Hello, everyone, and welcome to the Chewy Second Quarter 2025 Earnings Call. My name is Emily, and I'll be coordinating your call today. I would now like to hand over to Natalie Nowak, Director of Investor Relations. Natalie, please go ahead.

Thank you for joining us on the call today to discuss our second quarter results for fiscal year 2025. Joining me today are Chewy's CEO, Sumit Singh; and Will Billings, our Chief Accounting Officer and Interim Principal Financial Officer. Will is a respective leader with extensive finance and accounting experience, and we appreciate his dedication to Chewy as he takes on this expanded role while we continue to search for a permanent CFO. 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 website 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 in which we operate. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks, uncertainties and other factors that could cause actual results to differ materially from our forward-looking statements. We encourage you to review our SEC filings, including the section titled Risk Factors in our most recent Form 10-K for a discussion of these risks. 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 assume no 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. 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 2024. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of the audio webcast will also be available on our Investor Relations website shortly. And with that, I'd like to turn the call over to Sumit.

Thanks, Natalie, and good morning, everyone. Q2 net sales grew by nearly 9% year-over-year to $3.1 billion, exceeding the high end of our guidance range. Moreover, against an industry backdrop of low to mid-single-digit growth, our Q2 performance demonstrates a clear share gain outcome. Strength of our Autoship program in categories such as consumables and health anchored Q2 net sales performance. Second quarter Autoship customer sales of $2.58 billion represented 83% of our Q2 net sales, reaching a new record high for the company. Growth in Autoship customer sales once again outpaced overall top line growth increasing by nearly in Q2. We are also pleased to see the continued strength within our hard goods business, which grew over 15% in the second quarter, primarily on the back of structural volume growth. And finally, a rapidly strengthening CES program exceeded our expectations in the second quarter. I will comment more on our progress with this program in a moment. Moving to customers. We ended the second quarter with 20.9 million active customers, reflecting 4.5% year-over-year growth. Importantly, the strength and quality of our new customers continue to improve. New customer NSPAC for the Q2 2025 cohort strengthened quarter-over-quarter and is trending mid-single digits higher on a year-over-year basis relative to the comparable Q2 2024 cohort. For total Chewy, we continue to expand customer share of wallet in the quarter with NSPAC reaching $591, representing 4.6% year-over-year growth. Moving down the P&L to profitability. Gross margin reached 30.4% in the quarter, expanding on both a sequential and year-over-year basis by nearly 80 and 90 basis points, respectively. For Q2, main drivers of gross margin were both our fast-growing sponsored ads business and favorable mix into premium categories. Pricing and promotion remained rational and did not have a material impact on gross margins…

Thank you, Sumit, and thank you all for joining us today. Let's review our financial results and outlook. Second quarter net sales grew 8.6% and year-over-year to $3.1 billion, exceeding the high end of the Q2 guidance range we provided last quarter. We reported second quarter gross margin of 30.4% and representing approximately 90 basis points of margin expansion year-over-year. Shifting to operating expenses. Q2 SG&A, excluding share-based compensation and related taxes, came in at $592.8 million or 19.1% of net sales, deleveraging approximately 30 basis points year-over-year. Q2 deleverage was driven by the ongoing ramp of our Houston fulfillment center, which launched in April, coupled with the wind down of certain shifts at our Dallas facility. We also incurred higher inbound inventory processing costs, primarily within hardgoods to ensure we have the right assortment for pet parents as we head into the peak holiday periods, while also allowing us to mitigate impact from tariffs in 2025. Additionally, a smaller contribution came from increases in wage and benefit cost within the period. Importantly, we believe these increases are primarily temporary in nature, and we continue to expect to deliver modest SG&A leverage in fiscal year 2025. Second quarter advertising and marketing expense was $200.6 million or 6.5% of net sales, in line with our expectations and consistent with our previously stated target of 6% to 7% of net sales. Q2 adjusted net income was $141.1 million, representing a 34.8% increase year-over-year and we delivered $0.33 of adjusted diluted earnings per share within the guidance range we provided last quarter. Second quarter adjusted EBITDA came in at $183.3 million representing a 5.9% adjusted EBITDA margin, which reflects 80 basis points of year-over-year margin expansion. We reported Q2 free cash flow of $105.9 million, which reflects $133.9 million of net cash provided…

Our first question today comes from Doug Anmuth with JPMorgan.

