Chewy, Inc. (NYSE:CHWY) Q3 2023 Earnings Call Transcript

Chewy, Inc. (NYSE:CHWY) Q3 2023 Earnings Call Transcript December 6, 2023

Chewy, Inc. misses on earnings expectations. Reported EPS is $-0.08 EPS, expectations were $0.09.

Operator: Hello, everyone. Thank you for attending today’s Chewy Third Quarter 2023 Earnings Call. My name is Sierra, and I will be your moderator today. All lines will be muted during the presentation portion of the call with an opportunity for questions-and-answers at the end. [Operator Instructions] I would now like to pass the conference over to our host, Jen Hsu with Chewy. Please proceed.

Jen Hsu: Thank you for joining us on the call today to discuss our third 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 have been posted to the investor relations section of our website, investor.chewy.com. On our call today, we will be making forward-looking statements, including statements concerning Chewy’s future prospects, financial results, strategies and investments, industry trends, and our ability to successfully respond to business risk. Such statements are considered forward-looking statements under the Private Security Litigation Reform Act of 1995 and are subject to certain risks, uncertainties, and other factors described in the section titled Risk Factors in our annual report on Form 10-K and other subsequent quarterly reports, which could cause actual results to differ materially from this 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. Reconciliation 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 third quarter of 2023, and all comparisons are accordingly against the third 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 Smith.

Sumit Singh: Thanks, Jen, and thank you all for joining us on the call today. Before we jump in, as we have previously announced, we will be hosting our inaugural investor day next week on Thursday, December 14th. We look forward to seeing many of you in person and encourage everyone to tune into the live webcast which can be found on our Investor Relations website. I am excited to introduce you to our broader senior leadership team next week. We plan to provide a comprehensive update on our strategic roadmap, including a deep dive into our Chewy Health business, and will share refreshed long-term financial targets. In light of our Investor Day next week, we will streamline today’s call to focus on this quarter’s results and a few notable recent updates.

We will leave most strategy and innovation topics for next week. Now let’s review Q3. Chewy continues to outperform and gain market share through the present environment. We reported $2.74 billion in net sales this quarter, up 8% against an industry that grew in the low single digits with pet inflation continuing to return to historical levels. Additionally, the team is executing admirably against controllable factors as reflected by another strong quarter of 3% adjusted EBITDA margin. Consistent with the expectation we shared on our last earnings call, active customers declined marginally on a sequential basis. Looking beyond the near term, we believe we remain well positioned to drive improved active customer trends as the macro environment and pet household formation trends recover.

Notably, we yet again demonstrated our ability to grow wallet share with our customers as net sales per active customer or NSPAC exceeded $540, up nearly 14%. Throughout the third quarter, customer engagement remained strong. Our industry leading mix of non-discretionary consumables and health bolstered by our Autoship subscription service continues to reinforce the structural soundness and defensible nature of our business model. The loyalty and spending resiliency of our Autoship customers remains unabated with no changes to their ordering behavior. Additionally, our conversion of new customers into Autoship continues at a healthy rate. As a result, Autoship customer sales continue to outpace overall top line growth and were up nearly 13% in the quarter and represented over 76% of net sales.

Non-discretionary consumables and health categories anchor our business, collectively representing approximately 85% of third quarter net sales. Pharmacy continued to grow at a premium to the overall company and now represents north of $1 billion business for us, based on trailing 12 months net sales. At this scale, Chewy is the number one pet pharmacy in America. We look forward to sharing more with you about the financial performance and strategic direction of our health business holistically at next week’s Investor Day. As anticipated, we launched Chewy Canada at the end of September, bringing Chewy’s compelling value proposition to millions of pet parents in Canada. Initial customer demand has been strong. Autoship sign-up rates are healthy, our delivery experience is compelling and customer satisfaction is high.

While it is early, we are pleased with our progress in market thus far with key indicators of success pointing towards a bullish future. Turning to profitability, we reported gross margin of 28.5%, which is a new record in itself. Strength in gross margins reflects mixed-rate benefits, tightly managing promotional spend, and strong performance in logistics by our team. Finally, adjusted EBITDA margin came in at 3% for the quarter, even during a period in which we had planned pronounced growth investment. Shifting gears from in-quarter results, I’d now like to provide some commentary on how we performed on Black Friday and Cyber Monday of this year. We observed strong customer purchasing intent during this important holiday shopping week. Traffic and sales exceeded our expectation across all categories, including hard goods, and conversion rates were up year over year.

