Hello, and welcome to the Chewy Fourth Quarter FY 2023 Earnings Call. My name is Elliot, and I’ll be coordinating your call today. [Operator Instructions] Now, I’d like to hand over to, Jen Hsu, Vice President and Head of Investor Relations. The floor is yours. Please go ahead.

Thank you for joining us on the call today to discuss our fourth quarter and full-year results for fiscal year 2023. Joining me today are Chewy's CEO, Sumit Singh; and CFO, David Reeder. Our earnings release and letter to shareholders, which were filed with the SEC earlier today have been posted to the investor relations section of our website, 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 and the environment that we operate in. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks, uncertainties and other factors described in the section titled Risk Factors in our annual report on Form 10-K and 8-K filed earlier today and in our other filings with the SEC, 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. 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 earlier today. These non-GAAP measures are not intended as a substitute for GAAP results. Additionally, unless otherwise stated, all comparisons discussed today will be against the comparable period of fiscal year 2022. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of the webcast will also be made available on our Investor Relations website shortly. I'd now like to turn the call over to, Sumit.

Thanks, Jen, and thank you all for joining us on the call today. Before we cover our fourth quarter and full-year 2023 results, I'm thrilled to welcome David Reeder, who joined us in February as our Chief Financial Officer. Dave is a key addition to our leadership team, and I look forward to having many of you engage with him in his new role. I would also like to thank Stacy Bowman for her support as Interim CFO. Now, let's review our results. The team delivered a strong finish to the year with our fourth quarter and full-year 2023 performance demonstrating our ability to deliver market share gaining growth, while simultaneously expanding margins and accelerating free cash flow generation. I will provide an overview of our performance, followed by some perspectives on the pet industry and Chewy's strategic priorities as we embark on 2024. Dave, will then discuss our financial results in greater detail and share our guidance for the year. Q4 net sales increased by 4% to $2.83 billion resulting in full-year 2023 net sales of $11.15 billion representing 10% year-over-year growth. Our favorable mix of non-discretionary consumables and health categories continues to be a pillar of strength for Chewy, representing approximately 85% of full-year 2023 net sales. Additionally, our Autoship subscription program, which delivered $8.5 billion of Autoship customer sales in full-year 2023, continues to provide unparalleled convenience for pet parents, while enhancing customer stickiness for Chewy. Growth in Autoship customer sales meaningfully outpaced overall topline growth increasing by 8% in the quarter and nearly 15% for the full-year 2023. We continue to deepen our engagements with existing customers and delivered compelling wallet share growth. Net sales per active customer or NSPAC grew to $555 a year-over-year increase of approximately 12%. We believe there is significant runway for…

Thank you, Sumit. Before covering our quarterly and annual results, I'd like to take a moment to explain why I'm so excited to be part of Chewy. First, I'm a passionate pet parent and one of Chewy's 20 million loyal customers. We believe that the level of service that Chewy provides to customers is unmatched in the industry, and I wanted to be a part of the company that is the most trusted and convenient destination for pet parents and partners everywhere. But besides being passionate about the Chewy brand, I'm incredibly excited about the company's opportunities. We have a highly predictable, attractive business model where more than 75% of our approximately $11 billion 2023 sales was driven by Autoship customer sales, resulting in a subscription like revenue stream. With our world class infrastructure now having reached critical mass, we expect to deliver increasingly higher adjusted EBITDA margins and free cash flow. In summary, Chewy appealed to both my heart and my head. I couldn't be more excited about the road ahead, and I look forward to getting to know many of you over the many quarters to come. Now, let's review our financial results. Fourth quarter net sales grew 4.2% to $2.83 billion bringing our full-year 2023 net sales to $11.15 billion representing 10.2% growth year-over-year and exceeding the high-end of the guidance ranges that we provided last quarter. Autoship customer sales came in at $2.16 billion in Q4 and $8.49 billion for the year. Growth in Autoship customer sales outpaced overall topline growth by 390 basis points in Q4 and by 450 basis points in full year 2023. Autoship customer sales represented 76.4% and 76.2% of our total net sales in Q4 and full-year 2023, respectively. Chewy continued to consolidate share of wallet with NSPAC reaching a new…

Thank you. [Operator Instructions] Our first question comes from Douglas Anmuth with JPMorgan. Your line is open. Please go ahead.

Thanks so much for taking the questions. I have two. First, Sumit and David, can you just talk about the 24% revenue growth, obviously starting with 2% outlook in 1Q, but perhaps you can talk about what drives the confidence and acceleration as you go through the course of the year? And if there's anything else you can add just around the cadence in terms of the quarters going forward? And then, on active customers, I know you're talking about flat for ‘24. Can you give us any insights into dynamics between gross ads and what's happening with churn or attrition on existing customers? Thanks.

