On Wednesday, Chewy (NYSE:CHWY) discussed first-quarter financial results during its earnings call. The full transcript is provided below.

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Access the full call at https://events.q4inc.com/attendee/246126146

Summary

Chewy Inc. reported Q1 net sales growth of 7.7% year-over-year, reaching approximately $3.36 billion, with 21.5 million active customers, a 3.6% increase.

Autoship customer sales grew over 10% year-over-year, comprising 84.4% of total net sales, reinforcing the predictability and durability of Chewy's revenue base.

Chewy's Q1 adjusted EBITDA margin was 7.5%, with significant expansion driven by sponsored ads, category mix, and operational efficiencies.

The company acquired Modern Animal, enhancing its Chewy Vet Care clinics, with plans to operate approximately 60 clinics by fiscal 2026 end.

Chewy continues to invest in AI to improve operational efficiency, expecting a low tens of millions of dollars benefit in fiscal 2026.

Despite a challenging consumer environment, Chewy maintains its full-year adjusted EBITDA margin guidance at 6.6% to 6.8%, indicating structural durability.

Chewy updated its fiscal 2026 net sales outlook to $13.40 to $13.55 billion, reflecting a more conservative view on the consumer environment.

Chewy's strategic initiatives focus on expanding its health ecosystem, AI, and customer experience to strengthen its competitive position.

Management remains confident in Chewy's ability to gain market share and deliver long-term shareholder value despite current macroeconomic pressures.

Full Transcript

OPERATOR

Earnings Call after today's prepared remarks, we will host a question and answer session. If you would like to ask a question, please press Star one to raise your hand. To withdraw your question, press Star one again. I will now hand the conference over to Lee Horowitz, Head of Investor Relations and Strategic Finance. Lee, please go ahead

Lee Horowitz (Head of Investor Relations and Strategic Finance)

thank you for joining us on the call today to discuss our first quarter results from fiscal year end 2026. Joining me today are Chewy's CEO Sumit Singh and CFO Chris Deppy. 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 [email protected] on our call today we will be making forward looking statements including statements concerning Chewy 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 10K for discussion of these risks. Reported results should not be considered an indication of future performance.

All 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 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 2025. 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.

Sumit Singh (CEO)

Thank you Lee and good morning everyone. Chewy delivered solid results in Q1, continuing to outperform the broader pet category while further expanding profitability and free cash flow. Our results demonstrate the durability of our business model and the structural advantages embedded across the Chewy platform. Despite a consumer environment that weakened in the latter parts of the quarter. We delivered nearly 200,000 net customer additions achieved solid top line growth and record profitability, generated strong free cash flow and maintained consistent category share capture, all while continuing to advance strategic initiatives that we believe will deepen Chewy's competitive moats, drive meaningful free cash flow dollars and deliver long term shareholder value creation. Q1 net sales grew 7.7% year over year to approximately $3.36 billion. We ended the quarter with 21.5 million active customers up 3.6% year over year while net sales per active customer or NSPAC increased to $597. Autoship customer sales once again outpaced overall company growth, increasing over 10% year over year and reaching 84.4% of total net sales in the quarter, further reinforcing the predictability, durability and recurring nature of our revenue base.

Importantly, our performance continues to validate what we have consistently said about the PET category and about Chewy. Specifically. PET remains a resilient category driven by recurring non discretionary needs and strong emotional attachment. At the same time, consumers are growing more discerning, driven in part by elevated fuel prices and broader macroeconomic pressures. However, even against this more challenged backdrop, Chewy continues to steadily gain share.

Our value proposition remains exceptionally strong industry leading convenience, highly competitive pricing, trusted service, deep assortment and a recurring Autoship ecosystem that customers increasingly rely upon. We believe these advantages become even more relevant in periods where consumers prioritize value, reliability and trusted relationships. Importantly, our ability to continue expanding earnings and free cash flow in this environment further reinforces our confidence in the structural durability of the model.

Now let me spend a few minutes on margins and the underlying drivers supporting our profitability trajectory. Q1 adjusted EBITDA margin reached 7.5% representing approximately 130 basis points of year over year expansion on the back of exceptionally healthy EBITDA flow through of greater than 25%. This level of profitability at our scale reflects continued strength across multiple areas of the business including sponsored ads, category mix, supply chain efficiencies, marketing productivity, OPEX discipline and improving operating leverage across our network.

As we discussed previously, our long term framework for margin expansion remains unchanged. We continue to believe Chewy has a unique and differentiated operating model, one that combines a leading recurring revenue engine with a highly scaled fulfillment and health platform and we remain on track to reach our 10% adjusted EBITDA margin target over time. Importantly, our model does not require outsized industry growth or significant pricing inflation to expand margins.

The underlying drivers of profitability expansion remain structural in nature and continue to strengthen including the expansion of sponsored ads, product mix shift into higher margin categories including health and operating expense leverage from automation and scale Turning now to Chewy Health and Chewy Webcare, we continue to believe health represents one of the largest and most compelling long term opportunities for Chewy. Today, pet healthcare represents approximately $54 billion off TAM including over $40 billion associated with in clinic products and veterinary services alone.