Sumit, can you talk more about the investments that are required in the back half and into 2026 just as you lean into growth, a little bit more detail on those? And then also just how are you promoting and increasing awareness of some of the new offerings like Chewy+ and Get Real?

So let's start with the second question first because it will give you a sense for the investments that we're thinking about. So as you know, we have a very large base of customers, which continues to grow. This customer base is sticky and the programs like Chewy+ allow us to enhance the process of discoverability and get customers to attach both explore, discover and then attach even a greater set of product or a greater range of products and services offered by Chewy. So our first attack strategy is to essentially expose Chewy+ to existing members. And so far, we have not spent any incremental dollar on marketing the program externally, and we don't intend to do so as we ramp the program up. We're seeing really good participation of existing 2 members converting to become Chewy+ members. So the marginal cost of that acquisition is 0 or nearly 0 to us, and most of the exposure is being provided by on-site and funnel shopping experiences. Now coming to Get Real, our approach is very similar. Large audience, we have what we believe really good recognition of what looks like premium cohorts and consumables for us. So our strategy is much more leaning into the broader value proposition of Chewy externally as the place, which is a destination for you to take care of your pets and providing food supplies, health and other services and really gearing ourselves for conversion, right, rather than consideration building when customers come to our website. And so from that standpoint, the inputs that we've been really focused on is getting the quality of the product, the palatability of the product exactly where we want it. And we're pleased to see the customer response. Number two, we're price competitive. There are many products out…

Our next question comes from Nathan Feather with Morgan Stanley.

[indiscernible] encouraging momentum here a question on the SG&A deleverage. And you may to put some guardrails on the magnitude of temporary costs here and how much maybe we can attribute to some of the FC changes versus the hard good processing costs. And because of that, how should we think about the leverage path into the back half?

Yes. Nathan, me provide broader commentary on SG&A and also answer your question very specifically. So First of all, as we discussed on the call, we expect roughly 60% of our adjusted EBITDA margin expansion to come from gross margin and 40% to come from OpEx leverage. So we do expect to deliver SG&A leverage in 2025. And by inference of our first half performance, you can expect that, that leverage will come in the back half of the year. Number two, yes, the amount of SG&A leverage on a year-over-year basis in '25 will be lower than 24%. But I think that's the ebb and flow of SG&A, right? Let me kind of elaborate on that a bit. So this will ebb and flow in cycles a bit. As we elaborated in our Capital Markets Day in December '23, we set a target of roughly 200 basis points to deliver. So far, roughly 2 years out, we've already delivered 100 basis points or 50% of that target. The majority of that leverage has come from us ramping 4 fulfillment sites, which are automated 2G sites and roughly flowing 40-plus percent of the volume through these states of automation within the company, right? By Q2 of next year, we expect nearly 50% of our volume will be automated, especially as Houston ramps up. Now let me talk about the specifics in the quarter. So there's a couple of things that are happening in the quarter and in '25, right? So we launched Houston in April of this year, and it takes roughly 6 months for a Gen 2 facility to ramp sufficiently to start delivering leverage. And I went back and checked my notes from Q1 and perhaps we should have been a little more clear on that point upfront,…

Our next question comes from David Bellinger with Mizuho.

