Good afternoon. Thank you for attending today's Chewy Fourth Quarter Fiscal Year '22 Earnings Call. My name is Hannah, and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for question-and-answer session. [Operator Instructions] I would now like to pass the conference over to our host, Bob LaFleur with Chewy. Please go ahead.

Thank you for joining us on the call today to discuss our fourth quarter and full year results for fiscal 2022. 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, growth, financial results, business strategies, industry trends and our ability to successfully respond to macroeconomic conditions and business risks. 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 will also 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. Our fourth quarter results capped an incredible year. Against the backdrop of a rapidly changing operating and economic environment, Chewy produced record high revenue, profitability and free cash flow. Chewy's dedication to serving pet parents and partners with a widening ecosystem of offerings led to another year of market share gains in the pet category, which once again demonstrated its historical resilience despite evolving macro conditions. Looking ahead, we continue to be excited about the growth opportunities for our business. The pet category has a U.S. total addressable market that is over $130 billion, which has grown consistently through the ups and downs of economic cycles. Importantly, we continue to see significant white space for expansion, and we remain committed towards innovating at a high pace across both new product and service offerings as well as technological and operational advancements. Most importantly, our strategy remains focused on relentlessly advancing our mission of being the most trusted and convenient destination for pet parents and partners everywhere. Now let's review our Q4 and full year 2022 performance followed by a discussion of our operating philosophy. After that, I will turn the call over to Mario to discuss our results in greater detail and share our 2023 guidance. Q4 net sales increased 13% to $2.71 billion, which brought our full year 2022 net sales to $10.1 billion, reflecting annual growth of approximately 14%. Non-discretionary categories, including consumables and health care remained the pillars of strength with the offset coming from discretionary categories such as hard goods. Our top line expansion reflects our success in managing the dynamic pricing environment as well as the recurring nature of our business model and our ability to expand share of wallet from our…

Thank you, Sumit, and thank you all for joining us today. Fourth quarter net sales were $2.71 billion, a $319 million or 13.4% increase year-over-year. Our non-discretionary consumables and health care categories continued to demonstrate strength in the quarter as they had collectively represented 82% of total net sales and grew at a combined rate of 18.5% year-over-year. These favorable trends were modestly offset by a decline in sales in our hard goods category. For the full year, net sales reached $10.1 billion, increasing $1.2 billion or 13.6% year-over-year. Our Autoship business saw another year of strong growth as pet parents increasingly value the convenience and benefits of the program. Q4 Autoship customer sales increased 17.5% to $1.98 billion, exceeding the pace of our overall sales growth by 410 basis points. For the quarter, Autoship customer sales as a percent of total net sales reached 73.3%. For the full year, Autoship customer sales increased 18% to $7.4 billion, with ownership customer sales representing 73% of total net sales, a new record high on an annual basis. In Q4, Chewy continued to consolidate share of wallet from pet parents who shop with us as NSPAC reached a new record high of $495, up 15.1% or $65 year-over-year. As we have shared on previous calls, top line growth for Chewy is driven by our ability to attract and retain over time while capturing an increasing portion of their annual pet spend. In 2022, our active customer count remained relatively flat versus 2021, as we work through the short-term attrition of our record-sized cohorts acquired in the preceding two years. At the same time, customers continue to consolidate their shopping with us with our three oldest cohorts, each spending over $1,000 in 2022, and all but our two most recent cohorts spending over…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question is from the line of Nat Schindler with Bank of America.

A couple of quick questions. So one, looking at your margin guidance of actually there is slight -- flat to slightly down EBITDA guide for this coming year. Despite the fact you have NSCAP growing, and it looks like given your revenue growth, it's going to be -- revenue growth is going to be driven as it has been recently by NSCAP more than customer growth. And considering that your marketing cost is mostly customer acquisition, how would that not result other than investments in international and other, how would that not result in meaningful improvement in EBITDA? --:

Nat, it's Mario. Great to hear from you. So on -- I'll take the second question first, and then Sumit will talk about the first one. You're asking about the order declining, it's not -- that's not the case. So what you're seeing in the 10-K -- you're referring to it in the 10-K, it's more about packages that we ship out. We've been pretty consistent about the way we explained it in the 10-K. The reason why we are able to ship out fewer packages is because we are continuing to get better at cartonization, meaning we can fit more of an order into a single package, and therefore, lower our freight costs, as you can imagine, our packaging costs as well and improve the customer experience. So we do that because we're expanding our network and because we're just getting better and better at inventory placement. So a lot of good work has been done behind the scenes. And Sumit will answer the first question.