Our Chewy vet care clinics are delivering strong standalone economics while simultaneously acting as a powerful customer acquisition and retention engines for the broader chewy ecosystem. Approximately 40% of Chewy Vet Care customers are new to Chewy and these customers tend to reach a year one Nest hack of approximately $900. Furthermore, existing chewy customers who engage with Chewy Vet Care increase share of wallet meaningfully faster than other cohorts following their first visit.

At the same time, our veterinary teams deliver industry leading productivity metrics supported by the technology enabled workflows and AI assisted tools we are embedding across the platform resulting in vet retention and employee satisfaction that outperforms peers in a world where veterinarians are in short supply. This last point affords Chewy a structural advantage relative to peers as we look to scale our vet clinic footprint. As part of this strategy, we are excited about the recently announced acquisition of Modern Animal which closed shortly after quarter end.

Modern Animal adds a highly complementary and well established footprint with above industry unit economics, strong clinical expertise and an experience led technology enabled model that closely aligns with cvc. This transaction accelerates the expansion of Chewy Vet Care and and unlocks multiple avenues to accelerate clinic growth. Combining Chewy Vet Care's organic growth with Modern animals existing footprint and development pipeline combined, we expect to operate approximately 60 clinics exiting fiscal 2026 with embedded revenue contribution approaching approximately $290 million.

At a steady state, we believe Chewy Vet Care will be a meaningful driver of long term shareholder value at Chewy and we look forward to updating you on our progress in the coming quarters. Now turning to AI, we continue to believe AI represents a meaningful opportunity for Chewy both from a customer experience perspective and from an operational efficiency standpoint. Over the last several quarters we have continued to build the foundational infrastructure required to deploy AI broadly across the enterprise.

Today we are embedding AI across multiple layers of the business including customer service, pharmacy operations, fulfillment and marketing workflows. We continue to see meaningful opportunities to structurally lower cost to serve while simultaneously improving speed, efficiency and service quality. Based on our current roadmap and implementation progress, we continue to expect AI driven efficiencies to contribute a low tens of millions of dollars benefit in fiscal 2026 with a more meaningful ramp expected into 2027 and beyond.

Now, before I turn the call over to Chris, I would like to briefly address our outlook and and how we are thinking about the balance of the year. While we remain confident in the long term trajectory of the business and chewy share gaining posture, with an increasingly larger pet time available to us, we are also recognizing that the consumer pet environment has become incrementally more challenged since we initially established our fiscal 2026 outlook earlier this year.

As a result, our updated guidance, which Chris will discuss in more detail shortly, now reflects a more appropriately conservative view of the consumer environment and broader category growth assumptions for the balance of the year. For clarity's sake, we are seeing a modest level of incremental pressure on premiumization and product attach rates amongst our current customer base resulting in what we view as a short term nest back headwind. Conversely, our improved go to market initiatives including better CRM efforts resulting in greater conversion, increased engagement via our mobile app, continued success in reactivating Labs customers and ongoing success in driving down Churn is supporting an ongoing healthy trajectory of for customer net additions. That said, our confidence in the underlying strength of the business, our ability to continue gaining share and our long term growth and profitability algorithm remains unchanged. PET remains a more resilient category relative to other parts of the consumer landscape and Chewy is increasingly building the capabilities and and business lines to accrue a growing share of this incredibly attractive end market.

Additionally, the strength of our customer acquisition funnel continues to support sustained share gains across macro environments while also positioning Chewy to return to more typical nestback compounding rates as consumer conditions normalize, all on top of a meaningfully larger customer base. Furthermore, we believe our strategic initiatives across health, AI fulfillment and customer experience continue to strengthen the moat around the Chewy ecosystem.

In closing, I want to thank the entire Chewy team for another quarter of disciplined execution and innovation. We remain focused on delivering profitable growth, durable free cash flow generation and and long term shareholder value creation. With that, I will turn the call over to Chris.

Chris Deppy (CFO)

Thank you Sumit and thank you all for joining us today. Q1 results reflect continued disciplined execution across the business highlighted by continued share gains, meaningful margin expansion and strong free cash flow generation. Despite a micro environment that softened as we moved through the quarter, Q1 net sales reach approximately $3.36 billion representing 7.7% year over year growth. Reflecting the continued strength across our recurring revenue base, balanced contribution from both active customer growth and Nest PAC expansion and ongoing market share gains within the PET category.

We closed our acquisition of SmartPak in the first quarter as planned and the revenue contribution from the business was in line with our previously communicated $80 million net sales expectation for the full year 2026. We continue to grow active customers ending the quarter with approximately 21.5 million increasing 3.6% year over year. Autoship customer sales reached approximately $2.83 billion in the quarter, increasing over 10% year over year and representing 84.4% of total net sales Growth in Autoship continue to outpace overall company growth, reinforcing the durability and predictability of our recurring revenue model.

S PAC reached $597 in Q1, increasing approximately 4.6% year over year on a normalized basis when accounting for the extra week in the prior year comparable period and reflects continued customer cohort, maturation, growth in health and wellness penetration and increasing cross category engagement across the platform. Turning to profitability, we reported first quarter gross margin of 30.1% representing approximately 50 basis points of year over year expansion including a low single digit million dollar impact from fuel surcharges passed on by our carrier partners.

