Good afternoon. Thank you for attending today's Chewy Fourth Quarter Fiscal Year '22 Earnings Call. My name is Hannah, and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for question-and-answer session. I would now like to pass the conference over to our host, Bob LaFleur with Chewy. Please go ahead.

Thank you for joining us on the call today to discuss our fourth quarter and full year results for fiscal 2022. Joining me today are 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, growth, financial results, business strategies, industry trends and our ability to successfully respond to macroeconomic conditions and business risks. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 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. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of this call will also be available on our IR website shortly. I'd now like to turn the call over to Sumit.

Thanks, Bob, and thanks to all of you for joining us on the call. Our fourth quarter results capped an incredible year. Against the backdrop of a rapidly changing operating and economic environment, Chewy produced record high revenue, profitability, and free cash flow. Chewy's dedication to serving pet parents and partners with a widening ecosystem of offerings led to another year of market share gains in the pet category, which once again demonstrated its historical resilience despite evolving macro conditions. Looking ahead, we continue to be excited about the growth opportunities for our business. The pet category has a U.S. total addressable market that is over $130 billion, which has grown consistently through the ups and downs of economic cycles. Importantly, we continue to see significant white space for expansion, and we remain committed to innovating at a high pace across both new product and service offerings as well as technological and operational advancements. Most importantly, our strategy remains focused on relentlessly advancing our mission of being the most trusted and convenient destination for pet parents and partners everywhere. Now let's review our Q4 and full year 2022 performance followed by a discussion of our operating philosophy. After that, I will turn the call over to Mario to discuss our results in greater detail and share our 2023 guidance. Q4 net sales increased 13% to $2.71 billion, which brought our full year 2022 net sales to $10.1 billion, reflecting annual growth of approximately 14%. Non-discretionary categories, including consumables and health care remained the pillars of strength with the offset coming from discretionary categories such as hard goods. Our top line expansion reflects our success in managing the dynamic pricing environment as well as the recurring nature of our business model and our ability to expand share of wallet from our customers over time. Autoship customer sales increased 18% and generated 73% of our Q4 net sales, representing a 260 basis point increase over the prior year period. We further deepened our customer engagement with net sales per active customer, or NSPAC, growing 15% year-over-year to reach nearly $500 in Q4. With nearly 60% of our customers having joined our platform within the last three years, we believe there remains significant runway for our customers to spend progressively more with us, the longer they stay. Moving on to customers. We ended Q4 with 20.4 million active customers. We believe the modest sequential decline in active customers reflects the continued softness in discretionary spending experienced across the broader economy as well as the residual impact of attrition from our 2020 and 2021 cohorts. We anticipate returning to positive active customer growth this year and expect NSPAC will continue to strengthen. Turning to profitability metrics. Fourth quarter 2022 gross margin expanded 270 basis points to 28.1%. The significant improvement in year-over-year Q4 gross margin was driven by favorable pricing comps relative to Q4 of last year and, to a lesser degree, by our ongoing supply chain and transformation. Full year 2022 gross margin improved by 130 basis points to 28% in line with the high end of our long-term guidance, continued pricing strength combined with the progress we have made in our supply chain initiatives enabled us to deliver these results. In 2023, we are excited about our ongoing work to grow high-margin verticals, many of which remain in early stages and are expected to provide gross margin tailwinds in the current year and beyond. Staying on profitability. Q4 adjusted EBITDA was $92 million, and adjusted EBITDA margin was 3.4%, an increase of $120 million and 460 basis points, respectively. The strong gross margin performance and SG&A leverage were the primary drivers of Q4 adjusted EBITDA growth. We saw these same key drivers manifest themselves in our full year 2022 results as adjusted EBITDA nearly quadrupled from 2021 levels to over $300 million, and adjusted EBITDA margin expanded 210 basis points to 3%. Moving away from fiscal 2022, let me now spend some time sharing our operating philosophy for 2023 and beyond as well as various growth and margin-enhancing initiatives that we plan to launch. Delivering long-term profitable growth remains our North Star. Over the past four years, we have increased revenues from $3.5 billion to over $10 billion while concurrently expanding gross margins from 20% to 28% and adjusted EBITDA margins from negative 6.5% to positive 3%. These results are both a testament to our team's focus on scaling our core businesses and our ability to ideate new ways to improve customer experience or to launch new services for customers and partners and following through with disciplined high bar execution. Our 2023 strategy is consistent with this operating philosophy, scale our existing cost base and simultaneously make purposeful investments to drive sustainable growth and profits over a multiyear period. Let me provide a few examples of each of these, starting first with how we have already driven cost leverage in our business and how we plan on further scaling our existing cost base. The supply chain transformation initiatives that we began in 2021 have helped us expand our gross margin while simultaneously improving customer experience. As a reminder, these efforts included areas such as import routing, inventory planning and placement and middle mile. Additionally, our decision to invest in fulfillment center automation in 2019 is now providing significant leverage in SG&A with meaningful upside left to go. In 2023, we plan to continue scaling these efforts and drive further SG&A leverage. For starters, given the success of our automation initiatives and the productivity benefits we are realizing in ramping our first three automated facilities, we have made the decision to close our two oldest FCs, both of which are non-automated assets. Each of the facilities is located near one of our new automated FCs, which allows us to combine operations and offer team members the ability to transfer locations. We believe that this action will enable incremental order volume to flow through our automated facilities, which we expect will allow us to realize approximately 50 basis points of additional SG&A leverage in 2023. Furthermore, we are on track to open our fourth automated facility in Nashville in the first half of this year. The punch line here is that in 2023, we expect to continue benefiting from the strategic investments we made just a few years ago in warehouse automation. Moving forward, we remain committed to demonstrating strong operating discipline in running the business and tightly managing expenses along the way. Now moving on to the investments and innovation part of our operating philosophy. In addition to leveraging our existing cost base, in 2023, we plan on making conscious investments in areas that we believe will create sustainable growth and profits over the long term and generate high ROI for our shareholders. Such areas include our higher-margin verticals, where we plan to accelerate growth. Additionally, having strengthened our fundamentals over the past few years, we believe that the time is right to bring the Chewy brand and our superior value proposition to pet parents outside of the U.S. We are actively building the capabilities and team to launch our first international market over the next few quarters. We expect this important development to unlock meaningful incremental TAM, and we are excited to introduce Chewy to a broader customer base with whom we believe our brand and mission will resonate strongly. We look forward to discussing more specific plans with you on our Q1 call. Our operating history demonstrates a strong track record of making such capital allocation decisions. Chewy Pharmacy is a powerful example of investment and execution behind a new vertical that began four years ago and is now contributing superior growth and profit at scale. Today, we operate the largest pet pharmacy in the U.S. As we have demonstrated in the past, we plan to remain highly disciplined about our level of commitment to and support of the investments that we seed and will continually evaluate them against our expectations. In closing, I'm proud of our team's relentless execution that has enabled us to deliver strong results over the course of another dynamic year. As we enter 2023, I remain incredibly optimistic about our road map ahead.

