Earnings Call Transcript - CHWY Q3 2024

Operator, Operator

Hello, everyone, and welcome to the Chewy Third Quarter 2024 Earnings Call. My name is Emily, and I'll be coordinating your call today. I will now hand the call over to our host, Chewy's CFO, David Reeder, to begin. David, please go ahead.

David Reeder, CFO

Thank you for joining us on the call today to discuss our third quarter results for fiscal year 2024. Joining me today is Chewy's CEO, Sumit Singh. Our earnings release, which was filed with the SEC earlier today, has been posted to the Investor Relations section of our website. In addition to the earnings release, a presentation summarizing our results is also available on our website at investor.chewy.com. On our call today, we will be making forward-looking statements, including statements concerning Chewy's financial results and performance, industry trends, strategic initiatives, share repurchase program and the environment in which we operate. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks, uncertainties and other factors described in the section titled risk factors in our quarterly report on Form 10-Q for the first quarter of fiscal year 2024 and in our other filings with the SEC, 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 assume no obligation to update any forward-looking statements, except as required by law. Also, during this call, we will discuss certain non-GAAP financial measures. Reconciliation 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. These non-GAAP measures are not intended as a substitute for GAAP results. Additionally, unless otherwise stated, all comparisons discussed on today's call will be against the comparable period of fiscal year 2023. Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of the audio webcast will also be available on our Investor Relations website shortly. And with that, I'd like to turn the call over to Sumit.

Sumit Singh, CEO

Thank you, Dave, and thank you all for joining us on today's call. Our third quarter results continued to build on the positive momentum we observed in Q2. We delivered top line growth exceeding the high end of our net sales guidance range, a sequential increase in active customers, continued adjusted EBITDA margin expansion and robust free cash flow generation. These results underscore the durability of our business model and our team's relentless focus on high-quality execution and operational discipline. With that, let's dive into the details. Q3 net sales increased by approximately 5% to $2.88 billion. Both the strength of our flagship Autoship program and our customers' loyalty in nondiscretionary categories, particularly within consumables and health anchored our Q3 net sales performance. Our Autoship program enables high ability and predictability in our business and drives customer stickiness for Chewy. Autoship customer sales reached $2.3 billion in the quarter, representing 80% of Q3 net sales and a year-over-year increase of approximately 9%. Nondiscretionary categories, including consumables and healthcare products and services accounted for 85% of Q3 net sales. Customers appreciate our comprehensive product catalog and our ongoing efforts to refresh assortment across food, treats and hard goods. Over the last few quarters, we have increased our assortment across popular categories such as pet tech, wet food and supplements to name a few, adding several new premium brands, most of which launched exclusively on chewy.com. Additionally, we are continuously rolling out enhancements to our on-site and in-app experiences to ensure we are providing an even more enjoyable and convenient shopping journey for pet parents. Last quarter, I spoke about our efforts to redesign our mobile app and make the overall app experience more convenient for customers. In Q3, both unique customers who placed at least one order on the app and average app monthly active users, or app MAU, increased in the mid-teens range compared to Q3 of last year. I am excited by the strong engagement we continue to observe through our mobile app and the experience it brings to our customers. Continuing on the topic of customers, I am pleased to share that Q3 marked another quarter of sequential active customer growth, building on the momentum we established coming out of our second quarter. Our efforts to enhance shopping experiences, expand assortment and various ongoing innovations, combined with our powerful marketing and CRM strategy continue to drive outperformance while macro normalization steadily continues in the background. We ended the third quarter with approximately 20.2 million active customers, up 