Q4 2021 Chewy Inc Earnings Call

March 29, 2022

[music].

Good afternoon.

Thank you for attending today's chewy Q4 fiscal year 2021 earnings call. My name is Bethany and I'll be your moderator for today's call all lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end if you would like to ask a question. Please press star one.

Your telephone keypad.

Now I'd like to pass the conference over to our host Robert the floor 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 <unk>, CEO , Sumit Singh and CFO Mario Martech or.

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 Dot Chewy Dot 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 <unk> future prospects financial results business strategies and 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 fulfill.

And 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 <unk> 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 submit.

Thanks, Bob and thanks to all of you for joining us on the call let.

Let me first share some thoughts on 2021, and then more broadly about the pet industry overall, and why we remain optimistic about the sector and choice place in it.

2021 capped off the most remarkable two year period in our company's history.

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 households, and more of that spending being directed to online channels.

Ended up new pet families were formed and as a result demand for pet products and services searched our teams scale rapidly and our business nearly doubled delivering a $4 billion or 83% increase in net sales over these past two years.

Over that same timeframe, 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 family for many years and the puppies and kittens adopted during the pandemic Mark the start off of 10 to 15 year long relationship between those pets and pet parents.

And for many of those Cat family. It was also at the beginning of a long and rewarding relationship with chewy.

The predictable and recurring nature of these relationships gives us confidence that the customer and revenue gains that we've made are enduring and will provide a lasting foundation for future growth.

In many ways. We are just getting started we compete in $120 billion Tam today that is expected to grow rapidly over the next five years and within that broader pet that E. Commerce sales are expected to grow even faster.

We believe that we will continue to be a strong beneficiary of the secular tailwind as we continue to deliver a superior customer experience as the most trusted and convenient destination for pet parents and partners everywhere.

Operationally 2021 was a challenging year amidst an ever evolving pandemic, which continued to impact supply chain and disrupt the natural flow of consumer behavior and business execution.

As we close the book on 2021 and move forward in 2022, we are already seeing improvements in labor availability inbound shipping costs and pricing while out of stock levels and outbound shipping costs remain elevated.

Similarly, we believe most of these challenges are not permanent in nature and over time companies like chewy that are long term focused and built on the fundamentals of strong customer engagement and innovation will continue to enjoy a durable and sustainable competitive advantage.

The bottom line is that we remain optimistic about our future and our ability to execute to our customer trust gain market share and create shareholder value.

Now, let's move to a review of our Q4 and full year 2021 performance followed by an update on our latest innovation after that I will turn the call over to Mario to discuss our results in greater detail and share our guidance.

Q4, net sales increased 17% year over year to $2 three $9 billion, bringing 2021 full year net sales 288, $9 billion or 24% annual growth.

Our ability to deliver 24% net sales growth in 2021 on top of the outsized growth. We delivered last year reflects the durability of our business beyond the near term benefits of the pandemic.

What we saw play out in the fourth quarter of 2021 was a tug between the fundamentally strong consumer demand that underpins our business and the highly challenging operating environment.

Metrics that measure demand and customer engagement, such as site traffic conversion order volumes and basket size all showed positive trends in the fourth quarter and combined that helped drive a 16% increase in net sales per active customer or less Tac due a record $430.

Another noteworthy indicator of engagement is the continued strength of our auto ship program, which increased 180 basis points year over year to 72% of our 2021 net sales.

At the same time, we saw operating conditions in certain areas deteriorate as the quarter unfolded, particularly when omicron mid quarter arrival further disrupted already we can supply chain across our industry.

<unk> added additional pressure to out of stock levels and the impact from loss sales in the quarter was twice as high as we forecast it without this we estimate our Q4 net sales would have been near the high end of our guidance range.

Moving onto customers, we added $1 5 million active customers in 2021 to end the year with $20 7 million active customers an increase of 8%.

It's expanding customer base and a 16% increase in netback, where the key components of our 2021 sales growth.

Netback growth reflects strong contributions from our most recent cohorts and our ongoing efforts to develop customers overtime and capture a progressively larger share of wallet.

In fact, our 2021 cohort recorded the highest farseer NES pack, we have seen since 2017.

Similarly, our 2020 cohort recorded the highest secondly, rns back we have seen since 2017.

Our most recently added customers are off to strong starts following the same pattern of netback growth that we've seen over time.

As a proof point of the sustainability of that growth over time, our oldest cohorts are now spending nearly $1000 per year with us.

While the fourth quarter was the strongest quarter of 2021, four gross customer adds net adds at zero point $3 million were below our expectations.

In short the ear, one retention off our Q4 2020 core was below what we typically observe.

As we examined the drivers behind this the fact is we identified do not appear to be systemic but rather we are a function of the time period. When these customers were acquired within which coincided with the second wave of Covid infections and the arrival of stimulus checks as.

