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Earnings call: Chewy's net sales surpassed expectations reaching $2.88 billion

EditorLina Guerrero
Published 05/29/2024, 02:24 PM
© Reuters.
CHWY
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Chewy, Inc. (NYSE:CHWY), a leading online retailer of pet products, reported robust financial results for the first quarter of fiscal year 2024, with net sales surpassing expectations at $2.88 billion, marking a 3% year-over-year increase.

The company highlighted strong customer loyalty, particularly in its Autoship subscription service, which contributed to 77.6% of net sales. Chewy also announced a share repurchase program of up to $500 million and provided positive guidance for the second quarter and full-year net sales, with an emphasis on strategic initiatives such as the Chewy Plus membership program and expansion into Canada.

Key Takeaways

  • Chewy's Q1 net sales hit $2.88 billion, a 3% increase year-over-year.
  • Autoship program sales reached a new high, contributing to 77.6% of net sales.
  • Gross margin improved to 29.7%, with adjusted EBITDA of $163 million.
  • Free cash flow exceeded $50 million, and a $500 million share repurchase program was announced.
  • Q2 net sales are projected to be between $2.84 billion and $2.86 billion.
  • Full-year net sales outlook maintained at $11.6 billion to $11.8 billion.
  • Adjusted EBITDA margin is expected to be between 4.1% and 4.3% for the full year.

Company Outlook

  • Chewy provided a cautiously optimistic view on the pet industry's normalization.
  • The company is confident in executing its strategic roadmap, which includes the Chewy Plus program and expansion efforts.

Bearish Highlights

  • Margins are expected to decline sequentially throughout the year, mainly due to increased advertising expenses.
  • Some recent cohorts have higher churn rates, which the company aims to improve.

Bullish Highlights

  • Positive customer trends with higher response rates and an increase in new and reactivated customers.
  • Strong growth in non-discretionary categories and record-breaking Autoship sales.
  • Signs of more pet adoptions than relinquishments for the first time since 2022.

Misses

  • Despite positive trends, Chewy acknowledges the need to enhance its assortment and proposition in certain hard goods categories.

Q&A Highlights

  • CEO Sumit Singh discussed the positive response to sponsored ads and the focus on improving gross margins.
  • CFO David Reeder highlighted the improvement in product mix and scaling of the business as drivers of gross margin increase.
  • Executives noted the optimistic outlook for Chewy's vet care clinics based on response rates and demand trends.

Chewy's first-quarter performance demonstrates a strong start to the fiscal year 2024, with sales growth and profitability indicating positive customer engagement and strategic execution. The company's focus on customer loyalty and retention, as well as its expansion into new markets and services, positions it well for continued success in the evolving pet industry.

InvestingPro Insights

Chewy, Inc. (CHWY) has shown a commendable financial performance in the first quarter of fiscal year 2024, with several indicators pointing to a solid foundation for future growth. Here are some insights based on real-time data from InvestingPro and InvestingPro Tips:

InvestingPro Data highlights Chewy's market capitalization at approximately $9.35 billion, reflecting the company's substantial presence in the online retail space for pet products. The data also shows a P/E ratio of 233.04, which suggests that investors are expecting high future earnings growth despite the company trading at a high earnings multiple. This is further supported by a revenue growth of 10.17% over the last twelve months as of Q1 2024, indicating a healthy expansion in sales.

An InvestingPro Tip that stands out is Chewy's ability to hold more cash than debt on its balance sheet, providing the company with a strong liquidity position to navigate market uncertainties and invest in strategic initiatives. Additionally, analysts predict that Chewy will be profitable this year, which is a significant milestone for the company, especially considering that it has been profitable over the last twelve months.

For readers interested in a deeper dive into Chewy's financial outlook and performance, there are additional InvestingPro Tips available. These include insights such as analysts having revised their earnings downwards for the upcoming period, which could impact investor expectations, and the company trading at high valuation multiples in terms of EBITDA and Price/Book.

To gain access to these valuable insights, readers can visit InvestingPro at https://www.investing.com/pro/CHWY and use the coupon code PRONEWS24 to get an additional 10% off a yearly or biyearly Pro and Pro+ subscription. With 8 additional InvestingPro Tips listed, this is an opportunity to stay ahead with comprehensive analysis and data-driven investment strategies.

Full transcript - Chewy Inc (CHWY) Q1 2024:

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Chewy First Quarter 2024 Earnings Call. All lines have been placed on mute during the presentation portion of the call with an opportunity for question-and-answer at the end. [Operator Instructions] I would now like to turn this conference call over to our host, Jennifer Hsu, VP of Investor Relations. Please go ahead.

Jennifer Hsu: Thank you for joining us on the call today to discuss our first quarter results for fiscal year 2024. Joining me today are Chewy's CEO, Sumit Singh and CFO, David Reeder. Our earnings release, which was filed with the SEC earlier today, has been posted to the investor relations section of our website. In addition to the earnings release, a presentation summarizing our results is also available on our site at investor.chewy.com. On our call today, we will be making forward-looking statements, including statements concerning Chewy's financial results and performance, industry trends, strategic initiatives, share repurchase program and the environment that we operate in. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks, uncertainties and other factors described in the section titled Risk Factors in our quarterly report on Form 10-Q filed earlier today and in our other filings with the SEC, 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. 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, which were filed with the SEC today. These non-GAAP measures are not intended as a substitute for GAAP results. Additionally, unless otherwise stated, all comparisons discussed on today’s call will be against the comparable period of fiscal year 2023. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of the audio webcast will also be made available on our investor relations website shortly. I'd now like to turn the call over to Sumit.

