Q4 2022 Chewy Inc Earnings Call
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Good afternoon. Thank you for attending today's chewy fourth quarter Phil.
Fiscal year 'twenty two earnings call. My name is Anna 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 questions and answers at the end if you will.
I'd like to ask a question. Please press star one on your telephone keypad.
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 <unk> CEO , Mr Mckay and CFO Mario market.
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 Darci Dotcom.
The 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 growth financial results business strategies and 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 1985.
Subject to certain risks and uncertainties, which could cause actual results to differ materially from those contemplated by our Florida 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 contribute 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 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 would now like to turn the call over to submit.
Thanks, Bob and thanks to all of you for joining us on the call.
Fourth quarter results capped an incredible year.
Against the backdrop of a rapidly changing operating and economic environment should we produced record high revenue profitability and free cash flow.
It's really a dedication to serving pet parents and partners with the 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 is the 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 healthcare remain the pillars of strength with the offset coming from discretionary categories such as hard goods.
Our topline expansion reflects our success in managing the dynamic pricing environment as well as the record nature of our business model and our ability to expand share of wallet from our customers overtime.
Auto ship customer sales increased 18% and generated 73% of our Q4 net sales representing a 260 basis point increase over the prior year period.
We further deepened our customer engagement with net sales per active customer our netback growing 15% year over year to reach nearly $500 in Q4.
With nearly 60% of our customers having joined our platform within the last three years. We believe there remains significant runway for our customers to spend progressively more with us the longer this day.
Moving onto customers, we ended Q4 with $20 4 million active customers.
We believe the modest sequential decline in active customers reflects the continued softness in discretionary spending experienced across the broader economy as well as the residual impact of attrition from our 2020 and 2021 cohorts.
We anticipate returning to positive active customer growth this year and expect net pack will continue to strengthen.
Turning to profitability metrics fourth quarter 2022, gross margin expanded 270 basis points to 28, 1%.
The significant improvement in year over year Q4, gross margin was driven by favorable pricing comps relative to Q4 of last year and to a lesser degree by our ongoing supply chain transformation.
Full year 2022, a gross margin improved by 130 basis points to 28% in line with the high end of our long term guidance.
Continued pricing strength combined with the progress we have made in our supply chain initiatives enabled us to deliver these results.
In 2023, we are excited about our ongoing work to grow high margin verticals. Many of you had to remain in early stages and are expected to provide gross margin tailwind in the current year and beyond.
At the same time, we expect these contributions to be balanced against our expectation of continued suppressed demand in the discretionary categories, such as hard goods and the flexibility that we wish to retain to manage overall demand elasticity.
To elaborate on demand elasticity, considering the magnitude of price increases that consumers have already experienced and may yet to continue to experience. We will continue to take a surgical approach to optimize pricing.
Additionally, we had supply chain is recovering we are closely monitoring our catalog to ensure we remain competitive in light of current consumer mindset.
At this point in the year, we expect the overall result of these drivers to produce a net neutral impact on gross margin in 2023.
That said over a longer time horizon, given the nascency of many of our initiatives such as private brands Chewy health, including insurance sponsored ads and more we believe there is additional runway left for incremental gross margin expansion.
Staying on profitability Q4, adjusted EBITDA was $92 million and adjusted EBITDA margin was three 4% an increase of $120 million and 460 basis points respectively.
The strong gross margin performance and SG&A leverage were the primary drivers of Q4 adjusted EBITDA growth.
We saw the same key drivers manifest themselves in our full year 2022 results as adjusted EBITDA nearly quadrupled from 2021 levels to over $300 million.
And adjusted EBITDA margin expanded 210 basis points to 3%.
Moving away from fiscal 2022, let me now spend some time sharing our operating philosophy for 2023 and beyond as well as various growth and margin enhancing initiatives that we plan to launch.
Delivering long term profitable growth remains our north star.
Over the past four years, we have increased revenues from $3 5 billion to over $10 billion, while concurrently expanding gross margins from 20% to 28% and adjusted EBITDA margins from negative six 5% to positive 3%.
These results are both a testament to our team's focus on scaling our core businesses and our ability to ideate new ways to improve customer experience also launched new services for our customers and partners and following through with disciplined high bar execution.
