Chewy, Inc. Q4 FY2021 Earnings Call

Good afternoon. Thank you for joining Chewy's Q4 Fiscal Year 2021 Earnings Call. My name is Bethany, and I will be your moderator today. I will now hand the call over to our host, Robert LaFleur, Vice President of Investor Relations at Chewy. Please proceed.

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 gains 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 predictable 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 one 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 were 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 one retention rates for our first three 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 one into year two and then moderates 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 two 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 operating in a highly complex environment, we added an incremental $160 million of adjusted EBITDA to our bottom line and expanded our adjusted EBITDA margin to positive 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 two exciting new programs, in addition to the logistics and supply chain innovation we are undertaking which I alluded to in the gross margin section. Chewy remains focused on establishing itself as a leader in the fresh 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 within 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 meals. 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 owned 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 healthcare market by launching new products and services across the pet health and wellness space. We expanded our rollout of Practice Hub in January, and it is now available to clinics nationwide. As a reminder, Practice Hub is our B2B solution for veterinarians, 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 multi-unit veterinary groups. Interest levels remain high, and feedback from the vet community remains positive and productive. Equally exciting is the fact that we 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 two new businesses that we are gearing up to launch in 2023. 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, 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 aftereffects. 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 occurred in Q4 2020. This led to a higher mix of one-time 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 three 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 congestion 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 benefits 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 includes 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 footprint in 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.

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 kick things off and then Sumit will address the second part of your question. Before I discuss 2022, let me provide some insight into Q4, as it will help frame our perspective for the year. To start with the facts, we concluded 2021 with 20.7 million active customers, which represents a growth of 7.2 million over the past two years, marking a 54% increase. In Q4, we observed that the net addition of active customers was softer than anticipated and came in lighter than we had expected. This was due to year one retention rates for customers who joined in the first three quarters of 2020 being consistent with historical levels, as we previously noted in our calls. However, the retention rate for the Q4 2020 cohort, which we had described as high, did see a small decline compared to historical trends. This increase in attrition was significant enough to counterbalance some of the gross additions we reported in Q4, leading to softer sequential growth in active customer adds for the quarter. Sumit explained earlier why we think this happened. While our data isn't perfect, we believe it's linked to the macro environment in 2020, particularly the second wave of COVID-19 and the second round of stimulus checks issued in Q4 2020. All of this provides context for 2022. As we look ahead, we're still operating in a very fluid environment. The economy is reopening, supply chains remain constrained, and out-of-stock levels are higher than usual. These factors seem to be pushing some customers to shop across online and offline channels. We anticipate these challenges will lead to a slight near-term impact on retention rates for the customers acquired in 2020 and 2021, who represent large cohorts. Consequently, we expect net active customer additions for 2022 to be lower than in 2021 and muted at least through the first half of the year. On a positive note, we do expect NSPAC to grow at a healthy rate, and our net sales guidance is based on a combination of both NSPAC growth and active customer growth this year, which will drive net sales increases. Just to clarify one more thing before Sumit addresses the second part of your question: when we compare net active additions and net sales growth from 2019 to 2021, net sales grew by about $1.3 billion in 2019, with an additional 2.9 million active customers that year, and an NSPAC increase of 6%. In comparison, in 2021, net sales grew to $1.7 billion, which is $400 million more than in 2019, despite only adding 1.5 million active customers. This increase came as NSPAC grew by 16%. Therefore, when we consider our growth strategies, it’s about expanding our customer base and capturing a larger share of wallet. With an NSPAC of $430 reported versus an average spending of around $1,200 per pet household in the U.S., there’s still a significant opportunity to gain share from our existing customers. That’s a bit lengthy, but I’ll hand it over to Sumit for the second part.

Thanks, Mario. Doug, helpful to remember that two-thirds 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 the 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 routes 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.

