Chewy, Inc. (CHWY) Q4 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Chewy Fourth Quarter and Full Year 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Bob LaFleur, Vice President of Investor Relations and Capital Markets. Thank you. Please go ahead.

Thank you for joining us on the call today to discuss our fourth quarter and full year 2019 results. Joining me today are Chewy’s CEO, Sumit Singh; and CFO, Mario Marte. Our earnings release and letter to shareholders, which were filed with the SEC on Form 8-K earlier today, have been posted to the Investor Relations section of our Web site, investor.chewy.com. 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, industry trends and our ability to successfully respond to business risks, including those related to the spread of COVID-19, including any adverse impacts on our supply chain, workforce, fulfillment centers, other facilities, customer service operations and future plans. 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 information available to us as of today's date. We disclaim any obligation to update any forward-looking statements, except as required by law. For further information, please refer to the risk factors and other information in Chewy's 10-K and 8-K filed with 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 Web site and in our earnings release and letter to shareholders which were filed with the SEC on Form 8-K earlier today. These non-GAAP measures are not intended as a substitute for GAAP results. Additionally, as a reminder, prior period results this quarter include an extra week. So on an as reported basis, Q4 2019 results reflect 13 weeks of operations while Q4 2018 results reflect 14 weeks. Likewise, full year fiscal 2019 results reflect 52 weeks of operations while full year fiscal 2018 results reflect 53 weeks of operations. In our reported results for Q4 and full year fiscal 2018, the extra week contributed $82.9 million in additional net sales, which included $49.1 million of Autoship customer sales. For comparability during our call today, all year-over-year growth rates discussed regarding net sales, Autoship customer sales and net sales per active customer reflect comparable 13 or 52-week periods. Finally, this call in its entirety is being webcast on our Investor Relations Web site. A replay of this call will also be available on our IR Web site 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. Before I get started, I want to welcome Bob to the Chewy team. He brings extensive experience on both the sell side and Investor Relations areas and we are excited to have him on the team as we enter our second year as a public company. While 2019 closed on a high note and 2020 got off to a similarly strong start, suddenly the world changed in a big way. As we have seen, the COVID-19 outbreak has caused significant disruption to global commerce and financial markets. Our hearts go out to those directly affected by this disease and those suffering from the economic and social dislocations that have followed in its wake. It is in times like these when our mission to be the most trusted and convenient online destination for pet parents everywhere rings truer than ever. As pet parents, we know how special and comforting the bond is between humans and pets, especially in these stressful times; how soothing a simple act like a game of fetch with your dog or curling up on the couch with your cat can be. We devote ourselves everyday to supporting these special relationships. We are here for our pet parents and their pets, working 24/7 to meet their needs while caring for the safety and well being of our team members. Our shop-at-home business is proving resilient amidst the current economic disruption. Our volumes have increased as customers have chosen to stay at home and take advantage of the shopping convenience that we provide. We will discuss the financial impact of current trends and our guidance a little later in this call. Taking care of our team members’ health and well being is essential to all of us on the Chewy leadership team, and we are being highly proactive in our internal response to the COVID-19 outbreak. We are in constant communication to plan and adapt as swiftly as possible to these rapidly evolving conditions and our COVID-19 response team is providing daily updates to our team members across the company. We have expanded our health benefits and revised our PTO and sick day policies to meet the evolving needs of this unique situation. Additionally, we have materially increased cleaning and sanitizing procedures throughout our worksites, including our customer service sites and fulfillment centers. We have instituted work from home at our corporate locations as well as for a proportion of our customer service teams. Regarding our fulfillment centers and customer service centers, we have detailed contingency plans in place should we experience an on-site COVID-19 outbreak. We have the ability to divert fulfillment and/or customer service contacts to other facilities while we isolate and restore the affected facility. We believe we can absorb a facility being offline for a short period of time with minimal incremental disruption to customer service levels. So with that, let’s discuss our Q4 financial performance and some of the key milestones and achievements contained in our full year 2019 results. I’ll update you on some business initiatives and then turn the call over