As a result year on retention rates for our first three quarterly cohorts of 2020 within typical ranges further supporting our belief that the trend observed in Q4 2020 cohort was atypical.

It is also worth reiterating that the recurring nature of our model produces retention rates that are well above those typically found in consumer e-commerce business and that historically the attrition. We do see is highly concentrated in the transition from year one into year, two and then moderate significantly and all subsequent.

When theaters.

Coming to gross margins.

Fourth quarter 2021, gross margin declined 170 basis points to 25, 4%.

The main drivers of this were Q4 pricing not yet reflecting cost inflation and elevated inbound freight costs.

We believe that these near term pressures on gross margin likely peaked in Q4, and we are already seeing signs of recovery in our current Q1 quarter.

For instance in February 2020 to the first month of our first quarter, we saw a sequential improvement in gross margin.

Full year 2021, gross margin expanded 120 basis points year over year to 26, 7%, which was a new company high even with the inflation and freight headwinds that we encountered in the second half of the year.

Now let me also provide some more color on gross margins for full year 2022.

As we shared on our last earnings call, our new outbound shipping contract with Fedex went into effect in January the last month of our Q4 2021 and given its timing this had only a modest impact on fourth quarter gross margin.

For full year 2022, we estimate the outbound freight impact on gross margin will be between 100 to 150 basis points inclusive of higher fuel prices.

In anticipation of the pending increase in freight rates for 2022 and in the spirit of continuous improvement that is ingrained in our culture. Our teams were already contemplating several logistics and supply chain initiative to lower freight costs.

Several of these were launched this quarter, while others will launch in Q2 and beyond.

We expect these initiatives will help mitigate part of the impact from this new contract this year and helped mitigate most of the impact within two years.

Looking at full year 2022, and aggregate the current macro environment has many moving parts taking.

Taking everything into consideration we are estimating full year 2022 gross margin to be broadly in line with full year 2021.

Otherwise, we expect that the natural strength in our core business verticals and strong customer engagement will continue to drive incremental gross margin expansion to absorb the upward cost pressures I mentioned above.

On the whole this showcases what we've always believed and conveyed to you which is our overall value proposition and our relentless focus on innovation and customer experience to drive loyalty creates a durable advantage that is keeping us on track to attain the high end of our target long term gross margin range of 25 to 20.

Moving on to marketing Q4 advertising and marketing expenses scaled to six 4% of net sales.

This marks the second quarter in a row sequential improvement with AD costs continuing to normalize after the spike we saw in Q2.

As I've articulated previously we spend up to the level of optimal returns closely monitoring marginal CPA and LTV levels.

Throughout Q4, we continued to operationalize, the new targeting and site efficiency metrics that we began rolling out in Q3.

In Q4, we also leaned into multichannel full funnel marketing campaigns with the debut of our <unk> campaign.

This campaign is measured and subject to the same ROI standards of our lower funnel campaigns, but it has the benefit of driving new customers directly to chewy, while also keeping chewy top of mind with existing customers.

<unk>. These efforts continued to generate positive results, including a sequential improvement in Q4 CPA.

Our Q4 SG&A results reflect elevated labor costs and when combined with the gross margin pressures I just outlined our Q4 adjusted EBITDA margin declined 420 basis points.

Quarterly fluctuations aside it is worth noting the material progress that we have made over the past two years and improving our bottom line.

All of this time, while operating in a highly complex environment, we added an incremental $160 million of adjusted EBITDA to our bottom line and expanded our adjusted EBITDA margin to positive <unk>, 9% in 2021 from negative one 7% in 2019, despite one <unk>.

<unk> million dollars of pandemic related increase in labor costs of $160 million of investments in fulfillment centers, and pharmacy expansion and $190 million of incremental growth oriented marketing spend.

At the same time, we remain steadfast and focused on delivering our long term adjusted EBITDA margin target of 5% to 10%.

Next let me update you on the progress we are making on several key innovation across June and then introduce you to two exciting new programs. In addition to the logistics and supply chain innovation, we are undertaking which I alluded to in the gross margin section.

Chewy remains focused on establishing itself as a leader in the fresh prepared meals category, a tam that is expected to grow from approximately $1 billion today to north of $3 billion by 2025 as more pet parents seek premium fresh food solutions to this and we just expanded our selection of fresh and prepared meals.

To offer the full line of fresh human grade food options from just food for dogs, a leading category supplier. The addition of Jeff food for dogs combined with our existing Freshdirect relationship and our <unk> brand collectively offers a broad assortment across full meals mixers and treats with the fresh category.

We believe this broad assortment alongside our credibility with customers the ability to offer education through our differentiated customer service and reliable delivery experience through our world class fulfillment network will position us well to become the number one destination for fresh and prepared meal.

