Chewy (CHWY) Q2 2026 earnings call transcript

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 2nd quarter results for fiscal year 2026. Joining me today are Chewy CEO Sumit Singh and CFO Chris Deppi. 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. 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 10k 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-GAP financial measures. Reconciliation of these non-GAP items to the most directly comparable GAP financial measures are provided on our investor relations website and in our earnings release. These non-GAP measures are not intended as a substitute for GAP results. Additionally, unless otherwise stated, all comparisons discussed on today's call will be against the comparable period for fiscal year 2025.

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 submit.

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 discipline the 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 two to three times. 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 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 equine farm and exotics 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 chewy 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 smart pack and modern animal, Q2 organic net sales increased 5.7% year-over-year, driven by active customer growth, nest pack 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. Watership 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 even the margin reads 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 for 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 two 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 a broader chewy health ecosystem, providing meaningful runway for future growth. Furthermore, while 2026 is intended to be a foundational year for SmartPak as we strengthen the business core operating drivers and position it for durable growth, our early progress has been encouraging. SmartPak 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 strategy continues to progress from capability development towards scaled deployment and measurable financial impact. In Q2, we made strong progress deploying AI across three areas, improving the customer experience, increasing team member productivity, and structurally lowering our cost to serve. On the customer side, we recently launched CHI, 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, ownership, 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 Kali, which is supporting appointment confirmations, scheduling, and routine follow-ups while reflecting chewy's brand voice and customer's 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 scaling to approximately 50 million dollars on an analyzed 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 smart pack 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. She remains well positioned to gain share profitably, 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 so much, and thank you all for joining us today. Q2 performance demonstrates the strength and consistency of Chewie's execution across the business with total enterprise net sales at the high end of our guidance range, and adjusted even a margin exceeding our expectations.

Let me start with our financial and customer performance. Second quarter net sales reached 3.33 billion dollars, representing 7.3% year with your growth. Excluding smart pack and modern animal, organic net sales increased 5.7% year over year, consistent with the midpoint of our prior expectations. Load-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 nest pack, and ongoing market share gains. We ended the quarter with 21.7 million active customers, representing 3.8% year-of-year growth, and 208,000 sequential net additions. This included 43,000 unique customers who have transacted with smart pack since the acquisition and are now reflected in our active customer account. Autoship customer sales reached 2.8 billion dollars, increasing 9.3% year-of-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 revenue base. Nest pack reached 602 dollars. On reported basis, nest pack increased 1.9% year-of-year, and on a normalized basis, accounting for the extra week in the prior year comparable period, nest pack increased 3.8%. Nest pack 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, treats sales growth slowed more sharply than growth in core food, reflecting moderation and 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 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 growth 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 non-recurring map-related pricing and other benefits realized in the second quarter of fiscal 2025. Growth margin exceeded expectations supported by continued growth in sponsored ads and disciplined promotional activity. However, approximately $10 million of upside-reflected timing-related benefits, primarily tariff-free funds that were received earlier than anticipated, as well as certain rebate benefits that shifted from 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 discrete items accounted for essentially all of the adjusted EBITDA outperformance relative to expectations. Even excluding the benefits, adjusted EBITDA margin expansion remained very healthy and growth margin expanded year-over-year after normalizing for non-recurring items in both periods. At these timing benefits normalized, we expect growth margin to decline modestly on a sequential basis in Q3. 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 growth 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-GAP 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, discipline 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 $250 million for 6.5% of net sales, essentially flat year-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 discipline 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 in 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 36 cents. As discussed, the majority of the upside relative to our guidance reflected timing and other non-recurring 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 adjust an even 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 toward shared repurposes. We repurposed 9.9 million shares during the quarter. After accounting for shares issued on the chewy employee equity programs, these repurposes resulted in a 2% sequential reduction in weighted average looted 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 shares are undervalued at current levels. We purchases 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 review, 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, smart pack 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 year-of-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 expectations delivered 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 contemplated either an improvement in the market backdrop, stronger execution against our plan, or a combination of both. Conversely, the low end assumed some renewed deterioration in the operating environment, although less pronounced than the downside 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 four-year fiscal 2026 and just even a 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-of-year margin expansion.