New customer acquisition was 40% higher than our Q3 weekly average. While we have seen trends return to pre-holiday levels, our Black Friday and Cyber Monday performance is encouraging. Specifically, while consumer spending behavior remains opportunistic in the current environment, our results illustrate that Chewy’s value proposition continues to resonate loudly and will prevail when consumer demand and industry inputs improve. Before I turn the call over to Stacy, I would like to share some context regarding a couple of important company-wide developments. In November, as part of our 2024 strategic planning process, we implemented actions to reduce our headcount in certain areas of the organization. This decision was carefully considered as part of our ongoing focus on becoming an ever more agile and disciplined company and aligned our efforts into priorities which we believe will gain us the most significant customer wins and generate the highest business returns.

While we consolidated some roles within the organization, we continue to invest in other high priority areas. As we head into 2024, we expect these actions to create room for us to continue investing behind our growth initiative. We are incredibly grateful to our team members for their contributions and remain committed to supporting them during this transition. Lastly, I’m excited to announce that David Reeder will be joining us as Chewy’s new Chief Financial Officer starting early in 2024. Dave joins us from Global Foundries, where he is currently CFO. He brings with him extensive experience across a multitude of operational and financial roles at Global Foundries, Lexmark, Cisco, and Broadcom, amongst others. I look forward to working with Dave as we continue to execute against the many compelling growth and margin opportunities across our ecosystem.

I would also like to thank Stacy for all that she has done to support me and the Chewy team in her role as interim CFO. Following Dave’s start date, Stacy will continue to serve as our Chief Accounting Officer. With that, I will turn the call over to Stacy.

Stacy Bowman: Thank you, Sumit, and thank you all for joining us today. In the third quarter, net sales grew 8.2% to $2.74 billion. Autoship customer sales growth outpaced total net sales growth by almost 460 basis points and came in at $2.09 billion in Q3, up 12.8%. Autoship customer sales now represent 76.4% of total net sales. We ended the third quarter with 20.3 million active customers. Our primary measure of customer engagement, NSPAC, grew 13.8% year-over-year to $543, yet again reaching a new record high. As we move down the P&L, please note that my discussion of financials where applicable, refers to metrics excluding share-based compensation expense and related taxes, as well as certain other adjustments disclosed in our SEC filing where relevant.

The same applies to my discussion of guidance and financial outlook. Growth margin reached 28.5% in Q3. Our Q3 growth margin highlights our ability to deliver steady margin accretion in this part of the P&L, and we continue to believe there is meaningful room for continued growth margin expansion over time. Continuing on to OpEx. SG&A totaled $545.9 million, or 19.9% of net sales, de-leveraging 30 basis points compared to the third quarter of 2022. This increase was largely driven by investments related to our growth initiative. Q3 advertising and marketing expense was $179.2 million, or 6.5% of net sales, consistent with our expectation of 6% to 7% of net sales. Third quarter adjusted net income was $63 million, an increase of $14.6 million.

Third quarter adjusted EBITDA reached $82.1 million, up $11.7 million, implying an adjusted EBITDA margin of 3%. Third quarter free cash flow of $48.5 million continues to be strong, reflecting $80.2 million in net cash provided by operating activities and $31.7 million in capital expenditures. Our third quarter trailing 12 months free cash flow was over $300 million and demonstrates our ability to execute sharply and generate meaningful cash flow through all economic environments. Capital expenditures continue to be comprised primarily of automated fulfillment center investments and ongoing technology projects. As planned, our CapEx spend tapered this quarter, following above average CapEx intensity in the second quarter. And we expect 2023 CapEx to remain in the range of 1.5% to 2% of net sales, consistent with past investment levels.

We finished Q3 with $957.2 million in cash and cash equivalents and marketable securities, nearly $351 million higher than the balance at this time last year, and we remain debt-free. At the end of Q3, between cash on hand, marketable securities, and availability on our ABL, our liquidity stood at $1.7 billion. That concludes my recap of our third quarter results. So now, let me cover our fourth quarter and full year 2023 guidance. While we remain confident in the overall resilience of the pet category, as well as Chewy’s ability to deliver growth above the industry average, in light of the near-term macro environment, we are updating our top-line guidance as we head into year end. We expect fourth quarter net sales to be between $2.78 and $2.8 billion, representing year-over-year growth of approximately 3%.

We are narrowing and revising our full year 2023 net sales outlook to be between $11.08 and $11.1 billion, representing growth of approximately 10% compared to full year 2022. We are reiterating our full year 2023 adjusted EBITDA margin outlook of 3%. As you update your model, also note that we expect our free cash flow for full year 2023 to be in excess of 2.5 times the free cash flow we generated in full year 2022, implying an adjusted EBITDA to free cash flow conversion rate north of 80%. Our third quarter results once again demonstrate Chewy’s unique ability to deliver strong results in the current environment. We expect to continue taking share and expanding profitability, while the pet industry works its way back towards steady state trends.