to Mario to discuss our Q4 and full year results in more detail, and to discuss our guidance. As I indicated, we closed 2019 on a high note. In Q4, net sales grew 35% to $1.4 billion or 1.5x full year sales just three years, underscoring the power of our business model. We ended the quarter and year with 13.5 million active customers, an increase of 2.9 million customers compared to the end of fiscal 2018 and our net sales per active customer grew 10% to $360. Our subscription-like Autoship business remains strong with Autoship customers representing over 70% of total net sales in Q4. Higher spending from our existing customers and growing Autoship sales reflect strong business momentum as more customers continue to shift their spending to Chewy, driving increased basket size and higher repeat purchase activity. In Q4, we were again able to expand margin while growing the top line. Q4 gross margin expanded 320 basis points versus prior year fourth quarter to 24.1%. Q4 adjusted EBITDA margin expanded 470 basis points over Q4 2018 to negative 0.4%, reflecting the progress we have made of gross margin expansion and the ongoing scaling of our advertising and marketing spend. Looking broadly at 2019, the sum of our efforts came through in our results. For the full year, we grew net sales by 40% to $4.85 billion, expanded gross margin by 340 basis points to 23.6% and improved our adjusted EBITDA margin by 480 basis points to negative 1.7%. We continue to get big fast, while getting fit fast as demonstrated by growth in our top line and improvement in our bottom line. We know the opportunity in front of us remains large and now even more so. As some of you may already now, in 2019 the Chewy team made great strides towards becoming the most trusted and convenient destination for pet parents everywhere. We innovated that pace, made smart investments in marketing and site merchandising and introduced new products and solutions that enhanced and streamlined the shopping experience for pet parents, feeling greater trust towards our brand. We continued to grow and made targeted investments in our strategic pillars; private brand and Chewy pharmacy, and we expanded our network of fulfillment centers. The American Pet Products Association, or APPA, recently announced that U.S. sales of pet products and services surpassed $95 billion in 2019 and are projected to reach nearly $100 billion in 2020. So not only is the addressable market larger than previously estimated, but the pace of growth remains robust. Additional research from APPA indicates that 72% of pet owners reported making at least one online purchase for their pet in the past 12 months. Of those making subscription-based purchases of pet products, 94% report that their buying frequency has increased or stayed the same in the past 12 months. Clearly, these trends all bode well for the future sustainability of our overall value proposition in this space. The new combined growing category; customer migration from offline to online and Chewy's unique shopping experience and award-winning customer service, we believe that we are still in the early innings of our growth. To this end, the core inputs of our business continue to trend positively. We remain maniacally focused on execution and are delivering the best possible customer experience for pet parents. We are convinced that we are positively transforming an industry by creating a truly unique and personalized shopping experience; one that builds trust, brand loyalty and drives repeat purchasing. Our focus on these pillars ultimately supports our long-term goals of sustainable top line growth at scale and incremental margin expansion. Now, I would like to share a few business highlights from our fourth quarter and broadly full year 2019 and also provide insight into our thinking for fiscal year 2020. As I noted on the Q3 earnings call in December, we went into the Q4 holiday cycle well planned and ready to delight customers. Our thoughtful and integrated go-to-market approach resonated well with customers and reflected in both our demand and conversion metrics leading to record setting days with Cyber Monday being the single biggest shopping day in our company's history. We continue to remain disciplined and data driven in every investment-related decision that we make. For instance, in marketing, we closely track key metrics, like customer acquisition costs and lifetime value and have been investing in tools to optimize our model and drive further efficiencies. The data management platform, or the DMP, combined with our ongoing optimization in marketing data science, is enabling us to more efficiently target existing and new customer audiences across the industry resulting in more efficient use of our marketing spend. For example, in Q4, our performance marketing teams in conjunction with our marketing science teams used the DMP to target new prospective audiences. Within the specific channels where we were most utilizing our DMP, we observed favorable trends in both customer acquisitions and cost per acquisition. Looking back at 2019, we are pleased with the progress we have made across Chewy private brands and Chewy healthcare, two areas we discussed in some detail on last quarter’s call. Both are critical components of the value proposition we offer Chewy customers and in 2020, we will build upon the momentum established last year in these two important business lines. As we look ahead to 