Sumit Singh: Thank you, Jen, and thank you all for joining us on today's call. We kicked off the year with strong performance achieving solid top line results, record breaking profitability and robust free cash flow. First quarter success is a testament to the unwavering dedication and hard work of every Chewy team member, collectively delivering on our mission to be the most trusted and convenient destination for pet parents and partners everywhere. With that introduction, let's dive in into first quarter results. Q1 net sales exceeded the high end of our guidance range increasing by approximately 3% to $2.88 billion. Two key factors contributed to this performance: first, our customer's loyalty in non-discretionary categories such as consumables and health remain strong accounting for approximately 85% of our Q1, 2024 net sales. Second, Autoship customer sales achieved record levels totaling $2.2 billion and representing 77.6% of net sales. The convenience and value of our Autoship program continues to resonate with customers and Autoship customer sales growth outpaced our enterprise average, yet again increasing 6.4%. Our Autoship customer base remains healthy and is continuing to grow. Further, on the topic of customers this quarter, we saw some encouraging customer trends. The work we have been doing to sharpen our already strong value proposition, for example, through pet type personalization began to pay off this quarter. Our efforts are driving higher response rates and had a positive effect on net new customers as well as reactivated customers, which were particularly strong in the quarter and up mid-teens relative to the prior year period. Notably for the first time since 2022, both new customer acquisition and reactivations modestly exceeded our internal expectations in Q1. Progressing through the P&L, we set new records for the company across our profitability metrics. Gross margin for the quarter of 29.7% exceeded expectations as we benefited from the continued strength of our growing sponsored ads business, a higher mix shift into healthcare and a rational promotional environment. Additionally, there were some one-time items that benefited our P&L this quarter, which they will elaborate upon later in this call. We generated $163 million of adjusted EBITDA, representing a 5.7% margin supported by our strong gross margin performance and rigorous OpEx management. Across the company, teams at Chewy are executing methodically on all the controllable elements of our business in a highly disciplined manner. Finally, we generated more than $50 million of free cash flow in the quarter from both a profitability and cash generation perspective, we believe that we have reached an exciting inflection point in our business. Significant free cash flow generation coupled with our strong balance sheet enables us to financial flexibility to deploy our capital in a variety of areas. As we have always done, we will continue to invest in strategic initiatives across our business that supports our long-term growth and margin objectives. Additionally, as Dave will describe in more detail, we believe we have the cash generation and surplus to begin returning a meaningful portion of our cash to our shareholders. Now I'd like to provide an update on some of Chewy's strategic initiatives and innovations. I'm excited to share that earlier this month, we launched a compelling paid membership program, which we are calling Chewy Plus. Chewy Plus offers a range of benefits including free shipping, cash accrual rewards and exclusive member perks. The program is currently in its beta state and throughout the year, we will explore different test and learn approaches to understand how it impacts discovery of our growing products and services, wallet consolidation and NSPAC acceleration, all while maintaining economic sensibility. We are excited about the program and look forward to sharing more over the coming quarters. Turning to Chewy Health, we are excited to share that since our last earning calls where we announced the launch of our first Chewy Vet Care clinic, located near our company headquarters in Plantation, Florida, we have opened three additional Chewy Vet Care clinics, two locations in the Greater Atlanta, Georgia area and one in Denver, Colorado. With four locations opened today, we are excited to bring to market several more clinics later this year, reaching the high end of our stated range of four to eight clinic openings in 2024. We remain focused on our ability to attract talent and our capacity to generate strong demand for our veterinary services. And although it is early days, we are pleased with the performance across both areas. Clinic staffing and vet NPS scores remain strong, suggesting to us that our unique value proposition is resonating with that. As it relates to demand generation, we are encouraged by the early signs of success we are observing. Net new customers to Chewy and appointment utilization are both trending better than our modeled expectations. Moving to our sponsored ads business, our ads business continues to ramp well, delivering on the planned product roadmap of new digital products, while offering our partners a compelling and high ROI channel to deploy their marketing dollars. As we articulated at our Investor Day long-term, we see our sponsored ads business scaling to approximately 1% to 3% of net sales at attractive flow through to the bottom line. Lastly, our expansion into Canada continues to ramp in line with our expectations. We rolled out customer facing features such as mobile app and additional payment options as planned this quarter. Additionally, we continue to expand our assortment, particularly in categories such as premium consumables. Customer awareness and demand continues to gradually build. Customer NPS remains high and we remain focused on scaling a quality business underpinned by programs such as Autoship and personalized customer care. With the pet category continuing its migration online, we believe we are well positioned to become a meaningful player in the Canadian market over time. In closing, our Q1 outperformance underscores our ability to successfully navigate this period of normalization for the pet industry. Moreover, we are cautiously optimistic that pet household formation trends are progressing in the right direction. Based on data from our shelter and rescue partners, we saw healthy growth rates in Q1 adoption on a year-over-year basis, and for the first time since 2022, we observed a positive balance between adoption and relinquishment. While it is premature to declare an industry turnaround, we maintain our perspective that the pet industry is on track towards normalization. Meanwhile, we remain confident in our ability to execute against our strategic roadmap and to deliver compelling results for our shareholders. With that, I will turn the call over to Dave.

