Good day, and welcome to the Chewy Third Quarter 2021 Earnings Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Robert LaFleur, Vice President of Investor Relations. Please go ahead.

Thank you for joining us on the call today to discuss our third quarter 2021 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 earlier today, have been posted to the Investor Relations section of our website, investor.chewy.com. On our call today, we will be making forward-looking statements, including statements concerning 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-19. 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-Q and 8-K 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 financial measures to the most directly comparable GAAP financial measures are provided on our Investor Relations website and in today's SEC filings. These non-GAAP measures are not intended as substitutes for GAAP results. Additionally, unless otherwise noted, results discussed today refer to third quarter 2021, and all comparisons are accordingly against the third quarter 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. Demand and customer engagement remained strong throughout the third quarter. Q3 net sales were $2.21 billion, adding 24% growth on top of strong comps last year. These top line results and our continued growth this year demonstrate the durability of our business model and the overall strength of the pet category. Our metrics, measuring demand and customer engagement, such as site traffic, new customer acquisition, order volume, order size, purchase frequency and net sales per active customer or NSPAC were strong throughout the quarter. We ended Q3 with 20.4 million customers, a year-over-year increase of 15%. Consistent with the trends we have seen throughout 2021, gross customer adds continue to exceed pre-pandemic levels and retention rates continue to track in line with historical levels. More importantly, the strength and quality of our new and active customers continues to improve. For example, we estimate that the expected lifetime values of the Q3 2021 new customer cohort is 12% higher than the pre-pandemic counterpart. Additionally, third quarter Autoship customer sales as a percent of net sales increased 140 basis points to 70.6%, reaching a new company high. And last, but not least, the average order value for new to Chewy customers was 6% and 13% higher than the Q3 2020 and Q3 2019 cohorts, respectively. These positive new customer behaviors flow through to NSPAC, which is an important gauge of overall customer engagement and lifetime customer contribution. Here, we are pleased to share that the third quarter NSPAC increased 15% to $419. This reflects year-over-year growth of $56 which is a record increase for us. It is exciting for us to see NSPAC growth accelerate as a large 2020 cohort matures and our expanded customer choices and increased…

Thank you, Sumit. Our third quarter net sales were $2.21 billion, representing 24.1% growth. On a 2-year stack basis, year-to-date net sales through the third quarter grew by more than $3 billion or 80% versus the same period in 2019. As Sumit mentioned in his remarks, demand remained strong throughout the quarter, while inflationary pressures, product shortages and labor constraints made execution challenging. Shortages of wet dog food persisted, while out-of-stock levels in areas like third-party and proprietary branded hard goods also increased. As a result of these, the negative impact of supply shortages in Q3 net sales was approximately $15 million more than our internal expectations. Third quarter Autoship customer sales increased 26.7% to $1.56 billion, faster than overall net sales growth and up 80% on a 2-year stack basis. Third quarter Autoship customer sales as a percentage of net sales increased 140 basis points to 70.6%. This improvement in Autoship penetration rate reflects maturation of the 2020 customer cohort in Autoship's unmatched value proposition, including free access to Connect to the Vet. Third quarter net sales per active customer, or NSPAC, increased $56 or 15.4% to $419. On an absolute dollar and percentage basis, the year-over-year NSPAC improvements were the largest in the company's history. We expect NSPAC growth to remain strong for the balance of 2021 as we continue to successfully grow customer share of wallet across all cohorts. Our strong NSPAC performance is a clear indication of the health of the underlying customer demand that continues to drive our top line results. We had 20.4 million active customers at the end of Q3, an increase of 14.7% year-over-year. As a reminder, net customer adds are a function of new customers added in the period and the retention of customers acquired in prior periods. Consistent with our…

[Operator Instructions]. Our first question will come from Doug Anmuth with JPMorgan.

Sumit, maybe you could just talk about customer acquisitions a little bit. I know you said they remain above pre-pandemic levels. I'm not sure if you quantified perhaps at all relative to the 20% growth that you talked about in the first half of the year. And then related to that is your view on the higher LTV for the current cohort, is that essentially just driven by the higher NSPAC that you're seeing early on for that cohort? And then just perhaps on the cost side, any sense of visibility or how you're thinking about timing around easing of freight cost and product cost inflation, labor and I suppose the competitor pricing dynamics as well?

