Chewy Q1 2025 Earnings Call Transcript

Quartr
Provided by Quartr
May 29, 2024

There are 10 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Chewy First Quarter 20 24 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. I would now like to turn this conference call over to our host, Jennifer Su, VP of Investor Relations. Please go ahead.

Speaker 1

Thank you for joining us on the call today to discuss our Q1 results for fiscal year 2024. Joining me today are Chuy's CEO, Sumit Singh and CFO, David Reeder. Her 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 website at investor. Chewy.

Speaker 1

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.

Speaker 1

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 was 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.

Speaker 1

Finally, this call in its entirety is being webcast on our Investor Relations Web site. A replay of the audio webcast will also be made available on our Investor Relations Web site shortly. I'd now like to turn the call over to Sumit.

Speaker 2

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. 1st 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 Q1 results. Q1 net sales exceeded the high end of our guidance range, increasing by approximately 3% to $2,880,000,000 Two key factors contributed to this performance.

Speaker 2

First, our customers' loyalty in non discretionary categories such as consumables and health remained strong accounting for approximately 85% of our Q1 2024 net sales. 2nd, AutoShip customer sales achieved record levels totaling $2,200,000,000 and representing 77.6 percent 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.

Speaker 2

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 and L, we set new records for the company across our profitability metrics. Gross margin for the quarter of 29.7 percent exceeded expectations as we benefited from the continued strength of our growing Sponsored Ads business, a higher mix shift into health care and a rational promotional environment.

Speaker 2

Additionally, there were some onetime items that benefited our P and L this quarter, which Dave will elaborate upon later in this call. We generated $163,000,000 of adjusted EBITDA, representing a 5.7% margin supported by our strong gross margin performance and rigorous OpEx management. Across the company, teams at Chuy are executing methodically on all the controllable elements of our business in a highly disciplined manner. Finally, we generated more than $50,000,000 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.

Speaker 2

Significant free cash flow generation coupled with our strong balance sheet enables us the 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 support 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.

Speaker 2

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 netback acceleration, all while maintaining economic sensibility. We are excited about the program and look forward to sharing more over the coming quarters. Turning to TUI Health.

Speaker 2

We are excited to share that since our last earnings calls where we announced the launch of our first Chewy Vet Care Clinic located near our company headquarters in Plantation, Florida, we have opened 3 additional Chewy Vet Care clinics, 2 locations in the Greater Atlanta, Georgia area and 1 in Denver, Colorado. With 4 locations open today, we are excited to bring to market several more clinics later this year, reaching the high end of our stated range of 4 to 8 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 vets.

Speaker 2

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

Speaker 1

our

Speaker 2

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.

Speaker 2

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.

Speaker 2

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.

Speaker 3

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. 1st quarter net sales grew 3.1 percent to $2,880,000,000 exceeding the high end of our guidance range. Broadly in line with expectations, active customers declined marginally on a sequential basis to approximately $20,000,000 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.

Speaker 3

Net sales per active customer and nest pack reached $5.62 reflecting an increase of 9.6%. Best pack 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 auto ship and expansion into new categories, namely within Chewy Health. Our scaled auto ship business continues to be a pillar of strength and differentiation for Chewy, driving predictable subscription like revenue. Auto ship customer sales came in at $2,200,000,000 in Q1, representing 77.6 percent of our total net sales in the quarter, up 2 40 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.

Speaker 3

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 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 a normalized discounting environment. It is worth a reminder that in Q1 2023, the promotional environment was operating below historical levels.

Speaker 3

Moving to OpEx, please note that my discussion of SG and A excludes share based compensation expense and related taxes. OpEx in the quarter continued to scale nicely with revenue. 1st quarter SG and A totaled $533,100,000 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 and A expenditures.

Speaker 3

1st quarter advertising and marketing expense was 186,800,000 dollars or 6.5 percent 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. 1st quarter adjusted net income was 137 $100,000 representing a 56% increase year over year and a 71% increase sequentially. Finally, we reported an adjusted EBITDA margin of 5.7 percent for the quarter or 170 basis points of margin expansion relative to Q1 2023 and 2 60 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.

Speaker 3

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 accretive growth and profit initiatives. In the Q1, we reported free cash flow $52,600,000 reflecting $81,900,000 of net cash provided by operating activities and $29,300,000 of capital expenditures. We ended the quarter with more than $1,100,000,000 in cash, cash equivalents and marketable securities, and we remain debt free with a strong liquidity position of 1,900,000,000 dollars 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.