Yeah.

Now transitioning to truly help.

There's no fees under our TUI health brand continues to gain market share Julie.

Chewy pharmacy sales increased 75% in Q4 with nearly all of this growth now running through our three owned and operated and pharmacy.

On a two year stack basis, chewy pharmacy sales have more than tripled.

In addition to the momentum we have established in pharmacy Chewy health remains focused on expanding its penetration into the $35 billion of pet healthcare market by launching new products and services across the pet health and wellness space.

We expanded our rollout of practice hub in January and it is now available to clinics nationwide.

As a reminder, our practice hub is our <unk> solution for veterinary which allows them to earn revenue as a marketplace seller on chewy dot com by giving their clients access to unparalleled convenience and customer care that chewy customers have come to trust and love.

From the 50 clinics, who participated in our initial invitation only a few months ago in 2021, we've expanded to over 300 clinics, including independent practices large hospitals and multi unit veterinary groups.

Interest levels remain high and feedback from the vet community remains positive and productive.

Equally exciting is the fact that we've recently expanded the selection available on practice to include our compounding pharmacy.

What this means is that we are now offering compounding as a <unk> capability expanding it beyond our original b to C positioning and giving our vet partners and other opportunity to earn revenue with <unk>.

Yeah.

Rounding out our TUI health update we are getting closer to the launch of our exclusive suite of pet health insurance plans and wellness and preventative plant.

Our phased rollout is set to launch soon and we look forward to sharing more with you at that time.

These plants will be another step forward for chewy Health's mission to make healthcare more affordable and accessible for everyone.

Looking beyond two Ehealth I'm excited to share with you two new businesses that we are gearing up for 2023 launch at the first is truly loyalty or customer membership program through which we will drive even greater value to our customers improving engagement across our growing customer base and accelerated customer share of wallet consolidation across categories.

And services.

The second launch in 2023 will be sponsored ads on <unk> dot com, which will enable our suppliers to seamlessly advertise through our 21 million active customers across all our platform.

We have been building bespoke advertisements for years and chewy sponsored ads will allow us to scale. These efforts into contextual advertisements, which will deliver both highly relevant products to customers and high margin revenue to our business.

Suppliers are asking us for ventas to advertise in a durable privacy safe environment across <unk> Dot com one of the largest pad E Commerce search engine in the U S.

In closing, let me just share.

What I would characterize as the mindset of every single judo P and who is committed to achieving our mission of being the most trusted and convenient destination for pet parents and partners everywhere.

Each of US is looking beyond the present operating volatility and into the future with the firm belief that the secular trends of higher pet ownership and increasing online penetration when long outlast the near term disruption that we see today from the pandemic and its after effects.

Julie's value proposition remains as compelling as ever.

Moreover, our long term strategy and ability to attract customers both loyalty drive engagement and capture a greater share of wallet remains intact as we execute 2022 and plan 2023 and beyond we are as optimistic as we've ever been on the long term growth opportunity ahead of us with that.

Now I will turn the call over to Mario.

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 two year stack basis Q4, net sales were up over $1 billion, making it the largest two year increase for any quarter in fiscal 2021.

For the full year net sales increased 24, 4% to $8 89 billion.

On a two year stack basis full year net sales increased over $4 billion or 83%.

Auto ship closed 2021 on a strong note as the value proposition of the program continues to resonate with our customers.

Q4 auto ship customer sales increased 21, 2% to $1 $69 billion exceeding the pace of overall net sales growth.

On a two year stack basis, Q4 auto ship customer sales were up 77%.

As a percentage of net sales auto ship customer sales set a new record high of 77% in the fourth quarter and auto ship 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 netback increased 15, 6% to $430. This is up $70 from two years ago. When our netback was $360 and demonstrates our continued ability to capture a greater share of wallet from our customers as they mature in their relationship with chewy overtime.

We ended the year with $20 7 million active customers a year over year increase of $1 5 million customers or seven 6% and while the customer base continuing to expand net active outs 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 in Q4 2020.

This led to a higher mix of one time transactions and more discretionary are first time purchases in areas like hard goods that historically correlate with lower retention rates.

The impact of these timing factors was compounded by the absolute size of the Q4, 2020 cohort, which was 5% larger than the average cohort size for the first three quarters of the year.

Nearly 40% larger than the Q4 2019 cohort.

Moving down the financials fourth quarter gross margin declined 170 basis points to 25, 4% the year over year variance is mostly attributable to pricing inflation and inbound freight, which I will elaborate on in a moment.

Full year 2021, gross margin increased 120 basis points to 26, 7%, a new full year record high.

