Ladies and gentlemen, thank you for standing by, and welcome to the Chewy Second Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session [Operator Instructions]. I would now like to hand the conference over to your speaker today, Kelsey Turcotte. Please go ahead.

Thank you for joining us on the call today to discuss the results for our second quarter of fiscal 2019. Joining me on today's call are Sumit Singh and Mario Marte, Chewy's CEO and CFO respectively. Our earnings release and a letter to shareholders, which we filed with the SEC on Form 8-K earlier today have been posted to the Investor Relations section of our website, investor.chewy.com. A link to the webcast of today's conference call can also be found on our site. We will be making forward-looking statements on this call, including statements concerning Chewy's future prospects, financial results, business strategies and industry trends. Such statements are forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause actual results to materially differ from those contemplated by our forward-looking statements. Reported results should not be considered as an indication of future performance. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward-looking statements except as required by law. For further information, please refer to the risk factors and other information in Chewy's 10-Q filed with the SEC on July 19, 2019, and the Form 8-K that we filed earlier today and our other filings with the SEC. Also during this call, we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the earnings release or letter to our shareholders on our Investor Relations website, which were filed with the SEC on Form 8-K earlier today. These non-GAAP measures are not intended to be a substitute for GAAP results. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of this call will also be available on our IR website shortly. I'd now like to turn the call over to Sumit.

Thanks, Kelsey, and thanks to all of you for joining us on the call. We are pleased with our results for the second quarter. As Kelsey mentioned, our shareholder letter is posted to our Investor Relations website and I encourage you to review it. I'll start this afternoon by sharing financial highlights of the quarter, then I'll discuss a few business updates, and finally, I will turn the call over to Mario to discuss our financial results and guidance. Net sales for the quarter grew 43% year-over-year to $1.15 billion, reflecting the strength of our underlying business model including expansion in our customer base and higher spending among existing customers. Active customers grew 3.4 million year-over-year to 12 million customers. Net sales per active customer increased approximately 10% to $352, up from $320 in Q2 2018. Autoship customer sales as a percent of net sales reached 69.3%. Gross margin for Q2 was 23.6%, up 300 basis points year-over-year as a result of continuing execution on the growth and margin vectors that we have shared with you previously. Finally, our adjusted EBITDA margin of negative 2.5% improved 410 basis points versus Q2 2018, as a result of gross margin expansion and scaling of operating expenses. The inputs of our business remain strong, and we continued to drive topline growth at scale and optimize the business for margin expansion through disciplined data-driven decisions. Time and again, we hear from pet parents that their experience shopping with Chewy is one of the things that sets us apart in the industry. From our knowledgeable award-winning customer service teams to our broad assortment of brands, to our fast one to two-day delivery, to the convenience of e-commerce, high-touch personalized experiences drive customer engagement, which fuels brand loyalty and repeat purchasing. Keeping the customer at the…

Thank you, Sumit. Good afternoon, everyone. Our second quarter results highlight our business philosophy and focused execution. Net sales exceeded $1.15 billion, an increase of 43% compared to $805.6 million in Q2 2018, and Autoship customer sales reached $799.6 million, an increase of 49% compared to $538.4 million in Q2 2018, outpacing growth in overall net sales. We ended the second quarter with 12 million active customers, an increase of 3.4 million customers versus Q2 2018 and an increase of 1.4 million versus at the end of fiscal year 2018. Gross margin for the quarter was 23.6%, a 300-basis-point improvement driven by our disciplined execution to improve product margin and supply chain efficiencies. Q2 operating expenses were $355.3 million or 30.8% of net sales, increasing 240 basis points versus Q2 2018. SG&A was $244.6 million or 21.2% of net sales. As we have shared previously, SG&A for us includes all fulfillment and customer service costs, as well as credit card processing fees, and share-based compensation, a non-cash expense. Excluding share-based compensation expense in Q2 2019 and Q2 2018, SG&A as a percent of net sales increased 60 basis points year-over-year to 17.4%. The increase in SG&A as a percent of net sales was largely driven by costs related to operating as a public company. Advertising and marketing was $110.8 million or 9.6% of net sales, scaling year-over-year as a percent of net sales as our marketing investments continue to be primarily focused on customer acquisition. As a result, the recurring and long-term revenue stream from existing customers allows us to increase our acquisition and marketing investments in absolute terms over time, while also scaling this line as a percent of net sales. Q2 net loss was $82.9 million, an increase of $19.8 million compared to Q2 2018. Our net margin…

