Chewy Inc

NYSE:CHWY

Earnings Call Analysis

Chewy's Strong Q2 Performance and Optimistic Future Guidance

Chewy reported strong Q2 results, with net sales of $2.86 billion, growing 3% YoY. Autoship customer sales, a key strength, rose 6%. Net income was $299.1 million, including a significant one-time tax benefit. Adjusted EBITDA improved to $144.8 million, expanding margins by 190 basis points. Cash flow generation allowed significant capital returns, including $500 million in share repurchases. Chewy anticipates Q3 net sales between $2.84-$2.86 billion, with full-year 2024 sales expected to grow 4%-6%. Adjusted EBITDA margin guidance was raised to 4.5%-4.7%. Key growth drivers include Vet Care clinics and sponsored ads, enhancing long-term profitability.

A Quarter of Strategic Wins

In the second quarter, Chewy demonstrated solid performance against its strategic priorities. The company's net sales reached $2.86 billion, reflecting a growth of approximately 3%. This was at the high end of their guidance range, showcasing the predictability and durability of their business model even in a normalizing market.

Strong Customer Engagement and Growth

Chewy's Autoship program was particularly successful, with customer sales growing by 6%, reaching 78% of total sales. This program highlights the convenience and value it offers customers, especially in non-discretionary categories like consumables and health products, which made up about 85% of net sales. Additionally, the company's net sales per active customer (NSPAC) set a new record at $565, growing over 6%, driven by repeatable categories and premium products.

Mobile App and Customer Experience

Chewy’s investment in its mobile app redesign paid off, with unique customers placing orders through the app increasing by approximately 13% year-over-year. Overall mobile app orders saw a 15% increase, driven by higher units per order and better retention when customers used the app. Despite ending the quarter with approximately 20 million active customers, this was the first sequential increase since Q1 2023.

Profitability and Cash Flow

The company reported a robust gross margin of 29.5%, a 120 basis point increase year-over-year. Chewy generated $145 million of adjusted EBITDA, reflecting a 5.1% adjusted EBITDA margin, which is a year-over-year increase of approximately 190 basis points. The company ended the quarter with $695 million in cash, cash equivalents, and marketable securities and generated approximately $91 million in free cash flow.

Investment and Shareholder Returns

Chewy invested in strategic initiatives such as the Chewy Vet Care clinics and sponsored ads, enhancing customer acquisition and engagement. They also returned capital to shareholders, repurchasing about 17.6 million shares for $500 million independently from the existing repurchase program and spending $32.7 million on additional repurchases under the program. The company remains debt-free with a strong liquidity position of approximately $1.5 billion.

Strategic Initiatives and Innovation

The Chewy Vet Care initiative saw the opening of two new clinics, bringing the total to six. These clinics are exceeding expectations in customer acquisition and engagement, demonstrating the potential for Chewy to integrate veterinary services with their existing offerings. The sponsored ads business is also performing well, expected to reach 1% to 3% of net sales by the end of 2024.

Future Outlook

Looking ahead, Chewy anticipates third-quarter net sales of $2.84 billion to $2.86 billion, reflecting year-over-year growth of 3% to 4%. They maintain a full-year 2024 net sales outlook of $11.6 billion to $11.8 billion, or 4% to 6% growth. Additionally, they raised their full-year adjusted EBITDA margin guidance to a range of 4.5% to 4.7%, signifying confidence in their strategic execution and profitable growth efforts.

Earnings Call Transcript 2025-Q2

[Operator]

Good morning, all, and thank you for joining us for the Chewy Second Quarter 2024 Earnings Call. My name is Carlie, and I'll be the call coordinator today.

[Operator Instructions] I'll now hand over to your host, Jen Hsu of Investor Relations to begin.

[Jennifer Hsu, executive]

Thank you for joining us on the call today to discuss our second quarter results for fiscal year 2024.

Joining me today are Chewy's CEO, Sumit Singh; and CFO, David Reeder. 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 that we operate in. 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 from last quarter and in our other filings with the SEC, including the quarterly report on Form 10-Q filed earlier today, 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. 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, which was filed with the SEC today. 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.

I'd now like to turn the call over to Sumit.

[Sumit Singh, executive]

Thank you, Jen, and thank you all for joining us on today's call. Our Q2 results reflect another quarter of strong execution against our strategic priorities. We delivered top line growth at the high end of our guidance range, continued significant adjusted EBITDA margin expansion and compelling free cash flow generation. Initiatives including Chewy Vet Care and sponsored ads are performing well, and I look forward to telling you more about these in a few minutes. With that, let's dive in.

Q2 net sales grew by approximately 3% to $2.86 billion. Autoship customer sales grew by approximately 6% or double the rate of company-wide net sales to reach 78% of net sales, reflecting both the convenience and the value of the program and the strength of our nondiscretionary categories, including consumables and health, which collectively represented approximately 85% of our net sales in the quarter.