Gross margin performance was driven primarily by continued growth in sponsored ads, favorable category mix and continued operating discipline. Moving to operating expenses Please note that my discussion of SG&A excludes share based compensation expense and related taxes as well as transaction and integration related costs. First quarter non GAAP SGA was approximately $593 million or 17.7% of net sales. Note Q1 non GAAP SGA excludes approximately $10 million of transaction related costs associated primarily with acquisition and integration activities related to SmartPak and Modern Animal.

As planned, we delivered approximately 90 basis points of year over year SGA leverage reflecting continued operating discipline, fulfillment productivity improvements driving down our variable costs and early benefits from technology and AI enabled efficiencies across the organization. We continue to lower our cost to serve as we scale. Advertising and marketing expense was approximately $206 million or 6.1% of net sales reflecting modest leverage year over year.

As we have consistently stated, our marketing strategy remains focused on profitable customer acquisition and long term lifetime value generation and we continue to see strong returns across both lower and upper funnel investments. Q1 adjusted net income was approximately $180 million translating into adjusted diluted earnings per share of $0.43. Adjusted EBITDA reached approximately $253 million in the quarter representing a 7.5% adjusted EBITDA margin up approximately 130 basis points year over year and reflects adjusted EBITDA flow through of greater than 25%.

This level of profitability expansion reflects the structural strengthening of Chewy's earnings model. We are expanding earnings materially faster than revenue growth while continuing to invest behind strategic initiatives including QE Health, QE Vet Care, AI Infrastructure and Fulfillment Network Optimization. The power of our underlying profitability profile allows us to both deliver consistent margin expansion while simultaneously investing into core strategic growth drivers that give us an increasing right to win a growing share of of the PET parent wallet.

Free cash flow for the quarter was approximately $71 million, increasing over 45% year over year. Q1 free cash flow reflected approximately $109 million of net cash provided by operating activities and approximately $38 million of capital expenditures. Our continued free cash flow strength reflects the durability of the Chewy model, the recurring nature of our revenue base, and the structural expansion and profitability we continue to drive across the business.

During the quarter, we deployed capital across several strategic priorities including the acquisition of SmartPak and approximately $200 million of share repurchases under our existing program. These actions reflect our continued confidence in the long term opportunity ahead of us as well as our disciplined approach to capital allocation. We ended the quarter with approximately $520 million of cash, cash equivalents and marketable securities and over $1 billion of total available liquidity inclusive of our revolving credit facility.

Subsequent to quarter end, we completed the acquisition of Modern Animal, further expanding our presence within the highly attractive and underpenetrated pet health care market. In addition, earlier today we launched a $600 million term loan deed transaction. Given the scale of our business, the durability of our earnings profile and and our consistent free cash flow generation, we believe adding a modest amount of leverage is an appropriate evolution of Chewy's capital structure.

We intend to maintain a conservative balance sheet and over time target net leverage below 2 times adjusted EBITDA. Within that framework, the transaction enhances our financial flexibility and positions us to continue investing behind our strategic priorities, pursue attractive growth opportunities and return capital to shareholders while maintaining significant liquidity. Now, turning to our updated outlook. As Sumit mentioned earlier, while the PET category remains resilient overall, the consumer environment has become more challenged since we established Our original fiscal 2026 outlook earlier this year.

Most notably, we are seeing more pressure on discretionary attachment and premiumization behavior across portions of our customer base, resulting in slower nest pack growth than we had originally anticipated. Against this backdrop, we are updating our full year fiscal 2026 net sales outlook to reflect both the softer consumer environment as well as a more conservative set of internal assumptions for the balance of the year. For fiscal 2026, we now expect net sales of between approximately 13.40 and and $13.55 billion, representing approximately 6.3% to 7.5% year over year growth.

Including within this range is an expected net sales contribution of approximately $80 million from SmartPak and approximately $70 million from Modern Animal for fiscal year 2026. As we entered the year, we anticipated several company specific initiatives would support improving growth trends through the back half of fiscal 2026, including expectations that changes to our auto ship product flow would accelerate product line attachment rates and enhance digital advertising bidding algorithms would drive faster levels of customer growth.

While we remain confident in the long term value of these initiatives and both products are delivering strong underlying gains, the impact of both products have been muted by the macro environment. We no longer believe it is prudent to embed a meaningful acceleration in consumer spending into our outlook given the current operating environment. The low end of our guidance range assumes the current consumer backdrop worsens relative to the trends we are observing at this point, while the high end assumes spending patterns improve from current levels.

As we move through the second half, we continue to see healthy active customer trends, ongoing market share gains and continued strength in Autoship. That said, given the current environment, we now expect activity active customer additions to trend towards the lower end of our previously stated range of approximately 150,000 to 250,000 net adds per quarter. The Chewy customer funnel remains healthy with consistent churn gains during the quarter and extremely healthy reactivation rates which are being somewhat offset by new to chewy customer softness due to the challenged spending environment.