Yes. So, hi Doug, it's a pleasure to meet you virtually. Look forward to meeting you in person as we work through the coming quarters. With respect to the growth for the year, I think as Sumit had outlined in his portion of the script, we're expecting an environment where pricing is relatively flat and so most of the growth will be off volume as we progress through 2024. And, that's certainly the trend that we kind of saw in fourth quarter and we're extrapolating and extending that trend into 2024 given that we're not expecting a lot of inflation. With respect to first quarter versus the remaining three quarters as we progress throughout the year, first quarter, we've guided to 2% year-over-year growth and so we feel pretty good about that number as we roll into this first quarter. For the remainder of the year, we've got the benefit in the fourth quarter the extra week. If you do the math on that, we're given the high percentage of recurring business that we have through Autoship as well as consumables, and you would do the math on that and get about 2% growth for the year from that particular extra week about $220 million. So, the second half of the year, we do believe we'll have not only seasonality as we typically do, but also the benefit of the extra week. Sumit, anything that you would add to that?

Yes. On customers, the situation is quite similar actually. So, when you look at kind of the discretionary environment, it's essentially holding back on our side. It's impacting roughly kind of 300,000 to 400,000 active ads. I've kind of not sized that for you directly. I figured we'd come out kind of sized that for you so you get a sort of sense for how much of this is being held back. Our cohorts coming out of the pandemic have fully stabilized. So, we're not seeing any kind of further deterioration in cohort behavior. 2022 cohorts continue to settle out and we're continuing to see kind of low-single-digit higher cut churn from them just like we did from the pandemic cohorts. Our reactivation rate remains impressively high actually. We've improved reactivations from a year-over-year point of view and we will add roughly 15% more reactivated customers this year than we did last year. So on the balance, I think we're sort of getting into the year with a little bit of wait and watch approach. We are not expecting hard goods category or the discretionary to improve materially, so we're holding that into our forecast. And then as of right now, we're not expecting the Canadian business to contribute meaningfully in 2024 as the script sort of outlined. In addition to that, I think two more points I would add is our, all of our premium businesses, whether it's premium consumables, premium health, supplements, etcetera, acquisition remains strong and customer participation remains strong as well as kind of participation into Autoship sign up rates are actually also pretty healthy. So, hopefully that gives you some color on customer cohort analysis.

Okay. Thank you both. Appreciate that.

Sure.

We now turn to Mark Mahaney with Evercore ISI. Your line is open. Please go ahead.

Hey, I just wanted to ask about the advertising revenue opportunities. And I know you talked about what you've seen so far and your outlook seems relatively constructive for the year. Can you peel that back a little bit more? And where do you think you are on kind of ad load versus where you could be? Where do you think you are in terms of endemic and maybe non-endemic advertising in terms of where you could be? And any clear lessons that you've drawn so far that make you reasonably confident about the outlook for the year? Thanks a lot.

Hey, Mark. This is Sumit. I'll take that one. So overall, coming out of last year, we fully ramped into search product. We have recently launched branded product and we are currently ramping up the on-site portion of the ad revenue. We have the off-site portion of the ad revenue that starts ramping up towards the back half of this year. And so, what you'll see is essentially the ad load is split between 70% on the on-site, 30% on the off-site. And, the blended margin flow through is obviously pretty high that we're taking to the bottom line here, but more so on the on-site and less on the off-site. And then supplier participation rates are pretty healthy. Our [Oss] (ph) are pretty healthy as well. We're continuing to comp on an LTV basis, not on a per transaction basis, which is appreciated given kind of the power of the Autoship in the business itself or the recurring repeat revenue. So, as you would expect, we're leading with consumables followed by hard goods and health. We have to be a little more careful, making sure that we are completely respecting regulatory kind of constraints there per se. What else can I tell you about the ad business? Overall, we're pleased with the progress, response is all good.

Okay. Thank you, Sumit.

Sure.

Our next question comes from Dylan Carden with William Blair. Your line is open. Please go ahead.

Appreciate it. Sumit, back to that kind of cohort analysis on the churn side, I wonder if you could kind of speak to it on the NSPAC side. And I guess the broad question would be how relevant some of your historic cohort spending metrics are? And just whether or not there's any impact from higher levels of Autoship if those customers kind of set it and forget it and don't yield up in the same fashion because they don't visit the site with the same frequency? Any detail there would be helpful. Thanks.