David Reeder: Thank you, Sumit. To start, I will take us through our Q1 financial results and then turn to our capital allocation strategy and outlook for the balance of the year. First quarter net sales grew 3.1% to $2.88 billion, exceeding the high-end of our guidance range. Broadly in line with expectations, active customers declined marginally on a sequential basis to approximately 20 million modestly exceeding our internal expectations. Importantly to note, we believe that we are seeing early but positive signals with respect to macro pet household formation and we believe that our enhanced CRM initiatives are beginning to bear fruit. Net sales per active customer at NSPAC pack reached $562, reflecting an increase of 9.6%. NSPAC growth meaningfully outpaced our overall top line growth, driven by our ability to increase wallet share, as customer cohorts mature and continued strong engagement, particularly in programs like Autoship and expansion into new categories, namely within Chewy Health. Our scaled Autoship business continues to be a pillar of strength and differentiation for Chewy, driving predictable subscription like revenue. Autoship customer sales came in at $2.2 billion in Q1, representing 77.6% of our total net sales in the quarter, up 240 basis points on a year-over-year basis. We reported Q1 gross margin of 29.7%, representing 130 basis point increase year-over-year and 150 basis point increase sequentially. As Sumit previewed, Q1 gross margin benefited from certain one-time items, such as the timing of vendor reimbursements, lower fuel costs and lower-than-expected promotionality. Adjusted for one-time items, Q1 gross margin would have landed at approximately 29%, reflecting approximately 60 and 80 basis points of year-over-year and sequential improvement, respectively. On a year-over-year basis, our sponsored ads program was the largest driver of our gross margin improvement, followed by product mix as Chewy Health and premium consumables net sales penetration expanded. These benefits were partially offset by normalized discounting environment. It is worth a reminder that in Q1 2023, the promotional environment was operating below historical levels. Moving to OpEx, please note that my discussion of SG&A excludes share based compensation expense and related taxes. OpEx for the quarter continued to scale nicely with revenue. First quarter SG&A totaled $533.1 million or 18.5% percent of net sales, representing 50 basis points of improvement on a year-over-year basis and 150 basis points of improvement sequentially. This leverage was driven by our continued disciplined management of payroll with headcount across both our corporate and fulfillment network team members moderating favorably throughout the quarter and ending Q1 lower than planned. Additionally, we drove greater efficiency from our personnel in areas such as customer service and delivered improved cost management of G&A expenditures. First quarter advertising and marketing expense was $186.8 million or 6.5% of net sales. I would note that we expect our advertising and marketing expense to run closer to the high-end of our stated 6% to 7% target throughout the balance of the year, due to the timing of certain marketing campaigns. First quarter adjusted net income was $137.1 million, representing a 56% increase year-over-year and a 71% increase sequentially. Finally, we reported an adjusted EBITDA margin of 5.7% for the quarter or 170 basis points of margin expansion relative to Q1 2023 and 260 basis points of margin expansion sequentially. Adjusted EBITDA margin for the quarter exceeded our expectations due to better-than-expected gross margin and lower OpEx in the quarter as I described earlier. Overall, we are incredibly encouraged by the operating leverage we are unlocking in the business, which demonstrates the scalability of our cost structure. In turn, this leverage enables us to invest in a creative growth and profit initiatives. In the first quarter, we've reported free cash flow of $52.6 million, reflecting $81.9 million of net cash provided by operating activities and $29.3 million of capital expenditures. We ended the quarter with more than $1.1 billion in cash, cash equivalents and marketable securities and we remain debt free with a strong liquidity position of $1.9 billion. In light of our expanding free cash flow generation, I would like to share an update with you regarding our capital allocation strategy. Reinvesting back into the business towards high ROI opportunities remains our first priority. Our strong balance sheet further provides us with sufficient firepower to pursue value accretive acquisitions and strategic investments if and when such opportunities arise. Having taken all of this into account, we believe our growing cash position affords us the ability to further enhance shareholder returns by way of implementing a share repurchase program. Today, I'm excited to share that our Board of Directors has authorized Chewy's first ever share repurchase program of up to $500 million. In light of our strong balance sheet track record of margin expansion and long-term strategy, which we expect will continue to deliver incremental profitability. We believe share repurchases offer a compelling and accretive use of capital, while also enabling us to mitigate the dilutive impact related to share based compensation. We intend to commence repurchasing shares this quarter and look forward to providing you with updates as we progress through the program. Now, I'd like to turn to our second quarter and updated full year 2024 guidance, while we are seeing certain green shoots and demand trends, we believe it is premature to revise our view on the pet industry's overall outlook for the balance of the year. We are however incredibly pleased with our team's execution, irrespective of environment and our ability to exceed expectations with respect to profitability. With that, we anticipate second quarter net sales of between $2.84 billion and $2.86 billion, or approximately 2% to 3% year-over-year growth, and we are maintaining our full year 2024 net sales outlook of between $11.6 billion and $11.8 billion or approximately 4% to 6% year-over-year growth. As noted last quarter, this range includes the impact of a 53 week 2024 fiscal year and the 53 week will be fully reflected in the fourth quarter of 2024. Moving to profitability guidance, we are raising our full year 2024 adjusted EBITDA margin guidance to a range of 4.1% to 4.3%. This reflects 20% plus adjusted EBITDA flow through at the midpoint of our guidance ranges, notably above the average of 15% flow through that we expected to deliver on a per annum basis. Similar to the 2023 quarterly profile, we expect first quarter results to represent the high point of 2024 adjusted EBITDA margin, and we expect margin to decline sequentially throughout the year, averaging to the aforementioned guidance range. We continue to expect full year capital expenditures in the range of 1.5% to 2% of net sales and free cash flow conversion to remain above 80%. Before we open the call to questions, I'd like to reiterate that we are incredibly proud of our strong start to the year. We continue to believe that Chewy is exceptionally well equipped to execute against our strategic roadmap, deliver compelling results and drive shareholder value. I'd like to thank all of our dedicated Chewy team members for their collective efforts and execution in the quarter, as we advance our enduring mission of being the most trusted and convenient destination for pet parents destination for pet parents and partners everywhere. With that, I will turn the call over to the operator for questions.