Now turning to profitability guidance. Given the continued strength we are seeing across the earnings profile of the business, we are maintaining our full year fiscal 2026 adjusted EBITDA margin guidance range at 6.6 to 6.8% or approximately 100 basis points of year over year expansion at the midpoint. That said, as we mentioned, as part of the Modern Animal acquisition, while these clinics are highly profitable on a four wall mature basis, we expect the business to represent a modest margin rate drag in 2026.

Thus, our stable total margin guidance speaks to the increasing durability of Chewy's earnings algorithm at the midpoints of our guidance ranges. This implies approximately $900 million of adjusted EBITDA for the year. Importantly, our updated profitability outlook continues to reflect ongoing investment across several strategic priorities including Chewy Health, Chewy Vet Care automation initiatives, AI enabled productivity efforts and continued customer acquisition investments, our confidence and earnings power of the business continues to strengthen, supported by structural improvements across gross margin sponsored ads, fulfillment productivity, operating discipline, and broader operating leverage throughout the organization. Furthermore, as we look to continue to deliver robust profitability gains in spite of the more challenged consumer backdrop, we are able to action certain efficiency gains that we originally had slated for the back half of 2026 earlier in the year Supporting Full Year Margin Durability as you think about the cadence of profitability through the balance of the year, there are several important items to keep in mind.

First, as we discussed on our prior earnings call, we continue to expect quarterly gross margin cadence in fiscal 2026 to more closely resemble the patterns observed in fiscal 2023 and fiscal 2024. Specifically, we expect second quarter gross margin to contract modestly year over year, driven primarily by difficult comparisons associated with non recurring map pricing benefits realized during the second quarter of fiscal 2025. Despite this quarterly dynamic, we continue to expect gross margin expansion on a full year basis.

Second, we expect XG and a leverage to remain relatively consistent throughout the balance of the year as we continue investing behind strategic growth initiatives while also realizing ongoing operational efficiencies across the business. Taken together, these factors are expected to result in more muted adjusted EBITDA margin expansion during the second quarter relative to the first quarter, with stronger year over year expansion expected across the back half of the year.

Overall, while we are moderating our revenue expectations to reflect the current operating environment, our confidence in the long term structural margin opportunity and free cash flow generation profile of the business and continues to increase. Now turning to second quarter guidance for the second quarter of fiscal 2026, we expect net sales between approximately 3.30 and $3.33 billion, representing approximately 6 to 7% year over year growth. Our second quarter outlook assumes the current operating environment and consumer behavior trends remain generally stable with what we experienced exiting the first quarter, we continue to see healthy active customer engagement, Autoship program strength and continued market share gains. Although we expect ongoing pressure on discretionary attachment and premiumization behavior to persist near term. Given the number of moving pieces impacting quarterly profitability cadence, including the gross margin dynamics we discussed earlier and our desire to be more transparent and clear with quarterly profitability expectations, we are introducing quarterly adjusted EBITDA margin guidance for the second quarter.

We expect adjusted EBITDA margin of between 6.3 and 6.4%, representing approximately 50 basis points of year over year expansion at the midpoint. As a reminder, second quarter profitability will be impacted by more difficult year over year gross margin comparisons associated with non recurring map pricing benefits realized in the prior year period as well as elevated fuel surcharge costs flowing through the quarter which we expect to represent a roughly mid single digit million dollar headwind to the quarter.

At the same time, we continue to expect ongoing SG and a discipline and operational efficiency improvements across the business. Furthermore, our updated guidance for adjusted EBITDA margin in fiscal year 2026 contemplates similar levels of fuel cost headwinds for the balance of the year. Thus, while second quarter adjusted EBITDA margin expansion is expected to be more muted relative to the first quarter, we continue to expect stronger year over year profitability expansion across the back half of fiscal 2026 as reflected in our full year guide.

As we lap this one time map item, we also expect adjusted diluted earnings per share for the second quarter to be approximately 36 cents. And finally for the full year 2026 we continue to expect share based compensation expense including related taxes to remain broadly flat year over year. We are lowering our weighted average diluted shares outstanding by 5 million shares and now expect to end the year with approximately 420 million shares net interest expense of approximately 10 to $15 million given the interest expense on our recently launched term loan and an effective tax rate in the range of approximately 24 to 26%.

In closing, I would like to thank all of our chewy team members for their continued disciplined execution and focus on operational excellence. We believe the combination of our recurring revenue model, growing health ecosystem, structural margin expansion opportunities and strong free cash flow generation position chewy well to continue delivering long term profitable growth and shareholder value creation. With that, I will turn the call back over to Sumit for some closing remarks.

Sumit Singh (CEO)

Thanks Chris. While the consumer environment has become modestly more challenged, our first quarter results reinforce that the power of the Chewy model remains durable and continues to strengthen. We are continuing to gain share with an increasingly larger PET TAM by leveraging the assets and initiatives we have built across Autoship and health, vet care, AI fulfillment and customer experience. These capabilities are deepening our competitive modes, expanding the durability of our earnings and free cash flow profile and strengthening our right to win a greater share of the pet parent wallet over time.

As today's transitory headwinds subside, we believe Chewy will be even better positioned to compound those gains and deliver long term shareholder value. With that, I will turn the call over to the operator for questions.