Nat, this is Sumit. When you look at margin, I mean, 2022, I think it's important to frame up 2022 EBITDA in context of kind of how the year has played out. And EBITDA margin for 2022 was a result of strong gross margin performance and added to that SG&A leverage that we drove. So when you look at particularly gross margin, that was a result of pricing strength, combined with our work on supply chain transformation, offset by the headwinds that we faced on the freight and logistics side. So when you move that forward to 2023, we do not expect pricing leverage benefit as we did in 2022, including pricing float benefit, where pricing exceeded cost for a few months, if you recall. Further -- I mean we expect continued gross margin expansion driven by our efforts in higher-margin verticals. At the same time, given the uncertainties associated with the current macro backdrop, this guidance reflects a nuanced assessment of risks and opportunities and an appropriate level of cautiousness that we've baked in, which we are constantly monitoring performance around. And as always, we'll update guidance. Like for example, we're currently leaving room for the category to be slightly more promotional than last year. And should this not bear out, that could potentially create upside to our outlook. We're also not assuming any hard goods reacceleration happening in 2023 to any material degree. And to the extent that there's a macro reacceleration in hard goods, that should actually impact both sales and margin. And so there's assumptions like those that are built in, which are essentially having us guide to gross margin net neutrality. And then when you come down to the SG&A side, we're basically leveraging SG&A, but we're reinvesting the leverage back into driving growth. And as a result, our EBITDA guide kind of comes out at this point of the year in a way that we're guiding today.

Makes sense, but how much are you putting in is assumed in there in the international expansion in costs? So I assume that's almost no revenue.

Yes. We haven't -- we're not quantifying the two separately. But broadly speaking, 50 to 75 basis of investments in growth initiatives, including international, but it's safe to say that the largest contributor of the 50 to 75 is in the international.

And then when it comes to top line, active customers NSPAC, Nat, we are not assuming any material impact for those from the launch at this point.

Yes. Any impact -- we're not assuming any impact to core as well. Yes.

The next question is from Anna Andreeva with Needham. You may proceed.

Great. Two questions. In the past, I think you talked about international growth and margin expansion simultaneously. So could you talk about the specific buckets of investments in '23? And international typically takes a while to scale to domestic profitability. So does this change your longer-term goal for high single-digit EBITDA margin? That's my first question. And then secondly, you mentioned net adds improving in the back half. Are you seeing any improvements in the business quarter-to-date to give you any confidence for that back half improvement?

Anna, this is Mario. I'll take the first question, and Sumit will answer the second one. But when it comes to the investments in international, most of that you're going to see in SG&A and marketing. As we said, the 50 to 75 basis points, you'll hear us say that a few times. The largest portion of that is going to be international. No real material impact top line, gross margin, et cetera, in terms of investment for international launch.

The only thing to add, Anna, there is as we ramp up demand, we're going to view the market opportunistically. And if there is an opportunity to invest at the top -- to drive top line, there may be some gross margin impact there, but all of that is built into our guidance today. And then your second question -- go ahead.

Okay. That's helpful. On the net add improvements in the back half. Just curious, if you're seeing any improvements in the business quarter-to-date to give you confidence there?

Well, what we said on the early remarks was that we expect net adds to begin to improve in the second half of the year for that active customer base to grow in the second half of the year. We're stepping into it carefully into the first half. We still have the long tail attrition from the 2020, '21 cohorts to work through. And of course, there's still some somewhat subdued demand for -- in the discretionary categories, hard goods. So we expect there will be more in the second half of the year.