2020, we are staying ahead of the curve and driving innovations in areas that not only enhance the customer experience, but also increase efficiency and streamline in our cost structures. One such area this year is our fulfillment network where barring any disruptions related to a broadening of the COVID-19 crisis, we are planning to launch two new fulfillment centers, or FCs, in FY 2020, starting with our new facility in Salisbury, North Carolina which is planned to launch later this month. This will be our 10th FC and will enable us to more quickly and efficiently reach millions of customers across the mid-Atlantic and Southeast region. Then, later in the year, barring any unforeseen delays or schedule changes caused by COVID-19 related government mandates, we expect to launch our 11th FC in Archbald, Pennsylvania which is currently under construction. This will be our first automated fulfillment center and we are very excited about it. This state-of-the-art facility will raise the bar on future upgrades to our fulfillment network. Over the last few years, we have made significant improvements across our fulfillment operations which we may recall is largely manual and driven by lean manufacturing principles, driving efficiency and reducing our fixed and variable fulfillment costs per unit in the process. These initiatives have yielded meaningful cost savings that over time will accelerate our SG&A efficiency curve. Automating the Archbald fulfillment center will enable us to increase throughput capacity of this building versus similarly sized facilities by more than 25%, increased labor productivity by more than 50% and as a direct result of all of the above, enable us to further lower our fixed and variable fulfillment cost per unit by over 30%. Equally importantly, it will create a safer and more productive environment for our team members to work with them. Leaning on our disciplined and data-driven approach, we made bold investments in areas where we believe we can improve experience and generate outsized returns for our shareholders, put a rigorous measurement framework around it and then aim to execute flawlessly to achieve the results. The same framework is an application here and we expect to generate attractive returns on investments we are making into our fulfillment network. As in many ways, the payback is more direct. The investments we make in driving efficiencies in our fulfillment network, which you’ll see in our SG&A and CapEx result in direct cost savings which fall dollar for dollar straight to the bottom line and our meaningful profitability accelerators. A final note on COVID-19 situation before I conclude. I touched on the demand side of this equation in my opening remarks, but I know many of you are also curious about potential vulnerabilities in our supply chain. When you look at the details of our supply chain, consumables; mostly food and treats represent over 70% of our sales. These products are sourced almost exclusively in the U.S., and we were proactive in jointly planning supply and transportation requirements with our strategic vendors. Our hardgoods sourcing is more diversified and we actively manage our inventory levels to protect against potential disruptions in the supply chain, given the long lead times from order to having the inventory on hand. Last but not least, our proactive and extensive cleaning and sanitizing procedures throughout our worksites, including our fulfillment centers and customer service sites, have thus far prevented any confirmed COVID-19 cases across our worksites, minimizing any disruptions to our network. So far, we have not seen material disruptions in our operations or supply chain. However, the situation is involving on a daily basis and we continue to monitor the impact on our business and our future plans for the business Regarding guidance, given where we are in the first quarter, we are comfortable providing guidance for the current quarter, and Mario will discuss this shortly. Given the evolving situation with the COVID-19 outbreak as well as the active risk it poses to all of us, including our partners and network, we do not think it prudent to provide full year guidance at this time. We do not take this move lightly, especially because at this time, as I indicated in my opening remarks, volumes are running ahead of our expectations from earlier in the quarter. That said, in light of the unprecedented nature of the current pandemic, the steps being taken to mitigate the outbreak and the sheer number of other variables outside our control, we believe that this is the best course of action. We thank you in advance for your understanding on this matter and we hope to be able to update you with more clarity on our Q1 call in early June. 2019 was an important year for Chewy. And while I would note that we were pleased with our IPO last June, it was just one step in a long journey. We continue to believe that we are in early stages of a large market opportunity of offering pet parents a unique value proposition. We are working towards building an enduring franchise to exceptional rigor that delivers top line growth and expanded operating margins and disciplined cash flow management. We are as excited as ever about the opportunity ahead of us and we look forward to a great 2020. Now, I will turn the call over to Mario who will provide the details on our Q4 results and walk you through our current financial outlook. Mario?