Speaker 3

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 am excited to share that our Board of Directors has authorized Chuy's first ever share repurchase program of up to $500,000,000 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 Q2 and updated full year 2024 guidance.

Speaker 3

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 2nd quarter net sales of between $2,840,000,000 $2,860,000,000 or approximately 2% to 3% year over year growth, and we are maintaining our full year 2024 net sales outlook of between 11.6 $1,000,000,000 $11,800,000,000 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 53rd week will be fully reflected in the Q4 of 2024. Moving to profitability guidance.

Speaker 3

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 1st 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.

Speaker 3

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 and partners everywhere. With that, I will turn the call over to the operator for questions.

Operator

Thank Our first question comes from the line of Trevor Young of Barclays. Your line is now open. Please go ahead.

Speaker 4

Great. Thanks. First one on the net adds 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 1H and a back half inflection? And is that really a kind of a 2H uptick or is it more so a 4Q story?

Speaker 4

That's my first question.

Speaker 3

Good morning, Trevor. Yes, similar to the guidance or consistent with the guidance that we provided last quarter, year over year, we expect that 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?

Speaker 4

Yes. And on the launch of the 4 vet centers, how should we think about measuring progress there? What sort of guidepost 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?

Speaker 2

Hey, Trevor. This is Sumit. I'll start 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 a customer satisfaction scores, both across sort of key customers to Chewy or customers to Chewy and for the veterinarian community.

Speaker 2

Number 2 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're seeing, we're actually happy with. Our clinics are fully staffed.

Speaker 2

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 vet recruitment trends are all trending positive. In terms of returns, this is not a multiyear observation period. This is likely a few quarter observation period. And we'll be back with more.

Speaker 2

Dave?

Speaker 3

Yes. 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 testing process here. But I would say cautiously optimistic on the initial clinics that we've launched.

Speaker 4

Great. Thank you both.

Operator

Thank you. The next question comes from Rupesh Parikh of Oppenheimer. Your line is now open. Please go ahead.

Speaker 5

Good morning and thanks for taking the question. So first is 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?

Speaker 3

Sure. Good morning, Rupesh. From a share repurchase perspective, I think I'd start with we're going to be in the market this quarter here in Q2. We're very, very pleased with our cash generation. Last year, we delivered well over 80% conversion of EBITDA to cash.

Speaker 3

We've guided again for this year to do the same. So very happy with our current balance sheet position of cash, dollars 1,100,000,000 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.

Speaker 3

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?

Speaker 5

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?

Speaker 2

Hey, Rupesh, this is Smith. So yes, your observation is correct about us being able to arrest sort of the 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.

Speaker 2

And after a long period, we saw consumers return with also 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 move 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.

Speaker 2

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.

Speaker 2

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 hardwares.

Speaker 5

Great. Thank you for all the color.

Speaker 2

Sure.

Operator

The next question comes from Doug Anmuth of JPMorgan. Your line is now open. Please go ahead.

Speaker 6

Thanks so much for taking

Speaker 4

the questions. 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 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? Thanks.

Speaker 2

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.

Speaker 2

We've done that now. We've improved and increased the inventory as well as improved on the efficacy of return that we're seeing internally. And the demand that flowed through in Q1 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.

Speaker 2

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 NESTAC 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 3, 4 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.

Speaker 2

So overall, we remain bullish on the gross margin story. We haven't yet started talking about our private brands business credibility, which is something that we're excited about. Our other components of our health businesses are native or nascent. They're both native and they're nascent. And we're excited about the potential that they might contribute in the future.

Speaker 2

So there's a lot of fire in the fire and we're excited about the gross margin journey here. Number 2, Chewy rollouts and how it interacts, is that ownership? Yes. Okay. So that's a great question and a very insightful one.

Speaker 2

We believe, 1st of all, we're being very thoughtful. We've invited in beta a cohort of customers which is well represented across their 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 2 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.

Speaker 2

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 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 behaviors that we want to sort of incent and observe are consistent in terms of repeat purchase rate, nest pack, basket building engagement, so forth and so on.

Speaker 2

Lots to learn in front of us, but so far we're thinking of these as complementary programs. Thank you, Smedes. Sure.