160,000 sequentially. We now expect to end fiscal 2024 with active customers up modestly over last year, a trend which we expect to continue to strengthen in 2025. Turning to profitability. We generated $138 million of adjusted EBITDA in the quarter, representing a 4.8% margin and approximately 180 basis points of margin expansion year-over-year. Our Q3 adjusted EBITDA results reflect a continuation of our strong gross margin performance, a disciplined approach to cost management and the ongoing benefits of fixed cost leverage as we scale. Our increasing profitability has enabled us to continue to return meaningful capital to shareholders as reflected by the incremental $342 million we deployed to shareholders in the third quarter. Now let me provide an update on some of Chewy's strategic initiatives and innovations. The sponsored ads business continues to perform well, and as expected, we remain on track to reach the low end of our previously stated long-term target range of 1% to 3% of net sales in fiscal 2024. We remain on track with our 1P technology migration and look forward to starting the new fiscal year fully converted to our 1P software platform. Moving to Chewy's healthcare offerings. I am proud of the progress our team has made this year across healthcare products and services, especially Chewy Vet Care or CVC. With the launch of Chewy Vet Care clinics earlier this year, we not only unlocked the $25 billion vet services TAM opportunity, but we are also observing compelling complementarities across the entire Chewy ecosystem. We have six clinics opened today and expect to reach the high end of our previously stated target range of four to eight clinic openings in 2024 later this fiscal year. Performance across our clinic footprint is promising, and I'm happy to share that the early signs of success we spoke about last quarter have continued through Q3. The proportion of new to Chewy customers acquired through Chewy Vet Care continues to outperform relative to expectations. Additionally, broader ecosystem benefits, including cross-category shopping and post clinic visit purchases on chewy.com have strengthened since last quarter, indicating that our ability to seamlessly connect care with commerce is resonating with pet parents. I would also like to take a moment to talk about Chewy+, our paid membership program. Recall that we launched Chewy+ in summer 2024 to a representative sample of customers. Since launching the program, we have been carefully studying the shopping behavior of Chewy+ members and are tracking several key indicators of success, including the program's potential to accelerate wallet share consolidation and drive stronger cross-category engagement. Based on the data we have analyzed over the last several months, we are seeing that Chewy+ members consistently place more orders, have higher cross-category penetration and greater mobile app engagement relative to non-Chewy+ customers. Furthermore, we are seeing higher Autoship adoption rates from this early cohort of customers, signaling a potentially compelling flywheel effect of the Chewy+ program. While contribution to the overall enterprise remains immaterial, we are encouraged by these early results and look forward to introducing the program to our broader base of customers. Touching on Canada, where we completed a full year of operations in Q3. The Canadian business, while still relatively small and immaterial to the overall scale of Chewy, continues to improve across key metrics including Autoship penetration, net sales growth and profitability. Additionally, we remain focused on strengthening brand awareness in Canada and are excited by the brand partnership we've recently signed with the Toronto Maple Leaf's hockey team. We believe Chewy's passion for pets perfectly aligns with Torontonians' passion for the Maple Leafs, and we are bringing this to life with dynamic advertising and interactive fan moments during games at Scotiabank Arena. Lastly, I would like to acknowledge a notable milestone for Chewy with our recent inclusion in the S&P 400 Index as of November 6. We view our inclusion in this index as an endorsement of our performance, our enduring business and our compelling growth opportunities ahead. In closing, I would like to thank all of our dedicated Chewy team members for their hard work and strong execution in the third quarter. We are now focused on executing through our final quarter of 2024 and are excited about the customer engagement we have seen thus far through this holiday season and look forward to ending fiscal year 2024 on a high note. With that, I will turn the call over to Dave.