Our 2023 strategy is consistent with this operating philosophy.
Scale, our existing cost base and simultaneously make purposeful investments to drive sustainable growth and profit over a multiyear period.
Let me provide a few examples of each of these starting first with how we have already driven cost leverage in our business and how we plan on further scaling our existing cost base.
The supply chain transformation initiatives that we began in 2021 have helped us expand our gross margin while simultaneously improving customer experience.
As a reminder, these efforts included areas such as import routing inventory planning and placement and middle mile.
Additionally, our decision to invest and fulfillment center automation in 2019 is now providing significant leverage in SG&A with meaningful upside left to go.
In 2023, we plan to continue scaling these efforts and drive further SG&A leverage for.
For starters, given the success of our automation initiatives and the productivity benefits. We are realizing in ramping our first three automated facilities. We have made the decision to close our two oldest FCS both of which are non automated assets.
Each of the facilities are located near one of our new automated FCS, which allows us to combine operations and offer team members the ability to transport locations.
We believe that this action will enable incremental order volume to flow through our automated facilities, which we expect will allow us to realize approximately 50 basis points of additional SG&A leverage in 2023.
Furthermore, we are on track to open our fourth automated facility in Nashville in the first half of this year.
The punchline here is that in 2023, we expect to continue benefiting from the strategic investments. We made just a few years ago and warehouse automation.
Moving forward, we remain committed to demonstrating strong operating discipline in running the business and tightly managing expenses along the way.
Now.
Moving on to the investment in innovation part of our operating philosophy.
In addition to leveraging our existing cost base.
In 2023, we plan on making conscious investments in areas that we believe will create sustainable growth and profits over the long term and generate high ROI for our shareholders.
Such areas include our higher margin verticals, where we plan to accelerate growth.
Italy, having strengthened our fundamentals over the past few years, we believe that the time is right to bring the TUI brand and our superior value proposition to pet parents outside of the U S.
We are actively building the capabilities and team to launch our first international market over the next few quarters.
We expect this important development to unlock meaningful incremental Tam and we are excited to introduce <unk> to a broader customer base with whom we believe our brand and mission will resonate strongly.
We look forward to discussing more specific plans with you on our Q1 call.
Our operating history demonstrates our strong track record of making such capital allocation decisions chewy.
Chewy pharmacy is a powerful example of investment and execution behind our new vertical that began four years ago and is now contributing superior growth and profit at scale today, we operate the largest pet pharmacy in the U S.
As we have demonstrated in the past we plan to remain highly disciplined about our level of commitment to and support of the investments that we seed and we will continually evaluate them against our expectations.
In closing I am proud of our team's relentless execution that has enabled us to deliver strong results over the course of another dynamic here.
As we enter 2023 I remain incredibly optimistic about our roadmap ahead.
With that I will turn the call over to Mario Mario.
Thank you Sumit and thank you all for joining us today.
Fourth quarter, net sales were $2 $71 billion and $319 million or 13, 4% increase year over year.
Our non discretionary consumables and health care categories continued to demonstrate strength in the quarter.
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 auto show business. So another year of strong growth as pet parents increasingly value the convenience and benefits of the program.
Q4 auto ship customer sales increased 17, 5% to $1 $98 billion exceeding the pace of our overall sales growth by 410 basis points.
For the quarter Autosave customer sales as a percent of total net sales reached 73, 3%.
For the full year auto ship customer sales increased 18% to seven 4 billion with auto ship customer sales, representing 73% of total net sales a new record high on an annual basis.
In Q4 should we continue to consolidate share of wallet from pet parents, who shop with us as <unk> reached a new record high of $495 up 15, 1% or $65 year over year.
As we have shared on previous calls topline growth for two years, driven by our ability to attract and retain customers overtime, while capturing an increasing portion of their annual pet spend.
In 2022, our active customer count to remain relatively flat versus 2021, as we worked through the short term attrition of a record size cohorts acquired in the preceding two years.
At the same time customers continued to consolidate their shopping with us with our three oldest cohorts each spending over $1000 in 2022, and all but our two most recent cohort spending over $500.