[Operator Instructions] Your first question comes from Brian Nowak with Morgan Stanley. Your line is open.

Thanks for taking my questions. I have two. Just the first one, I think it's interesting you have a new Data Management Platform on marketing. I'd be curious to hear about as you're looking at data, what do you think are the one or two key factors you need to bring new pet owners onto the platform who are pet owners but not yet current buyers? How do you target those people? Then the second question is on healthcare. Walk us through sort of the roadmap to really drive more of your current buyers to start purchasing healthcare and pharmacy products from you guys. Thanks.

Hey Brian, this is Sumit. Good to hear from you. I'll take the first one and then I'll probably have you repeat the second question. On the marketing side, remember we target -- I think it's helpful to recognize that primarily our spend is acquisatory marketing, direct response. And so not only are we able to target across offline channels and online channels such as the classical TV and direct mail techniques, but also across an array of digital techniques, starting with kind of the Google network moving over to social media networks and so forth and so on. And because of the nature of our spend and the response pattern we're able to not only target, we're also able to attribute spend pretty accurately. And the investment that we're making in our marketing technology stack continues to refine that attribution so that we can essentially effectively recognize the fact -- we recognize already that our customers live full lives across marketing channels. So for us it's about reaching them and then optimizing -- or optimizing both their experience as well as our spend on our side. That's how we think about it. And then second question was around healthcare that was not [live] [ph] customers to start buying healthcare products. Yeah, it's a great question. I think, we think about it in multiple different angles. First of all, most of our current healthcare growth, which we're pleased with is coming via organic momentum, both organic momentum of the business as well as the exposure that we are bringing to our existing active customers on the proposition of health and wellness, a broad catalog of superior customer experience, and utilizing mostly our offline and some part of our online tactics to be able to reach newer customers. So I said two things there. On active customers, we're relying on, A, the great conversations we're having with our customers that our customer service teams are having with our customer base. We're also relying on the knowledge that we have more than 3 million pet profiles on file and the way that we -- and the fact that we have a connection and a direct reach into these customers. On newer customers, go back to the tactics that we deploy and there we're actively utilizing existing channels to layer on the proposition of healthcare, not just pharmacy because we recognize how customers buy and shop across either prescription diet or medication, but could also use the health and wellness supplements, et cetera, et cetera. And then last but not least, don't forget the site merchandising efforts that we put in. Rx Product Manager is an example that we put in our customer engagement there, is something that we measure pretty maniacally. And we're happy with the way that customers are engaging with that particular product, and across our site merchandising assets.

Great. Thanks, guys.

Your next question comes from Doug Anmuth with JPMorgan. Your line is open.

Thanks for taking the question. I just want to ask a few. Just first on gross margins, it looks like they expanded about 300 basis points year-over-year and then also 70 basis points sequentially. Can you just talk about the initiatives that are having the biggest impact there? And then how do you think about that as you're kind of approaching the low end of your longer-term target? And then on Autoship, a nice increase there to 69% in the quarter. Can you just talk about how much of that was driven around promotions around Prime Day, and then if there is anything early around retention for that cohort? Thanks.

