Good afternoon. Thank you for attending today's Chewy's Q4 Fiscal Year 2021 Earnings Call. My name is Bethany, and I will be your moderator for today's call. [Operator Instructions] I would now like to pass the conference over to our host, Robert LaFleur, Vice President of Investor Relations at Chewy. Please go ahead.

Thank you for joining us on the call today to discuss our fourth quarter and full year results for fiscal 2021. Joining me today are Chewy's CEO, Sumit Singh; and CFO, Mario Marte. Our earnings release and letter to shareholders, which were 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 is also available on our site. On our call today, we will be making forward-looking statements, including statements concerning Chewy's future prospects, financial results, business strategies, industry trends and our ability to successfully respond to business risks, including those related to the spread of COVID-19, including any adverse impacts on our supply chain, workforce, fulfillment centers, other facilities, customer service operations and business expansion plans. Such statements are considered 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 differ materially from those contemplated by our forward-looking statements. Reported results should not be considered an indication of future performance. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward-looking statements, except as required by law. For further information, please refer to the risk factors and other information in Chewy's 10-K and 8-K filed earlier today and in our other filings with the SEC. 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 and letter to shareholders, which were filed with the SEC on Form 8-K earlier today and in our 10-K. These non-GAAP measures are not intended as a substitute for GAAP results. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of this call also will be available on our IR website shortly. I'd now like to turn the call over to Sumit.

Thanks, Bob, and thanks to all of you for joining us on the call. Let me first share some thoughts on 2021, and then broadly about the pet industry overall and why we remain optimistic about this sector and Chewy's place in it. 2021 capped off the most remarkable 2-year period in our company's history. As the pandemic unfolded, Chewy benefited from an acceleration of the secular trends that have been driving our business for many years. Increased pet ownership, increased average spending per pet household and more of the spending being directed to online channels. Millions of new pet families were formed and as a result demand for pet products and services surged. Our team scaled rapidly and our business nearly doubled, delivering a $4 billion or 83% increase in net sales over these past 2 years. Over that same time frame, we expanded our active customer base by 7.2 million customers or 54%. More important, we believe that these games are sustainable over the long term. Pets are part of our families for many years, and the puppies adopted during the pandemic marked the start of a 10 to 15-year long relationship between those pets and their pet parents. And for many of those pet families, it was also the beginning of a long and rewarding relationship with Chewy. The predicable and recurring nature of these relationships gives us confidence that the customer and revenue gains that we made are enduring and will provide a lasting foundation for future growth. In many ways, we are just getting started. We compete in a $120 billion pet TAM today that is expected to grow rapidly over the next 5 years. And within that broader pet TAM, e-commerce sales are expected to grow even faster. We believe that Chewy will continue…

Thank you, Sumit, and thanks to all of you for joining us today. Fourth quarter net sales were $2.39 billion, reflecting a 16.9% year-over-year increase. On a 2-year stack basis, Q4 net sales were up over $1 billion, making the largest 2-year increase for any quarter in fiscal 2021. For the full year, net sales increased 24.4% to $8.89 billion. On a 2-year stack basis, full year net sales increased over $4 billion or 83%. Autoship closed 2021 on a strong note as the value proposition of the program continues to resonate with our customers. Q4 Autoship customer sales increased 21.2% to $1.69 billion, exceeding the pace of overall net sales growth. On a 2-year stack basis, Q4 Autoship customer sales were up 77%. As a percentage of net sales, Autoship customer sales set a new record high of 70.7% in the fourth quarter and Autoship customer sales exited the fourth quarter on an annualized run rate pace of $6.8 billion, which is nearly equal to the level of total net sales we reported in 2020. Customer spending remained strong as Q4 NSPAC increased 15.6% to $430. This is up $70 from 2 years ago when our NSPAC was $360 and demonstrates our continued ability to capture greater share of wallet from our customers as they mature in their relationship with Chewy over time. We ended the year with 20.7 million active customers, a year-over-year increase of 1.5 million customers or 7.6%. And while the customer base continued to expand, net active adds were below our expectations due to lower retention rates for the Q4 2020 cohort. We believe these lower retention rates reflect several factors. The first was timing related as the second major wave of COVID infections and the arrival of the second round of stimulus, both occurred…

[Operator Instructions] First question is from the line of Doug Anmuth with JPMorgan.

