Chewy, Inc. (CHWY) Q4 2021 Earnings Report, Transcript and Summary

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

Thank you for joining us on the call today to discuss our fourth quarter and full year results for fiscal 2021. Joining me today are Chewy's CEO, Sumit Singh; and CFO, Mario Marte. Our earnings release and letter to shareholders, which were filed with the SEC on Form 8-K earlier today, have been posted to the Investor Relations section of our website investor.chewy.com. A link to the webcast of today's conference call is also available on our site. On our call today, we will be making forward-looking statements, including statements concerning Chewy's future prospects, financial results, business strategies, industry trends and our ability to successfully respond to business risks, including those related to the spread of COVID-19, including any adverse impacts on our supply chain, workforce, fulfillment centers, other facilities, customer service operations and business expansion plans. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those contemplated by our forward-looking statements. Reported results should not be considered an indication of future performance. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward-looking statements, except as required by law. For further information, please refer to the risk factors and other information in Chewy's 10-K and 8-K filed earlier today and in our other filings with the SEC. Also during this call, we will discuss certain non-GAAP financial measures. Reconciliations of these non-GAAP items to the most directly comparable GAAP financial measures are provided on our Investor Relations website and in our earnings release and letter to shareholders, which were filed with the SEC on Form 8-K earlier today and in our 10-K. These non-GAAP measures are not intended as a substitute for GAAP results. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of this call also will be available on our IR website shortly. I'd now like to turn the call over to Sumit.