While inflation and freight headwinds in the second half of the year kept our full year margin expansion. They did not prevent us from meeting our stated goal of delivering incremental and gradual margin expansion in 2021 now let me elaborate on the various factors that affected Q4 gross margin performance and provide more color on how we see these factors affecting gross margin and <unk>.

2022.

Product cost inflation was the biggest gross margin headwind in Q4 as.

As we shared on our December call, we observed a lagging market prices adjusting to reflect higher product costs and that continued for most of Q4.

To expedite closing this gap, we took additional measures to adjust prices.

In many places doing so proactively while keeping an eye on demand elasticity.

These measures started to gain traction as we exited Q4 and are making steady progress into Q1.

Importantly, we have been able to execute these measures while preserving our competitive position in the market and maintaining the strong value proposition that customers expect from Chile.

We also saw inbound freight costs related to port congestion and elevated spot rates emerge as a gross margin pressure point in the second half of 2021.

The situation improve in Q4 compared to Q3, and we now believe that most of the adverse cost impact from this has already flowed through our results and we don't expect to see meaningful margin pressure from inbound freight in Q1 or the rest of 2022.

On the outbound transportation front, our new freight contract with Fedex had only a modest impact on fourth quarter gross margin.

Ah submit elaborated on in his remarks, we believe the near term pressures on gross margin likely peaked in Q4 2021, and we're seeing sequential improvements in Q1 2022.

We're making progress on pricing and inflation inbound freight costs have moderated and various initiatives are working to mitigate higher outbound freight costs.

With continued progress in these areas and solid topline growth, we expect to hold gross margin broadly in line in 2022 versus 2021.

Fourth quarter operating expenses, which include SG&A and advertising and marketing were $668 $7 million or 28% of net sales compared to 26, 1% in the fourth quarter of 2020.

The 190 basis point increase reflects ongoing labor pressures and SG&A offset by positive operating leverage in advertising and marketing expenses.

For the full year 2021, operating expenses were $2 $45 billion or 27, 5% of net sales up 80 basis points from 26, 7% of net sales in 2020.

Let's review Q4 SG&A in more detail.

As a reminder, our SG&A includes all fulfillment customer service cost credit card processing fees corporate overhead and share based compensation.

Q4, SG&A expenses were $516 $5 million or 21, 6% of net sales compared to 18, 7% in the fourth quarter of 2020.

Three primary factors contributed to the 210 basis points increase normalized for the $16 million tax reserve release in the fourth quarter of 2020.

The largest of these is a $30 million of higher quarterly wage benefit and recruiting costs that we have discussed throughout 2021.

We also incurred incremental labor costs due to a considerable increase in the number of fulfillment center members, who are out on sick leave during the omicron search.

Combined this accounted for approximately 140 basis points of the increase.

The balance can be attributed to upfront investments, we are making in our new business and growth initiatives. We expect these investments to begin to scale as we exit 2022.

On a full year basis, SG&A expenses were $1 $83 billion or 25% of net sales and Deleveraged 90 basis points year over year.

Adjusting for elevated FC labor expenses and the favorable tax item in 2020, we would have leveraged our 2021 SG&A expenses by 50 basis points.

We were able to accomplish this even with our significant investment in growth oriented infrastructure that since late 2020 included opening three new fulfillment centers, one pharmacy and expanding our corporate office footprint, including our newest office in Seattle.

Overtime, we expect top line growth will naturally lead to leverage in our fulfillment and corporate infrastructure and SG&A.

Moving on to marketing fourth quarter advertising and marketing was $152 2 million or six 4% of net sales scaling 90 basis points year over year on.

On a full year basis advertising and marketing represented 7% of net sales scaling 20 basis points versus 2020.

Wrapping up the income statement fourth quarter net loss was $63 $6 million and net margin was negative two points of a percent a year over year decline of 370 basis points.

Our full year 2021, net loss improved to $73 8 million from $92 $5 million in 2020, and our net margin improved 50 basis points to negative <unk>, 8%.

Excluding share based compensation full year net income was $11 $5 million compared to $36 $7 million last year ended margin excluding share based compensation declined 40 basis points to 0.1%.

Fourth quarter, adjusted EBITDA was negative $28 $1 million and adjusted EBITDA margin declined 420 basis points to negative one, 2%, primarily reflecting gross margin pressure and elevated labor costs.

Full year adjusted EBITDA remained positive for the second year in a row and reached $78 $6 million adjusted EBITDA margin declined 30 basis points year over year to <unk>, 9%, taking a longer view, while we may experience fluctuations quarter to quarter over the last two years, we've expanded our adjusted EBIT margin by 200.

60 basis points and move from adjusted EBITDA negative to adjusted EBITDA positive.

Turning now to free cash flow fourth quarter free cash flow was negative $113 $4 million, reflecting $66 million in cash used in operating activities and $47 $5 million of capital expenditures.