At the midpoint, this implies over 100 basis points of year-of-year adjusted even to margin expansion and $912 million of adjusted even for fiscal 2026. Consistent with our comments last quarter, this guidance includes a modest margin rate drag for modern animals. For the third quarter of fiscal 2026, we expect net sales of $3.323 billion to $3.358 billion, representing reported year-of-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 four-year guidance I just described. For the third quarter, we expected just an even margin of 6.6 to 6.7%, representing roughly 85 basis points of year-of-year expansion at the midpoint. We also expected just the 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 to $15 million, capital expenditure of 1.5 to 2% of net sales, and an effective tax rate of 24 to 26%.

In closing, Chewie'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 submit for closing remarks.

Thank you, Chris. Two clues. The key takeaway from the quarter is that Chewie 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 Chewie, while authorship 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 Chewie health, including the early performance of modern animal and the continued scaling of Chewie wet care.

As these businesses grow, we believe they can deepen customer engagement, expand wallet share, and become an increasingly meaningful contributor to Chewie'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 Chewie 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 Chewie team member for their continued dedication and to our customers for their trust.

Operator, we are now ready to take your questions.

I'll stay away from precisely defining the penetration of treats within the business. But candidly, what you're hearing is essentially discretionary doesn't just mean supplies. I think that's the meta point that currently consumers are continuing to spend at a pretty normal level on their core food meds and the engagement through authorship remains very strong and healthy with chewy. And from a discretionary part of consumables, if the treats and the toppers, if you look at an average consumer, an average consumer with experiment with over 10 types of treats 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 household that we serve.

Some go on auto ships, some don't go on auto ships, some go on auto ship and come off. So there's 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. 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. And so the two businesses are being influenced by different underlying factors.

Consumables remains our largest and most mature category and auto ship 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, you know, 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 outside share capture, given that we 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, you know, there are certain types of these merge classes that are a bit more, you know, 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 term, might be our health related categories or the large, you know, and strong equine business that we're building, very healthy growth rates there.

Yeah, both good questions. So we haven't yet sized the, so we've sized the impact of net ads. 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 ads. 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 smart pack this time. In terms of conversion of customers to auto shift, 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 on 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 auto shift platform trending to be high. There is no reason to believe that this would not translate much like a chewy customer or normal chewy based does.

Sure.

Yeah, 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 just share my thinking a bit out loud. So I think you should think about it two ways. One, either the question sort of like, hey, how much would you consider investing to accelerate revenue growth? And then the second part is, you know, I guess what levers do we have available to accelerate sales growth, right? And so investments 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 slash drive growth at very healthy ROI.

You know, so those, if I take you down the list on the top of my mind, a remain enthusiastic about chewy plus, and we expect to introduce a refreshed program design very shortly into the market. You heard me talk about, you know, 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, you know, 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, you know, accept and deterioration in marketing efficiency.

So for Q2, we leaned in a bit and, you know, we did not tolerate any deterioration in marketing efficiency, and our targeting conversion CRM and app capabilities are the areas that we essentially leaned in on. And that continued to improve, you know, they continue to improve those capabilities. And they supported more efficient acquisition of high quality customers for us in Q2, which we expect to repeat, you know, going into Q3. You also heard on the earnings call that we said, we expect to lean in a bit and, you know, invest in brand building that we believe is a prudent investment in front of the holidays. But it also sets up, you know, importantly, 2027 in a very strong way.

You know, this is a playbook that we're boring 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, you know, 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 nest pack 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 earnings and margin objectives. Right? But I will leave you with this thought. Look at fiscal 25 and 26 out there, 25 results and 26 outlook.

Incremental margins reflect several moving pieces. Right? We have structural margin drivers that we've articulated for some time, and we continue to deliver across those as expected. You know, we have the cost associated 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, you know, leaving ourselves the room in the capability to drive accelerated growth without taking away from the algorithm that we've shared with you.

Just one small follow-up there on the Chuy plus redesign. I guess how to take through what the learnings have been from that program to date and where you feel you can drive some economic improvements to increase adoption?