Operator

The next question comes from the line of Eric Sheridan of Goldman Sachs. Your line is now open. Please go ahead.

Speaker 7

Thank you so much. Maybe if I could just ask a 2 parter. 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 maximize 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 terms of a range. Is that brand spend, is that lined up against Plus following up on Doug's question?

Speaker 7

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's sort of aimed at? Thank you so much.

Speaker 2

Sure. Eric, this is Sumit. I'll start and Dave might add that's pertinent. So good question on the current dynamic and marketing priorities. Think of it this way.

Speaker 2

We're focused on first of all, these are 2 independent efforts around new customer acquisition as well as the CRM reactivation or retention of cohorts. They're led by 2 teams and the redundancies are avoided when we make sure that we're not passing the same customer back and forth to each other, 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 market, marketing effort. So we are building awareness up in the upper funnel and our awareness and our familiarity levels have increased several 100 basis points, particularly as it comes to Gen Z in the Medennial segment, which is something that we were internally focused on and something that we're happy about.

Speaker 2

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.

Speaker 2

You recall a couple of quarters ago, perhaps 2 quarters ago, I'd mentioned to you that we now have the ability to segment and target our cohorts because we've rebuilt the entire content platform internally inside the company. And so that allows us more precise targeting once we identify the customer even with the loss of kind of targeting because we have fingerprinting ID that we can sort of associate the customer back to an account or back to their browse 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%.

Speaker 2

So the variance is not that much. There's a lot of fear 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 one direction than the other, then we can respond to that.

Speaker 3

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. Q1, just due to some timing of some marketing campaigns, it was a little bit lower. It was about 6.5%.

Speaker 3

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.

Speaker 7

Great. Thank you.

Operator

The next question comes from the line of Nathan Ever of Morgan Stanley. Your line is now open. Please go ahead.

Speaker 8

Hey, everyone. Thanks for the question. So in 1Q sales came in, a bit above your guidance, I guess, 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? Thanks.

Speaker 3

Sure. Let me start and then Sumit, if there's anything you want to highlight, feel free. 1st 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 and primarily in gross margin, if you excluded 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.

Speaker 3

We are mixing up our business being led by sponsored ads, also being led by healthcare and within healthcare pharmacy. So we do continue to accrete product margin and product mix, which is averaging up our business, which of course gives us that confidence that we presented at Capital Markets Day in December of last year to 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, 1, 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 in rollouts and capabilities and features. So improving product mix, scaling infrastructure, increasing margin and profitability. Did you have a follow-up, Nathan?

Speaker 8

Yes. Just and as we think about the top line guidance, what would exceeded there for 1Q? And then anything you can share kind of the quarter to 8 and 2Q, how those green shoots are kind of flowing into your progress?

Speaker 3

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 $11,600,000,000 to $11,800,000,000 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 1, 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.

Speaker 3

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 2 metrics that we're kind of looking at that we're seeing, I would say, some signs of normalization in the industry.

Speaker 3

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 Stephen Forbes of Guggenheim Partners. Your line is now open. Please go ahead.

Speaker 2

Good morning, Sumit, David.

Speaker 9

Sumit, realizing it's probably early, but you sound pretty optimistic about the Vectra care clinic. So I was curious if you could maybe speak to what you're seeing in regards to the customer journey, your 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?

Speaker 2

Hey, 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? As you know, we very thoughtfully designed the clinic, both the sort of the infrastructure as well as the experience that we're providing to the customers.

Speaker 2

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 that tailwind. And you're seeing that, right?

Speaker 2

Response rates have been really good. Customer NPS is really strong. Vet NPS is really strong. Number 2, what plays the industry is really vet recruiting and in parallel or very next to it is vet retention. That's our stressed capacity is going to continue to outrun or under run the wet demand.

Speaker 2

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 that. And then 3, 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 a 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.

Speaker 9

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?

Speaker 3

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 auto ship penetration, as well as continuing to provide product mix shift into areas such as sponsored ads and healthcare. And if we continue to perform and execute as we did in the Q1, 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.

Speaker 3

And 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 1st part of the year all the way through the Q4 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 the more aggressive promotional environment, which are all things that we're not currently seeing.

Speaker 3

And so we feel good about what we delivered in Q1. We feel good about the long term trends for us to continue to product mix up our business, both in sponsored ads into healthcare 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.