Thank you, Sumit, and thank you all for joining us today. Fourth quarter net sales were $2.71 billion, a $319 million or 13.4% increase year-over-year. Our non-discretionary consumables and health care categories continued to demonstrate strength in the quarter as they had collectively represented 82% of total net sales and grew at a combined rate of 18.5% year-over-year. These favorable trends were modestly offset by a decline in sales in our hard goods category. For the full year, net sales reached $10.1 billion, increasing $1.2 billion or 13.6% year-over-year. Our Autoship business saw another year of strong growth as pet parents increasingly value the convenience and benefits of the program. Q4 Autoship customer sales increased 17.5% to $1.98 billion, exceeding the pace of our overall sales growth by 410 basis points. For the quarter, Autoship customer sales as a percent of total net sales reached 73.3%. For the full year, Autoship customer sales increased 18% to $7.4 billion, with ownership customer sales representing 73% of total net sales, a new record high on an annual basis. In Q4, Chewy continued to consolidate share of wallet from pet parents who shop with us as NSPAC reached a new record high of $495, up 15.1% or $65 year-over-year. As we have shared on previous calls, top line growth for Chewy is driven by our ability to attract and retain over time while capturing an increasing portion of their annual pet spend. In 2022, our active customer count remained relatively flat versus 2021, as we work through the short-term attrition of our record-sized cohorts acquired in the preceding two years. At the same time, customers continue to consolidate their shopping with us with our three oldest cohorts, each spending over $1,000 in 2022, and all but our two most recent cohorts spending over $500. Said differently, we believe a tremendous opportunity remains ahead of us to fully unlock the revenue potential of our existing customer base. Moving now to financials. Fourth quarter gross margin expanded 270 basis points to 28.1%. More than half of the improvement was the result of favorable comping relative to Q4 2021. The balance came from our continued supply chain transformation initiatives, leverage in freight and packaging due to increased basket sizes and other one-time true-ups. The items that were one-time in nature contributed approximately 40 basis points of benefit to our Q4 gross margin. Relative to our expectations, the lower-than-expected spend on promotions and fuel this holiday season drove the outperformance in the quarter. Full year 2022 gross margin increased 130 basis points to 28%, a new full year record high. As Sumit noted in his comments, our ability to maintain pricing strength overcame persistent cost inflation, and our team's hard work across various supply chain and logistics initiatives continued through Q4. Collectively, they also helped achieve gross margin outperformance relative to our expectations at the beginning of the year. Moving to OpEx. SG&A, which includes all fulfillment and customer service costs, credit card processing fees, corporate overhead and share-based compensation, totaled $561 million in the fourth quarter or 20.7% of net sales, scaling 90 basis points compared to the fourth quarter of 2021. On a full year basis, 2022 SG&A deleveraged by 50 basis points to 21%, sorely due to higher share-based compensation. Excluding share-based compensation, SG&A totaled $510.8 million or 18.9% of net sales. This is an improvement of 210 basis points compared to the fourth quarter of 2021. On a full year basis, SG&A, excluding share-based compensation, leveraged 20 basis points to 19.4%. Now I'll take a moment to walk through the details of how we were able to scale SG&A, excluding share-based compensation in Q4. Variable fulfillment and customer service costs provided 170 basis points of year-over-year SG&A leverage in the fourth quarter. Our variable fulfillment costs declined as a result of productivity gains and continued volume shift into our automated facilities, which collectively drove a 13% year-over-year reduction in system-wide variable fulfillment cost per order. Additionally, our improving in-stock position, supply chain initiatives and technology deployments across our customer care organization have improved overall customer experience, resulting in fewer customer contacts. This led to a 15% year-over-year reduction in customer service cost per order. We drove additional leverage of 70 basis points through our automated fulfillment centers as they absorb more incremental fixed carrying costs alongside with our ongoing management of corporate expenses. Partially offsetting these gains are the investments in personnel and technology we began making in Q4 2021 to support the many initiatives we shared with you throughout the year as well as the higher D&A costs associated with the facilities we launched in the last year. Altogether, these areas contributed approximately 30 basis points of year-over-year deleveraging. These results are consistent with our stated operating philosophy, scale-based costs, fund new initiatives, grow revenue and profits from those new initiatives and redeploy some of the gains into additional areas that we believe will