Hey Doug, this is Mario. I'll take the first part of the question, and then Sumit will answer on the Autoship. In regards to second quarter gross margins, there are a few factors here at play. One is, as we've shared before, as we grow the scale and predictability of the revenue, enables us to lower the cost out of the entire supply chain, which benefits us and benefits our partners as well. The second item is that we expanded our catalog and we're always looking for additional product to include in our product offering. In the second quarter alone, we expanded the SKU count by about 10% and three quarters of that was in hard goods, which have a better margin profile as we've shared before. And the third one is the mix of sales. As the percent of sales that come from existing customer increases, that provides a nice tailwind to our margin. I would say, going forward, that we do expect promotional activity seasonality to cause some gross margin fluctuations from quarter to quarter.

Doug, this is Sumit. I'll take the second part of your question around Autoship. So we are pleased by the fact that 69% of our net sales came from Autoship. I think there are a couple different factors. And to hit the question head on, nothing of this number was really driven by promotions around Prime Day. This is a longer-reaching number. And so there are a couple different factors that are playing in here in the increase. One is of course, I'll pick up from the point that Mario mentioned as his third point, which is as the mix of sales increases, you're sort of seeing the power of active customers engaged with Autoship program over a larger base. So that's one. Number two, I think I'll repeat the two inputs that we're constantly improving and improvising upon. One is the assortment that we put in front of our customers that is eligible for Autoship. And then two is the fact that our recommendation and personalization engines continue to sense and our care [indiscernible] recommend better and more meaningful choices for customers to be able to interact into when they're browsing and engaging with our site. The third thing that we're seeing there, which is I think interesting for me to point out and for us to observe as an entity are the hypotheses that our healthcare customers are building complementary baskets and engaging in -- and the way that they are engaging with the Autoship product. It was our hypothesis that with our way of engaging with our customers, the tactics that we use, the way we educate them, the products we develop, and the way we communicate with them, the response pattern for Autoship should even be stronger for healthcare and we're seeing that come through. So without getting into specific numbers today, I think I can leave you with some of those nuggets.

Thank you, both.

Your next question comes from Nat Schindler with Bank of America. Your line is open. Nat Schindler with Bank of America, please go ahead. Your line is open.

Sorry about that. Probably expanding a little bit on what Doug asked. If you look at your gross margin growth and compare that also to your Autoship growth, one thing seems pretty clear is that you're actually not getting the benefit yet or it seems that you're not getting the benefit yet from mix shift towards your higher gross margin products, i.e. away from food. Autoship would mostly be food, I assume. If that's the case, how much more incremental margin do you think that you could get besides vendor efficiencies, which you seem to be driving these, how much more could you get just for simply increasing the share of your revenue coming from hard goods, house brands and also pharmacy?

Nat, elaborate on that question. Before I answer it, I think it's a bit of a broad question. I started tracking with you, but I lost track of the question kind of midway. Can you maybe rephrase that?

Well, okay. Actually, could you give us a little bit more data on your mix shift in the quarter? Are you continuing to see mix shift towards higher gross margin products like hard goods and pharma? And if they are not the major driver as you have said of gross profit, the 300 basis points improvement on year-over-year, probably because they're too small at this point, I'm guessing, how -- if they became -- in your estimation as you grow those businesses further, how much more could they contribute to gross margin?

Got it, okay. Here is how we answer that question, right. The way we think about it is that we're going to go back to the way that we're executing our strategy. The first part is doing more of the same, which is the larger the base of active customers, bringing on more customers to the platform and growing our assortment in a meaningful manner, are sort of the first bucket that we always talk about. And so the expansion that you are seeing today is attributed primarily to those three. Right. The second bucket that we always talk about is expanding or the way that we are differentiating ourselves with, A, the healthcare segment, and then B, bringing private branded assortment, not that is competitive to our national brands but bringing private branded assortment that is differentiating to our customers and filling out voids. These are two vectors that we fired that haven't fully landed. And my previous response to Doug was an allusion of the -- was alluding to the fact that our healthcare hypotheses is of course the fact that when customers interact with healthcare, we should be seeing them engaged with Autoship and build mixed baskets. So a small portion of that is starting to show through. Essentially our hypotheses are starting to show through. But not much to talk about there. And then the third vector was -- the third bucket is our strategy on vectors that we have not yet fired or launched, which are future expansions. Does that help answer the question?

