Chewy Inc Aktie

All right. I think in the interest of time, we're going to move on to our next fireside chat. For those who don't know me, my name is Eric Sheridan. I'm Goldman Sachs' U.S. Internet and Entertainment analyst on the research side. It's my pleasure to have Chewy here at the conference this year. Sumit Singh, CEO. Sumit, welcome to the conference.

Thank you.

Okay. So Sumit, before we get into it, I'm going to dust off my legal degree. Before we begin, please note that today's discussion may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied. For a discussion of these risks, please refer to the Risk Factors section of Chewy's most recent Form 10-K and its other SEC filings. Forward-looking statements speak only as of today, and Chewy assumes no obligation to update them, except as required by law.

So let's kick off with the journey you've been on. So we take a step back before we take a step forward. The company has been on a journey where you've evolved from a pet retailer to a broader pet care platform. As you look at the mix of businesses today, where are you most pleased with the progress? And how are you thinking about the journey ahead?

Thank you. Most pleased with our focus on rebuilding the supply chain and technical infrastructure of the company and then layering the food and med side of the house on Autoship. What that has done is it's given us the stability and the predictability to be able to invest those cash back into growing a very large health TAM, which we decided to enter in 2018. Health is $50 billion, $12 billion to $15 billion comes from products, merchandise, meds, diet, health and wellness supplements, flea and tick, et cetera.

And so we obviously built our -- so that's one. The second thing, I guess, I'm most excited about then is the health growth, given the large TAM and the need to step in and drive a much improved mousetrap in what the industry has been used to over the last several decades. And so there, we started with the product space. We quickly became the #1 pet pharmacy in the country. We currently continue that position of picking up $0.70 of every dollar that is moving online into the meds and product space.

And then 2024, we entered into the veterinary space more seriously into the health services space by, a, building a software for veterinarians, which is now used by half the veterinarians in the country, and then applying that technical capability into launching our own clinics for which we have 60 of now, and they're performing better than the case that we laid out. I know we'll talk about them, so I won't go into this detail.

But broadly speaking, if you look at incremental growth on Chewy, over the last 6 years, we roughly added, I would say, $9 billion or so of incremental growth, $4 billion out of the $9 billion have come from Chewy Health. If you look at the last 7 years or -- 6 or 7 years of us going public, gross margins have gone from 18% to roughly 30%, 1/3 came from Autoship, 1/3 came from health and 1/3 came from us rebuilding our supply chains like we have.

Okay. There's a lot in there, and I do want to unpack a lot of it, but let's start with the consumer as a jumping off point. You play in both sides of the consumer landscape with a lot of discretionary and nondiscretionary purchase behavior on your platform. What are you seeing in terms of consumer behavior today? And how is it informing your outlook for spend through the remainder of the year?

Yes. I think let's start a bit higher. Let's talk about consumer behavior and also attributing their intent towards the category in itself because I feel this is an important one to address. So it is true that the pet industry is seeing a little less enthusiasm in terms of customers actively voting to participate in discretionary categories.

However, what's important to recall is that -- so go back to January and how this year started, right? The narrative that you heard from me on a stage like this was, hey, we're excited about coming into '26. We're seeing normalization starting to occur. We're seeing adoption starting to run in front of relinquishments and pet parents are leaning in with their wallets.

And we had estimated 150,000 to 250,000 net adds. And we've said, hey, if the year essentially turns out to be like '25 was, we essentially expect a net add acceleration in the back half of the year, right? What happened in March and April post the war -- as soon as the war started, we started seeing some signs of customer pullback, particularly tied to fuel, tied to stress in the marketplace, and that impacted attachment rates.

And we essentially also came back and readjusted our forecast. And so the two changes that we made was we said, "Hey, it's April. We don't yet know whether this is going to stabilize or not". And so we're going to leave it as the JPMorgan conference, we said -- in Boston, we said, "Hey, we're going to leave it as we've seen trends worsening, we're going to readjust our forecast a bit".

What you heard from us now is we've said, okay, we've seen this trend for a few months now. Trends have stabilized. We see adoptions and relinquishments roughly at parity. We see food and meds at Chewy running strong, and we see our health services outperforming our forecast relative to what we had in April.

So some part of the narrative that you're hearing about the dog population slowdown and then the cost leading to slowdown in vet services visits. Yes, the dog population has slowed down a little bit, but we're not seeing the second part of that equation come through on our side. That's one.

Number two, when we go pulse shelters and rescues, in this country, shelters and rescues drive roughly 2/3 to 70% of the adoptions in pet. The rest come from breeders. We talk to both communities. Shelters and rescues, yes, dogs are slightly underrunning, cats are overrunning. Overall, it's a balance. But when they pulse consumer intent, the intent stands as strong as ever. So in terms of -- so we view -- and then on the breeder side, breeders have seen no slowdown in these kind of elevated breeds that essentially got popularity in the last 10 years.

All they have seen is their Goldendoodle that they used to be marketing for $2,200 a puppy is now selling for $4,500 a puppy. And they're still producing an equal number of litters. So what that tells you is that on the shelters and rescue side, it's what we consider a pent-up demand rather than any sort of specific fracture in the inputs of long-term trend in the industry.

Okay. And then in terms of -- maybe I'll bridge from that to active customers, talk a little bit about that. The company went through a period coming out of COVID where you struggled with customer growth and you've seen a marked improvement in customer growth and retention this year. Talk a little bit about what you've learned about the consumer from a growth and a retention standpoint this year and how it informs your view of where we're going in terms of the medium term for that metric.

So we feel quite good about our ability to attract consumers and particularly attract them from -- see, in market, you can grow two ways. You can either bring customers over who are shopping somewhere else or you can accrete net new customers entering into the category. We've already established that the pain that the industry is seeing is this net new customer entrant into the category.

On an average, you should expect 10 million to 12 million pets to come into the market every year in a normalized market. That number is running quite a fair bit below that. Even with that, our ability to pick up and add increased gross adds today with these customers shopping an existing retailer is running higher than our gross adds in 2019. So what that tells you is that the propositions that we have launched with, which is improvement in hard goods that has driven hard goods growth has brought in many customers over 2023 time frame into hard goods.

Our accelerated pace of pharmacy continues to drive customer growth into the pharmacy business. Fresh, we are leading the innovation and go-to-market from a Fresh standpoint. We have the largest number of brands set up on a built-out supply chain, which we don't have to invest in because we already passed the investment cycle, which we are now accelerating into the growing fresh and frozen TAM business.

Net new products like Chewy+ have brought in new customers. We're about to go to market with a new and improved Chewy+. And so I feel like our ability to continue to drive net adds in this range of 150,000 to 250,000 in a market that perhaps if the market chooses not to recover or stay in this current state for a bit longer, we're not concerned about that.

Okay.

You've heard me say our aspiration is to drive high single-digit to low double-digit growth. There are 2 inputs into that growth algorithm. Net adds increasing low to mid-single digits, NSPAC increasing mid- to high single digits. We are currently staying at low single-digit net adds times mid-single-digit NSPAC. That's what gives you this 6% to 7%, 7% to 8% kind of growth, right?

When the market -- we believe we have it on our ability. I'll talk about our ability to accelerate growth past the organic growth that we're delivering. But when the market normalizes, you should expect us to be on the high end of both those metrics, right? Mid-single-digit growth in net adds and high single-digit growth in NSPAC is kind of what we would expect when the market normalizes.

Let's stick with NSPAC or spend per active customer and try to drill in there a little bit. What are you seeing right now from a mix standpoint and a pricing power standpoint when you think about all the various categories that you participate in, in the category -- in the broader end demand environment of the industry?

So first, from a unit economic standpoint, our unit economics on an AOV basis has held up really well. Even though we have communicated to you the pressures in attach. So what's happening is consumer household, right? The average consumer household allocates a budget to pet. With the inflation that the industry has seen over the last few years, right, that more of that budget is being eaten up by food and meds and therefore, less to be allocated to discretionary.

Sure.

You should expect AOV to come down. Our AOV has gone up over these years. Why? Because, a, yes, sure, inflation helps. But, b, but broadly, Autoship helps. An average Autoship order is mid-single-digit higher AOV than a non-Autoship order for us. Number two, our penetration of mobile app has essentially doubled over the last 3 years. We have a lot more opportunity to grow in mobile app. Mobile app customers are stickier, more Autoship penetration, frequent visits, repeat rates and higher AOV in their behavior.

Overall NSPAC. About 1/4 of our customers are Chewy Pharmacy customers. We have continued opportunity to develop existing customer base to buy more pharmacy. Today, half the customers in market do not know Chewy sells pharmacy. So if you combine this question with what do you guys want to do differently in marketing, we want to go to market and earn more points on unaided awareness and familiarity.

So if I ask you an average customer, do you know Chewy sells Pharmacy? You'd say, yes, I thought so. But if I ask you in general, where can you buy your pet meds, less than half the people today say I can buy them from Chewy. And we run the largest pharmacy in the country. So we have a ton more room. Every time an existing Chewy customer becomes a pharmacy customer, NSPAC expands by $300 to $500. And our marginal cost on that transition is very efficient because you already are an existing Chewy customer. So our NSPAC expanders on the health space are very credible, whether it's pharmacy, whether it's supplements where we lead market share today, whether it's diet where we lead market share or whether it's clinics that are the fastest NSPAC compounder. On the other side, it is Autoship, but it's not just base Autoship. It is getting to get more number of Autoship prescriptions attached to a customer. That's the work that we're doing right now.

And I do want to stick with that theme on Autoship, just the evolution of it because it's obviously, as you referenced in your first question, been such a big powerful driver for the business, the percentage of revenue that comes from Autoship today. Talk to us a little bit about how you see Autoship evolving over time. And maybe feed back to your last comment there of how it could impact either wallet share or market share when measured against the broader industry?

Yes. So on Autoship, this is a question that I've sort of asked myself also all the way back into 2018, '19 when Autoship was mid-50s. You have to appreciate what has driven the growth of Autoship to be able to appreciate what continues to drive the flywheel of Autoship.

What's driven the growth in Autoship is -- so Autoship layer cake building is a combination of gross Autoship adds and net Autoship retention. So there's both an add and a churn prevention effort that is required. Up until a couple of years ago, we were not focused on Autoship retention. Sometimes it's surprising for people to hear that, but it's true.

We were focused on opening up the funnel wider. And so what we've done is we opened up our eligible assortment into Autoship. Pharmacy was a big boost into Autoship revenues. We developed products that made Autoship pricing much more transparent to customers, and therefore, the attach rate was starting to go up there. Then a couple of years ago, we started focusing on retention of Autoship, specifically settlement rates into Autoship. We don't give promotions, Mind you, this is not about like me incenting you to settle down. This is me being mindful with my relationship because I have a one-on-one relationship with the consumer.

So my engine now predicts when the next frequency, next order is due. And if it comes off that curve that I expect to build for a certain cohort, I can lean in with an intervention. And the intervention is essentially just perhaps a reminder or perhaps just catching you as you're getting ready to order per se.

So Autoship, now our effort, this product that we developed in the beginning of the year that we had actually included in our forecast. We talked about this in our Q1 call is this notion of accumulating personalized signals from pet profile, ingesting those and getting the customer to attach other lines of merch categories into the Autoship product. So expanding Autoship beyond food and meds. And the -- from a market test point of view, the product works. But currently, given the pressure generally on attach, the -- our expectations were not as strong as what we had forecasted coming into the year. And that's what you saw us pull back in terms of revenue pullback.

Got it. But that's still something that's on the...

100%.

Okay.

The Agentic world, you heard me talk about us continuing to lead in Agentic. You should expect us to launch customer-facing AI products that allows us to not only aggregate search demand, but improve the efficacy of search and discovery and therefore, conversion of that demand on our platforms, which is currently something that we internally are contemplating and testing in beta modes, but we haven't yet announced public market launch announcements to nor are we forecasting revenue behind. Credible -- it could be a credible driver of revenue in the future.

Yes. I do want to turn to international. It feels like we had a conversation about international for a number of years, and then you finally launched the Canadian market a couple of years ago. Talk to us a little bit about the lessons learned from the Canadian launch and what those lessons might mean for the potential to expand into other markets over time.

So international was a very deliberate learning go-to-market use case for us. The tenets behind which we wanted to learn more in international were the following: a, we believe we have customer permission to enter markets. We believe pet parents are more the same than different. We believe we have permission from customers and the Chewy brand, therefore, is resonant in markets.

Number two, each market, as we've learned, is unique to that particular type of demographic or psychographic in the market. This learning comes from many of us in the company have experience launching international markets for consumable-based businesses. I've launched Amazon's fresh and grocery categories in Germany, Japan, U.K., et cetera. Each of these markets has very specific consumer behavior that you need to understand.

Number three, we don't -- we are not keen on chasing dilutive growth. Number four, focus matters -- number four, the share positions that we essentially want to accrue in international markets need to be commensurate or better than the share positions we can capture in home. And then number five, we wanted to test out the prowess of our technology stack, go to market with a stack, go to market with a stack that we can essentially replicate rapidly if we wanted to continue with our pace of expansion.

I would say we've been happy with Canada. We've learned a ton. We've understood each of these data points a bit more closely. We've also learned things like going back to the classic sort of innovator's dilemma, needs of big companies aren't met in smaller markets. So some part of that has been -- part of -- some part of that has been that. But overall, I would say we were very clearly able to prove out how we can drive profitable demand in a region. And that's been a learning for us, a positive learning.

But international isn't a primary priority. Our priority for investments is the United States. Within the United States, it is our premium health businesses. It is launching digital products and services and physical services in the health space, clinics, for example, and therefore, capturing a very large mind share, a large TAM and continuing to see Chewy as a platform that aggregates NSPAC in a much more credible manner than anybody has done in the past.

Well, let's stick with that priority around health. You've been on an evolution with health. We've had announcements at various Investor Days over the last couple of years. Now you sit here, you've got the pharmacy offering. You've got the scaling of the vet care clinic offering. Talk to us about what you want the health ecosystem for Chewy to look like a few years down the road. What are your big strategic priorities in terms of scaling the business and investing in the business?

So the health TAM of $50 billion, you have to interpret it in a few different verticals, like that's how we do it, at least our point of view. The B2C vertical, which is led into products and merchandising like I talked about. We've built a very credible network. It doesn't require ongoing investment. We are now leveraging that investment in driving customer adoption and NSPAC growth.

Then we entered into B2C services, which we thought was an underpenetrated market. Insurance, B2C services, U.S. insurance is sub 3% penetrated. Insurance in the U.K., Australia, New Zealand, general Europe, mid-20s percent penetrated. We believe we have the ability to commercialize pet insurance. We still believe we have the ability to commercialize pet insurance. But insurance, the cost of insurance is one that pet parents seriously grapple with.

Still, we're happy with our entry into insurance and how we've partnered with some credible players in essentially picking up that gold nugget and making it a part of our portfolio. I'll come back to it in 1 second. So hold it there.

We then launched B2C telemed during the pandemic that we have continued to perfect. So far, we've offered teletriage in terms of the product, but we have -- but we -- as the industry continues to open up, and it will open up in the near future, we are ready to go to market with a scaled telemed product.

B2B. We built -- we're a 1P tech stack. So we built technology for veterinarians that 18,000 -- half the veterinarians in the country today use. And then we took that stack, and we essentially have layered in these capabilities into building our clinics. So essentially, if you look at the industry. We are unique in going to market with an integrated technology and experience stack that can combine the overall power of the health vertical faster and larger than any one player has done in the past.

In many ways, Chewy started as a retail company, but if you fast-forward this equation 5, 7, 10 years, we can very much be a scaled platform or perhaps a leading health brand that also has a very credible retail offering as opposed to the other way around.

Why I said I'll come back to insurance is because when we are building the stack, right? The stack currently we're applying in our clinics, this stack is also being used by a handful of players that are testing the stack, right, in our ability to offer them a SaaS offering. We can blend in all of these capabilities into the same stack, right? The current market is restricted because 1/3 of pet parents do not take their pets to the vet at a normal frequency or don't do so at all.

Affordability and access to veterinarians is the constraint there. You've all heard about it's harder to get the vets. You've all heard about vets are retiring, not enough vets are coming in. We're not seeing that problem in the CVC network or in the modern network. Our average vet recruiting time is 4 months against an industry which is much longer than that.

Our average vet retention 1-year cohort is high 80s, low 90% against an industry that is much lower than that. And then finally, this notion of these products like telemedicine will essentially lower the cost to serve. So it will address affordability. It will also improve access to veterinarians because you can then bifurcate your capacity using tech and product to deliver the experience while keeping vets reserved for any type of backup that you need per se.

Maybe just one more on this area before we pivot. You obviously also made an acquisition with Modern Animal. Talk a little bit about the rationale for that deal and how this broadly fits into what you just laid out there, Sumit, with respect to where you want to take the health business over the long term.

So what we saw in clinics was our ability to -- and we entered as a new operator in the space, right? So we earned our battle scars. And what we saw very quickly was our ability to ramp these clinics up to an estimated revenue per clinic that was 20% to 30% better than the average clinic was producing in the market.

We have said a CVC box produces $3.5 million in revenue. On top of that, it drives $800,000 in attach back to chewy.com. So total clinic revenue out of this box is $4.3 million. By the way, we are outperforming these metrics, which we've shared in April, which gives us confidence that this is a durable incremental growth lever as we enter '27 and '28.

Yes.

We're breaking even in 20 months. We have had success when we put a box in a DMA, and we've spent much lower marketing than anticipated because the Chewy brand carries the halo of attracting customers and driving clinic demand pretty quickly. And then finally, 4 out of 10 customers that are walking into these clinics are net new to Chewy. That was a staggering sort of realization to us.

Okay. So we said, great, we can continue building at the current rate of 8 to 10, 10 to 12 or we should opportunistically go find another player like Chewy, which we found in Modern to be able to immediately 2x our base. It's a culture orientation that we like. There's a customer orientation that we like. It is a tech-forward stack. There's low risk of integration and low risk of operations. But now most importantly, you have 2 teams that can build organically at 2x the rate.

It also gives us options to explore what we consider many different forms of going to market with clinics, all the way from asset-light to this current model that -- where we are essentially dropping our own boxes into the market. And there are a few options in there to consider. So broadly speaking, the economics are highly attractive, and you should think of us as operating a scaled vet. We're now nearly -- I think we're the largest de novo in the market with 60 clinics, and our build pace will increase. We've given you the numbers to do the math. It's highly attractive ROI. So now the question becomes how fast do you want to go? How fast can you go?

Understood. You referenced earlier and fairly topical coming off of some of the announcements across the technology ecosystem last week. How are you thinking about Agentic commerce? What role do you play in a world that could potentially be more Agentic over time? What particular assets that sit inside the company do you think could also differentiate you guys in terms of some of the relationships you can develop with Agentic platforms?

Excited about Agentic. The reason I am excited, and we view Agentic, I will give you -- the framework that I will have you take away is you have to view Agentic in two different areas. Agentic in partnership with external Agentic services and companies that will aggregate demand perhaps and route services back into you.

Agentic in your own capability to do 2 things: a, capture that demand, receive that demand, right? Just because the demand is being routed, doesn't mean you will naturally receive that demand. Your tech and your data has to be ready to be able to respond. Those back-end services need to be hardened and ready. And most Fortune 300 companies in the country are not ready for that. We will be because we're a newer company. We've rebuilt our stack in the last 5 years. There's no more technology investment that we need, services oriented. We're hardening those services as we speak. I've already talked about that on the earnings call.

But the second is developing AI-forward products. So you heard me talk about CAI this earnings call, C-A-I, CAI stands for Chew AI, could also be the name of your pet. So it kind of works both ways. CAI today essentially has the capability of offering you self-service. It can take care of your post-purchase needs. You already placed an order. Now CAI can take care of all those needs.

Now we're building agents that essentially allow you to search, discover and shop more efficiently, right? Then we're going to build agents that essentially unify customer signals and manage each customer relationship on a one-on-one basis without us spending broad marketing dollars on customers, right?

So in an Agentic world, you are able to essentially -- and all of this is going to hook in through the app, right? So that's, a, how we're getting Chewy ready for it. On Agentic surfaces, we are leading the partnership with as many players as our serious in the industry. We lead in the number of citations. We led with Google in terms of the partnerships, whether it's the price bot in response to Muse, Gemini has come up with their own kind of model, which Chewy is already demo ready for. You can actually go see it on Gemini's website. They essentially showcase this notion of agents kind of shopping.

We are excited because when agents try to accumulate demand, they will route demand to the retailers that win on price, that win on selection, that win on convenience and that win on trust. And Chewy essentially has each of those 4 against any competitor that you can match us against, including the likes of the biggest ones like Amazon and Walmart.

From a pricing standpoint, we go to market with absolute parity. We have homegrown tech that responds to that very quickly in 15-minute increments and the pricing is mapped. So it isn't like players with deep pockets can crash profitability floors in the industry. Health, very protected ecosystem, much harder for agents to penetrate to begin with.

Post-purchase service. Pet is a category where high-touch personalized service is needed. Our Agentic framework is essentially -- I talked on this earnings call, which is you have to essentially -- we're going to build in the brand tone voice and respond to customers so that you're not essentially talking to a chatbot. You're talking to -- you should try diving into a CVC network and if you get Calie, if you send me a call -- send me an e-mail, if you can determine that Calie is not human, but an AI.

We're being very thoughtful in building these, and these are 1P-built services. These are not 3P products that you will find outside. So our ability to essentially hack into Agentic or be toe-to-toe in driving innovation and participating in these trends is high. We're excited about this.

Okay. So a lot of areas to continue to follow up going forward, both your partnerships with Agentic platforms as well as what you're building and scaling yourself on your own offerings across the site and the app. We've talked a lot about health. We've talked about AI. We've talked about the growth opportunity that presents in the end market. How do you think about balancing all the things you want to invest in the business against continuing to deliver operating margin trajectory for investors?

So a couple of things. One, we are not about to enter an investment cycle. I just want that to be kind of clearly heard. Number two, we don't need investment to continue to gain market share as we have -- as we are doing now. If the market doesn't improve, we don't have to invest to stand steady.

At the same time, we want to accelerate growth. We feel we have some durable levers that we should consider investing behind to drive incremental growth. When you hear the word investment, I do not want you to hear promotions. These are -- that's not what I mean. I mean durable nondilutive to growth type of investments.

What I would say to you is that we have the ability with our base business performing as it is, alongside the network of health clinics growing as they are and producing the margins, alongside the $50 million of AI savings that we have mentioned to you for '27. We have enough dry powder to be able to self-fund a majority of these investments that we are talking about to drive incremental growth and still give you incremental margins in the range that you've come to expect from us in the last few years of performance.

So that's how you should think about -- and also, we are not baking in -- although there's been some enthusiasm in terms of pricing coming back into the market in '27, we are not baking that in yet. So all of my comments and call it, mental framework is assuming that the market does not recover and assuming that there is no pricing that comes back.

Okay. Last one, if I can squeeze one in. As you've laid out, companies becoming more profitable, throwing off a lot of cash flow. How do you think about allocating cash flow between reinvesting back in the business, but also looking at the capital structure and possibly continuing to return capital to shareholders?

So perfect segue. So this is essentially the proof point of that where we will identify and are identifying some very high credibility growth levers that will create durable, sustained incremental margin type of growth and reinvest in them while self-funding a majority of them. That's first level of priority.

Second level of priority is to opportunistically evaluate M&A, should we find great deals at great prices in the marketplace. You should know these M&As are primarily when we consider them, there's nothing that I'm going to market with right now. You should also know that. But if I do, it will be in the health space, okay? Number three, if -- once we are past number one, and there is no opportunistic evaluation on an M&A standpoint, returning capital to shareholders return -- remains a third and important priority for us.

Okay. Sumit, I always appreciate the opportunity to have a conversation, especially busy couple of days right after earnings. Please join me in thanking Chewy for being part of the conference. Thank you.

Hello, everyone. Thank you for joining us, and welcome to the Chewy Second Quarter earnings call. [Operator Instructions]

I will now hand the conference over to Lee Horowitz, Head of Investor Relations and Strategic Finance. Lee, please go ahead.

Thank you for joining us on the call today to discuss our second quarter results for fiscal year 2026. Joining me today are Chewy's CEO, Sumit Singh; and CFO, Chris Deppe. 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, the presentation summarizing our results is also available on our website at investor.cree.com.

On our call today, we will be making forward-looking statements, including statements concerning Chewy's financial results and performance, industry trends, strategic initiatives, share repurchase program and the environment in which we operate. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks, uncertainties and other factors that could cause actual results to differ materially from our forward-looking statements.

We encourage you to review our SEC filings, including the section titled Risk Factors in our most recent Form 10-K for a discussion of these risks. Reported results should not be considered an indication of future performance. 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. 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. 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 for fiscal year 2025. And finally, this call in its entirety is being webcast on our Investor Relations website. A replay of the audio webcast will be available on our Investor Relations website shortly.

And with that, I'd like to turn the call over to Sumit.

Thank you, Lee, and good morning, everyone. Chewy delivered strong results in the second quarter, continuing to gain share and expand profitability. Our performance underscores the strength of our business model and disciplined execution. Our recurring revenue base supports durable sales, while our expanding ecosystem and the growing contribution from Chewy Health drives structural wallet share gains. Together, these advantages position us to outperform in the current environment. Our earnings algorithm also provides the capacity to continue investing for long-term growth.

During the second quarter, while we did not see a meaningful recovery in the more pressured consumer backdrop for the pet market, importantly, however, we did not see further deterioration. The environment has broadly stabilized to the trends we observed exiting the first quarter. And against this backdrop, Chewy continues to outperform the broader pet category by roughly 2 to 3x and we continue to generate compelling growth across both scaled areas of our business and newer strategic growth platforms.

Chewy Vet Care continues to scale in line with the economic framework we outlined at our recent investor event with our total clinic portfolio, again delivering triple-digit revenue growth in the second quarter. Meanwhile, our fresh and frozen portfolio is meaningfully outpacing the broader category, delivering triple-digit unit growth. And our in Pharma and Exotic business delivered its seventh consecutive quarter of mid-double-digit year-over-year sales growth.

Taken together, this momentum demonstrates the breadth of growth opportunities across the CE ecosystem and our ability to capitalize on them without relying solely on a recovery in the broader pet market. We delivered Q2 total Enterprise net sales at the high end of our guidance range of $3.33 billion, representing 7.3% year-over-year growth. Excluding the impact of SmartPack and modern animal, Q2 organic net sales increased 5.7% year-over-year, driven by active customer growth, NSPAC expansion and ongoing market share gains.

We ended the quarter with 21.7 million active customers, up 3.8% year-over-year, while net sales per active customer increased to $602. Autoship customer sales once again outpaced overall company growth, increasing 9.3% and representing 84.6% of total net sales in the quarter, further reinforcing the predictability, durability and recurring nature of our revenue base.

Importantly, our customer funnel remains healthy. We continue to add customers, improve retention, reactivate lapsed customers and deepen engagement across the Chewy ecosystem. These dynamics support our ability to continue gaining share within the pet industry.

Now turning to profitability. Q2 adjusted EBITDA margin reached 6.8%. While the upside relative to our expectation was largely driven by timing and discrete benefits, the underlying business continued to deliver substantial year-over-year margin expansion. Our sponsored ads portfolio continues to scale through robust impressions growth, while generally stable pricing despite rapidly expanding supply reflects a healthy underlying auction ecosystem.

Our retail product mix continues to shift towards high-margin categories, such as health and we continue to lower our variable cost to serve through automation, scale, operating discipline and increasingly AI-enabled productivity. Importantly, our strengthening earnings profile also gives us the flexibility to reinvest in the business. Where we see opportunities with compelling returns, we will continue to deploy capital behind initiatives that can accelerate growth while maintaining the operating discipline that has driven our margin expansion up until this point.

Turning to Chewy Health. We remain highly encouraged by the progress across our health ecosystem. Chewy Vet care continues to demonstrate strong customer satisfaction, attractive veterinarian productivity and retention, compelling 4-wall economics and importantly, the ability to drive incremental engagement across the broader ecosystem. We are also making strong progress integrating modern animal, which performed ahead of our expectations in the quarter. These early results reinforce our conviction in the strategic combination of modern animal and Chewy Vet Care.