Said differently, we believe a tremendous opportunity remains ahead of us to fully unlock the revenue potential of our existing customer base.
Moving down the financials fourth quarter gross margin expanded 270 basis points to 28, 1%.
More than half of the improvement was the result of favorable comping relative to Q4 2021.
The balance came from our continued supply chain transformation initiatives leverage in freight and packaging due to increased basket sizes and other onetime true ups.
The items that were onetime in nature contributed approximately 40 basis points of benefit to our Q4 gross margin.
Relative to our expectations the lower than expected spend on promotions and fuel. This holiday season drove the outperformance in the quarter.
Full year 2022, gross margin increased 130 basis points from 28% of new full year record high.
As <unk> noted in his comments, our ability to maintain pricing strength overcame persistent cost deflation and our team's hard work across the various supply chain and logistics initiatives continued through Q4.
Collectively they also help to achieve gross margin outperformance relative to our expectations at the beginning of the year.
Moving to Opex.
SG&A, which includes all fulfillment and customer service costs credit card processing fees corporate overhead and share based compensation totaled $561 million in the fourth quarter or 27% of net sales scaling 90 basis points compared to the fourth quarter of 2021.
On a full year basis, 2022, SG&A deleveraged by 50 basis points to 21% solely due to higher share based compensation.
Excluding share based compensation SG&A totaled $510 8 million or 18, 9% of net sales.
This is an improvement of 210 basis points compared to the fourth quarter of 2021.
On a full year basis, SG&A, excluding share based compensation leveraged 20 basis points to 19, 4%.
Now I will take a moment to walk through the details of how we were able to scale SG&A excluding share based compensation in Q4.
Dave will fulfillment and customer service costs provided 170 basis points of year over year SG&A leverage in the fourth quarter.
Our variable fulfillment costs decline as a result of productivity gains and continued volume shift into our automated facilities, which collectively drove a 13% year over year reduction in system wide variable fulfillment cost per order.
Additionally, our improving in stock position supply chain initiatives and technology deployments across our customer care organization have improved overall customer experience, resulting in fewer customer context.
This led to a 15% year over year reduction in customer service cost per order.
We drove additional leverage of 70 basis points to our automated fulfillment centers as they absorb more incremental fixed carrying costs alongside with our ongoing management of corporate expenses, partially offsetting these gains are the investments in personnel and technology, we began making in Q4 2021 to support the many initiatives we shared with you throughout the year.
<unk> as well as the higher D&A costs associated with the facilities, we launched in the last year.
Altogether. These areas contributed approximately 30 basis points of year over year deleveraging.
These results are consistent with our stated operating philosophy scale based cost fund new initiatives grow revenue and profit from those new initiatives and redeploy some of the games into additional areas that we believe will drive further growth and profitability overtime.
Moving onto marketing fourth quarter advertising and marketing was $183 4 million or six 8% of net sales a 40 basis point increase from Q4 2021.
Sequentially advertising and marketing expenses scaled by 20 basis points as a result of the marketing efficiencies, we normally see in the fourth quarter.
On a full year basis advertising and marketing represented six 4% of net sales scaling 60 basis points versus 2021.
For both the quarter and year, our marketing spend was in line with our expectation of 6% to 7%.
Wrapping up the income statement fourth quarter net income was $6 1 million and net margin was 0.2% a year over year improvement of 290 basis points.
We marked our first full year of positive GAAP net income in 2022, with a reported $49 2 million and net income a $123 million improvement versus 2021.
Our net margin reached 0.5% expanding by 130 basis points versus 2021.
Fourth quarter, adjusted EBITDA was $92 million and adjusted EBITDA margin expanded 460 basis points to three 4%, reflecting gross margin momentum and SG&A leverage.
Full year adjusted EBITDA was positive for the 30 in a row, reaching $305 $9 million and adjusted EBITDA margin expanded 210 basis points year over year to 3% both of which are new records for Julien.
Turning now to free cash flow fourth quarter free cash flow was $42 $1 million, reflecting $106 million and net cash flow from operating activities and $58 4 million of capital expenditures.
The majority of our capital expenditures in the fourth quarter, we're focused on future automated fulfillment center launches.
