Chewy, Inc. (NYSE:CHWY) Q2 2023 Earnings Call Transcript

Chewy, Inc. (NYSE:CHWY) Q2 2023 Earnings Call Transcript August 30, 2023

Chewy, Inc. misses on earnings expectations. Reported EPS is $0.04 EPS, expectations were $0.11.

Operator: Good afternoon. Thank you for attending today’s Chewy Second Quarter FY ’23 Earnings Call. My name is Anna and I will be your moderator for today’s call. [Operator Instructions] I would now like to pass the conference over to our host, Jen Hsu, Head of Investor Relations, you may go ahead.

Jen Hsu: Thank you for joining us on the call today to discuss our second quarter 2023 results. Joining me are Chewy’s CEO, Sumit Singh; and Interim CFO, Stacy Bowman. Our earnings release and letter to shareholders, which were filed with the SEC earlier today has been posted to the Investor Relations section of our website investor.chewy.com. On our call today, we will be making forward-looking statements, including statements concerning Chewy’s future prospects, financial results, strategies and investments, industry trends, and our ability to successfully respond to business risks. 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 entitled Risk Factors in our Annual Report on Form 10-K and other subsequent quarterly reports, 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 and letter to shareholders, which were filed with the SEC today. These non-GAAP measures are not intended as a substitute for GAAP results. Additionally, unless otherwise noted, results discussed today refer to the second quarter of 2023 and all comparisons are accordingly against the second quarter of 2022.

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

Sumit Singh: Thanks, Jen, and thank you all for joining us on the call today. Before we begin, I want to introduce Stacy Bowman, our Chief Accounting Officer. As previously announced, CFO, Mario Marte, retired on July 28, and Stacy, is serving as our Interim CFO, while we continue to search for a permanent CFO. She is a respected leader, who has been with Chewy for more than eight years and is deeply familiar with our finance organization, systems, and processes. Welcome, Stacy. Now, let’s begin. Our second quarter carried on the positive trends we saw in our Q1 results , delivering mid-teens growth exceeding guidance as well as robust profitability. In Q2, we reported $2.78 billion in net sales, up 14% and a 3% adjusted EBITDA margin.

Consistent with our expectation, active customers were broadly flat on a sequential basis, while net sales per active customer or NSPAC reached $530, reflecting a 15% increase. Net sales growth was underpinned by strong participation from our customers, underscoring the ever-increasing strength of the Chewy ecosystem. This momentum was evident across many of our focus areas, including Autoship, where sales continued to grow at a faster pace than our topline, increasing their share of total net sales to 76% in the second quarter. Autoship remains a key differentiator of Chewy’s business model, enabling high visibility and predictability, driven by recurring revenue streams while engendering customer loyalty. Additionally, we are also successfully driving the discovery of our Chewy Health platform.

For example, cross-category penetration into pharmacy now represents nearly 20% of our overall active customer base. Elsewhere across Chewy, our teams are continuously enhancing our CRM capability, improving targeting, and supporting strong customer engagement. Moving down the P&L, we delivered another quarter of robust profitability. The gross margin of 28.3% was broadly in line with expectation. As anticipated, promotional activity in the second quarter was higher than in the first quarter, however, the promotional environment on the whole remains largely rational. Adjusted EBITDA margin came in at 3% for the quarter, benefiting from our strong gross margin trends and fulfillment cost efficiencies, offset by the impact of our exciting growth investments, including our Canada expansion, which remains on track for a Q3 launch.

As we indicated during our Q1 earnings call, we continue to utilize our growing free cash flow to self-fund a meaningful portion of these growth initiatives. Additionally, our automation efforts continue to be both a driver of margin improvement to date, as well as a source of continued upside. Two of our four automated facilities are still ramping and our fifth automated site is opening in early 2024. Combined, we expect them to provide additional operating efficiency in the future years. Before spending time on business initiatives, let me share our perspective on consumer behavior in the pet industry and in particular how these trends may impact active customers and NSPAC at Chewy. Coming out of the summer months, we are sensing a shift in consumer mindset towards being more discernible, and at the same time, with a higher willingness to consolidate their share of wallet to their trusted retailer of choice.

This behavior is driven by a more fluid macro-environment, including high levels of inflation, which have been passed through the industry over the past 18 months. Our dialog with our suppliers confirms that these trends are permeating throughout the pet industry. At Chewy, we are in many ways insulated from these pressures given our high-quality customer base, the mix of our consumables and healthcare businesses, which drove nearly 85% of our net sales in Q2 Our powerful Autoship subscription service, best-in-class healthcare experience, and our overall promise of competitive prices, convenience, and unparalleled customer service. Our loyal customers recognize these attributes as key differentiators and continue to demonstrate robust ordering behavior, which in turn continues to support our strong performance.