Yes. So the NSPAC side of the house will be continued to be driven by both the health as well as participation in Autoship. Those are the two primary drivers of NSPAC expansion that we see in 2024. And the, so those are the pluses. The minuses are obviously you don't get the pricing benefit in NSPAC that you saw last year. So if you average out NSPAC benefit over the last four years, we essentially have 80% of the NSPAC growth that came since the time of the IPO in 2019. On the back of organic work that the team has done, right, improvement in Autoship, improvement in health, launch of pharmacy, growth in the supplements business, etcetera, etcetera. And 20% or less has come from inflation. But if you look at last year, right, the weight on inflation was higher as NSPAC kind of grew. So, this year we're not expecting, this year as in ‘24, we're not expecting the impact of pricing or inflation in this. And so NSPAC is going to grow on the back of pure Autoship and health. On the health side, if you look at cohort analysis, we're likely going to add north of 1 million customers to pharmacy and that is a direct expansion of NSPAC in addition to the usual subscription rate growth that we will drive towards in the Autoship business. So, those two will be a combination. We just don't get any pricing benefit this year.

Got it. Thank you.

Our next question comes from Anna Andreeva with Needham and Company. Your line is open. Please go ahead.

Great. Thanks so much for taking our questions. We have two. On the adjusted EBITDA, I think the guide implies slightly less than the 15% incremental margins you guys outlined during the Analyst Day. And you mentioned the guide does imply some OpEx leverage. So, should we expect more muted gross margin gains for the year? Just any color there would be super helpful. And then secondly, CapEx, as you mentioned, came in a little lower, than the guide for '23. Should we expect it to stay at similar 1.3% of sales or below for ‘24? Any thoughts on initiating a buyback, just given this ramping free cash flow generation? Thanks so much.

Sure. Hi, Anna. Let me take that one and let me speak a little bit more broadly perhaps and philosophically about profitability first. We outlined at Capital Markets Day our philosophy and our path to 10% EBITDA margin and the corresponding free cash flow that would of course come from that. And so, when we think about profitability within 2024, we are expecting to get leverage not only on the gross margin line, but also on the operating expense line as well. And specifically within gross margin, let me call out a few areas. Given our infrastructure and the fact that it's reached critical mass, we're actually able to flow through incremental volume at a much higher accretive rate for the company. So, as we get more volume given the infrastructure we've built out, we have moderated CapEx on a go forward basis. The fall through is higher for that incremental volume fixed cost absorption, if you will. In addition to that, we also have product mix. So, we're mixing up from a product perspective as we continue to grow into healthcare, into pharmacy, that also averages up or accretes up our gross margin. And then finally, within the gross margin line, we also have sponsored ads that we've already spoken about a little bit. We expect sponsored ads. We ramped those in the fourth quarter. We expect continue to grow those quarter-to-quarter-to-quarter sequentially throughout 2024. And so, that's the accretion that we expect to occur on the gross margin line. With respect to OpEx, we are making some investments on the OpEx side. We expect our core OpEx to continue to scale. But then, of course, we're thoughtfully entering Canada as we expand into Toronto, and of course, we're also investing in our long-term initiatives around vet care. And so, the rate and pace of those investments will be thoughtfully managed as we proceed throughout the year, but we're expecting to get benefits and profitability from both gross margin as well as OpEx. On the CapEx side of the house, we've guided long term 1.5 points to 2 points of net sales. You're correct last year in 2023 we were slightly below that. I think a good midpoint would be take the midpoint of that guidance between 1.5% and 2% and think about the midpoint of the guidance we've given you on the topline, that will put you in a good spot from a capital expenditures perspective. We do expect to generate meaningful free cash flow as we mentioned in our script.

All right. Thank you so much. Best of luck.

Thank you, Ana.

Thank you.

Our next question comes from Steven Zaccone with Citigroup. Your line is open. Please go ahead.

Great. Good afternoon. Thanks for taking my question. And, Dave, congrats on the new role. Sumit, I wanted to ask about the broader pet industry. We've heard about some higher promotional activity and then some trade down activity in terms of the pet food space. What are you seeing in your business? And I guess as you think through the year, do you think we're in the worst of it now or could the space a little bit more competitive as we get into the back half? Thanks.