OPERATOR

We will now begin the question and answer session. Please limit yourself to one question and one follow up if you would like to ask a question, please press star one. To raise your hand. To withdraw your question, press star one. Again, we ask that you pick up your handset when asking a question to allow for optimum sound quality if you are muted locally. Please remember to unmute your device. Please stand by while we compile the Q and A roster. Your first question comes from the line of Nathan Feather with Morgan Stanley. Your line is open. Please go ahead.

Nathan Feather (Equity Analyst)

Hey everyone, and thanks for taking the question. I appreciate the quarterly EBITDA guidance. That's really helpful. Can you just put a finer point on the puts and takes here that are leading to the sequential margin improvement in the back half of the year? Thank you. Yeah, so thanks for the question, Nathan. And So you know, Q2, I'll just emphasize, is really all about phasing. The SG&A expansion that we expect in Q2 remains broadly flat to what we saw in Q1 and what we'll see for most of the year.

But if you look at our gross margin curve from last year, Q2 had a much higher and sort of outsized increase quarter over quarter. That's, that's not our normal seasonal pattern that you can see in our fiscal 2023 and 2024. And so Q2 is really just a phasing of that gross margin where 2026 looks more stable quarter over quarter on gross margin rate. So as you get to the back half of the year, we continue to think back half of the year looks like our full year where SG&A delivers slightly more than gross margin improvement.

Gross margin will continue to expand year on year, but the seasonality of gross margin in the back half of the year looks quote unquote more normal versus what we experienced prior. And so again, Q2 is really all phasing. Structurally. SG&A continues to leverage with fulfillment costs. We continue to leverage corporate payroll costs. Gross margin will continue to expand with sponsored ads, premiumization and a rational promotional environment. Very helpful, thank you.

Eric Sheridan (Equity Analyst)

Your next question comes from the line of Eric Sheridan with Goldman Sachs. Your line is open. Please go ahead. Thanks so much for taking the question. Maybe one and a follow up if I could. With respect to the comments you made about the consumer, how should we be thinking about going one level lower on consumer behavior? And are you seeing any deviation in behavior relative to age of cohort or income levels that you want to call out in terms of consumer behavior on the platform?

Sumit Singh (CEO)

Hey Eric, this is sumit. Not really. Those are not data points that we collect sort of on a periodic basis, more so on a twice a year basis. But I can tell you that underneath of it, when we look at sort of cumulative reorder rates for customers, you know, these type of trends are holding very positive. I'm also looking at and that's true for new customers as well as reactivated customers. When I look at NSPAC by cohort for the customers that we acquired in the period one of this year that is now lapping sort of two periods or that has now been with us for two periods now, you know, those cohort trends are positive.

So broadly speaking, you know, this is, as we shared on the call, more so around the broad trends of premiumization and a modest sort of, you know, impact on attach rates. But in terms of consumer demographic, those type of data we don't collect on a periodic basis.

Eric Sheridan (Equity Analyst)

And it's just one follow up if I can against the macro environment you find yourself in now, when you think about some of the longer term platform and product initiatives that you guys highlighted in your prepared remarks, how do you think about either maintaining or accelerating the investment case cadence in the business to capitalize on your market share potential relative to the rest of the industry as you look out towards the remainder of this year?

Thanks so much.

Sumit Singh (CEO)

So we're always taking the steps. So we plan twice a year for the long range plan and then sort of break those plans down into what we would execute over the next 12 months or so. And so our focus is always investing in activities that allow us to grow our Tamil and continue to gain incremental share of wallet from customers. So you've seen. And then underneath the gross margin line, we're investing in activities like building up infrastructure capabilities to invest back in AI that are driving efficiency savings that we've obviously quantified last quarter and we've again confirmed this quarter.

So if you take that framework, then at the most strategic level we're investing behind, you know, initiatives like Chewy Health and underneath of that it's you know, chewy vet care and clinic initiatives that opened up the Tam by incremental $40 billion and is the fastest compounder of Nest Back, you know, is a good way to look at it. When you think about, you know, our product initiatives, they are much more so to drive Nest Back curves up. Whether this is, you know, investment in ownership that drives repeat recurring purchase behavior, whether it's improvement and experience that drives incremental.

So one of the projects that we mentioned on the script that we are now not underwriting as bullish of behavior as we initially concept did when we tested it is this kind of notion of attaching more lines to Autoship per se. And that again goes back to the way the consumer behavior is acting rather than the direct loss of our belief that these products will continue to drive product attach rate. Chewy plus is another investment for us, although I should be very clear in saying that from a margin investment point of view it is neutral, not dilutive to 2026.

But again that's one of those initiatives that we essentially are very closely evaluating our product market fit for in pushing Naspac curves between $300 and $800 up. Now when you go kind of below the gross margin line, then we've clearly talked about continuing to invest in automation, continuing to invest in AI and that drives SGNA curve leverages while we maintain really strong corporate payroll discipline across the company. So we're evaluating every line of the income statement and ensuring that maximized profit converts into free cash flow on a moving basis.

And then the last capital allocation which not directly a capital allocation question but is how do we efficiently return capital back to shareholders?