Operator: [Operator Instructions] Our first question comes from the line of Trevor Young of Barclays.

Trevor Young: First one on the net ads improving a bit Q-on-Q versus the prior trends and appreciate some of the commentary on the improving macro. Should we still contemplate kind of a softer two -- 1H and a back half inflection? And is that really a kind of a 2H uptick or is it more so a 4Q story? That's my first question.

David Reeder: Yes. Similar to the guidance or consistent with the guidance that we provided last quarter. Year-over-year, we expect active customers to be pretty flat slightly down in the first half with some recovery in the second half, but very consistent with what we said last quarter. Did you have a follow-up?

Trevor Young: And on the launch of the four vet centers, how should we think about measuring progress there? What sort of guideposts are you going to give us in the coming quarters to kind of track that ramp? And how many quarters do you expect a typical center to get to EBITDA breakeven?

Sumit Singh: This is Smith. I'll start on and Dave might add here. So, as we've articulated in the past, there are a few dimensions that we are viewing success from. The inputs that we will be highly focused on are customer satisfaction scores, both across sort of key customers to Chewy or customers to Chewy and to vet -- for the veterinarian community. Number two is our ability to recruit staff and retain veterinarians. So it's demand generation, vet retention and recruitment. And the third one is operational execution throughout these clinics. And so far what we are seeing, we're actually happy with our clinics are fully staffed. We have a good building pipeline for future clinics that we're contemplating at this point. And so, as we roll these through the initial returns, as we've sort of mentioned in the earnings script around net new customer acquisition traffic or demand generation trends or web recruitment trends, they're all trending positive. In terms of returns, this is not a multi-year, observation period. This is likely a few quarter observation period and we'll be back with more. Dave?

David Reeder: I'd reiterate what Sumit said, and I would just add that, as we're currently running ahead of our internal models and we do still expect towards the end of this year to release some type of white paper after we get a little bit more learning through the testing process here. But I would say cautiously optimistic on the initial clinics that we've launched.

Operator: The next question comes from Rupesh Parikh of Oppenheimer.

Rupesh Parikh: First just on the share buyback program, I'm just curious how you approach share buybacks, is it more of an opportunistic strategy or more of a consistent cadence to offset dilution?

David Reeder: From a share repurchase perspective, I think I'd start with we're going to be in the market this quarter here in second quarter. We're very, very pleased with our cash generation. Last year, we delivered well over 80% conversion of EBITDA to cash. We've guided again for this year to do the same. So very happy with our current balance sheet position of cash, $1.1 billion and our future cash generation. With respect to how we'll be in the market, we think this is an attractive valuation at this stage. So we have plenty of capital. We have the authorization from the Board. We have the willingness to enter the market and I think you'll see us enter the market on the share repurchase side both opportunistically as well as somewhat consistently and methodically. So we'll do both. Did you have a follow-up Rupesh?

Rupesh Parikh: Yes. Just one follow-up question. So as we look at the hard goods category, so it declined this quarter. As you look at the category, are you guys seeing any green shoots in hard goods at this point? Or is it -- or do you expect challenges to continue in the near-term?

Sumit Singh: This is Smith. So yes, your observation is correct about us being able to arrest sort of declining trends that we've been seeing. So we saw a couple of things, from an industry point of view, this is sort of the encouragement that we pushed through in the script as well. Search volume for hard goods was up, intent was up. And after a long period, we saw consumers return with specific categories that they're declaring intent for. This is likely tied to the adoption and relinquishment trend that was mentioned in the script, so these inputs kind of moved together. On our side, we saw traffic -- our traffic has continued to increase in the low to mid-single digit every period this year. And year-to-date, we're up about mid-single digits as well. Secondly, we saw the rate of hard goods decline arresting inside the company. We've actually cut it by to the tune of high teens to the low 30% start from where we started the year. So it's encouraging and we're not sort of resting. We know the environment will take a little bit of time to normalize here. So everything that is controllable on our side, we've put our best talent on this type of stuff. We are looking at turning all knobs and levers, while being economically sensible about how we both generate demand as well as maximize demand conversion for our categories. That's a general comment for the way that we're going to play through 2024 and especially true for hard goods.

Operator: The next question comes from Doug Anmuth of JPMorgan.