Together, the 2 businesses provide greater scale, complementary capabilities, attractive unit economics and differentiated telehealth offerings. Collectively, these trends create a powerful foundation from which to expand our veterinary platform, improve access to care and connect more customers with the broader Chewy Health ecosystem, providing meaningful runway for future growth.

Furthermore, while 2026 is intended to be a foundational year for SmartPack as we strengthen the businesses core operating drivers and position it for durable growth, our early progress has been encouraging. SmartPack performed ahead of our expectations, reinforcing our conviction in the opportunity ahead. The early performance of both businesses reinforces our confidence in our ability to use Chewy scale and capabilities to improve acquired assets and generate compelling returns as we expand the power of the Chewy platform.

Now turning to Ai. Our AI strategy continues to progress from capability development towards scaled deployment and measurable financial impact. In Q2, we made strong progress deploying AI across 3 areas, improving the customer experience, increasing team member productivity and structurally lowering our cost to serve.

On the customer side, we recently launched Kai our AI-powered assistant to a select group of customers in the mobile app. Early results are encouraging with approximately 30% of chats resolved through self-service across common needs such as orders, returns, auto ship and account management. To keep true to our Chewy spirit, customers who prefer or require human support are seamlessly connected to a care team member within seconds. At the same time, we are deploying AI-enabled tools across customer care, pharmacy and Chewy Vet Care to reduce manual work and improve productivity.

In Customer care, we launched agent-facing AI capabilities, which are helping transform customer signals into intelligent insights, reducing burden on agents and increasing team member productivity. In Pharmacy, AI is helping automate data extraction and validation while improving review consistency. In Vet Care, at select Chewy Vet Care locations, we launched our AI-powered capability called Cali, which is supporting appointment confirmations, scheduling and routine follow-ups while reflecting Chewy's brand voice and customers first tone.

These initiatives are beginning to translate into tangible financial benefits. We continue to expect AI-related initiatives to generate low tens of millions of dollars of cost savings in fiscal 2026 and scaling to approximately $50 million on an annualized basis in fiscal 2027. Importantly, we view these benefits as another durable lever within our earnings model. As these capabilities scale, they should help us improve productivity, lower our variable cost to serve and create additional flexibility to reinvest behind attractive growth opportunities.

Before I turn the call over to Chris, let me briefly address our outlook. Three months ago, we reset our expectations to reflect a more cautious consumer environment. Since then, the trends underlying that outlook have broadly stabilized. We are not assuming a meaningful consumer recovery for the balance of this fiscal year. Instead, our confidence remains grounded in what we can control: gaining share, growing and retaining customers, scaling health and driving structural efficiencies across the business.

At the same time, Modern animal and SmartPack are collectively contributing above the levels contemplated within our prior outlook, and our profitability performance continues to demonstrate the structural improvements underlying our earnings algorithm. Chewy remains well positioned to gain share profitability, grow earnings and free cash flow and build the capabilities that will drive long-term shareholder value.

With that, I will turn it over to Chris.

Thank you, Sumit, and thank you all for joining us today. Q2 performance demonstrates the strength and consistency of Chewy's execution across the business, with total enterprise net sales at the high end of our guidance range and adjusted EBITDA margin exceeding our expectations. Let me start with our financial and customer performance. Second quarter net sales reached $3.33 billion, representing 7.3% year-over-year growth. Excluding SmartPack and Modern Animal, organic net sales increased 5.7% year-over-year, consistent with the midpoint of our prior expectations. Both acquired businesses performed ahead of the assumptions embedded in the prior outlook, which I will address in more detail when I discuss our updated guidance.

Organic growth in the quarter was supported by continued active customer growth, higher NSPAC and ongoing market share gains. We ended the quarter with 21.7 million active customers, representing 3.8% year-over-year growth and 208,000 sequential net additions. This included 43,000 unique customers who have transacted with SmartPack since the acquisition and are now reflected in our active customer count.

Autoship customer sales reached $2.8 billion, increasing 9.3% year-over-year and representing 84.6% of total net sales. Autoship continues to grow faster than the overall business reinforcing the durability, predictability and recurring nature of Chewy's revenue base. NSPAC reached $602. On a reported basis, NSPAC increased 1.9% year-over-year, and on a normalized basis, accounting for the extra week in the prior year comparable period, NSPAC increased 3.8%. NSPAC growth continues to benefit from customer cohort maturation, increasing engagement across health and pharmacy and broader cross-category adoption.

These drivers were partially offset by continued pressure on discretionary attachment and premiumization. Pressure on premiumization and discretionary spending materialized broadly in line with our expectations during the quarter. affecting both the consumables and hard goods categories. As we discussed last quarter, purchasing behavior within consumables is influenced by both premiumization and discretionary attachment. In the second quarter, treat sales slowed more sharply than growth in core food, reflecting moderation in discretionary purchases and the broader macroeconomic pressures we have been describing.

Importantly, Chewy continues to gain meaningful share across categories. Industry data suggests that the broader consumables market is broadly flat year-over-year, making Chewy's mid-single-digit growth, a healthy level of outperformance. Similarly, our mid-teens hard goods growth substantially outpaced the broader market, reflecting the benefits of the assortment and merchandising improvements we have made over the past year despite continued pressure on discretionary spending. .

Finally, Pet Health and Specialty Products delivered strong organic growth, underscoring the momentum across our expanding suite of health-related offerings for pet parents.

Turning to profitability. Adjusted EBITDA reached $227 million in the quarter, representing a 6.8% adjusted EBITDA margin above our guidance of 6.3% to 6.4%. Second quarter gross margin was 30.4%, flat year-over-year and up 30 basis points sequentially. As a reminder, the year-over-year comparison was against certain nonrecurring MAP-related pricing and other benefits realized in the second quarter of fiscal 2025.

Gross margin exceeded expectations, supported by continued growth in sponsored ads and disciplined promotional activity. However, approximately $10 million of the upside reflected timing-related benefits, primarily tariff refunds that were received earlier than anticipated as well as certain rebate benefits that shifted in the second half into the second quarter. The quarter also included more than $5 million of discrete benefits related to gift card breakage, inventory adjustments and certain vendor-funded merchandising activity. While these items benefited second quarter results, they are not indicative of our underlying margin run rate.

Taken together, these timing-related and discrete items accounted for essentially all of the adjusted EBITDA outperformance relative to expectations. Even excluding these benefits, adjusted EBITDA margin expansion remained very healthy and gross margin expanded year-over-year after normalizing for nonrecurring items in both periods. As these timing benefits normalize, we expect gross margin to decline modestly on a sequential basis in Q3. We broadly consistent with the seasonality we experienced last year.

As a reminder, we continue to expect fuel to represent a mid-single-digit million dollar headwind through the balance of the year. Even with these factors and normal second half seasonality, we continue to expect full year gross margin expansion, although at a more moderate pace than we delivered in fiscal 2025. Please note that my discussion of SG&A excludes share-based compensation expense and related taxes as well as transaction and integration-related costs.

Second quarter non-GAAP SG&A was $612 million or 18.4% of net sales compared with 19.1% in the prior year period. We delivered 70 basis points of year-over-year SG&A leverage reflecting improved fulfillment center utilization, lower variable cost to serve, disciplined headcount management and continued productivity gains across the organization. Lower variable cost to serve remains the largest contributor to SG&A leverage. As our automated facilities continue to scale and utilization improves, we are leveraging the fixed cost infrastructure embedded within the network while also reducing variable costs through automation, process improvements and AI-enabled tools. We continue to expect SG&A leverage in the second half to remain broadly consistent with what we delivered during the first half.

Advertising and marketing expense was $215 million or 6.5% of net sales, essentially flat year-over-year as a percentage of sales. We continue to allocate spend towards channels and customer cohorts where we see attractive acquisition economics and long-term value, supporting healthy active customer growth while maintaining disciplined returns. Looking ahead, we expect to increase advertising and marketing activity in the second half relative to Q2, with spending more heavily weighted towards Q3 than Q4. This cadence reflects attractive opportunities we are seeing to invest and brand awareness ahead of the holiday season, which we expect to support customer engagement during peak and beyond.

Q2 adjusted net income was $149 million, translating into adjusted diluted earnings per share of $0.36. As discussed, the majority of the upside relative to our guidance reflected timing and other nonrecurring gross margin benefits. At the same time, the underlying margin performance continued to benefit from the structural SG&A leverage and operating efficiencies I described earlier. Modern animal was included in these results and as expected, represented a modest drag to adjusted EBITDA margin in the quarter.

Let me close the discussion of second quarter results with cash flow and capital allocation. Free cash flow for the quarter was $90 million compared with $106 million in the prior year period. This reflected $137 million of net cash provided by operating activities and $48 million of capital expenditures. Note that while free cash flow was down year-over-year, this was entirely timing related, and we continue to expect full year free cash flow through of roughly 80%. We ended the quarter with $612 million of cash, cash equivalents and marketable securities and over $1 billion of total available liquidity.

During the quarter, we completed the acquisition of Modern Animal for $400 million, raised $600 million through our inaugural term loan issuance and deployed $200 million towards share repurchases. We repurchased 9.9 million shares during the quarter. After accounting for shares issued in the Chewy employee equity programs, these repurchases resulted in a 2% sequential reduction in weighted average diluted shares outstanding this quarter. Chewy's capital allocation framework remains unchanged. We will continue to invest behind strategic priorities where we see attractive returns, maintain a conservative and flexible balance sheet and return excess capital to shareholders. Within that framework, we continue to believe that Chewy's shares are undervalued at current levels. Repurchases, therefore, remain an attractive use of capital, and we expect to remain opportunistic in our activity.

Based on our performance through the first half and the increased visibility we now have, let me move to the outlook for the balance of the year. As I discussed, while we continue to see modest pressure on discretionary attachment and premiumization, in line with what we discussed last quarter, importantly, trends have not deteriorated further relative to the assumptions embedded in our prior outlook. This increased visibility into the operating environment, combined with the consistency of Chewy's market share gains, gives us confidence to narrow the full year organic net sales growth range.

In our view, the downside scenario underpinning the prior low end of guidance, which assumed a more meaningful weakening of the end market has become less likely. Additionally, SmartPack and Modern Animal are performing ahead of initial expectations as we progress with the integration, leading us to raise our forecast for their contributions. For fiscal year 2026, we now expect total net sales of $13.46 billion to $13.57 billion, representing a year-over-year growth of 6.8% to 7.7% including organic net sales growth of 5.5% to 6.3%. The performance of our core business in the quarter supports our continued expectation to deliver near the midpoint of the updated sales guidance.

Importantly, the midpoint does not assume any meaningful improvement in the consumer environment, but consistency at the levels we have seen for the last several months. Consistent with the prior outlook, the high end of the range contemplates either an improvement in the market backdrop, stronger execution against our plan or a combination of both. Conversely, the low end assumes some renewed deterioration in the operating environment, although less pronounced in the downsize scenario embedded in the prior guidance.

Now turning to profitability guidance. As mentioned previously, while we delivered strong underlying performance in the second quarter, essentially all of the upside relative to expectations reflect the timing related and discrete items. That said, reflecting the strength of our underlying performance year-to-date, including the continued scaling of AI initiatives, we are raising the low end of full year fiscal 2026 adjusted EBITDA margin guidance by 10 basis points and narrowing the range to 6.7% to 6.8% from 6.6% to 6.8%. This outlook reflects our continued confidence in the underlying earnings profile of the business and our ability to deliver substantial year-over-year margin expansion.

At the midpoint, this implies over 100 basis points of year-over-year adjusted EBITDA margin expansion and $912 million of adjusted EBITDA for fiscal 2026. Consistent with our comments last quarter, this guidance includes a modest margin rate drag for Modern Animal. For the third quarter of fiscal 2026, we expect net sales of $3.323 billion to $3.358 billion, representing reported year-over-year growth of 6.6% to 7.7% and organic net sales growth of 5.3% to 6.2%. This outlook reflects the same operating assumptions embedded in the full year guidance I just described.

For the third quarter, we expect adjusted EBITDA margin of 6.6% to 6.7%, representing roughly 85 basis points of year-over-year expansion at the midpoint. We also expect adjusted diluted earnings per share of around $0.39. Finally, for the full year, we now expect share-based compensation expense, including related taxes, to remain broadly flat to last year, weighted average diluted shares outstanding of approximately 410 million shares, net interest expense of $10 million to $15 million; capital expenditures of 1.5% to 2% of net sales and an effective tax rate of 24% to 26%.

In closing, Chewy's Q2 results reinforce our confidence in the underlying health and earnings power of the business. We continue to gain share, grow our recurring customer base and expand profitability through structural improvements across the organization. Our updated outlook reflects increased visibility into the balance of the year and continued confidence in our ability to deliver profitable growth.

With that, I will turn the call back over to Sumit for closing remarks.

Thank you, Chris. To close, the key takeaway from the quarter is that Chewy continues to grow customers, gain share and expand earnings even in a pet market that remains under pressure. We are growing both sides of the customer equation, the number of customers we serve and the amount that they spend with Chewy, while Autoship continues to reinforce the recurring and durable nature of our revenue base. At the same time, our earnings profile continues to strengthen. We are driving greater efficiency across the business, scaling higher-margin growth areas such as health and sponsored ads and beginning to realize tangible productivity benefits from AI and automation. .

We are particularly encouraged by the progress across Chewy Health, including the early performance of Modern Animal and the continued scaling of Chewy Vet Care. As these businesses grow, we believe they can deepen customer engagement expand wallet share and become an increasingly meaningful contributor to Chewy's long-term growth and earnings power. Importantly, our outlook does not depend on a meaningful recovery in the broader pet category. We remain focused on the things we can control, serving customers exceptionally well. gaining share, scaling our strategic growth platforms and continuing to improve the efficiency of the business.

Taken together, we believe these capabilities position Chewy to compound earnings and free cash flow over time while continuing to invest behind attractive growth opportunities and create durable long-term shareholder value. Thank you to every Chewy team member for their continued dedication and to our customers for their trust.

Operator, we are now ready to take your questions.

[Operator Instructions] Your first question comes from the line of Steven Forbes with Guggenheim.

Sumit, you mentioned the sort of the moderation in treat sales during the quarter, I guess, at a more accelerated pace than consumables. Is there a way to frame up for the group here on sort of what percentage of consumables is treats or what you would consider to be more discretionary, and then any particular pockets within treats that are more notable in terms of what you're seeing from a consumer behavioral standpoint?

Thanks, Steve. I'll stay away from precisely defining the penetration of trades within the business, but candidly, what you're hearing is essentially discretionary doesn't just mean supplies. And I think that's the matter point. that currently consumers are continuing to spend pretty -- at a pretty normal level on their core food, meds and the engagement through Autoship remains very strong and healthy with Chewy.

And from a discretionary part of consumables, it's the treats and the toppers. If you look at an average consumer, an average consumer with experiment with over 10 types of treates across a variety of treat categories might be soft, might be hard, might be choose, might be jerky, dental, premium, rehydrated, raw, freeze-dried and these all come at different price points and different consumption patterns relative to the households that we serve.

Some go on Autoship, some don't go on Autoship, some go on Autoship and come off. So there is a dynamic behavior that customers follow as it comes to what we consider the discretionary part of consumables, which is if you're allocating a budget from a household perspective, you prioritize core food, you prioritize meds, you prioritize categories like supplements, which are health and wellness oriented and then everything else falls a little bit more towards the discretionary side. right?

And so within that, what I would also then categorize perhaps to answer the next type of question is like we interpret the relative growth rates as consumers prioritizing discretionary hard goods over essential consumables, right? And so the 2 businesses are being influenced by different underlying factors. Consumables remains our largest and most mature category and Autoship fuels it with large penetration towards dog and a very healthy penetration towards cat.

Hard goods is a bit of a different story, and that's more of the work that we've done to bring to the category and drive the category towards double-digit growth over the last couple of years that we've been candid in talking about, right? So the growth primarily reflects improved execution and outsized share capture given that we've materially expanded the breadth and relevance of our assortment that has improved our ability to serve customer needs and capture demand in that category.

So there's a lot going on under the categories here, but I think the main takeaway is there are certain types of these merged classes that are a bit more -- consumers are viewing them as a bit more discretionary and for everything that is based in core business plus the newer parts of the businesses that might be fresh food, that might be, which is actually a growing TAM might be our health-related categories or in the large and strong equine business that we're building, very healthy growth rates there.

Helpful. And then just a quick follow-up. I don't know if it's possible for you to frame up how you expect the Modern Animal acquisition to impact net adds during the 3Q, given the SmartPack impact during the second quarter, and then any early comments on how the conversion of those customers to the Chewy Autoship platform is trending? I don't know whether in absolute or just relative to expectations?

Yes, both good questions. So we haven't yet sized the -- so we've sized the impact to net adds. I think we gave you a preview when we bought the asset, and we said they have roughly 100,000 customers, and we expect roughly 40% of that or in the 40% to 50% range to be net new to Chewy. We're continuing the integration. So once we are ready to sort of disclose that, we will build that in presently, when we are giving you forecasting, it is not including the Modern Animal net adds. So you should view our guidance as organic growth in the business. And when we do disclose it, we will come back and share the specifics just like we did with SmartPack this time.

In terms of conversion of customers to Autoship, we expect that to be super healthy. We're in the process of integration. The acquisition closed a couple of months ago. So our focus in the back half of the year, particularly Q3 is on integration. Trends are the initial inputs that we had forecasted are performing better than our initial forecast, which is why the commentary on the strengthening part of the business that you heard on the call, but we expect Autoship platform trending to be high. There is no reason to believe that this would not translate much like a Chewy customer or normal Chewy base does.

Your next question comes from the line of Nathan Feather with Morgan Stanley.

Given some of the pressure you've seen in organic growth from the weaker macro, I guess, how are you thinking about balancing margin expansion with potentially the ability to lean in a little bit more to reaccelerate growth. And you noted in the script that you have flexibility to reinvest in the business. Can you touch on the key areas you believe you can lean deeper in here.

Yes. I think it's a prudent question at this time. I'll keep my remarks -- I'll elaborate on this. And so just expect me to share my thinking a bit out loud. So I think you should think about it 2 ways. One, the question is sort of like, hey, how much would you consider investing to accelerate revenue growth? And then the second part is, I guess, what levers do we have available to accelerate sales growth, right? And so investment is not always a part of our consideration and planning at Chewy when we are planning for sales growth. We believe we have credible levers in front of us where we can self-fund/drive growth at very healthy ROIs.

So those -- if I take you down the list on the top of my mind, a, we remain enthusiastic about Chewy Plus and we expect to introduce a refreshed program design very shortly into the market. You heard me talk about aligning and arriving at a strong product market fit. And we believe that the redesigned offering will strengthen consumer value proposition and deliver that compelling product market fit that I've been talking about for the last one quarter or so.

Number two, we continue to identify attractive opportunities to deploy marketing dollars and bring more customers into the Chewy funnel, right? And so when you look at our performance in Q2, right, primarily a few weeks of effort where we pushed a deliberate investment decision rather than accept a deterioration in marketing efficiency. So for Q2, we leaned in a bit and we did not tolerate any deterioration in marketing efficiency and our targeting conversion CRM and app capabilities are the areas that we essentially lean then on and that continued to improve -- they continue to improve, those capabilities and they're supported more efficient acquisition of high-quality customers for us in Q2, which we expect to repeat going into Q3.

You also heard on the earnings call that we said we expect to lean in a bit and invest in brand building that we believe is a prudent investment in front of the holidays, but it also sets up importantly, 2027 in a very strong way. This is a playbook that we're borrowing from the end of 2024 in the way that we entered 2025 and we're taking some learnings from that playbook and deploying it in the back half of 2026.

And then lastly, I would say, we're also moving with urgency to bring some unique products and experiences designed to deepen engagement, increase attachment across additional categories and compound NSPAC to market in the back half of this year. right? So you should expect us to have some incremental conversations with you about some net new launches as we play through Q3, right?

So that's how you should think about the levers that we have and the mind share on where we're putting that mind share to drive accelerated growth. In terms of investment levels, we've not yet determined the appropriate levels of reinvestment for 2027 as that work remains part of our '27 planning process, right? And you can expect that any decision will be grounded in attractive long-term returns and calibrated against our broader earnings and margin objectives, right?

But I will leave you with this thought. Look at fiscal '25 and '26 out -- '25 results and '26 outlook. Incremental margins reflect several moving pieces, right? They have structured -- we have structural margin drivers that we've articulated for some time, and we continue to deliver across those as expected. We have the costs associated with bringing new fulfillment capacity online, balanced with ongoing efficiencies across the organization, including our contribution from AI initiatives.

So we've got a really healthy playbook that we can deploy against while keeping highly disciplined and trying to self-fund a bunch of our investments leaving ourselves the room and the capability to drive accelerated growth without taking away from the algorithm that we've shared with you.

Great. That was really helpful. Just 1 small follow-up there. On the Chewy Plus redesign, I guess, how take through what the learnings have been from that program to date and where you feel you can drive some income improvements to increase adoption?

Yes. So we really like the program so far. It's helped us drive -- it helped us learn the boundaries of sales, customer penetration and profitability guardrails, which were important to learn. At one level beneath that, it's helped us understand specific cohort interaction, cohort behavior, maturity curves of cohorts given that we played the program through for roughly 5 quarters now. And that's, in our opinion, a good amount of learning. And what we found was, through the voice of the customer, the customers have loved the same sort of Chewy forward customer-centric principles that we've leaned in with trying to maximize the value that they extract from the platform, the convenience that they have, the loyalty features that we bring forward.

At the same time, we heard that while customers really appreciate the components that we've brought forward, they would appreciate it even more if we connected the broad offerings that make Chewy the ecosystem of choice to bring those offerings to them, right? And so I'm hinting towards the program design evolving to include a multitude of health benefits that then drive the customer to interact across a variety of our businesses in new and existing and therefore, deepen their engagement.

So if I were to design a marketing tagline and I'm not a marketing copywriter, I'd say, meet the new Chewy Plus, cheaper, better, more care integrated, right? And that's a terrible copy, but that's why I'm not a marketing copy writer. But you should expect us to listen to customers and go out and really position the program to gain scale and drive the attachment and the incrementality in sales stronger than what we are seeing today. So we're excited without really disturbing the margin kind of contribution profile of that particular program. So that's how we're thinking about it. More to come in Q3.

Your next question comes from the line of Dylan Carden with William Blair.

Appreciate it. Curious if you can help us understand sort of the pet industry stabilization commentary as it relates to pricing units at household formation. And particularly sort of how you're envisioning pricing to trend in your guide into the back half?

Sure. I can take the first part. Chris will take the second part. There's a lot here in what's going on within the pet industry. I would say broadly when we entered Q1, we started noticing some signs. You'd heard me comment at some of the conferences around hey, the industry, we're not essentially baking in a rebound coming into '26, but we were expecting that rebound in '25. The stability that we were expecting coming into Q1 started deteriorating a bit in the April -- late March, April time frame, which is what you heard us comment on our Q1 earnings call, and we reset our guidance at that particular point, right?

So we said, hey, we're not essentially baking in a rebound of sales growth at this particular point. We don't expect pricing inputs to materially change. What that means is we don't expect pricing to be a benefit -- net benefit in '26, but we also don't expect the promotionality environment to be irrational, which is, by the way, what we are continuing to see for the most part. There are sort of peaks and valleys in some promo -- in some months, but for the most part, the environment is relatively stable.

And then underneath of that, we'd said to you that, hey, dog seems to be worsening, cat seems to be strengthening. So for the most part, those inputs that I talked about have continued as we've played through Q2. Importantly, however, the inputs of traffic, right, have stable/strengthened towards Chewy and online continues to pull share from the overall industry. And so the secular tailwind plus the value prop that we're bringing to the table allows us to continue to aggregate share, albeit in the slightly more pressured consumer industry, right, in the consumer pet -- consumables pet world.

So that's kind of how we're projecting. So you heard in our comments, stable. We're not baking in a rebound. We believe we have the ability to continue to drive and outperform the market in the back half, and then you just heard me take you through a series of levers and a broad thinking on the fact that we are not sitting idle as we move into 2026, regardless of what the macro does. Chris?

Yes. Just to reiterate the thing about how we set guidance. We updated our outlook, and it does not assume any recovery as Sumit noted, or any improvement in consumer behavior the trends we've seen have been broadly consistent with what we saw exiting Q1, and we view that moving forward. Within that backdrop, our outlook reflects continued execution against the drivers that we can control, which is active customer growth, retention and reactivation, Autoship engagement, cross-category adoption, health care growth, market share gains. And so we expect to grow meaningfully ahead of the category without needing that external recovery.

We do believe we have a greater visibility into the range of outcomes. The stability and trends allowed us to remove the more severe downside scenario that we contemplated last quarter, allowing us to narrow that organic growth range. For us, the high end would require either some better market backdrop, stronger execution against our initiatives or some combination of those 2 and the low end reflects a bit more pressure consumer than we're seeing today, but not as bad as what we expected in the prior original outlook that we gave you last quarter.

From a pricing standpoint, just to reiterate what Sumit said, we are operating in a very low price environment, and we're not seeing any benefit there, which we have factored into our guidance. As Sumit noted, we're not seeing deflation in the category, just not meaningful pricing contribution to sales growth.

Excellent. And as a follow-up, Sumit, you've been very helpful in kind of thinking to the agent side of all of this. Any update on sort of AI chat product discovery and now that you've got perhaps half a year in from when this really kind of started taking off, how your platform is integrated with that? Is it headwind as the business become more reliant on Autoship. Anything kind of update there would be helpful.

It's -- we think of it as a net hit, and Dylan, as -- and I've continued to maintain that point of view, including writing about it pretty publicly a few months ago. On agentic surfaces, we continue to lead with product innovation. We're following those metrics closely, and we're pleased with Chewy's position in terms of search aggregation and search demand traffic driving towards Chewy. Secondly, on our surfaces and evolving consumer behavior in terms of product discovery, it's one of the unique products that I mentioned on my remarks a bit earlier when responding to Nathan in terms of the unique products that we're bringing to life that is very much on the back of our minds to offer customers a net new way of interacting with Chewy and deepening their engagement. So I won't give the details over here. But broadly speaking, we will continue to innovate behind this new technology and utilize it to improve experience and drive deeper customer engagement while making sure that as the aggregation shifts upwards to agentic surfaces, Chewy is positioned to lead and capture an outsized portion of that demand.

Your next question comes from the line of Doug Anmuth with JPMorgan Chase.

Sumit, I just wanted to go back to some of your margin and cost-related comments. I guess, first, just what kind of confidence do you have just around the AI-driven efficiencies that you talked about, the low tens of millions, I think, in fiscal '26 then with $50 million plus in '27. And then perhaps more importantly, even how do you think about the headroom in lowering cost to serve going forward just on a multiyear basis?

Yes. So high confidence. Let's start with answers first. High confidence in our AI-driven efficiency, both the framework as well as the results that we are seeing flow through into the P&L. We expect -- and we're just getting started. The update that I provided this morning on our customer-facing AI assistant named CAI. We are still less than 10% or 15% of our traffic is exposed to that. And it's been in the market less than a month. but we accelerated that deployment from Q3 to Q2. When we lowered the sales guidance -- as you recall, we had to have enough confidence in our own ability to essentially absorb all of that profit impact and overdrive to profitability in the back half and some part of that is us pulling in the initiatives that were slated to launch in the back half especially those where we had high confidence.

And so this is one of them where we're seeing a very high customer take rate. And now it's about scaling our capability to open up the coverage radius to both customers as well as use cases. Other examples that I provided to you around building customer-facing -- internal team member facing agents, whether that's deployed in the pharmacy fulfillment space, which is allowing us to lower our cost to serve in pharmacy, which is durable. And so we don't expect these to essentially -- these are structurally lowering the fulfillment costs that it takes us to essentially pick, pack and ship and order to you. And so that's very durable.

Same thing in customer service. Our agents interact with a multitude of softwares and spend time in looking for answers and building that coherence, particularly for agents that are net new in a way that we help them ramp up and therefore not suffer the productivity dilution. The internal tools that we're launching are rapidly allowing us to essentially level those net new agents and their performance much closer to our experienced agents and therefore embed that productivity and lower the cost to serve structurally.