First, just hoping you could provide some color on how you're thinking about the mix in growth between active customers and then NSPAC in '22. And then you talked about mitigation efforts offsetting some of the gross margin headwinds around shipping and logistics. Are those the same initiatives that you talked about a couple of quarters ago related to software and fulfillment efficiencies? And any more color you can provide there on timing?

Doug, it's Mario. I'll start us off and then Sumit will answer the second part of your question. And before I give you sort of color on '22, let me just give you a bit of explanation about Q4 because that will give you some intuition into how we think about 2022. So let me start with the facts. We ended 2021 with 20.7 million active customers. That's an increase of $7.2 million over 2 years or 54% increase. And in Q4, we did see the net active adds came in softer than we expected. It came in a bit lighter than we expected. And here's why. When we look at year 1 retention for customers who joined the platform in the first 3 quarters of 2020, those rates were all within historical ranges, and we shared this before in our previous calls. When we look at the Q4 2020 cohort, that their retention rate which we said is high, did decline by single digits versus the historical trend. And that extra attrition was enough to offset some of the gross adds we had in Q4, the gross customer adds we had in Q4. And the result, as we had softer sequential active growth -- active customer adds, in the fourth quarter. You heard Sumit statement about why we think that is. We don't have perfect data, certainly. But we do believe it's a function of the macro environment in 2020 because of the second wave COVID and then obviously, the second round of stimulus checks that arrived in Q4 2020. Now I say all that, so I can give you a perspective of '22. When we look at 2022, we are still in a very fluid environment. We have an economy that's reopening. We have supply chains that are…

Thanks, Mario. Doug, helpful to remember that 2/3 of our 21 million active customers have been with Chewy less than 2 to 3 years. And so as we kind of amplify the curve as it grows from the cohort spend point of view, that's the healthy spend that Mario is talking about capturing. Now coming to the second part of your question on gross margin mitigating initiatives. So first, these are incremental initiatives to the ones we've talked about before. And two, let me provide you some details on what is it that we're after here. So to combat the impact in FY '22, as we said, we're launching several new logistics and supply chain inventory and floor related initiatives that will be scaled, launched in '22, but also scaled over later half of '22 and '23. So in January, we launched a transfer initiative to optimally load balance inventory across our network. And that's helping us combat kind of long zone shipping and place products closer to customers and, therefore, mitigate some part of that impact. Number two, in Q1, in early into Q2, we're launching what I would call our transload overseas shipping initiative. And that will actually help out international inventory more optimally across our network and position them more ideally in front of our fulfillment centers. Number three, and this one is actually something we're proud of as well. We're launching what I would call Chewy Freight Services or CFS, which is starting out as a line-haul initiative, where we will operate a portion of our own middle mile fleet and network. We launched this into the Phoenix market in Q1 2022, and we'll look to scale this in 2022. And what this does is it allows us deeper injection into the carrier network and enables a smoother package flow that helps both cost and customer experience, particularly during the kind of macroeconomic environment that we live in right now. And then in addition to these logistics initiatives, our newly formed supply chain research and planning function is focused on building and improving capabilities. That will enable improved topology and inventory buying and placement, including geo-located inventory discovery for customers. And order routing that you're talking about is an example that lives as part of this team, but these initiatives that I'm talking about are incremental to that. So the order routing technology was the proprietary homegrown system that analyzes inventory availability in real time, if you recall, and efficiently route orders to the appropriate fulfillment centers to minimize the incidence of split orders or orders sent over long distances. These will further complement our logistics initiatives that I talked about and collectively help us mitigate a majority of the increase that we're seeing from the freight rate rate card. Hopefully, that was helpful.