Let me just squeeze a few together here. Maybe if we could just start on the Q2 gross margin improvement. You mentioned the premium products. That seemed like somewhat of a shift also maybe talking about some of this price investment in the back half. So can you unpack all that for us and how we should think about the drivers of gross margin expansion in Q3 and Q4? And then also just on the new OpEx investments, can you help us understand, is all this fully in your control and making decisions to further accelerate the top line and share gains versus something more reactionary or something changing in the external marketplace is forcing you to do this. Can you just help us understand that split in chewy+ and fresh and frozen, this might impact the 15% incremental EBITDA margins for the business?

Yes. Sure. No, it's a good question. Let's dive into it. So there's a couple of questions built into that. So let's carry on the part. So gross margin first. We're pleased with the gross margin expansion that we've delivered this quarter, right? And the drivers of gross margin, David, have remained very consistent over the past few quarters and overall in line with our story or the narrative that we brought to the street, right? They include product mix across our merchandising led businesses. So you've heard us talk about health, premium consumables. Now hard goods is starting to grow double digit, albeit at a smaller contribution, but still were encouraged to see kind of where this goes. So that's kind of why we use the word product mix across merchandising led businesses because it isn't just pharmacy, which has continued to contribute. It is health and wellness supplements, it's premium consumables. It's hard goods growth, et cetera, et cetera, et cetera. So number 2 -- so the drivers of gross margin include product mix across merchandising led businesses, increasing auto ship penetration and scale that provides economies of scale and our ramping sponsored ads initiative, right? So that's very consistent commentary. For Q2, the promotional environment remained highly rational, right? And we don't expect the promotional environment to be irrational in the back half of the year. So as Will mentioned in his remarks, the high point of gross margin for the year, and I especially want to note that gross margin will fluctuate on a quarterly basis, right? And that would be helpful to remember. This is the case because while we pride ourselves on being disciplined, we also pride ourselves in being able to run the business dynamically each quarter. So for example, we will lean…

Our next question comes from Rupesh Parikh with Oppenheimer.

So just going back to Get Real and some of your fresh frozen efforts at this juncture, how big do you think the business can go over time? And then I know it's early, but just any characteristics of the initial customers that you're getting into the franchise. And in this sense, are you getting sense of -- do you have a sense of whether you're actually getting new customers just given that launch?

Sure. Yes. So if we look at the TAM of the category today, we believe it's somewhere in the $3 billion, $4 billion range. And over the next several years, we expect this category to be north of $8 billion, so somewhere in the $8 billion to $12 billion range. The category is growing at mid-teens levels. It was growing faster up until last year. Now it's growing at mid-teens level. And that's a really healthy growth rate for us to be able to get excited about, right? Number three, there is a lot of interest in this category from around the industry, right? You've seen some de novo players already leaning in. You've seen national branded players start announcing their announcement or their product offerings. We're really excited to be partnering with the national branded partners as they bring their products to life in the back half of this year. And alongside that, right, get real we expect to have a meaningful amount of share as the category grows. What is meaningful? We would consider roughly a share position commensurate to Chewy's share position in the industry to be a meaningful share outcome, right? Now given that we've built the capacity, given that we've built the topology to be a 1-day network, right, and given the sophistication that we have in our supply chain, we expect, right, the high gross margin possibility of the vertical to efficiently translate into high EBITDA as well, right? And alongside, you asked about the quality of the customer. Let me answer that now. So, so far, it's early days. We've been at it, what, less than 4 weeks, 5 weeks. And so far, we're seeing roughly 70% of the customers are existing customers, 30% of the customers are net new customers. And that is -- as my earlier comments to Doug indicated, we'd expect that, right? So we're benefiting from the general traffic that the industry will create in marketing the product and we are priming ourselves for conversion using our site experience with Get Real. We'd expect the net pac of this customer to be north of $800 for toppers because we believe they will attach 2 or 3 more categories. And for full meals, we expect this to be a plus $2,500 customer on an annual basis. So we're excited about it.

The next question comes from Curtis Nagle with Bank of America. Curtis, your line is opened, please proceed with your questions. We are not receiving a response, and so I will move on to the next question, which comes from the line of Shweta Kajaria with Wolfe Research.