The negative operating cash in Q4 was primarily a function of our net loss and our negative working capital cycle related to the approximately $100 million in incremental inventory, we built throughout the year to prepare for the holidays and protect from further supply chain disruptions.

Capital investments in the quarter continued to be growth oriented.

And included spending on our recently opened FC in Kansas City, a recently opened pharmacy in Pennsylvania, our soon to be opened FC in Reno and continued investments in it infrastructure.

For the full year, we generated approximately $9 million of positive free cash flow.

So at the end of 2018, we have been essentially free cash flow neutral in line with our stated growth strategy over.

Over those same three years, we increased net sales by 150% launched five new FCS opened a new pharmacy expanded our corporate precedent to talent dense cities made meaningful investments in chewy health and other growth initiatives.

Still expanded our adjusted EBITDA margin by 740 basis points.

Again, we've done all this while remaining debt free and consuming no cash.

We finished the year with $603 million of cash and cash equivalents on the balance sheet and between cash and availability on our ABL total year end liquidity stood at nearly $1 1 billion.

That concludes my fourth quarter and 2021 recap so now, let's discuss our first quarter and full year 2022 outlook.

While the core fundamentals of our business remain intact, the operational and macro crosscurrents that we have discussed today make accurate forecasting more difficult.

As always our current guidance reflects the balance of the opportunities and risks that we see in the current environment.

With that we expect first quarter net sales of between 2.40 and $243 billion representing year over year growth of 12% to 14% full.

Full year 2022, net sales of between $10 to $10 4 billion representing year over year growth of 15% to 17%.

And we expect full year 2022, adjusted EBIT margin to be breakeven to positive 1%.

As you update your models for 2020 to hear a few other things to keep in mind full year 2022, Capex should equal approximately two 5% of net sales slightly above our historical target range of 1.5% to 2%.

Given longer project lead times, our total spending on new FC capacity over the next two years is frontloaded into 2022.

This is simply a matter of timing and we expect Capex will balance out in our normal range of one 5% to 2% of net sales across 2022 and 2023 in aggregate.

Finally, full year 2022 share based compensation is expected to be approximately $170 million.

Shall we see ability to deliver significant topline growth in 2021 on top of the unprecedented growth we experienced in 2020, when coupled with our ability to expand full year gross margins and grow adjusted EBITDA is a strong testament to the durability of the pet category and <unk> ability to execute in the face of rapidly evolving macro conditions.

As we move forward, we remain focused on investing in the long term and executing against our strategic plan to grow our customer base expand share of wallet and drive market share.

When we combine that with a growing tam secular growth in the online portion of the industry and <unk> leadership position in the market, we see continued upside in our future.

With that I'll turn the call over to the operator.

Operator.

Thank you.

If you would like to ask a question. Please press star followed by one on your telephone keypad. If for any reason you would like to remove that question. Please press star followed by team again to ask a question. Please press star one if youre using a speakerphone. Please remember to pick up your handset before asking a question.

We will pause briefly to allow questions to Rajasthan.

First question.

Is from the line of Doug Anmuth with J P. Morgan. Please go ahead.

Oh, great. Thanks for taking the questions.

First I was hoping you could provide some color on how youre thinking about the mix and growth between active customers in the NASDAQ in 'twenty two and then you talked about mitigation efforts are offsetting some of the gross margin.

Headwinds around shipping and logistics are those the same initiatives that you talked about a couple quarters ago related to software and fulfillment efficiencies anymore color you can provide there on timing. Thanks.

Hey, Doug It's Mario I'll start us off and then <unk> will answer the second part of your question and before I give you and sort of color on 22, Let me. 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 a 27 million active customers.

That's an increase of $7 2 million over two years or 54%.

Kris.

And in Q4, we did see a day net active adds came in softer than we expected came in a bit lighter than we expected.

And here's why.

When we look at your one retention.

For customers, who joined the platform in the first three quarters of 2020.

Those rates were all within historical ranges and we shared this before in our in our previous calls.

When we look at the Q4 2020 cohort that their retention rate, which we said is high did decline by low single digits.

Versus the historical training 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 then as a result.

As we had a softer sequential active growth active customer adds.

And 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 of Covid and then obviously the second round of stimulus checks that arrived in Q4 2020, now I say all of that sort of thing. So I can give you a perspective of.

'twenty two.

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 still constrained and we are out of stock levels that remain higher than normal.

All of that we believe is driving some customers who cross shop.

Online offline et cetera.

We expect those factors will have a near term retention rate.

Impact in the low single digits for customers, we acquired in 2020, and 2021 and remember those are very large cohorts.

As a result, we do expect net active adds for 2022 to be.

Lower than they were in 2021 and to be muted at least through the first half of the of 2022.

On the other hand to your to your question, we do expect <unk> to grow at a healthy pace.