Sure, Doug. So three questions. In terms of quantifying the ratio or the volume of acquisitions, they remained within range that we've reported before, Doug, so not much to report there. The exciting trend continued to be on the NSPAC side without any concern on the acquisition side is the way that we interpreted the business in third quarter. And so on the LTV, we're projecting or estimating this on 2 bases. One, yes, on the way the customers are interacting with NSPAC. So for example, when you look at the cohort now that has completely matured 1 full year the cohort of customers that we acquired even last year, when they've lapped the full year, they're actually spending roughly $420 in NSPAC, which is higher than the 3 quarter cohorts when you compare them to 2019 levels by a reasonable amount. So that's sort of a data point on indication. Number two, we're looking at customers engaging with Autoship and the way that they're building baskets and the way that they're interacting with our other verticals, institutions that we're launching. So a combination of all of that is how we're sort of estimating or predicting LTV. And usually, we're fairly good at -- we're fairly accurate at this point. Because this is also something that we guide in the background to be able to make marketing investments, which then guide their LTV to CAC ratios in the way that it spins and amplifies our investments in marketing and the customer acquisition. And then that spins the NSPAC [indiscernible] et cetera, et cetera. Your last question on cost and timing. So costs, we're really seeing -- just to summarize, we're seeing 3 different types of costs. One is in terms of the flow of material domestically and internationally, what hit…

Our next question will come from Steph Wissink with Jefferies.

Can we have two rated questions about marketing. The first is just on your marketing efficiency. It seemed like there was a nice step-up in efficiency in the quarter. I'm wondering how sustainable you think that is. Is that related to ad rates or just better precision around the money you're spending? And then related to that, I think you mentioned in your prepared remarks, there were some shortages that accounted for about $50 million of maybe missed revenue in the third quarter. Did you pull back on marketing because of shortages? Or was there an opportunity maybe to lean a little bit more heavily into marketing or can you in the coming quarter to try to drive either actives or NSPAC?

Steph, it's Sumit. I'll take that one. So your read on marketing in Q3 is exactly right. It was a combination of both ad costs reverting from their Q2 highs as well as the team executing just on a more targeted and just executing sharp. And we provided the details in the script around the way that we demand generated across certain audiences and the way that our propensity modeling kicked in to be able to generate greater efficiency, which we also saw when customers came through our website. If you were to quantify the 2, I would say, likely a 65-35 sort of ratio where ad costs probably were responsible for 60% of the improvement, 60%, 65%. And then the rest was our own efforts. In terms of sustainability, so far, Q4 is coming in line with our expectation. So we'll continue to monitor this. And any investments that we've baked in are already reflected in the way that we were providing guidance today. And yes, of course, when out-of-stocks escalate, it does reflect directly in the way that we go to market and spend marketing towards that particular set of assortment that then drives customer acquisition. So there was definitely opportunity, probably a few more million dollars that we could have spent in marketing. But outside of that, we optimize marketing to the full extent.

Our next question will come from Mark Mahaney with Evercore ISI.

Okay. I apologize, I came in late. I hope these aren't repetitive questions. At the end, you talk about a new road -- the last 2 road map components, one is non vet services. Could you just remind us again what would be in there? Secondly, on the Trupanion deal, are you disclosing any economics around that? And how should we interpret that? Our guess from Evercore's part is that, that should be a nice over time and nice gross margin boost for you. But if you could explain -- talk through that and who's going to own the customer relationship or who's going to record the revenue maybe that would be a useful way for us to think through the gross margin impact of that deal.