In addition to the engagement created through our Autoship program, our ability to grow share of wallet was also evident in Q2, with metrics such as net sales per active customer, or NSPAC, which set a new record at $565, growing over 6% in the quarter. NSPAC growth is being driven by factors such as strengthening mix of repeatable categories and growth in our premium product lines, for example, premium food and Chewy Health.

Also notable this quarter was the strengthening customer engagement through our mobile app. Over the past year or so, we have been hard at work redesigning our mobile app and making the overall user experience more convenient for our customers. This quarter, we saw some early signs of this strategy paying dividend. Unique customers who placed orders through our app increased by approximately 13% year-over-year, with overall mobile app orders increasing approximately 15% year-over-year. We observed both higher units per order and better retention when customers download and use the Chewy app.

On the topic of customers, we ended the second quarter with approximately 20 million active customers and are encouraged to see net adds grow even if modestly on a sequential basis for the first time since Q1 2023. Our second quarter performance carried on the trends we saw in Q1, with new customer acquisition, reactivations and retentions, exceeding our internal expectations for the second quarter in a row. Additionally, this quarter, we observed sequential improvement in gross churn and minimal inflationary cost pressure.

Moving down the P&L, we delivered another quarter of robust profitability with gross margin coming in at 29.5%. Our category teams are executing well, effectively navigating a dynamic and normalizing industry, ensuring that we remain competitive on things customers care about most. For example, keeping prices sharp at our assortment fresh, innovative and delivered quickly. Though gross margin will fluctuate on a quarterly basis, we expect this metric to continue to expand over time as our higher-margin businesses become a larger portion of our total sales.

We generated $145 million of adjusted EBITDA in the quarter, representing a 5.1% adjusted EBITDA margin and a year-over-year increase of approximately 190 basis points. Our Q2 adjusted EBITDA results reflect our ongoing rigor around managing our operating expenses and driving operational efficiencies where we overdelivered relative to our internal expectations. Notably, over 40% of order volume is now benefiting from automation, and our proprietary supply chain software is enabling us to place inventory more optimally across our FC network, thus, leading to both lower fulfillment cost and an improved customer experience. We continue to demonstrate strong discipline in managing the controllables, while also seeing our business model benefit from fixed cost leverage. Together, these levers enabled us to deliver compelling year-over-year margin expansion and have set us up to materially exceed our profitability commitments for the year.

Moving on to cash flow. In the second quarter, we generated approximately $91 million of free cash flow and ended the quarter with $695 million of cash, cash equivalents and marketable securities. Our strong balance sheet, combined with our compelling free cash flow generation enabled us to not only invest in strategic initiatives that support our long-term growth and margin objectives, but also return capital to our shareholders in a meaningful way through various share repurchase transactions, which Dave will describe in more detail.

Now I will shift gears and provide an update on some of Chewy's strategic initiatives and innovation. I am excited to share that since our last earnings call, we have opened 2 additional Chewy Vet Care clinics, one in Denver, Colorado area and another in South Florida, increasing our density in both of these markets and bringing our clinic count to 6 locations against our previously stated target range of 4 to 8 clinic openings in 2024. With each additional week and month of operations across our clinic footprint, we are steadily accumulating data to prove out our initial [ thesis ] around Chewy Vet Care. Although it is early, the leading indicators are promising.

First, Chewy Vet Care is serving as an acquisition funnel with the proportion of net new customers acquired through our clinics exceeding our expectations. Second, clinic engagement is accelerating our NSPAC curves supported by both spending on veterinary services and strong cross-category shopping behavior. In clinic, many customers are deepening their commitment to the Chewy ecosystem by purchasing pharmacy or food for the first time. And similarly, we are seeing a highly positive impact on chewy.com visits following a clinic appointment.

Finally, and importantly, we continue to see high interest levels from the veterinarian community, who view the Chewy Vet Care value proposition as compelling and recognize the strength and halo effect of the Chewy brand. Vet NPS remains high, and we are pleased with the engagement that our brand promise and commitment to veterinarians is resonating. We look forward to sharing more with you in due course as we continue to build out this business.

Moving to sponsored ads. Our ads business continues to ramp up nicely and is on track to reach the low end of our long-term target of 1% to 3% of net sales exiting 2024. Performance has continued to exceed expectations, driven by our thoughtful expansion of inventory, including mobile volume, advertiser demand growth and increasing kick through rates as we refine customer relevancy. Furthermore, the team is on track to implement a new 1P technology stack, which will enable us to both improve supplier experience and lower our cost to serve. We are optimistic about further growing and refining this business over time and look forward to keeping you updated on our progress.

To conclude, our Q2 results reiterate Chewy's differentiated value proposition, stickiness of our business model and the efficiency of our rapidly scaling operations, which are enabling us to keep customers engaged as well as deliver strong margin expansion and increasing levels of free cash flow. We are, in turn, both returning capital to shareholders and prudently and strategically investing in areas of our business that we expect will continue delivering attractive long-term returns.