Thank you, Sumit. Good afternoon, everyone. Our fourth quarter results highlight our disciplined execution and the power of a customer-centric model combined with the convenience of e-commerce in the pet category. Fourth quarter net sales reached $1.35 billion, bringing our total fiscal 2019 net sales to $4.85 billion. Removing the impact of the extra week in the fourth quarter last year, this represents 35% growth in the quarter and 40% growth for the year driven by continued growth in our customer base and net sales per active customer. Autoship customer sales growth outpaced overall net sales growth for both Q4 and full year 2019. Autoship customer sales for the fourth quarter 2019 were $954.2 million, representing 70.4% of total net sales and reflected 40.8% growth compared to the fourth quarter of 2018. Autoship customer sales for the full year were $3.36 billion, 69.4% of total net sales reflecting 37.9% growth compared to 2018. We ended the fourth quarter and year with 13.5 million active customers, an increase of 2.9 million customers versus the end of fiscal year 2018. The increase in active customers is new customers added in the period minus any customers who have not made a purchase in the last 364 days. Net sales per active customer for fiscal 2019 increased 10.4% year-over-year to $360. As a reminder, net sales per active customer for any period equals that period’s trailing fourth quarter net sales divided by the number of active customers at the end of set period. Net sales per active customer in fiscal 2018 and first three quarters of 2019 benefited by approximately $7 to $8 dollars from the inclusion of the extra week in Q4 2018 without any corresponding increase in active customers. Q4 gross margin increased 320 basis points to 24.1%. For the full year, gross margin increased 340 basis points to 23.6%. As we have shared previously, our goal is to deliver gradual and incremental gross margin expansion on an annual basis. In 2019, gross margins benefited from growth in average order values, higher Autoship sales, increasing mix from our newest verticals and the overall leveraging of our cost structure. Q4 operating expenses, which include SG&A and advertising and marketing, were $386.8 million or 28.6% of net sales. For the full year 2019, operating expenses totaled $1.4 billion or 28.8% of full year net sales. SG&A, which comprises of all fulfillment costs, customer service, credit card processing fee, corporate G&A, public company costs and corporate payroll, including share-based compensation, total $284.9 million in the fourth quarter, 21% of net sales. Excluding share-based compensation and public company costs, such as D&O insurance and increased audit and legal services, SG&A was 17.2% of net sales in the fourth quarter of 2019 compared to 15.8% last year. For full year 2019, SG&A was 20% of net sales compared to 16.7% in 2018. Excluding share-based compensation and public company costs, SG&A was 16.8% of net sales in 2019 compared to 16.3% in 2018. We continue to aggressively manage our SG&A cost structure. The operational areas of SG&A; fulfillment and customer service, represent most of this line item. In these areas, we have successfully scaled our headcount and reduced our related expenses as a percent of net sales by 20 basis points in 2019. The rate of growth we saw in SG&A in 2019 in excess of our net sales growth was almost exclusively related to the share-based compensation and the additional professional services and other costs associated with becoming and being a public company. As we look forward, we believe we will continue to scale SG&A and that on a fully loaded basis annual SG&A as a percentage of net sales should decline versus fiscal 2019. Looking at SG&A, excluding share-based compensation and public company expenses, we expect to see positive leverage materialize towards the back half of 2020. Q4 advertising and marketing was $101.8 million or 7.5% of net sales, tailing 330 basis points year-over-year. For the year, advertising and marketing improved 230 basis points to 8.8% of net sales. As Sumit mentioned, customer retention remains strong and we are pleased that our various growth initiatives and investments in enhancing the customer experience are contributing to ongoing expansion in the lifetime value, or LTV, of our customers. LTV measures the cumulative contribution profit we derive from each of our cohorts. When we compare our customer acquisition costs, or CAC, to lifetime values on our most recent marketing investments, we are finding equal or faster payback periods that prove out the efficacy of our recent efforts. Fourth quarter net loss was $60.9 million as net margin improved to 160 basis points to negative 4.5%. Excluding share-based compensation of $45.9 million, our fourth quarter net loss was $15.1 million and net margin improved 460 basis points to negative 1.1%. For the full year, net loss was $252.4 million and net margin improved 240 basis points to negative 5.2%. Excluding share-based compensation of $136.2 million, our net loss was 116.1 million and net margin improved 480 basis points to negative 2.4%. Our Q4 adjusted EBITDA loss was $5.8 million and our adjusted EBITDA margin improved 470 basis points to negative 0.4%. For the full year 2019, adjusted EBITDA loss was $81 million and our adjusted EBITDA margin improved 480 basis points to negative 1.7%. The improvements in both adjusted EBITDA and adjusted EBITDA margin reflect our ability to grow the top line, improvements in gross margin, scaling of our advertising and marketing and improved efficiency and SG&A, all of which is consistent with our strategy of long-term sustainable growth and margin expansion. Adjusted EBITDA continues to be a managed output and that we invest the profits we earn from repeat orders and the cash we generate from managing our working capital into new customer acquisition. In Q4, we generated positive free cash flow of $60.42 million [ph] million with 74.3 million of positive cash from operations offset by $10.1 million in capital investments. Q4 is a seasonally strong cash generating quarter for us, whereas in Q1 we expect to be a net user of cash. Q4 capital investments were primarily comprised of cash outlays for IT equipment, capitalization of internal and external labor and payments associated with our new fulfillment centers in Dayton, Ohio and Salisbury, North Carolina. For the full year 2019, free cash flow was negative $2.1 million with $46.6 million of positive cash from operations offset by $48.7 million in capital investments. We ended the year with $212 million in cash and cash equivalents on the balance sheet. As evidence by our full year results, in 2019 we successfully reinvested our profits from existing customers and cash from working capital to essentially breakeven on a free cash flow basis. Now, I’ll turn to guidance. Entering 2020, our team is singularly aligned on our mission and we continue to see investment opportunities that will bolster our growth strategy and further expand our market leadership. As Sumit mentioned, the disruption caused by the COVID-19 outbreak has altered consumer shopping behavior in recent weeks. We have seen this at Chewy as concerned pet parents stocked up on necessities, like food and other essentials, and as customers shifted their shopping from offline to online channels in support of social distancing efforts. Beginning late February, we saw an acceleration in sales which has continued through today and our first quarter guidance reflects these trends. So for the first quarter 2020, we are expecting net sales between $1.50 billion and $1.52 billion, representing year-over-year growth of between 35% and 37%. To reiterate Sumit’s comments, we are still in a rapidly evolving situation, one in which we are planning and adapting to swiftly and appropriately and at this time we do not believe it is prudent to provide full year guidance. While we are not getting full year guidance at this time, I would leave you with a few things to keep in mind as you build out your models. The high operational tempo required to meet peak demand periods, like we are experiencing now, can impact efficiency on the fulfillment side. Also, when the coronavirus situation abates, we may experience moderation of demand as customers’ drawdown their stockpiled supplies. As you expect from us by now, we are monitoring all relevant metrics and would make decisions based on all available data keeping the long-term strategic goals in mind. My last modeling note is a reminder that 2020, like 2019, will be a 52-week year. In fact, we won't have another 53-week year until 2024. I will conclude by saying we are pleased with our full year 2019 results, and look forward to full year 2020. With that, I’ll turn the call over to the operator for questions. Operator?