David Reeder, CFO

Thank you, Sumit. Third quarter net sales grew 4.8% year-over-year to $2.88 billion, exceeding the high end of the guidance range we provided last quarter. The pricing, promotion and discount environment remained stable throughout the quarter. As such, year-over-year revenue growth was primarily driven by active customer growth and cross-category product penetration, resulting in continued customer wallet share gain. We ended the quarter with 20.2 million active customers, reflecting a sequential net increase of approximately 160,000 customers. Gross additions exceeded pre-COVID levels and gross churn improved year-over-year. Within gross additions, both new customers and reactivations grew year-over-year in the quarter. We are encouraged by the positive momentum in active customers and expect these trends to continue through the balance of the year. Against the backdrop of a modestly improving pet industry and strong Chewy specific execution, we now expect to end fiscal year 2024 with modest year-over-year active customer growth. Third quarter Autoship customer sales increased by 8.7% to $2.3 billion, outpacing total net sales growth in the quarter by approximately 390 basis points. Autoship customer sales as a percentage of total net sales increased by 290 basis points to 80%, a new company record. Additionally, we continued to grow share of wallet with Q3 net sales per active customer, or NSPAC, reaching $567. Moving to profitability. We reported third quarter gross margin of 29.3%, representing 80 basis points of margin expansion year-over-year. Our growing sponsored ads business was the largest driver of gross margin improvement in the quarter, followed by product mix shift into premium categories, including consumables and pharmacy. Additionally, promotional activity in the third quarter was in line with our expectations and the promotional environment to date in the fourth quarter remains rational. Shifting to operating expenses. Please note that my discussion of SG&A excludes share-based compensation expense and related taxes. Third quarter SG&A totaled $546 million or 19% of net sales, representing 90 basis points of improvement on a year-over-year basis. SG&A leverage was primarily driven by continued discipline and efficiency with respect to corporate payroll, fulfillment and other at-scale efficiency benefits. Third quarter advertising and marketing expense was $191.8 million or 6.7% of sales. I would note that we expect advertising and marketing expense to come in at the high end of our previously stated range of 6% to 7% of net sales for the full year. This is primarily due to the timing of certain marketing pains in Q4. Third quarter adjusted net income was $84.9 million, representing a 34% increase year-over-year. Net income for the quarter was $3.9 million, which translated into $0.01 earnings per share on both a basic and diluted basis. Finally, we reported adjusted EBITDA of $138.2 million, representing a 4.8% adjusted EBITDA margin and 180 basis points of year-over-year margin expansion driven by the improvements in gross margin and SG&A described earlier. We reported free cash flow of $151.8 million in the third quarter, reflecting $183.5 million of net cash provided by operating activities and $31.7 million of capital expenditures. Our third quarter trailing 12-month free cash flow was over $360 million and demonstrates our ability to generate increasing levels of free cash flow while continuing to invest in our growth initiatives and returning significant capital to shareholders. I'd like to provide an update on our share repurchase activity completed in the quarter. In September, concurrently with a $500 million underwritten secondary offering of Class A common stock by BC Partners, we repurchased approximately 10.2 million shares of Class A common stock directly from BC Partners for an aggregate repurchase price of $300 million. This repurchase transaction allowed us to continue to reduce the ownership position of our largest shareholder and was executed separately from our existing $500 million share repurchase program. Additionally, during the quarter, we repurchased approximately 1.6 million shares of Class A common stock, spending approximately $42.4 million under our $500 million share repurchase program. At the end of the quarter, we had approximately $424.8 million of remaining capacity under the program for future repurchases. Collectively, the company has repurchased and retired a total of 30.7 million shares year-to-date. Our ability to generate increasing levels of profitability and free cash flow will continue to enable us to invest in our business and return meaningful capital to shareholders. We ended the quarter with approximately $508 million in cash, cash equivalents and marketable securities, and we remain debt-free with an overall liquidity position of approximately $1.3 billion. With that, I'd like to turn to our fourth quarter and updated full year 2024 guidance. We anticipate fourth quarter net sales of between $3.18 billion and $3.20 billion or approximately 13% year-over-year growth, which reflects the full impact of the 53rd week, and we are narrowing and raising our full year 2024 net sales outlook to be between $11.79 billion and $11.81 billion or approximately 6% year-over-year growth. This range includes the impact of a 53-week 2024 fiscal year, and as previously noted, the 53rd week will be fully reflected in the fourth quarter of 2024. We are raising our full year 2024 adjusted EBITDA margin guidance to a range of 4.6% to 4.8%. The midpoint of our full year adjusted EBITDA margin guidance range indicates approximately 140 basis points of year-over-year margin expansion and implies approximately 3.4% adjusted EBITDA margin for the fourth quarter. Consistent with our comments last quarter pertaining to the quarterly progression of 2024 adjusted EBITDA margin, we expect Q4 adjusted EBITDA margin to decline sequentially due to typical seasonality and the timing of certain investments, primarily pertaining to marketing campaigns. Given the results of our previous three quarters, we anticipate 2024 capital expenditures to come in at the low end of our previously stated range of 1.5% to 2% of net sales, and we expect free cash flow conversion to remain above 80% for the full year. Finally, we expect basic shares outstanding at fiscal 2024 year-end to be approximately 415 million. This incorporates the nearly 31 million shares that we have repurchased and retired year-to-date and does not incorporate any potential future share repurchases. In closing, our third quarter results reflect another quarter of strong execution. I want to thank credible Chewy team members for their collective efforts as we continue to execute against our strategic priorities to deliver long-term profitable growth. With that, I will turn the call over to the operator for questions.

Operator, Operator

Our first question today comes from Nathan Feather with Morgan Stanley. Please go ahead.

Nathan Feather, Analyst

Thanks for the question, and congrats on the strong results. Really encouraging to see the continued momentum. Active customer growth continues to accelerate. Can you double click on what you're seeing in overall pet ownership trends and how we should think about the relative contribution to customer growth as compared to some of the idiosyncratic initiatives you've been working on? And then given the expectation for customer growth to improve further in 2025, how should we think about the key puts and takes you're considering for growth in the year? Thank you.