drive further growth and profitability over time. Moving on to marketing. Fourth quarter advertising and marketing was $183.4 million or 6.8% of net sales, a 40 basis point increase from Q4 2021. Sequentially, advertising and marketing expenses scaled by 20 basis points as a result of the marketing efficiencies we normally see in the fourth quarter. On a full year basis, advertising and marketing represented 6.4% of net sales scaling 60 basis points versus 2021. For both the quarter and year, our marketing spend was in line with our expectation of 6% to 7%. Wrapping up the income statement, fourth quarter net income was $6.1 million and net margin was 0.2%, a year-over-year improvement of 290 basis points. We marked our first full year of positive GAAP net income in 2022 with a reported $49.2 million in net income, a $123 million improvement versus 2021. Our net margin reached 0.5%, expanding by 130 basis points versus 2021. Fourth quarter adjusted EBITDA was $92 million, and adjusted EBITDA margin expanded 460 basis points to 3.4%, reflecting gross margin momentum and SG&A leverage. Full year adjusted EBITDA was positive for the third year in a row, reaching $305.9 million and adjusted EBITDA margin expanded 210 basis points year-over-year to 3%, both of which are new records for Chewy. Turning now to free cash flow. Fourth quarter free cash flow was $42.1 million, reflecting $100.6 million in net cash flow from operating activities and $58.4 million of capital expenditures. The majority of our capital expenditures in the fourth quarter were focused on future automated fulfillment center launches. For the full year, we generated $119.3 million of positive free cash flow. Full year 2022 is the first year in our history where our free cash flow generation was materially above breakeven. From the end of 2018 through 2021, we were essentially free cash flow neutral, which was in line with our growth strategy, before turning meaningfully positive in 2022. Over that period, we nearly tripled our net sales, launched six new fulfillment centers, opened three new pharmacy locations, added two new customer service centers, one dedicated pharmacy customer service center and scaled multiple other growth initiatives. We accomplished all of this without consuming any cash and while remaining debt free. We finished the year with $677.4 million of cash and cash equivalents and marketable securities on the balance sheet, $74 million higher than 2021. Further boosting our liquidity position in the fourth quarter, we expanded our ABL by $300 million to $800 million with an additional $250 million accordion that will give us incremental liquidity should we choose to exercise it. At year-end, between cash on hand, marketable securities and availability of our newly expanded ABL, total year-end liquidity stood at over $1.4 billion. That concludes my fourth quarter and full year 2022 recap. So now let's discuss our first quarter and full year 2023 outlook. Our guidance reflects a balanced view that incorporates the strength and visibility of our business model, while also providing some flexibility against an uncertain economic backdrop. With that, we expect first quarter net sales of between $2.72 billion and $2.74 billion, representing year-over-year growth of 12% to 13%. Full year 2023 net sales of between $11.1 billion and $11.3 billion, representing year-over-year growth of 10% to 12%, and full year 2023 adjusted EBITDA margin to be flat to 50 basis points below our full year 2022 adjusted EBITDA margin of 3%. Our 2023 adjusted EBITDA margin guidance reflects approximately 50 to 75 basis points of impact across SG&A and marketing as a result of the investments related to the international launch and other growth initiatives. Without the impact of these growth initiatives, our expected 2023 adjusted EBITDA margin would be around 3.5%. As you update your models for 2023, here are a few other things to keep in mind. Regarding net adds, we are maintaining a balanced view in light of the uncertain macro backdrop and the long-tail attrition for our large COVID cohorts. Therefore, we anticipate returning to net adds growth during the second half of this year. As such, we expect NSPAC to be the primary driver of revenue growth through the first half of the year before shifting to a blend of customer and NSPAC growth in the second half of the year. We anticipate our overall growth investments to be front-end loaded with adjusted EBITDA margins expected to reaccelerate in the back half of this year. We expect CapEx in full year 2023 to return to our historical target range of 1.5% to 2% of net sales and full year 2023 share-based compensation, including related taxes, to be approximately $250 million. Finally, after factoring in the investments we intend to make in 2023, we expect to generate meaningfully positive free cash flow at approximately twice the level that we generated in 2022. To conclude, our 2022 results demonstrate our unwavering focus on day-to-day execution and our ability to get big fast and fit fast. Meanwhile, we remain highly encouraged by the growth roadmap ahead of us and ongoing opportunity to maximize value for the millions of pet parents whom we serve, our team members, and our shareholders alike.