And, Anna, our gross adds rate continues at mid- to high single digit higher than pre-pandemic and our reactivations also continue to be strong. So to the extent that those could be considered signals, I think you could take that into account, and then Mario's answer kind of rounds out the perspective.

Yes. I would add to that, Sumit, the retention for those cohorts is basically in line with what we have said in the past. So that's also a good indicator for us that things are stable on that end.

The next question is from the line of Mark Mahaney with Evercore ISI. You may proceed.

Great. This is Jian Li for Mark Mahaney. First, I want to just ask on -- I guess, higher-level question on the international. If you can just talk through what is kind of the TAM opportunity you see for international market? And how are you going about -- like what's the game plan for expansion? Are you thinking about it mostly -- it sounds like it's going to be organic expansion. Are you considering inorganic? And if you can kind of talk through the key regions? That's my first.

Sure, Jian. This is Sumit. I'll take it. So international expansion has long been a part of our strategy, as we've noted on prior calls, it was a matter of when, not if Chewy would take our superior value proposition into new geographies. So we're excited to talk about it now. We took into account the size of TAM, the geographic proximity and consumer behavior similarities to the U.S., among other factors, as we thought about entry markets that possess attractive characteristics for our initial international expansion plans. And yes, at this point, this is an organic play, not an acquisition per se. In terms of operationalization, I would say, consistent with our track record of operationalizing investments, such as pharmacy could be one. We are thinking about our international plans and stages with certain milestones that will responsibly govern the pace of our expansion. And then as Mario already noted a few minutes earlier, the revenue active customer and NSPAC impact of launching international operations is fully reflected in our guidance and is not a material contributor to any of those items in the guidance or for core. We -- that's as much as we can share today. We're excited about sharing more details on our Q1 call.

Great. And one more on the gross margin. Beyond this year -- this is, I think, the third quarter that you hit the high end of your current long-term gross margin. So how should we think about kind of an updated long-term gross margin target beyond this year? And what are the key drivers to that? I think you mentioned the -- this year going to accelerate some higher-margin verticals. So if you can kind of expand on that?

Sure. This is Sumit again. So we're excited about the continued gross margin or the continued journey that we're on to expand our gross margins. In the core businesses, we have continued work to do on our private brand area. Private brands is mid- to high single digit, and we want to get it to between 15% and 30% of net sales. At that ratio, we expect several hundred basis points higher premium to our core business as that business achieves that penetration level. Number two, when you look at Chewy Health, Chewy Health is in its early stages relative to categories such as pharmacy. And we have a tremendous runway in this category as consumers more and more shift their preferences to online, and Chewy leads in delivering customer value proposition in that particular area. It is also a tremendous NSPAC expansion driver for us and is fueling both our growth and mix impact on our gross margin performance. On top of that, then there are verticals which are more nascent in their categories. Sponsored ads is the next one that we are quickly ramping up, happy to click into details if anybody is interested. But we're pleased with the progress there. We will expect to bring sponsor live at a more fuller scale this year ramping into 2024. Behind that is our categories like insurance, which are on slightly longer arcs because you have to build customer consideration and the consideration to conversion arc there is slightly longer, and therefore, those might be on a one- to three-year arc and can contribute meaningful gross margin expansion opportunities as well. And then last but not least, our continued work on either expanding our Autoship benefits, working towards loyalty programs or continued supply chain initiatives that we've talked about, provide us tailwind opportunities in the future. So we're excited. There's a lot of work in front of us. This will not be easy, but at the same time, we have a clear road map and the team's hard work so far has paid off, and we will continue to remain resilient and focused as we play through 2023 and beyond.

Great. And if I might just like one quick follow-up to that. Is there any -- I guess, can you quantify how much of sponsored ads is embedded in the full year guide?

Yes. At this point, it's still fairly small. It's still a small expectations for this year. We're just ramping -- we're excited about where it is and the trajectory it's on, but it's still not a meaningful driver yet.

The next question is from the line of Doug Anmuth with JPMorgan. You may proceed.