Sure. Mark, this is Sumit. Your first question was the -- okay, the non-vet services. So on non-vet services, we interpret that market to be everything that is not related to health care services, which is boarding, grooming, puppy training, anything that you would like to add in there in that regard. So we anticipate or estimate that to be roughly $10 billion to $14 billion in TAM. And the way we think about it, I think I'll just add a note here. Our entry here will not -- we will not have to prepare our business and our teams to enter this vertical from scratch. And in that way, the investments that we've made in developing our architecture and technology around health care solutions, you should -- the best way to think about that is we're creating a scalable and dynamic platform that allows us to reach customers. And on the other side of the platform today in terms of the business provider, you could consider a veterinarian. But tomorrow, we could very -- we could efficiently extend that same service to a different service provider such as a groomer. And so in that way, it's not a net new effort on our part, and it's a matter of focus and prioritization. And that's why we say it's a matter of when and not if. Now coming to the second part of your question in terms of insurance. So a couple of different things there. We haven't disclosed the deal structure in its entirety or detail, and we'll have more detailed conversations when we get closer to launch in the spring timeframe. But what I can tell you today is that the deal is a combination of cash and equity. And we will essentially respect Trupanion's IRR guidelines and allowing them to stay within their IRR guidelines and extracting a maximum value against that, some in cash and some in equity. And we will utilize the cash, which will essentially be -- you can view that as cost of marketing or acquisition to be able to fund the growth in business, to be able to drive customer conversion, education awareness. And we are essentially providing the customer base and the platform, and Trupanion is underwriting the policies.

Our next question will come from Brian Fitzgerald with Wells Fargo.

You kind of talked to us a little bit, but I wanted to ask about the reduction of the high end of the annual revenue guidance range. Could you walk us through the key factors influencing your thinking there? Is that supply chain issues and stock-outs or the need to get a little slower in marketing despite the improved efficiencies you're seeing given the various supply chain issues, cost pressures, SG&A and so forth. I want to drill down a little bit on the key drivers there.

Sure. Brian, it's Mario. So I'll take that question. Look, as we said in the opening remarks, the consumer is healthy, demand was strong. Site traffic, conversion, customer acquisition, order volume, basket size, purchasing frequency, all those are strong and we see positive trends in the third quarter. What we're doing with the guidance is we're acknowledging what we're seeing in the market. And as you said, out-of-stock remains a persistent in certain part of the catalog. So coming into the third quarter, we expected additional capacity to come online in the wet food category specifically, and that has yet to happen. In fact, supply has become more constrained than it was in the second quarter. So I think you're exactly right. The short answer to your question is, that our updated guidance is simply just reflecting the facts, the reality on the ground. Now keep in mind that we have continued to provide top line guidance throughout the entire pandemic. And even with all the macro uncertainty that has been around supply chain and labor, we've been exceptionally accurate. If you look at our net sales guidance range and where we've come in, we have either hit or exceeded our guidance range for the -- since we went public, by the way. And in the last 2 quarters, we've been right in the middle of the very tight guidance range. So again, what we're doing is reflecting the reality on the ground when it comes to supply.

Our next question will come from Deepak Mathivanan with Wolfe Research.

Just a couple of ones from us. So first, on the NSPAC side, you're seeing nice benefits from the maturation of large COVID cohorts this year. But as we go into next year, what will be the main drivers of sustained NSPAC growth? I mean can NSPAC continue to grow at these rates as some of the larger cohorts mature further? And then the second question on the cost side, thanks for all the color on the cost side, in response to Doug's question. Could you elaborate on 2 areas? One is the aggressive competitor pricing that you noted in the prepared remarks. And then the second, the increase in freight cost that's kicking off in January. Maybe some color on how much they contributed to gross margin and how we should think about some preliminary expectations for gross margin trends for next year.