Our net sales guidance assumes a combination of both netback inactive customers to grow.

This year driving net sales increase.

I think sorry, one more installation and ongoing a bit long here, but just before some of it speaks to the second part of your question.

Because it is worth.

So at this stage for this when.

When we think about net <unk> and net sales growth.

If you compare 2019 to 2021.

Our net sales growth net sales grew about $1 $3 billion in 2019, and we added $2 9 million active customers a year netback that year increased 6%.

When you compare to 2021, so last year Nick.

Net sales grew at one grew $1 $7 billion, so 400 million more than 2021, despite only adding one 5 million active customers last year.

Why because netback grew 16% so.

So when we look at the levers of growth it is both.

To expand the customer base, but certainly capture more of the share of wallet and at $430 that we just reported for NASDAQ.

Versus an average spend of about $1200 give or take in the U S.

For pet household we still have a lot of share of wallet. We can gain we can capture from our existing customers and I know that was a bit long, but I'll turn it over to Sumit for the second part thanks, Doug.

Doug. This is helpful to remember that two thirds of our 21 million active customers have been virtually less than two to three years and so you know as we kind of amplify the curve as it grows from from from the cohort spend point of view.

The healthy spend that morry was 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 to let me provide you some details on what is it that we're after here.

So to come back the impact in FY 'twenty two as we said, we're launching several new logistics and supply chain.

Inventory and floor related initiatives that will be scaled launched in 'twenty two but also scaled over later half of 2002 and 23. So in January we launched our transfer initiative to optimally load balance inventory across our network.

And that is helping us.

Combat kind of along his own shipping and and placed products closer to customers and therefore mitigate some part of that impact.

Number two in Q1 and early into Q2, we're launching what I would call our trans load overseas shipping initiative and that will actually help route international inventory more optimally across our network and position down more ideally in front of our fulfillment centers.

Number three and this one's actually of.

Something we're proud of as well, we're launching what I would call chewy freight services or CFS, which is starting out of the line haul initiative, where we will operate a portion of our own middle mile Fleet.

In network with.

Launched us 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 enabled a smoother package flow that helps both the cost and customer experience, particularly during the kind of macroeconomic environment that we're living 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 Youre talking about is an example that lives in as part of this team, but these initiatives that I'm talking about at <unk>.

Mental to that.

So the order routing technology was a 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 order sent over long distances.

These will further complement our logistics initiatives that I talked about.

Collectively help us mitigate a majority of the increase.

That we're seeing from the from the freight rate card.

Hopefully that was helpful. Thank you both thank you I appreciate all the details.

Sure. Thanks, Doug.

Thank you Mr Anmuth.

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

Thanks, a couple questions on the sponsored ads launch maybe three there first off.

There's a large amount of vendor spend in terms of trade promotions in slotting fees at a grocery in 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 of that is being spent in trade promotion sodding fees, specifically in pet category.

Number two.

Wondering if you could remind us how often you see a customer onsite once they're enrolled in auto ship, 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.

Thanks, guys.

Hey, Brian Smith.

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.

Large and and the dollars you know in our opinion are uniquely positioned outside the trade funds and suppliers see tremendous value in getting advertising across to the customer base.

And to the experiences that we offer so in that way, we see it as a as a potentially meaningful.

High margin recurring revenue opportunity in the future.

Secondly in terms of auto ship customers, our ultrashape customers, even though theres subscribe to the service are highly active and record <unk>.

And their purchase and shopping behavior to give you a perspective.

Two thirds of our base is or our ownership base is what we consider a base load.

Which is a record repeat staple in nature and the rest of it is highly experimental.

See customers with multiple open order ships at the same time they come in they go out.

And they remain highly engaged including through our promo campaigns when we actually do and choose to include those customers to be a part of it are also customers are also part of our active kind of launching innovation campaigns and they do highly actively participants. So we believe that this will be opened and therefore, an opportunity for that customer base as well.

And then finally, a third part of the question is the line of off site advertising using in total data.

You're going to have to explain that a little bit because I'm not sure if you're on.

On the question you asked.

Yeah.

An ad network.

Extensibility type of thing.

I see.

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

Okay. Thank you.

Thank you Mr Fitzgerald.

Our next question.

Comes from the line of.

Stephen with Snake with Jefferies.

Please go ahead.

Yes.

Hi, everybody as 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 but help us think through the availability of inventory and the constraint on the first quarter.

Do 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.

Your liquidity standings, and do you think youll need to raise cash as we progress through the year. Thank you.

Hey, Steph.

I'll take both questions in so they can add something else to the to the inventory if I Miss anything.

Inventory levels. So you heard us say that the impact of omicron in mid quarter or had an impact negatively impacted our out of stock levels. So the the increase 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 that you saw us carry elevated levels of inventory throughout the year and then in the fourth quarter, we burned through some of that.