Okay. Let me try 2, please. Sumit, could you please talk about the advertising environment is the conversations you've had through the quarter? And what is top of mind across advertisers as we think about the back half of this year and potentially even next year? And how it is and how ad revenue is trending or I guess, advertising business, not revenue is trending for you versus your expectations? And then the second question is, generally, what are your expectations as we think about the macro in terms of net household formations for the remainder of this year and also next year. And I asked because there could be inflationary pressure. So how are you thinking about the mix of customer growth versus pricing? Do you still expect it to be call it, low to mid-single-digit percentage growth rate in the back half? Or is there potential for acceleration in the back half of this year?

Okay. There are 3 questions there. State of the industry and key inputs, our composition of new customers and NSPAC and then 3 [indiscernible] pricing. So let's take them 1 by 1. So in terms of the lay of the land, so let's start with pet household formation trends. Overall, the trends that we spoke about last several quarters have remained consistent, and we're not seeing notable changes relative to those comments, right? With respect to data, the shelter channel, net adoptions remain stable and relinquishments continue to trend down year-over-year. And so overall, we expect at households to be broadly flat to slightly up in 2025, right? So the point on industry continues to normalize, seems to be holding true. Now across the conversations that we're having with our suppliers and interpreting the market from a consumer standpoint, we believe the back half of the year or generally for 2025, the industry remains in low single digit to kind of perhaps the low end of the mid-single-digit range in terms of growth. And so we are clearly taking share, growing on a 52-week basis between 10% and 8% and 53-week basis, the 6% range or so. which we're excited about. And this is on top of the fact that we have tougher comps that we're comping as we move into the back half of the year. So we're excited about that. Now let's talk about our composition. So our growth algorithm, as we've guided long term is a combination of active customers growing low single digit to mid-single digit and NSPAC growing mid-single digits, right? And so we're pleased to essentially maintain that for the rest of the year. We're encouraged by the steady and consistent return to active customer growth that we have delivered over the past several…

Our next question comes from Michael Morton with Towers.

Question for Sumit. Bigger picture and then maybe a more near-term one. But Chewy has done an excellent job kind of disproving the fears around competing with retail giants and there are the obvious competitive advantages like customer service. But we were wondering if you could maybe speak to some of the aspects that are missed by us on the outside, where you think your real opportunity is to continue gaming incremental share? And then maybe just internally how this is reflected in your outlook as pet household formation continues to improve? And then just on the hard goods recovery, maybe just a little bit details on volume versus ASP would be helpful.

So let's start with the second question. It's all primarily volume. There is a very little ASP benefit right now in the hard goods recovery. The primary drivers of hard goods recovery are, as you've heard me talk about it last quarter, I will reiterate that a rapid acceleration and expansion of in stock, higher more products for customers to choose from. We've onboarded over 1,500 brands this year already, and customer reception on the freshness of that inventory is really encouraging for us to see. Number two, our in-stock levels have remained really high, and we want to keep them high and hence, the investment in inventory in Q2 as we move into the back half of the year. Number three, continued exposure for hard goods customers in the way that we're communicating with them, both on-site and off-site. And so overall, we're encouraged by what we are seeing in hard goods and don't expect it to slow down as we've played Q3 so far. So a good story there. And then you -- your higher order question around differentiation. And look, we really always interpreted the playing field as much broader than food and supplies. And when you essentially interpret $140 billion, $150 billion TAM, right, which is increasingly online. The value prop that we are bringing to the market, which is credibly connecting food suppliers, the entire health ecosystem alongside B2B or B2B2C type services options. And then really keeping customers in our funnel and building that layer cake. We do it, in my opinion, in 1 of the most efficient and powerful ways relative to anybody out there. And so there are reasons for that, right? So in the food and supply side, you would think that we are a scaled e-commerce player, but with the…

We have time for 1 final question. And our last question today comes from the line of Dylan Carden with William Blair.