Yes. There's a lot in that question, hey, Steve, let me kind of unpack it. So, let's start with promotional environment. So, Q4 promotional environment was rational and in-line with our expectations. It was modestly higher than 2023, but we've been signaling that all the way through 2023. And so Q1 and Q2 hadn't picked up and Q4, we did see kind of the 30 basis points to 50 basis point incrementality and promotion pickup that we were forecasting throughout the year. Obviously, we were able to absorb it given that we were planning for it. So, the silver lining here is that we've sort of returned to normality from a promotional standpoint in our opinion from a pre-pandemic post-pandemic world, right. Post-pandemic we sort of through the pandemic, we got this benefit of sort of float as a result of kind of either supply pullbacks or just general normal demand generation. So, all of that is normalized. We don't expect promotional environment to remain more volatile or to become more volatile as we move through 2024. That's sort of the assumption that we're making in with. Generally, when you look at the industry so let me kind of shift to industry trends. So generally, when you look at the industry, if you take the $90 billion pet food and supplies category, over the past decade, unit growth has been driven by mostly supplies and treats. So that's all discretionary. And pricing growth has been driven by premiumization trends, right. So when you put that in context in today's macro, it helps you understand why the industry is expecting kind of modest unit growth in ‘24 and limited pricing benefit given that we're coming out of the inflationary environment getting into ‘24 and there's no premiumization trends. That sort of…

Okay. Thank you very much.

We now turn to Nathan Feather with Morgan Stanley. Your line is open. Please go ahead.

Thanks for taking my question, everyone. So, thinking about the 50 basis points of EBITDA margin expansion guided to for the year, can you help us walk through the key drivers to get there and what could really drive upside for that? And then anything you can share on how much international expansion is weighing on margins? Thank you.

Sure. Let me start with the EBITDA expansion of 50 bps that we guided. Look, it's really when you think about the growth there, let's talk about the gross margin line first. It's really the three items that I mentioned before. We've got the opportunity given our fixed infrastructure to get some fixed cost absorption out of the model. So, if volume grows faster than we expect throughout the course of the year then that's going to be a benefit to us. It's going to flow through at a higher rate given that we don't have to correspondingly make the same level of investments to ship that incremental volume. And so, we're going to get some nice fixed cost absorption to the extent that volume picks up throughout the year. In addition to that, we have been product mixing up the business. As we expand into healthcare, into pharmacy, into services, all of those are accretive to us from a corporate margin perspective. And so as those become a larger part of our business over time, which they have, then that margin will fall all the way through the P&L to the bottom line. And then, of course, the final piece that we've spoken about a little bit here and that's sponsored ads. We really kind of ramped that up in a bit more meaningful way in the fourth quarter of '23. And as I mentioned, we expect sponsored ads to grow throughout 2024, Q1 to Q2 to Q3 into Q4. So, that's an area of growth for us that is accretive as well. On the OpEx side, I'll just kind of reiterate that, the rate and pace of those investments will be the rate and pace at which the business needs those investments to be made. So, we have committed to profitable growth at Capital Markets Day. We do believe that we are going to deliver that profitable growth, but we also want to continue to invest for the future. And so, we feel like this business plan that we've kind of outlined for you today for the full-year irrespective of the macro environment, it is a plan to continue to take share. And then, of course, it's also a plan to deliver profitable growth and meaningful free cash flow, I would add.

Our next question comes from Alex Steiger with Goldman Sachs. Your line is open. Please go ahead.

Great. Thank you for taking my question. First, one on competition. So, how would you characterize the competitive landscape as we enter 2024 and what gives you the confidence in continuing to gain market share this year? And then, one follow-up on the Q4 EBITDA outperformance. So, can you maybe just help us understand the contribution from the various initiatives you have laid out versus some of the efficiencies you're seeing on automation and or OpEx discipline? Thank you.

Sure. I'll take the first one, this is Sumit. So, in terms of competitive intensity, it's not elevated from our point of view. Promotional intensity was obviously higher coming out of Q4. Ad intensity and ad competition remains high. If you look at CPCs, CPCs were up roughly 14% to 16% in Q4, but they were met with demand given that supplies had recovered in Q4 of this year. So, we were anticipating higher CPCs given kind of bidding intensity was higher coming into the holiday season. That has pared back some as we've come into Q1. Some part of that is naturally expecting, some part of that is when you look at across the industry, we believe three, there's at least from what we can tell, there's kind of three companies that are taking share. Chewy is clearly gaining share in the market. Walmart and Amazon are the next two competitors. But each of the portfolio has kind of different strengths, in my opinion with someone like Chewy kind of being able to sort of span the entire gamut here. So, what I mean by that is our performance I mean our performance continues to be supported by non-discretionary categories which make up 85% of our sales. And so, we excel in many pockets in that 85%. In the current environment, some of the other companies that I'm mentioning have been likely primarily winners in the discretionary categories where we are not winning. So that, lower mix of hard goods is both a strengthen an opportunity to Chewy given that it shields us from the discretionary impact that you've seen, announced in some other places. And then, Walmart has unsurprisingly shined in the value segment amidst the current macro backdrop, including kind of outside successes that have been seen in areas like private label, where as we were candid in the Investor Day presentation, we do not have kind of like-for-like assortment, but it's part of our strategic plan to come out and provide strategic like-for-like assortment there. So, if you kind of summarize it, what is important to I think note is we believe Chewy remains differentiated from both these players or the industry generally through our comprehensive offering that we provide to the pet parent, the type of relationships and the loyalties that we build, the [Quartz] (ph) subscription business and the strength of that ecosystem, the pet health ecosystem which is first party proprietary that extends both through product and services across our retail offerings, All of it positions us well to compete in 2024. Alongside that, we've made several investments in future categories which are both topline growth and margin expanding categories. So, we feel bullish about our ability to compete through 2024 as well as accelerating pace as we come out of ‘24 into ‘25 and ‘26.