Uh huh.

<unk> totally clear and stuff, we would rather have purchased inventory of course.

The reason for that is as you've heard US say, we are baking into our guidance something in the range of $200 million to $300 million.

Of out of stock.

Sales lawsuit to out of stock.

For 2022.

That gives you an idea of how we think about inventory and AR and the.

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 that we would have used cash in the fourth quarter.

Second 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, there's 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.

Startup with a $600 million.

Of cash and cash equivalents, we have on the balance sheet.

Second to that is thinking.

Think about that we are spending slightly incrementally more in capex this year about <unk>.

Half a point more than net sales, so, let's let's call it $50 million.

If we're looking at a.

10, $10 billion or so full year.

So you see there's not a lot of our cash burn and then when it comes to the Capex side of things.

And the last thing a step is look at our history.

We have a history of being very diligent and efficient in the way we deploy our cash.

I would expect that to be the case again this year.

Okay. That's helpful can I ask a point of clarification on the guidance for the first quarter versus the balance of the year. It would assume that your in stocks improve so should we overweight the burden of the out of stocks from that $2 million to $300 million in the first quarter and then just maybe give us some reassurance.

From your vendor community that they're committing to improving your in stock position.

As the year progresses.

That's the stuff that is this is something that 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 chain is really integrated coming into Q3, if you recall and the continued or they got worse in Q4, and you know that.

When the war in Ukraine has actually caused some incremental near term shortages.

It will actually.

The commentary that we're hearing from the from our supplier base right. Now is that this is expected to continue through 2022 with early signs of recovery in 2023, but within 2020 to the first half is going to be worse than the second half.

Okay very helpful. Thank you.

Thanks, though.

Thank you Ms listening.

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

Hey, Mark Hey, Thanks can you hear me.

Hello.

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 true pinion chip partnership and the timing of that is is that on track ahead of plan any new insights as you've done more work to prepare for that for that launch. Thank you.

Hi, Mark the system I'll start with the second one so we're on track to launch our first set of insurance offerings with our partnered for Banyan.

But in the very near future I would say that in the next 30 to 90 days timeframe.

So that's on track and we're excited about that.

In terms of international not much more to add there today.

<unk> recognized international as a as an additional Tam expansion opportunity beyond the 120 billion U S market that we bought it's a bit in today.

And so it's a credible source of growth for us.

Whether we do it organically or Inorganically I think we'll be thoughtful about both paths.

And do our diligence accordingly relative to the market.

Inputs around e-commerce penetration logistics operations infrastructure and our go to market and then be able to appropriately decide the right course of outcome. So.

So it's a matter of events.

<unk>.

Okay. Thank you sumit.

Thanks Mark.

Thank you Mr Marrone.

Our next question comes from the line of.

Deepak My T. Barnum with Wolfe Research. Please go ahead.

Hey, guys. Thanks for taking the questions just a couple ones. So first can you talk about pricing levels. You noted easing off from the inflationary impact on gross margins.

The competitive landscape sort of catching up on 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 'twenty two on the active customers. You know is the retention softness that you are expecting for 'twenty two from the 2020 cohorts or is it that 2021 cohort just trying to understand basically if you're to retention behavior is different or as the year, one behavior compared to historically.

And maybe you can provide some color on kind of like a marketing with <unk> gross adds.

This year that would be great too. Thanks, so much.

Hey, Deepak summit I'll try to take both and model will jump in.

As he sees fit.

So first first part let's talk about inflation. So we are 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.

Aggregate this is translating to us passing.

Single digit cost inflation in our category.

There's also as you as you kind of rightly mentioned, it's a it's a top line and a margin kind of impacting a lever.

Importantly, we're being surgical and deliberate about our pricing strategy.

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.

So that probably provides you some perspective in terms of your second question.

It's both it's 'twenty 2020 , one as Mario alluded 2020 was a large sized cohort and so you know our attrition even though it's small when customers get from year two into your three there is a portion of attrition that continues into <unk>.

Into the subsequent theaters and then 'twenty. One you know his perspective is our is.

It's something that we share and something that we are broadly observing.

But as the economy kind of broadly opens up so all combined that answer and I'll combine the marketing kind of question that you asked and answer it. This way it right I think marketing in 'twenty two is going to be impacted by a few things, which will actually impact the dynamic of gross adds net adds also.

One it's clear that as the economy reopens customers are exiting the home to conduct in person shopping and consumer.

Consuming more in person services.

Number two you know elevated industrial or a lot of stock, which Mario mentioned is leading to suboptimal purchase experience for our customers and it's encouraging them to cross shop multiple retailers in our opinion. This will keep our acquisition and retention kind of at an interesting kind of balance with each other and.