[Operator Instructions]. Your first question comes from Lauren Cassel with Morgan Stanley. Your line is open.

Great. Thanks so much. I wanted to ask about the acceleration that you’ve seen since late February. Maybe give us some color on what the key drivers of that acceleration have been? Has it been existing customers placing large orders or ordering more frequently or have you actually seen an acceleration in new customer growth over the past four to five weeks?

Hi, Lauren. It’s Sumit. I’ll take that. So, first of all, I think as we anticipate, our business continues to be recession resilient during this time and we’re proud to be serving millions of customers who are relying on us. We’ve seen – the acceleration in demand and the elevated demand patterns are coming from both sides. We’ve seen our existing customers, 13.5 million of them, order in but we’ve also seen a meaningful lift in new customers coming in through the platform. So at this point, it’s a combination.

Okay, great. And then just any incremental color on – not specific numbers, which is sort of the cadence of the acceleration, was there a peak maybe two weeks ago when things had moderated a bit? Are you still seeing really strong demand even this week?

We are continuing to seeing strong demand through – as Mario mentioned in his script – through the end of February up until as of yesterday.

Great. Thanks so much.

Your next question comes from Doug Anmuth with JPMorgan. Your line is open.

Thanks for taking the questions. First, I just wanted to ask about gross margins. We saw the 320 basis points of year-over-year expansion. Can you just update us where you are on private label and how big you think that can become? And then anything to specifically point out in terms of where you saw some other leverage and scale with partners? And then just on the COVID-19 impact, just trying to understand kind of your view and confidence in your ability to handle the extra demand? I understand why you wouldn’t give guidance for the full year, but given the fact that you’re two-thirds through the quarter, as you pointed out, why not give a 1Q profit guide? Thanks.

Hi, Doug. This is Sumit. I’ll take that one. So private brands continue to be a strategic vector for us. We continue to see private brands grow at the rate of 1.5x. We also continue to see private brands improve their profit margin roughly 500 basis points year-over-year. And most of that was led by our focus on hardgoods, because as you remember from our strategy we are careful about going into market not creating one-for-one SKU where customers might have loyalty to certain brands but where product lines are commoditized or where we can find differentiated value proposition, we are opportunistic about offering that assortment and convenience to customers. So that’s how I would look at that. In terms of COVID – your second question was – handling the extra demand. Can you repeat the second question, Doug?

Confidence in handling the extra demand that you’re seeing in terms of fulfillment in the warehouses and then why not at least guide at profitability for fiscal 1Q.

Okay. So super proud of the internal team at Chewy at this time coming together in the way that we have. We continue to take care of our team members and our team members continue to take care of our customers. Of course, demand requires executing to it and we’re executing to our demand. We don’t have concerns. All of the controllable factors which we control and maniacally focused on and we believe our ability to execute is – and confidence towards executing that demand remains high. In terms of not guiding to profit, we believe that we’re still in a rapidly evolving situation. We’re seeing headwinds and tailwinds that might – that do not provide us the full clarity at this time. For example, we’re making meaningful investments in personnel to make sure that our employees feel valued at this time and we’re also investing in making sure that we are hiring 6,000 to 10,000 more people during this time. So our level of operation and investment is as you would expect to see during peak periods. We’ve also invested in elevated sanitization and cleaning procedures. On the flipside, if you look at the demand side, we’re seeing increased AOE [ph] and increased participation from customers but we’re also seeing an increased meaningful lift in new customers that actually – where we have to provide first time discounts and ownership discounts that are going out. And then finally, we’re just not sure of any kind of disruptions that might occur from this point onwards. So at this point we don’t believe it’s prudent to provide proper guidance.

Is that 6,000 to 10,000 you mentioned, is that all in fulfillment centers or is some of that in customer service as well?