Thanks, Bob, and thanks to all of you for joining us on the call. Let me first share some thoughts on 2021, and then broadly about the pet industry overall and why we remain optimistic about this sector and Chewy's place in it. 2021 capped off the most remarkable 2-year period in our company's history. As the pandemic unfolded, Chewy benefited from an acceleration of the secular trends that have been driving our business for many years. Increased pet ownership, increased average spending per pet household and more of the spending being directed to online channels. Millions of new pet families were formed and as a result demand for pet products and services surged. Our team scaled rapidly and our business nearly doubled, delivering a $4 billion or 83% increase in net sales over these past 2 years. Over that same time frame, we expanded our active customer base by 7.2 million customers or 54%. More important, we believe that these games are sustainable over the long term. Pets are part of our families for many years, and the puppies adopted during the pandemic marked the start of a 10 to 15-year long relationship between those pets and their pet parents. And for many of those pet families, it was also the beginning of a long and rewarding relationship with Chewy. The predicable and recurring nature of these relationships gives us confidence that the customer and revenue gains that we made are enduring and will provide a lasting foundation for future growth. In many ways, we are just getting started. We compete in a $120 billion pet TAM today that is expected to grow rapidly over the next 5 years. And within that broader pet TAM, e-commerce sales are expected to grow even faster. We believe that Chewy will continue to be a strong beneficiary of these secular tailwinds 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. Ultimately, 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 earn 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 innovations. 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 $2.39 billion, bringing 2021 full year net sales to $8.89 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, they helped drive a 16% increase in net sales per active customer or NSPAC to a record $430. Another noteworthy indicator of engagement is the continued strength of our Autoship program, which increased 180 basis points year-over-year to 70.2% of our 2021 net sales. At the same time, we saw operating conditions in certain areas deteriorate as the quarter unfolded, particularly when Omicron's mid-quarter arrival further disrupted already weakened supply chains across our industry. This added additional pressure to out of stock levels and the impact from lost sales in the quarter was twice as high as we forecasted. Without this, we estimate our Q4 net sales would have been near the high end of our guidance range. Moving on to customers. We added 1.5 million active customers in 2021 to end the year with 20.7 million active customers, an increase of 8%. This expanding customer base and a 16% increase in NSPAC were the key components of our 2021 sales growth. Sustained NSPAC growth reflects strong contributions from our most recent cohorts and our ongoing efforts to develop customers over time and capture a progressively larger share of wallet. In fact, our 2021 cohort recorded the highest first year NSPAC we have seen since 2017. Similarly, our 2020 cohort recorded the highest second year NSPAC we have seen since 2017. Our most recently added customers are off to strong starts following the same pattern of NSPAC growth that we've seen over time. As a proof point of the sustainability of NSPAC growth over time, our oldest cohorts are now spending nearly $1,000 per year with us. While the fourth quarter was the strongest quarter of 2021 for gross customer adds, net adds at 0.3 million were below our expectations. In short, the year 1 retention of our Q4 2020 cohort was below what we typically observe. As we examined the drivers behind this, the factors we identified do not appear to be systemic, but rather we're 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 a result, year 1 retention rates for our first 3 quarterly cohorts of 2020 were 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 businesses and that historically the attrition we do see is highly concentrated in the transition from year 1 into year 2 and then moderate significantly in all subsequent years. 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 2022, 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 margins will be between 100 to 150 basis points, inclusive of higher fuel prices. In anticipation of this 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 initiatives 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 help mitigate most of the impact within 2 years. Looking at full year 2022 in aggregate, the current macro environment has many moving parts. Taking everything into consideration, we are estimating full year 2022 gross margin to be broadly in line with full year 2021. Said 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 the 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 28%. Moving on to marketing. Q4 advertising and marketing expenses scaled to 6.4% of net sales. This marks the second quarter in a row of 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 continue 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 Chatty Pets campaign. This campaign is measured and subject to the same ROI standards of our lower funnel campaign, but it has the benefit of driving new customers directly to Chewy, while also keeping Chewy top of mind with existing customers. Collectively, these efforts continue 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 2 years in improving our bottom line. Over this time, while offering 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 0.9% in 2021 from negative 1.7% in 2019 despite $100 million of pandemic-related increase in labor costs, $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 innovations across Chewy and then introduce you to 2 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 and 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 out premium fresh food solutions. To this end, 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 just food for dogs combined with our existing Freshpet relationship and our Tylee’s 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, 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 meat. Now transitioning to Chewy Health. Businesses under our Chewy Health brand continued to gain market share. Chewy pharmacy sales increased 75% in Q4 with nearly all of this growth now running through our preowned and operated pharmacies. On a 2-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 pet health care 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, Practice Hub is our B2B solution for veterinarian, which allows them to earn revenue as a marketplace seller on chewy.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 multiunit veterinary groups. Interest levels remain high, and feedback from the vet community remains positive and productive. Equally exciting is the fact that we recently expanded the selection available on Practice Hub to include our compounding pharmacy. What this means is that we are now offering compounding as a B2B expanding it beyond our original B2C positioning and giving our vet partners another opportunity to earn revenue with Chewy. Rounding out our Chewy Health update, we are getting closer to the launch of our exclusive suite of pet health insurance plans and wellness and preventative plans. Our phased rollout is set to launch soon, and we look forward to sharing more with you at that time. These plans will be another step forward for Chewy Health’s mission to make pet healthcare more affordable and accessible for everyone. Looking beyond Chewy Health, I'm excited to share with you 2 new businesses with you that we are gearing up to launch in 2023 launches. The first is Chewy Loyalty, our customer membership program, through which we will drive even greater value to our customers, improve engagement across our growing customer base, and accelerate customer share of wallet consolidation across categories and services. The second launch in 2023 will be sponsored ads on Chewy.com, which will enable our suppliers to seamlessly advertise to our 21 million active customers across all our platforms. 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 ways to advertise in a durable privacy-safe environment across chewy.com, 1 one of the largest pet e-commerce search engines in the US. In closing let me just share what I would characterize as the mindset of every single Chewtopian 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 pet penetration will long outlast the near-term disruption that we see today from the pandemic after effects. Chewy's value proposition remains as compelling as ever. Moreover, our long-term strategy and ability to attract customers build loyalty, drive engagement and capture greater share of wallet remains intact. As we execute 2022 and plan 2023 and beyond, we are as optimistic as we have ever been on the long-term growth opportunity ahead of us. And with that, 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 2-year stack basis, Q4 net sales were up over $1 billion, making the largest 2-year increase for any quarter in fiscal 2021. For the full year, net sales increased 24.4% to $8.89 billion. On a 2-year stack basis, full year net sales increased over $4 billion or 83%. Autoship closed 2021 on a strong note as the value proposition of the program continues to resonate with our customers. Q4 Autoship customer sales increased 21.2% to $1.69 billion, exceeding the pace of overall net sales growth. On a 2-year stack basis, Q4 Autoship customer sales were up 77%. As a percentage of net sales, Autoship customer sales set a new record high of 70.7% in the fourth quarter and Autoship customer sales exited the fourth quarter on an annualized run rate pace of $6.8 billion, which is nearly equal to the level of total net sales we reported in 2020. Customer spending remained strong as Q4 NSPAC increased 15.6% to $430. This is up $70 from 2 years ago when our NSPAC was $360 and demonstrates our continued ability to capture greater share of wallet from our customers as they mature in their relationship with Chewy over time. We ended the year with 20.7 million active customers, a year-over-year increase of 1.5 million customers or 7.6%. And while the customer base continued to expand, net active adds were below our expectations due to lower retention rates for the Q4 2020 cohort. We believe these lower retention rates reflect several factors. The first was timing related as the second major wave of COVID infections and the arrival of the second round of stimulus, both occurred in Q4 2020. This led to a higher mix of onetime transactions and more discretionary 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 3 quarters of the year, and 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 capped 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 in 2022. Product cost inflation was the biggest gross margin headwind Q4. As we shared on our December call, we observed a lag in 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 Chewy. We also saw inbound freight costs related to poor congestions and elevated spot rates emerge as a gross margin pressure point in the second half of 2021. The situation improved 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 transportation front, our new freight contract with FedEx had only a modest impact on fourth quarter gross margin. As Sumit 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 top line 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 in 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 costs, 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 with a $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 center members who are out on sick leave during the Omicron surge. 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 20.5% 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 a significant investment in growth-oriented infrastructure, that since late 2020, include opening 3 new fulfillment centers, 1 pharmacy and expanding our corporate office footprint, including our newest office in Seattle. Over time, 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 6.4% of net sales, scaling 90 basis points year-over-year. 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 2.7%, 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 0.8%. Excluding share-based compensation, full year net income was $11.5 million compared to $36.7 million last year, and net 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 1.2%, 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 0.9%. Taking a longer view, while we may experience fluctuations quarter-to-quarter, over the last 2 years, we've expanded our adjusted EBITDA margin by 260 basis points and moved 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 a 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, our 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. Since the end of 2018, we have been essentially free cash flow neutral in line with our stated growth strategy. Over those same 3 years, we increased net sales by 150%, launched 5 new FCs, opened a new pharmacy, expanded our corporate 2 cities, made meaningful investments in Chewy Health and other growth initiatives and 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 billion and $2.43 billion, representing year-over-year growth of 12% to 14%. Full year 2022 net sales of between $10.2 billion and $10.4 billion, representing year-over-year growth of 15% to 17%. And we expect full year 2022 adjusted EBITDA margin to be breakeven to positive 1%. As you update your models for 2022, here are a few other things to keep in mind. Full year 2022 CapEx should equal approximately 2.5% of net sales, slightly above our historical target range of 1.5% to 2%. Given longer project lead times, our total spending on capacity over the next 2 years is front-loaded into 2022. This is simply a matter of timing, and we expect CapEx will balance out in our normal range of 1.5% 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. Chewy's ability to deliver significant top line growth in 2021 on top of the 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 Chewy's 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 Chewy's leadership position in the market, we see continued upside in our future. With that, I'll turn the call over to the operator. Operator?