Sumit Singh, CEO

Hey Nathan, this is Sumit. I'll begin, and Dave can chime in as he sees fit. Regarding household formation trends, we are still seeing signs of industry normalization. Pricing is stable, and inflation is moving towards a more normalized level. In fact, we noted that there was no pricing benefit as we progressed through Q3. As for pet household formation, there isn't a single definitive source for this data, but our analysis indicates that the latest adoption and relinquishment trends are both improving. We estimate that year-over-year adoption growth was in the high single-digit to low double-digit range, while relinquishments declined by low single digits. Overall, we are witnessing a return to positive net adoptions in Q3 from an external perspective. In response to your question about expectations for active customer growth in 2025, there are numerous factors at play. Ultimately, we believe that our ongoing efforts, coupled with the industry's normalization, are key to driving active customer growth. On our end, we are enhancing the on-site and mobile experiences, expanding our assortment, and refining our performance and CRM strategies. A significant breakthrough for us has been connecting the marketing funnel to a wider audience, which allows our teams to achieve the right level of efficiency and flexibility in our spending to capture both voice and demand. This enables us to convert visitors effectively with our improved site experience, customer choices, and assortment innovations. Our strategy for 2025 aligns closely with the operating playbook we've developed and strengthened throughout 2024. Additionally, I want to highlight that we have enhanced our ability to identify and segment customers, allowing us to improve second purchase rates, autoship signups, and mobile app engagement. We’ve implemented this strategy for at least two quarters now, and we plan to continue this approach in Q4 and 2025, further strengthening our channels and market performance.

Nathan Feather, Analyst

Great. Thank you.

David Reeder, CFO

Thank you, Nate.

Operator, Operator

The next question comes from Curtis Nagle with Bank of America Merrill Lynch. Curtis, please go ahead.

Curtis Nagle, Analyst

Awesome. Thanks very much for taking the question. So I want to focus a bit on the 4Q guidance and maybe specifically on the comments in terms of the advertising and marketing spend. Just in terms of context, at the high end of the range, around 7% for the year, it implies like a really big dollar increase, right? Certainly relative to the other quarters, like no relative leverage from the extra week. So, I guess just kind of digging into that, what does this spend pertain to? Looks to me, it's like implied like $40 million to $50 million year-over-year, is that correct? And, are other specific products or customers you're targeting at one time? Just kind of dig into that and kind of how we should specifically think about that increase and whether just apply some conservatism or not.

David Reeder, CFO

Good morning, and thanks for the question. I'll take this one, and then Sumit, if you want to build upon any of it, let me know. I'll build upon Sumit's comments about active customers. So in the third quarter, when you think about the elements that go into gross additions, you’ve got new customers added, you've got reactivations, and then, of course, you have churn. And we actually saw improvement across all three of those metrics in the third quarter on a year-over-year basis. And so we're entering the fourth quarter with some momentum on the activities that we're driving across those three elements I mentioned. We're entering the fourth quarter with the continuation of what we believe is a normalizing industry as we previously referenced with moderating inflation as well as the shelter data that we've mentioned previously as well, which has continued in the third quarter. So with that momentum going into the fourth quarter, there's a couple of elements to consider. Number one, you typically have a little bit higher elevated advertising and marketing in the fourth quarter, given the holiday season as well as the timing of certain campaigns. And then building on that, we see an opportunity in the industry in the fourth quarter where we believe that we want to invest and lean into the fourth quarter such that we can continue to build on what we believe is some improvement in the industry and then continue that of course into 2025. So, net-net, you take a step back, you think about what we've told you for the year in terms of our guidance, active customer growth, flat to down in the first half, flat to up in the second half ending flat. We've moved up that guidance. We've pulled in that guidance and we see an opportunity to invest in the fourth quarter in advertising and marketing and we're doing that. For the full year, we'll be at the high end of the 6% to 7% range. And as you mentioned, to get to the high end of that 6% to 7% range for the year, that would imply being above 7%, specifically for the fourth quarter. Sumit?

Sumit Singh, CEO

I would like to remind everyone of our previous discussions on this call regarding our spending strategy, which is based on the return on investment and lifetime value potential we observe in the current group of customers we acquire from the market, as well as from our existing customer base where we aim to increase share of wallet. Previously, we significantly reduced our marketing spend, going down 70 to 80 basis points below our average, but now we are starting to increase that spend again. The reason for our previous reduced spending was a lack of observed ROI, which has changed now. The cohorts we are bringing in and the efficiencies we are achieving through extensive audience expansion are encouraging, prompting us to invest further to sustain this positive trend and ensure growth into 2025 and beyond. For some specific data points, about three-fourths of the new customers we are acquiring have at least one SKU from a repeatable category, which is a positive sign as it fosters Autoship growth and supports our overall momentum. We're noticing improvements in the reorder rates and settlement rates from these new customers as we engage with consumable categories. When we analyze the year-to-date 2024 customer cohorts, the year-over-year reorder rates in the initial periods following acquisition are about 300 to 500 basis points higher than the previous month averages. These insights help us evaluate and adjust our investment strategy based on expected returns, which is precisely what we are doing at this moment.