It is primarily in fulfillment centers to handle the demand shock that we’ve seen, we’re seeing slightly elevated levels of backlog and to handle that backlog we’re upping our forecast at this point for labor, which we’re proud of. Supporting employment at this time in the marketplace is something that we’re proud that we’re doing.

Great. Thank you, Sumit.

Your next question comes from Brian Fitzgerald with Wells Fargo. Your line is open.

Thanks, guys. I wanted to ask about stock-outs and extended shipping times, what impacts that’s having on demand? It does not seem to be dissuading purchases. We’ve done some simple polling and it says, hey, I may not be getting the beef but I’m switching over to chicken, that type of thing. Can you talk about is it dissuading purchases or causing breakage or is it instead a substitution maybe into more private label, can you unpack that a bit for us?

Sure. So we’ve seen no material disruption to supply chain or customer ordering behavior. Our conversion for the most part remains intact. And the reason for that is as you intuited. Even though a small percentage of our portfolio is out of stock, most customers – two points here. One, we preempt and protect and reserve inventory allocation for Autoship customers. And then two, most customers are able to either switch into a different pattern, design or brand. So the overall loss at this point is minimal driven by other stocks. We’re also jointly deep with planning and recovery efforts with our suppliers and vendors who are being super supportive at this point.

Thanks, Sumit. I appreciate it.

Sure.

Your next question comes from Mark Mahaney with RBC. Your line is open.

Thanks. Two questions please. First, the increase in the – is it APPA estimate of pet sales, Sumit, do you have any details behind that? What would it cost them to increase their estimates, any color there? I assume you probably have a little bit of background on that. And then in terms of new customers that have come on, you’ve talked about the acceleration in growth, greater than expected growth whatever this quarter being both existing and the new customers. Do you have any read into what the quality of these new customers is like in the first four, six weeks? Are they acting like new customers have in the past? Is there anything to suggest that they are going to be less loyal, less spending in the future with you, that they are migrating faster or slower, is there anything to suggest that they’re going to act differently than your prior cohorts or is it just too early to tell? Thank you.

Hi, Mark. Both good questions. I’ll take the second one first. It is too early for us to tell. We know that we are offering the same great service and similar value proposition. Some of the core input metrics of AOE and units per order and basket size and the mixing seems very similar to our existing cohorts. But then again, we’re acquiring these customers during duress and an unprecedented time and so it’s hard for us to really calculate at this time how sticky these customers are going to be or how much similarly they’re going to behave to our existing cohorts. That being said, we are going to work very hard on our side to ensure that we have – we engender long-term loyalty from this particular cohort that we’re acquiring during this time. So that’s sort of the checks and balances that I was talking about when I was answering Doug’s question earlier as well. In terms of the first question, I think the increase is driven by a couple of different trends. One, there’s a lot more awareness about pet. And as millennials come into the marketplace, there’s a higher degree of pet ownership that we’re seeing from that segment. Number two, we’ve always known and talked about the premiumization in this space, which is actually pushing up ASPs for newer and fresher categories that are entering the marketplace right now that might mature over the next few years. Likely combination there we continue to monitor and watch this one.

Okay, that’s very interesting to hear. Thank you, Sumit.

Your next question comes from Eric Sheridan with UBS. Your line is open.

Thanks so much for taking the question and thanks for the updates, Sumit, from you and team. I hope everyone’s family and friends are well with what we’re dealing with. I want to ask a question about the data-driven marketing push. There’s been a lot of dislocation in digital and offline advertising over the last four to six weeks. You guys have made a lot of investments around data-driven marketing. Is there anything you guys are doing in terms of changing the channels where you might be allocating investments to drive positive ROI marketing decisions? Are you arcing [ph] any changes in the way you’re making investments or are you seeing any changes in ROI in the current environment? Thanks so much.

Hi, Eric. Thank you for the question. Hope you’re safe and well as well. I won’t speak to the specific channels for competitive sensitivity reasons. I will provide overall color. We have seen a strong influx of organic demand and we’re utilizing and doubling down on our relationship and content-driven marketing in this time to be able to reach consumers and utilizing those channels to be able to educate consumers not only on the benefit of health and wellness, but also on how to engage with pets during stay at home. So what that’s done to us is it’s driven – we’ve taken advantage of this period and actually scaled back on marketing where we believe it’s not prudent to overspend during this time and are banking on those efficiencies during this time fully realizing that we don’t really, really, really know the quality of the cohort that we’re acquiring, so we might have to go back and actually invest a little bit of that back into retention. But we’ll continue to be data driven and disciplined around that as well.

Thank you.

Your next question comes from Erin Wright with Credit Suisse. Your line is open.

Great. Thanks. How big is your pharmacy segment now? Does that include prescription as well as over the counter therapeutics? And are you seeing more meaningful traction just in the current environment? Are veterinarians more willing to work with you in light of the COVID disruption?