Deep, it's Mario. So I'll start off and maybe Sumit can touch on the second part of your question. So in terms of NSPAC, let me not comment on 2022 just yet. But what I'll tell you is this, if you look at what's happened this year, Sumit touched on this in one of his answers just a few minutes ago. We've had the maturation of our 2020 cohort, which is very large, and it's proven to be a more engaged early on cohort than prior than if we look at, for example, 2019. So we're seeing their first year revenue or purchases with us to be even higher than the 2019 cohort. If you then turn to what we're seeing this year. Cohorts that we've acquired in 2021 are showing that their first order is even higher than the ones from last year, which already was higher than the year before. And in fact, it was about 6% higher than what we saw customers purchase in the initial order in 2020 and 13% higher than 2019. Factors that are driving that of course, it is we expand the catalog. We've gotten better at our -- at the selection we're providing to our customers. We certainly have provided a broader set of categories. And we've talked about that in terms of our proprietary brand catalog and the development in that area, which tends to focus on the white space. So products that are not in the market that we create and offer to our customers. And of course, our pharmacy business, which is doing very well, and the more customers get exposed to and buy from our pharmacy, the bigger the NSPAC. All of that is absolutely evident in our revenue breakdown that we show in the 10-Q. If you look at our other category, which includes proprietary brand and pharmacy, that's growing at almost twice the speed as the rest of the business. So think about it that way. There are -- there's catalog expansion, there's category expansion, and we're just getting better at presenting the customer with what they want, when they want it, which means that their -- we can continue to expand NSPAC. And Sumit, if you want to touch on the [indiscernible] contract.

Deepak, you had two questions in your second question. I'm not sure I fully followed the competitive pricing comments, I'll have you repeat that, but let me offer you the FedEx answer first. So logistics companies, as you know, were very clear in their recent earnings call that they were looking to raise rates in 2022. And we recently completed negotiations on a new contract that goes into effect in January, and we will see outbound shipping rates in 2022 go up under this calendar. That said, we're pleased with our new contract as pleased as we can be and believe that our new rate card, while higher and it remains favorable relative to the broader market. It's too early to quantify the impact of gross margin, impact of these higher rates, given the many factors that will ultimately drive our outbound freight costs in '22 including volume, average shipping distance and others, plus we're very actively still dealing with many macro uncertainties and constraints. So we'll have more details to share with you in the next quarter when we provide 2022 guidance.

Got it. Yes. Sumit, the first part was, basically, you noted one of the factors of gross margin that impacted gross margins were aggressive competitive pricing. Is that just related to the product inflation that you're not seeing some competitors kind of follow in the marketplace? Or is there something else, maybe one competitor is being aggressive with prices more broadly?

Is that a Q3 question you're asking? Or is that a carryover from Q2 that you're asking about?

Q3 question.

Because the -- all we're essentially saying is that there is a delay between MAP and cost inflation increases given the -- because it takes some -- it takes a little bit of time on the online channels for the MAP pricing that determines the floor in the market and the prices to reflect that. Plus if you notice the range of the cost inflation that has come through, that usually needs to be piecemealed back into the market, so as to not impact demand or momentum. Any pricing comment that I believe was made in the past has been in relation to muted pricing environment or the lack of promotions and discounting given the supply chain constraints. And we've seen that obviously starting to abate a bit, but it normally does as you exit Q3 into Q4 because it's a more seasonal and demand-elastic period. But on the balance, that phenomenon or that effect has not gone away yet.

Our next question will come from Dylan Carden with William Blair.

Just curious the comments about stable NSPAC fourth quarter to third quarter. Was that meant to be in dollar terms or sequential or annual growth. I'm just curious when the sort of churn overhang eases. Should we start seeing that by the fourth quarter? Or do we really need to get into 2022? And then finally, related on the gross adds running higher than sort of pre-pandemic levels. Do you attribute that to still some benefit in that there's some broader sort of consumer anxiety and being in stores? Or do you think that's actually now at this point, more organic online migration?

Dylan, this is Mario. Maybe I'll start and maybe Sumit can add some to my answer. But when it comes to the stable NSPAC, I'm not sure -- I don't think I mentioned that. I don't think I said that. So maybe I'll ask for a clarification on that one. Maybe, let's start there.

Yes. Sorry, that might have just been me being distracted. I thought the comment was that NSPAC growth would be stable 3Q versus 4Q. And I was just wondering if that was in dollar terms or if you think maybe you'll get 15% sort of steady-state growth into the next quarter?