Just on the international expansion, is it safe to assume that at the core, you'll be looking to replicate the strong and differentiated approach in terms of customer service? So that's number one. And then second, just circling back to the customer growth in '23. Just trying to understand really what drives the confidence there given that you're not really building in either macro improvement or discretionary product really coming back much. It sounds like it's just some improvement or working through the big cohort over the last couple of years.

Sure. Doug, this is Sumit. So on international, your assumption is 100% right. We plan and expect to bring all components of our value proposition to the international market. And at the same time, we are going to be very actively listening to the voice of the customer and designing our launch working backwards from that. So that there is no dissidence in the way that we show up in the cultural nuances as Chewy's brand enters the international market. On the balance, we are excited and confident about our brands' resilience and extension outside of the United States per se. So that's the first one. In terms of customer adds, there are several programs that we are working internally inside the Company, which are -- they're not dependent on the macro, but despite the macro, we are excited about these particular programs. These are -- when you look at kind of the way that we're optimizing our site, improving our search results, maximizing conversion, particularly as it comes to new search traffic that lands on our website. And we're seeing some early, very early signs of goodness there. Number two, we've talked about this in the past where Chewy is not actively invested in CRM type capability, and we're building out our CRM capability in 2023 to a much more fuller extent than we had in 2022. Now the work will continue through 2023. But again, these are programs that allows us to recognize customers, segment them accordingly, target them and then track them through their life cycle to be able to either incentivize, motivate or offer propositions to be able to reactivate towards Chewy at a greater degree. So the combination of those two kind of gives us confidence that there is more than just the market that is happening inside Chewy. But of course, we have to bring these to life and play them through.

The next question is from Corey Grady with Jefferies. You may proceed.

I wanted to ask about the automated FC initiative. So apologies if I missed this, but what percent of volumes did you say are running through the automated fulfillment centers currently? And where do you think that can get by the end of the year? And then what's assumed in that 50 bps of SG&A leverage?

Yes, this is -- Corey, this is Mario. I'll answer that. So, we've said that we're about 30% of the volume going through automated facilities at this point, which is an increase from where we were certainly in the third quarter and almost double the volume that was going through our quarter at the same time last year, meaning Q4 '21. But we haven't given a target by the end of the year. But you can see that we're going from having three out of 13 to now having four facilities are automated out of 13 once we launch our Nashville in the next couple of months. So, we are -- we continue to move volume into the automated facilities for many reasons. One of them, obviously, is a lower cost to variable cost per order, which then flows through to SG&A and EBITDA. So we'll continue to push as much volume as we can into those facilities. Anything to add, Sumit?

No. Corey, did you have a follow-up? Or was that the main question?

Yes. If I can, I'll ask a quick follow-up. I would love for you to just say more about the sponsored ads beta? I mean I don't know if you can share speak to any initial learnings, customer feedback? Any update around timing of full launch? And any change in how you're thinking about the long-term opportunity?

Sure, sure. So we're pleased with the progress of the sponsored ad vertical. The beta that we launched in Q4 has continued building towards the full product, which we expect to have live in the first half of 2023 as per original expectations. Our team is hard at work right now on the supply side of the platform, where we expect to deliver a great customer and partner experience with improvements in ad serving, tracking and relevance. The reception from brands has been and continues to be positive, including the reception on our ROAs framework. So we're looking forward to the program launch in first half and then continuing to ramp throughout 2023 and into 2024.

Our next question is from Seth Basham with Wedbush. You may proceed.

My question is on gross adds. Good to hear your continued mid- to high single-digit growth there. As you look to 2023, you're expecting that type of growth to continue, and what does that mean for advertising growth?

Yes. Seth, this is Mario. So yes, so we are continuing to see strength in gross adds versus the pre-pandemic. In fact, you've heard us talk about all year that we've been in the -- somewhere in the 6% to 10% range, give or take, increase versus the same quarter 2019, and that continued into Q4. So that's a good indicator for us, the strength of the platform. For '23, let me not try to split out between gross adds and net and retention initiatives. But you've heard us certainly explain what we think is going to happen to our -- we project is going to happen to our active customer base and how we expect it to grow in the second half of the year. But it's going to be a combination of those two things, continue to reactivate and add brand-new customers and work hard to keep the ones that are on the platform.