For the full year, we generated $119 $3 million of positive free cash flow.
Full year 2022 is the first year in our history, where our free cash flow generation was materially above breakeven.
From the end of 2018 through 2021, we were essentially free cash flow neutral, which was in line with our growth strategy before turning meaningfully positive in 2022.
Over the period, we nearly tripled our net sales launched six new fulfillment centers opened three new pharmacy locations added two new customer service centers, one dedicated pharmacy customer service center and skilled in multiple other growth initiatives.
We accomplished all of this without consuming any cash and while remaining debt free.
We finished the year with $677 $4 million of cash and cash equivalents and marketable securities on the balance sheet $74 million higher than 2021.
Further boosting our liquidity position in the fourth quarter, we extended our ABL by $300 million to $800 million.
With an additional $250 million accordion that will give us incremental liquidity should we choose to exercise it.
At year end between cash on hand, marketable securities and availability of our newly expanded ABL total year end liquidity stood at over $1 4 billion.
That concludes my fourth quarter and full year 2020 to recap so now, let's discuss our first quarter and full year 2023 outlook.
Our guidance reflects a balanced view that incorporates the strength and visibility of our business model, while also providing some flexibility against an uncertain economic backdrop.
With that we expect first quarter net sales of between $2 72, and $2 4 billion.
<unk> year over year growth of 12% to 13% full.
Full year 2023, net sales of between $11, one and $11 3 billion.
Representing year over year growth of 10% to 12%.
And full year 2023, adjusted EBITDA margin to be flat to 50 basis points below our full year 2022, adjusted EBITDA margin of 3%.
Our 2023 adjusted EBITDA margin guidance reflects approximately 50 to 75 basis points of impact across SG&A and marketing as a result of the investments related to the international lunch and other growth initiatives.
Without the impact of these growth initiatives are expected 2023, adjusted EBITDA margin would be around three 5%.
As you update your models for 2023 here a few other things to keep in mind.
Regarding net adds we are maintaining a balanced view in light of the uncertain macro backdrop and the long tail attrition for a large COVID-19 cohorts.
Therefore, we anticipate returning to net adds growth during the second half of this year.
As such we expect an aspect to be the primary driver of revenue growth through the first half of the year before shifting to a blend of customer <unk> that growth in the second half of the year.
We anticipate our overall growth investments will be front end loaded with adjusted EBITDA margins expected to reaccelerate in the back half of this year.
We expect Capex in full year 2023 to return to our historical target range of one 5% to 2% of net sales and full year 2023 share based compensation, including related taxes to be approximately $215 million. Finally after factoring in the investments we intend to make in 2023, we expect to generate.
Fully positive free cash flow at approximately twice the level that we generated in 2022.
To conclude our 2022 results demonstrate our unwavering focus on day to day execution, and our ability to get big fast and fit fast.
Meanwhile, we remain highly encouraged by the growth roadmap ahead of us.
Ongoing opportunity to maximize value for the millions of pet parents, whom we serve our team members and our shareholders alike.
With that I'll turn the call over to the operator.
Thank you.
We will now begin the question and answer session. 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 turn that question. Please press star followed by two again to ask a question press Star one.
A reminder, if you are using a speaker phone. Please remember to pick up your handset before asking a question. We'll pause here briefly ask questions are about just stared.
The first question is from the line of Nat Schindler with Bank of America. You May proceed.
Yes, hi, guys.
Quick question. So one looking at your margin guidance absolutely.
Flat to slightly down EBITDA guide for this coming year.
Right. The fact, you have net slot growing in it.
It looks like given your revenue growth is going to be revenue growth is going to be driven as it has been recently by mascot more than customer growth.
And considering that your marketing cost is mostly customer acquisition, how would that not result, other than investment in international and other I would not result in meaningful improvement in EBITDA.
Second question.
Yes. It does look like the first time you've seen orders.
Declined on a year over year basis.
Is there anything that really changed here or is it just simply part of that cohort maturation and youre, just shifting to fewer larger orders and thats whats driving that and finally, the very last question and I'm sorry to do three in a row here.
Any update on.
Mario as replacement and what you guys are doing for CFO succession. Thank you.
And have it tomorrow.