So hopefully, that kind of gives you a sense for why we don't just believe that these are in experiment mode. We believe these can be embedded. And as the scale, right, it sort of compounds the earnings that you've heard us say, to the -- or educate you on the range of $50 million.

Now I do want to clarify one thing, right? As investors look to '27, it would not be appropriate to mechanically layer the growing contribution on AI or from AI on top of our fiscal '26 margin trajectory, right? We view AI as an increasingly important component of our broader productivity agenda. and it gives us greater confidence in our ability to deliver against those financial objectives. However, these efficiencies will also help offset the normal cost pressures, right? So whether that's wage inflation or other trends in the industry, so they will help us offset the normal cost pressures, and we may reinvest some of these funds to drive attractive growth opportunities.

So net-net, we view AI as a powerful enabler of continued margin progression not as a stand-alone pool of savings that will flow directly into the bottom line. So I think both sides of the equation just have to be sort of appropriately understood. In terms of headroom that we see in lowering cost to serve, I can provide a quick point, Chris is nodding at me, he's going to take this one.

Yes, absolutely. Doug, we feel strongly about our multiyear outlook and road map to lower verbal cost to serve Sumit talked about some of the AI initiatives. We also have continued automation. We're north of 50% of our volume flowing through automated states, and we'll continue to grow that over time. And so we have a robust road map there to continue to lower our variable cost to serve and deliver SG&A leverage in the P&L.

Then our confidence in hitting the long-term margin path of 10% plus EBITDA that we've mentioned is stronger at this point and continues to strengthen with every quarter and year. And how I would wrap that up.

Your next question comes from the line of Steven Zaccone with Citi.

I wanted to ask about some of the gross margin puts and takes in the second half of the year. Chris, I'd love you to dig into that a little bit more. You talked about gross margin being down year-over-year in the third quarter, if you just elaborate on that a little bit. And maybe to zoom out, sponsored as has been a gross margin tailwind for quite some time. Help us understand the contribution this year from an accretion perspective and can that continue to be accretive as we look into next year? .

Yes. Thanks, Steve. So just one clarifying point here. In the script, we talked about Q3 being down sequentially from Q2. It will not be down year-over-year. So the quarterly margin progression in the second half of the year will look more like 2025 or Q3 will step down from Q2 but it will leverage year-on-year, both Q3 and Q4, we expect to modestly leverage year-on-year. And so sponsored ads will be a tailwind, has been a tailwind for some time since we launched the program in fiscal 2023.

We continue to deliver gross margin tailwinds from sponsored ads, both on-site ads and off-site ads are growing this year. And gross margin also continues to benefit structurally from mix, premiumization as we move forward and grow our Chewy Health ecosystem. And so sponsored-ads will continue to grow. And I think you can continue to expect that next year as well.

The gross margin story hasn't changed, Steve. At the beginning of the year, we said it's going to be a driver -- 2 main things are going to be drivers of gross margin. This year, it's going to be our continued mix premiumization. It's going to be continued tailwind from sponsored ads, albeit at a lower level than what you saw in 2025. And so essentially, we said margins are expected to expand, albeit at a lower rate relative to '25. The only thing that has changed since -- well, things keep changing up monthly, but the broad trending that has changed is when we came into the year, we didn't really understand how much tariff -- no, sorry, no tariff, how much fuel impact should we bake in relative to the war in the Middle East. And so we started with sort of low, low single-digit impact that we obviously have updated to mid-single-digit impact that we talked about in Q1. And so we're absorbing that incremental headwind while continuing to deliver expanded gross margins as we move through the year. So overall, quite satisfied with the story.

Okay. Understood. My follow-up is -- to follow up on some of the questions around the industry. So when you think about what's missing for the industry to see higher growth, how do you break it down, whether it's macro or whether it's just the softness in sort of the dog category that continues to be a bit of a challenge?

Well, so the softness in dog category, the trending around net dog adoptions is tied closely to some of the macro factors as we talk about. So these 2 things are correlated/casual in nature. Dog formation is closely linked to household formation, less linked to kind of a renter's market per se. So when you look at the density of dog, right, you need a bit of an underlying stable economy, driving household penetration to drive dog penetration. That's one of the reasons for the rise of cat is because on a real estate basis, cats are much more friendly and economical from that standpoint; and b, we're seeing a lot more cat innovation happen now than we've seen over the last decade or so.

Number 2 is pricing. Now recall -- helpful to recall that we've gone through double-digit inflation for a few years compounded as we've come out of the pandemic years. Now it's been stable for the last several quarters. But there have been other factors that have been pressured the consumers' mindset, albeit fuel, gas, grocery, et cetera. And so to us, all of this goes into what we believe is a headwind towards cost of ownership, right, which is why retailers and e-tailers that are trusted in delivering value, passing on that value, passing on convenience and helping consumers deal with this kind of life -- on a life cycle basis are the ones that will durably continue to compound their advantage, which is why we view this as a short-term or transitory headwind, and our focus is to continue to build Chewy and strengthen our proposition and compound advantages to rapidly accelerate as we come out of this short-term blip. Overall, we don't expect the resilience in the category or the relative immunity in the category to decline over the long term.

And the next question will be the last question for this call. It is coming from the line of Benjamin Black with Deutsche Bank.

Maybe a follow-up on AI. Sumit, can you dig in a little bit more on the early takeaways from CAI, and how do you think the customer impact and the customer experience will evolve over the next 12 to 18 months?

Yes. So obviously, when we took a customer-facing project that -- a product that essentially offers a parallel capability that we've been known to deliver through our exceptional human service agents. You can expect that the bar that this product has to meet is exceptionally high. And so that's the first design principle that from a service bar standpoint in terms of being crew to brand and tone, it has to be spot on. And so in terms of success parameters and dimensions, that is built into it. In terms of customer impact and experience, how it will evolve.

So I talked about expanding coverage use cases, right? So today, CAI is -- if you're in the beta, you're welcome to try this. If not, you will be pulled into beta because we're expanding the program quite rapidly. It is addressing what we believe are the top contact drivers, right? Where is my stuff, where is my order, shipment status, I need help with Autoship management, those type of customer inquiries. We've also embedded automated returns and refunds, which is powered by our deep study and knowledge of machine learning in the background into CAI. And so these are multiple agents that sit under an orchestrator that essentially allow us to direct customer traffic to bring back the appropriate response and self-help.

It is particularly suited to consumers that are propensed towards self-help. These are younger cohorts that continue to become a large portion of our consumer base right? The Gen Zs and the alphas are less inclined to pick up the phone and call an agent. And so experiences like these not only keep the convenience right on top of mind, it meets them where they want to be met.

And then imagine in the future, we could essentially -- because we're building this in a multi-agent orchestration framework, you could essentially keep building agent capabilities and layering in to build more holistic solutions that then combine product recommendations and deepen customer engagement from a service interaction point of view, right? And we spent several quarters building the infrastructure and focusing on our data being right. So now we can essentially build these type of solutions on top. We believe we have a durable competitive advantage here because companies will take years to get to this point or they'll essentially have to go out and integrate through third-party providers where all of our solution is first-party built.

So we're quite excited about the journey of this. We can't wait for inference cost to continue to come down because, candidly, we -- I believe we can scale faster than right now how some of the cost is actually scaling. Overall, we're quite excited about this type of stuff.

CALI, same thing. These are outbound appointments, scheduling type of use cases that we're trying out with Cali, which is a voice agent. So we have both capabilities at this point. Cai is a chat-based capability and Cali's a voice-based capability. We're trying out with multiple different types of use cases.

This concludes today's call. Thank you for attending. You may now disconnect.

Hello, everyone. Thank you for joining us, and welcome to the Chewy First Quarter 2026 Earnings Call. [Operator Instructions].

I will now hand the conference over to Lee Horowitz, Head of Investor Relations and Strategic Finance. Lee, please go ahead.

Thank you for joining us on the call today to discuss our first quarter results for fiscal year-end 2026. Joining me today are Chewy's CEO, Sumit Singh; and CFO, Chris Deppe. Our earnings release, which was filed with the SEC earlier today, has been posted to the Investor Relations section of our website. In addition to the earnings release, a presentation summarizing our results is also available on our website at investor.chewy.com.

On our call today, we will be making forward-looking statements including statements concerning Chu's financial results and performance, industry trends, strategic initiatives, share repurchase program and the environment in which we operate. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks, uncertainties and other factors that could cause actual results to differ materially from our forward-looking statements. We encourage you to review our SEC filings, including the section titled Risk Factors in our most recent Form 10-K for a discussion of these risks.

Reported results should not be considered an indication of future performance. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We assume no obligation to update any forward-looking statements, except as required by law. Also, during this call, we will discuss certain non-GAAP financial measures. Reconciliations of these non-GAAP items to the most directly comparable GAAP financial measures are provided on our Investor Relations website and in our earnings release. These non-GAAP measures are not intended as a substitute for GAAP results.

Additionally, unless otherwise stated, all comparisons discussed on today's call will be against the comparable period of fiscal year 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.

Thank you, Lee, and good morning, everyone. They 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 the 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 $3.6 billion. We ended the quarter with 21.5 million active customers, up 3.6% year-over-year, while net sales per active customer or netback 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. At remains a resilient category, driven by recurring nondiscretionary 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, 1 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 Vet Care. We continue to believe health represents one of the largest and most compelling long-term opportunities for Chewy. Today, Vet Health care represents approximately $54 billion of TAM, including over $40 billion associated with in-clinic products and veterinary services alone. Our vet care clinics are delivering strong stand-alone economics while simultaneously acting as a powerful customer acquisition and retention engines for the broader Chewy ecosystem.

Approximately 40% of CVC customers are new to Chewy, and these customers tend to reach a year 1 less tax of approximately $900. Furthermore, existing Chewy customers who engage with CVC 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 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 CVC and unlocks multiple avenues to accelerate clinic growth, combining CVC'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 CVC 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 road map 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 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 TAM 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 NSPAC 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 lapsed customers and ongoing success in driving down churn is supporting an ongoing healthy trajectory 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. That remains a more resilient category relative to other parts of the consumer landscape and Chewy is increasingly building the capabilities 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 NSPAC 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 long-term shareholder value creation.

With that, I will turn the call over to Chris.

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 macro environment that softened as we move through the quarter.

Q1 net sales reached 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 NSPAC expansion and ongoing market share gains within the pet category.

We closed our acquisition of SmartPack 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. NSPAC 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 SG&A was approximately $593 million or 17.7% of net sales. Now, Q1 non-GAAP SG&A excludes approximately $10 million of transaction-related costs associated primarily with acquisition and integration activities related to SmartPack and Modern animal.

As planned, we delivered approximately 90 basis points of year-over-year SG&A 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 Chewy Health, Chewy 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 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 stream 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 B transaction. Given the scale of our business, the durability of our earnings profile 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 2x 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 NSPAC 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 billion 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 for modern animal for fiscal year 2026.

As we entered the year, we anticipated several company-specific initiatives which support improving growth trends through the back half of fiscal 2026, including expectations of the changes to our Autoship product flow would accelerate product line attachment rates and enhanced 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 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%, and 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 4-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 midpoint 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 in 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 act on certain efficiency gains that we originally halted 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 nonrecurring 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 X G&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 continues to increase.

Now turning to second quarter guidance. For the second quarter of fiscal 2026, we expect net sales between approximately $3.30 billion 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 nonrecurring 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&A discipline and operational efficiency improvements across the business. Furthermore, our updated guidance for adjusted EBITDA margin in fiscal year 2026 contemplate 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 onetime MAP item.

We also expect adjusted diluted earnings per share for the second quarter to be approximately $0.36. 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 million 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.

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, health, vetcare, AI, fulfillment and customer experience. These capabilities are deepening our competitive moats, 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 -- they 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 Instructions]. Your first question comes from the line of Nathan Feather with Morgan Stanley.

I appreciate the quarterly EBITDA guidance. That's really helpful. Can you give us sort of finer point on the puts and takes here that are leading to the sequential margin improvement in the back half of the year?

Yes. So thanks for the question, Nathan. And so Q2, I'll just emphasize, is really all about phasing -- the SG&A expansion that we expect in Q2 remained 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, had a much higher and sort of outsized increase quarter-over-quarter, 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 the 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 more normal versus what we experienced prior. And so Again, Q2 is really all phasing. Structurally, SG&A continue 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.

Your next question comes from the line of Eric Sheridan with Goldman Sachs.

Maybe 1 and a follow-up, if I could. With respect to the comments you made about the consumer, how should we be thinking about going 1 level lower on consumer behavior or you're seeing any deviation in behavior relative to age of cohort income levels that you want to call out in terms of consumer behavior on the platform.

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, 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 Nasdaq by cohort for the customers that we acquired in the period 1 of this year that is now lapping sort of 2 periods or that has now been -- who've been with us for 2 periods now those cohort trends are positive.

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

Okay. And then 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 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?

So our -- 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 TAM 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 initiatives like Chewy Health and underneath of that, it's Chewy vetCare and clinic initiatives that opened up the TAM by incremental $40 billion and is the fastest compounder of NSPAC is a good way to look at it.

When you think about our product initiatives, they are much more so to drive netback curves up whether this is investment in auto ship that drives repeat recurring purchase behavior, whether it's improvement in 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'd initially concepted 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 kind of loss of our belief that these products will continue to drive product attach rate.

The 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 NSPAC 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 SG&A 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.

Your next question comes from the line of Doug Anmuth with JPMorgan.

Sumit, can you talk about just how you get the confidence that the weaker environment late 1Q and into 2Q 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 in fiscal '26. Are you still expecting kind of what you had talked about previously, like $50 million plus in fiscal '27?

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 to fit. So when you look at customer retraction 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 Chuy's absolute clicks, 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, right, we are continuing to -- outside of the modest pressure that we've talked about in the attach rate consumables and health care categories that are recurring in nature, fueled by the Autoship flywheel continue to be super strong. And then when we look at underneath the share kind of where the share dynamics lie today.

We believe the primary source of share gain in the pet 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 have given 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.

Your next question comes from the line of Shweta Khajuria with Wolfe.

Let me try 2, 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 thinking about your growth as sort of 2x the overall industry growth rate driven by the initiatives that you were taking outside of macro environment?

And then the second is on on CBC 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?

Sure. So I'll take the first one. Chris can take the second one and I'll add as required. So I guess the answer to the first question is we still expect us to continue to grow share and to grow 2x 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 Plus, et cetera, 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 through. 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?

Yes. On CVC, so clinics. We still believe we're a compelling revenue and earnings growth driver for TV going forward. We closed the last fiscal year with 18 CVCs and now that we have modernimal closed. We've added 29 cleanings from them, putting in to 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.

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

So if you try to summarize, we will exit '26 we'll exit 26 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.

Your next question comes from the line of Michael Morton with MoffettNathanson.

I just wanted some additional clarity on what you're seeing with the consumer trying to connect some prior comments Sumit in May when you were at an industry conference, you said you saw gross adds increasing and then churn improving quarter-over-quarter. But the guidance in the fourth time and Harry 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 consumer behavior over the last 30 to 60 days that seems to be driving such a reset.

And then part of that is the question we get a lot is Amazon's push into same-day grocery is having an impact in the competitive environment at all?

So on the first one, Mike, 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 250,000 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 moved from the first half of the year to the back half of the year. Underneath of those 2 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 of '25, 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 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 which is a modest pressure on NSPAC driven by attach rate, particularly on the discretionary side as well as premiumization headwinds. So that is what is leading us to update the guidance right? 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 Nasdaq curves and therefore, drive the revenue.

I would summarize it as the following, right? If you look at our long-term revenue guidance, it has consistently been high single-digit to low double-digit revenue growth. And the 2 inputs of that algorithm or active adds growing at low to mid-single digit and then NSPAC growing at mid- to high single digits, 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 NSPAC.

And so our curve this year, right, is -- 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 150,000 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 push into 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 sort of pull away an orbit, if you would, relative to the innovation that we are driving in pet, not only in plastic products that drive our Food and Supply segment, but also in net new categories such as health, [indiscernible], 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 a 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, right? And our approach continues to center on delivering a strong customer experience while maintaining the business well -- or managing the business with appropriate discipline.

So there were times in Q1 when we leaned in on promotions for a discrete period of time because we saw the opportunity in the first 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.

Your next question comes from the line of Anna Andreeva with Piper Sandler.

Sumit, we just wanted to follow up the pressure with premiumization on the aspect. 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 net back 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 the softer macro.

Okay. Let's unpack those one by one. So on the first one, premiumization and discretionary, what is the penetration of discretionary strategy Okay. So 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 NSPAC growth. So this is less specifically pointing towards hard goods softening, right? What we are referring to is not a decline in hard book demand rather, the pace of discretionary attachment is running below our original expectations entering the year. And so as you would expect, we forecast down to the line item level on that we bring on to 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 attach rate forecast.

So what we are referring to is not a decline in parcels. -- rather the base 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 good assortment remains healthy, and is continuing to support growth. The distinction is simply that what we consider it because you could consider treats or reconsider treats also as a discretionary item.

If you look at the way pet parents are experimental with creeks and 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 kind of 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 Auto share business has continued to grow strongly, and is a premium driver of attach for us. At the same time, some of these other non-sysgen-driven behaviors including some customers adding line items to Autoship that one of our products were supposed to drive. Those are some of the things that we're sort of going staring at and saying, okay, I might have been a bit more bullish on our forecasting.

And then your second is promotion over to accelerate?

We don't view -- so we view investment in the business broadly across the spectrum. We don't consider promotions. So when we are investing behind initiatives right? 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 over pouring dollars into marketing with the outcome being us picking up lower quality customers. Anna, 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 head 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 lever that we keep in front of us. And so the ROI of the investment is also very important to us.

Your next question comes from the line of Mark Mahaney with Evercore.

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 if there's anything new in terms of the types of advertisers that you've been able to bring on to the platform? Any color there would be great.

Mark, I can start. Chris can add as he sees spread. So sponsored ads, we continue to be bullish, optimistic and pleased with the progress of this particular initiative -- if you recall, we exited last year at roughly 25%, we exited roughly at midpoint of our growth curve, overall expectation of 1% to 3%. And with [indiscernible] with on-site ads as the primary growth driver of margin contribution in 2024 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%, right, we expect overall contribution to be at or 70% of that to be converted in 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 sponsor ads is helping us offset some part of the fuel pressures that we are now citing and are persistently loaded into our P&L. 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 optimizing supply and ramping up offsite ads.

We have time for one more question, which will come from the line of Michael McGovern with Bank of America.

Given CVC customers are about $900 in year 1 NSPAC. 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?

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. What we've seen is the halo of the Chewy brand when a box is dropped in a particular MSA attracts with very little local activation, attracts 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 this 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 2, 2.5 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 Chewy brand awareness is helping a lot.

Yes, 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 $1 neutral EBITDA, so that provides a modest margin rate drag for the year.

From a timing and curve perspective, perhaps that drag is a little higher in Q2 and wanes through the year. But that's the overall view for [indiscernible].

Thank you for all your questions. This concludes today's call. You may now disconnect.

All right. We are going to get started. I'm Doug Anmuth, JPMorgan Internet analyst. We're pleased to have with us Chewy's CEO, Sumit Singh. Chewy is the largest pure-play online pet retailer in the U.S. The company has more than 21 million active customers. We estimate Chewy will generate about $13.7 billion in net sales this year, including around 85% of which come from Autoship customers. Chewy is guiding to 6.7% EBITDA margins at the midpoint this year, and we project about $750 million in free cash flow. Sumit became Chewy's CEO in March of 2018 after previously serving as Chief Operating Officer, and he previously held senior management positions at both Amazon and Dell. So welcome, Sumit.

Thank you. Good morning.

All right. So kicking off, maybe you can just help us understand kind of the overall state of online pet spending. Third-party data estimates that more than 40% of pet food and treat spend in the U.S. occurs online. What drives this next leg of digital penetration gains? And do you need secular pet household formation to reaccelerate?

So there's a lot there in that question. Let's unpack it. So overall, we interpret the pet industry to be now $160 billion in TAM, of which roughly $15 billion is non-health care services. So these would be grooming, boarding, lodging, et cetera. So if you take that out, what is digitally propensed at this particular point is roughly $150 billion of TAM. We interpret that TAM broken into 3 pillars.

So I took the $15 billion out of the $150 billion, roughly $90 billion approaching $100 billion is food and supplies and about $50 billion plus is health care. And so food and supplies has been digitizing for a long time. So over the last 6 years or so, food and supplies e-commerce penetration has gone from mid-teens to, as Doug mentioned, sort of mid-30s to high 30 levels. And then health care is what I would consider 5, 7, 8 years behind where food and supplies is. And so we are right now entering the mid-teens level of penetration for health overall.

When you look at Chewy's composition in the way that we drive growth underneath of it, for every dollar that moves online, we pick up $0.40 to $0.45 in the food and supplies vertical, and we're picking up $0.70 of every dollar that is moving online in the health vertical. So underneath of it, our drivers are secular trends of e-com, in our opinion, will continue. They have continued for a number of years. The pandemic brought in what you would consider the high tide and then sort of the tide reverted back to normalize back in retail. But the secular wind, the currents that have been blowing towards online will continue to do so.

In fact, over the next several years, we believe the category should cross 45%, 50% of online penetration and health will continue to get more and more digitized and Chewy is building over the last 6 years, we focused on building a very large platform that is integrated through one-party data and is now continuing to pull in a lot of commerce from chewy.com into our physical presences with the clinic. I'm sure we'll talk about that a little bit. Yes, I'm sure there's a question there I did not answer, so happy to go at it again. But overall, we're bullish about the category and the secular trends that fuel e-commerce.

Okay. Great. You've talked about the company delivering low single-digit active customer growth in fiscal '26 with kind of broadly consistent cadence through the year and the revenue growth will accelerate for a few quarters. What is driving Chewy's implied share gains? And how do you think about kind of interplay across gross adds, reactivations and churn?

Okay. So I gave you some data points on the dollar that we are picking up relative to every dollar that is moving online. When you look at share positions, we are -- on an aggregate basis, we are roughly 8% to 10% of the share of the larger TAM of $160 billion. When you consider e-commerce, we are likely 40%, 42% of the share of the market at this particular point.

And underneath of it, our trends are fueled by a very strong Autoship business on the retail side and primarily on the health side. So between food and medication, over 85% of our sales or nearly 85% of our sales are driven by this quasi-subscription program, Autoship, which has continued to grow from low 50s 7, 8 years ago to now having crossed the 80% mark. So very durable, predictable, repeatable revenue. On top of that, now I also want to remind you that Autoship customers are not dormant customers. So it's not set it and forget it. They very actively engage through attach. And so the base load of Autoship provides a healthy tailwind. But on top of that, Autoship customers also attach to a very healthy degree and a high degree.

The second part of our share gain is fueled by health. Clearly, I mentioned we're picking up $0.70 for every dollar. We run the largest pet pharmacy in the country. And so from a business point of view, you've got to look at us as 2 strong pillars, one fueled by Autoship and the other one as a secular trend where we are outpacing the market growth per se. If you look at industry growth, we estimate industry to grow roughly at low single digits percentage point this year, roughly about 3% or so, plus/minus 1%, give or take. The -- our algorithm for growth is driven by a combination of new customer growth, so customer file increase and share of wallet increase. Share of wallet increase, the way you have to look at it is the following.

So if you divide $160 billion TAM by roughly 90 million U.S. pet owning households, you get to about $1,800 share of wallet per household. That's how you think about the entitlement. We are at $600 share of wallet per household. So we're about 1/3 of our way there. And we are the largest aggregator of share of wallet as publicly available data would suggest. Why? Again, back to a program like Autoship, back to the attach rates that we drive, back to the health premiumized mix that we've been shifting the business into, all of these provide very healthy NSPAC accretion. And in terms of file increases, we've guided to grow customer file to the tune of low single digit. And so our revenue composition is a combination of both active file increase and NSPAC increase.

On active file, Doug, we are continuing to see gross adds increase, and we continue to see our churn improve on a quarter-by-quarter basis, given, again, the fact that we have highly propensed repeatable, sticky categories that are less propensed to immediate macro volatility per se. We're not immune from it, but we clearly are resilient to the point where we have confidence in our share gain story.

Okay. Let's hit that last point just in terms of the macro environment. Historically, Chewy has been -- in the category has been more durable, just given significant majority of net sales coming from nondiscretionary type spend. What are you seeing in terms of impact on consumer spending or sentiment due to higher gas prices?

So I agree pet is resilient and continues to be resilient. Pets don't eat more in Q4. They don't eat less in Q1, and that provides the category a stable categorization, if you would. Underneath of that, our business, as I will keep iterating, is fueled by a very large subscription service and a very large health vertical. The emotive nature of the category alongside these durable levers that we bring to market puts us in a category which is relatively much more inert to some of these macro headwinds. For example, when the tariff wars were going on, we shared a data point to the market saying 85% of our sales comes from food and meds and only 15% comes from discretionary. And that was helpful at that point because as consumers shifted out of discretionary, Chewy was relatively well insulated. So this year is not much dissimilar to some of those trends.

Over the last -- so while pet remains resilient, it is not immune to the macro changes that we are seeing. In the last couple of months, we are continuing to see and interpret the consumer as being more stretched than we were when we entered the year. There's no shortage of data points that supports that. Leaders here are actively talking about that. And we are very closely watching these trends for what they mean towards the end of the year. So only time will tell. What I want to impress upon is that even if we are -- we enter a period of relatively softer macro in the future, our ability to draw and continue to gain share against an industry that we believe is growing low single digits remains intact.

More so, I would say that our ability to underwrite the profit algorithm, which we have continued to build resiliency into over the last few years. So on a structurally foundational basis, we are not concerned about the macro volatility in a way that we will deliver or underwrite earnings. Specific to fuel prices, we're underwriting low single-digit millions of impact to fuel in our Q1 quarter. And we have not yet forecasted it for the rest of the year. So if we were to underwrite a similar amount of impact for the rest of the year, we have the ability to absorb it, again, without coming off of our earnings algorithm.

Got it. Okay. All right. That's helpful. Maybe let's just go back for a minute to NSPAC, which is essentially spend per active customer. Inflation and pricing tailwinds kind of subsiding somewhat. I guess when you think about cohort maturation, cross-selling new verticals, MAP, which is obviously the way the industry is primarily priced, what kind of drives the sustained pricing power and NSPAC growth going forward?

Okay. So the best way to understand NSPAC is if you trace it all the way back to 2019 when we came to market, I believe NSPAC at that time was roughly $350 to $380. NSPAC is sitting at $600. And the industry has gone through unprecedented amounts of inflation through the pandemic. So if you break down the growth of NSPAC, less than 20% of this growth came from inflation. The rest of it is structural share of wallet growth. So let me take that off the table, first of all. So our NSPAC growth comes in the following manner. We have a very repeatable, predictable way in which customer cohorts spend their money. You can -- we've shared this disclosure twice, once in 2019, once in December 2023. Our customers spend $150 first year or up to $150, $250 year 2 and $300.

By year 5, they're spending $500, $600. Our cohorts that are 9-, 10-year olds are spending $1,000 plus. Very predictable build of NSPAC fueled by our ability to drive very strong customer relationship, our ability to put customers on Autoship. What an Autoship order does is that it takes the thinking out of the next order out of the picture. So it builds a repeatable layer cake in a way that revenue compounds for these cohorts that we essentially mature or graduate through the year. So a bunch of our NSPAC comes as part of our maturity curves as these cohorts are developing. Then in 2018, we introduced the health business. What -- and health is broad at this point. So I'll say we introduced pharmacy particularly.

What a pharmacy vertical does to a customer is every time we expose an existing Chewy customer to a pharmacy vertical, share of wallet increases by $300 to $500. The marginal cost of acquisition is nearly zero because this is an existing Chewy customer. So today, roughly 25%, a little bit below of our customers, so existing 21 million customers, about 25% or so are subscribed to pharmacy, which tells you -- and you can see the weighted impact contribution then in terms of -- if you back out in terms of mathematics as to how much a category like this can contribute to the NSPAC weight, which also tells you there's a lot of headroom for us to grow into as we continue to mature businesses like pharmacy, veterinarian diet, health and wellness supplements. To give you a data point, from 2019 until 2024, Chewy grew $9 billion in incremental revenue.