Thank you. We will now begin the question-and-answer session. The first question is from the line of Nat Schindler with Bank of America.

A couple of quick questions. So one, looking at your margin guidance of actually a flat to slightly down EBITDA guide for this coming year. Despite the fact you have NSPAC growing, and it looks like, given your revenue growth, it’s going to be driven by NSPAC more than customer growth. Considering that your marketing cost is mostly customer acquisition, how would that not result in meaningful improvement in EBITDA?

Nat, it's Mario. Great to hear from you. I'll address your second question first, and then Sumit will tackle the first one. Regarding the decline in orders, that's not accurate. The information in the 10-K relates more to the number of packages we ship. We have been consistent in our explanation. The reason we're shipping fewer packages is that we are improving our cartonization, allowing us to fit more of an order into a single package, which reduces our freight and packaging costs while enhancing the customer experience. This improvement is a result of expanding our network and refining our inventory placement. A lot of good work has been done behind the scenes. Now, Sumit will respond to your first question.

Nat, this is Sumit. To understand the margin, it's important to view the 2022 EBITDA in the context of how the year unfolded. The EBITDA margin for 2022 was driven by strong gross margin performance and the SG&A leverage we achieved. Specifically, the gross margin benefited from robust pricing and our supply chain transformation efforts, although we faced challenges with freight and logistics. As we look ahead to 2023, we do not anticipate the same pricing leverage benefit that we experienced in 2022, including the period when pricing outpaced costs. However, we do expect continued gross margin expansion due to our focus on higher-margin sectors. Given the uncertainties of the current economic landscape, our guidance reflects a careful evaluation of risks and opportunities, incorporating a level of caution that we are regularly assessing. We may allow for the category to be slightly more promotional than last year, and if this does not occur, it could enhance our outlook. We are also not counting on a significant acceleration in hard goods in 2023. These considerations lead us to guide towards gross margin neutrality. On the SG&A front, we are effectively managing our SG&A costs while reinvesting the savings to fuel growth, resulting in our current EBITDA guidance.