It should also be said and it'll it'll impact in our opinion every player in the pet category in 2022.

Additionally, we see this as a transient impact and not a long term impact.

The third is the high degree of inflation is currently causing compression in discretionary categories. Like for example, when you look at the U S retail business today, not just Pat but broadly U S retail across the industry hard lines category not just Pat is expected to grow low to mid single digits. This year.

Associated platform source data across market platforms kind of confirms that in fact in February hardline sales search queries were down 15% on a year over year basis.

And so what you will see in our opinion in 2022 is these factors will lead retailers and E tailers.

Amidst this kind of economic volatility to compete for a pool of customers that are appropriately stressed and divided mindshare and that in turn will keep the AD market demand and supply sort of precariously balanced leading to variability in kind of marketing cost gross adds and net adds I should tell you you know we're not guiding to a special.

Correct levels of spend in this area and the marketing section.

But you know you've seen us kind of be within the long term range of 6% to 7% of net sales and I expect that we will remain there, but some quarters being higher and others being lower overall.

Hopefully that's helpful.

Yeah, No that's very helpful. Thanks for the elaborate answer estimate.

Thanks, Steve.

Yeah.

Thank you Mr. Matthew Conlan.

Our next question comes from the line of Lauren snack with Morgan Stanley . Please go ahead.

Great. Thanks for taking my question you know.

Understanding that a lot of the headwinds youre seeing them.

Or are not specific to you, it's sort of a broader supply chain inflation etcetera, 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.

The incremental margins that flow through of the business acts and you know.

Some of what you believe is more transitory headwinds.

Any color around that would be really helpful. Thanks.

Sure Hey, Steph system.

We could 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, you know we're confident in our ability to overcome these headwinds that we view as sort of a you know not department.

And 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 scaled 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 were between 6% and 7% and we believe that these are the right levels to stay with it and we will see some leverage as our CRM and loyalty initiatives.

Pick up in the future.

How much that leverage will be will will 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 in in SG&A. There is three 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 $100 million of 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 do you see underneath is the fulfillment center productivity and therefore, the base variable costs in 2021, indeed scaled by roughly 8% against a backdrop of wage inflation, which was 17% during the same time.

And so fulfillment center automation and in house productivity improvements by the FC operations teams and our support teams drove that leverage and we'll continue to do so going forward.

The three automated fulfillment centers will contribute an incremental 40 to 60 basis points of leverage over the next two years and we expect there to be further leverage beyond the 40 to 60 basis points as we increase our automated FC count and drive further productivity.

Number one.

The sub point under this opex component variable Opex is the current state of supply chain imbalance and disruption is impeding optimal operations flow in our FCS and in 2022. This is dropping 20 to 30 basis points of leverage.

The second component of SG&A beyond the the the variable opex is the fixed fulfillment expense to run the buildings here capacity imbalance is we're absorbing capacity imbalances that are caused by both inventory and labor that are causing lower fulfillment center utilization levels in the current moment. So we believe there.

30 to 50 basis points of leverage that is temporarily held back here and we expect this to normalize over the next 12 to 18 month period.

And then third and final component is G&A, which is primarily comprised of investments in software technology and in teams and capabilities that drive growth for us here.

Here, we're investing to fund new initiatives that will be growth in profit accretive to us over time as you've heard kind of won several you've heard several on the call today ranging from supply chain logistics, two new launches in 'twenty, two and 'twenty three healthcare is our best example of this you know which required startup standup investment and is now a credible fast growing margin accretive business for us.

Overall does G&A bucket will begin to scale as we exit 2022.

So hopefully that provides you kind of perspective on SG&A and hopefully the the impression on the message that I'm, providing you is we're disciplined we're thoughtful we're focused.

And we're determined to scale. These P&L line items to get kind of within the range of 5% to 10% that we've promised or committed.

Very helpful. Thank you.

Thanks, Lauren Thank you Ross.

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

Yeah.

Hey, Matt Norton here on for Steve Forbes 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.

Was hoping we can get an update on the line items in there.

Evert label, how it is trending I think we've gotten an update on the penetration rate there.

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 too.

What are you seeing any differences by cohort that would be useful. Thanks.

Marty will have to repeat the second part of the question on the first part private label private brands just to recall and refresh.

We believe as a strategic vertical we want to get it to between 15 and 30% of our net sales.

Sales and we've been growing that at a premium to accompany 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 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.

As 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 hardgoods categories, right, where as I mentioned.

Tumors have.

Look for value and the look for you know a high rated high rated consumer products.

And conversion has driven as a result of conversion opportunity and less kind of prebuilt brand conversion per se our brand consideration per se. So that is an opportunity for us.

In terms of pharmacy can you repeat the question I didn't catch thoughtfully.

Q4 2021 Chewy Inc Earnings Call

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