We've given you a data point that at least $3 billion of that $9 billion has come from Chewy Health. Margins in pharmacy are 1,500 basis points higher gross margin than the base business. So these are structural moats. These are structural differentiators. Underneath of that, I would say we've completely rebuilt our supply chain, Doug from the first time that we met you in 2018, '19 up until now. And that then durably protects our margin from fluctuations that happen in the market or to the transportation industry or to any other last mile network that is built out there. So overall, I would say we feel pretty good about our ability to compound NSPAC. I have not yet talked about CVC, Chewy Vet Care, which is the fastest compounder of NSPAC. I'm sure Doug will get there, so we'll address it at that point.

Okay. Yes, we'll get to CVC in one moment. We get the question a lot just about promotions in the space and MAP. So maybe you can just talk a little bit more about how kind of the other primary players in the space are abiding by MAP and how you think about promotional environment in general?

Sure. So to understand, first, to get to promotions, you have to understand how pricing works in the pet category. So let me just sort of break that in a very simple concept called MAP, minimum advertised price. For those who may not be familiar with MAP, it is a price point, a floor set by the suppliers on which you can price their particular product. Retailers and e-tailers can price at or above MAP up until the MSRP, but not below it. If you price below it, it comes immediately with financial and supply chain in-stock type penalties, which are quite severe. And so there is a high degree of discipline that is maintained in the pet industry at MAP pricing levels. Now I said you can choose to price above MAP.

So the lowest price point that a consumer can pick up a product is at MAP, and we price at MAP. If you compare Chewy prices, and this has been done and proven time and time again from studies. In fact, I wrote about this and Agentic a few weeks ago. It's on my LinkedIn, pick up the article. It's an insight as to why we're protected from disintermediation and what is our position on pricing. I'll pick up a point from there. We run pricing neck to neck with Amazon. When we compare our pricing to Petcos and the PetSmarts and Targets or the food, drug and masses of the world, we are price advantaged between 3% to 16%. So first of all, you have to understand the fact that we don't need to promote or discount because we are already price advantaged.

Further, when you subscribe to Autoship, you get an incremental 5% discount on top of the base price, which is not funded by us. It is funded by suppliers because Autoship builds loyalty and repeat purchase rate. And Chewy does it the best in the industry. So for us to consider promotion, right, we are -- that is not a lever that we generally believe we need to essentially take to market. Amazon ran their Pet Day the last 5 days. We didn't match. We didn't feel need to match. We saw no loss of demand. We're past that. This was in 2018, '19, when we just come to public when we're $2 billion, $3 billion, okay, like we used to watch. We're still in the rearview mirror, we have the ability, by the way, don't be confused. We have technology that monitors industry-level pricing at 15-minute increments, and we have the ability to adjust industry level -- to react to industry-level pricing should we choose to.

So we have the ability. We choose when to do so and when not to do so. And for the most part, industry has remained pretty rational on promotionality, and we don't really expect this as a lever to pull on a credible basis moving forward.

Okay. Great. Let's shift gears. I want to talk about Vet Care, and then we'll get to Agentic after that as well. But you mentioned -- so you published an extensive investor presentation on Chewy Vet Care. You've been acquisitive with Modern Animal. What are the key initiatives just in terms of vet experience, vet retention and customer acquisition as you build out this offering?

So it's funny. So we didn't really know what to expect when we started launching Chewy Vet Care in April of 2024. We built 6 clinics in '24. They have now hit a 2-year mark. We built 8 in '25 -- we built 8 in '24 and 10 in '25. So we exited '25 at 18 clinics. In each of these clinics that we dropped into the marketplace, we saw a very similar theme. We saw 40% of customers that were walking into the clinics were net new to Chewy. We saw our forecast for marketing that we had put behind the clinics come in much lower spend than expected. So the Chewy brand name carried a lot of weight and awareness and drove organic traffic that built quickly clinic utilization to the levels that we were -- exceeded clinic level to our expectations.

In terms of existing customer interaction, half of the customers that are walking into CVCs are then within a very short period of time, attaching themselves to other categories at chewy.com, pharmacy, supplements, food in that order. And then in terms of retention, we track a metric called forward booking deployment rate -- forward booking rate. So this would be an Autoship type of metric for services, if you would. So if 100 customers walked in, how many walked out with a prebooked appointment for their next lot. That metric is running 2.5x what we believe industry forward booking rate to be. Our vet retention, so there's been a narrative in the industry around supply shortages for vet and the long amount of time it's taking companies to recruit vets. That is true. For Chewy, however, we are the employer of choice. Our vet recruiting time is 4 months or less against an industry that has taken an average of 12 months to recruit vets.

Our vet retention at the 2-year data point that we have is running high 80s to low 90% levels. Our vet NPS, our customer NPS has continued to run at 4.8 stars or higher. These are not internal data points. These are published Google Star ratings that I'm quoting to you. So the mousetrap is a better mousetrap. It's resonating with customers. It's resonating with veterinarians. And exiting 2018 -- 2025, I said we had 18. Exiting 2026, we were going to be at 30. The Modern Animal acquisition puts us at 60. These 60 clinics have an embedded revenue run rate of $300 million in them. And so we're quite excited about the experience that CVCs are delivering, the growth compounding at much higher profitability that these can -- or the impact that these will deliver from a profitability point of view.

Okay. Maybe you can talk about that a little bit because if we go back to your Investor Day a few years ago, when you talked more about the strategy, there was -- I think there was kind of some natural skepticism in the market about going into these physical spaces and what profitability would look like. But you're targeting actually about $3.5 million, as you mentioned, of steady-state revenue per clinic and then an additional, I think, $800,000 per clinic on top of that and better EBITDA margins than the industry. So I guess what drives your bullishness on running all these metrics and running these basically more profitably on a 4-wall EBITDA basis?

So just to repeat the data points or to put them on the table, we project $3.5 million per clinic. An average clinic in the United States produces between $2 million and $3 million. We also -- on top of the $3.5 million per clinic, Doug mentioned, we are essentially projecting and we're proving this out every day, $800,000 attach per clinic. So these are the attach rates that I talked about. So clearly, CVC is fueling the ecosystem, the full platform sort of view of what Chewy is and should be. Underneath of that, the inputs that are fueling that type of revenue output is the following. We have the highest DVM productivity in the market or one of the highest that we've seen, $1 million per DVM, right?

Underneath of that, our pricing and location strategy is fueling the premiumization that we expect to deliver in the services industry. We're not -- these are not in low-income neighborhoods. These are in mid- to high-income neighborhoods. They are driving premium service for a price point that is very palatable to customers. And so the demand-supply ratios that we're seeing are very positive. So our utilization, we are essentially projecting breakeven at 20 months or lower at this particular point. In fact, that's the data point that we've shown for our oldest clinics that have launched in April 2024. So go pick up this presentation that we're talking about. A new customer is spending $900 in their first year, 5x the amount of share of wallet that an average chewy.com customer spends. An existing customer expands their share of wallet 20% or plus when they walk into our clinics. So the economics are powerful here.

And profitability -- industry average profitability is between 18% and 20% levels. We've projected profitability at plus 22% levels. So we're highly confident of not only the revenue, but also the flow-through to the bottom line. You asked how are we doing this? So on the -- if you look at the way that we've built the clinic, we work backwards from what veterinarians spend their time on and what customers spend their time on. And we have essentially built tech and product in the way that the clinic delivers experience that takes out the non-value-added time and pushes that towards productively engaging customers, both higher appointment mixes, but also higher DVM productivity that comes as a result of it. So what do I mean by that? If you -- I'll give you an example, the way that we're embedding AI in our clinics. We have embedded AI in 3 places. When a customer walks in, our doctors don't spend any time pulling up data or understanding what the customer background and history is.

The agent automatically schedules it and prints out a full triage report that gets right to the bottom line and cuts out all of the check-in time that the vet essentially used to have. Number two, when the vet is in conversation with the customer, the interaction is fully scribed. So our agent is listening to this and fully scribes it in medical terminology back into the software that then hooks into our PIMS, practice integration management software that then updates all customer records and vet records. Post the appointment, the agent essentially is writing post follow-up notes so that the veterinarian neither has to enter data or the information nor do they have to write notes. That freed up 2 hours per day per veterinarian for us. And so instead of -- so we essentially put that back into increasing the number of slots offered and so higher vet productivity plus more number of slots drives the high revenue that you're talking about. It also lowers our cost to serve.

We don't carry -- we carry very minimal inventory in the clinics. So not just from a P&L income statement point of view, from a balance sheet point of view, it is much more profitable to run this clinic because we've hooked this back into a 24-hour pharmacy delivery. We now have 5 pharmacies that we service from. So we can get your prescription to you. If you have a prescription approved from us, we can get it back to you. 75% of our orders are delivered in one day, 24 hours or less. And so these are durable structural advantages. And in the world of AI, this builds into the moat, not disintermediates from it.

Okay. That's great. Very helpful. Just last one on -- just on CVC, and I want to get to Agentic. But you're talking about kind of approaching $300 million in revenue from vet clinics exiting this year. How do you bridge that gap toward $1 billion over a multiyear time frame?

Each box costs us $1.5 million to put into the ground, okay? We are building at the rate of 10 to 12. We've acquired Modern. We now have 2 competent teams who can build at the rate of 10 to 12. So suddenly, we've gone from building 10 a year to maybe 25 a year. On an average of $4 million to $5 million per clinic, we are embedding roughly $125 million per year of clinic revenue if we wanted to, if we choose to, right? I'm not discussing my LRP. I'm essentially getting you to appreciate the mental concept of how we grow from this point onwards.

So we could choose to continue to grow organically at some rate between 10%, let's say, 30%, 35%, right? All of that is incorporated within the 1.5% to 2% CapEx guidance that we've provided. So we don't expect to come off of that. In addition to that, we have shared with you that with the tech that we have built and are continuing to build, with the strength in our brand name to be able to acquire and retain customers and with our strength in fulfillment, we are also thinking of how we can do this in an asset-light manner. So if Doug wants to come to market and open a clinic, well, Doug could essentially partner with Chewy, Chewy could partner with Doug. We could lend Doug our brand name, we could lend Doug our tech.

We could connect Doug's clinic back into our ecosystem. So we're fueling demand. Doug is the service provider. We are fulfilling the demand. On a GMV basis, Doug earns $100, we perhaps take 15% of that. And so in this particular case, you value the business on a GMV basis, much higher profit flow-through. On the organic side, you view the business on $4 million to $5 million per clinic at 22% to 25% of EBITDA. And so the combination of that, in our opinion, right, gets us to roughly $1 billion run rate exiting 2030.

Okay. Great. Let's shift gears. I know we have about 6 minutes left. I want to talk about Agentic. You mentioned the thought piece that you wrote recently on Agentic. You said it was on LinkedIn. So that reiterates your view that Chewy will be a beneficiary of Agentic commerce. What makes you so confident that the company and the broader pet category is a beneficiary rather than disrupted in an Agentic world?

Yes. So the headline of the article, just to sort of preface it is AI will not disintermediate Chewy. It will route demand to it. So not only -- we believe not only are we not disintermediated, we are advantaged in the world of Agentic. It's a gift that we look forward to receiving as time moves on. There are a few key assertions that build into that belief. One is pet and pet is not your average category in the level of emotiveness, in the level of care. An average pet parent thinks about their pet 10 times a day. An average pet parent doesn't go to sleep thinking did my pet eat? Are they eating well? They care about longevity. 80% of the customers would put their pet in front of them when it comes to medical appointments or insurance requirements, et cetera, et cetera. Chewy then is also not your average retailer, right?

80% plus on Autoship, 21 million customers deeply loyal to us, the way that we deliver service in a highly personalized manner, so not just the purchase experience, but the post-purchase experience. The fact that we have no CRM department per se and yet the surprise and delight from the way that we run our customer care or we deliver the experience drives -- I mean, coming in here, every time that we checked into somebody or we asked Chewy, the person was like, oh, I'm a Chewy customer, I love it, right? And that you don't hear about -- it makes you feel really good about that. So first of all, like it's not like buying a transactional toothpaste where you can essentially outsource your thinking to anybody.

But let's argue that the consumer ultimately wants to -- wants to get the maximum value out of their purchase. Well, that's what agents will be good at doing. So what the Agentic world, in our opinion, will do is it will shift the search interface upwards to these Agentic services. And the agents that are essentially cross comparing will route demand to the place where they will find the maximum value for that particular customer. Well, that place will be chewy. Two reasons because I just said -- I explained to you or shared my point of view on how we price.

So we're advantaged on pricing, but also Autoship compounds that advantage for us because it's even cheaper. So not only will we win the first order, we will also -- in our expectation is we will win every subsequent order from that point onwards. And so -- and then third, we are not sitting idle. We are building actively interfaces into the Agentic world. So a team at Chewy is focused on leading the integration and shaping protocol or commerce protocols for pet with the Googles of the world and the OpenAIs of the world, right? So we are leading there. You can go check for yourself.

And another team is essentially making sure that SEO goes to Agentic and Chewy is the one that feeds in catalog information, attribute data, content data, vet information, health information because we are one of the largest purviewers of this type of information that exists on one platform. So our view is the 300 million active users that live on Gemini on a monthly basis, when they start engaging with the platform and interact with the pet category, Chewy should be a net beneficiary of this.

Okay. Let's stick with AI. You've also cited tens of millions of dollars of AI cost benefits this year and more than $50 million annualized in '27 -- fiscal '27. Can you just help us understand where these efficiencies are being realized across your business?

Yes. So I believe we are one of the very few companies that has quantified AI savings. And we're doing so because we can see sort of where we're implementing and the impact that it will have. So the way that we've built it, first of all, is we have a completely services API-driven tech stack. It is modern in nature, on top of which we sit an enterprise data platform which we've been reformatting over the last few quarters to become self-sufficient in the native AI world that we're moving into.

And now we're essentially putting applications on top of it. So as opposed to a lot of companies that will run to the market and integrate with third-party providers, we essentially have our own infrastructure stack, on top of which sits our data stack, on top of which sits a central AI tooling platform that the company has internally built, on top of which we are building applications. So it gives us full control in terms of the stack, the capability, the go-to-market ability as well as the cost benefit quantification that we bring as a result of it. We're embedding AI in 3 different pillars. So the way that I want you to think about it is 3 different pillars. The first one is Agentic experiences that are customer-facing. That's not where we are sizing the benefit.

We'll come talk to you about that in the future. We're in the process of building that. The other 2 pillars where we have cited tens of million dollars of benefits in '26 and up to $50 million or greater in '27 are we're embedding AI in our service operations layers and in our fulfillment and supply chain layers. We run the third largest -- we are the third largest direct-to-consumer shipper in the country at this point. We run 18 fulfillment centers, 5 pharmacies and are a very sophisticated and large supply chain and fulfillment provider, which means we have an ability to embed AI in many of our workflows and drive productivity and OpEx leverage into our networks. That's one.

Number two, we're embedding AI in pharmacies. We're embedding it in customer care. We're embedding it in marketing operations. That's what I call the service operations layer. So overall, Doug, I believe we have the visibility and the confidence to deliver what we are saying we can deliver.

All right. Excellent. We're going to leave it there. Thank you, Sumit.

Hello, everyone. Thank you for joining us, and welcome to the Chewy Fourth Quarter 2025 Earnings Call. [Operator Instructions]

I will now hand the call over to Natalie Nowak, Head of Investor Relations. Natalie, please go ahead.

Thank you for joining us on the call today to discuss our fourth quarter and full year results for fiscal year 2025. Joining me today are Chewy's CEO, Sumit Singh; and CFO, Chris Deppe. Our earnings release, which was filed with the SEC earlier today, has been posted to the Investor Relations section of our website. In addition to the earnings release, a presentation summarizing our results is also available on our website at investor.chewy.com.

On our call today, we will be making forward-looking statements, including statements concerning Chewy's financial results and performance, industry trends, strategic initiatives, share repurchase program and the environment in which we operate. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks, uncertainties and other factors that could cause actual results to differ materially from our forward-looking statements. We encourage you to review our SEC filings including the section titled Risk Factors in our Form 10-K filed earlier today for a discussion of these risks.

Reported results should not be considered an indication of future performance. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We assume no obligation to update any forward-looking statements, except as required by law.

Also during this call, we will discuss certain non-GAAP financial measures. Reconciliations of these non-GAAP items to the most directly comparable GAAP financial measures are provided on our Investor Relations website and in our earnings release. These non-GAAP measures are not intended as a substitute for GAAP results. Additionally, unless otherwise stated, all comparisons discussed on today's call will be against the comparable period of fiscal year 2024.

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

Thank you, Natalie, and good morning, everyone. I'm thrilled to be joined today by our newly appointed CFO, Chris Deppe. Chris has been with Chewy since 2022 and brings valuable continuity and deep institutional knowledge, enabling a particularly seamless transition. He has a strong understanding of our business and the opportunities ahead for Chewy. I look forward to having many of you engage with Chris as he steps into his new role as CFO.

I want to start by thanking our Chewy team members for executing a strong finish to the year. Once again, we delivered strong net sales growth, significant margin expansion and record free cash flow in 2025. As we enter 2026, we are focused on repeating this formula for success, disciplined execution, profitable growth, continued margin expansion and strong free cash flow generation, all in support of sustained long-term shareholder value.

Instead of taking the traditional approach of diving straight into our results, I'd like to share my perspective on what we are seeing in the pet industry and Chewy's place in it in 2026 and beyond. So let's begin.

Pet is a uniquely attractive industry, fueled by increasing pet humanization, premium product adoption and expanding lifetime value per household. Spending in this category is driven by an emotional attachment and recurring nondiscretionary needs which translates into resilient demand across economic cycles.

We expect 2026 pet industry dynamics to largely mirror 2025, steady and resilient to macro trends, but without cyclical acceleration. Pet household formation appears stable with no evidence of deterioration. However, we are not underwriting a meaningful rebound in that variable.

Current estimates suggest low single-digit industry growth with dog at the lower end of that range and cat at the higher end. Further, we expect industry growth to be predominantly volume driven, with little or no contribution from pricing. Importantly, we expect a secular shift towards e-commerce penetration to continue as consumers increasingly prioritize convenience, transparency and auto replenishment, structural advantages that persist across economic environments and benefit scaled digital platforms like Chewy.

Against this backdrop, we once again expect to deliver share gaining growth. We believe that Chewy is unique with a differentiated flywheel-like operating model, powered by a leading sales engine with over 80% of net sales on Autoship, supported by a world-class fulfillment network, delivering best-in-class consumer satisfaction. The algorithm supporting our underlying growth remains balanced and durable, driven both by active customer growth and NSPAC expansion. We reached an inflection point in net adds in 2024 and built on that progress throughout 2025, adding approximately 150,000 to 250,000 net adds per quarter.

In the current environment, we believe we can continue to deliver quarterly sequential net adds within that range. At the same time, we see a long runway to grow NSPAC through premium and health mix shift, private brand expansion and deeper engagement. Now shifting to margins.

On margin expansion, including its trajectory and durability, we remain equally bullish. As I noted during our last earnings call, our long-term margin framework is unchanged. And the underlying drivers of margin expansion are strengthening.

In 2026, we expect to further expand profitability with the rate of expansion expected to build relative to 2025. SG&A leverage will further strengthen as we move through the year supported by the continued ramp of our next-generation Houston Fulfillment Center and efficiencies from the use of AI that helps structurally lower our cost to serve. I will talk about these shortly.

And finally, we believe Chewy remains well positioned to compound growth, expand share and drive sustained margin and free cash flow expansion in 2026 and beyond, independent of a macro reacceleration. Said simply, as we look to 2026, our model does not depend on a minimum net sales growth threshold to expand profitability.

Now an update on some of our strategic priorities, and then Chris will take you through our financial results and 2026 guidance. Starting with Chewy Vet Care, we opened 10 new practices in 2025, reaching the high end of our target range, bringing our CVC footprint to 18 locations across 5 states. Performance continues to exceed expectations, supported by strong utilization and consistently high customer and veterinarian satisfaction scores. CVC is also driving compelling ecosystem-wide value, serving as both a customer acquisition engine and an engagement flywheel that deepens relationships with high-value health customers. And the results are compelling. CVC is the fastest NSPAC compounder in the business. We believe veterinary care is a powerful growth vector and a key pillar of value creation for Chewy. We are confident in the path ahead as we continue to execute and scale this platform.

Turning to AI. For those of you familiar with Chewy, it will come as no surprise that our ability to adopt technology and drive rapid innovation is a core strength. We operate on a modern, nimble and scalable tech stack supported by a world-class team of designers, product managers, marketers and technologists who excel at building applications that enhance the customer experience while lowering costs. The arrival of AI only amplifies this advantage, enabling us to innovate faster, operate more efficiently and unlock entirely new capabilities, and that is exactly what we're focused on.

Over the past several quarters, we have focused on building the foundation required to deploy AI at scale across Chewy. Today, with our unified enterprise data platform and central AI tooling in place, we are embedding AI across key layers of the business, specifically, the purchase experience our service and operations layer and our supply chain and fulfillment network. Let me elaborate.

Within the purchase experience, we are progressing quickly to apply AI across our platforms to improve search relevance, product discoverability and personalization. Externally, we are closely following the emergence of Agentic Commerce models and view it as a future incremental demand and distribution channel for Chewy.

Pet remains a deeply emotional category where trust, relationships and empathy matter. And these are enduring strengths of the Chewy brand. Combined with our leadership in price selection and recurring convenience, both purchase and delivery, we believe our competitive position remains strong.

Across the broader organization, we are already deploying AI to drive greater structural efficiency. Functions such as customer service, fulfillment pharmacy and marketing operations are leveraging internally developed AI tools to streamline workflows and improve productivity.

As we move through 2026, these efforts will translate into measurable financial impact. Based on our current road map, we expect AI-driven efficiencies to contribute a low tens of millions of dollars benefit in 2026 with a meaningful step-up in 2027, where we see a path to approximately $50 million or more in annualized savings as these capabilities scale.

Moving on from AI, let me briefly talk about Chewy private brands. After the launch of our fresh brand, Get Real, in Q2 last year, we are entering an exciting new chapter for Chewy private brands with the launch of Chewy Made. Chewy Made is our unified owned brand platform designed to deliver trusted high-quality products while driving durable profitable growth for Chewy.

Starting in April and throughout 2026, we will expand our presence across both dog and cat consumables. This includes a balanced offering of dog food positioned at more accessible price points to broaden our reach into everyday nutrition, a broader assortment in every day and gourmet cat nutrition as well as entry into high-demand formats where we currently have low penetration.

In addition to the expanded assortment, we are consolidating some existing brands under this platform, creating a more cohesive and streamlined experience for customers. We look forward to keeping you updated on the progress of Chewy Made.

In closing, we continue to execute from a position of strength. We are delivering share gains, expanding margins through structural efficiencies and generating growing free cash flow. Looking ahead to 2026, we are well positioned to further build on this momentum and drive sustained earnings growth. With that, I will turn it over to Chris.

Thank you, Sumit, and thank you all for joining us today. Having been part of Chewy's journey for nearly 4 years, I'm excited to step into the CFO role and continue building on the strong foundation our team has established. I look forward to engaging with many of you in the quarters ahead. Let's start with a review of our financial results.

As we get into the details, a reminder, fiscal year 2024 included a 53rd week and comparisons for Q4 and full year 2025 are discussed on a comparable 52-week basis where applicable. Fourth quarter net sales reached over $3.26 billion bringing our total fiscal year 2025 net sales to over $12.6 billion, delivering year-over-year net sales growth of 8.1% in Q4 and 8.3% for the full year 2025, reflecting strong execution, continued share gains in a stable category environment and consistent performance across both customer growth and spend per customer.

We continue to grow active customers ending the year with 21.3 million, increasing by approximately 4% year-over-year and net additions up by more than 810,000 year-over-year in fiscal 2025. We once again saw year-over-year improvement across all elements of the active customer equation. We also continue to grow with a high-quality revenue base.

Autoship customer sales reached over $2.7 billion in Q4 and $10.5 billion for the year, representing 84% of total net sales in Q4 and 83.3% for the full year 2025.

Growth in Autoship customer sales outpaced overall top line growth, increasing by nearly 13% in the fourth quarter and 14% for the full year 2025 on a comparable basis, reinforcing the strength of our recurring revenue model. NSPAC reached $591 in Q4 2025, increasing by approximately 4% year-over-year on a comparable basis.

Moving to profitability. We reported fourth quarter gross margin of 29.4% and full year 2025 gross margin of 29.8% representing approximately 90 basis points of year-on-year margin expansion in Q4 and 60 basis points of expansion for the full year. Strong gross margin performance was driven by sponsored ads growth, premium mix into high-margin categories, including health and wellness verticals and a rational promotional environment.

Shifting to operating expenses, please note that my discussion of SG&A excludes share-based compensation expense and related taxes. Fourth quarter SG&A was $607 million or 18.6% of net sales and full year 2025 came in at $2.4 billion or 18.8% of net sales. Q4 and 2025 SG&A include approximately $10 million of onetime transaction costs primarily related to the SmartEquine acquisition. Excluding SBC and these onetime costs, we delivered SG&A leverage of approximately 20 basis points in Q4 and full year SG&A as a percentage of net sales came in flat year-over-year.

Fourth quarter advertising and marketing expense was $233 million, bringing full year 2025 A&M expense to $825 million or 6.5% of 2025 net sales reflecting approximately 30 basis points of leverage year-over-year. Fourth quarter adjusted net income was $115 million and full year 2025 came in at $541 million, which translated into $0.27 adjusted earnings per share in Q4 and $1.27 in full year 2025.

Fourth quarter adjusted EBITDA came in at $162 million representing a 5.0% adjusted EBITDA margin, up 120 basis points year-over-year and adjusted EBITDA flow-through of approximately 19%. The Full year 2025 adjusted EBITDA came in at $719 million or 5.7% adjusted EBITDA margin, growing approximately 26% year-over-year reflecting 90 basis points of year-over-year margin expansion and flow-through of over 16%. This level of profitability expansion at our scale reflects the structural strength of our model and continued operating discipline across the business. We are consistently expanding earnings at a rate meaningfully above net sales growth, demonstrating the operating leverage embedded in the model.

The results we are delivering today are a clear reflection of the underlying strength of the business and where it is going. In the fourth quarter, we reported free cash flow of $232 million. And in fiscal year 2025, we generated $562.4 million of free cash flow, both record highs for the company, highlighting the continued improvement in earnings quality and capital efficiency.

The consistency, scale and continued growth of our free cash flow underscore the quality and resilience of our model. Our full year 2025 free cash flow reflects $691.6 million of net cash provided by operating activities at $129.2 million of capital expenditures. We ended the year with approximately $879 million in cash, cash equivalents and marketable securities, and we remain debt-free with an overall liquidity position of approximately $1.7 billion.

Over the course of the year, we repurchased and retired approximately 6.8 million shares, spending approximately $257 million on share repurchases in 2025.

Overall, our capital allocation priorities are unchanged, advance the strategic priorities of the business where returns are attractive, maintain a strong balance sheet and return excess cash to shareholders. Share repurchases will remain a key part of our capital allocation strategy and we expect our level of activity to increase relative to 2025, reflecting both the strength of our cash generation and our view of the current valuation.

Now turning to forward-looking guidance. As we enter fiscal 2026, I want to clearly frame how we expect the year to progress both from a full year standpoint and in terms of quarterly cadence. In addition to our guidance ranges, I will provide perspective on pacing so that our expectations for growth and profitability are well understood and appropriately reflected in how you model the year.

Our 2026 outlook is built around three consistent priorities. First, continued share gains supported by stable demand and balanced growth across active customers in NSPAC. Second, ongoing margin expansion driven by a combination of mix improvement and increasing operating leverage. And third, improved incremental flow-through relative to 2025, reflecting strengthening cost discipline and the scaling benefits embedded in our model.

Let me now walk through the specifics of our 2026 outlook. For the full year 2026, we expect net sales of between $13.6 billion and $13.75 billion or approximately 8% to 9% year-over-year growth with the recently closed SmartEquine acquisition expected to contribute approximately $80 million of net sales for the total company in 2026. Overall net sales growth will continue to be driven by a combination of active customer growth and NSPAC expansion. Our forecast assumes no price inflation in 2026 and we remain confident in delivering low single-digit active customer growth with net additions broadly consistent throughout the year.