Yeah. So we really liked the program so far. You know, it's helped us drive. It's helped us learn the boundaries of, you know, 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, you know, five quarters now. And that's, in our opinion, a good amount of learning. And what we found was, you know, through the voice of the customer, customers have loved, you know, the same sort of chewy forward customer centric principles that we've leaned in with, you know, 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, you know, we heard that while customers really appreciate the components that we brought forward, you know, 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, you know, the program design evolving to include, you know, a multitude of health benefits that then drive the customer to interact across a variety of our businesses, you know, 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, you know, meet the new chewy plus, you know, cheaper, better, more care, you know, integrated, right?

And that's a terrible copy, but that's why I'm not a marketing copywriter. But you should expect, you should expect us to listen to customers and go out and really position the program to gain scale and drive, you know, the attachment and the incrementality in sales stronger than what we are seeing today. So we're excited without, without really, you know, disturbing the margin kind of contribution profile of that particular program. So that's how we're thinking about it. More to come in two, three.

I can take the first part. Chris will take the second part. There's a lot here in, in what's going on within the pet industry. I would say broadly, you know, when we entered Q1, we'd started noticing some signs. You'd heard me comment at some of the conferences around, hey, the industry, you know, 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, you know, started deteriorating a bit in the April, late March, April timeframe, which is what you've heard us comment on our Q1 earnings call, and we reset our guidance at that particular point. 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, you know, the promotionality environment to be irrational, which is, by the way, what we are continuing to see for the most part. You know, there are sort of peaks and valleys in some promote promo, you know, in some months, but for the most part, the environment's relatively stable. And then underneath of that, you know, 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 slash strengthened towards chewy, and online continues to pull share from the overall industry. And so the secular trend tailwind plus the value prop that we're bringing to the table allows us to continue to aggregate share, albeit in this slightly more pressured consumer industry, right, in the consumer pet world.

So that's kind of how we're projecting. So you heard in our comments, stable, we're not faking 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?

Yeah, just to reiterate, you know, I think about how we said guidance, we updated our outlook, and it does not assume any recovery, assuming noted, or any improvement in consumer behavior. You know, the trends we've seen have been broadly consistent with what we saw exiting Q1, and we view that moving forward. You know, within that backdrop, you know, our outlook reflects continued execution against the drivers that we can control, which is active customer growth, retention or reactivation, auto-ship engagement, cross-category adoption, health care growth, market share gains. And so, you know, we expect to grow meaningfully ahead of the category without needing that external recovery. You know, we do believe we have a greater visibility into the range of outcomes.

The stability and trends, you know, allowed us to remove the more severe downside scenario that we contemplated last quarter, allowing us to narrow that organic growth range. You know, for us to high end would require either some better market backdrop, you know, stronger execution against our initiatives or some combination of those two. And the low end, you know, 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 last quarter.

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

And as a follow up, Sumit, you've been very helpful in kind of thinking through the agenda side of all of this. Any update on sort of AI chatbot, 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 a headwind, does the business become more relied on auto shit, anything updated really helpful. Thanks.

It's a we think of it as a net tip when Dylan has and I've continued to maintain that point of view, including, you know, 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 Chewie's position in terms of search aggregation and search demand, you know, traffic driving towards Chewie. Secondly, you know, on our surfaces and evolving consumer behavior in terms of product discovery. So one of the unique products that I mentioned, you know, 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 Chewie and deepening their engagement.

So, you know, I won't give the details away here. Shortly speaking, we will continue to innovate behind this new technology and utilize it to improve experience and drive deeper consumer engagement, while making sure that as the aggregation shifts upwards to agentic surfaces, Chewie's position to lead and capture an outsized portion of that demand.

Hey, Doug. 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, you know, the update that I provided this morning on our customer-facing AI assistant named CHI, CAI. You know, we are in still, you know, 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. You know, when we lowered the sales guidance, as you recall, you know, 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, you know, 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, you know, essentially, these are structurally lowering the fulfillment costs that it takes us, you know, to essentially pick, pack and ship an order to you.

And so that's very durable. Same thing in customer service, you know, 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 in and lower the cost to serve structurally. So yeah, hopefully that kind of gives you a sense for why we don't just believe that these are an experiment mode, we believe these can be embedded.

And as the scale, right, it sort of compounds the earnings that you 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, you know, 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, you know, attractive growth opportunities. So net net, we view AI as a powerful enabler of continued margin progression, not as a standalone 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. Yeah, absolutely. Doug, we feel strongly about our multi-user outlook and roadmap to lower the cost to serve. You know, Sumit talked about some of the AI initiatives. We also have continued automation. You know, 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 roadmap there to continue to lower our verbal costs to serve and deliver SGA leverage, you know, you know. 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 in here and how I would wrap that up.