Curtis Nagle, Analyst

Okay. That makes total sense. Just a quick follow up. The point you made in response to Nate's question about the adoptions was really interesting. I think you mentioned that on a grocery basis, it was high singles to low doubles, transitioning to low singles, which is a pretty good number. How did that compare to the second quarter? I am trying to understand the relative improvement.

Sumit Singh, CEO

It's positive by, I think the margins extended by low to mid-single-digit ranges relative to Q2.

Curtis Nagle, Analyst

Okay, awesome. Appreciate it. Thank you.

David Reeder, CFO

Thank you.

Operator, Operator

The next question comes from Doug Anmuth with JPMorgan. Please go ahead.

Doug Anmuth, Analyst

Great, thanks for taking questions. Two, if I could. First, just on vet clinics, looks like you're on track to the eight locations by year end. Can you talk more about what you've learned this year and how that informs your ‘25 expansion plans and the investments that may be required then. And then, Sumit, if you could also perhaps give us an update on automation, just kind of how you're tracking relative to the 70% to 80% kind of long-term percentage of volume that you've talked about over time? Thanks.

David Reeder, CFO

Yeah. So, with respect to the vet clinics, as we talked about, we were planning to roll out four to eight vet clinics this year. We're going to be at the high end of that range. The positive trends that we've seen on vet clinics have continued. Some of those positive metrics have been the operational utilization of those clinics. It's been high. The customer engagement from those clinics and the corresponding customer service levels have been high. The net promoter kind of score around those clinics and the service level high. The new customer cross category penetration, new customers to Chewy that come in through vet clinics, and then their propensity to go to chewy.com and then shop online at chewy.com, also high. In fact, more than half of those new customers, consistent with last quarter, actually an improvement from last quarter, are leaving the vet clinic, new customer to Chewy, and then going online and also shopping at chewy.com. So, all the metrics across the vet clinics trending positive. I'll leave the 2025 guidance for 2025, but I would just tell you that we've been very encouraged by our engagement with customers. We're encouraged by the size of the TAM, roughly $25 billion, that we've opened up through these vet clinics, and we're excited about continuing to grow our presence in this space. Sumit, anything that you would build on there?

Sumit Singh, CEO

On the automation front, that's great. We are seeing a positive trend in automation. Nearly half of our volume is now being processed through our 2G fulfillment centers and is utilizing some form of automation within the network. This, along with our enhanced supply chain tools, is enabling us to manage a very successful peak period. We're continuously achieving efficiencies that positively impact our bottom line, as reflected in the operational expenses scaling that Dave mentioned. I'm happy to go into more detail on any specific area if you're interested.

David Reeder, CFO

And just to build on that comment, using some data points from the third quarter, given the efficiencies that you've mentioned, we had an improvement on the variable fulfillment side. We had improvement on the fixed fulfillment side. In other words, we got more fixed cost absorption through those fulfillment centers. And orders every quarter this year, year-over-year, so Q1, Q2, Q3 on a year-over-year basis, orders are up across all those quarters and in total year-to-date. In fact, we had our highest order period during this most recent peak holiday cycle over the last week or so. And so the team is executing very well and the automation that's been referenced here is a big contributor to that, both in terms of output as well as efficiency and productivity. Did you have a follow-up, Doug?

Doug Anmuth, Analyst

That's great. Thank you both. Appreciate it. No, all good. Thank you.

David Reeder, CFO

Thanks.

Operator, Operator

The next question comes from David Bellinger with Mizuho. David, please go ahead.

David Bellinger, Analyst

Okay, good morning. Thanks for the question. First one, I wanted to revisit the app, which I think you mentioned last quarter was around 20% of revenues. Is there any update on how quickly that percentage could ramp up? How fast can we get to 30% or 40%? And then secondly, how should we think about the P&L impact of that? Can you simply bypass marketing spend and sort of get more leverage on the ad expense line by getting more volumes through your app?