Great to hear from you. So on your second question first and then submit it will talk about the first one.
You're asking about the order declining it's not that's not.
The case, so what youre seeing in the 10-K, you referred 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.
To ship out fewer packages, because we are continuing to get better at cauterization, meaning we can we can fit more of a an order into a single package and therefore lower our freight cost 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 replacement, there's a lot of them.
Work is being done behind the scenes.
And so but to answer the first question.
Hey, Matt Smith.
When you look at margin in 2022, I think it is important to frame up 2022, EBITDA in context of kind of how the year was played out.
And EBITDA margin for 2022 were the result of strong gross margin performance and added added to that.
SG&A leverage that we drove so when you look at.
Daily 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.
<unk> cost for a few months if you recall.
Further we expect continued gross margin expansion driven by our efforts on 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.
We've baked in which we are constantly monitoring performance around and as always we'll update guidance like for example, as we're currently leaving room for the category to be slightly more promotional than last year and so it does not bear out that that could potentially create upside to our outlook. We're also not assuming any hardwood re acceleration happening in 2023.
<unk>.
Two to any material degree and to the extent that there is a macro re acceleration in hard goods that should actually impact both sales and margin and so there is there is assumptions like those that are built in which essentially.
Yep.
Having those guide to gross margin net neutrality and then when it comes down to the SG&A side, we're basically leveraging SG&A, but we're reinvesting that leverage back into driving growth.
And as a result, our EBIT guide kind of comes out at this point of the year in a way that we're guiding today.
Yes.
Makes sense.
How much are you putting in is assumed in there in the international expansion and cost.
Assume that's almost no revenue.
Yeah, 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 isn't internationally.
And then when it comes to top line active customers Ness back now we are not assuming any material impact for those from that from that launch at this point any impact we're not assuming any impact to cortisol yes.
Okay.
Great.
Thank you.
Sure.
Thank you Mr Sandler.
The next question is from Andrew <unk> with Needham You May proceed.
Great. Thank you so much good afternoon.
Two questions in the past I think you talked about international growth and margin expansion simultaneously.
Talk about the big buckets of investments in 'twenty, three and international typically it takes a while.
Yes.
<unk> longer term goal for high single digit EBITDA margin.
My first question and then secondly, you may have.
Net add improving in the back half.
Any improvement in the business quarter to date.
Are you confident that back half improvement.
Hi, Ana this is Mario I'll take the first question and then somebody 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 it secures say that a few times the largest portion of that is going to be international.
No no real material impact topline gross margin et cetera in terms of investment for international launch.
The only thing to add there.
As we ramp up demand, we're going to view the market Opportunistically and if there is opportunity to invest at the top to drive topline 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, and then that as improvements in the back half.
Any quarter.
Quarter to date.
Confidence.
Well, what we said on the on the.
Early remarks was we expect net adds to begin to improve in the second half of the year for the 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.
And from the 2000 2021 cohorts two to work through.
And of course, there so.
What subdued demand for in the discretionary categories hard goods.
So we expect that it will be more of a second half of the year.
And our gross ads.
Good news at mid to high single digit higher than pre pandemic and a reactivation has also continued to be strong so to the extent that those could be considered signals.
I think you could take that into account in the models answer kind of rounds out the roundup the perspective, yes.
I would add I would add to that.
The.
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 and let them.
Alright. Thank you guys appreciate it.
Thanks Scott.
Thank you Ms <unk>.
The next question is from the line of Mark Mahaney with Evercore ISI you May proceed.
Alright. This is Joanne Lee for Mark Mahaney. Thanks for question.
First I wanted to just ask on that I.
I guess a higher level question on the international if you can just talk through what is the 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 most of 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 John .
I'll take it.
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 market that possess attractive characteristics for our initial international expansion plans and yes at this point.
And organically.
An acquisition per se in terms of Operationalization I would say consistent with our track record of operationalized investments such as pharmacy, it could be one of them.
We are thinking about international plans in stages with certain milestones that will responsibly govern the pace of expansion.
And then as Mario already noted a few minutes earlier, the revenue active customer and netback impact of launching international operations is fully reflected in our guidance and is not a material contributor to.