Doug Anmuth (Equity Analyst)

Your next question comes from the line of Doug Anmuth with JP Morgan. Your line is open. Please go ahead. Thanks for taking the questions. Sumit, can you talk about just how you get the confidence that the weaker environment late Q1 and into Q2 is macro driven and just weighing on the broader category rather than anything market share specific to Chewy. And then when you think about the AI savings that you talked about the low tens of millions in fiscal 26, are you still expecting kind of what you talked about previously like 50 million plus in fiscal 2027?

Sumit Singh (CEO)

The answer to the second question, because it's such a direct question, is yes. Now moving to the first question on how are we confident, what are we viewing, et cetera. So we're very clearly gaining share. Our data suggests that competitive data across the industry suggests that and there are a few things underneath of it. So when you look at customer attraction towards Chewy, it remains solidly driven by both our efforts as well as when you look at branded searches towards Chewy or direct traffic that is migrating to Chewy, that traffic was stronger that relative to underlying trends.

When we look at industry level trends in Q1 we saw weakening trends within the overall pet food and supplies from an impressions index point of view. And that trend declined year over year underscoring the cautious consumer. And despite this, when you look at Chewy's absolute metrics, they increased mid single digit percentages year over year and that was true for pretty much every category that we play in Number three, when you look at spend cohort behavior, we are continuing to outside of the modest pressure that we've talked about in these attach rate consumables and health care categories that are recurring in nature fueled by the auto ship flywheel, continue to be super strong. And then when we look at underneath the share where the share dynamics lie today we believe the primary source of share gain in the pen industry are still within large E commerce players such as ourselves. And furthermore, when you look at our customer behavior, we continue to see lower churn healthier reactivation rates as well as healthy yet modestly worse than expected new customer acquisition. So all those are indicators in a world where the consumer behavior is changing less so than our proposition is diluting in any particular way.

And that gives us the confidence that the pressures that we're seeing are primarily macro related. And then finally, when you look at the fact that E commerce continues to take strength, we continue to hold on to our customers, we don't see indicators that suggest a meaningful change in the competitive environment. And so taken together, these are the trends that are giving us the confidence that the pressure we are seeing today is primarily macro related, reflecting a more cautious consumer environment rather than a result of increased competition or share loss.

Eric Sheridan (Equity Analyst)

Thank you. Appreciate that.

Shwetar Khajuria (Equity Analyst)

Your next question comes from the line of Shwetar Khajuria with Wolf. Your line is open. Please go ahead. Thank you for taking my questions. Let me try two please. So when we think about your mid to longer term growth rate, in your view, does anything change in the growth algorithm, should we be be thinking about your growth as sort of 2x the overall industry growth rate driven by the initiatives that you are taking outside of macro environment and then the second is on CVC and the veterinarian efforts now that the acquisition is closed, could you please remind us what your goals are between now and year end and how we should be thinking about your expansion efforts there?

Thank you.

Sumit Singh (CEO)

Sure. So I'll take the first one, Chris can take the second one and I'll add as required. So yes, the answer to the first question is we still expect us to continue to grow share and to grow two times or more relative to the market. The value proposition of how we are going to market is only strengthening across from broader initiatives where we're expanding TAM to the precision and quality of execution within those initiatives underneath those tam, whether that's on the food and supply side of the house, or whether that's product experience led products such as Autoship or Chewy, etc. Or whether that's consumer behavior that we continue to accrue on our platforms. All of those are strengthening. We have clearly signaled our aspiration in continuing to play and gain meaningful share in the categories that are health related and we are continuing to see that come true. So overall, none of the expectation nor aspiration has changed in our ability to accrue market share and drive outsized growth relative to the market.

Chris Deppy (CFO)

Chris yeah, on CVC shorter so you know, clinics we still believe are a compelling revenue and earnings growth driver for Chewy going forward. Now we closed the last fiscal year with 18 Chewy Vet Cares and now that we have Modern Animal closed, we've added 29 clinics from them putting us at 47 clinics. We will continue with our plan as stated of 10 to 12 new openings in fiscal 2026 for chewy vet Care and focus on integrating Modern Animal into our operating and technology stacks and then evaluate the business going forward.

You know, we'll plan to attack it aggressively via expansion as we move forward and continue to evaluate all of our both organic and inorganic opportunities in the space. So you know, 2026, we'll stay with our 10 to 12 clinic opening plan of record and go from there.

Sumit Singh (CEO)

So Shweta, to summarize, we will exit 2026, where we'll exit 2026 with roughly 60 clinics. And then as Chris said, our focus is stabilization and integration alongside ensuring that the synergies that we saw both from Modern to Chewy and Chewy to Modern are essentially starting to get unlocked so we can have a really healthy 2027 relative to those.

Shwetar Khajuria (Equity Analyst)

Okay, thanks Amit.

Michael Morton (Equity Analyst)

Your next question comes from the line of Michael Morton with Moffitt Nathanson. Your line is open. Please go ahead. Good morning. Thank you for the question. Just wanted some additional clarity on what you're seeing with the consumer and trying to connect some prior comments. So Sumit In May when you were at an industry conference you said you saw gross additions increasing and then churn improving quarter over quarter. But the guidance and the forward commentary talks about customer additions coming in at the low end of the net adds range per quarter. I would just love to get a better understanding maybe of some of the breakdown in consumer behavior over the last 30 to 60 days.