Further to this point, we see significant potential to continue growing share of wallet with our existing customers, evidenced by our strong track record of sustainable NSPAC expansion. As you may recall, we have grown NSPAC from around $330 in the year preceding our IPO to $530 this quarter, up approximately 60% over that time. While we saw a modest benefit from price increases efforts, such as growing Chewy Health ecosystem, increasing uptake of our Autoship program and our large customer base that spends more with us over time have driven the majority of our NSPAC expansion. This underscores the sustainability of our track record as well as the ongoing potential to outperform the pet industry and deliver strong and profitable growth. Now, while we are more insulated than some others, we are not fully exempt from the pressure is currently facing the pet industry.

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That household formation remains relatively muted and as I mentioned above, the consumer mindset continues to be pressured. These factors taken together, make the current environment a challenging period to forecast consumer behavior. Taking this into consideration, we continue to see the potential for returning to net-adds growth during the second half of this year, but in light of recent trends, we are now expecting a wider range of potential outcomes. While the industry-wide trends, I just described, make it challenging to forecast net adds. These dynamics are not specific to Chewy and we believe we are well-positioned to drive improved active customer trends as macro factors and consumer behavior patterns normalize. Now, I would like to provide an update on some of our strategic initiatives.

Our upcoming expansion into the Canadian market remains on track for Q3 of this year. Canada represents a large and fast-growing pet category, and our teams are hard at work finalizing selection, ensuring the same convenient delivery experience and high bar service that our US customers enjoy. We look forward to sharing our progress over the quarters to come. In sponsored ads, one of our prospective margin-accretive growth vectors, we are executing against a compelling roadmap and remain on track to ramp the program throughout the second half of the year and into 2024. We remain encouraged by the opportunity ahead and will continue to update you on progress as we scale the business. Lastly, I’m excited to announce that we intend to host our first Investor Day later this year.

Chewy has come a long way since our 2019 IPO, having nearly tripled our net sales to north of $10 billion, expanded gross margin by 800 basis points, and adjusted EBITDA margin by nearly 1,000 basis points. Yet, we are just getting started and believe that we still have considerable runway with clear potential to outperform the broader pet industry and drive both strong growth as well as significant margin expansion. We look forward to sharing a deep dive on our highly integrated pet ecosystem, unveiling our exciting roadmap ahead, and recalibrating our long-term financial expectations to reflect the upside we see in the Chewy platform. In closing, I am particularly proud of our strong results and high levels of customer engagement that we achieved in Q2.

We operate in a secular growth category that demonstrated consumer resiliency and Q2 once again showcased the strength and durability of our platform. With that. I will turn the call over to Stacy.

Stacy Bowman: Thanks, Sumit. I look forward to engaging with many of you in this new role. In the second quarter, net sales grew 14.3% or $347 million to $2.78 billion. Non-discretionary consumables and healthcare categories continued to meaningfully contribute to growth in the quarter, collectively representing approximately 85% of second-quarter net sales. Autoship customer sales were $2.1 billion, up 18.1%, and continue to outpace aggregate topline growth by almost 400 basis points. Autoship customer sales now represent 75.5% of total net sales. Active customers remained broadly flat on a sequential basis and finished Q2 at $20.4 million. However, our primary measure of customer engagement NSPAC grew 14.7% to $530. Notably, both NSPAC and Autoship customer sales yet again reached new record highs.

As we move down the P&L, please note that my discussion of financials where applicable refers to metrics excluding share base compensation expense and related taxes, as well as certain other adjustments disclosed in our SEC filings, where relevant. The same applies to my discussion of guidance and financial outlook. Gross margin reached 28.3% in Q2, which reflects a 20 basis point expansion, broadly consistent with our expectations for the quarter. Continuing onto OpEx, SG&A excluding share-based compensation and related taxes, totaled $550.9 million or 19.8% of net sales, deleveraging 20 basis points compared to the second quarter of 2022. This temporary increase was largely driven by corporate payroll increases related to our growth initiatives such as sponsored ads and our expansion into Canada, ahead of realizing the associated expected net sales growth.

The SG&A deleveraging was partially mitigated by continued fulfillment cost efficiencies, supported by our automation initiatives. Q2 advertising and marketing expense was $185.5 million or 6.7% of net sales, consistent with our expectation of 6% to 7% of net sales. Second quarter adjusted net income was $63.3 million, an increase of $1.2 million. The second quarter adjusted EBITDA reached $86.9 million, up $3.8 million, implying an adjusted EBITDA margin of 3.1%. Second quarter free cash flow was $101.1 million, reflecting $158.8 million in net cash provided by operating activities and $57.6 million in capital expenditures. Capital expenditures were primarily comprised of automated fulfillment center investments and ongoing technology projects.

