peter Keith with Piper Sandler. Please go ahead. Hi, thanks. Good afternoon. I was hoping you could just discuss a little bit more around the new homepage launch, Around some of the customization and localization features that you have, maybe just provide some specific examples on how you think that can improve the customer experience? Sure, Peter. So, Meta Points, it improves our ability to target. It improves our ability to personalize the experience by showing you a content that is relevant I make an inspiring that speaks directly to the needs of a pet parent and their emotive state or their journey in their life cycle with their specific pet. And so from that standpoint, we already offer a personalized high touch model and this actually provides that on a virtual digital basis, Which allows that targeting allows us efficiency of conversion and an efficiency customer development, which allows us to then, obviously grow basket sizes and share of wallet with customers. So that's how we're approaching it. If you go to the homepage today, we have the ability to obviously target knowing if you have a dog, what So think of it as a data driven and behavior driven experience rather than an unauthenticated experience The follow-up and unrelated question I had Just around the net customer adds, I know this was asked earlier in the call. But referencing back to the 2019 levels, And you did come in below that for Q1. I would think that then the customer adds moderate as the year progresses just from Maybe gross adds slowing or 2020 cohort churn picking up in just sheer magnitude. Is my thinking incorrect? Or is $560,000 kind of a good level to think about on a run rate basis? Yes, Peter, I'll answer that. So look, it's I think the dynamics of net active adds is exactly what I had mentioned before. We do have the headwind of the very, Very large customer cohort we acquired last year. So even as the retention levels that we're seeing, which are still high, we still would have a net headwind. The key to net active assets that you have to think about it over a period of time, over a longer period of time than just year over year, so you can see The trend of additions, the very large cohort last year is going to have a headwind impact in this year. But the other side of that is how many more new customers we add, gross adds that is, how many of them we reactivate this year. It's I think to take just the one piece, which is customer retention, it's going to lead us to the wrong Our next question will come from Lauren Schenck with Morgan Stanley. Please Go ahead. Great. I just wanted to ask about what you're seeing from sort of a COVID cohort spending perspective. If here in sort of year 1 they were already spending sort of over that $400 that you typically see in a second year Customer. And if that is the case, what kind of gives you the confidence that the COVID cohort will continue to expand spend at the same rate as previous cohorts? Lauren, as we hi, Lauren, this is Sumit. I'll take it. As we've mentioned in the script, we continue to see positive and engaged Behavior from the cohort. Their frequency of purchase, their subscribe rates into AutoShip, their basket size Attach rates all indicate positive momentum. And we believe that the uptick is driven by, as I mentioned, improved Discoverability, merchandising, growth in our new verticals and our work in connecting these all together. So we're still not planning on deploying marketing spend to retain customers, which is an important indication if we believe that We're going to lose them. We don't believe so, nor are we spending time on other initiatives that might drive customer development in an If I'm not answering your question or if you have follow ups, please ask. I guess, if you look at sort of the COVID cohort of customers, is there spending because of just sort of the Phenomenon that was COVID, is that already above where a year a normal year 2 cohort will be spending? Or is there do you Still think that the year over year growth opportunity in their spending is similar to previous cohorts? Yes. I think if I'm understanding your question right, Lauren, I would Expected to follow the same pattern as historical cohorts, where 1st year is X, 2nd year is greater than X. So we're seeing that already. And in fact, even if you just look at the Q1 cohort that we acquired this year, their Spend is 13% above last year's Q1 cohort. And last year, remember, there was a bit of pantry loading, and I would Call it some panic buying really. And last year's Q1 cohort spending was higher than the previous year. So we're seeing those curves in the overall Yes, Lauren, we believe the LTV potential of our customer is stronger given the newer launches, the expansion and assortment and all the work that we're doing And at the same time, we believe that we're capturing their share of wallet faster or sooner than we were with older mature Our next question will come from Nick Bauchus with Raymond James. Please go ahead. Yes. Thanks for taking my question. So, you talked a lot about new customer acquisition continuing to be Strong, but at a moderating pace, some of the headwinds from year 1 retention, but Netspac continues to accelerate. How do you think about these Drivers longer term, so kind of in the 5 year plus plan, how much of your top line growth is going to come from Each of those drivers, how do you think about that? Yes. Let me try to answer the question and then Sumit can add anything if I missed anything, but first, I want to not break it down into active customers or nest bag, because I won't give you the even if we get it wrong, that's not going to give you the right answer, The right sort of for your models. Think about it more in the sense of the average customer today has a Tenure with us is less than 2 years. And we've shown over time that the longer customers stay with us, the more they spend. So not only do we expect our customers as a base to mature Sure over time and spend more and more, and in fact, we've seen some customer cohorts spending $800,000 $900 today, the older cohorts that is. We also would expect us to continue to attract more customers to the platform over time. So you find 2 tailwinds Working at once. Overall, the base growing and maturing over time, spending more, us capturing more share of wallet and attracting more customers Add to that, the fact that we continue to innovate and launch new verticals. 2 years ago, we had just launched at this point actually, 3 years, we had just Launched pharmacy. 4 years ago, we had just launched proprietary brands. In the last couple of years, you've seen us grow our catalog, especially in the hard goods and specialty categories. So we continue to add more and more Products and more categories for customers to shift more of the share of wallet to us and shift it faster. So you have a combination of Tailwinds, and I would say, sort of normal maturation of customers over time, shifting their spend with things that we're actively doing, which is attracting customers to the site and also adding more categories and more to our catalog. So hopefully that gives you an idea how we think about it. That's very helpful. And then just quickly on gross margin, you talked about obviously a very strong quarter, Half the improvement was driven by efforts to increase customer engagement, proprietary brands, etcetera, and Remainder from the normalization of some of the kind of more one time or one time effects from last year, promotional environment, etcetera. So from a comparative perspective, as we move to the year, how do the compares line up where that half that's coming? Yes. Nick, hopefully we didn't lose you. Are you still there? Nick, you cut out for the last bit, but I think you were getting How does the gross margin sort of develop over time if we look at Q1? Did I paraphrase it right? Yes. Yes. And as you look to the balance of the year and come to comparisons from prior year. Yes. If you remember, one of the things we called out, you're right, is that about half of the year over year improvement came from muted competitive environment, which is Fairly new. We started seeing that in the Q4 of 2020. And part of it is the fact that we did not have the same higher freight costs that we did in the Q1 If you recall, Q1 'twenty, we experienced significant backlog, a surge in demand, an imbalance in inventory, and therefore, we had Higher freight costs. So that did not repeat because our inventory is more balanced today, more aligned with our customer demand. So That benefit, I would not expect it to continue. It was a one time, right? It was a one time event in 2020 that did not reoccur, and we don't expect that to Yes, a driver going forward. Then it comes to promotional environment and pricing, and that will Okay. We've said that we expect the out of stock situation, to come back online more or less in the second half of the year. Timing is TBD, but we don't just as that out of stock It is to would move into a more normalized state. We potentially could see promotions and pricing to also move into a more normalized state. So think about it that way. That might be temporary. Great. Thanks very much. This concludes our question and answer session. I would like to turn the conference back over to Sumit Singh for any closing remarks. Thanks. The Chewy team remains busy and excited about 2021 to execute with vigor and take care of our customers. Have a great evening. It was great having you. Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.