So actually, I would maybe flip that, Dylan, and say that we expect NSPAC growth to continue to be strong through the rest of the year. That's maybe more of the takeaway there. You can see that in our sales guidance and obviously where we're trending in terms of active customers for the year. In terms of the overhang, you really have to get into 2022. And the reason being is that when we look at the 2020 cohort, very large cohort like we talked about before, it was pretty evenly spaced throughout the year. And so any first year into second year attrition that we normally see with every cohort from the beginning of the company, we're going to see that happen throughout this year. So the impact will continue to be through 2021, and we should work through that as we enter 2022.

Great. And then I was just curious on the sort of the comments around gross adds being above pre-pandemic levels to what you attribute if that's more organic online migration or still some benefit from sort of the environment that we're in?

Yes. So maybe I'll touch on this one and then Sumit if you want to add anything. But part of it is we are investing more. You can see that in our financials to drive -- to help more people find us. But it is the shift to online that we are not only benefiting from, but also we're helping customers find the -- find us and find the products and the services they need online.

Yes, Dylan, we're not -- this is not -- I don't think it's apples and oranges compare. So we're purely comparing organic state that existed up until 2019 to the same organic state, and I don't believe we're getting any benefit from the pandemic movement or the ongoing pandemic in this particular case.

Our next question will come from Lauren Schenk with Morgan Stanley.

This is Nathan Feather on for Lauren Schenk. I know in the past, you guys have talked about being more of a price taker in the market. Given the inflationary environment, is there any change in your price strategy? Or is that broadly similar? And then are you able to quantify to what extent you're flowing through this increased cost and prices? Or how much that delay between the change in MAP pricing and the actualization within prices affects revenue.

Sure. Not much more to add than what I've already provided context. So at the risk of being slightly redundant, we are reflecting in one of our tenants, the most competitive prices that we can be at, which is usually respecting MAP guidelines. So -- because we believe that's an important tenant to retain customer trust in the marketplace and through -- and in relation to our brand. The comment on MAP and the cost and price catching up, we're not estimating yet the number of quarters it might take us. But in certain large consumables brands, MAP's already reflected and fully caught up. So I think we will have to go and observe this on a piece-by-piece and a portfolio-by-portfolio basis. It will also depend upon the demand and supply balance between in the way that inventory flows through or supply becomes available in the marketplace in how quickly or how much of a lag there exists in the way that this corrects itself. So as we play through Q4, we'll come back and educate you and share with you more in the -- on the March earnings call relative to that.

Our next question will come from Eric Sheridan with Goldman Sachs.

Maybe just one question on the health side of the equation. You gave the stat around 15% as the overlap between core customers and health customers. Can you give us a little bit sense of how you want to align investments, especially on the marketing side to drive adoption of the health initiatives and create a sort of larger Ven diagram between the customer sets as we look out to '22 and beyond?

Eric, this is Sumit. I think the mental model is very much aligned to investing as heavily as we can up until the point that we see a return. So this is, as you know, is a legacy category. And the rate of migration towards online has been muted up until the point we believe we've credibly improved the customer experience on the online side, and therefore, we're driving sort of a rate of migration towards online, which is different than what consumers have enjoyed or are used to as it comes to buying dog food or their accessories online. So there's a little bit of that, that impacts this particular conversion that we're driving. In that way, we're balancing investment, the conversion and the returns that we're getting. Now of course, we've mentioned in the past that health care customers are more profitable than higher LTV, given the stickiness and the longevity of the need state that we're serving there. So that naturally also suggests that the LTV of a customer is higher, and therefore, we tolerate a higher marketing cost on a per customer basis in health care as well. But again, it goes back to the methodology of LTV to CAC and we don't have a specific budget that we spend to. We spend as long as there is a return that we can find. Overall, this is an enterprise-level priority for us. And we're -- what you're seeing us do here is we're leaning in, offering many different choices. So if you're interested in insurance, we can offer you that. If you're interested in telehealth, we can get you to that. If you just have a pharmacy prescription need, we can serve you the best customer experience in the market right now. If you would like to subscribe to veterinarian diet, we can do that as well. And so overall, you should think about us building an ecosystem that has many tentacles and attracts customers through many different dimensions and keep them within that ecosystem and connect it in a closed-loop manner across the veterinarian community is the way that we would grow health care.