As a reminder, we regularly see fluctuations in CapEx intensity from quarter-to-quarter. Following below-average CapEx intensity in the first quarter, CapEx spending increased in the second quarter. Overall, we expect 2023 capital expenditures to remain in the range of 1.5% to 2% of net sales. We finished Q2 with $905.4 million in cash and cash equivalents and marketable securities, nearly $300 million higher than the balance at this time last year and we remain debt-free. At the end of Q2 between cash-on-hand, marketable securities, and availability on our ABL, our liquidity stood at $1.7 billion. That concludes my second quarter recap. So now let me cover our third quarter and full year 2023 guidance. As always, our guidance reflects a balanced view that incorporates the strength of our business model and customer engagement, along with the latest views on the evolving economic outlook.

We expect third-quarter net sales to be between $2.74 billion and $2.76 billion, representing year-over-year growth of approximately 8% to 9%. We are reiterating our full-year 2023 net sales outlook of $11.5 billion to $11.35 billion, representing growth of approximately 10% to 12% compared to the full year 2022. We are also reiterating our full-year 2023 adjusted EBITDA margin outlook of approximately 3%. As you update your models, also note that we expect our free cash flow for full-year 2023 to be approximately 2.5 times the free cash flow we generated in the full year 2022. Before we open the call to questions, I’d like to reiterate that our strong second-quarter earnings reflect the resilience of our operating model in an evolving macro-environment.

We believe that Chewy is exceptionally well-equipped to navigate the road ahead and deliver strong performance, as our execution is grounded in our operating philosophy of driving sustainable, profitable growth. And with that, I’ll turn the call over to the operator for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is from the line of Doug Anmuth with JPMorgan. You may proceed.

Doug Anmuth: Thanks so much for taking the questions. Sumit, if you could talk more about the wider range of outcomes for active customers in the back half, curious how much hard goods-driven acquisitions are factored here, even though it’s not a big piece of your business. And if my math is right, the 4Q guidance ranges around 5% to 12%, which feels pretty wide. Just hoping you can help us understand what’s happening at both of those extremes? Thanks.

Sumit Singh: Okay, just to clarify the guidance range, you’re talking about is revenue guidance range or somehow customer guidance range?

Doug Anmuth: Revenue. Yes, the implied revenue guidance range for 4Q?

Sumit Singh: Okay. That’s not, so just to address that head-on, that’s not how wide we’re thinking. We’re estimating the range of outcomes on net adds to be a bit wider. We clearly communicated that. We expect growth in the back half of the year. And while that’s certainly possible, we’re sort of modeling a couple different types of scenarios. But on the back of that, I want to reiterate the guidance that we provided, which we actually feel pretty good about given the strength that we’re seeing from ordering customers and the engagement from those customers on our platform. Now let me go back and kind of give you the color on why we are projecting a wider outcome or wider range on the net adds or active adds kind of conversation that we’ve been having in the last couple of quarters So essentially what’s happening is, I’ll provide a short course.

I’m happy to dive into the details here. So consistent with what we previously communicated, the large COVID cohorts that were a headwind to net adds during the first half of the year, where we continue to expect this impact to diminish in the second half, now that we’ve reached the two-year mark for a majority of these cohorts. At the same time, coming out of Q2 what we’ve seen is a slightly more discernible customer and it really started in July for us, much more than it did in May and June. And so we just haven’t had enough time for this to play through. And we’re projecting what we’re seeing right now forward and what it is, is that for the more recently-acquired or newer cohorts of customers, who’s behavior is proving difficult to forecast given kind of the pressures that they’re under given the high inflation, we just have to – we believe we have to work harder, we will have to work harder to earn their trust, simply because they are more distracted by the current macro pressure, and they haven’t yet had the cycles to experience the Chewy magic.

So we know that we have to execute even more sharply to deliver value to the cohorts of customers that are seeking value in the near term, such that we are winning with them as much as we win with the customers that are already loyal to Chewy. So it’s really kind of a tale of two cities. The loyal cohorts stay loyal and they’re consolidating their share of wallet with us. So that is driving the NSPAC expansion and then this recent kind of July trends that were slightly is being projected into August so far is what’s causing us to say, hey, maybe we should widen the aperture here and play through a range of sensitivities. Yes, but on the back half, we’re pretty confident about delivering or holding our guidance, which by the way is going to be a share-winning position in the back half of the year.

Doug Anmuth: And if I could just follow up on NSPAC. Can you just help us parse out what’s happening kind of 2Q and 3Q between inflation and like-for-like pricing?