Sumit Singh, CEO

Hi, David. This is a priority for us, and we are quickly increasing our efforts to push this volume. I see it as a long-term effort, potentially a couple of years, to reach market standard rates of about 40% to 45%, essentially doubling the volume moving through the app. We appreciate the progress we’re making each quarter. We value it particularly because it's a closed-loop ecosystem, enabling us to gather first-party data, market on a first-party basis, leverage direct traffic, engage with customers more effectively, and capitalize on encouraging trends in the app that enhance revenue conversion into profitability. For instance, Autoship engagement rates, average order values, and retention rates in the app are significantly higher compared to web or desktop interactions. Additionally, we observe a higher cross-category attach rate in the app. Overall, this not only leads to a more productive experience but also a more enjoyable and personalized one, allowing us to strengthen our customer relationships while reaping P&L benefits. We'll assess the benefits as we approach 2025. I’ll take note of your question and provide an update in 2025.

David Bellinger, Analyst

Perfect. We'll come back on that one. And then just to follow up, in your 10-Q filing, it looked like there was some new language around a project on the finance IT side, not meaningful from a capital investment perspective, but can you elaborate on the SG&A portion? How much will that detract in 2025? And are there any deficiencies within the system that this is correcting?

David Reeder, CFO

No. No, there are no deficiencies in the system that this is correcting. This is new capability for us. So I think you should think about this as the migration of some of our planning engines to a more comprehensive online suite. And by being able to do that, which at no material impact really to the P&L. By being able to do that, we're able to get more granularity with respect to all of our operations. And we're also going to be able to apply some AI to those same operations to get some automated intelligence and reporting out of the system in a more comprehensive way.

David Bellinger, Analyst

Perfect. Thank you both.

David Reeder, CFO

Thanks, David.

Operator, Operator

The next question comes from Steven Zaccone with Citigroup. Steven, please go ahead.

Steven Zaccone, Analyst

Hi. Good morning. Thanks very much for taking my question. First question I had was just on pricing. Sumit, you said there was no benefit from pricing in the third quarter. How do you see that playing out in 4Q and then any preliminary views on 2025? It seems like the industry overall has been flattish for some time. So your thoughts on maybe what looks like next year would be helpful.

David Reeder, CFO

So, hi, Steve. This is David. I'll take this one and then, Sumit, if you want to build on it, chime in. With respect to pricing in third quarter, really no material benefit nor detriment in the third quarter with respect to pricing. We had goodness on the gross margin line, largely driven by sponsored ads and product mix. And then of course that flowed all the way through the P&L ultimately to give us a pretty sizable EBITDA beat for the quarter on a year-over-year basis, roughly half driven by gross margin and half driven by leverage through the remainder of the P&L. But really no impact either way from pricing. With respect to fourth quarter, you typically do have some pricing and discounting in the fourth quarter related to the holiday season. We fully baked that into our guidance for the fourth quarter. But again, no material kind of impact from inflation nor deflation, which the inflation piece is obviously we had seen in prior years and in prior periods, but really no meaningful impact. Really throughout 2024, we had a little bit in the first quarter, second quarter moderated significantly, third quarter relatively non-existent, fourth quarter expecting the same other than the traditional seasonality. And that's how we're kind of expecting rolling into 2025. We're expecting those trends to largely continue.

Sumit Singh, CEO

Yeah, the overall environment, Steven, the market remains very rational with, of course, some seasonal spikes that you would expect as we played through the CyberWeek last week, which was a very good week for us. If you remember our comments from the beginning of this year, the composition of revenue has shifted from part pricing, part unit growth, or structural growth coming into Q1 of this year to much more weighted towards structural growth as we exit this year. We are not seeing deflation happen in the category. The category that, of course, is more elastic right now as we move to Q4, particularly cyber, is more on the hard goods and discretionary side, but you would expect that as the industry normalizes and we push volumes through this seasonal holiday peak season. But outside of that, you should expect ‘25. If you recall our long-term growth algorithm, the revenue is a function of active customer growth in the low to mid-single-digit and NSPAC growth in the mid to high single-digit and there's a benefit of roughly 2% to 2.5% of pricing built in when the industry normalizes and that long-term growth algorithm we expect will come true as the industry continues to normalize, and we move out of ‘24 into ‘25 and ‘26.

Steven Zaccone, Analyst

Okay, that's very helpful. The follow up I had is just in the context of raising the customer count outlook and then the commentary about that strengthening in 2025, how much of that is driven by the industry data points getting a little bit better, like you mentioned, pet adoptions versus your own idiosyncratic efforts, talking about marketing and stuff of that nature?