It seems to be driving such a reset and then part of that is the question we get a lot if Amazon's push into same day grocery is having an impact in the competitive environment at all. Thank you.

Sumit Singh (CEO)

So on the first one, nothing has changed relative to how we had forecasted the curve of the year. If you recall our comments from last quarter and Then again, at Boston we've essentially provided a range of active ads to be between 150,000 to 20250,000 customers on a quarterly basis. And a further comment that we provided was that we will start out the year probably between the low to mid end of that and then we had baked in an acceleration as we move from the first half of the year to the back half of the year.

Underneath of those two comments, if you recall, we have reiterated that we are not underwriting a rebound in how adoption or relinquishment trends are essentially changing. So we were not underwriting any kind of rebound relative to the industry. So all of the progress that you're seeing is primarily driven by Chewy's efforts against a macro that was expected to normalize coming out at 2025. But then we prudently observed that perhaps we should not underwrite that normalization.

So all that has changed from that point until now is that we have seen seen right a further so instead of the back half getting stronger, we now maintain a point of view that we should be appropriately conservative given the trending that we have seen as we've played through the back half of Q1, which is a modest pressure on NSPAC driven by attach rate, particularly on the discretionary side as well as, you know, premiumization headwinds. So that is what is leading us to update the guidance.

So you could call it, hey, it's majority on the macro and there's a smaller amount based on our initiatives that we had underwritten or forecasted to provide us a tailwind as we had moved towards the back half of the year to consolidate NSPAC curves and therefore drive the revenue. I would summarize it as the following. If you look at our long term revenue guidance, it has consistently been high single digit to low double digit revenue growth and the two inputs of that algorithm are active ads growing at low to mid single digit and then NSPAC growing at mid to high single digit, right? So Q4 performance or 25 performance was very much written with the high end of low single digit in terms of customer additions and then squarely mid single digits for nest pack. And so our curve this year right, was also initially set for low to mid single digit customer additions which we are now kind of forecasting to perhaps being in that low to mid range of that 150 to 200,000 customers as indicated on our earnings call today. So very consistent with our commentary relative to last quarter coming into this quarter with the update being seen primarily on a slightly weaker macro and then second Amazon's pushing to same day grocery.

No real comments. As I've mentioned, we're not seeing any change to competitive environment. We keep competitors in the rearview mirror, but clearly we're focused on our proposition, our customers. That continues to compound and we continue to pull away in orbit. If you would, relative to the innovation that we are driving in pet, not only in classic products that drive our food and supply segments, but also in new categories such as health, equine,, specialty animals, et cetera, et cetera.

So overall we feel very good about our positioning. If you look at pricing or promotional intensity, which is generally a sign of more competitive environment, I mean we would say the broader retail environment is active from a promotional standpoint, but remains rational and consistent with what we've seen for quite some time now. And our approach continues to center on delivering a strong customer experience while maintaining the business or managing the business with appropriate business discipline. So there were times in Q1 when we leaned in on promotions for a discrete period of time because we identified the opportunity in the front half of the quarter. And as we moved into the back half of the quarter we pulled back and are being deliberate about deploying these dollars to drive higher ROI when we see the opportunity.

Michael Morton (Equity Analyst)

Thank you.

Anna Andreeva (Equity Analyst)

Your next question comes from the line of Anna Andreeva with Piper Sandler. Your line is open. Please go ahead. Great. Thank you so much for taking our question. Good morning and thank you for all the color. Sumit. We just wanted to follow up the pressure with premiumization on the NSPAC and I think you mentioned that more across discretionary. Can you remind us what's the penetration of what you guys consider discretionary on the platform? Are you seeing this more with new or existing customers and just your thoughts on company specific initiatives to accelerate that?

Naspac, I think you mentioned promotional environment is pretty rational for the industry, but do you view higher promotional activity as a lever for chewy to drive the business just as you go through this softer macro? Thank you so much.

Sumit Singh (CEO)

Okay, let's unpack those one by one. So on the first one, premiumization and discretionary, what is the penetration on discretionary strategy? Okay, so you know if you look at our filing, it is clear that hard goods continues to perform well and remains an important contributor to customer engagement and nest back growth. So this is less specifically pointing towards hard goods softening. Right. What we are referring to is not a decline in hard goods demand.

Rather the pace of discretionary attachment is running below our original expectations entering the year. And so you know, as you would expect, we forecast down to the line item level on customers that we bring onto the platform. The spending behaviors of those customers, new existing customers and reactivated customers each have different type of cohorts curves that we build in and within each of these we're building an attached rate forecast. So what we're referring to is not a decline in hard codes. Rather the pace of discretionary attachment is running below.