So any of those items.
In the guidance all four core.
Yes, we did.
That's as much as we can share today, we're excited about sharing more details on our Q1 call.
Great. Thanks, and one more on the gross margin.
Beyond this year.
I think in the third quarter that you hit the high end of your current long term gross margin how should we think about.
And then updated long term gross margin target beyond this year and what are the key drivers to that I think you mentioned the.
This year I can accelerate some higher margin verticals. So if you can expand on that.
Sure.
Does this limit again so.
We're excited about the continued gross margin are 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 brands 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 helped to Ehealth 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 and delivering customer value proposition that particular area.
It is also a tremendous netback 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 and it's in their categories sponsored ads is the next one that we are quickly ramping up.
Happy to kick into details if anybody's interested but we're pleased with the progress there we would expect the brand sponsored labs alive at a more fuller scale. This year ramping into 2024 behind that is our categories like insurance, which are on slightly longer arc, because you have to build customer consideration.
The consideration to conversion art, 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 ownership benefits working towards loyalty programs.
Or continued supply chain initiatives that we've talked about.
Provide us.
And opportunities in the future.
So we're excited there is 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 teams 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 one quick follow up to that is there any I guess can you quantify how much of a sponsor that is embedded in the full year guide.
Yes at this point is still fairly small it's still a small expectations for this year were just ramping we're excited about where it is and the trajectory upon.
But it's still not.
Not a meaningful driver yet.
Thanks for your time guys.
Yes. Thank you.
Thank you.
Question is from the line of Doug Anmuth with Jpmorgan you May proceed.
Thanks for taking the questions 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 thats number one and then second just circling back to the customer growth in 'twenty three just trying to understand really what drives the confidence there given that you are not really building in either macro improvement or discretionary product truly coming back much. It sounds like it's just some improvement or working through the <unk>.
Cohort over the last couple of years. Thanks.
Sure Hey, Doug Smith, so on international.
<unk> is 100% right.
No plan and expect to bring all.
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.
Launched working backwards from that.
There's no difference in the way that we show up in the cultural nuances.
<unk>.
<unk> brand.
The international market on the balance we are.
Cited and confident about our brands resilience.
An extension.
Inside of the United States per Se. So that's the first one in terms of us.
Customer ads there are several programs that we are working internally inside the company, which are there.
We're not not dependent on the macro but despite the macro we are excited about these particular programs.
When you look at kind of the way that we are optimizing our site improving our search results maximizing conversion, particularly as it comes to new search traffic at that lands on our website and we're seeing some early early very early signs of goodness. There number two we've talked about this in the past where she is not actively invested in CRM type.
And we are building out our CRM capability in 2023 to a much more fuller extent than we had in 2022 now that 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 lifecycle to be able to.
Either incentivize motivate.
Offer propositions to be able to.
Reactivate towards two you had a greater degree so the combination of those two kind of gives us confidence that there's more than just the market that is happening inside chewy, but of course, we have to bring these to life and play them through.
Great. Thank you.
Thank you Mr Anmuth.
The next question is from Cory <unk> with Jefferies. You May proceed.
Hi, Thanks for taking my question. So wanted to ask about the automated FC initiative. So I apologize if I missed this but what percent of volumes did you say are running through the automated.
On the centers currently and where do you think that can get by the end of the year and then whats assumed in that 50 bps of SG&A leverage.
Yes.
Cory This is Larry 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 a quarter at the same time last year.
I mean in Q4 'twenty one.
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 two.
So now having four facilities are automated.
13, once we launch our our Nashville in the next in the next couple of months.
So we are we're continuing to move volume into the automated facilities for many reasons one of them, obviously is a lower cost too.
Variable cost per order, which then flows through to two.
To SG&A and EBITDA so.
So we're going to do to.
To push as much volume into account into those facilities.
When you think about Smith <unk>.
Or was that the main question.
Yes, if I can ask a follow up.
Not for you to just say more about the sponsored ads beta I don't know if you can share speak any initial learnings customer feedback.
Update around timing of full launch and any change to how youre thinking about the long term opportunity. Thanks sure sure.
So we're pleased with the progress of the sponsored ads 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.
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 relevant.