Speaker 4

Thank

Operator

you. The next question comes from the line of Michael Slasser of UBS. Your line is now open. Please go ahead.

Speaker 8

Thank you for taking the question. This is Sachin Verma on behalf of Michael Lasser. 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 has seen in the last few years?

Speaker 3

Maybe I'll start on year over year customer counts and Smith, please chime in if you have anything

Speaker 1

to add. And so as we

Speaker 3

mentioned last quarter, we did expect this year to be relatively flat from an active customer account with a little bit weaker kind of flat to slightly down maybe in the first half, flat 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 4th in the Q1, 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 accounts, 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 adoption versus relinquishment of pet perspective.

Speaker 3

That's certainly the data that we saw from the shelter, 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.

Speaker 3

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?

Speaker 2

On the question on why would higher e commerce penetration continue? Well, look, I mean, the core insights around customers not wanting to lug heavy product back from retail stores, dog food bags are heavy, cat litter pails are heavy and inconvenient. And so the convenience of transacting through the online channel remains a value proposition that continues to propel 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 interests over time, etcetera, etcetera.

Speaker 2

So overall, we're bullish on e comm penetration trends continuing from this point onwards.

Speaker 8

Thank you. And my follow-up is, how do you plan on growing revenue without increasing your customers this year? Is growing nSpac a sustainable strategy?

Speaker 2

This is something that we've talked about in the past as well. Look, 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 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? A pet lives for 12, 14, 15, 18 years.

Speaker 2

During that time, a pet parent spends anywhere from $1200 to $2,500 with an average of 16 dollars to $1800 of LTV. And we've shown the power of growing that nest pack. It grew over 9.5% this quarter reaching $5.62 which means that right now we're capturing about onethree of the nest pack 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? So our other businesses are fairly nascent.

Speaker 2

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 adds, that's comprised of 3 different components: acquisition, retention and reactivation. So 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.

Speaker 2

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.

Speaker 8

Thank you.

Speaker 2

Sure.

Operator

The next question comes from the line of Seth Basham of Wedbush. Your line is now open. Please go ahead.

Speaker 3

Hi, this is Matt McCartney on for Seth. I was hoping you'd 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 nest pack maturation?

Speaker 2

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.

Speaker 2

In terms of when you take a look at our cohorts from back half of twenty twenty two 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.

Speaker 3

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 auto ship 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, Seth? Yes.

Speaker 3

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?

Speaker 2

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 multifold on a year over year basis.

Speaker 3

Great. Thank you.

Operator

The last question comes from the line of Lee Horowitz of Deutsche Bank. Your line is now open. Please go ahead.

Speaker 6

Great. Thanks for fitting me in. 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 healthcare, you're most certainly taking share in that vertical. Discretion on hard goods, you seem to have decided to not chase bad share in that vertical and perhaps seeing some there.

Speaker 6

Then I guess that leaves consumables, which grew about 2% in the quarter. But 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 share in the consumable category is progressing at the moment and how you expect that to evolve through the course of the year?

Speaker 2

Sure. I'll start with the 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 we're observing. And we generally have a fairly good read of demand in the marketplace.

Speaker 2

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?

Speaker 2

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 proposition resonates loudly within hard goods and 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 premium segments in consumables. So that's it's a bit of it's a positive story overall, but there's a bit of a range depending upon the customer segmentation and the cohorts that you see.

Speaker 3

Did you have a follow-up, Lee?

Speaker 6

Very helpful. And maybe one follow-up on users. We've 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 we maybe just talk a bit more on how churn is progressing at this point?

Speaker 6

And I think, Sumit, you talked about churn down, churn improving year on year. But I guess, how does that foot relative to reactivations and new 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 there would be helpful.

Speaker 2

Thanks so much. Sure, sure, 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.

Speaker 2

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.

Speaker 2

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 3 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 twenty twenty two 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.

Speaker 3

Yes. And perhaps just for some helpful color, churn in Q1 of 2024, it's a decline in absolute numbers from the churn and percentage for that perspective, churn from Q1 of 2023 and it's down from a churn of Q1 of 2022 and it's of course, it's down sequentially from Q4 of 2023. 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.

Speaker 6

Very helpful. Thank you.

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 line.

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Earnings Conference Call
Chewy Q1 2025
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