Doug Anmuth: Sumit, you talked about sponsored ads being the biggest driver of gross margin upside. Maybe you can just talk a little bit about the early feedback that you're hearing from marketers and do you have any thoughts on quantifying the impact here early on? And then second, just on Chewy Plus, anything you can add on how the rollout might proceed going forward? And how that kind of interacts with Autoship?

Sumit Singh: Sure. I'll make the gross margin question a bit longer, Doug. So, just kind of fair warning. But let's start with the question that you asked. So sponsored ads, we're seeing good response curve. Last quarter, I mentioned us bringing forward even more products to life, such as branded search ads on the platform. We've done that now. We've improved and increased the inventory as well as improved on the efficacy of return that we are seeing internally. And the demand that flowed through in first quarter were stronger than our forecast. And so all of that is positive. We're on track to exit the year with the low end of the 1% to 3% range that we've guided for, which is consistent with what we communicated a few months ago. So, all is good on this side. In terms of -- just if you back out and sort of look at the forest from the trees here, so to say, gross margin improvement has been a journey over the last few years, right? And we've consistently talked about the building blocks of gross margin starting from strong NSPAC development, premiumizing the business, achieving stability in the economies of scale, improving freight and logistics. All of that, the work that we've been working through sort of the last three, four years is starting to culminate and then there are these newer green shoots, such as sponsored ads, which are now starting to compound the yield that you're seeing pass-through right? So overall, we remain bullish on the gross margin story. We haven't yet started talking about our private brands business, credibly, which is something that we're excited about. Our other components of our health businesses are native or nascent, though they're both native and they're nascent. And we're excited about the potential that they might contribute in the future. So there's a lot of irons in the fire, and we're excited about the gross margin journey here. Number two, Chewy rollout and how it interacts, is that Autoship?

Doug Anmuth: Yes.

Sumit Singh: So that's a great question and a very insightful one. We believe, first of all, we're being very thoughtful. We've invited in beta a cohort of customers, which is well represented across they're buying kind of behavior and their pet type. And we've also sort of diversified the thinking across Autoship and non-Autoship customers. We see these two really nested and complementary to each other. I mean think of a -- I mean, why wouldn't you be attracted to a message that says, hey, here's a paid membership program that gives you all of these perks. And by the way, if you want even greater savings and convenience subscribe to Autoship and the whole thing just compounds on itself. And vice versa, Autoship can be an attractive funnel of entry, which it currently is and then you essentially approach customers with saying, look, like the price of the program is less than what you pay for a latte. And for all of this, you get all these great benefits. So we believe the behavior is that we want to sort of incent and observe are consistent in terms of repeat purchase rate, NSPAC, basket building engagement and so forth and so on. Lots to learn in front of us, but so far, we're thinking of these as complementary programs.

Operator: The next question comes from the line of Eric Sheridan of Goldman Sachs.

Eric Sheridan: Maybe if I could just ask a two part. When you see the environment you're characterizing with respect to customer dynamics. Can you give us a little bit better sense of what your priorities are on the marketing side? When you think about the SKU of either acquisition of new net customers versus retention or incentivizing behavior among existing customers that might maximized for ROI against those marketing investments? And then the second part would be you talked about marketing being towards the upper band of what you've historically talked about in just a range. Is that brand spend? Is that lined up against plus following up on Doug's question? Or how would you characterize what's pushing the upper band of that spend, as we go through this year, just so we know what that sort of aimed at?

Sumit Singh: Sure. Eric, this is Sumit. I'll start and Dave might add pertinent. So a good question on the current dynamic and marketing priorities. Think of it this way. We're focused on -- first of all, these are two independent efforts around new customer acquisition as well as the CRM reactivation or retention of cohorts. They're led by two teams. And the redundancies are avoided when we make sure that we're not passing the same customer back and forth to, right? So we're being careful about that. So now when you look at the marketing efforts, you could essentially think of this as a full funnel marketing effort. So we are building awareness up in the upper funnel. And our awareness and our familiarity levels have increased several hundred basis points, particularly as it comes to Gen Z and the millennial segment, which is something that we were internally focused on and something that we're happy about. So as a result of that, we want to capture incremental traffic that comes to the website. So we are spending to capture that incremental traffic. And once you come to the website or when customers declare kind of intent at the lower funnel, then they're primed for conversion which the efforts that we're putting across our site then allows you to sort of say what type of conversion do we want? Is it a net new conversion? Or is it an existing customer that wants to convert to a highly lucrative or a high LTV type of category. So it's the full funnel effort that we're essentially spending money across. You recall a couple of quarters ago, perhaps two quarters ago, I had mentioned to you that we now have the ability to segment and target our cohorts because we rebuilt the entire content platform internally inside the company. And so that allows us more precise targeting once we identify a customer even with the loss of kind of targeting because we have fingerprinting IT that we can sort of associate the customer back to an account or back to their browser behavior per se. So this type of work is exciting to us in the future. And as the market kind of recuperates or shows signs of recovery, we hope and we believe that this will compound and generate greater returns. In terms of the marketing spend, look, I mean, it's a tight range, 6% to 7%. And so the variance is not that much. There's a lot of year to play through and we want to retain the option value of, a, making sure that all of the nascent efforts that we've got going on, if we see the need to invest, we can essentially lean in and do that or if we see the market change in 1 direction, the other that we can respond to that.