Sumit Singh, CEO

It's difficult to quantify exactly, but we believe that most of the changes we've observed are due to our internal initiatives. Therefore, we are optimistic that we'll benefit further once the industry fully recovers. At this moment, we aren't factoring that potential into our forecasts, as we prefer to let it serve as additional momentum. Currently, our remarks regarding the growth in active customers are based on the successful efforts we are implementing internally.

Steven Zaccone, Analyst

Very helpful. Thanks for the questions.

Operator, Operator

The next question comes from Rupesh Parikh with Oppenheimer. Please go ahead.

Rupesh Parikh, Analyst

Good morning and thanks for taking my question. Also congrats on this quarter. So just going back to the hard goods category, we'd love to get more color in terms of what you saw during the quarter, expectations going forward, and then from a tariff perspective, if there’s any exposure on the tower front. Thank you.

Sumit Singh, CEO

I'll take the first part, and Dave will address the second. As you can see, hard goods continue to improve, and that trend was evident in Q3 as well. It's encouraging to see the industry normalizing. We believe the steady improvement in hard goods performance stems from our initiatives and reflects industry stabilization. Specifically, we have been expanding our assortment across various merchandise categories and are focused on integrating high-value products onto our platform. Our suppliers and vendors are enthusiastic about collaborating with us in this area. We're also upgrading the site experience to enhance user engagement, product discovery, and conversion rates, complemented by strategic campaign execution. We are confident that our team's efforts are yielding positive results. However, we recognize that we will reap the full benefits once we witness a more significant recovery in discretionary spending. Nevertheless, we are pleased with the outcomes so far.

David Reeder, CFO

And building on that, we're excited about hard goods growing two quarters in a row now on a year-over-year basis. So, both second quarter of this year and third quarter of this year have now grown on a year-over-year basis. We're pretty excited about that growth. And we're also excited about the early trends that we've seen here in fourth quarter. So don't want to guide by a product category, but certainly we feel good about hard goods where we stand today in the fourth quarter. With respect to the tariff question that you mentioned, we have a very small reliance and presence on China specifically. We do source some hard goods from China, primarily related to some of our hard goods, but the vast, vast majority of our net sales at Chewy are pretty much domestically sourced. So our reliance on the region and our, the impact of any potential tariffs relatively low on Chewy.

Rupesh Parikh, Analyst

Great, thank you, I'll pass it along.

Operator, Operator

The next question comes from Mark Mahaney with Evercore ISI. Please go ahead, Mark.

Mark Mahaney, Analyst

Thanks, two questions please. So this active customer growth, can you tell how much of that is from reactivated customers, customers you've had in the past who've churned off for whatever reasons and have come back and if so, any color on what those reasons are. And then secondly, it sounds like competitive intensity is relatively moderate given your comments on pricing. But other than pricing, is there anything else you're seeing notable in the competitive landscape? Thank you.

Sumit Singh, CEO

Hi, Mark. A greater number of customers were from net new customers that we acquired, but relative to the reactivated customers that we count towards gross adds. The other encouraging factor that we saw this time was, the cohort stabilization that we've been talking about. So churn stabilized as we would expect, which was Dave's earlier comment on all three indicators were positive, net new reactivated as well as lower churn. But between the gross add, the portion of net new customers on an absolute basis, absolutely exceeded reactivation. So, we were happy to see that of course, and we would want that. And then if you combine that with some of the results that I shared around how these cohorts are engaging in terms of second purchase rates, et cetera, that is encouraging to see. On the retention side, we're tracking settled orders, which is a metric that we developed as we came out of the COVID timeframes. So, to be really able to see turnover settlement rates so that we're not calling early success or early wins on these customer cohorts. And we're seeing turnover customer settlement rates also improve from cohorts that we've acquired from P5 of this year and before that. So all encouraging signs. Competitive intensity, you're right. It seems relatively moderate. Pricing environment is rational. And overall, we're playing a pretty strong playbook, continuing to differentiate ourselves, both in terms of the basics of the category on price and convenience and assortment, but also in bringing new innovations to life. Super excited about Chewy+, super excited about the app initiative, Canada's ramping well, sponsored ads are ramping well. So nothing else to report.

Mark Mahaney, Analyst

Okay, thank you, Sumit.

Operator, Operator

The next question comes from Shweta Khajuria with Wolfe Research. Please go ahead.