The reception from brands has been and continues to be positive, including the reception on our Ros framework. So we're looking forward to the program launched in first half and then continuing to ramp.
Throughout 2023 and into into 2024.
Thank you.
Sure.
Thank you Mr <unk>.
Our next question is from Seth Basham with Wedbush You May proceed.
Thanks, a lot and good afternoon. My question is on gross that's good to hear continued mid to high single digit growth. There and you look at 2023, you're expecting that type of growth to continue and what does that mean for advertising growth.
Yes.
This is Mario so yes. So we are continuing to see strength in gross adds versus pre pandemic. In fact, you've heard us talk about all year that we weren't in the somewhere in the 6% to 10% range give or take increase versus the same quarter 2019 and that continue into Q4.
So that's a good indicator for us.
The strength of the other platform for 'twenty three let me not try to split up between gross adds and net.
And.
Retention initiatives, but you've heard us certainly explain why we think it's 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 in 2021 cohorts with.
The churn rates are those turn rates higher than you expected, even just three months ago and how did you get from 'twenty, two however repeat purchase behavior trending.
Let me see if I can decouple us into the two separate questions. When it comes to the 2020. One course, the retention levels have continued to remain.
More or less where we expected them and we have been talking about for several quarters now.
Hi, but but still.
No 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.
You probably heard US say early in 'twenty, two that we were trending to acquire more customers into our <unk>.
Non discretionary categories are repeatable categories consumables health care.
And.
So thats.
The behavior has proven out throughout the year.
Thank you.
Thank you Mr Bastian.
The next question is from Brian Fitzgerald with Wells Fargo. You May proceed.
Thanks, guys. We think this is the first time you provided 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.
Potentially getting back to growth at some point in 2023.
Hey, Brian This is Mario but let me try to.
Clarify the question here, you're saying we've provided specific guidance or are you talking about when we talk about.
The discretionary part of how we don't expect to a break on the trends that we've seen recently is that.
Just to be specific I think.
We think this is the first time, you've kind of broke out discretionary versus non discretionary growth.
So we're wondering on the discretionary side, how has that been tracking.
Are trends improving on the discretionary side, how do you think about the cycling through discretionary weakness and wonder kind of gets back to stronger growth.
Hey, Brian this is sumit.
Discretionary continues to be continues to be suppressed and pressured when you look at hard goods.
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.
At this time as it comes to the discretionary categories and we are making in things like hard goods creates and stuff like that we're not expecting a material re acceleration in 'twenty three.
And we stand prepared to invest if we see further deterioration of our opportunities.
Ultimately specifically as it considers the categories such as our 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.
We're not providing specific guidance of course at the category level and we're not expecting.
Material Reacceleration in 'twenty, three that's what's baked into the guidance right now.
Got it thanks, Jim I appreciate it sure.
Sure.
Thank you Mr Fitzgerald.
Our last question is from the line of Lauren Sync with Morgan Stanley You May proceed.
Great. Thanks, just a couple on gross margin if I can.
First what are you assuming around price increases this year from a manufacturer perspective was there one.
In this current first quarter.
And then secondly, you mentioned in your.
Prepared remarks, a surgical approach to optimize pricing in the shareholder letter you talked about sort of increasing value proposition are you looking to lower pricing.
Select categories.
Any color there would be really helpful. Thank you.
So starting with the second one no we are not looking to actively lower prices.
So it can be vigilant.
Across the catalog, particularly as a result of improving supply chain positions.
To ensure that if there is heightened market competitiveness lower 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 expect.
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 were seeing overall good enough compliance Lauren. So at this at this point, we believe that the frequency and pace of cost increase is largely behind us.
But of course as we receive more information from our suppliers will pass that on.
But we're not expecting more cost increases for the balance of the year at this point.
Okay, great. Thank you.
Sure.
Thank you Mr. Chen.
Sorry, Mr shrink.
Yeah.
We have reached the end of our allotted time for questions and I will now turn the call over to Simon for closing.
Thank you all for joining we appreciate it and we'll see you next time.
That concludes today's <unk> fourth quarter fiscal year 'twenty two earnings call. Thank you for your participation you may now disconnect your lines.