David Reeder: Yes. And perhaps just for clarification of the guidance. In 2023, advertising and marketing was about 6.7% of sales. We've historically guided from 6% to 7% of net sales. First quarter just due to some timing of some marketing campaigns, it was a little bit lower. It was about 6.5%. And so for the remainder of the year, what we articulated in our prepared commentary was that we would be towards the higher end of the 6% to 7% range for the rest of the year, landing ultimately probably in a spot that's somewhat similar to 2023.

Operator: The next question comes from the line of Nathan Feather of Morgan Stanley.

Nathan Feather: So in 1Q, still came in a bit above your guidance. Where did you see that outsized strength, anything you can share on how that evolved over the quarter, given the green shoots you called out along with 2Q quarter to date?

David Reeder: Sure. Let me start and then, Sumit, if there's anything you want to highlight feel free. First quarter, as you highlighted, we ended up from an EBITDA margin perspective at 5.7% gross margin percentage of 29.7% so due to some one-time items primarily in gross margin. And if you exclude those items, we would have ended at about 29% and that's what we articulated in the prepared commentary. When you think about the underlying drivers that's driving the gross margin increase from Q1 of last year to really, let's call it a normalized Q1 of this year. It's really our improvement in product mix, which we expect to continue as we work through time here. We are mixing up our business being led by sponsored ads, also being led by health care and within health care pharmacy. So we do continue to accrete product margin and product mix which is averaging up our business, which, of course, gives us the confidence that we presented at Capital Markets Day in December of last year. So ultimately, over time get to that 10% EBITDA margin marker that we placed out there. And so on a go-forward basis, really, I would summarize by saying continued improvement in product mix, continued scaling of the business and the scaling of the business is really associated one with our fixed cost infrastructure, which is at scale and more of a kind of run maintain mode at this stage, although with ongoing productivity improvements and our digital infrastructure, which is also at scale, albeit with continued improvements and rollouts and capabilities and features. So improving product mix, scaling infrastructure, increasing margin and profitability. Did you have a follow-up, Nathan?

Nathan Feather: Yes. Just -- and as we think about the top line guidance, what would exceeded there for 1Q? And then anything you can share on kind of the quarter-to-date in 2Q, how those green shoots are kind of flowing into your progress?

David Reeder: Sure. So from a top line perspective, I would say, broadly in line with our guidance, obviously, at the high end of the range or slightly above the high end of the range. As we look across the outlook for this year, I would say that our sentiment is pretty much very much in line with what we communicated last quarter for the full year, which is why we held our guidance for the year of $11.6 billion to $11.8 billion. And as we take a step back and we say, well, what did we see that leads to the commentary that we think the industry is continuing to normalize and maybe there's a precursor to green shoots that we're seeing in the market. Number one, for the first time since 2022, we had more adoptions versus relinquishments in our pet shelter data that we received from the many pet shelters around the U.S. that we collect data from. So that was a positive signal and then also internally specific to Chewy, for the first time since 2022 as well, we actually exceeded our own internal models and forecasts for active customers and that was really driven by net new customers as well as by reactivations of prior customers. So those are the two metrics that we're kind of looking at that we're seeing, I would say, some signs of normalization in the industry. It's probably premature to determine that the industry is going to be fully normalized this year. But certainly, we're seeing what we think are signs of green shoots.

Operator: The next question comes from the line of Steven Forbes of Guggenheim Partners.

Steven Forbes: Sumit, realizing it's probably early but you sound pretty optimistic about the vet care clinics. So I was curious if you could maybe speak to what you're seeing in regards to the customer journey new versus existing chewy.com account members repeat trends, transfer rate right over to other product categories? I mean what's sort of underpinning the excitement and the optimism around maybe a more accelerated rollout.

Sumit Singh: Steve, I'll try to satisfy your curiosity, might not be able to get into it in too much detail, but let's look at it. So why I sound optimistic is because we believe the inputs are thoughtfully planned and designed, and the outputs are responding as expected or better than our plan. So what are these inputs? A, as you know, we're very thoughtfully designed the clinic, both the sort of the infrastructure as well as the experience that we're providing to the customer, it's modern, it's customer forward, it's veterinarian forward. And so it's just -- we expect to be able to cash in on the tailwind. And you're seeing that, right? Response rates have been really good, customer NPS is really strong, vet NPS is really strong. Number two, what plagues the industry is really vet recruiting. And in parallel or very next to it is vet retention. Vets are stressed capacity is going to continue to out or under run the vet demand. And so from that standpoint, getting the team that is motivated is very important and we believe we have the right attractive value proposition to be able to attract vets. And then three, when we look at demand generation trends, when we look at the sell-through rate of the membership plans in the clinic, when we look at new customer versus existing customer mix. When we look at the repeat purchase rate of appointments that have been signed up, these are all indicative kind of metrics that suggest future larger building and more profitable business. So it's a bit of a long-winded answer, but hopefully, you understand sort of the -- how we're evaluating the inputs and what our expectations are.

Steven Forbes: That's great to hear. And then maybe just a quick follow-up for David. I was just -- maybe if you can maybe expand on the expectation. I think your comments for margins to decline sequentially throughout the year, if I heard you correctly, I get the step-up in advertising expenses that you guys have called out very specifically. But maybe just help us on what would be the incremental pressure on margins 3Q over 4Q, 4Q over 3Q?