Yes, but just to maybe nail a little bit what Doug said before, you're already at 23.6%. You only have 140 basis points to go to the low end of your five-year target. With more mix shift, shouldn't you easily exceed that and way before five years?

I think the way that we think about it is, we provided a five to eight -- 500 to 800 basis point expansion opportunity from the 20 points that we exited 2018 at, so just to sort of baseline it. And the way we think about it is that bucket number one and two that I talked about, right, should get us -- as you're seeing, I mean that's the major progress that we're making. So that's where we're delivering the margin. And then a combination of bucket one, two and three essentially over the long term gets us to the upper range of that. And honestly, we continue to improvise and innovate. So at some part of this is, we're kind of learning our way into this. And as we learn our way -- as we learn stronger, we update our guidance accordingly.

Great, thank you very much.

Your next question comes from Deepak Mathivanan with Barclays. Your line is open.

Hey guys, thanks for taking the question. Two questions. So first, can you talk about the benefits of the new Data Management Platform and the master dataset specifically with respect to the marketing initiatives? Should we expect to see ROI improve from better attribution and targeting from these? Is that something that would show up in net adds over the next few quarters? And then the second question related to SG&A in the quarter. It was a little bit higher than our forecast. Obviously some of that was due to SBC and then the new fulfillment center line. Are there other areas like transport management systems, maybe from a technology standpoint or actually initiative standpoint where expenses are meaningfully incremental? Thank you.

Thanks, Deepak. So Sumit will take the first question. I'll take the second one on the SG&A. Actually, let me just try to answer the SG&A portion. I think to your point, the percent -- as a percent of -- SG&A as a percent of revenue, it did increase, but it is really limited to a couple of items. One is we launched the new FC in Dayton, Ohio. We also booked higher share-based compensation expense, and that was a $37 million increase versus Q1. And then we also began to report some costs related to operating as a public company. If you normalize for those three items, Deepak, you are basically at the same percent of net sales as Q2 last year. So really, it's those three items that drove the increase.

And the first one, Deepak, on the DMP, so there's two things that happen, right. So we -- one, we internally have now created a master dataset that connects our pet data, our vet data, our customer data all at the same time, which is a pretty powerful combination to have, because if you think about us as -- I want us to think -- internally, right, Chewtopians know that Chewy -- we don't think ourselves as an e-tailer of products and supplies. We think of ourselves as building an experience-led proposition on the back of product technology and good data. And that's essentially the stepping stone of this. So when you have data like that, it allows you to do a couple of different things tactically and strategically. The measurements since we just put it in, there is not much data or measurement to talk about, but I'll speak to you on two fronts on how we seek to utilize this information. One is obviously allowing us to better -- segmentation ability gets better and our targeting gets sharper. As we do that, the efficient frontier -- for us to find the efficient frontier and drive efficiencies through our marketing gets better. So that's kind of your point on are you going to be able to attribute better. Yes. That's our learning hypotheses and that's what we are leading in with. Number two, what it allows us to do is build experiences. I mean, think about the fact that we have the millions of active pet profile data that allows us to connect and personalize that experience into a customer, but not just that, when we recognized health and wellness needs, we can actually surface that and connect the pet parent to the vet community. And that's the second angle that we're thinking of it there. So there is two there. And on the back of product and tech that we're bringing to the -- to our platform and to the marketplace, that's how we think about those two connecting.

Okay. Mario, if I can just ask you to elaborate sort of related to that point on with respect to the full-year guidance, obviously, you raised the full-year revenue guidance and gross margins continue to see pretty good tailwind, but the EBITDA margin was only revised like 20 basis points higher on the low end. I mean are there incremental costs that you think as you go forward for the rest of the year that we should be aware of?

Deepak, the way I would answer is that we do have incremental costs, that we're beginning to see those reflected in the Q2 results and us operating as a public company, Things like insurance and professional fees, and filing fees and the like. But we've accounted for that in the guidance we provided.