Shweta Khajuria, Analyst

Thank you so much for taking my questions. Let me try two please. One is, could you please talk to some of the marketing channels that are working really well for you, we a positive surprise, or have been a positive surprise for you over the past couple of quarters as you lean into different channels and seeing better returns? That's one. And then second is, could you please talk about trends you saw quarter-to-date, so through October, November, December, and how the trend did versus your internal expectations? Thanks a lot.

Sumit Singh, CEO

Sure. I can't fully share which specific marketing channels are working for us, but I want to reiterate a point I made at the beginning of the call. If you're looking for what's different, I would highlight our focus on connecting the marketing funnel to broader audiences and ensuring full funnel exposure. This has been a major change for us in recent quarters. Coupled with our ability to effectively target customers when they engage with our platforms and improve conversion rates, I believe this strategy is highly effective, and we are continuously refining it. There is still room for improvement, but we are enthusiastic about our current results. Regarding quarter-to-date trends, we are pleased with our performance so far. We just completed CyberWeek, and I would consider our peak holiday event performance to be successful. We implemented a well-thought-out plan that included a great selection of offers, experiences, and marketing strategies, which led to strong customer engagement with visits and expenditures surpassing our expectations, resulting in some of the highest net sales days in Chewy’s history. As David mentioned in the prepared remarks, we are raising our net sales guidance for the year. Although we didn't specifically address the last few weeks we've experienced, this increase is a reflection of the strengths we are currently seeing in our operations. David, do you have anything to add?

David Reeder, CFO

Yeah, if I could build on that with a few softer points here that don't necessarily show up in the P&L, but they certainly give us a good brand umbrella. Number one, Chewy Claus. I'll call that out, especially this time of year. It's a program where pets submit their Santa wish list and it's gotten quite a bit of traction in prior years. It's gotten even more traction this year. It's not part of a paid marketing program, but it is a program that's organic and it's trending. And it's a program that when people associate pets, pet parents, the humanization of pets, and an emotive category like this. It is an organic trend that gets a lot of play this time of year, and it's a program that we love to run. And then finally, I'd be remiss if I didn't just point out the wow experience that our customer service provides every day and the brand uplift and emotive attachment to Chewy that that type of program does.

Sumit Singh, CEO

Shweta, if the CFO is talking about it, the Chewy Claus program must really be working good.

Operator, Operator

We have time for one more question. And so our final question today comes from Anna Andreeva with Piper Sandler. Anna, please go ahead.

Anna Andreeva, Analyst

Great, thanks so much. Happy to have made it and congrats, nice results. Two questions from us. I wanted to follow up on hard goods. Sumit, just remind us what's the size of your own brand's business within that? Are you starting to see growth there and should that continue into next year? And is own brand still a higher margin category for Chewy? And secondly, I guess to Dave, FC automation has been a pretty big story here and you quantified that benefit in the 10-Q to OpEx. Can you remind us how many FCs are automated now? What's the benefit in OpEx savings you see per FC? And how many do you still have to automate ahead into ‘25 or beyond? Thank you so much.

David Reeder, CFO

Sure. Let me start with hard goods. If you review the 10-Q, you will find our reporting on hard goods. As I mentioned earlier, after several quarters of decline, we have now seen two consecutive quarters of year-over-year growth in hard goods. In the second quarter, we experienced growth compared to last year, and the third quarter has shown even faster growth. Although we do not provide guidance by product line or category, we have seen positive trends in hard goods for the fourth quarter, which pleases us. Regarding our private brands, whether in hard goods or other categories, we typically do not provide extensive commentary. However, private brands have remained stable for us. We have several initiatives underway to expand our assortment in both consumables and hard goods. Most of these initiatives will bring future benefits that are not yet reflected in the P&L for the third quarter or in our guidance for the fourth quarter. So those benefits are expected to materialize later. In general, hard goods have seen two consecutive quarters of growth and are trending positively for the fourth quarter. Additionally, private brands within hard goods are continuing to improve in assortment and selection.

Sumit Singh, CEO

For hard goods, we previously indicated that our private brands have a penetration rate in the mid-teens to high teens. This rate fluctuates throughout the year, but remains relatively stable. Currently, six fulfillment centers are automated. It's important to note that at Capital Markets Day, we discussed our plans to continue automating our network, aiming to handle over 70% of our volume through these enhanced processes. Specifically, in our fulfillment centers, we have reported productivity gains of up to 50%, a 30% increase in volume per square foot, and up to a 60% improvement in ergonomics and safety. These results continue to hold true today.

Operator, Operator

Those are all the questions we have time for today. And so this concludes today's call. Thank you everyone for your participation. You may now disconnect your lines.