Our next question comes from the line of Brian Fitzgerald with Wells Fargo.

A couple of questions on the sponsored ads launch, maybe 3 there. First off, there's a large amount of vendor spend in terms of trade promotions and slotting fees at grocery and brick-and-mortar retail, something like $150 billion to $200 billion in the U.S. Do you know -- or do you have a sense of how much is being spent in trade promotion specifically in pet category? Number two, wondering if you could remind us how often you see a customer on site once they're enrolled in Autoship? How often is your audience on site going to be there to potentially receive ad messages? And then last one is just -- do you have any thoughts over time on lining up off-site advertising, leveraging your internal data?

Brian, this is Sumit. I'll take them. So not much to add today beyond what we said in our prepared remarks. Suppliers see what I can tell you is that the opportunity size is large. And the dollars in our opinion, are uniquely positioned outside the trade funds. And suppliers see tremendous value in gaining advertising across to the customer base and to the experiences that we offer. So in that way, we see it as a potentially meaningful high-margin recurring revenue opportunity in the future. Secondly, in terms of Autoship customers, our Autoship customers, even though they're subscribed to the service are highly active and recurring in their purchase and shopping behavior. To give you a perspective, 2/3 of our base is -- our ownership base is what we consider base load, which is recurring, repeat, staple in nature. And the rest of it is highly experimental. We see customers with multiple open Autoships at the same time. They come in, they go out. And they remain highly engaged, including through our promo kind of campaigns when we actually do choose to include those customers to be a part of it. Our ownership customers are also part of our active kind of launch and innovation campaigns and they do highly actively participate. So we believe that this will be open, and therefore, an opportunity for that customer base as well. And then finally, your third part of the question is the line of off-site advertising using internal data. You're going to have to explain that a little bit because I'm not sure clear on the question you're asking.

Look, at an ad network extensibility type of thing.

I see. It is on our radar, but not much to share today.

Our next question comes from the line of Stephanie Wissink with Jefferies.

Steph Wissink from Jefferies. Two-part question. The first is just on the inventory levels. It looks like your balance sheet inventory was down quite a bit. Help us think through the availability of inventory and the constraint on the first quarter what you expect through the balance of the year as your in-stocks improve? And then just on the cash flow, Mario, a question for you. How should we think about the burn rate in Q4, the available cash you have to fund the business, slightly higher CapEx in 2022. How are your liquidity standings? And do you think you'll need to raise cash as we progress through the year?

Steph, I'll take both questions and Sumit can add something else to the inventory, if I miss anything. Inventory levels, so -- you heard us say that the impact of Omicron in mid-quarter had an impact -- it negatively impacted our out-of-stock level. So they increased. Therefore, we were not able to get as much inventory as we would otherwise have purchased. And so the short answer to the inventory levels is that you saw us carry elevated levels of inventory throughout the year. And then in the fourth quarter, we burned through some of that. But to be totally clear, Steph, we would rather have purchased the inventory, of course. The reason for that is, as you heard us say, we are baking into our guidance, something in the range of $200 million to $300 million of out of stock of sales loss due to out of stock for 2022. So that gives you an idea how we think about inventory and the impact that it has on net sales. In terms of the cash use in the fourth quarter, it's -- A, it's not unusual that we would have used cash in the fourth quarter. Second is, it's really a result of the inventory build that we did go through throughout the year. We have a very favorable cash conversion cycle, where we buy the inventory, we sell it, and then we pay for it later. In this case, the time to pay for it was in the fourth quarter. And then I think the last part of your question was about how do we think about cash for 2022. Start off with the $600 million of cash and cash equivalents we have on the balance sheet. Second to that is think about that we're spending slightly incrementally more on CapEx this year, about 0.5 point more in net sales. So let's call it $15 million if we're looking at a $10 billion or so full year. So you see there's not a lot of cash burn in when it comes to the CapEx side of things. And the last thing, Steph, is look at our history. We have a history of being very diligent and efficient in the way we deploy cash. And I would expect that to be the case again this year.