David Reeder: Sure. And for clarity, you're referring to EBITDA margin or at least I was referring to EBITDA margin in the prepared commentary. So first, let me kind of start at a high level. We're just incredibly excited about our ability to drive continued Autoship penetration as well as continuing to provide product mix shift into areas such as sponsored ads and health care. And if we continue to perform and execute as we did in the first quarter, then we're going to have a very good year and we would expect to be aligned more towards the high end of our range versus the lower end of our range. From a seasonality perspective, if you look at 2023, we did guide that the profile this year would look similar to that. So I think kind of a step down in EBITDA margin from kind of the first part of the year all the way through the fourth quarter of the year would be somewhat normal and customary of a normalized market. And so that's what we've kind of indicated. And then finally, talking about the lower part of the range. The lower end of the range would really require something significant softening in either macroeconomic environment or the pet industry or perhaps a more aggressive promotional environment, which are all things that we're not currently seeing. And so we feel good about what we delivered in first quarter, we feel good about the long-term trends for us to continue to product mix up our business, both in sponsored ads into health care and pharmacy ultimately into vet clinics as well. And we think the year from a profile perspective looks pretty similar in 2024 to what it looked like in 2023.

Operator: The next question comes from the line of Michael Lasser of UBS.

Sachin Verma: This is Sachin Verma on behalf of Michael Lasser. The question is when do you expect your year-over-year customer counts turn positive? And longer term, what would drive higher e-commerce penetration in the category, given the growth that I've seen in the last few years?

David Reeder: Maybe I'll start on year-over-year customer counts and Sumit, please chime in if you have anything to add. And so as we mentioned last quarter, we did expect this year to be relatively flat from an active customer account with a little bit -- a little bit weaker, kind of flat to slightly down maybe in the first half, flat to slightly up in the second half. But ultimately, for the full year period, looking pretty flat 2024 to 2023. In terms of what we saw in the fourth -- in the first quarter, we saw kind of exactly what we expected, albeit with one slight difference. And that was that we actually exceeded our internal forecast with respect to active customer count driven by both new customer adds as well as an increase in reactivations. And then in addition to that, as I mentioned, it feels like that we're starting to see normalization in the industry from an adoption versus relinquishment of pet perspective. That's certainly the data that we saw from the shelters, so positive on that front as well. So from what would turn customer accounts positive versus maybe the trends that we've seen over the last couple of years, we have mentioned a couple of times over the last several calls that really we needed inflation to normalize. And that inflation in the market normalizing would free up kind of discretionary income for consumers would give them the ability to then become additional pet parents in the future. And then as more of the market moves online, we would be disproportionately favored in that scenario. And so when we talk about normalization of the market, what we're really referring to is normalization of pet households, normalization of inflationary pressures that are putting discretionary spending with the consumer under pressure, so normalization of that. And I would say that we're currently seeing -- I think what we're seeing is some green shoots with respect to that normalization that we've been talking about. Sumit, anything you'd add?

Sumit Singh: On the question on the why would higher e-commerce penetration continue? Well, look, I mean, the core insights around customers not wanting to love heavy product back from retail stores, dog food bags are heavy. Cat litter pills are heavy and inconvenient. And so the convenience of transacting through the online channel remains a value proposition that continues to propels the migratory trends from retail to online. Online is expected to reach 45% or north of 45% over the next few years. And the second thing is when you look at delivering personalized experiences, the way that you can deliver personalized experience via digital sort of touch points technology is much better and we do a much better in the way that we understand customers, put them through the high-touch ecosystem that we have and keep them and retain their trust and develop and nurture their interest over time, et cetera, et cetera. So overall, we're bullish on e-com penetration trends continuing from this point onwards.

Sachin Verma: And my follow-up is, how do you plan on growing revenue without increasing your customers this year is growing and NSPAC a sustainable strategy?

Sumit Singh: This is something that we've talked about in the past as well. It looked like unlike a fixed subscription model, right, where you must have customers to continue your growth at Chewy share of wallet, it has been a bit of an underappreciated strength of the ecosystem. So first -- and the second point is we're not shifting our focus away from customer addition to share of wallet. We believe in combining the power of customer addition to share of wallet, right? Our pet lives for 12, 14, 15, 18 years. During that time, a pet and a pet parent spend anywhere from $1,200 to $2,500 with an average of $1,600 to $1,800 of LTV, and we have shown the power of growing that NSPAC. It grew over 9.5%. And this quarter reaching $562, which means that right now, we're capturing about 1/3 of the NSPAC in the market, roughly about 20% of our customers are health customers and they continue to mix in into the overall pool of customer bases, right? Our other businesses are fairly nascent. So we are bullish and expectant of growing our net sales per active customer number. And at the same time, when you look at net ads, that's comprised of three different components: acquisition, retention and reactivation. Our reactivation engine is firing on all cylinders, so we're happy about that. In terms of retention, we're seeing better retention in cohort behavior. We saw lower churn come into the quarter from a year-over-year point of view. So we were pleased with that. And then finally, on acquisition, as Dave was explaining, right now you essentially have a shallower pool of customers that are not declaring intent given inflation is still pretty high, food and treats are suppressed and discretionary categories haven't yet sort of recovered. So broadly speaking, the value proposition of Chewy continues to resonate really loudly, whether it's price selection and convenience or whether it's overall personalization and customer intent capture. So we remain bullish.