Sumit, curious, you had some earlier comments about sort of the quality of cohorts improving year-over-year. And I was just wondering if you could elaborate on that. Is that just sort of simply the industry itself stabilizing and improving? Are you doing things to kind of stimulate that? And the growth maybe sort of a related topic, but the growth in auto ship and the outperformance there, which has been relatively sustained over the last 3 quarters. How long do you think that runs?

So the quality of the cohorts improving is a result of 2 different things, Dylan, and they're both complementing us. One is -- the more customers we push into programs like AutoShip or bring in through programs like Chewy+, the more our ability to keep them in the funnel get them more opportunities we have to talk to them to get them to consolidate their NSPAC and the faster netback consolidation that we see from them. So within the program itself, then we have worked towards improving settlement rates. So for example, if you think about auto ship, there's a -- it's a 2-sided far, right? We're bringing in growth subscription and then we're retaining net subscribers. So we will grow book -- our rate of gross subscription add to autoship has increased, and our second order, third order, fourth order settlement rates into autoships has improved, which then means that the net retention in auto ship is much better. And you see that layer cake building pretty effectively that continues to push a greater portion of our sales moving through ownership. With Chewy+, we're seeing a similar effect, right? Chewy+ members are engaging with and adding and on an average, 3 more categories than nonmembers to their baskets, right? And the mix of cohort is really interesting to us because it opens up Chewy right, to all of the low spending cohorts where we can rapidly consolidate baskets and it's opening us up for high-spend cohorts to expand and discover other products, which are also expanding basket size. So on an average, we see really strong incrementality and the quality of cohorts of the Chewy+ program is healthy. Then we have a large and growing health business and a premium consumables business. Remember, every time I've talked about this in the past, we've mentioned that when it comes to the low-end value segment of the market, which is roughly, in our opinion, 12% of the market or customers it's slightly not the place for Chewy, but everybody else, right, Chewy is the place. And then the final thing is more and more people move in online. So clearly, online is consolidating share from off-line and once we lock these customers in, which we were not doing as well, in my opinion, in '22, '23, you're seeing the results sort of come through here.

And just curious, Chewy+, I get that it's early days as far as sort of mid-single-digit revenue penetration. But for a lot of loyalty programs, you mentioned Prime, as kind of the majority of the business. Is that part of the intention here. And just from a margin standpoint, let's assume it's the majority of the business, that would be margin accretive.

So look, I mean, I think we've shared the stat in the fact that in the past that at some point, we did the survey not so long ago, 3/4 of our customers are prime members, right? And so I think that's probably well understood, given how broad the penetration of that program is. But candidly, what we're observing is what we've also shared in the past is that our -- generally, it is well understood that we retain a very high percentage of our customers from going into year 2, right? And so our attrition is de minimis, past kind of a 30-month mark. And you saw that in the way that our pandemic cohorts have settled out, right? And so what happens is that once we have a customer past the 30-month mark, in the past, right, they would rapidly consolidate their share of wallet over to Chewy, right, regardless of whether they are a prime member or not. And now with Chewy+, we're seeing that, that consolidation is happening even faster, right? With Autoship, we're seeing that, that consolidation happens even faster because we've improved the proposition on the Autoship program itself. So that was my point on why we're seeing it both accelerated as well as credibly built netback curves on the back of these 2 programs. And then your other question was around margin. Yes, we expect Chewy+ to be margin accretive right? So as the program ramps, obviously, we're leaning in into the 30-day free trial period. There is the mix of new members to paid members. It will take a few months for the netback consolidation to start coming through. But broadly so, yes, the program will be gross margin rate dilutive, but on a dollar basis, it will be highly accretive and on a contribution profit basis, it will be highly accretive. And so I think you would essentially underwrite a business case where we came to you and said, "Hey, we're investing x basis points, but we get 6x the return in top line, okay? I think that [indiscernible] something that we will underwrite.

Thank you. Those are all the questions we have time for today. And so this concludes our call. Thank you all for your participation. You may now disconnect your lines.