Makes sense, but how much are you putting in is assumed in there in the international expansion in costs? So I assume that's almost no revenue.

Yes. We haven't quantified the two separately. However, generally speaking, the investments in growth initiatives, including international, are around 50 to 75 basis points, with the majority of that amount coming from international efforts.

And then when it comes to top line, active customers NSPAC, Nat, we are not assuming any material impact for those from the launch at this point.

The next question is from Anna Andreeva with Needham. You may proceed.

Great. Two questions. In the past, I think you talked about international growth and margin expansion simultaneously. So could you talk about the specific buckets of investments in '23? And international typically takes a while to scale to domestic profitability. So does this change your longer-term goal for high single-digit EBITDA margin? That's my first question. And then secondly, you mentioned net adds improving in the back half. Are you seeing any improvements in the business quarter-to-date to give you any confidence for that back half improvement?

Anna, this is Mario. I'll take the first question, and Sumit will answer the second one. But when it comes to the investments in international, most of that you're going to see in SG&A and marketing. As we said, the 50 to 75 basis points, you'll hear us say that a few times. The largest portion of that is going to be international. No real material impact top line, gross margin, etc. in terms of investment for international launch.

As we increase demand, we will approach the market with an opportunistic mindset. If an opportunity arises to invest at the top to boost revenue, there may be some impact on gross margin, but we have accounted for that in our guidance today. Now, feel free to ask your second question.

Okay. That's helpful. On the net add improvements in the back half. Just curious if you're seeing any improvements in the business quarter-to-date to give you confidence there?

Well, what we said on the early remarks was that we expect net adds to begin to improve in the second half of the year for that active customer base to grow in the second half of the year. We're stepping into it carefully into the first half. We still have the long-tail attrition from the 2020, '21 cohorts to work through. And of course, there's still some somewhat subdued demand in the discretionary categories, hard goods. So we expect there will be more in the second half of the year.

And, Anna, our gross adds rate continues at mid- to high single digit higher than pre-pandemic, and our reactivations also continue to be strong. So to the extent that those could be considered signals, I think you could take that into account, and then Mario's answer kind of rounds out the perspective.

Yes. I would add to that, Sumit, the retention for those cohorts is basically in line with what we have said in the past. So that's also a good indicator for us that things are stable on that end.

The next question is from the line of Mark Mahaney with Evercore ISI. You may proceed.

Great. This is Jian Li for Mark Mahaney. First, I want to ask a higher-level question about the international market. Can you discuss the total addressable market opportunity you see internationally? What is your strategy for expansion? Is your approach mainly organic, or are you considering any inorganic options? Additionally, could you elaborate on the key regions you are focusing on? That's my first question.

Sure, Jian. This is Sumit. International expansion has always been part of our strategy, as we've mentioned in previous calls; it was just a matter of timing for Chewy to introduce our superior value proposition in new regions. We're thrilled to discuss it now. We considered the size of the total addressable market, geographic proximity, and similarities in consumer behavior to the U.S., among other factors, when identifying appealing entry markets for our initial international expansion plans. At this point, we are focusing on organic growth rather than acquisitions. In terms of operational execution, similar to our history of successfully implementing investments like pharmacy, we are approaching our international ambitions in stages with specific milestones to govern the speed of our expansion responsibly. Additionally, as Mario mentioned earlier, the revenue, active customer, and NSPAC effects from starting international operations are fully integrated into our guidance and do not significantly impact those metrics or the core business. That's all we can disclose today. We look forward to providing more details in our Q1 call.

Great. I have one more question about the gross margin. This is now the third consecutive quarter that you’ve reached the high end of your current long-term gross margin. How should we look at an updated long-term gross margin target for the years ahead? What are the main factors influencing this? I believe you mentioned that this year, there will be an acceleration into some higher-margin verticals. Could you elaborate on that?