As you think about the quarterly progression of net sales, Q1 is expected to represent the low point of the year from a growth perspective, largely reflecting timing and lapping dynamics. We expect net sales growth to build in Q2 and continue to strengthen through Q3.

From a profitability standpoint, we expect to deliver another year of meaningful expansion in 2026. We anticipate full year 2026 adjusted EBITDA margin in the range of 6.6% to 6.8% or approximately 100 basis points of year-over-year expansion at the midpoint.

Based on our guidance ranges, we expect to deliver adjusted EBITDA of approximately $900 million to over $930 million with growth to once again outpace net sales growth by approximately 3x in 2026.

Let me provide some perspective on how margins are expected to progress through the year. The composition of adjusted EBITDA margin expansion in fiscal year 2026 is expected to shift relative to 2025. We expect a larger share of our EBITDA margin expansion to come from operating leverage, reflecting structural improvements within SG&A and modest leverage in A&M with gross margin continuing to expand year-over-year, though at a more moderate pace than in 2025.

Turning to gross margin. As a reminder, in 2025, gross margin peaked in the second quarter due to the timing of certain initiatives in the business. In 2026, we expect quarter-over-quarter gross margin pacing to be more in line with our historical performance as observed in prior years.

Turning to SG&A and advertising and marketing, we expect to deliver SG&A leverage in 2026 with SG&A as a percentage of net sales broadly consistent throughout the year. We also expect advertising and marketing expense to follow a similar sequential quarterly progression as what you observed in 2025. And finally, we anticipate a sequential moderation in Q4 margins consistent with typical seasonality and the timing of promotional activity as observed in prior years.

Now turning to the first quarter. We expect Q1 2026 net sales of between $3.33 billion and $3.36 billion or approximately 7% to 8% year-over-year growth, which as previously mentioned, we expect to represent the low point of the year. Additionally, quarterly net sales contribution from SmartEquine is expected to be broadly consistent throughout the year. We also expect first quarter adjusted diluted earnings per share in the range of $0.40 to $0.45.

And finally, to provide additional color on other line items for the full year 2026, we expect share-based compensation expense, including related taxes, to be broadly flat compared to 2025. Weighted average diluted shares outstanding of approximately 425 million. We also expect 2026 net interest income of approximately $10 million to $15 million and our effective tax rate to be in the range of 20% to 22%.

In closing, I'd like to thank all of our Chewy team members for their disciplined execution in 2025. As we look ahead, we remain confident in our strategy and in our ability to deliver continued share gaining growth, expanding margins and strong cash generation. We believe the momentum in the business positions us well to deliver another successful year of profitable growth in 2026. We look forward to updating you on our progress in the quarters ahead.

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

[Operator Instructions] Your first question comes from the line of Mark Mahaney with Evercore ISI.

Two questions, please. One on this A&M leverage going forward. Just talk about where you think that can go. The biggest drivers of that going forward? Is your such a heavily subscription Autoship type model, you think that you're showing leverage, you should be able to continue to show leverage, I would imagine, for the next couple of years, any thoughts on when we could break below 6%?

And then, Sumit, could you talk a little bit about the Chewy Made strategy a little bit more, the impetus behind that? And what do you think the financial so what of that will be? Do you think that -- is that more of a kind of a -- with lower -- you mentioned some lower price points. Is that kind of more of a TAM expander? Or is it something that could just expand NSPAC per customer?

I'll take them one by one. So on the first one, yes, we expect to show A&M leverage going forward. I will refrain from commenting as to what the extent will be on an annual basis. I'll take you back to our long-range plan that we communicated or the targets that we communicated at December 2023. If you recall from that point, we're essentially running ahead of our profit targets at this point. So we've got roughly 350 basis points to go to hit the 10%, and then we start the journey of moving beyond the 10% EBITDA.

If you look at the remaining left to go, we believe roughly half or a little bit less than half will come from gross margin and the rest will come from SG&A and marketing. And so we believe at our levels, spending somewhere in the 6%, 6.5% is reasonable in the near term. And then as our brand continues to build even further with the CVCs that we're putting in ground or the upper funnel connections that we're making that is giving us really good leverage, plus the way that the app, the mobile app strategy is essentially progressing. We do believe we're shifting the mix from third-party mixes to direct mixes quite effectively and that strategy should essentially continue to fuel the leverage that we're talking about.

Now the second question, Chewy Made strategy. So if you -- again, I'll take you back to the high-level view of the forest first. So we believe private brands should be mid-teens level -- low to mid-teens level penetration of net sales for Chewy. At that scale, we expect private brands to be roughly 500 basis points higher gross margin than the base business. And so this essentially is a step in that direction because today, we're sitting at, I would say, low to mid-single digits of penetration of net sales. And especially when you look at our penetration, we are penetrated quite reasonably well on the hard goods side. So on supplies, we're mid-teens to high teens level penetration. And therefore, the opportunity staring us in the face is on the consumables side.

Now it also happens that consumables is the largest TAM. Of the $90 billion food and supplies TAM, consumables is about $50 billion to $60 billion of that. So for us, the way that we are bringing forward assortment, it allows us to fill in gaps in assortment at the high end. So you saw that with the launch of Fresh Food that is a very high NSPAC compounder. We're also looking at value offerings across the surface and going, okay, where can we inject strategically utilize the power of a scaled e-com network to be able to lower our cost to serve and deliver those price points effectively without really sacrificing margins along the way. And so in that way, it becomes a margin boost for us.

So for us, this will ebb and flow relative to the assortment that we bring to life, but we're filling in assortment, both in dog. In cat, we've been, I would say, anemic in the past. And so you've seen me talk about two new assortment categories in cat this time around. We'll continue to keep you updated, but we're excited about where we go from here.

Your next question comes from the line of Eric Sheridan with Goldman Sachs.

Maybe building on Mark's question and, Sumit, some of your earlier comments on the call on AI. Can you identify some of the key areas in the cost structure of the business where you believe the application of AI can earn outsized returns in terms of efficiency gains?

And then the second part of the question would be philosophically, how do you think about letting some of those efficiency gains continue to drop to the bottom line and accelerate your pathway to a higher margin framework or the philosophical balance would be reinvesting some of those back into the business to [ incent ] growth and producing a more sort of linear or managed margin progression for the business?

Eric, there's a lot in that second question. Let's start from the first one, which is a really good one. So as mentioned in the prepared remarks, we're applying AI across a number of areas in the business, right? And so I'll stay away from the future applications that we're developing that will increase search relevance and discoverability. So we'll talk about that as 2026 moves forward. What we are already deploying in the business is applications and agents that we are starting to use across customer service, across fulfillment, across pharmacy, marketing operations and general marketing areas for campaign optimization, creative optimization, so forth and so on.

So if you start from customer care, I'll stay away from specific road maps and specific projects for sake of kind of competitive outlays. But you should think about these applications that allows us to essentially reduce handle times, improve on the ability for us to self-serve customers that then drives reduced contact rates, which then directly leads to lowering of costs.

So an example would be earlier, roughly 8 weeks ago, we've essentially launched refunds and returns in a self-service manner and the engagement and the success rate that we are viewing in that particular launch is quite impressive. And so that becomes very encouraging for us. We also recognize that there is a cohort of customers out there that will continue to grow that are much more propense towards self-service and digitize use of platforms in the way that they demand service from platforms. And so we will extend ourselves in the use cases that we go offer to them.

Internally, we're developing applications for agents that allows them to extract information and deliver coherent consistent level of service with a reduced amount of effort but also then improves the agent experience. So it improves our retention and quality that the agents essentially provide to customers but it also concurrently reduces our cost structure given that input metrics like average handle times and contact rates essentially decrease as a combination of those two, right?

On the health spectrum, we're using a lot of computer vision in our FCs. We're using AI to be able to be able to codify our -- the way the scripts are being read, the scripts are being processed, et cetera, et cetera. Happy to go into details when we do a one-on-one. But essentially, we're quite bullish in the way that we're going to use these applications in the near to medium term.

Now over the long term, we believe we're a pretty good case for when humanoids essentially come to life, right? So today, we're not going to talk about that. But if you look at the fulfillment space in the world, 60% of your variable cost essentially is spent in picking and packing. And so if you can build relevant solutions in the future to bring to life in these fulfillment areas, you can drive dramatic productivity alongside kind of the human -- without losing the human element that we're so good at delivering to the market. So that's sort of our medium -- near, medium and long-term thinking.

Now your second question is how do we manage this? I will take you back to our broad aspirations of how we manage growth, profitability and free cash flow. We want to grow revenue to be between high single-digit and low double-digit percentage points. The composition of that revenue will remain with net adds growing and NSPAC growing. We want to also deliver 100 basis points of margin expansion on an average and so you can see that this print sets us up for a high-quality durable performance, not just in '26, but also '27, right? At midpoint, we're delivering 100 and we're set up to perhaps exceed that relative to how the performance comes in for the rest of the year.

Now we also want to convert at least 80% of that profitability into free cash flow. And so we're not just going for one or the other. I think we want to deliver a trifecta of growth, increased profitability that builds durably on top of previous year's performance and then accumulating or compounding free cash flow that we can deploy to reinvest in high ROI opportunities but also to return cash to shareholders.

Your next question comes from the line of Doug Anmuth with JPMorgan.

One for Sumit and one for Chris. Sumit, you talked about Agentic as incremental demand and distribution channel. I just want to get your latest views here and how you'll implement Agentic on your own platform for customers. And I think you're more insulated just given the 84% of the revenue coming from Autoship customers.

And then, Chris, can you just talk about fuel costs, some of the impact that you may be seeing in real time and how we should think about that in context of the '26 outlook?

So I agree with your thoughts. If you're selling a commodity, I think the disintermediation issue is likely one that needs paying attention. But from that point of view, we believe Chewy is quite well insulated, given our value proposition is not primarily search aggregation and because our customer relationship is not primarily built around onetime discovery. So we have continued to view ourselves and are more and more seen as a trusted recurring service-rich pet care platform. So in categories like food, pharmacy, broader health care, the customer is often not asking where to buy, they're asking for a seamless dependable experience that consistently meets their needs and that essentially plays to our strengths.

So now in terms of how we think about Agentic developments, we essentially believe that these developments may over time, perhaps shape the interface of where the consumer is interacting, but it doesn't necessarily change who wins the order. And that's where our focus is, right, in making sure that Chewy remains the most trusted and convenient platform behind that transaction, whether it's through an owned experience or through future integrations, right, that we are also pursuing amongst others, and we are leading with many of these partners out there, right, that make our assortment, service and capabilities easy to access. So in that way, we see it as an opportunity.

So broadly, we think the right strategy is to be present wherever pet parents choose to engage, including emerging Agentic Commerce interfaces because those platforms in our opinion can expand discovery and put Chewy in front of a much larger pool of high-intent users.

And so for us, success is not just showing up. It's to make sure that behind the transaction, our assortment, service, health care capabilities and recurring relationships are durably integrated. And we have quite high confidence in being able to do that.

Now another thing that I've heard is, will that impact sponsored ads business? Like that's another question that I've gotten, so I'll just kind of proactively hit that. And there, again, I believe that Chewy's retail media proposition is differentiated, because it is highly tied to an engaged pet audience, strong first-party data, recurring purchase behavior and closed-loop conversation. So said otherwise, right, our ad proposition is not just we have page views, it is that we have a very high intentful pet audience, strong first-party data, recurring behavior and the closed-loop attribution that I talked about right?

So if you look at us, we convert a large portion of ad attributed purchases directly to Autoship orders because that's how our ad model is built. And so then we combine that with on-site and off-site formats increasingly tied together through Chewy data. So it continues to give suppliers a very strong reason to advertise with Chewy even if Agentic interfaces grow because we sit close to that conversion repeat behavior, right? So that's kind of my point of view externally.

Internally, I've talked about sponsored ads and AI. I talked about creating applications that will allow consumers not only to self-serve, so post-purchase support but also in purchase discoverability and conversion, right, with the use of AI that drives personalization driven by memory we call injection of pet profile data, type to order data that then delivers, right, a highly curated and personalized in-app experience to you as the customer. That's the future that we're headed into. And in our opinion, we're not that far off.

And Doug, on fuel. In the near term, we're relatively well insulated. Given the scale of our Autoship business and the strength of our relationships with key partners, and so our guidance for both Q1 and the full year stands and is what we expect.

Your next question comes from the line of David Bellinger with Mizuho.

Congrats to Chris on the new seat. On the guidance, looking at revenue growth on an organic basis, it's implied about 8% growth at the midpoint and very consistent with 2025. You've got revenue guidance for Q1 a bit lighter than the full year. The organic range may be a full percentage point lower. Can you give us some additional detail on why revenue growth should pick up through the balance of the year? Is there anything unique that's hitting Q1 or something else planned throughout the year that gives you added conviction in this reacceleration?

David, I appreciate that. In Q1, we're not seeing material change in our underlying demand trends. When we look across the business, across customer engagement, retention, overall spend behavior, the trends we see remain stable and consistent with what we've seen over the past several quarters.

From a quarterly perspective, Q1 is simply the lowest point to the growth profile for the year. And we move through the year, we do expect growth to build supported by continued share gains and consistent execution across the business. We have a high level of confidence there because it's really all driven by the core components of our model, which are stable and consistent, right? We're seeing strong customer adds, steady customer adds, strong retention, customers continue to engage more deeply.

And third, we continue to take share in the category, which is growing at a low single-digit rate. So when you put all those together, the stable customer growth, the consistent spend expansion and our ongoing share gains, you get a model that builds in a predictable way. And so we're not relying here on any one driver for the Q2 to Q3 growth. It's really broad-based execution across the business and so that's what gives us the confidence in that ramp and delivering on our full year outlook.

Got it. And then just one follow-up on the EBITDA margin guidance, about 100 basis points of expansion. Can you help us understand the lapping of any onetime like or non-repeatable items that hit the P&L in 2025? You had the Chewy+ investments in the back half, also the Get Real launch, some front-loaded SG&A costs ahead of the tariffs. So how much of a benefit on EBITDA or EBITDA margin is assumed in 2026 as you lap these? And are there any other offsets we should consider any flexibility around further reinvestment in the business?

Yes. If you remember correctly, David, we talked about particularly in the back half of the year last year, it was a low single-digit million investment number. And so they're not material onetime impacts that we're lapping there that drive that 100 basis points. That 100 basis points really is driven by leverage in the model and improvements in the business. And so that's kind of where I would guide you there.

David, just to elaborate on that, if you recall the number, we've given a guidance of somewhere around $18 million to $20 million as what we had expected to spend. And on the Q3 call, we said we're on track to spending roughly half of that. So that was about $10 million or so. And ultimately, as Chris said, we spent kind of mid -- low to mid-single digits in revenue because we were keeping some to see if we want to invest in pricing as Q4 played through. So that -- we gave that we were keeping some to see if we wanted to accelerate the fresh demand if the demand didn't come in as per our expectations. And then the third one was we were sort of navigating Chewy+. But we were pleased with the level of efficiency that we saw there. So it's low to mid-single-digit millions.

And then on the SG&A, the [ Dallas ] and the inventory impact was also $2 million to $4 million. So that's how you should size it.

Your next question comes from the line of Steve Forbes with Guggenheim.

Sumit, given the growth in net adds the last couple of years and I think your initial comments in the prepared remarks about expanding lifetime value, I was wondering if you can maybe revisit and update us on spending trends by cohort, maybe some of those newer customer cohorts? And then what type of growth are you still seeing within your most mature cohorts as we think about building conviction around NSPAC?

So both good questions. So overall, our newer cohorts, '24 and '25 are stronger than '22 and '23 cohorts. They are much more in line with our legacy cohorts. There was this kind of 3-year period where we were sort of staring at the pandemic cohorts sideways to go, really trying to interpret the quality of customers there. But we're cleanly past that. The quality of cohorts that we've been picking up is really good. Repeatable purchase rate remains high. The order rate remains high and NSPAC trending trends to the higher end of the $150 to $200 that we expect customers to spend in the first year.

Now in terms of the oldest cohorts, it's less older cohorts, oldest cohorts. I think we're seeing this across a bunch of cohorts that are interfacing with our value-added services. So whether it's cohorts that are native to the app, cohorts that are native to health, particularly cohorts that are native to CVC, these cohorts are the fastest compounders of NSPAC in the company. That remains true for the fresh platform also when we get customers settled into our Get Real fresh platform, we see NSPAC compounding immediately.

And so our goal is to essentially push customers more and more into these closed-loop ecosystems and accelerate their NSPAC, which we are seeing us do quite successfully. So the larger the number of customers we push into this, the faster NSPAC compounds. The oldest cohorts have continued to progress well and sound, but I felt I would give you a bit of a broader context as to why we should be excited about the durability of this in the future.

That's helpful. And then maybe just a quick follow-up regarding Chewy+ penetration. I think you commented on low single-digit penetration by year-end 2025. Any sort of initial thoughts on what the guidance implies or the expectation around penetration to end 2026, again, once to build conviction.

Yes, yes. So we like Chewy+. We are, I would say, still in a test-and-learn phase. We did achieve the low single-digit penetration that we talked about. Specifically Chewy+ exited at about 4% penetration for 2025. And the reason we're not giving you guidances for Chewy+ is because we want to retain the flexibility to ebb and flow the program to land the incrementality and the spend in the right order, right?

So we like what we are seeing so far. It is compounding NSPAC in the order that we want to. The incrementality ranges that we're observing, we'd like them to be tighter, right? So we're seeing incrementality ranges in a really healthy range, but we would like to see kind of the variability around those incrementality tighten even more around the mean.

And then three, there are a few metrics or KPIs that we need a little more time to accrue before we come share that with you. So one is the retentive nature of Chewy+ cohorts, right? Because Chewy+ cohorts have been developing over the last year or so, [ here in ] the quarter, each sample size is not yet wide enough or large enough for us to be able to study retentive capability independent.

So what I want to be able to come say is that, hey, if we get 10% of Chewy customers into Chewy+, it should have a wide impact on our retention, which should then directly impact our NSPAC. And so that particular equation, the inputs and outputs is what we want to study a bit longer.

Number two, we're also studying the impact of Chewy+ in terms of the efficiency it drives both in terms of promotion, promotional intensity as well as in terms of marketing spend or retargeting spend. And so there's enough out there for us to continue to learn.

And then finally, the program value prop continues to evolve. I mean remember, today, the program has primarily product merchandise tied into it, right? And so we're sort of ebbing and flowing back and forth to go great. Like how are customers perceiving that value? Are we giving too much value? Are we extracting how much value, et cetera, et cetera. So it is natural for us particularly given how impactful this program can be to be optimistic yet prudent in our approach in the way that we progress. So we'll continue to be transparent. At the same time, we'll stay away from providing immediate targets right away.

Your next question comes from the line of Shweta Khajuria with Wolfe Research.

This is Andrew on for Shweta. I want to be click on that customer adds. So look...

Can you speak up a bit? We're having a hard time hearing you.

So I want to double-click on net customer adds. It looks like they came in above expectations in Q4. Basically, to what extent is this being driven by a broader refresh in the pet adoption cycle versus maybe your own efficiency in performance marketing? And then as we look into 2026 guidance and really the cadence, does that sort of embed a slight improvement in household formation over time? Or is it just largely based on getting wallet share through your key initiatives?

So just interpreting your question, I think you had two parts there. It's a little bit hard to hear you, so I'm going to rephrase it back to you. So I think you're asking if there is any pet household formation improvement built into our forecast. The answer is no. We said in our prepared remarks today, we're interpreting the industry as quite stable, and we're not underwriting a rebound or an acceleration in pet household formation metrics. I think that was one part of the answer.

And then the second question you asked was around customer adds came in above expectations in Q4. That was primarily seasonality and primarily the go-to-market that we deploy. It was well within our forecast. So Chris, anything else to comment there?

No, I think that's right. If we missed some of the questions, you were just a bit hard to hear. Happy to follow up in the callbacks and double click.

Your next question is from Anna Andreeva with Piper Sandler.

First, to Sumit on Equine and congrats on closing the acquisition. And recognizing it's still pretty early, but how are you thinking about the growth there for this year? And are you seeing more of an incremental consumer to Chewy? And how is that behavior on the Chewy platform?

And then secondly, on gross margin to Chris, can you talk a little more about the puts and takes? Should we think sponsored ads still the biggest driver for the year followed by the mix shift? And should we think gross margin expansion more levered in the first half? 1Q, I believe, will be lapping, I think, 60 basis points of one-timers from last year.

Anna, I will start with your first question, which was pertaining to the SmartEquine category, I believe, or the SmartEquine acquisition. So overall, this acquisition as we've sized it to about $80 million of top line in our forecast this year. And we like the business. It is a high-quality business of pet health nutraceuticals that essentially the category gross margins are really high. We expect to run this in the plus 35% gross margin ranges in the near future.

But in 2026, what we're focused on is essentially stabilizing the business. So -- and so we don't expect a material contribution from this particular line into the P&L. In fact, we're going to ensure that we take the time to get the business to a high-quality -- I'll say this, we like the high-quality nature of the business in the category, but the business that we've picked up requires a little bit of fixing. And so 2026 is that year.

We don't expect it to take any investments from us, right? But we don't expect it to be materially contributive to the P&L. So our guidance that we provided fully incorporates our excitement and the work that it will take to get this business to its future aspiration.

Where do we see it in the future? We feel or we believe that we can add -- grow this to become a few hundred million dollar category at 35% to 45% gross margin. And so we're quite excited in the way that this plays in the larger health and supplement space, very much synchronous with our overall health strategy. We like the quality of the customers that are engaging with it. We really like the team that essentially has come over with it. They're passionate people, and they're happy at Chewy.

On margin expansion, we remain bullish. As we noted in the call, our long-term margin framework is unchanged. And in 2026, we're going to further expand profitability with the rate of expansion higher than 2025.

We also shared we do expect the composition of EBITDA margin to shift with a larger share from operating leverage. The gross margin will continue to expand year-over-year albeit at a more moderate pace than in 2025. We will continue to see improvement from premium mix and sponsored ads. We do expect sponsored ads impact to taper a bit in 2026. But SG&A leverage further strengthens to deliver the total 100 basis points of your expansion at the midpoint of our adjusted EBITDA guidance.

And on sponsored ads, Anna, the rate of growth of sponsored ads will continue at a really healthy pace. So this is less to do with growth moderation. It is to do with the natural phenomenon that we've been talking about which is as more shifts or mixes into offsite advertisement, right, we would expect a different margin mix to essentially flow through. And so you'll see -- so that is baked into our 2026 guidance.

We have time for one more question, and this question will be coming from the line of Michael McGovern with Bank of America.

Could you just characterize kind of the industry growth backdrop in the low single-digit range relative to where you would kind of expect it on a normalized basis? And if you saw the industry backdrop improve, do you expect that your share gains would also improve and accelerate a bit?

The second part of the question is very easy. The answer is yes. We are not baking in any benefit that we get from the industry. So we're baking in a stable environment, not an accelerating environment. When the industry -- we've continued to say when the industry normalizes, we expect to also improve every metric that we are currently talking about, top line profitability and free cash flow.

On the first one, industry growth backdrop in the low single-digit range versus what is normalized. We would like to see that household formation return to the 1% to 2% level. We would like to see pricing return to roughly 1.5% to 2% normalized in an industry, and we'd like to see overall growth rates get into the mid-single-digit growth rates that essentially are in the forecast for long-term growth of the pet category. That's what we consider normalized.

And can you also just double-click on your health category expectations for 2026. I think in the past, you've talked about your health category is kind of accretive to both growth and margins and close to about 30% of revenue. How is that tracking into 2026?

We continue to be bullish about our place in health, Mike. And the question is sort of really broad, so trying to sort of interpret what might be helpful. But we remain highly bullish. We run at this point a really high-quality ecosystem of products, consumer services as well as B2B services. That has now been complemented with an expanding and high-quality clinic footprint that essentially is providing us layered ecosystem benefits, both to chewy.com and is the highest compounder of NSPAC. So broadly speaking, for health, it is a high-growth, high-margin category, and we expect it to continue to contribute to Chewy for long periods of time to come.

There are no further questions at this time. This concludes today's call. Thank you for attending. You may now disconnect.

Great. Good afternoon, everyone. Thank you so much for joining us. My name is Nathan Feather, I'm Morgan Stanley's small and mid-cap Internet analyst. I'm pleased to be joined today by Sumit Singh, CEO of Chewy. Thanks so much for having here.

Nice to be here. Thank you.

Now before we get in a quick housekeeping anything for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.comresearchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

And with that, let's kick it off. We're now about 2 years since your Investor Day, where you outlined your strategic plans along with long-term financial targets of high single-digit revenue CAGR and 10% or higher adjusted EBITDA margins. How are you progressing towards those long-term targets you outlined?

We believe we are ahead of targets and expectations. It was the first capital markets that we'd hosted. We had a lot of fun doing it. It really gave us a view into what had worked from 2018 or '19 onwards since we've come to the market with an IPO and then what our focus should be over the next 3, 5, 7 years per se. And from all sense of the word, in our opinion, we've exceeded our own internal targets and expectations. So let me break that down.

From a top line point of view, back in '23, it was a pretty tepid year from -- for the market and category overall. And we had sort of said, hey, we want to get growth rate back into the high single-digit to low double-digit or low double-digit growth rates. And so we've clearly been able to do that. And so the difference between the high single digit or low double digit, we'd also assume that the market would normalize by this particular time, so we can get into the industry a little bit more. But barring the industry thing back to sort of pre-COVID levels of health, everything else from an execution point of view has gone really well. So net adds are running ahead of expectations.

We've inflected coming in 2024. We expect that to be sustainable and durable. We've clearly hit the high single-digit growth that we were talking about as a combination of net adds growing, but also share of wallet growing. So we expect share of wallet also to have durability. Underneath it, Autoship has exceeded our internal cash, reaching over 80% of net sales. And then on Capital Markets Day, we'd also said it was sort of our announcement of getting into health clinics or CVC, Chewy Vet Care.

And we had really not a good idea on how to forecast these. We had a pretty good understanding of what it would take to execute something like this. But we were coming to market as a new sort of a novice team. We knew we had the power of the homegrown tech that we were putting behind it and a really high-quality experiential mindset. And on the back of those, we sort of launched first in the first 12 months. We had a target of [ 6% ] to [ 8% ], so we launched [ 8 ]. And that business continues to exceed our expectations. So I'm sure we'll talk about that as well, but we're super bullish about where Chewy Health can go, not just the CVC part of the business, but Chewy Health can go in general over the next 3 to 5 years.

When you look at profitability, I mean clearly, the numbers speak for themselves. We came to market at 3.3% adjusted EBITDA in 2023. And we provided a guidance of improving profitability, roughly 100 or expanding profitability, roughly 100 basis points per year, 15% flow-through or more. We've beat both those expectations. '24 was a really solid year, many things compounding to be able to produce that type of a performance and then '25, despite being characterized as an investment year, we're very close to the average 100 basis points that we've talked about. In fact, averaging the 2 years, where I think sitting somewhere in the 130, 140 basis points of expansion. So we're super pleased.

Sitting here, I would say we have more confidence looking forward than we did in 2023. Our most bullish bets or our most -- our boldest bets are working even better than we had expected. And so that's really a great feeling to have. So all positive.

Well, a lot I want to get into the -- but first, you recently announced Chris Deppe as your new CFO. Help us peak behind the curtain at why the company chose Chris and what he brings to the role.

Yes. So I don't know if you know, I have a supply chain and operations background, 2 degrees in industrial engineering and operations research and then later went to [ Chicago Booth ] and became dumber. But I have a deep respect for what you need to make an e-comm engine. We were then a DTC player in 2017, '18 when I joined Chewy. But the power of delivering empathy at scale, I've often said we are delivering the convenience of e-commerce at the personalized service that you can only expect at your best local neighborhood pet store.

And so to deliver empathy at scale, if you look at the best e-commerce engines out there, they're built on 2 pillars, strong supply chain and operations, strong product and tech. And both of them are powerhouses of ours. So Chris, I knew back from his Amazon days. Chris has been with us now a little less than 5 years. And really, back in 2018, when I've taken the bet of reforming the fulfillment centers to go away from 1G sites to 2G sites, and we were quickly becoming one of the larger DTC players in the country. I'm not sure how many of you know, but we are the third largest DTC player in the country today.