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

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

Doug, it's Mario. I'll start us off and then Sumit will answer the second part of your question. And before I give you sort of color on '22, let me just give you a bit of explanation about Q4 because that will give you some intuition into how we think about 2022. So let me start with the facts. We ended 2021 with 20.7 million active customers. That's an increase of $7.2 million over 2 years or 54% increase. And in Q4, we did see the net active adds came in softer than we expected. It came in a bit lighter than we expected. And here's why. When we look at year 1 retention for customers who joined the platform in the first 3 quarters of 2020, those rates were all within historical ranges, and we shared this before in our previous calls. When we look at the Q4 2020 cohort, that their retention rate which we said is high, did decline by single digits versus the historical trend. And that extra attrition was enough to offset some of the gross adds we had in Q4, the gross customer adds we had in Q4. And the result, as we had softer sequential active growth -- active customer adds, in the fourth quarter. You heard Sumit statement about why we think that is. We don't have perfect data, certainly. But we do believe it's a function of the macro environment in 2020 because of the second wave COVID and then obviously, the second round of stimulus checks that arrived in Q4 2020. Now I say all that, so I can give you a perspective of '22. When we look at 2022, we are still in a very fluid environment. We have an economy that's reopening. We have supply chains that are still constrained, and we have out of stock levels that remain higher than normal. And all of that, we believe, is driving some customers to 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 2022. On the other hand, to your question, we do expect NSPAC to grow at a healthy pace. And our net sales guidance assumes a combination of both NSPAC and active customer to grow this year, driving net sales increase. I think -- sorry, 1 more explanation. I know I'm going a bit long here, but just before Sumit speaks to the second part of your question because it's worth -- set the stage for this, when we think about net active adds 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 that year. NSPAC that year increased 6%. Then you compare to 2021, so last year, net sales grew $1.7 billion. So $400 million more than 2021 despite only adding 1.5 million active customers last year. Why? Because NSPAC grew 16%. So when we look at the levers of growth, it is both continuing to expand the customer base, but certainly capture more of the share of wallet. And at $430 that we just reported for NSPAC versus an average spend of about $1,200, give or take, in the U.S. per pet household, we still have a lot of share of wallet we can gain -- we can capture from our existing customers. I know that was a bit long, but I'll turn it over to Sumit for the second part.

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

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

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

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

Look, at an ad network extensibility type of thing.