Sure. This is Sumit again. So we're excited about the continued gross margin or the continued journey that we're on to expand our gross margins. In the core businesses, we have continued work to do on our private brand area. Private brands is mid- to high single digit, and we want to get it to between 15% and 30% of net sales. At that ratio, we expect several hundred basis points higher premium to our core business as that business achieves that penetration level. Number two, when you look at Chewy Health, Chewy Health is in its early stages relative to categories such as pharmacy. And we have a tremendous runway in this category as consumers more and more shift their preferences to online, and Chewy leads in delivering customer value proposition in that particular area. It is also a tremendous NSPAC expansion driver for us and is fueling both our growth and mix impact on our gross margin performance. On top of that, then there are verticals which are more nascent in their categories. Sponsored ads is the next one that we are quickly ramping up, happy to click into details if anybody is interested. But we're pleased with the progress there. We will expect to bring sponsor live at a more fuller scale this year ramping into 2024. Behind that is our categories like insurance, which are on slightly longer arcs because you have to build customer consideration and the consideration to conversion arc there is slightly longer, and therefore, those might be on a one- to three-year arc and can contribute meaningful gross margin expansion opportunities as well. And then last but not least, our continued work on either expanding our Autoship benefits, working towards loyalty programs, or continued supply chain initiatives that we've talked about, provide us tailwind opportunities in the future. So we're excited. There's a lot of work in front of us. This will not be easy, but at the same time, we have a clear roadmap and the team's hard work so far has paid off, and we will continue to remain resilient and focused as we play through 2023 and beyond.

Great. Can you quantify how much of the sponsored ads is included in the full year guide?

Yes. At this point, it's still fairly small. The expectations for this year are modest. We're ramping up and are excited about its current status and growth trajectory, but it hasn't become a significant contributor yet.

Our next question is from the line of Doug Anmuth with JPMorgan. You may proceed.

Just on the international expansion, is it safe to assume that at the core, you'll be looking to replicate the strong and differentiated approach in terms of customer service? So that's number one. And then second, just circling back to the customer growth in '23. Just trying to understand really what drives the confidence there given that you're not really building in either macro improvement or discretionary product really coming back much. It sounds like it's just some improvement or working through the big cohort over the last couple of years.

Sure. Doug, this is Sumit. Regarding international expansion, you're absolutely correct in your assumption. We intend to introduce all aspects of our value proposition to the international market, while actively listening to customer feedback to guide our launch strategy. This approach will ensure that we respect cultural nuances as Chewy's brand makes its entry internationally. Overall, we feel optimistic and assured about our brand's resilience and potential beyond the United States. Regarding customer acquisition, we are implementing several internal programs that operate independently of the macroeconomic landscape. Regardless of the current economic conditions, we are excited about these initiatives. We are optimizing our website, enhancing search results, and improving conversion rates, especially for new visitors arriving at our site, and we are already seeing some promising early indicators. Additionally, we have previously mentioned that Chewy has not heavily invested in CRM capabilities, but we are significantly expanding our CRM functionality in 2023 compared to 2022. This effort will continue throughout the year. These programs will help us better recognize customers, segment them effectively, target them appropriately, and track their journey to continuously incentivize and engage them with Chewy. Together, these strategies give us confidence that our activities at Chewy will drive growth, but we must ensure we execute these plans effectively.

The next question is from Corey Grady with Jefferies. You may proceed.

I wanted to ask about the automated FC initiative. So apologies if I missed this, but what percent of volumes did you say are running through the automated fulfillment centers currently? And where do you think that can get by the end of the year? And then what's assumed in that 50 bps of SG&A leverage?

Yes, this is Mario. I'll answer that. Currently, about 30% of our volume is processed through automated facilities, which marks an increase from the third quarter and is nearly double the volume from the same time last year. We haven't set a target for the end of the year, but we're moving from three automated facilities to four with the upcoming launch of our Nashville facility in the next couple of months. We're continuing to shift more volume to automated facilities for several reasons, one being the reduced variable cost per order that positively impacts SG&A and EBITDA. We will keep pushing to move as much volume as possible into those facilities.

No. Corey, did you have a follow-up? Or was that the main question?

Yes. If I can, I'll ask a quick follow-up. I would love for you to just say more about the sponsored ads beta? I mean I don't know if you can share speak to any initial learnings, customer feedback? Any update around timing of full launch? And any change in how you're thinking about the long-term opportunity?