I have a few questions regarding the launch of sponsored ads. Firstly, there's a significant amount of vendor spending on trade promotions and slotting fees in grocery and brick-and-mortar retail, estimated to be between $150 billion to $200 billion in the U.S. Do you have an idea of how much is specifically spent on trade promotions within the pet category? Secondly, could you remind us how frequently customers access the site after signing up for Autoship? How often is your audience likely to visit the site and potentially see ad messages? Lastly, do you have any insights on the future of coordinating off-site advertising by utilizing your internal data?

Brian, this is Sumit. I'll address those questions. There's not much to add today beyond our prepared remarks. From what I can tell, the opportunity size is significant, with funds uniquely positioned outside of trade promotions. Suppliers see great value in accessing our customer base and the experiences we provide. Therefore, we view this as a potentially high-margin recurring revenue opportunity moving forward. Regarding Autoship customers, even though they have subscribed to the service, they are very active and regularly engage in purchases. To give you some perspective, two-thirds of our customer base falls into what we consider base load, which is recurring and staple in nature, while the remaining third is quite experimental. Many customers maintain multiple open Autoships simultaneously, demonstrating high engagement, especially during our promotional campaigns when we include those customers. Our ownership customers are also active participants in our launch and innovation efforts. Thus, we believe there are ample opportunities for this customer base. As for your last question about off-site advertising using internal data, I'll need you to clarify a bit because I'm not entirely sure what you're asking.

Just a couple of points. 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 two retention behavior is different or is the year one behavior compared to historical levels. And maybe you can provide some color on kind of marketing versus gross adds 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 fit. 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 are 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 2021, as Mario alluded. 2020 was a large-sized cohort. And so our attrition, even though it's small when customers get from year two into year three, there is a portion of attrition that continues into the subsequent years. And then 2021, 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 the marketing kind of question that you asked and answer it this way, right? I think marketing in 2022 is going to be impacted by a few things, which will actually impact the dynamic of gross adds and 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.

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. This is Sumit. I will break this down into a few parts. First, regarding the components that contribute to the 5% to 10% EBITDA margin, the initial aspect is increasing the gross margin to between 25% and 28%. As mentioned in today's remarks, we are confident we can navigate the current challenges, which we consider temporary. Our business's core strengths, including engagement, loyalty, and upcoming programs, will help us maximize our gross margin potential. The second factor is SG&A. We will first address marketing, which is currently between 6% and 7%, and we believe these figures are appropriate. We anticipate leveraging our CRM and loyalty initiatives in the future, but we will provide details on the extent of that leverage during a future call. Now, regarding SG&A, it's important to clarify how we analyze this category. SG&A encompasses three components. The first is the variable OpEx, which constitutes a significant part of SG&A and grows in line with our revenue. This is where we made around a $100 million investment in wages and benefits back in 2021. A large portion of this expense is likely to be permanent. However, when we adjust for wages, you'll see that fulfillment center productivity has grown by roughly 8%, despite wage inflation of 17% during that period. Automation in our fulfillment centers and productivity enhancements by our operations and support teams have driven this efficiency and will continue to do so. The three automated fulfillment centers are expected to provide an additional 40 to 60 basis points of leverage over the next two years, with the potential for further improvement as we expand our automated facilities and enhance productivity. The second SG&A component is the fixed costs related to running our fulfillment centers. Currently, we are facing capacity imbalances due to inventory and labor issues that are leading to underutilization of our fulfillment centers, which we believe is holding back about 30 to 50 basis points of potential leverage. We expect these challenges to normalize in the next 12 to 18 months. The final component is G&A, which mainly includes investments in technology, software, teams, and capabilities essential for our growth. We are investing in new initiatives that will contribute to our growth and profits over time. A prime example is our healthcare sector, which requires upfront investment but has become a fast-growing, margin-enhancing business for us. Overall, we anticipate that the G&A expenses will begin to scale as we move beyond 2022. I hope this gives you some clarity on our approach to SG&A. We are committed and strategic in our efforts to improve these areas and achieve the 5% to 10% margin range we have promised.

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 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. 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.