And we remain highly encouraged by the various strategic opportunities that lie ahead. We look forward to seeing many of you next week. With that, I will turn the call over to the operator for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from Eric Sheridan with Goldman Sachs. Please proceed.

Eric Sheridan: Thank you so much for taking the question. I just want to come back to the Q4 guidance on the revenue side. Can you walk through some of the headwinds and tailwinds we should be thinking about in terms of the revenue build for Q4? And how much of this is down to broader promotional or competitive intensity versus elements of the macro environment and basket size or just the lapping effect of inflation from a year ago? Thanks so much.

Sumit Singh: Hi, Eric, this is Sumit. So I’ll speak to it. Our guidance reflects sales growth that is expected to outpace the industry, first of all. So we’re continuing to see changes happen post our commentary from the July-August time frame when we last spoke. So here are a couple of main points. When you look year-over-year, the revenue composition is shifting out of pricing and more into structural unit and attach. So there’s little or no benefit from pricing from a comp point of view. That, combined with continuing lower mix of hard goods and discretionary this year relative to last year explains sort of the year-over-year comps that you’re seeing. As it relates to guidance, the softness that we called out last quarter, that we started seeing in the July-August time frame, has persisted.

We’re seeing the impact of this softness most materially in the non-Autoship portion of our business, right? So the 25% of the business that doesn’t go through Autoship, and primarily across highly discretionary components, some consumable components. This is related and coupled with the impact of the newer customer cohorts that we talked about last time where loyalty is still continuing to be earned, right? These customers are early tenure, and we’re taking steps to engage with them and making forecasting a little bit difficult across the macro that is keeping discretionary soft and overall spending patterns a little bit opportunistic. So that is all reflected in the new guidance that we’re providing. We came out of last quarter, starting to see these trends, the trends have sort of persisted.

So this time was the right time to make the call to update the guidance as we’re seeing it at this time. Having said all this, we have a moat in Autoship portion of the business that remains strong and has proven to be resilient through the current macro per se. Happy to take a follow-up. And I just want to reiterate that at the midpoint of our 2023 net sales guidance, we will deliver approximately 10% growth year-over-year, which is share gaining. And then next week’s Investor Day, we intend to share additional perspective on our long-term growth algorithm and expectations.

Eric Sheridan: Great. Thanks for the color, Sumit.

Operator: Your next question comes from Doug Anmuth with JPMorgan. Please proceed.

Douglas Anmuth: Thanks for taking question. Sumit, got the color there on 4Q revenue. Can you just help us square a little bit the strong Black Friday and Cyber Monday performance you called out with the rest of the outlook for 4Q? Is that just purely promotional driven? And I guess why does that give you some degree of longer-term confidence? And then second, perhaps you can just provide a little bit of color on how you’re thinking about gross margins in 4Q. Obviously, the EBITDA — implied EBITDA guidance is down. You mentioned a few things there on revenue, but is that related to promotions, normalizing inflation, some seasonality? Any other factors we should think about?

Sumit Singh: Sure. There’s a lot there. Nice to hear from you, Doug. There’s a lot there. So let me decouple it one by one and Stacy can jump in at any point if I miss anything. So first of all, promotional activity during Black Friday was slightly steeper than prior year, although it remained broadly rational. So what we are essentially calling out is the way that we went to market, the specific offers that we took to market, the way customers engage with the overall proposition, our existing customer is engaging along with the healthy mix of new customers that we picked up, essentially signals to the fact that structurally, right, the business is sound and when stimulated the right way and customers being in the right mind frame, they do respond.

So it sort of speaks to the tenability of the industry rebouncing once customer pressure sort of abate. That’s the reason we provided those commentary, we thought it would be helpful. Overall, the way that we’re thinking about gross margin, we expect to hold within the 28% range is that we’ve been communicating so far. So we don’t expect an impact to gross margin because we expect the promotional environment moving forward to remain rational with typical seasonal guardrails similar to what we’ve observed over other Black Fridays, Cyber Mondays. Happy to provide more promotional color in the way that we’ve played through Q4. So all of the Q3 implied EBITDA that you’re seeing is essentially as a result of incremental dollars spent during this Black Friday, which was roughly approximately 30 basis points higher than last year.

So that component is building in. And then two, our growth investments started flowing through in Q3 and are continuing to flow through to Q4. So if you normalize for that, it essentially gets you back to the to the healthy levels of EBITDA that we’ve delivered in the front half of the year. Anything to add, Stacy?

Stacy Bowman: Yes, I would just reiterate that our Q4 profitability reflects the usual seasonal impact of holiday promotional activity. But as Sumit just mentioned, it is largely rational and within our expectations. And we will see some investment behind our growth investments. So that flows through to the adjusted EBITDA. But I do want to reiterate that we are really proud that we’re able to self-fund our growth. And so we continue to do so throughout the year.