Sure, sure. So we're pleased with the progress of the sponsored ad vertical. The beta that we launched in Q4 has continued building towards the full product, which we expect to have live in the first half of 2023 as per original expectations. Our team is hard at work right now on the supply side of the platform, where we expect to deliver a great customer and partner experience with improvements in ad serving, tracking, and relevance. The reception from brands has been and continues to be positive, including the reception on our ROAs framework. So we're looking forward to the program launch in the first half and then continuing to ramp throughout 2023 and into 2024.

Our next question is from Seth Basham with Wedbush. You may proceed.

My question is on gross adds. Good to hear your continued mid- to high single-digit growth there. As you look to 2023, you're expecting that type of growth to continue, and what does that mean for advertising growth?

Yes, we are seeing continued strength in gross additions compared to pre-pandemic levels. Throughout the year, we've mentioned that we've been experiencing an increase in the range of 6% to 10% compared to the same quarter in 2019, and this trend continued into Q4. This is a positive sign for us regarding the platform's strength. For 2023, I'm not going to differentiate between gross additions and net retention initiatives. However, we have shared our projections for the active customer base and its expected growth in the second half of the year. It will involve a combination of reactivating existing customers, acquiring new ones, and diligently working to retain the customers currently using the platform.

Okay. Fair enough. And then as a follow-up, just thinking about the 2020, 2021 cohorts with the churn rates. Are those churn rates higher than you expected even just three months ago? And how is the 2022 cohort repeat purchase behavior trending?

Let me address your two questions separately. Regarding the 2020 and 2021 cohorts, the retention levels have remained largely in line with our expectations, which we have discussed over several quarters. They are high, but still in the low single digits and below the levels seen with pre-COVID cohorts. This trend has been consistent for several quarters now. As for the repeat purchase behavior of the 2022 cohorts, we noted earlier in 2022 that we were seeing an increase in customer acquisition in our essential categories, such as consumables and health care, and this behavior has been confirmed throughout the year.

The next question is from Brian Fitzgerald with Wells Fargo. You may proceed.

We think this is the first time you provided a specific growth breakout for non-discretionary. Wondering if you could give us some color on how discretionary has been tracking? Have you seen any trend improvement? How are you thinking about cycling the discretionary weakness and potentially getting back to growth at some point in 2023?

Brian, this is Mario. Let me clarify the question. You're asking if we provide specific guidance. Are you inquiring about how we expect to analyze the trends we've seen recently in the discretionary segment?

Brian, this is Sumit. So discretionary continues to be suppressed and pressured. When you look at hard goods, the second half was better than the first half. That was primarily due to easier comps. When you look at hard goods sequentially, Q4 ramped because of seasonality and was expected. So at this time, as it comes to discretionary categories, and we're baking in things like hard goods, we're not expecting a material reacceleration in '23. And we stand prepared to invest if we see further deterioration or opportunities alike. Ultimately, specifically as it considers categories such as hard goods, we believe that this is cyclical and tied to the inputs of the macro environment. And as the macro and those inputs improve, we expect hard goods to revert to its historical growth mode. But as of right now, we're not providing specific guidance, of course, at the category level, and we're not expecting material reacceleration in '23. That's what's baked into the guidance right now.

Our last question is from the line of Lauren Schenk with Morgan Stanley. You may proceed.

Great. Just a couple on gross margin, if I can. First, what are you assuming around price increases this year from a manufacturing perspective? Was there one in this current first quarter? And then secondly, Sumit, you mentioned in your prepared remarks a surgical approach to optimize pricing, and in the shareholder letter, you talked about sort of increasing value proposition. Are you looking to lower pricing in certain categories? Any color there would be really helpful.

Starting with the second one, no, we are not looking to actively lower prices. We are certainly vigilant across the catalog, particularly as a result of improving supply chain positions to ensure that if there is heightened market competitiveness or market activity that we stand ready to respond to that. But no, we are not actively looking to price down. Number two, in terms of price increases that we expect or have come through, those are in the low to mid-single-digit range.

Any timing of when you would expect this?

Sure. So as anticipated, we have experienced cost increases in Q1, and this is already reflected in our pricing. The market is adjusting and has adjusted well, and we're seeing overall good math compliance. So at this point, we believe that the frequency and taste of cost increases is largely behind us. But of course, as we receive more information from our suppliers, we'll pass that on, but we're not expecting more cost increases for the balance of the year at this point. Thank you all for joining. We appreciate it, and we'll see you next time.

That concludes today's Chewy's Fourth Quarter Fiscal Year '22 Earnings Call. Thank you for your participation. You may now disconnect your lines.