Thank you, Sumit. Let me address the EBITDA question that was posed. Let me speak a little bit more broadly about the year first. When you compare 2023 versus 2022, we did expand gross margin by roughly 40 bps on a year-over-year basis. And so, when you look at how that flowed through from an EBITDA perspective, I think what you saw us do, what you saw us execute in 2023 was you saw us execute with long-term investments in the business, but still return a good portion of the gross margin expansion to the bottom line and the EBITDA margin line. And so, we were quite pleased by our ability to take gross margin as it expanded and then push it all the way through the P&L to the EBITDA margin line on a year-over-year basis. With respect to fourth quarter, we did grow gross margin slightly on a year-over-year basis in fourth quarter by 10 bps. We did have some timing issues with respect to expenses. And so, on a year-over-year basis, adjusted EBITDA did decrease from 3.4% to 3.1%. I would characterize again many of those as the investments that we were making throughout the year to be able to support both our international expansion as well as Chewy Vet Care as the primary reason for that. But again, for the full year quite pleased with our ability to deliver profitable growth.

I would just add that when we started the year, we sort of carved out a bunch of growth initiatives that we were impact, that we'd sized for you. And as we move through the year, we increasingly found the ability to self-fund a lot of these initiatives ending the year strong. And as you've seen us kind of provide guidance for 2024, we continue to invest in growth initiatives for the future and are self-funding a bunch of that alongside the EBITDA expansion that we're providing you.

Very helpful. Thank you.

Sure.

Our final question today comes from Rupesh Parikh with Oppenheimer. Your line is open. Please go ahead.

Good afternoon. Thanks for taking my question. So, a question for Dave. So, you've obviously been there a few weeks now, so it's still early, but just curious if you see any new opportunities in the business?

Thanks for the question, Rupesh, and look forward to meeting you all in person. This is my fifth week at Chewy and I think one of the things that I am most pleased to report is that the business performance trajectory, the opportunity set, all of the things that kind of went into my diligence thesis when I was joining Chewy, all of it seems very much in-line with what my expectations were. And specifically, the consistency, predictability, the repeatability of the revenue stream was high on my list of items to kind of test as build with Autoship and consumables. The infrastructure is world class. The build out of our infrastructure and the critical mass that we have there, and our ability to ship some significant incremental volume through the same footprint as that volume becomes available for us to tap in the industry, I do believe we're going to get not only moderating CapEx, but increasing free cash flow. The margin opportunities as we mix up the business from healthcare are meaningful. And then finally, when you think a little bit longer term, some of the opportunities that we have to penetrate direct vet care, expand international, add incremental services, I think all those thesis that I had about the business about Chewy as well as of course the loved brand all of those things are as built. I'm incredibly excited to be here. Did you have a follow-up Rupesh?

Yes. And I guess just my follow-up question. So, it sounds like this year, a household formation is likely going to be weak. So, if you guys think about a return to positive net active customer growth, is that essentially you just need a better macro and a return to stronger pet household formation? Is that the key ingredient at this point?

That is definitely one of them, but that's not the only one. I mean, we continue to pick up customers at a pretty healthy clip. All of the other categories that we're performing within continue to resonate loudly. In pharmacy, I mentioned north of a million customers migrating over, which is obviously not showing up in the active customer file, but you show that in the NSPAC number and the amplifying revenue growth number. And then, all of the newer innovations that we're looking at, whether it's introduction of new marketing channels that we might be experimenting with at any given point or launching of new verticals such as services, these are all customer acquisition, bolt acquisition and retention type verticals. So yes, there is the macro, but we're also focused on what is controllable on our side and making sure that no stone goes unturned per se.

Great. Thank you.

Sure. Thank you.

Ladies and gentlemen, this concludes our Q&A and today's Chewy fourth quarter and full-year 2023 earnings call. We'd like to thank you for your participation. You may now disconnect your lines.