Okay. That's helpful. Could I ask some point of clarification. So on the guidance for the first quarter versus the balance of the year, it would assume that your in-stocks improved. So should we overweight the burden of the out-of-stocks from that $200 million to $300 million in the first quarter. And then just maybe give us some reassurance from your vendor community that they are committing to improving your in-stock position as the year progresses?

Steph, this is Sumit. That is accurate. We are also assuming first half of the year is going to be more impacted than the back half of the year. And that also follows from the continuation of back half of 2021, where supply chains really degraded coming into Q3, if you recall, and they continued or they got worse in Q4. And that, given the war in Ukraine has actually caused some incremental near-term shortages, which will actually -- the commentary that we are hearing from our flyer base right now is that this is expected to continue through 2022 with early signs of recovery in 2023. But within 2022, the first half is going to be worse than the second half.

Our next question comes from the line of Mark Mahaney with ISI.

Could you -- I'm sorry, if you talked about it already, but international, where are you in terms of considering international ramps? And then you want to give us any color on whether that would be organic or not. And then could you spend a little bit of time on an update on the Trupanion partnership and the timing of that? Is that on track ahead of plan? Any new insights as you've done more work to prepare for that launch?

Mark, this is Sumit. I'll start with the second one. So we're on track to launch our first set of insurance offerings with our partner, Trupanion, in the very near future, I would say, within the next 30 to 90 days time frame. So that's on track, and we're excited about that. In terms of international, not much more to add there today. We recognize international as an additional TAM expansion opportunity beyond the 120 billion U.S. market that we participate in today. And so it's a credible source of growth for us. Whether we organically or inorganically, I think we'll be thoughtful about both paths and diligent accordingly relative to the market, the inputs around e-commerce penetration, logistics, operations, infrastructure and go to market and then be able to appropriately decide the right course of outcome. So it remains a matter of and not if.

Our next question comes from the line of Deepak Mathivanan with Wolfe Research.

Just a couple of ones. So first, can you talk about the pricing levels. You know that easing of the inflationary impact on gross margins. Now is that the competitive landscape sort of catching up and becoming more favorable? And what is happening to demand with the higher prices? And then second question, Mario, can you elaborate a little bit on the retention comments for '22 on the active customers? Is the retention softness that you're expecting for '22 from the 2020 cohorts or is it the 2021 cohort? Trying to understand, basically, if year 2 retention behavior is different or is the year 1 behavior compared to historical levels. And maybe you can provide some color on kind of like a marketing versus gross ads for this year, that would be great, too.

Deepak, this is Sumit. I'll try to take both and Mario will jump in as he sees So first part, let's talk about inflation. So we're taking a detailed view of our assortment and our pricing based on the cost inflation that we're seeing at the SKU level. In aggregate, this is translating to us passing single-digit cost inflation in our category. This also, as you kind of rightly mentioned, it's a top line margin kind of impacting lever. Importantly, we're being surgical and deliberate about our pricing strategy. So we're balancing demand elasticity, so as not to impact growth. And yet, we're finding specific opportunities to optimize price in the marketplace, while maintaining the strong value prop that customers have come to expect from Chewy. Generally speaking, this is a topic where there are several moving pieces on how the year will play out given the current macro environment. And we plan on being diligent and we'll let the data guide the way as much as possible. If you look at Q1 so far, prices leading cost by low single digits. And so that probably provides you some perspective. In terms of your second question, it's both. It's 2020 and '21, as Mario alluded. 2020 was a large-sized cohort. And so our attrition, even though it's small when customers get from year 2 into year 3, there is a portion of attrition that continues into the subsequent years. And then '21, his perspective is something that we share and something that we are broadly observing as the economy kind of broadly opens up. So I'll combine that answer and I'll combine marketing kind of question that you asked and answer it this way, right? I think marketing in '22 is going to be impacted by a few things, which…

Our next question comes from the line of Lauren Schenk with Morgan Stanley.