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

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

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

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

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

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

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

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

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

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

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

Deepak, this is Sumit. I'll try to take both and Mario will jump in as he sees So first part, let's talk about inflation. So we're taking a detailed view of our assortment and our pricing based on the cost inflation that we're seeing at the SKU level. In aggregate, this is translating to us passing single-digit cost inflation in our category. This also, as you kind of rightly mentioned, it's a top line margin kind of impacting lever. Importantly, we're being surgical and deliberate about our pricing strategy. So we're balancing demand elasticity, so as not to impact growth. And yet, we're finding specific opportunities to optimize price in the marketplace, while maintaining the strong value prop that customers have come to expect from Chewy. Generally speaking, this is a topic where there are several moving pieces on how the year will play out given the current macro environment. And we plan on being diligent and we'll let the data guide the way as much as possible. If you look at Q1 so far, prices leading cost by low single digits. And so that probably provides you some perspective. In terms of your second question, it's both. It's 2020 and '21, as Mario alluded. 2020 was a large-sized cohort. And so our attrition, even though it's small when customers get from year 2 into year 3, there is a portion of attrition that continues into the subsequent years. And then '21, his perspective is something that we share and something that we are broadly observing as the economy kind of broadly opens up. So I'll combine that answer and I'll combine marketing kind of question that you asked and answer it this way, right? I think marketing in '22 is going to be impacted by a few things, which 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 consuming more in-person services. Number two, elevated industry level out of stock, which Mario mentioned, is leading to suboptimal purchase experience for customers, and it's encouraging them to cross-shop multiple retailers. In our opinion, this will keep acquisition and retention kind of at an interesting kind of balance with each other. And it should also be said, and it will impact, in our opinion, every player in the pet category in 2022. Initially, we see this as a transient in-year impact and not a long-term impact. The third is the high degree of inflation is currently causing compression in discretionary categories. For example, when you look at the U.S. retail business today, not just pet, but broadly U.S. retail, across the industry, hardlines category, not just pet is expected to grow low to mid-single digits this year. Search 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 that amidst this kind of economic volatility to compete for a pool of customers that are appropriately stressed and divided mind share. And that, in turn, will keep the ad market demand and supply sort of precariously balanced, leading to variability in kind of marketing costs, gross adds, and net adds. I should tell you, we're not guiding to specific levels of spend in this area in the marketing section. But you've seen us kind of be within the long-term range of 6% to 7% of net sales. And I expect that will remain there with some quarters being higher and others being lower overall. Hopefully, that's helpful.

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

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

Sure. Hey, this is Sumit. It could be a longer answer. So I'll try to piece it apart and frame it up in a couple of different portions. So if you recall, the components that make up the 5% to 10% EBITDA margin, the first one is scaling gross margin to between 25% and 28%. And as we reiterated in today's prepared remarks, we're confident in our ability to overcome these headwinds that we view as sort of not permanent. And the core strength in our business, the engagement, the loyalty and the future programs that we're launching, including the current ones that haven't yet sale fully and have meaningful potential left in them to be able to scale us through the high end of the gross margin range. And then the second component is SG&A. The third component is marketing. Marketing, let's take marketing first, and then I'll detail on the SG&A component. Marketing, as I've just alluded to, we're were between 6% and 7%, and we believe that these are the right levels to stay within, we'll see some leverage as our CRM and loyalty initiatives pick up in the future. But how much that leverage will be, we'll probably kind of reserve that for a call in the future. So now come to SG&A. Let me help you kind of understand how we look at this line item better, right? So in SG&A, there's 3 components of SG&A. First is the variable OpEx component that forms a large portion of SG&A, and it grows with top line. This is where we made approximately the $100 million investment in higher wages and benefits that we talked about in 2021. A large portion of that is likely permanent. When we normalize, however, for the wages, what you see underneath 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 3 automated fulfillment centers will contribute an incremental 40 to 60 basis points of leverage over the next 2 years. And we expect there to be further leverage beyond the 40 to 60 basis points as we increase our overall automated FC count and drive further productivity. That's kind of point number one. The subpoint 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 trapping 20 to 30 basis points of leverage. The second component of SG&A beyond the variable OpEx is the fixed fulfillment expense to run the buildings. Here, capacity imbalances -- we're observing 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's 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 the 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, we're investing to fund the new initiatives that will be growth and profit accretive to us over time. As you've heard kind of on several -- you've heard several on the call today, ranging from supply chain to logistics to new launches in '22 and '23. Health care is our best example of this, which requires stand-up investment and is now a credible fast-growing margin accretive business for us. Overall, this 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 impression and 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 promised or committed to.

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

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

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

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

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

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

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

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