Okay. Fair enough. And then as a follow-up, just thinking about the 2020, 2021 cohorts with the churn rates. Are those churn rates higher than you expected even just three months ago? And how is the 2022 cohort repeat purchase behavior trending?

Let me see if I can decouple that into the two separate questions. The -- when it comes to the '20 and '21 cohorts, the retention levels have continued to remain more or less what we expected, and we have been talking about for several quarters now. High, but it's still low single digits, lower than pre-COVID cohorts. And that has been pretty steady for several quarters at this point. The repeat purchase behavior of the 2022 cohorts. Well, you probably heard us say early in '22 that we were trending to acquire more customers into our non-discretionary categories, the repeatable categories, consumables, health care. And so that's -- the behavior has proven out throughout the year.

The next question is from Brian Fitzgerald with Wells Fargo. You may proceed.

We think this is the first time you provided a specific growth breakout for non-discretionary. Wondering if you could give us some color on how discretionary has been tracking? Have you seen any trend improvement? How are you thinking about cycling the discretionary weakness and potentially getting back to growth at some point in 2023?

Brian, this is Mario. Let me try to clarify the question here. You're saying we provide specific guidance. Are you talking about how -- when we talk about the discretionary part, how would you expect to break on the trends that we've seen recently, is that -- just to be specific about?

We think this is the first time you kind of broke out discretionary versus non-discretionary growth. So we're wondering on the discretionary side, how has that been tracking? And are trends improving on the discretionary side? How do you think about cycling through discretionary weakness and when it kind of gets back to stronger growth?

Brian, this is Sumit. So discretionary continues to be suppressed and pressured. When you look at hard goods, second half was better than first half. That was primarily due to easier comps. When you look at hard goods sequentially, Q4 ramped because of seasonality and was expected. So at this time, as it comes to discretionary categories, and we're baking in things like hard goods, creates and stuff like that, we're not expecting a material reacceleration in '23. And we stand prepared to invest if we see further deterioration or opportunities alike. Ultimately, specifically as it considers categories such as hard goods, we believe that this is cyclical and tied to the inputs of the macro environment. And as the macro and those inputs improve, we expect hard goods to revert to its historical growth mode. But as of right now, we're not providing specific guidance, of course, at the category level, and we're not expecting material reacceleration in '23. That's what's baked into the guidance right now.

Our last question is from the line of Lauren Schenk with Morgan Stanley. You may proceed.

Great. Just a couple on gross margin, if I can. First, what are you assuming around price increases this year from a manufacturing perspective? Was there one in this current first quarter? And then secondly, Sumit, you mentioned in your prepared remarks, a surgical approach to optimize pricing and in the shareholder letter, you talked about sort of increasing value proposition. Are you looking to lower pricing inflect categories? Any color there would be really helpful.

So starting with the second one, no, we are not looking to actively lower prices. We are certainly vigilant across the catalog, particularly as a result of improving supply chain positions to ensure that if there is heightened market competitiveness or market activity that we stand ready to respond to that. But no, we are not actively looking to price down. Number two, in terms of price increases that we expect or have come through, those are in the low to mid-single-digit range.

Any timing of when you would accept this?

Sure. So as anticipated, we have experienced cost increases in Q1, and this is already reflected in our pricing. The market is adjusting and has adjusted well, and we're seeing overall good math compliance, Lauren. So at this point, we believe that the frequency and taste of cost increases is largely behind us. But of course, as we receive more information from our suppliers, we'll pass that on, but we're not expecting more cost increases for the balance of the year at this point.

We have reached the end of our allotted time for questions, and I will now turn the call over to Sumit for closing.

Thank you all for joining. We appreciate it, and we'll see you next time.

That concludes today's Chewy's Fourth Quarter Fiscal year '22 Earnings Call. Thank you for your participation. You may now disconnect your lines.