And so customers are still purchasing discretionary categories but are somewhat being a little more deliberate in their spending decisions than they were several quarters ago. So when we take a step back, our product expansion with hard goods assortment remains healthy and is continuing to support growth. The distinction is simply that what we consider it because you could consider treats or we consider treats also as a discretionary item. If you look at the way pet parents are experimental with treats, an average pet parent can try up to 12 different treat brands a year. And those brands, depending upon the willingness to pay rather than affordability characteristics of the consumer can really lead to high end premium treats being attached and driving the overall basket.

So the whole thing for us kind of moves together in our ability to drive stronger attach. Our autoship business has continued to grow strongly and is a premium driver of attach for us. At the same time, some of these other non CIS gen driven behaviors, including some customers adding line items to auto ship that one of our products was supposed to run drive. Those are some of the things that we're sort of going staring at and saying okay, might have been a bit more bullish on our forecasting.

And then your second is promotions are never to accelerate. We don't view so we view investment in the business, you know, broadly across the spectrum. You know, we don't consider promotions. So when we are investing behind initiatives, we're essentially first interested in ensuring that our TAM and profitability expand on a sustainable basis. So we are less interested in chasing dilutive growth. We are also careful about not just overpouring dollars into marketing with the outcome being us picking up lower quality customers. Ana, you may remember 2023 when we essentially ran sort of cash acquisition offers and these type of offers just don't have high ROI and generally produce hit and run customers.

So is promo lever I would say demand elasticity is a very proven dynamic in the economics of a business. At the same time, LTV to CAC is a highly disciplined leverage that we keep in front of us. And so the ROI of the investment is also very important to us.

Mark Mahaney (Equity Analyst)

Your next question comes from the line of Mark Mahaney with Evercore. Your line is open. Please go Ahead. All right, thanks. I just wanted to ask about sponsored ads and if you could provide a little bit more of an update on this. I know you've been citing it for a while as a driver of gross margin expansion. If you could be more specific about that. And then, and then if there's anything new in terms of the types of advertisers that you've been able to bring onto the platform, any color there would be great.

Thank you.

Sumit Singh (CEO)

Hey Mark, I can start. Chris can add as he sees red. So, sponsored ads, we continue to be bullish, optimistic and pleased with the progress of this, this particular initiative. You know, if you recall, we exited last year at roughly or 25. We exited, you know, roughly at midpoint of our growth curve overall expectation of 1 to 3%. And we'd leaned in with on site ads as the primary growth driver of margin contribution. You know, in 20, 24 and 25, as the program continues to grow, we will continue to mix into off site ads.

So broadly speaking, at our entitlement, which we are currently underwriting as 3%, we expect overall contribution to be at 2/3 or 70% of that to be converted into, to move to the bottom line, the quarter we were pleased with, given our efforts to accelerate a product launch that we call CMax, which allows advertisers to collaborate with us even faster, our ability to solve cold start challenges with new or smaller brands with more efficacy. And so we saw roughly 40% of our advertisers try out the product and give us really high marks for what we've taken to market. And essentially part of sponsored ads is helping us offset some part of the fuel pressures that we are now citing and are persistently loaded into our PLs.

So broadly speaking, it remains a product that has high customer reception, receives strong scores from our advertisers, we have a healthy level of demand and we continue to focus on a optimizing supply and ramping up off site ads.

Chris Deppy (CFO)

Nothing to add.

OPERATOR

We have time for one more question which will come from the line of Michael McGovern with Bank of America. Your line is open. Please go ahead.

Michael McGovern (Equity Analyst)

Hey, thanks for taking my question. Given CVC customers are about $900 in year one. Nest Pack. Can you speak to the customer acquisition cost of a clinic acquired customer versus your primary digital channels? And then second question, just more broadly, can you kind of talk about the EBITDA margin headwind from Modern animal in the Q2 guidance? Anything along the lines of just how much of the quarter on quarter margin headwind is a self directed investment there.

Sumit Singh (CEO)

Thank you. I'll take the first one, Chris will take the second. So, Mike, in terms of customer acquisition costs relative to digital, this has been a pleasant surprise for us. You know, what we've seen is the halo of the Chuwi brand. When a box is dropped in a particular MSA attracts, with very little local activation, attracts a high quality set of customers to cvc, therefore making our overall acquisition costs also highly efficient. So as you recall, 40% of customers, 4 out of 10 customers that are walking into CVC are net new to chewy. And we expect we've essentially seen this behavior or this particular trend stay true for every box that we have dropped so far in the last 18 boxes that have been dropped.

And so at this point, after having operated the infrastructure for roughly two, two and a half years, we have some good data points from our original cohorts as well as our newer cohorts. So we're quite pleased with what it's costing us to acquire these customers. The Chuwi brand awareness is helping a

Chris Deppy (CFO)

lot of Mike on the Modern Animal EBITDA margin headwind. As we shared when we announced the transaction, we expect Modern Animal to be generally adjusted EBITDA dollar neutral in 2026. So we shared there's a $70 million revenue or net sales impact for the year, roughly dollar neutral EBITDA. So that provides a modest margin rate drag for the year from a timing and curve perspective. You know, perhaps that drag is a little higher in Q2 and wanes through the year, but that's the overall view for modern animals.

Michael McGovern (Equity Analyst)

Got it. Thank you.

OPERATOR

Thank you for all your questions. This concludes today's call.

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