Operator: The next question comes from the line of Seth Basham of Wedbush.

Matt McCartney: This is Matt McCartney on for Seth. I was hoping you could give some more color on behavior for existing cohorts, just specifically on the recent cohorts, just how they're trending relative to historic levels in terms of retention and their NSPAC maturation?

Sumit Singh: Sure. Not much deviation from the trends that we've seen. We continue to see customers lean into health related categories. We continue to see customers lean into condition based and premiumized categories, treats and toys continues to be sort of muted given the pressure, but we're seeing kind of strong performance across other categories. In terms of -- when you take a look at our cohorts from back half of 2022 and project cohort membership retention for 12, 15, 18 month time frame, each of these cohorts is in the positive in the low single-digit percentage point range relative to past cohorts or relative to pandemic cohorts. So that is definitely encouraging. So broadly speaking, Matt, not much more to comment relative to what we've already said on the call today.

David Reeder: Yes. I would just build on that and say that one very positive trend that we're also seeing is that new customers signing up for Autoship is some of the highest that we've seen in the company. So that's another positive signal for us with respect to the new cohorts. Did you have a follow-up?

Matt McCartney: Yes. Just so I was wondering, specifically on your ability to target specific cohorts with your new CRM. I know it's pretty early, but are you seeing benefits from that program yet in terms of retention? Or when might those sorts of benefits materialize here?

Sumit Singh: We are seeing benefit. We're seeing benefit both in terms of improvement in second purchase rate as well as in reactivation. Both the programs are run out of our CRM teams. We're also seeing greater participation on the Chewy app business, which is up multi-fold on a year-over-year basis.

Operator: The last question comes from the line of Lee Horowitz of Deutsche Bank.

Lee Horowitz: Maybe one on share and then just a follow-up on users. I guess on share, it strikes us that given the success you guys are seeing in health care, you're most certainly taking share in that vertical discretionary in hard goods, you seem to have decided to not chase bad share in that vertical and perhaps seeing some there. Then I guess that leaves consumables, which grew about 2% in the quarter. Would that likely -- that number likely a bit higher given some contribution from health in that line of your business? Can you help us better understand how you think Chewy share in the consumable category is progressing at the moment and how you expect that to evolve through the course of the year?

Sumit Singh: Sure. I'll start with a higher-level commentary. If you look at the market growth in Q1, it ranged from negative 2% to positive 2% to 3%. That's sort of the range in the market relative to the players that we're observing. And we generally have a fairly good read of demand in the marketplace. We're obviously sitting on the high end of that and therefore, the share story is consistent, right? We will take share this year. Now when you break that down, I would reframe the way you positioned our intent in discretionary and hard goods. It's not that we're not chasing. In fact, we remain competitive as a team and we're seeing positive green shoots in that category relative to where the industry performed in at least half of the categories, right? The other half, we're still focused on making sure that as I mentioned in the past, there are certain categories that we just need to make sure that our assortment and proposition resonates loudly with a hard goods in discretion. So we're absolutely focused on it. And then in consumables, we held share in the kind of the value segment, you could say and then we gained share across all or premium segments and consumables. So that's -- it's a bit of -- it's a positive story overall, but there is a bit of a range depending upon the customer segmentation and the cohort that you see.

David Reeder: Did you have a follow-up, Lee?

Lee Horowitz: Yes. Maybe one follow-up on users. We talked a lot about reactivation and new acquisition exceeding your expectations with green shoots in terms of household formation. But I guess overall customer declines, I guess, steepened in the quarter. Can you maybe just talk a bit more on how churn is progressing at this point? And I think, Sumit you talked about churn down churn improving year-on-year. But I guess, how does that fit relative to reactivations and the acquisition being the bigger outperformer in the quarter? And I guess, how you think churn should progress through the balance of the year? Any more color maybe helpful.

Sumit Singh: Sure. I can see kind of what you're trying to correlate here. So here's the deal. So our reactivations was up mid-teens as we said year-over-year. At the same time, our net new acquisition was higher than the reactivation rate, right? So I just want to be clear about that, that reactivations aren't surpassing net new acquisition, right? Our acquisition is continuing to be held back by the amount of customer share -- customer intent declaration in the discretionary categories, right? So there is a pool of customers that's missing there that will add to the trend that we're seeing or connecting to industry normalization. Then you come to churn. So the statement is true that churn was down year-over-year, yet the -- if you recall, we had signaled that our cohorts in the last three years or so are churning right, at rates that are low to mid-single digit higher than our legacy cohorts, right? And so that number hasn't reversed materially given that we're still playing through those cohorts but the green shoots that we are seeing is in the back half of 2022 cohorts, which are sort of more out of the pandemic cohorts per se. So year-over-year trending is better, but there's still a healthy base that we need to sort of arrest at the bottom, which continues to normalize alongside us.

David Reeder: Yes. And perhaps just for some helpful color. Churn in Q1 of ’21, it's a decline in absolute numbers from the churn and percentage for that perspective churn from Q1 of '23, and it's down from a churn of Q1 of 2022. And it's, of course, it's down sequentially from Q4 of '23. So all data points that kind of, again, kind of point to some of those early green shoots that we believe we're seeing in the normalization of the industry.

Operator: Ladies and gentlemen, this now concludes today's call. I'd like to thank you all for joining. Have a great rest of your day. You may now disconnect your lines.

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