Hi, Erin. I’ll start with the second one. We’re not seeing material disruption at this point. There are a couple of things that we’re observing in the environment and the field right now. We’re seeing vets more and more either reduce their hours or reduce the availability of services to more critical type services. That being said, parasiticides and heartworm that drive primarily the share in the category, we haven’t seen – we actually have seen continued growth and acceleration across the pharmacy business for us during this time fully realizing we’re in peak. I think another thing that we are benefitted by is our scripts that are on Autoship continue to be fulfilled and we haven’t seen a drop in approval rates during this time. So on a macro level, we’re not seeing much. Heartworm prescription is where you do need to go see the vet. And if the vet is closed, if there was any impact we wouldn’t be seeing it right now because there’s a bit of a lag, because only the scripts that are expiring in the last few weeks would be subject to that particular condition. So hopefully that provides a little bit of color. Overall, we continue to see strong demand and the same acceleration in our Rx business as well. And then in our pharmacy – when we talk about pharmacy, we speak only specifically prescription. We don’t consider – we’re not counting OTC drugs as part of that.

Okay, great. And then we also noticed – this is another healthcare question, but we also noticed you had a meaningful presence at VMX this year for the first time. Are you seeing material traction when establishing those formal relationships with veterinarians and utilization of your prescription management platform? I guess, can you speak to sort of the economics behind some of those relationships directly with the veterinarians where you’ve been able to establish those?

Good question. We were at VMX because we continue to believe that we are a brand that can drive meaningful penetration into the category by educating consumers and driving more and more consumers to visit vet clinics which then expands the overall share of the TAM that is currently available, not only by increasing the visits but also increasing repeat purchase rates for prescription. On the basis of that, we were there educating – displaying our products that essentially go towards educating customers. We were also showcasing our products that we’ve developed for vet offices and for vets to be able to increase their productivity in office and also to invite them to write for PetMD, which is a tremendous asset that they engage with that provides benefit back into our customers and the vets actually are compensated for that. So there’s a lot in the evolution right now. We were pleased to be there. We will continue to talk about how we can add meaningful value and also find opportunities where we can meaningfully partner with veterinarians, but still early in the journey there.

Your next question comes from Deepak Mathivanan with Barclays. Your line is open.

Hi, guys. Thanks for taking the questions. Two questions from us. So first, Mario, can you elaborate a little bit on the first quarter guidance? March accelerated nicely compared to Feb. Are you expecting acceleration in April in your outlook? And is there any way you can kind of maybe quantify the March trends versus Feb? And then a big picture question for Sumit. Where do you think online/offline mix would be in the post COVID-19 world? Do you expect any meaningful disruption to the offline channels that could accelerate the online penetration gains in the next, say, 12 to 18 months?

Hi, Deepak. Good to talk to you. To your question on what we expect in April? Look, we just provided guidance and the fact that we are operating in an unprecedented time, and this situation is evolving as we speak. So at this time, I think we’re comfortable providing the guidance that we just shared a few minutes ago and there’s probably nothing more to add in terms of speed or velocity for April.

Deepak, hi. This is Sumit. In terms of the second question, we’ve always maintained that the data that we’ve known is that the online penetration should get to north of 20%, 25% over the next couple of years. We’ve remained bullish on that trend. We don’t know why online penetration cannot get north of 35%, 40%, 45%. And occurrences like the one that we’re in right now provide motivation and tailwinds to shift in consumer pattern and behavior. We are yet to obviously see how much of that is going to be sticky over the long term, but there’s definitely going to be an impact here over the long term.

Got it, okay. Thanks, guys. Very helpful.

Thanks, Deepak.

Your next question comes from Mark Kelley with Nomura. Your line is open.

Great. Thanks, guys. Two quick ones. The first one just on the acceleration that you’re seeing, curious if it’s concentrated in that hardest hit areas, like in New York City area or is it broader than that? And second, I’d love to hear what you guys are seeing on the advertising front given that your ad budget is fairly broad. You gave some good color on the D&P, but curious where are you seeing the biggest opportunities with less demand on the advertising front? Thank you.

Hi, Mark. Good to hear from you. No, we’re not seeing any major concentrations in the way that demand is right now segregated. We’re seeing a fairly uniformed lift across the country and we’re fulfilling that across our fulfillment centers all across the country. In terms of advertising channels, I will refrain from speaking specifically to the advertising channels again for sensitivity reasons. But we – as you would expect, people are – folks have more time to be able to engage with content-driven channels and we are fairly observant of that and we’re adapting to our strategy in a similar manner and also pulling back on channels where we don’t believe is optimal due to the organic nature of people translating their queries and therefore being able to find us in an organic fashion. Hopefully that provides some color.