And Eric, this is Mario. So 2 quick things. One is welcome back. It's good to hear you, your voice. Number 2 is, last time we spoke about the overlap, it was about 10%. We had said -- so you can see the progress we're making and getting more of our customers to shop across more categories on our platform.

Our next question will come from Seth Basham with Wedbush Securities.

My first question is just around the gross adds that you mentioned. So you said that they're higher than 2019. Last quarter, you said that the first half was up about 20% versus 2019. Year-to-date now, are they still up 20% versus 2019?

Yes. I think -- so Sumit answered that question a few minutes ago that it is -- they're still about in line with what we had shared with you before.

So in line with the rate of the second quarter or 20% versus 2019?

It's not a metric that we're planning on repeating every quarter. I think the perspective was important and slightly different when we shared it last time, but mostly customer adds continue to run above 2019 and very much in line with what we've seen so far throughout the rest of the year as well throughout the preceding year as well.

Got it. Okay. And my follow-up question is just around the supply product constraints that you mentioned, which were more pronounced on the branded side of the business. But I don't think you called out private label mix shift being a positive driver of gross margin like you did last quarter. Can you square away those two things?

So private label was a driver. If you look at the overall hardgood growth, 3P hardgoods grew at about 8% year-over-year, but private label grew 32% year-over-year, taking share. And so the private label component is also where our import supply chain kicks in. And as a result of the disruptions, we were, in fact, delayed in launching some assortment that we had planned to launch in Q3 and in Q4, which is, of course, reflected in the elevated out-of-stock numbers that we've quoted here in Q3 and that we're baking into the guidance. But on a growth basis, private label in Q3 grew at 32% and the penetration remained between 18% and 20% levels.

Our next question will come from Peter Keith with Piper Sandler.

Looking at the guidance now for EBITDA margin to be flat, I guess, we're calculating Q4 EBITDA margin is going to decline about 300 basis points year-on-year. So I'm wondering if -- is this kind of the low point for margin decline because there's maybe some nuances to Q4 with hardgoods or freight wages. Could you just kind of help frame that up for us? Or is this the pressure that certainly could continue into next year?

The answer essentially lies in a combination of how do we see -- so far, right, if you break down Chewy's progress, through our IPO, gross margin has expanded 700 basis points. Marketing has scaled roughly 400 basis points. And SG&A was on track of scale up until we started absorbing the cost that has come through the pandemic. So in terms of the way you should think about EBITDA moving forward is we still have room to expand gross margin along with the balance of dealing with headwinds of obviously rising freight costs and the inflation that we talked about today. In terms of marketing efficiency, we continue to deliver that. And so that brings us back to EBITDA -- brings us back to SG&A, where we've essentially incurred roughly $100 million of investment in 2020. And up until the point the labor markets kind of relax or the imports get better, it's hard to assess the health and state of SG&A as of this point. And all of that is baked into the EBITDA guidance for the year. If there's a more specific question, happy to answer it.

Sure. Maybe I'll just focus specifically on gross margin. You're not guiding for gross margin. But it seems like what you're talking about with ocean freight pressure in the competitive environment that gross margin is going to be abnormally pressured in the fourth quarter. So can you confirm that? And then are these pressures peaking in the fourth quarter? Maybe hardgood mix come down a little bit as we get into the early part of next year, and so the overall gross margin pressure abates somewhat.

Certainly, this is Mario. So I won't comment on 2022 just yet. But it's what we talked about when we explained the Q3 results and how some of the challenges on the cost side are not abating just yet for the fourth quarter. So let's take that off the table and say, look, we expect that to continue in the fourth quarter. If you compare it to -- so that would obviously affect gross margin. If you compare it to last year -- Q4 last year, we also had a, let's call it, a onetime item or a special item that was a $16 million reserve release that flowed through to EBITDA. So you have to take those 2 things off the table. And then you say, okay, what else is new this year? Well, we have the higher labor costs that are still affecting us, and we expect it to continue into fourth quarter. We expect that to abate -- we expect that not to abate in the second half. However, it did not abate in Q3, and now we're expecting to continue into Q4. And in fact, for Q4, we expect it now to be $13 million as opposed to the roughly $15 million that we had guided to or had spoken about and when we did the second quarter call. So take the onetime item off the table, you say gross margin continues to be somewhat pressured in the near term. And then you have the higher labor cost and that kind of gets you the maths on fourth quarter.