We're a very sophisticated supply chain and operations team. 16 fulfillment centers, 5 pharmacies, multiple compounding sites. We have a lot of infrastructure that is built underneath of it, that is highly efficient and scaled for all practical purposes. To run this big office sophisticated engine, you need a big, sophisticated finance partner. And so back in the day, I reached out and we brought Chris over to Chewy and we were lucky that we were able to have him over at Chewy. And so he's seen this journey over the last few years of how we've built out a really large-scale network.

Then alongside as Dave was exiting a few months ago, we sort of leaned into Chris and said, why don't you take over FP&A and long-range planning for us. And so he's been -- he's had that under his belt for now about 15 months or so. And then 8 months ago, when Dave left, I really leaned into Chris to be able to help me on the business better. And at Chewy, we pride ourselves on being strategic, but also each level of management is -- has an operator owner mindset. So you're going to be able to get a lot of detail out from each of us regardless of the level we operate on.

And having a strong finance partner who had continuity could understand or does understand our strategy really well and is culturally such a strong fit. Candidly, I mean I'm thrilled actually of having Chris at the company, and that's why I used the word that the Board and I were throw when we were actually able to tap into, Chris internally rather than going to seek a new leader externally. That's the background.

Great. Now looking at the broader pet macro, can you give us your latest view on the pet industry and how you think both 2026 pet ownership growth and pricing are going to come in?

Yes. So the -- we -- in Q3 prepared remarks a few months ago, we said, hey, we interpret 2026 to be materially the same as 2025. Let me take a step back and start at the higher level. So when we interpret pet in the United States, we call it $150 billion TAM broken into 3 categories: food and supplies at about $90 billion, held at about $50 billion and the remaining non-health care pet services.

Chewy now with us expanding ourselves into specialty and win a couple of years ago, and expanding into the vet services space, we now fully address the $140 billion TAM out of the $150 million. So we play in nearly all of the TAM. Underneath of it, the market essentially has been growing at low single-digit percentage points over the last couple of years. Most of the growth has come on the back of volume very little in the last 2 years has come on the back of price. And those inputs aren't necessarily expected to change as we go into '26. We were hoping they would.

In '24, we started seeing -- or sorry, coming into '25 out of '24, Q4 '24, we started seeing green shoots where pet adoption was starting to outrun relinquishments. But the rate of outpacing relinquishments is something that we would like to see increase by a few factors. So today, when we compare, again, one of these data points where we're integrated with about 50% of the shelters and rescue community in the United States. So we get a pretty good ground-up data back into us. And shelters and rescues produce a majority of the pets back into the market.

In a normalized environment, you want to see about 10 million to 15 million pets, pardon my choice of words, but getting sort of recycled every year, pets die, pets get adopted. So 10 million to 15 million pets, and I'm talking dogs and cats only. I'm not talking specialty animals, chicken and equine, which by the way, runs in -- equine runs in million. In fact, I don't know if you know, but in equine -- or sorry, chicken is the third most popular pet in the United States. Maybe that's intuitive. It wasn't to us, but there you have it.

So the dog and cat market, household formation is running at roughly in the $2 million to $4 million aggregated positive range, which is great. Because in '23, it was negative $2 million. So clearly, the market is inflecting. But to achieve the $10 million to $12 million, $15 million pet refresh rate that we would like to call normalized, I don't believe we get there in '26. Pricing, we don't see material benefit in pricing in '26. We also don't see -- we see a rational promotional environment in '26. So we don't see discipline coming off the rails in '26.

Dogs are currently running slightly softer than cats. You may have heard this. You may have read about it. Suppliers who we talk to, whether it be Nestle's or [ Mars ] or Hills, [ Rycan into the world ] or the Blue Buffalo, [ General Mills ] of the world. Everybody seems to be essentially coalescing on these data points now.

Underneath of it, you should expect 2 strong trends favoring Chewy. A, the secular tailwind towards e-commerce continues. B, we continue to differentiate ourselves or we continue to extend ourselves outside of squarely the dog and cat segment into segments like equine, specialty animals, health, et cetera. So underneath of it, you should expect us to continue to gain share pretty nicely, I would say, just like you saw in 2025. You should expect us to continue to capture a very healthy percentage of growth that is moving online, both in the retail segments, which are dog food -- dog, cat food supplies as well as the health segments. Overall, we're bullish about '26.

Got it. Let's dive into the P&L here. And starting at the top with customers. We've seen a strong rebound in customer growth over the past 6 quarters. What would you consider a normalized level of net adds? And then what are opportunities that you're pursuing to further increase your share gain here?

Yes. So let me tie this question to the components of the growth algorithm first, and then I will dive deeper into this question. I was talking to you about growth in 2026. We will guide when we come to market on March 25 in our -- on our earnings call. The composition of the growth will primarily be led by volume, that's price. In terms of customer algorithm, you should expect us to continue to expand on net adds, just like we did in '25 and expand on NSPAC. So the combination of net adds and NSPAC will drive growth.

You have now coming to customers. You've seen us add in 2025, expand net adds at the rate of 150,000 to 250,000 customers per quarter. We believe that to be durable and sustainable in a market where we expect no greater tailwind going into 2026. So if you connect that with my original commentary on when the market normalizes, we expect to further increase our net add expansion. If you look at gross ads expansion, pre-pandemic at peak, we were adding 1.4 million to 1.6 million customers. This is pre-pandemic, not pandemic. So I'm normalizing for the pandemic.

So at our peak, you should expect us to add 1.4 million to 1.6 million customers, which was the rate that we were adding pre-pandemic. Currently, you're right, we're adding somewhere in the [ 600,000 ] to 1 million range in a market that is essentially flat. I think that's pretty compelling performance. It showcases the durability as well as the differentiation that we bring to the marketplace against any competitive forces or against any market headwind. We're super proud of that.

Okay. Got it. Well, one of the things you are doing on the customer side is new paid loyalty program Chewy+ seems to be driving improved NSPAC for adopted cohorts. Certainly, it's improved my NSPAC as a customer. Can you help us visualize how big Chewy+ can get as a percentage of revenue? And what's the right way to pace that expansion over the next few years?

For those of you who have studied Chewy and know the management team, you will appreciate we are thoughtful and deliberate and highly disciplined about financial guardrails on one side and customer experience on the other. We gated and pasted sponsored ads very -- in equitable kind of model per se. So Chewy+ is our way of putting another flywheel next to Autoship on purely the product merchandise side, mostly consumables, right? So you didn't really have a compelling hook for customers for supplies or for non-consumable categories or discretionary categories.

Number two, the deeper a retailer penetrates into a category, the more you open yourself up to sort of cross-category compares. Number three, Chewy has so much more to offer than we did in 2018. Instead of us trying to brand every product and go to market from a product marketing point of view, we thought why don't we come up with a paid membership program and test product market fit. So you should imagine or you should envision Chewy+ in its card phasing to be part of that product market for testing. We expect incrementality out of the program at very little capital deployed or very little margin impact for the program. That's our current sort of guardrail.

And this fitting out Chewy+ as to what the sweet spot really is or where it sits, I think it's going to take us a bit. In fact, it took -- if you go back and trace the history of Amazon Prime, it took several years before Prime truly had incrementality data or was able to sort of figure out like, okay, what actually does it do to consumers. We have some positive, very positive signs coming out of Chewy+ in its initial first 4 quarters, I would say. What are those?

It's helping discover choices at Chewy faster. It is helping customers consolidate share of wallet faster. Incrementality is positive. The range of incrementality is wide from low double-digit percentage for high-spend customers to healthy levels of double-digit expansion for low-spend customers. The sweet spot is for us to really drive incrementality for cohorts that sit between $300 to $800.

And so we continue to sort of refine our targeting abilities. We continue to build more value prop into the program without actually having to put dollars on the table. And we've gotten it to the point where it's not materially dilutive to us. And at the same time, we are seeing incrementality come through. Is it material enough to swing our growth rates, right, beyond kind of the tailwinds that we would see from the market? Not yet. We would exit this year exactly where we've guided, just at the low end of the low single-digit penetration. And going into '26, we don't see material profit impact at all out of Chewy+.

Okay. Great. Now one of the areas we've been really stated about is the clinic opportunity. Can you talk to us about your key learnings from clinics you've opened already. One of the biggest pushbacks we received is that the business is simply too small to value. I guess, what are the key steps you have to take to scale that business to a more material level?

Yes. We're happy we're at this point that the questions have turned from show me this works to how fast can you scale. Although we haven't truly shown you this works, but we intend to. So give us -- we're nearing the completion of 18 months to 2 years with our original cohort of April 2024. And that is our time line for us to come and share a whole lot more with you to give you sort of a onetime look under the hood, so you can truly appreciate and get excited -- as excited, perhaps even more relative to why we are so excited.

But let me give you a few data points. So we are viewing success on CVC across a few different dimensions. One is the Net Promoter Score or customer sat and vet satisfaction rates. That also includes our ability to hire and retain events. That is exceeding our expectation. You can open up. We now have 18 in operation, and we've run these over a period of 2 years. It's easier for you to -- it's easier when a product launches, and perhaps you could even throw at me that you launched it in familiar markets.

But to have a 4.8, 4.9 consistent rating on Google reviews, that cannot be influenced by us than is really public rating. NPS is running phenomenally high. So we love kind of the product market fit that we're finding out there and the customer responds to it. Number two, web satisfaction scores are high. Our ability to retain, recruit and retain that continues to run at par, continues to run ahead of where we believe the industry hiring and recruiting time lines are, so we're happy about that. So that is definitely not a bottleneck for us.

Number two, we've guard railed this on the ability to ramp clinic utilization levels. And bounce against marketing spend in the market that we're entering. Both are running ahead of our expectation in the right way. So for example, we are ramping these clinics faster than our internal forecast. And our marketing spend that we had originally forecasted is running lower than what we had originally forecasted. What we're finding is that the Chewy brand overall is so strong, then we go drop a box inside the market. We don't necessarily have to spend localized marketing at the levels that we thought to be able to attract demand into the marketplace.

Number three, financial success. So from a ramp point of view, we've benchmarked ourselves to standard clinics out there, which are $2 million to $3 million in revenue, 4-wall revenue and roughly 15% to 18% EBITDA margins. Currently, we're running ahead of these plans. And so we want to come talk to you about that. We're super excited about how they're ramping and the financial metrics that we're seeing. So basically, across all of our metrics, the scorecard is a bright green.

The final thing I would say is customer incrementality, which was a thesis that we had, but there was really no way of putting numbers behind it. There is some market research that we've conducted. So this is something you've heard. 4 out of 10 customers are net new to Chewy that has maintained. In fact, that number is higher in certain markets than others. So at a minimum 4 out of 10 customers are net new to Chewy. Half the customers within a very short period of time are attaching themselves to other categories on chewy.com, pharmacy, supplements, food in that order. And CVC currently is the fastest NSPAC compounder inside the company to a scale that we believe is very impressive. So to us, when we come back and share with you greater details in April, that's the time line we've set for ourselves. We want to be able to set a path for how we think about expansion on Chewy+.

Let me give you the framework. We will deploy both capital and capital-light models to be able to our asset-light models to be able to scale a network of clinics. In the investment portfolio, you're looking at us build right now 8 to 10, 10 to 12 clinics per year. That may go up some, but not materially. We will also continue to -- we are in the market continuing to look at very specific curated culture forward, tech forward acquisition opportunities or integration opportunities or strategic business opportunities, which I look forward to talking to you about in the near future. And then next to it, as you know, we build our own technology.

So currently, Chewy -- CVCs run Chewy Tech. Chewy Tech is more efficient. Why? Because an average clinic out there. So why do we believe our margins are going to be better. This is 1 data point. An average clinic out there runs on 8 different software integrations. We run on one, which is [ Chewy Tech ]. And so for us to be able to have that efficient attack alongside a better experience allows us to build a moat that is much more attractive than any mousetrap you've seen in the marketplace.

When we take this software stack and come to market alongside the Chewy brand name, we believe we're going to be able to create affiliates using an asset-light model that will really help tie in the ecosystem and scale profitability at an even greater rate on different types of revenue models. So hopefully, that's helpful, but we're super excited about CVC.

Very helpful. And looking forward to learning more in April. Now on the sub side, one of the things you haven't been as vocal about is AI. And so can you help us think through what are the most underappreciated opportunities for Chewy in your view and the most underappreciated challenge.

I love it. Most companies are going to get AI incorrect or they're going to get off course in my opinion in the near term. The reason is that for AI to work, you really have to build AI use cases and solutions on top of strong data sets and a really fundamentally sound infrastructure. Given that we are [ 1P ], so you should know something about the [ Chewy Stack ] for those of you who are who appreciate tech literacy.

So we are built on a completely services-oriented architecture. For a company of this scale and size, we run roughly 450 microservices that essentially are tied with a really nimble cloud engineering team, right, where we are dual sourced in the cloud. And from a data point of view, we now have our data consolidated at the enterprise level across 1 main platform rather than multiple platforms, right? Very soon in the near future, we're going to have certified data lakes and layers that are essentially going to allow us to unify data signals. So if you go to chewy.com today, our experience in the app is much better than it used to be a year or 2 ago, right? Two years ago, I couldn't even recognize whether you are a dog customer or a cat customer. That's how basic we were.

Today, not only do I ingest your pet profiles, I am able to connect your pet profile data to my order engine and put that through my discoverability and my search algorithms. In the future, we're going to be able to unify signals that come from other pet parents and essentially go to market with you or allow you to be able to use us as a fully full pet [ concierge ]. But let me kind of back up because I'm painting you the future. Let me talk about what we're doing now so that you can sort of not just say, okay, we'll see when that works.

So AI is going to be implemented in 3 places at Chewy. We've already started that. Let me break that out for you. The purchase experience, which I'm sure we'll talk about all of the latest sort of news that you're hearing about disruptions and agentic commerce and all of that stuff. I'll come to that at the end. Number two, the middle layers of the company, the service layers of the company. So whether that's workflows, inside functions or whether that's customer care going out and meeting customers. I will refer to this as the middle service layer. And then finally, supply chain and fulfillment. Yes. That's the way to understand an engine like Chewy.

When we talk to you about the plan for 2026, you should expect us to talk to you about how we're deploying AI across our pharmacies, across our fulfillment centers. to be able to provide leverage that wasn't picked in our original 2023 Capital Markets Day business cases, right? We gave you a target of reaching OpEx, 17% to 19%. And right? We have visibility with the use of AI across our middle layers and our supply chain and fulfillment to be able to exceed right, those long-range targets that we've provided to you. And the impact will start -- we will start showing you the impact in 2026.

Now coming to the purchase side of the funnel. First of all, I will loudly reject this notion that we are exposed or are at risk of disintermediation from any agentic activity that is happening out there. In fact, quite the opposite. Not only do we feel we are really well insulated, we actually believe this is going to serve as an incremental channel to Chewy. So -- why are we well insulated? So agented commerce protocols are essentially going to integrate the most basic available signals before they turn into having recall and context of customer shopping. That's great, right? It doesn't disrupt empathy at scale or kindness at scale, which is sort of the main moat that we're built on.

Chewy getting disrupted on tenants of price or selection, I mean those days are far behind us. That has been tested over and over again against the fact that we've been playing stalwarts like Amazon and Walmart over the last 5 years and have continued to gain share and differentiate ourselves. So that differentiation is durable. The moat is very durable. Underneath of it, on a pricing purely pricing side. So if this notion is, hey, there's an agent out there that will price compare and you essentially -- the user will directly buy from whichever the best place is, right? We welcome that.

Because on a weighted price index point of view, we are still positioned 5% to 7% cheaper than retail or independent channels. And by the way, we have yet to lose on price on any large [ skid ] e-com player. And so pricing is just not a tool that competition will be based on. In fact, we are -- we were one of the first layers to come out into the market. So you heard about retailers like Wayfair and Etsy and so forth. We are also integrated with Google's UCP, it's a commerce protocol. So we're leading some of the use cases that they're coming out to market with. We have an agentic team internally that is essentially building AI forward solutions with all of the AI native company that you're hearing about.

So to us, we will essentially find ourselves where customers are. And this will open up a net new channel. The analogy is similar to when TikTok came to market. And in fact, it led Facebook and YouTube to launch reels and shorts. And clearly, they are more valuable companies today than they were prior to that product being in the marketplace. These are incrementally new channels. They'll find new users, younger generations that will essentially perhaps shop, but we'll be right there with them. And don't forget, there's a whole post-purchase experience that needs to be delivered. And we have categories like health that are very hard to disintermediate. We will continue to be bigger in physical spaces that are very hard to disintermediate. So we're not worried about this.

Okay. Great. Well, let's flip below the line. You made a host of investments in 2025. Well, still deliver in a margin expansion. As we enter 2026, you said in the last earnings call, you expect the balance of investment to shift towards operating leverage. I guess, given that, how should we think about margin expansion levers in 2026 versus 2025?

Yes. So 2020 -- just to recap 2025, we have guided to EBITDA margins of 5.6% to 5.7%, 5.65% at the midpoint. That's an 85 basis point expansion. At the high end, that's a 90 basis point expansion. Profits will flow through at 3x the rate of revenue or profits will grow at 3x the rate of revenue. As you go into 2026, I will leave you with a few things. A, the rate of EBITDA margin expansion, our expectation is that it will exceed 2025.

Number two, profit flow-through will happen at a minimum at 18%, right? Number three, profits will continue to exceed -- the rate of profit growth will continue to exceed revenue growth by a significant margin, right, just like 2025. The composition of profitability, as we had guided or in my prepared remarks in Q3, this is now coming directly to your question.

We believe the composition of profitability. So in 2025, we said to you a majority of the profits will be driven by gross margin, right, followed by SG&A. In 2026, we believe the algorithm will be reversed, right? We believe we will continue to give you gross profit expansion, but the majority of the EBITDA that you will see or the expansion that you will see is due to healthy levels of SG&A expansion. Some part of that is because we don't have [ Houston ] fulfillment center, as we've been talking about starting from the Q2 earnings call, right, that it will start delivering leverage in Q3 and Q4 of this year. So you should expect it to deliver more leverage next year.

Keep in mind that every fulfillment center that we launched, the fully automated fulfillment center, you should expect it to give you roughly 25 to 30 basis points of leverage at the SG&A level. And '26, we will have Houston ramp up to provide a nice bit of that leverage. I talked about some part of AI solutions that we are putting in across our customer care teams across our full centers. You should see the expect of that starting to come through.

In 2025, we took some tactical investments, right, in the low to mid-single-digit million right, around buying up a feel like inventory or some Dallas, the curve that we were managing as Houston was ramping and Dallas was nailing down, shouldn't expect a repeat of that. And broadly speaking, outside of strategic deployment in continuing to build a really -- and transparently build the network of CVC. We will continue to focus on running the business as efficiently as we possibly can. So overall, we're quite bullish about going into 2026.

Okay. Great. Well, one last thing. Can you leave us with 1 or 2 aspects of the business you feel are most misunderstood or underappreciated by investors?

Yes. Yes. I think we're one of the more consistent deliveries of result and consistent growers of top line and incremental profitability. We should expect to continue to see about 80% or more of that profit converted into free cash flow. We have no debt. It's a fairly -- it's a very disciplined team. I think power of Chewy held as a compounder of financial metrics, I think is still not well understood.

I think the differentiable and durable moat that we go to market with is perhaps also not as well appreciated as it should be. We run one of the largest scale fulfillment networks, world-class fulfillment, backed by 80% plus of our revenue coming through quasi subscription type products like Autoship. We run the #1 pet pharmacy in the country in terms of scale, and we continue to diversify and strengthen our moats by penetrating deeper into categories like health.

And yes, so the durability and the heart that we go to market with and the lifelong relationships that we formed with customers. I think I'm not sure if all of that is well understood. But '26 gives us another chance, and we're looking forward to doing so.

Okay. Great. Sumit, thank you so much for being here.

Yes. Thank you.

Hello, and welcome to the Chewy Third Quarter 2025 Earnings Call. My name is Emily, and I will be coordinating your call today. [Operator Instructions] I will now hand over to our host, Natalie Nowak, to begin. Please go ahead.

Thank you for joining us on the call today to discuss our third quarter results for fiscal year 2025. Joining me today are Chewy's CEO, Sumit Singh; Will Billings, our Chief Accounting Officer and Interim Principal Financial Officer; and [ Chris Depee ], our Head of Commercial Finance and FP&A. Our earnings release, which was filed with the SEC earlier today, has been posted to the Investor Relations section of our website. In addition to the earnings release, a presentation summarizing our results is also available on our website at investor.chewy.com. .

On our call today, we will be making forward-looking statements, including statements concerning Chewy's financial results and performance, industry trends, strategic initiatives share repurchase program and the environment in which we operate. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks, uncertainties and other factors that could cause actual results to differ materially really from our forward-looking statements.

We encourage you to review our SEC filings, including the section titled Risk Factors in our most recent Form 10-K for a discussion of these risks. Reported results should not be considered an indication of future performance. Also, note that the forward-looking statements on this call are based on information available to us as of today's date. We assume no obligation to update any forward-looking statements, except as required by law. Also, during this call, we will discuss certain non-GAAP financial measures. Reconciliations of these non-GAAP items to the most directly comparable GAAP financial measures are provided on our Investor Relations website. A replay of the audio webcast will also be available on our Investor Relations website shortly. And with that, I'd like to turn the call over to Sumit.

Thanks, Natalie, and good morning, everyone. Chewy continues to outperform the pet category and expand market share with profits once again growing faster than sales. We are delivering consistent year-over-year profitability gains and remain firmly on track toward our long-term objective of 10% adjusted EBITDA margin.

Q3 results build on the momentum from the first half of fiscal 2025 and highlight the structural resilience of our model as well as the efforts and execution quality of every team member at Chewy. We exceeded the high end of our net sales guidance, expanded margins and accelerated free cash flow generation. Let's get into the details.

First, our financial and customer performance. Q3 net sales grew over 8% year-over-year to $3.12 billion, primarily driven by unit volume growth, not price. Growth in Autoship customer sales outpaced total company growth increasing 13.6% to $2.61 billion. As we have discussed before, Autoship revenues are highly predictable and allow operational planning to reduce cost and grow margin in a way that gives Chewy unique structural competitive advantages. We ended Q3 with 21.2 million active customers, up nearly 5% year-over-year and delivered improvements across every part of the active customer funnel.

Marketing efficiency continues to strengthen as we deploy spend with greater precision, attracting high-quality customers, driving stronger conversion and improving LTV to CAC ratios. Enhanced mobile app functionality is lifting direct traffic with app customers and app orders up approximately 15% year-over-year. These improvements supported marketing leverage in the quarter while enabling year-over-year growth in both new customers and reactivations alongside lower churn. Net sales per active customer reached $595, up nearly 5% year-over-year.

Now let's review profitability and free cash flow. After which, I will comment on some of our ongoing initiatives. Gross margin expanded roughly 50 basis points year-over-year to 29.8%, driven by sponsored ad growth, a strong Autoship baseline and favorable category mix. We believe that these gains will structurally enhance our margins going forward. Adjusted EBITDA reached $181 million, up 30% year-over-year. Adjusted EBITDA margin reached 5.8%, representing 100 basis points of year-over-year expansion and flow-through of about 18%. Margin gains reflect strong gross margin execution disciplined SG&A management and continued efficiency in advertising and marketing. And finally, we generated approximately $176 million of free cash flow in the quarter up nearly $70 million sequentially. Our profitability and cash generation enabled us to repurchase $55 million of shares, while self-funding strategic investments that position Chewy for durable long-term value creation.

Now I would like to provide an update on some of Chewy's ongoing initiatives, starting with Chewy's health offerings. Chewy Vet Care or CVC, continues to exceed expectations, driving strong utilization, supporting ecosystem engagement and strengthening customer loyalty through recurring high-margin services. Each clinic acts as both an acquisition channel and a retention driver supporting deeper Autoship and health program participation. We have opened two additional CVC practices since our last earnings call including our first one in Phoenix, bringing our total to 14 locations across five states. Two more clinics are opening soon keeping us on track with our previously stated plan to open 8 to 10 locations this fiscal year.

Staying on the topic of Chewy's health offerings, on October 30, we announced the acquisition of [ Smart Equine ] a leading [ Equine ] Health brand with strong loyalty and repeat purchase behavior. The transaction is expected to be accretive to adjusted EBITDA margins upon closing. [ Smart Equine ] enhances Chewy's premium health and [ nutraceutical ] assortment and strengthens our position in high-value wellness categories.

By layering its premium assortment over Chewy's network and scale, we see significant opportunity to enhance our health and wellness mix and expand both net sales within this category as well as margins. Our paid membership program, Chewy+, continues to outperform our expectations, driving higher order frequency, broader category engagement, higher mobile app adoption and stronger auto ship participation. After launching at an introductory price of $49 per year with a 30-day free trial, we raised the annual fee to $79 at the end of October.

Early data shows continued growth and strong conversion from free to paid memberships. Paid Chewy+ members are already delivering gross margins in line with the overall enterprise and with higher pricing in place, we remain confident in the program's growth and margin potential. I would now like to turn the call over to Will for a detailed recap of our results and guidance. After which, I will make some final closing remarks about 2026 and Chewy's future. Will?

Thank you, Sumit. Third quarter net sales grew 8.3% year-over-year to $3.12 billion, above the high end of our Q3 guidance range. Gross margin expanded approximately 50 basis points to 29.8%. Q3 SG&A, excluding share-based compensation and related taxes, was $588.6 million or 18.9% of net sales and includes approximately $2.7 million of onetime transaction costs primarily related to the pending [ Smart Equine ] acquisition. Excluding SBC and these onetime costs, we delivered SG&A leverage of 20 basis points year-over-year. Consistent with our expectations, we returned to SG&A leverage as our newest automated facility in Houston scaled and as we cycle past certain transitory costs related to the Dallas FC and inventory pull forward.

Advertising and marketing expense was $197.9 million or 6.3% of net sales, reflecting about 40 basis points of year-over-year leverage. As Sumit noted, this leverage is driven by higher productivity of spend, not reduced investments. We are attracting high-quality customers and are quickly converting them into Autoship, Chewy+ and health programs, which deepens loyalty and increases lifetime value. These efficiencies reflect more discipline, allocation of marketing dollars and stronger flywheel effects that we expect to build as we scale.

Q3 adjusted net income was $135.7 million, up 59.6% year-over-year and adjusted diluted earnings per share of $0.32, landed near the high end of our prior guidance range. Third quarter adjusted EBITDA was $180.9 million, representing a 5.8% adjusted EBITDA margin, up 100 basis points year-over-year and adjusted EBITDA flow-through of 17.9%. Free cash flow for the quarter was $175.8 million, driven by $207.9 million of cash from operating activities and $32.1 million of capital expenditures.

For full year 2025, we continue to expect to convert approximately 80% of adjusted EBITDA to free cash flow. In addition, based on year-to-date performance, we now expect 2025 capital expenditures to come in around 1.3% of net sales, below the low end of our prior target range of 1.5% to 2% of net sales.

During the quarter, we repurchased approximately 1.5 million shares for $55 million. We ended Q3 with $304.9 million of remaining authorization under our existing repurchase program. We closed the quarter with approximately $675 million in cash and cash equivalents, remain debt-free and had total liquidity of approximately $1.5 billion.

Turning to guidance. Recall that in Q2, we raised our full year net sales guidance by $175 million at the midpoint, reflecting our bullishness to outperform a market which is expected to grow low single digits in FY 2025. Today, we are narrowing our full year 2025 net sales outlook to between $12.58 billion and $12.6 billion, or approximately 8% year-over-year growth when adjusted to exclude the impact of the 53rd week in fiscal year 2024, with even greater confidence in our ability to deliver incremental margins. We are also narrowing our full year 2025 adjusted EBITDA margin outlook [ to 5.6% to 5.7% ] or approximately 90 basis points of adjusted EBITDA margin expansion at the midpoint year-over-year. Consistent with our comments last quarter, we expect approximately 60% of our adjusted EBITDA margin expansion to be driven by improvements in gross margin.

We expect fourth quarter 2025 net sales of between $3.24 billion and $3.26 billion or approximately 7% to 8% on year-over-year growth when adjusted to exclude the impact of the 14th week in Q4 of fiscal year 2024. Our fourth quarter guidance takes into account the strong year-over-year comps of approximately 7% net sales growth in the fourth quarter of last year.