It does. Thank you so much.

Your next question comes from Brent Thill with Jefferies. Your line is open.

Thanks. Just on the headcount side, if you took the midpoint of your headcount hiring, that would be a 67% increase from the February. And I’m just curious how you think about the efficiency of those hires and there’s been a lot of conversations around the cost of hiring right now. Give us a sense of how you’re able to build that out with controlling the expense scale?

We continue to see headcount leverage across our businesses that are stable and mature across corporate headcount, and we’re very prudent and very disciplined in the way that we invest for that headcount. To give you a perspective, we’re a company of somewhere between 13,000, 14,000 employees and our corporate even at this point, at being the scale that we are, is roughly 1,200 people. So most of our investments are in fulfillment and customer service and we are continuing to invest in our fulfillment capabilities and customer service to be able to service customers because that really is our moat in the way that we earn trust and maintain long-term loyalty.

And when you think about the positive momentum you’re seeing, does that give you more conviction to experiment and look at adjacent spaces where you’re out or you say in this period just stay focused on your core mission right now which is the core products you’re serving today?

We continue to remain focused in making sure that experience is protected and our services are coming across to customers in a high-fidelity, high-accuracy manner.

Great. Thanks.

Your next question comes from Nat Schindler with Bank of America. Your line is open.

Yes. I think my question might have been touched on at several other places, but as you’ve seen an acceleration in Q1 particularly as we’ve come into stay-at-home and work-at-home environments, are you also seeing a drop in the marketing costs to acquire those customers both from the fact that there are more customers coming in the door? But additionally, have other companies pulled out of marketing channels that have allowed you to now make less expensive options available?

Both of those assumptions are correct. I won’t go into quantifying each of them versus the other, but yes there is a higher degree of marketing efficiency and a greater yield and the dollar invested is going much farther. But then again, remember we are not sure of the quality of the cohort that we’re acquiring. So we stand ready to ensure that we’re engaging with customers and reinvesting for long-term retention purposes.

Well, I know you said that there was a little bit of what you think of this kind of panic buying or hoarding mentality that people were building up supply. Of your new customers coming in, were they of the similar percentage that were signing up for your Autoship as normal?

More or less, yes.

Okay. Thank you.

Your next question comes from Oliver Wintermantel with Evercore ISI. Your line is open.

Thanks very much. Just on the existing customers that are now spending more, is that more ticket or traffic? So in other words, is it more – do they spend more or do they just come more often right now? And the related question to that is of the sales, is that mostly consumable or do you also seen hardgoods and pharma sales?

Hi, Oliver. This is Mario. I’ll take that one. It’s a combination of both; so existing customers buying up some bigger baskets and also placing orders. In terms of what we’re seeing in the mix of what they’re buying, it is as in the past we see a larger uptick – greater percentage of the sales being on the consumable side is the kind of behavior you would expect if you’re stocking the pantry.

I can provide some more color there. So you’re seeing essentials as number one. We’re seeing – with also the pet adoption trend that’s up, so a lot of new pets being brought home we’re seeing a healthy uptick on the hardgoods side, everything that a pet parent would need to service that need. And then the category that might be really impacted at this time across the industry is truly discretionary spend, such as pet tech.

Your next question comes from Dylan Carden with William Blair. Your line is open.

Thanks very much. Just curious, reading some things to suggest things, particularly like fostering and adoption is maybe up in this environment. Are you seeing – of the new customers coming in, can you tell how many of those are actually new pet owners as well? And then can you just remind us sort of what happened in the last recession as per the acceleration in this space, sort of what drove that and what maybe you’re expecting from here?

Could you repeat the question please? We didn’t quite catch it.

Sorry about that. Just curious if you’re seeing any – of the new customers coming in, in this environment, if you can tell how many are – is also new pet owners and if there’s any sort of reason to suggest that might be a stickier long-term customer? And then why the industry itself accelerated in the last recession, what was sort of the driving force behind that?

So we haven’t really gone back to the drawing board and pulled that data. It would be dependent upon customers creating a pet profile and telling us really how many are new pet parents or – it’s a little bit harder to sort of really get at that right now as we’re focused on really handling the demand shock and making sure that our experience and fulfillment remains intact. On the increase, the fact that the nature of this business is recurring staple purchases and during this time attention and care for pets actually goes up, a combination of all of that is what in our mind maintains and drives the spending patterns during times like these.

Ladies and gentlemen, we have reached the end of the allotted time for the question-and-answer session. I would turn the call back over to management for closing remarks.

Thanks all for the continued interest in Chewy. Please stay safe, stay healthy and we will talk to you again in June. Thank you.

This concludes today’s conference call. You may now disconnect.