Our next question will come from Rick Patel with Credit Suisse.

I'm hoping we can zoom out and we can talk about how you see NSPAC trending in the future relative to your IPO plan. So historically, I believe when you acquire a new customer, year 1 spend is between $150 to $200, jumps to $300 in year 2 and so on. But the curve has obviously shifted higher. So just curious what's the right way to think about spend for newer cohorts as we think about their multiyear journey with you?

Spend to acquire those customers? Or you mean their spend? Yes, the NSPAC. Yes. So I answered this question a few minutes ago. I won't comment on 2022 and beyond at this point. But I can tell you that what we're seeing from customers that we acquired last year and that we acquired this year is that their NSPAC curves are shifting up. One of the things that we talked about before is that the way we improve LTV to CAC for our customers over time or accelerated payback period is by acquiring more of the share of wallet earlier, moving up the NSPAC and making every order more profitable. We're doing exactly that. Over the last 2 years, you've seen us expand gross margin by 300 basis points roughly. And year-over-year, we're looking to increase gross margin. You've seen us also increase NSPAC. And we've talked about specifically for cohorts in 2020 and 2021 and how their NSPAC is moving up. So normally, we are grabbing more of the share of wallet from those customers, then also moving out the overall curve and we're making those orders or those dollars more profitable. All of that helps us in the payback period. All of that helps us in improve the LTV to CAC. And so these are very good indicators for us this early on in their journey.

Our next question will come from Chris Bottiglieri with BNP Paribas Exane.

So first one is just more high level on the Trupanion partnership. Should we view this as an isolated high-margin revenue stream? Or are there meaningful synergies with your broader health offering? Trying to understand if there's incentives in place for insurance to use telehealth, Rx drugs or even to like refer some of these pet insurance customers towards Practice Hub. Can you give us any sense of the strategic view there would be helpful.

Sure. So we believe the value of insurance is dual fold. Presently, pet insurance in the U.S. is 2% to 3% penetrated versus markets such as U.K., where the penetration, as I was mentioning, was north of 25%. So we view this as a huge opportunity to open up TAM. Additionally, we expect -- we even expect insurance to be a profit center in itself. But in addition to that, we also expect it to drive greater customer engagement, brand loyalty, and greater consideration for health care purchases that happens on or through our platforms, like the ones that you're alluding to. Now we aren't -- we have a lot of innovation left. We will launch in spring and kind of go on a state-by-state basis. So there's going to be many opportunities for us to have these type of conversations as we come and share sort of the plans that we're bringing to market, the value proposition behind that plan, the way that we will perhaps think about go-to-market or marketing strategy in a way that we talk to customers and veterinarians, which I believe will provide more light to some of these questions that you're asking. But broadly speaking, what you should walk away with it is it's a long-term play. We expect it to drive greater engagement and greater consideration for health care purchases that happens on or through our platforms.

Got you. That's really helpful. And then just the last one, I'm not sure if you can answer this or willing to answer it. But can you give us a sort of sense that there's obviously a difference between MAP pricing and the hardgood side. Can you give us a sense of either cost inflation or price inflation, how that compares between the 2 and overall, I think just throughout retail, we're seeing somewhere between 4% and 7% inflation in a lot of our categories. Just trying to get a sense of where that stands for pet and how that's impacting NSPAC.

That's actually a pretty good range. Our upper end of the range lies all the way up to 9%, but that's a fairly -- you've banded it fairly well.

This concludes our question-and-answer session. I would like to turn the conference back over to Sumit Singh, CEO, for any closing remarks.

Thank you very much. We hope you have a happy, healthy and safe holidays. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.