Chris, I'd love for you to dig into that a little bit more. You talked about gross margin being down. You're over here in the third quarter. Just elaborate on that a little bit and maybe to zoom out, you know, a gross margin tailwind for quite some time. Help us understand the contribution this year from a creation perspective and that can that continue to be a creative as we look into next year. Yeah, thanks Steve. So just one clarifying point here. You know, in the script we talked about Q3 being down sequentially from Q2. It will not be down year over year. So Q3, the quarterly margin progression 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, you know, sponsored ads will be a tailwind, has been a tailwind for some time since we launched program in fiscal 2023. You know, we continue to deliver gross margin tailwinds from sponsored ads, both on-site ads and off-site ads are growing this year. And, you know, gross margin also continues to benefit structurally from Bix premiumization as we move forward and grow our Q2 health ecosystem. And so, you know, sponsored ads will continue to grow and, you know, 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.

Two 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 the lower level than what you saw in 2025. And so, essentially, we said, you know, margins are expected to expand, albeit at a lower rate relative to 25. The only thing that has changed since the, well, things keep changing monthly, but the broad trending that has changed is when we came into the year, we didn't really understand, you know, how much tariff, no, sorry, not tariff, how much fuel impact should we bake in relative to, you know, the war in the Middle East. And so, we'd 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, you know, headwind while continuing to deliver expanded gross margins as we move through the year. So, overall, quite satisfied with the story.

So, when you think about what's missing for the industry to see higher growth, you know, how do you break it down, whether it's macro or whether it's just the softness and 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 adoption is tied closely to some of the macro factors as we talk about. So, these two things are, you know, correlated slash causal in nature.

You know, dog formation is closely linked to household formation, less linked to, you know, kind of a renter's market per se. So, when you look at, you know, 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, you know, on a real estate basis, CATs are much more, you know, friendly and economical from that standpoint. And B, we're seeing a lot more CAT innovation happen now than we've seen, you know, over the last decade or so. Number two is pricing.

Now, you know, recall helpful to recall that we've gone through double-digit inflation for a few years compounded, you know, as we've come out of the pandemic years. Now, it's been stable, you know, for the last several quarters. But, you know, there have been other factors that have then pressured the consumer's mindset, albeit, you know, fuel, gas, grocery, et cetera. And so, to us, you know, all of this goes into, you know, what we believe is, you know, headwind towards cost of ownership, right, which is why, you know, retailers and retailers that are trusted in delivering value, passing on that value, passing on convenience, you know, and helping consumers, you know, 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, you know, as a short-term or transitory headwind, and our focus is to continue to build chewy and strengthen, you know, 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.

Thank you for taking my questions. Maybe a follow-up on AI Summit. Can you dig in a little bit more on the early takeaways from Cali or Kai? And, you know, how do you think the customer impact and the customer experience will evolve over the next 12 to 18 months? Thank you.

Yeah, so obviously, you know, when we took a customer-facing project that product that essentially, you know, 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, and in terms of being true to brand and tone, it has to be spot on. And so, you know, in terms of success parameters and dimensions, you know, 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, Kai is, you know, 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. You know, it is addressing what we believe are the top, you know, contact drivers, right? Where's my staff? Where's my order? You know, shipment status? I need help with ownership management, those type of customer inquiries. We've also embedded automated returns and refunds, you know, which is powered by our deep study and knowledge of machine learning in the background, you know, into Kai. 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 propensity 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, you know, the convenience right on top of mind, it meets them where they want to be met. And then imagine, you know, 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, you know, to build more holistic solutions that then combine product recommendations, you know, 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, you know, or they'll essentially have to go out and integrate through third party providers where all of our solution is force party built. So we're quite, quite excited about, you know, the the journey of this, we can't wait for inference cost to continue to come down, because candidly, you know, 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, you know, these are outbound appointments, scheduling, you know, type of use cases that we're trying out with Cali, which is a voice agent.

So we have both capabilities at this point. Kai is a chat based capability and Cali is a voice based capability. We're trying out with multiple different types of use cases.

Sure.