Got it. Okay, super helpful. Thanks, guys.

Thank you.

Your next question comes from Brent Thill with Jefferies. Your line is open.

Great, thank you. You've done a great job of adding customers to the base. I guess many are asking about the competitive differentiators that you're seeing that are helping to stand out. Anything new that you're seeing from some of the larger players in this space that have been notable, either headwinds or tailwinds that you're seeing currently? Thanks for taking the question.

No problem. This is Sumit. I'll take that one. It's good to hear from you. I think it's -- we are completely focused on running our business, executing to the strategy that we've laid out and ensuring that our team is fully focused and feels empowered to go out and deliver the results that we seek to deliver. From that standpoint, as you can see, we're focused on the innovation, we're focused on bringing the customer base on, we're focused on differentiating ourselves, we're focused on the same vectors that we always talk about, the healthcare, the private brands, expansion of assortment, the experience building. I think now what you're starting to hear us also talk about is our emphasis on building products -- experiences on the back of product and tech. And that's how we see ourselves. If there is a more specific question, happy to take it.

Yeah, I guess, just anything new competitively that you've seen from anyone in the last couple of quarters that's changed your view in terms of what the landscape looks like?

Nothing that I would characterize out of normal run of the business operation.

Perfect, thanks.

Your next question comes from Mark Mahaney with RBC Capital Markets. Your line is open.

Thanks. Could you just drill down on customer acquisition costs? What you saw in the quarter? And then just talk about how you think those should trend going forward. Thanks a lot.

Hi Mark, this is Mario, I'll take that question. No difference in the trends that we've seen in years past. Q2, some of the input costs tend to rise a bit there, TV [ph] is a bit more expensive in Q1 on a regular basis. And we've seen that in prior years. But other than that, we didn't see a significant difference in the acquisition costs. I would say if you look at what did happen in our active customers, we did see an increase, significant increase year-over-year; 12 million active customers at the end of Q2, a 40% increase versus Q2 last year. So we feel really good about where we are in active customers.

Mark, this is Sumit. Here's what I will layer on, on top of that then. So when you think about -- recall the commentary on the way that we go to market today in a way that -- in both our targeting and our response is acquisatory in spend, and we are starting to lean in, recognize the fact that there is opportunity for us to take advantage of our low awareness numbers. And therefore connect the dots across lower, middle and upper funnels, and refining our approach and sophistication in how we go to market. So I think that's what we mentioned in the earnings script as well. So as we go learn, I think we'll come back and talk to you more about that, but we expect that to drive a lot of good learning into our engine.

Thank you, Mario. Thanks, Sumit.

Thanks, Mark.

Your next question comes from Eric Sheridan with UBS. Your line is open.

Thanks for taking the question. Maybe one about Chewy Pharmacy. Obviously it's still relatively early days, but curious about what sort of uptake of the product you're seeing. How are you thinking about that product maybe arching or changing the trajectory of customer lifetime value on the platform as people sort of adopt it? And what are some of the key investments you think you need to make as you look out over the next 6, 12, 18 months to make sure you're successful in that vertical, just so it's front of mind for investors? Thanks, guys.