Understanding that a lot of the headwinds you're seeing are not specific to you as a sort of broader supply chain inflation, et cetera. I guess, but what gives you the confidence in the 5% to 10% margin long term? Is there any way to sort of help us think about incremental margin, the flow-through of the business ex some of what you believe are more transitory headwinds. I think any color around that would be really helpful.

Sure. Hey, this is Sumit. It could be a longer answer. So I'll try to piece it apart and frame it up in a couple of different portions. So if you recall, the components that make up the 5% to 10% EBITDA margin, the first one is scaling gross margin to between 25% and 28%. And as we reiterated in today's prepared remarks, we're confident in our ability to overcome these headwinds that we view as sort of not permanent. And the core strength in our business, the engagement, the loyalty and the future programs that we're launching, including the current ones that haven't yet sale fully and have meaningful potential left in them to be able to scale us through the high end of the gross margin range. And then the second component is SG&A. The third component is marketing. Marketing, let's take marketing first, and then I'll detail on the SG&A component. Marketing, as I've just alluded to, we're were between 6% and 7%, and we believe that these are the right levels to stay within, we'll see some leverage as our CRM and loyalty initiatives pick up in the future. But how much that leverage will be, we'll probably kind of reserve that for a call in the future. So now come to SG&A. Let me help you kind of understand how we look at this line item better, right? So in SG&A, there's 3 components of SG&A. First is the variable OpEx component that forms a large portion of SG&A, and it grows with top line. This is where we made approximately the $100 million investment in higher wages and benefits that we talked about in 2021. A large portion of that is likely permanent. When we normalize, however, for the wages, what you see underneath…

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

Matt Norton here on for Steve Forbes. I wanted to touch on the other sales because growth there continues to be strong, and we're seeing it grow as a percent of sales. I was hoping we can get an update on the line items in there. Private label, how it's trending? I don't think we've gotten an update on the penetration rate there and maybe what you've seen in terms of differences by cohort. And then within that, do you guys kind of view that as a potential lever that you could use to take share in an environment where consumers begin to show some price elasticity, maybe specifically within the hard goods category. And then if we can get any update on the pharmacy operations, maybe where sales have grown to and whether you're seeing any differences by cohort there, that would be useful.

Matt, you'll have to repeat the second part of the question. On the first part, private label or private brands, just to recall and refresh, we believe is a strategic vertical. We want to get it to between 15% and 30% of our net sales. And we've been growing that at a premium to company category growth rate. Our penetration in hard goods has reached north of 20%, and consumables is in the low to mid-single digits right now. And we expect, by the way, hard goods to lead the way into the 15% to 30%, given that hard goods are more commoditized and customer loyalty is within context when you take a look at consumables brands. So overall, we're pleased with the progress. And in terms of your second part of the same question around capability to drive growth, we are essentially going to -- we are surgically experimenting within our private brands and the categories, right, where, as I mentioned, consumers have -- they look for value and they look for high-rated consumer products. And conversion is driven as a result of conversion opportunity and less kind of prebuild brand conversion per se or brand consideration per se. So that is an opportunity for us. In terms of pharmacy, can you repeat the question? I didn't catch that fully.

Similar question there. I think the last update we got was over $500 million in sales at the end of last year. Maybe how that's trending, if we can get an update there. And then if there's been any differences with adoption by cohort.

Sure. So we haven't refreshed that number. We will do so at some point in the future. But take cue from the fact that we shared the growth rate at 75% for Chewy-owned pharmacy and then the business has essentially tripled over the last 2 to 3 years. That should provide you a good kind of ballpark estimate of where the business is. In terms of cohorts, we see strong participation continue from existing customers, and it remains a source of new customer acquisition for us. So we're pleased with it.

I would now like to pass the conference back over to Sumit Singh for any closing remarks.

Thanks, team. Appreciate you joining us. Have a great evening.

That concludes the Chewy Q4 Fiscal Year 2021 Earnings Call. I hope you all enjoy the rest of your day. You may now disconnect your lines.