We also expect Q4 adjusted diluted earnings per share in the range of $0.24 to $0.27. The which includes an estimated $10 million of closing costs related to the pending acquisition of [ Smart Equine ].

And finally, given our performance in the first 3 quarters of the year, we now expect advertising and marketing expense to come in at approximately 6.5% to 6.6% of net sales for the full year.

For the full year, we are also expecting share-based compensation expense, including related taxes of approximately $315 million and weighted average diluted shares outstanding of approximately $430 million. We now expect 2025 net interest income of approximately $15 million to $20 million. And lastly, we expect our effective tax rate to be between 16% to 18% for 2025. The I would now like to turn the call back to Sumit for some closing remarks.

Thanks, Will. Before we take your questions, I would like to make a few important remarks. First, on Chewy's margin expansion and its path cadence and durability as we head into 2026. Chewy has an unmatched position in a uniquely attractive industry. In chewy.com, we have the leading sales engine in our industry, evidenced by the 84% of our sales on Autoship layered on top of a built-out world-class fulfillment network. The best-in-class consumer satisfaction that results from this combination leads customers to trust us with ever-increasing levels of business. As you can see from the growth of our pharmacy business, and our multiyear steadily rising NASDAQ.

Q3 shows the result. We delivered both revenue growth and margin expansion even as we made high-return targeted investments in the business. Gross margins continue to expand on a structural basis, supported by sponsored ads, category mix and a growing health ecosystem. SG&A leverage is returning as automated facilities scale and as we cycle through transitory costs. And marketing is becoming more efficient as we increase direct share of traffic and grow our business inside the mobile app. And to be clear, we grew at approximately twice the market rate, taking share again without pricing below inflation or sacrificing margin.

In 2026, we intend to press these competitive advantages and continue our pursuit of scalable self-funding initiatives that simultaneously enhance profitability. While we will always prioritize disciplined customer-centric growth, our unique flywheel-like operating model gives us high confidence in our ability to deliver consistent durable EBITDA expansion over the next several years. Our long-term framework is unchanged, and the underlying engines that drive margin expansion are strengthening. We remain firmly on track towards the long-term margin profile of 10% adjusted EBITDA that we outlined at Investor Day.

Turning to investment levels into 2026 and beyond. What is temporary versus structural? We are highly disciplined in how we deploy capital. A number of the cost impacts you have seen in recent quarters, such as inventory pull forward one-time launch expenses within fresh food, for instance, and early stage Chewy+ incentives are all temporary by design. Our structural investments include automation and health services. And all investments have clear ROI thresholds and measurable payback periods.

As we move into 2026 and as we press our unique competitive advantages, we expect the balance of investment to shift towards operating leverage. The framework is simple. Invest where returns are compelling and durable moderate spend where benefits have been captured and drive leverage using our scale across the platform. We look forward to wrapping up 2025 from a position of strength and to a successful 2026. With that, we will now take your questions.

[Operator Instructions] our first question today comes from Eric Sheridan with Goldman Sachs.

Maybe two, if I can. Curious as the team continues to scale offerings like Autoship and Chewy+ how you continue to evolve your learnings about the lifetime value of customers on the platform. And the second part of the question would be how does those learnings feed back into your strategic initiatives in support of growth given the commentary right there towards the end of the call can submit on some of your priorities over the next 12 to 18 months.

The way -- first of all, it's a broad question. So I'll try not to ramble and give you some frameworks on how we're thinking about this and why we believe these sort of build on top of each other. Like an intersecting one diagram, there's a strong intersection and strong complementarity between the programs.

So I want you to visualize three sort of flywheels, the Autoship, Chewy+, CVC. And I want you to then imagine all of these built onto a closed-loop, highly personalized app mobile app. And so as you envision that these are separate programs that essentially compound NSPAC curves, increased retention, cohort retention, reduced churn and drive both top line as well as greater efficiency in the way that we deliver profitability.

Autoship is a rinse-and-repeat product merchandise program that has high reliability and accuracy both in terms of planning, in terms of delivery and high satisfaction rating. Chewy+ is a program that is designed to accelerate the process of discoverability of multiple offerings at Chewy beyond consumables and health, which are sort of top discoverable categories. And in addition to accelerating discovery, it is meant to accelerate NSPAC consolidation. Chewy+ Autoship is applicable to the entire cohort of customers that Chewy. Chewy+ is more propense in our intention to grow NSPAC for customers that spend somewhere between $300 and $700 with Chewy so that there is tremendous incrementality that we can extract from them.

A proof point of Chewy+ now that we've continued to run the program, another 6 or 7 weeks since the last time we spoke to you, penetration in categories like hard goods and specialty is running higher than the average penetration for Chewy+ indicating the power of Chewy+ to consolidate discretionary categories, build AOE and provide larger basket sizes.

And then CVC, as the -- as we've spoken in the past, and as I spoke on the script, is a lever that essentially expands TAM to incremental $40 billion of health services but also creates an entire health ecosystem where the customer can start the journey online or offline, and ultimately, their Chewy is better off for it and the customer is better off for it. The mobile app, obviously, is a closed-loop system that pushes more and more direct traffic, much more personalized interactions, repeat purchase rates and apps are stronger, AOEs are stronger Autoship subscriber rates, there's a lot of complementarity of Chewy+ and Autoship inside the app, et cetera.

So if you think about the way that we're making investments at the top level, we have multiple top line and margin driving initiatives. Then comes the automation and the power of scale that we are -- and in the future, not too long, not too far out the power of AI to compound those gains across our fulfillment, customer care and the rest of the company. And then at the bottom, it built on a really strong unified data layer and modern architecture built around a world-class fulfillment network. So I'm not sure if I hit kind of exactly what you were looking for, but happy to take a follow-up.

Our next question comes from Doug Anmuth with JPMorgan.

Sumit, the active customer growth was the strongest it's been in a few quarters. Can you just talk about some of the drivers there and then just how you're thinking about that in 4Q and into '26 along with just health of the industry. And then just a follow-up on the investment levels in '26. Is there a way to frame just kind of how you're thinking about that relative to what we've seen in '25?

Doug, thank you for the questions. So let's start with the active customers. So yes, so Q3 active customer performance exceeded our expectation and was driven by improvements across the customer fund. The strength in active customer reflects sort of both gross adds strengthening as well as churn lowering or improvements in retention as we would call it. .

On the acquisition side of gross add side, we're benefiting from higher direct traffic, increasing engagement in the mobile app and improved conversion across our platforms, both app and web. To give you data points, we lowered first time to have conversion. We increased daily active usages. We improved SEO performance by double-digit gains on a year-over-year basis. our traffic was up mid-single digits on a year-over-year basis. So the combination of SEO plus app and overall increased traffic was then met with better experiences on the platforms that drove higher conversion and as such, new customer conversion was better. So these things added up in Q3 and in our opinion, are durable moving forward. Retention at the same time, continues to strengthen as customers deepen their engagement especially across categories like premium consumables, health care, our goods, once again, was strong, I think, 18% year-over-year growth. And as customers increasingly consolidate their spend with us, given that they're finding both value and convenience set.

Now moving to the subpart of the same question. So you're asking about how we're thinking about Q4 and then in '26. So '26, we expect durability in net adds file continuing to increase. Let me hit Q4 more directly. So the implied moderation in Q4, if you calculate the fill in the blanks kind of question, you'll end up at the high end of low single digit for Q4. And that perhaps offers some moderation of roughly 150,000 customers from Q3 on a sequential basis, right? So the implied moderation in Q4 is largely comp driven and reflects timing more than anything else. We're cycling a much stronger Q4 from last year in terms of net adds, that naturally creates a tougher comparison.

I should also note that when looking at Q4 quarter till date, we like the momentum that we're seeing on net adds, and we're running ahead of our forecast. There's still half the quarter left to go. So for now, it's prudent to hold kind of the conservatism that we're bringing forward here. What else. Okay. Now moving to the second part of your second question, which was investment levels on second let me just read this frame up for. Can you repeat the second question?

Just really just trying to understand your comments towards the end there just on investment levels in '26 relative to what we've seen in '25.

Yes. Okay. So first of all, I would like to perhaps just say that we've seen 2025 being characterized as an investment year. And the reality is, I mean, we're driving both strong top line growth and meaningful margin expansion. We're growing at more than 2x the market. We've narrowed our margin guidance, delivering 90 basis points of expansion at midpoint. And we're doing this simultaneously growth in margin kind of moving together. '26 going to be better, right? So we expect to take share. And at the same time, investment levels are more structural and durable investment levels moving forward, while we continue to self-fund a bunch of the temporary investments that you've seen us take in kind of Q1 or Q2 of this year.

So overall, we're going to be thinking about investments in a much more strategic manner and fund structural investments while pulling back on temporary investments because we feel they can self-fund them. The business is continuing to perform better and better each quarter as we move from '25 into '26, especially as our fulfillment center scale, our customer service skills and our marketing drives greater efficiency into '26.

Our next question comes from Steven Zaccone with Citigroup.

I want to follow up on Doug's question there. When you think about '26, can you share a little bit more on your mining outlook for demand you talked about net adds, but how do you think about the overall backdrop of the industry? And obviously, '25 has been an improvement versus '24. So how do you think about '26. And then in that context, pricing, we haven't really seen it in the industry. Do you see that being more of a tailwind as we get into next year?

Yes, sure. So as of this point, we're looking at '26 more or less like 2025. When we'd entered '25, we were expecting stronger industry normalization by the time we exited 2025. A as defined in terms of net household formation in terms of pricing returning back into the industry and strong demographic growth across the category.

As we exit 2025, we -- our current read is to view '26 more or less like '25. So industry growing at low single digit, perhaps the low end of mid-single digit. Net household formation kind of remaining flattish. We are -- if you look at the shelf in adoption numbers, we're running at about 100,000, 150,000 surplus between adoption and returns we would like to see this number probably 5, 6x higher to be able to call it a normalized industry.

Pricing, if you look at pricing growth in the industry, typically, you'd see a 1.5%, 1% to 2% pricing improvements on a year-over-year basis. And we'll wait for 2026 to kind of the signals to become a little more clear. I'll address your pricing question here in 1 second. But for the most part, we're viewing '26, much like '25.

Underneath of it, as you've heard us comment we plan to bring forward a plan that is very clearly share taking in '26. I'll stay away from guidance and we will come talk to you more in March, when we report Q4 and discuss 2026.

In terms of latest perspective on pricing, so pricing has remained rational and stable, with no material benefit or detriment from inflation or deflation in recent quarters, right? And as I alluded, we're maintaining healthy and regular dialogue with our supplier partners, and so far, we're watching this very closely. For the most part, we believe is going to be a structural unit volume growth here, perhaps the pricing benefit is going to be slightly larger than what we've seen in '25, which was nearly muted or 0. So more to come when we talk 2026.

Our next question comes from Nathan Feather with Morgan Stanley.

[indiscernible] my end, first, we talked about the strong net adds, and with that marketing still showing really nice leverage year-on-year. So what's working in the customer acquisition funnel to help you be more efficient in acquiring cohorts should that persist? And then on the margin side, the full year '25 margin guidance does imply 4Q EBITDA margins take a step down on a sequential basis. Can you just help us think through the margin puts and takes at the end of 4Q.

Sure, Nathan. So on marketing, I think you have to go back 2 years and build from there. And I'm sorry to take you back 2 years. But really, this is the compounding effect of the journey that I have been very transparent and articulating over the last 2 years. If you recall, we started with connecting the funnel all the way from lower middle and upper funnel. And that takes time to sort of build and mature because you have to essentially rev up your creative engine, you've to rev up your concepting and go to market. And so that takes a little bit of time.

Underneath of that, we were pushing for -- I came to this call 2 years ago and I said, we're going to be mobile first and mobile is going to be a priority. And so we have continued to see the mobile app become stronger in terms of the percentage of traffic going through a percentage of owners going through it and overall metrics of retention of the customer file that we essentially extract through our mobile ecosystem.

Number three, we last year, you heard me come to the call and talk about rebuilding our CRM engines, rebuilding bidding protocols, improving models and connecting these together. And so essentially, if you step back from the details, two things have happened, right? The output of these efforts have been, a, there's increased traffic that we are pulling which is the result of net new assortment programs like Autoship strengthening, much more offerings, [indiscernible] program. So we've continued to innovate and bring new offerings to customers. We've continued to improve the way that we go to market.

These two results, we have continued to improve these results in higher traffic. Then we -- underneath of it, there is the power of SEO and the power of apps that actually converts a bunch of the third party into one traffic. Then when traffic hits the website, you're working on improvement and experiences, and our app fundamentally looks different from how it looked 18 months ago. Next year, it is going to look even better than what it looks right now. So we expect continued improved conversion. And so it's basically a calls and clicks and conversion-driven sort of phenomena underneath of it is a lot of activity and built around a lot of innovation that we are bringing to the market in leading as a single category [ captain ].

And then -- so yes, as we do this, marketing is getting more efficient. We've talked about it now for a couple of quarters. This one, this quarter was more definitive than the previous one. Signals are more clear to us. We expect to take these signals into 2026 and come talk to you more in greater detail in March.

Was there a follow-up?

Margin [indiscernible].

Yes. So on margin, it's not atypical for us to view Q4 as an investment quarter, right? Multiple things are going on. A, promo levels are higher, pricing is generally not help -- not your friend in Q4. On top of that, structurally, you're essentially pushing a lot more units through your fulfillment center. So leverage that you expect in other quarters, you don't get the same type of leverage in Q4 and then marketing intensity and media rates are elevated in Q4. So it's kind of hard to evaluate Q4 on a sequential basis. We feel very good about the momentum that we have right now and the quality of execution that the team is delivering through.

On a year-over-year basis, we're delivering at midpoint 90 basis points, and that equates to roughly 25% profit increase year-over-year on growth that is roughly -- that is at 8% levels. So 3x incremental profit than growth on a rate basis. We're quite pleased with that.

Our next question comes from Shweta Khajuria with Wolfe Research. .

Can I please try to -- first, Sumit, on gross margins, can you please talk about the trends in gross margins and how we should be thinking about it going forward, especially as we think of 2026 and just the puts and takes, how much of 2025 will actually apply for 2026 when we think about gross margin trends? And second, is when you think about the customer adds for '26 and the durability of customer adds, how should we be thinking about how much of retention is a driver versus gross adds? Where do you feel more confident? And which of the two factors do you think will be a bigger contributor.

So on the first one, gross margin. So again, I'll stay away from specifics on '26. But let's look at the view the forest rather than the trees on this particular call, and we'll come talk to you on the trees in 2026. So the view of the forest is the following, right?

At exit of this year, we have less than 450 basis points to go to hit the 10% long-term EBITDA margin. We expect roughly half of that will come from gross margin. The other half will come from OpEx. And so what that tells you is, first of all, there are expansion opportunities, growth opportunities and gross margin that we will continue to bank upon. Now what are the -- now there are several gross margin expanding levers, and these expand gross margin on a structural basis. There is adds that is continuing to grow steadily. There are premium category mixes that we are very well known for and continue to capitalize and consolidate share in private label is strengthening with the launch of fresh. We will have more exciting news on private label to share with you on our March April call, the health ecosystem is continuing to strengthen Chewy+. There were concerns coming into last quarter about margin headwinds. We've kind of clearly articulated our position on it. So there's not a drag from that point of view moving forward. We expect incrementality perhaps.

So when we look at our scale, continued growth of Autoship, there are so many different vectors that are on different arcs. Now there will be a few years where these vectors will compound and you will see amplified gross margins for that particular year. On other years, we might essentially choose to -- in other years, you'll see more similarly focused returns coming from a handful of these vectors versus the cumulative effect. But when you take the long view, when you take a multiyear view, these are compounding vectors that give us confidence on the trajectory of gross margin. As we've continued to educate and earn trust relative to the fact when we came to market in 2018, '19, when gross margins were at 20% levels. So that's how I would characterize gross margin.

In terms of customers, as I mentioned, we expect customer adds to be durable. On the backdrop of a market that is going to look very much like '25, we're in the middle of forecasting 2026. And so I'll stay away from guidance, but we do expect the performance that we've shown this year alongside some of the improvements that I've talked about the marketing and the engine and the innovation to be durable as we move into '26.

In terms of gross adds versus retention, look, this is actually -- it's not which one is more important. The purpose of a business is to both acquire and to retail customers. So it's an and, it's not an or, in our opinion, but it's a mathematical equation. If you look at the overall market, there is 90 million U.S. households on a normal year when normalizations kicked in, you're seeing 10 million to 15 million new pets incrementally in each sort of household. On top of that, we believe we have roughly 50 more million people that we should be touching out there. Of which 15 million of these are highly propense to online. And the last 5 million, 7 million, 10 million are perhaps not the right type of Chewy customer.

So the point is that we have a very large set of households that we can still touch. The refresh rate is not a static refresh rate. So when normalization kicks in, you should only expect tailwind on top of the results that we're delivering. And then our internal engines like Chewy+, like Autoship, like app, CVC, the health ecosystem, et cetera, this helps us continue to improve retention. So it's an and equation to us, and we are squarely focused on both, not just one.

Our next question comes from Anna Andreeva with Piper Sandler. Please go ahead.

Let me add my congrats. Nice quarter. Curious on Chewy+, can you talk about if you've seen any changes in retention when you raised the fee to $79 from $49 previously. And great to hear about expectations that the program is no longer dilutive. How should we think about that penetration into next year? And then we had a follow-up.

Okay. So in terms of the elasticity, the conversion that we saw once we raised price, conversion has remained quite strong, and has exceeded our internal expectation from an elasticity point of view. So the percentage of price increase and the loss of demand conversion is essentially the ratio that I'm talking about, that is better than what we forecasted. So we like that. .

Number two, yes, on the margins, like, look, I mentioned that our paid -- is members are already delivering gross margins that are in line with the enterprise and the higher pricing only strengthens the profile. So from an economic standpoint, we feel good about where the program is today and how it scales. It is early.

Another data point that I'll give you is, at this point, 80% of our member mix is now paid right? So you can kind of see that as the program scales, right, it will continue to become more efficient, right? So the initial investments get recouped very quickly even quicker with the increased pricing and then the conversion is holding better than expected. Obviously, it's slightly lower than what it was at 49%, but nothing that we're too concerned about at this point.

Let me see. How should we think about penetration next year? So I'll stay away from comments on next year. In terms of what we've said about last quarter, our expectations for the program haven't changed since we've spoken last quarter. Another data point that I shared on this call today was we're seeing strong member penetration in categories like hard goods and specialty that aid basket building and drive NSPAC consolidation. So we kind of like all the signals that we're getting. It's acting as a complementary program driving discovery across platform especially across some of the discovery discretionary categories.

That's really great. And just as a follow-up, on the 4Q guide, you mentioned that a running ahead of plan. Just anything else you can share what are you seeing in the business quarter-to-date? Just any learnings from the Black Friday and Cyber Week. I think you had mentioned previously that Chewy might lean into promotions in the fourth quarter. So far, I don't think we've seen that any update on that thinking?

Yes. So we were pleased with the performance during this important peak period, the Black Friday, Cyber Monday week. The week came in, in line, very much in line with our expectations. The team performed really well. Execution was strong. Supply chain backlogs were healthy in-stock levels were maintained at really healthy levels. So overall, we were very pleased with it. The discipline around promotional spend and marketing efficiency we talked about in the call continued through this important holiday event. So your observation is spot on. Net sales in Engage sessions were up year-over-year, while total event spend and customer acquisition costs were down year-over-year. right?

Overall, we've built this -- as I answered Doug's question, we are running ahead of plan currently. So I don't want to get into revised guidance given that we just gave guidance, but yes, quarter-to-date, we like the momentum that we're -- that we've headed into December with still sort of a lot of the quarter left to go. So we'll come talk to you about this in April. And all of our scenarios are built into the guidance that we've just provided for a few minutes ago.

We have time for one final question. And our last question today comes from Dylan Carden with William Blair. Dylan, please go ahead.

Really appreciate that. I'm curious the interaction between Chewy+ and Autoship is the idea that the number of auto ship customers could equate to the number of plus customers and it's just expanding the basket, reaching into more discretionary categories. And to the extent the scalability of that, you've provided numbers on box productivity, which, given your current scale, it doesn't move the needle much. But can you provide -- you kind of mentioned some of the broader ecosystem implications, Kind of where are you seeing the benefits and maybe some of the markets where you have those open.

In, so the interaction of Chewy+ and Autoship. So I think I was trying to articulate this at the beginning of the call with Eric's question, let me take a crack at it again. So these two are complementary programs. Autoship to us is a merchandise product level membership program. It's free in nature, and it delivers, it works like -- it works like a quasi subscription, very much predictable and highly reliable. It's sort of a rinse and repeat, fill it, shut it, forget it kind of a model. What we like about Autoship is it's not a dormant program. So we see continued activity on customers from customers that participate in core seasonal events and attach rates. At the same time, Chewy Plus, right, the purpose of launching Chewy+ is multifold. A, it is a discoverability driver given that Chewy has so much more to offer than just consumables and health. So it is a discoverability offering.

Number two, it accelerates NSPAC consolidation. And number three, we're early, so the data is still sort of building for us. But hopefully, next year, we're going to come and talk to you about this when the cohorts are large enough, it should aid in a very healthy way in improving our retention from already strong levels that we are seeing currently. So those are the three sort of net purposes. As you can see, the purpose is kind of aligned back and forth between Chewy+ and Autoship. The difference is live here Chewy+ is targeted and propense to members that are spending $300 to $600, $700 with us so that there is incrementality of spend.

Number two, it's driving consolidation of basket. So faster discoverability of hard goods, the toy that you have to add, you don't have to think about kind of reaching shipping thresholds. So it's improving order frequency, the repeat sort of traffic that we've seen on the website is multifold increase from customers, et cetera, et cetera.

So those are the two -- and they layer on because if you combine the two, the value and convenience essentially increases multifold, and so underneath of it, we'll make sure that the program retains economic sensibility. But from a customer end point of view, these are very good programs to go to market with.

On CVC wet, you said box productivity not overly material. Can you expand on the ecosystem benefits. So I mean recall, again, at the end of the year, we will come forward with a detailed review memo on how CVC is performing and our expectations for the future. So we are going to open up a look under the hood in the next few months. For now, I'll stick to the commentaries that we provided. We're seeing customer incrementality, 4 out of 10 customers that are walking into CVC, our net new to Chewy. In a very short time, we see 50% of customers in CVC reach out and expand their connection to chewy.com by adding many more categories. Our Retention rates are running high. Our CSAT has continued to run at 4.8%, and these are not internal metrics. These are Google ratings that I'm quoting. So overall, the product is resonating really well. Wet recruiting and retention has remained really well for us, and we continue to expand. At the end of this year, we expect to be in the 16% to 18% range that we have originally forecasted.

Great. I'll wait for that. I guess the question on Autoship versus plus -- I mean, is it simple math to think that all Autoship customers are available to become plus numbers and therefore, expanding you mentioned sort of net bet consolidation? .

Yes. Yes. But remember, the comments that I'm making now, Chewy+ affords us the ability to be targeted and segmented. And that's the power of running programs on digital platforms. We can consume unified data signals in a much more accurate and precise way and target and segment the program to customers who we believe will benefit from the programs or who will find the program attractive, but also Chewy will benefit equally well from those type of sign-ups.

So while Autoship is applicable to 100% of customers, Chewy+ may or may not be and the overlap, you have to sort of combine my two statements in terms of NSPAC thresholds. And penetration in X categories, ex being nonconsumer and health categories to be able to find the intersection there.

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

Hello, everyone, and welcome to the Chewy Second Quarter 2025 Earnings Call. My name is Emily, and I'll be coordinating your call today. [Operator Instructions]

I would now like to hand over to Natalie Nowak, Director of Investor Relations. Natalie, please go ahead.

Thank you for joining us on the call today to discuss our second quarter results for fiscal year 2025. Joining me today are Chewy's CEO, Sumit Singh; and Will Billings, our Chief Accounting Officer and Interim Principal Financial Officer. Will is a respected leader with extensive finance and accounting experience, and we appreciate his dedication to Chewy as he takes on this expanded role, while we continue to search for a permanent CFO.

Our earnings release, which was filed with the SEC earlier today, has been posted to the Investor Relations section of our website. In addition to the earnings release, a presentation summarizing our results is also available on our website at investor.chewy.com.

On our call today, we will be making forward-looking statements including statements concerning Chewy's financial results and performance, industry trends, strategic initiatives, share repurchase program and the environment in which we operate. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks, uncertainties and other factors that could cause actual results to differ materially from our forward-looking statements. We encourage you to review our SEC filings, including the section titled Risk Factors in our most recent Form 10-K for a discussion of these risks.

Reported results should not be considered an indication of future performance. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We assume no obligation to update any forward-looking statements, except as required by law.

Also during this call, we will discuss certain non-GAAP financial measures. Reconciliations of these non-GAAP items to the most directly comparable GAAP financial measures are provided on our Investor Relations website and in our earnings release. These non-GAAP measures are not intended as a substitute for GAAP results.

Additionally, unless otherwise stated, all comparisons discussed on today's call will be against the comparable period of fiscal year 2024.

Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of the audio webcast will also be available on our Investor Relations website shortly.

And with that, I'd like to turn the call over to Sumit.

Thanks, Natalie, and good morning, everyone. Q2 net sales grew by nearly 9% year-over-year to $3.1 billion, exceeding the high end of our guidance range. Moreover, against an industry backdrop of low to mid-single-digit growth, our Q2 performance demonstrates a clear share gain outcome. Strength of our Autoship program in categories such as consumables and health anchored Q2 net sales performance.

Second quarter Autoship customer sales of $2.58 billion represented 83% of our Q2 net sales, reaching a new record high for the company. Growth in Autoship customer sales once again outpaced overall top line growth increasing by nearly 15% in Q2. We are also pleased to see the continued strength within our hard goods business, which grew over 15% in the second quarter, primarily on the back of structural volume growth.

And finally, a rapidly strengthening Chewy+ program exceeded our expectations in the second quarter. I will comment more on our progress with this program in a moment.

Moving to customers. We ended the second quarter with 20.9 million active customers, reflecting 4.5% year-over-year growth. Importantly, the strength and quality of our new customers continue to improve. New customer NSPAC for the Q2 2025 cohort strengthened quarter-over-quarter and is trending mid-single digits higher on a year-over-year basis relative to the comparable Q2 2024 cohort.

For total Chewy, we continue to expand customer share of wallet in the quarter with NSPAC reaching $591, representing 4.6% year-over-year growth.

Moving down the P&L to profitability. Gross margin reached 30.4% in the quarter, expanding on both a sequential and year-over-year basis by nearly 80 and 90 basis points, respectively. For Q2, main drivers of gross margin were both our fast-growing sponsored ads business and favorable mix into premium categories. Pricing and promotion remained rational and did not have a material impact on gross margins in the second quarter.

Continuing on the topic of profitability. We generated $183.3 million of adjusted EBITDA in the quarter, representing a 5.9% margin and a year-over-year increase of over 80 basis points. We also generated nearly $106 million of free cash flow in the quarter.

Our robust profitability and compelling free cash flow generation enabled us to not only invest in our strategic growth initiatives, but also return meaningful capital to shareholders as reflected by the nearly $125 million we deployed towards share repurchases in the quarter.

Now I would like to provide an update on some of Chewy's strategic initiatives. The Chewy Vet Care, or CVC network continues to outperform relative to expectations in terms of demand generation and driving broader ecosystem benefits. We are consistently observing that CVC customers drive both the highest and fastest NSPAC curves for Chewy.

Additionally, we remain on track to open 8 to 10 new practices in fiscal year 2025 to reach a total count approaching 20 by year-end, and we look forward to keeping you updated on our progress.

Shifting gears, let's talk about Chewy+, our paid membership program. As a reminder, today, Chewy+ members receive the following benefits: free shipping on all orders, 5% rewards to redeem on future orders, limited time seasonally relevant member exclusive offers, and a 30-day free trial period. At the end of the free trial period, members pay an introductory price of $49 per year and convert to paid members. As I shared in my remarks earlier, the Chewy+ membership program is rapidly strengthening, indicating a strong product market fit.