Sure. It's good to hear from you, Eric. First of all, what we know is that greater than 75% of pet parents out there have at least one pet that has a necessity for a health and wellness check or a health and wellness need in some way or the other. Recognizing that we also know that we have 12 million active customers and we're early in that stage. Our level of focus and investment has gone in two areas so far. One in understanding our customer needs and providing an assortment in front of them, and then tying that back with an experience and targeted marketing, which is where I think the comment that I made was that the Autoship subscriber rate into healthcare, the stickiness of that customer, the way that they're building baskets, our hypotheses across the board on these three or four different metrics that we're tracking, we're pleased with it. The type of investments that we're making is we are investing sometimes ahead of the curve to protect customer experience, and that's how we do business. And I believe that's the right way to do business. And in that, we are expanding our capacity. Last time I talked to you about expanding our presence in the Phoenix location. So we have -- so we're shipping out of Phoenix now. There our licenses have expanded. We have now licenses to ship to 40 states from our Phoenix location. So we're coming along as planned. And then in Q2, we also opened another location where we brought on a wholesale license. So at this point we have not only retail licenses, we also have wholesale licenses in the way that we want to service our customers, as well as our vet community. I will say one last thing. Our focus on building products for not only for pet parents, but also for the vet community is something that we are completely focused on. Last time I spoke about the Rx product manager launch, which our customers are engaging with. As we continue to interact with each other, I hope to come back and talk to you more about the products that we're building for the vet community, which we believe should be tremendously powerful as well.

Thanks for the color.

Your next question comes from Brian Fitzgerald with Wells Fargo. Your line is open.

Thanks, guys. A couple of questions on the Salisbury coming online, can you remind us how the tempo progresses there in terms of -- and how that's been trending from ground break to launch? And on the transportation management system that fully rolled out across all the FCs? Finally one more on the logistics side. Given the Ohio and North Carolina builds, how do you think about regional penetration or awareness differences and how do you think you can penetrate those areas and those opportunities where you're less densely populated with consumers?

This is Sumit. I'll take a crack at that. So three questions there. North Carolina remains on track to open next year. No change there, nothing new to share. Second question is TMS. We rolled out TMS. We consider this a Phase 1 successful roll-out. And we are rolling it out in three phases. And the next two, we believe are fast followers and the full roll-out will happen before the end of the year. The third question is how do we think about logistics across Ohio and North Carolina build and how can -- I'm trying to recall, how can we penetrate those areas of opportunity.

Yeah, thanks. The question was around building more East Coast-centric versus West Coast-centric, and how you think about regional penetrations and awareness differences maybe across different regions, now you penetrate those opportunities?

Sure. I mean if you look at traditionally, logistics networks in North America are built to support where the demand and population density lies. So kind of roughly breaking down -- that breakdown is generally 40% on the East/Northeast, 30% Mid; 30% West. And if -- we're very diligent and very strategic about where we place FCs. We have a long planning process that goes behind it. We want to connect the logistics arc in the right way. We take -- we look at where our transportation partners are playing. We want to make sure that our click to deliver -- our delivery to our customers is fast, reliable. All of those factors go into play. And on the back of that is how we are thinking about launching Ohio and North Carolina. If there is something more specific that you're going for, just ask.

No, that's great. Appreciate it, Sumit.

Great.

Your next question comes from Mark Kelley with Nomura. Your line is open.

Hey, great, thanks guys for taking the question. I appreciate it. The first one is, can you just talk about the labor market a bit? I know it remains tight. But it sounds like some areas are tighter than others, like Wilkes-Barre for example. What are your thoughts on just how competitive you are in the market? And second, along with your DMP commentary, it sounds like you're continuing to build out the marketing tech stack. I was curious what else do you think you need at this point and what investments you still need to make there?

Hey Mark, this is Mario. I'll answer the first part of the question. In regards to labor market and how competitive we are, look, we believe we provide our nearly 11,000 team members with competitive wages, good and improving benefits, and a great working environment, and we strive to do that every single day. So from our point of view, we've been successful at attracting talent in all our locations.

I'll take the second one. On our marketing stack journey, I would characterize as us being 70% of the way there. We have a DMP, a DSP identification software and all that stuff already hooked up together. And now it's about really connect back and understanding how we really -- rather than treating these as singular unit systems, how do we collectively go to market with smart segmentation and smart attribution in the back. That's what we have to do.

Great. Thanks, guys.

There are no further questions. I will turn the call back to Sumit Singh for closing remarks.

Thank you all for your attention and participation today. We look forward to seeing many of you in the coming quarters. Have a nice evening.

This concludes today's conference call. Thank you for joining us. You may now disconnect.