In the month of July, roughly 3% of Chewy's total monthly sales were to Chewy+ members. Importantly, we are observing strong incrementality in spend, NSPAC and positive contribution profit per customer across Chewy+ customers compared to nonmembers. Furthermore, other key leading indicators of success are promising. These customers are buying at a higher frequency and attaching a higher number of products to their orders.

Additionally, we are observing incremental Autoship adoption and greater mobile app usage from Chewy+ members relative to nonmembers. All of this is leading to both higher as well as accelerated NSPAC curves for Chewy+ customers compared to nonmembers, which in turn is contributing positively to Chewy's net sales flywheel. As we exit this year, we expect approximately mid-single-digit percentage of our net sales to go through the Chewy+ program. Further, we expect the program to generate positive gross profit dollars in fiscal 2025, though at a gross margin rate below Chewy overall, reflecting both the ramp that we anticipate in the second half of this year and the mix of paid versus free trial members. As we scale, we will remain disciplined in evaluating the program structure, including pricing and member benefits.

Moving on. Now let's talk about Chewy Private Brands. I am excited to share that in August, we launched Get Real, our new Chewy exclusive private brand of healthy fresh dog food. The Fresh & Frozen segment represents a fast-growing TAM fueled by trends of humanization and premiumization in pet. Consumers believe that their pets deserve fresh and nutritious food, leading to longevity and an overall higher quality of life for their beloved pets.

Get Real, a new line of minimally processed fresh dog food available only at Chewy comes in 3 different pup-approved recipes, including Chicken & Brussels Sprouts, Beef & Sweet Potato and Turkey & Cranberry, all available as both full meals and meal toppers made with 10 or fewer ingredients plus vitamins and minerals.

Additionally, this premium product is delivered to your doorstep in pre-portioned, ready-to-serve meals, just [paw and serve]. Although the product has only been in market a few weeks, customer reception is strong. Customers are pleased with the palatability, quality and overall experience, which includes shopping, delivery and consumption.

I am also pleased to share that we have already built up sufficient capacity through 2028 to support our growth in the Fresh Frozen segment broadly, both for Get Real and for our national brand partners while remaining very much at the lower end of our previously set CapEx guidance range of between 1.5% to 2% of net sales.

With the capital investment behind us, we are now in process of scaling to a national footprint by leveraging our existing fulfillment center topology. By the end of 2025, we expect to be ready to deliver a majority of our fresh food offering to customers within a 1-day transit time. Furthermore, Get Real is exclusively an Autoship subscription business that results in high gross profit per unit at scale, supporting both broad leverage across our operational infrastructure and our aspiration of becoming a leading profitable player in the fresh and frozen segment.

While still early, we are pleased with the launch of this product and the positive response from our customers. Beyond Get Real, we are working on bringing other Chewy branded product innovation to market in the second half of 2025, and I look forward to keeping you updated on our progress.

Before I turn the call over to Will, I would like to leave you with a few closing thoughts. The first half of 2025 has been an exciting and productive period for Chewy, reflecting the strength of our differentiated value proposition and the momentum across our business. Looking ahead, we expect the second half of the year to be even more dynamic given the evolving macro.

As many retailers prepare to pass tariff-related costs on to customers, we believe Chewy is well positioned to mitigate these pressures. Our higher mix of consumables and health and proactive investments in onshoring incremental discretionary inventory provide meaningful safeguards. These actions will help deliver a superior customer experience by selectively evaluating pricing while protecting product margins.

Additionally, instead of absorbing these pressures, we plan to lean into growth by investing behind the expansion of programs like Chewy+ and our private brands. Customers are embracing these initiatives for their compelling value proposition, and we are equally encouraged by their strong return on investment.

Overall, we see the second half of 2025 as an opportunity to further accelerate market share gains in the U.S. and position Chewy for even greater long-term success.

With that, I will turn the call over to Will.

Thank you, Sumit, and thank you all for joining us today. Let's review our financial results and outlook. Second quarter net sales grew 8.6% and year-over-year to $3.1 billion, exceeding the high end of the Q2 guidance range we provided last quarter. We reported second quarter gross margin of 30.4%, representing approximately 90 basis points of margin expansion year-over-year.

Shifting to operating expenses. Q2 SG&A, excluding share-based compensation and related taxes, came in at $592.8 million or 19.1% of net sales, deleveraging approximately 30 basis points year-over-year. Q2 deleverage was driven by the ongoing ramp of our Houston fulfillment center, which launched in April, coupled with the wind down of certain shifts at our Dallas facility. We also incurred higher inbound inventory processing costs, primarily within hard goods to ensure we have the right assortment for pet parents as we head into the peak holiday periods, while also allowing us to mitigate impact from tariffs in 2025.

Additionally, a smaller contribution came from increases in wage and benefit cost within the period.

Importantly, we believe these increases are primarily temporary in nature, and we continue to expect to deliver modest SG&A leverage in fiscal year 2025.

Second quarter advertising and marketing expense was $200.6 million or 6.5% of net sales, in line with our expectations and consistent with our previously stated target of 6% to 7% of net sales.

Q2 adjusted net income was $141.1 million, representing a 34.8% increase year-over-year and we delivered $0.33 of adjusted diluted earnings per share within the guidance range we provided last quarter.

Second quarter adjusted EBITDA came in at $183.3 million representing a 5.9% adjusted EBITDA margin, which reflects 80 basis points of year-over-year margin expansion. We reported Q2 free cash flow of $105.9 million, which reflects $133.9 million of net cash provided by operating activities and $28 million of capital expenditures.

For full year 2025, we reiterate our expectation to convert approximately 80% of adjusted EBITDA to free cash flow and CapEx will be at the low end of our previously stated range of 1.5% to 2% of net sales.

In the second quarter, we repurchased approximately 3 million shares for a total of approximately $125 million. At the end of Q2, we had $359.8 million of remaining capacity under our existing program for future repurchases. We ended the quarter with approximately $592 million in cash and cash equivalents, and we remain debt free with an overall liquidity position of approximately $1.4 billion.

Now I'd like to discuss our third quarter and full year 2025 outlook. We expect third quarter 2025 net sales of between $3.07 billion and $3.1 billion or approximately 7% to 8% year-over-year growth, and we are raising and narrowing our full year 2025 net sales outlook to between $12.5 billion and $12.6 billion or approximately 7% to 8% year-over-year growth when adjusted to exclude the impact of the 53rd week in fiscal year 2024. This represents $175 million increase to the midpoint of our guidance range.

Moving to profitability guidance. We are maintaining our full year 2025 adjusted EBITDA margin outlook of 5.4% to 5.7%.

As Sumit shared in his remarks, we believe it is prudent to remain on the offense in the second half of 2025 and invest to strengthen Chewy's share position in the pet category.

The midpoint of our guidance range indicates 75 basis points of adjusted EBITDA margin expansion year-over-year. Furthermore, at the midpoint of our 2025 net sales and adjusted EBITDA margin guidance ranges, we expect to deliver approximately 15% adjusted EBITDA flow-through for the year, in line with our previously stated long-term target. Importantly, and consistent with our comments last quarter, we continue to expect approximately 60% of our adjusted EBITDA margin expansion to be driven by improvements in gross margin, confirming that we expect to continue to deliver healthy gross margin expansion year-over-year in fiscal 2025 with Q2 being the high point for the year.

And finally, we also expect Q3 adjusted diluted earnings per share in the range of $0.28 to $0.33.

For the full year 2025, we are also reiterating our previously stated expectations related to share-based compensation expense, including related taxes, of approximately $315 million and weighted average diluted shares outstanding of approximately $430 million. 2025 net interest income of approximately $25 million to $30 million, and we continue to expect our effective tax rate to be between 20% to 22% for 2025.

Before we open the call for questions, I'd like to reiterate that our strong Q2 results underscore the continued momentum in the business and strength of execution by our Chewy team members. We believe that Chewy remains exceptionally well positioned to continue to deliver share gaining growth and enhanced shareholder value.

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

[Operator Instructions] Our first question today comes from Doug Anmuth with JPMorgan.

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

So let's start with the second question first because it will give you a sense for the investments that we're thinking about. So as you know, we have a very large base of customers, which continues to grow. This customer base is sticky and the programs like Chewy+ allow us to enhance the process of discoverability and get customers to attach both explore, discover and then attach even a greater set of product or a greater range of products and services offered by Chewy.

So our first attack strategy is to essentially expose Chewy+ to existing members. And so far, we have not spent any incremental dollar on marketing the program externally, and we don't intend to do so as we ramp the program up. We're seeing really good participation of existing Chewy members converting to become Chewy+ members. So the marginal cost of that acquisition is 0 or nearly 0 to us, and most of the exposure is being provided by on-site and funnel shopping experiences.

Now coming to Get Real, our approach is very similar. Large audience, we have what we believe really good recognition of what looks like premium cohorts and consumables for us. So our strategy is much more leaning into the broader value proposition of Chewy externally as the place, which is a destination for you to take care of your pets and providing food supplies, health and other services and really gearing ourselves for conversion, right, rather than consideration building when customers come to our website. And so from that standpoint, the inputs that we've been really focused on is getting the quality of the product, the palatability of the product exactly where we want it. And we're pleased to see the customer response.

Number two, we're price competitive. There are many products out there that are priced much higher. And we believe the value prop or the balance of quality and price that we deliver really passes good value to the consumer.

Third, if you explore this product in the way that we've built it, this is not a standard product listing page experience. We've built a curated experience that allows customers to engage with this category in a manner that it allows them to seek the education, have the content at their fingertips. We've paired that up with really high CRM capability internally. And that will be our strategy moving forward as well.

So from that standpoint, we're not -- you shouldn't expect us to lean very heavily in marketing dollars. Currently, we're pairing Get Real with a strong acquisition offer, but candidly, Get Real customers or fresh and frozen customers are high NSPAC customers, you're looking at plus $2,500 spend full meal customers and running into the high hundreds for topper customers. But these customers are also really propensed towards health and wellness and other high spend categories. So broadly, we see tremendous potential for this category being the highest gross profit per unit category in the company. The fact that we've already spent the money in building CapEx or capacity should essentially make you comfortable to the point that we don't have incremental CapEx investments coming up through 2028.

Of course, if the program exceeds our expectation in a major manner, then that's a high-quality problem to have, and we'll talk about it at that particular point. But broadly speaking, these are high-margin sales, high sales, high-margin verticals, and we're excited to be finally leaning into them and driving even stronger NSPAC consolidation.

Our next question comes from Nathan Feather with Morgan Stanley.

Encouraging momentum here. I want to question on the SG&A deleverage. Any way to put some guardrails on the magnitude of temporary costs here? And how much maybe we can attribute to some of the FC changes versus the hard good processing costs. And because of that, how should we think about the leverage path into the back half?

Yes. Nathan, me provide broader commentary on SG&A and also answer your question very specifically. So First of all, as we discussed on the call, we expect roughly 60% of our adjusted EBITDA margin expansion to come from gross margin and 40% to come from OpEx leverage. So we do expect to deliver SG&A leverage in 2025. And by inference of our first half performance, you can expect that, that leverage will come in the back half of the year.

Number two, yes, the amount of SG&A leverage on a year-over-year basis in '25 will be lower than '24. But I think that's the ebb and flow of SG&A, right? Let me kind of elaborate on that a bit.

So this will ebb and flow in cycles a bit. As we elaborated in our Capital Markets Day in December '23, we set a target of roughly 200 basis points to deliver. So far, roughly 2 years out, we've already delivered 100 basis points or 50% of that target. The majority of that leverage has come from us ramping 4 fulfillment sites, which are automated 2G sites and roughly flowing 40-plus percent of the volume through these states of automation within the company, right? By Q2 of next year, we expect nearly 50% of our volume will be automated, especially as Houston ramps up.

Now let me talk about the specifics in the quarter. So there's a couple of things that are happening in the quarter and in '25, right? So we launched Houston in April of this year, and it takes roughly 6 months for a Gen 2 facility to ramp sufficiently to start delivering leverage. And I went back and checked my notes from Q1 and perhaps we should have been a little more clear on that point upfront, right? So this facility is ramping well. It's ramping as expected, but it takes about 6 months for a Gen 2 facility to ramp for it to deliver sufficient leverage. As such, we do expect to see leverage out of the facility beginning in the second half of this year.

Now the second thing that's going on in SG&A is, look, the faster we grow in 2025 and as you can infer, we're growing purely on the basis of units. Its structural growth, which is comping first half growth where we had pricing benefit. And so what you'll see is that SG&A that is a variable cost element, right, will essentially be enhanced, the faster we grow on the basis of units. But that's a high-quality problem to have because it builds density. It allows us to extract more cost out and get the economies of scale as our facilities fully ramp up. So again, that's a transitory thing and we expect this to be a lot easier and better as we step out from '25 into '26.

Now let's talk about the onetime elements. So we picked up incremental inventory in hard goods because as you can see from the commentary in the market, prices are expected to rise in the back half of the year, right? And so we wanted to both shore up the inventory to deliver an immaculate customer experience from an in-stock point of view. But you know what, we might invest in price, right? We may invest in price to take share while everybody else is raising price, Chewy becomes another destination for pet parents to really extract the maximum value. So temporarily, we believe this is a situation which is opportunistic and we should lean in and improve our share position. You talked about -- and so roughly, we spent about $3 million to $5 million in this particular element in higher inbound processing cost, right? And the last component that we talked about in the script was higher wages and benefits and higher wages and expenses, which was a smaller element, which is sometimes cyclical, and that was about $2 million to -- $2 million to $3 million per se.

So the important takeaway is that you can expect SG&A costs to moderate in the back half of the year relative to the first half, and we expect to deliver SG&A leverage in '25.

Our next question comes from David Bellinger with Mizuho.

Let's just squeeze a few together here. Maybe if we could just start on the Q2 gross margin improvement. You mentioned the premium products. That seemed like somewhat of a shift also maybe talking about some of this price investment in the back half. So can you unpack all that for us and how we should think about the drivers of gross margin expansion in Q3 and Q4?

And then also just on the new OpEx investments, can you help us understand, is all this fully in your control and making decisions to further accelerate the top line and share gains versus something more reactionary or something changing in the external marketplace is forcing you to do this? Can you just help us understand that split and how Chewy+ and Fresh & Frozen, this might impact the 15% incremental EBITDA margins for the business?

Yes. Sure. No, it's a good question. Let's dive into it. So there's a couple of questions built into that. So let's pair them apart. So gross margin first. We're pleased with the gross margin expansion that we've delivered this quarter, right? And the drivers of gross margin, David, have remained very consistent over the past few quarters and overall in line with our story or the narrative that we brought to the street, right? They include product mix across our merchandising-led businesses. So you've heard us talk about health, premium consumables. Now hard goods is starting to grow double digit, albeit at a smaller contribution, but still were encouraged to see kind of where this goes. So that's kind of why we use the word product mix across merchandising led businesses because it isn't just pharmacy, which has continued to contribute. It is health and wellness supplements, it's premium consumables, it's hard goods growth, et cetera, et cetera, et cetera.

So number two -- so the drivers of gross margin include product mix across merchandising led businesses, increasing Autoship penetration and scale that provides economies of scale and our ramping sponsored ads initiative, right? So that's very consistent of commentary. For Q2, the promotional environment remained highly rational, right? And we don't expect the promotional environment to be irrational in the back half of the year. So as Will mentioned in his remarks, Q2 represents the high point of gross margin for the year, and I especially want to note that gross margin will fluctuate on a quarterly basis, right? And that would be helpful to remember. This is the case because while we pride ourselves on being disciplined, we also pride ourselves in being able to run the business dynamically each quarter.

So for example, we will lean into opportunities where we believe Chewy will benefit long term. For instance, we may lean into Autoship subscription growth if we're seeing the right conditions that signals from our marketing teams or on the program ramp supplier ramp, the ramp of phasing the suppliers and sponsored ads may lead to one quarter being more meaningful than the other in terms of contribution. The important point to remember for 2025 and in general, is that we plan on delivering a healthy level of gross margin expansion on an annualized basis.

So specific to '25, if you recall our guidance, we expect approximately 60% of '25 EBITDA margin expansion to come from gross margin. So clearly, the inferring here is that we do expect to deliver meaningful gross margin expansion this year as well. So where are we investing in the back half? So if you look at our guidance, I'll just sort of like play and math it out for us, right? At the midpoint, our guidance is expanding by roughly $175 million, 15% of flow-through, you'd expect probably an incremental $20 million, $25 million to flow through the bottom line.

But we're choosing, right, to invest that back into the growth of the company, whether that's growing the Chewy+ membership program that we believe is going to be super incremental. And part of that incrementality is reflected in our top line guidance or whether it's continuing to grow Autoship stronger or whether it's opportunistically evaluating the market in the back half and seeing if there is selective pricing lean-in opportunity.

If there isn't, then great, we'll take it to the bottom line. But we've sort of left ourselves open to play the marketplace. And SG&A, structurally, this is all within our control. So these are 2 different things that are happening in the way that we will invest in the growth of the business. And the SG&A story, which is a very standardized certain onetime elements, but generally the ramp of our fulfillment facility.

Our next question comes from Rupesh Parikh with Oppenheimer.

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

Sure. Yes. So if we look at the TAM of the category today, we believe it's somewhere in the $3 billion, $4 billion range. And over the next several years, we expect this category to be north of $8 billion, so somewhere in the $8 billion to $12 billion range. The category is growing at mid-teens levels. It was growing faster up until last year. Now it's growing at mid-teens level. And that's a really healthy growth rate for us to be able to get excited about, right?

Number three, there is a lot of interest in this category from around the industry, right? You've seen some de novo players already leaning in. You've seen national branded players start announcing their announcement or their product offerings. We're really excited to be partnering with the national branded partners as they bring their products to life in the back half of this year. And alongside that, right, get real we expect to have a meaningful amount of share as the category grows. What is meaningful? We would consider roughly a share position commensurate to Chewy's share position in the industry to be a meaningful share outcome, right?

Now given that we've built the capacity, given that we've built the topology to be a 1-day network, right, and given the sophistication that we have in our supply chain, we expect, right, the high gross margin possibility of the vertical to efficiently translate into high EBITDA as well, right?

And alongside, you asked about the quality of the customer. Let me answer that now. So, so far, it's early days. We've been at it, what, less than 4 weeks, 5 weeks. And so far, we're seeing roughly 70% of the customers are existing customers, 30% of the customers are net new customers. And that is -- as my earlier comments to Doug indicated, we'd expect that, right? So we're benefiting from the general traffic that the industry will create in marketing the product and we are priming ourselves for conversion using our site experience with Get Real. We'd expect the NSPAC of this customer to be north of $800 for toppers because we believe they will attach 2 or 3 more categories. And for full meals, we expect this to be a plus $2,500 customer on an annual basis. So we're excited about it.

The next question comes from Curtis Nagle with Bank of America.

We are not receiving a response, and so I will move on to the next question, which comes from the line of Shweta Khajuria with Wolfe Research.

Okay. Let me try 2, please. Sumit, could you please talk about the advertising environment? Just the conversations you've had through the quarter? And what is top of mind across advertisers as we think about the back half of this year and potentially even next year? And how it is -- and how ad revenue is trending or I guess, advertising business, not revenue is trending for you versus your expectations?

And then the second question is, generally, what are your expectations as we think about the macro in terms of net household formations for the remainder of this year and also next year? And I ask because there could be inflationary pressure. So how are you thinking about the mix of customer growth versus pricing? Do you still expect it to be, call it, low to mid-single-digit percentage growth rate in the back half? Or is there potential for acceleration in the back half of this year?

Okay. There are 3 questions there. State of the industry and key inputs, our composition of new customers and NSPAC, and then, three, advertising. So let's take them one by one.

Exactly.

So in terms of the lay of the land, so let's start with pet household formation trends. Overall, the trends that we spoke about last several quarters have remained consistent, and we're not seeing notable changes relative to those comments, right? With respect to data, the shelter channel, net adoptions remain stable and relinquishments continue to trend down year-over-year. And so overall, we expect at households to be broadly flat to slightly up in 2025, right? So the point on industry continues to normalize, seems to be holding true.

Now across the conversations that we're having with our suppliers and interpreting the market from a consumer standpoint, we believe the back half of the year or generally for 2025, the industry remains in low single digit to kind of perhaps the low end of the mid-single-digit range in terms of growth. And so we are clearly taking share, growing on a 52-week basis between 7% and 8% and 53-week basis, the 6% range or so. So which we're excited about. And this is on top of the fact that we have tougher comps that we're comping as we move into the back half of the year. So we're excited about that.

Now let's talk about our composition. So our growth algorithm, as we've guided long term is a combination of active customers growing low single digit to mid-single digit and NSPAC growing mid-single digits, right? And so we're pleased to essentially maintain that for the rest of the year. We're encouraged by the steady and consistent return to active customer growth that we have delivered over the past several quarters and we expect that to continue on a sequential basis, right? I would remind you that we will be lapping our return to active customer growth in Q4 which will result in modestly tougher comps for us in Q4. And even with the tougher comps, we continue to expect to grow active customers at the high end of the low single-digit range in 2025, right?

And then when you look at NSPAC, we delivered 4.5% growth in Q2. That is in a normalized environment, which would -- where there is some pricing benefit. Right now, there is no pricing -- or no material pricing benefit flowing through. So we're growing NSPAC at 4.5%, and we would expect, right, NSPAC to continue to trend in that 4.5% to 5%, 5.5% range as we move into the back half. And again, this is through stronger Autoship, stronger product mix, programs like Chewy+ that are driving consolidation. So it makes a lot of sense for us to lean in and continue to capitalize on the growth that we're seeing.

And then your final question on advertising, the market -- competitive intensity is high. We don't see generally from a lean-in point of view, either suppliers nor competitors lean out. So competitive intensity remains high. We are really pleased with the metrics that we are seeing on our side. For example, our net traffic was up 14% in the quarter, number of sessions. And then on the mobile app side, right, sessions were up over 25% year-over-year. And so broadly speaking, we're attracting customers, and we like that translation layer. When we think about sponsored ads, that continues to resonate really loudly. And we feel good about the continued progress that the business made on ads this quarter, which, again, grew sequentially and we have strong conviction in our long-term target of the 1% to 3% that we have brought to the table.

Our next question comes from Michael Morton with Towers.

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

So let's start with the second question. It's all primarily volume. There is a very little ASP benefit right now in the hard goods recovery. The primary drivers of hard goods recovery are, as you've heard me talk about it last quarter, I will reiterate that a rapid acceleration and expansion of in stock, higher -- so more products for customers to choose from. We've onboarded over 1,500 brands this year already, and customer reception on the freshness of that inventory is really encouraging for us to see.

Number two, our in-stock levels have remained really high, and we want to keep them high and hence, the investment in inventory in Q2 as we move into the back half of the year.

Number three, continued exposure for hard goods customers in the way that we're communicating with them, both on-site and off-site. And so overall, we're encouraged by what we are seeing in hard goods and don't expect it to slow down as we've played Q3 so far. So a good story there.

And then you -- your higher order question around differentiation. And look, we really always interpreted the playing field as much broader than food and supplies. And when you essentially interpret $140 billion, $150 billion TAM, right, which is increasingly online. The value prop that we are bringing to the market, which is credibly connecting food supplies, the entire health ecosystem alongside B2C, B2B or B2B2C type services options. And then really keeping customers in our funnel and building that layer cake, we do it, in my opinion, in one of the most efficient and powerful ways relative to anybody out there.

And so there are reasons for that, right? So in the food and supply side, you would think that we are a scaled e-commerce player, but with the personalized service you would expect in a local neighborhood pet store. And that combination is very hard to achieve. And we continue to achieve and outperform and are never satisfied with our performance when you think about it at the scale that we're operating.

Then next to it, we have stood up a very large and compelling health TAM, which now we're playing in nearly 100% of the $50 billion health TAM that is growing at 2x the rate of food and supplies and within that, we've built a very credible set of offerings. So whether it's the fact that less than 1/4 of our customers are interacting through verticals like pharmacy which gives us tremendous headroom to continue to grow in pharmacy, particularly as the vertical continues to move more and more online or whether it's the growth of our compounding business.

We haven't talked about compounding for a while. That -- the gross margin -- the compounding -- there's only 2 credible compounders in the country, and we stepped into compounding to offer the first B2C offering for customers, but we're also becoming a more and more choice product for veterinarians who want to lean into compounding services. And the gross margins for compounding are even higher than gross margins for pharmacy and the barriers to entry are really high, right? Next to it, we've built a very credible B2C and B2B software business, which continues to ramp. And so broadly speaking, and now with CVC ramping higher than expectation, it's only excitement that we can sort of project moving in the future.

Chewy+ is a program we're excited about, and that's why we believe it was important to inform you that the program is quickly ramped up to become 3% of net sales, exiting the last month of last quarter, and we expect it to continue, right? We see this program in line with an Amazon Prime or Costco membership or a Walmart+ with similar benefits and similar returns. And so our job is to position it as the best pet membership program in the industry. We're excited about that. So there's lots, there's lots in front of us that allows us to compete without really being concerned about competitive intensity, that's always -- we are observant of that, but we're really obsessed over our customers.

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

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

So the quality of the cohorts improving is a result of 2 different things, Dylan, and they're both complementing us. One is -- the more customers we push into programs like Autoship or bring in through programs like Chewy+, the more our ability to keep them in the funnel get them more opportunities we have to talk to them to get them to consolidate their NSPAC and the faster NSPAC consolidation that we see from them. So within the program itself, then we have worked towards improving settlement rates.

So for example, if you think about Autoship, there's a -- it's a 2-sided funnel, right? We're bringing in gross subscription and then we're retaining net subscribers. So we've improved both. Our rate of gross subscription add to Autoship has increased, and our second order, third order, fourth order settlement rates into Autoships has improved, which then means that the net retention in Autoship is much better. And you see that layer cake building pretty effectively that continues to push a greater portion of our sales moving through Autoship.

With Chewy+, we're seeing a similar effect, right? Chewy+ members are engaging with and adding and on an average, 3 more categories than nonmembers to their baskets, right? And the mix of cohort is really interesting to us because it opens up Chewy, right, to all of the low spending cohorts where we can rapidly consolidate baskets and it's opening us up for high-spend cohorts to expand and discover other products, which are also expanding basket size. So on an average, we see really strong incrementality and the quality of cohorts of the Chewy+ program is healthy.

Then we have a large and growing health business and a premium consumables business. Remember, every time I've talked about this in the past, we've mentioned that when it comes to the low-end value segment of the market, which is roughly, in our opinion, 12% of the market or customers, that's slightly not the place for Chewy, but everybody else, right, Chewy is the place. And then the final thing is more and more people move in online. So clearly, online is consolidating share from off-line and once we lock these customers in, which we were not doing as well, in my opinion, in '22, '23, you're seeing the results sort of come through here.

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

So look, I mean, I think we've shared this stat in the fact that in the past that at some point, we did the survey not so long ago, 3/4 of our customers are Prime members, right? And so I think that's probably well understood, given how broad the penetration of that program is. But candidly, what we're observing is what we've also shared in the past is that our -- generally, it is well understood that we retain a very high percentage of our customers from going into year 2, right? And so our attrition is de minimis, past kind of a 30-month mark.

And you saw that in the way that our pandemic cohorts have settled out, right? And so what happens is that once we have a customer past the 30-month mark, in the past, right, they would rapidly consolidate their share of wallet over to Chewy, right, regardless of whether they are a prime member or not. And now with Chewy+, we're seeing that, that consolidation is happening even faster, right? With Autoship, we're seeing that, that consolidation happens even faster because we've improved the proposition on the Autoship program itself. So that was my point on why we're seeing it both accelerated as well as credibly built NSPAC curves on the back of these 2 programs.

And then your other question was around margin. Yes, we expect Chewy+ to be margin accretive, right? So as the program ramps, obviously, we're leaning in into the 30-day free trial period. There is the mix of new members to paid members. It will take a few months for the NSPAC consolidation to start coming through. But broadly so, yes, the program will be gross margin rate dilutive, but on a dollar basis, it will be highly accretive and on a contribution profit basis, it will be highly accretive. And so I think you would essentially underwrite a business case where we came to you and said, hey, we're investing x basis points, but we get 6x the return in top line, okay? I think that ROAS is something that we would underwrite.

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