With that, I will turn the call over to Dave.

[David Reeder, executive]

Thank you, Sumit. Second quarter net sales of $2.86 billion came in at the high end of our guidance range and grew 2.6% year-over-year. These top line results demonstrate the predictability and durability of our business model even in a normalizing market. Active customers grew modestly on a sequential basis to approximately 20.0 million. As Sumit earlier, gross adds once again exceeded our internal expectations this quarter, signaling that, in addition to macro normalization, our efforts with respect to customer engagement continue to gain traction.

While we are encouraged by the trend of this metric, and the team continues to execute our customer engagement strategy, we believe it is prudent to maintain our 2024 view of approximately flat active customers for the year. Net sales per active customer, or NSPAC, came in at $565, reflecting an increase of 6.2%. NSPAC yet again reached a new record high, demonstrating our continued ability to grow share of wallet.

Our subscription-like Autoship business continues to be a core pillar of strength for Chewy, with Autoship customer sales of over $2.2 billion in the quarter, growing 5.8% and representing 78.4% of our total net sales, up 230 basis points on a year-over-year basis.

Moving to profitability, we reported second quarter gross margin of 29.5%, representing a 120-basis-point year-over-year increase, coming in slightly ahead of expectations and underscoring the increasingly attractive mix of our business as well as our position as a strategic channel for our vendor partners. We believe we have continued headroom to expand gross margin over time.

Shifting to operating expenses, please note that my discussion of SG&A excludes share-based compensation expense and related taxes. We continue to demonstrate OpEx leverage in the quarter, with SG&A coming in at $538.8 million or 18.8% of net sales, representing 100 basis points of improvement on a year-over-year basis and also shrinking on an absolute dollar basis for the first time. SG&A leverage was driven by continued discipline with respect to corporate payroll and the ongoing benefits resulting from our fulfillment center automation investments and other software and fulfillment-related efficiencies.

Second quarter advertising and marketing expense was $190.5 million or 6.7% of net sales, consistent with our previously stated expectation of 6% to 7% of net sales. Second quarter adjusted net income was $104.8 million, representing a 62% increase year-over-year. This quarter's adjusted net income excludes a onetime income tax benefit of approximately $276 million related to the release of a valuation allowance on our U.S. federal and other state deferred tax assets. Net income for the quarter was $299.1 million, which translated into $0.70 and $0.68 earnings per share on a basic and diluted basis, respectively. Our basic and diluted earnings per share include the onetime tax benefit of $0.64 and $0.63, respectively.

Finally, we reported adjusted EBITDA of $144.8 million, representing a 5.1% adjusted EBITDA margin and 190 basis points of year-over-year margin expansion. Approximately 2/3 of the improvement was driven by gross margin, with the remaining 1/3 driven by fulfillment and operating expense leverage. We reported free cash flow of $91.5 million in the second quarter, reflecting $123.4 million of net cash provided by operating activities and $31.9 million of capital expenditures. Our significant free cash flow generation and strong balance sheet position afforded us the opportunity to return significant capital to shareholders within the quarter.

I will now spend a few moments summarizing the various share repurchase transactions we completed in the quarter. In June, we repurchased approximately 17.6 million shares of Class A common stock directly from [ BC ] Partners for an aggregate repurchase price of $500 million. This repurchase was executed separately from our existing $500 million share repurchase program and allowed us to reduce the ownership position of our largest shareholder. Additionally, during the quarter, we repurchased approximately 1.3 million shares of Class A common stock, spending approximately $32.7 million under our $500 million share repurchase program. At the end of the quarter, we had approximately $467.3 million of remaining capacity under the program for future repurchases.

We remain excited about our ability to generate increasing levels of profitability and free cash flow, enabling us to invest in our business both organically and inorganically as well as returning capital to our shareholders. We ended the quarter with more than $695 million in cash, cash equivalents and marketable securities, and we remain debt-free with an overall liquidity position of approximately $1.5 billion.

With that, I'd like to turn to our third quarter and updated full year 2024 guidance. We anticipate third quarter net sales of between $2.84 billion and $2.86 billion, or approximately 3% to 4% year-over-year growth, and we are maintaining our full year 2024 net sales outlook of between $11.6 billion and $11.8 billion, or approximately 4% to 6% year-over-year growth. This range includes the impact of a 53-week 2024 fiscal year and 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 4.5% to 4.7%. This second increase of the year demonstrates our continued execution towards a richer product mix and the increasing leverage in our business model.

The new guidance midpoint indicates expected adjusted EBITDA margin expansion of approximately 130 basis points year-over-year. We continue to expect the 2024 adjusted EBITDA margin profile to follow a similar quarterly trend as that of 2023, declining sequentially throughout the year, averaging to the aforementioned guidance range due to the typical seasonality and timing of certain investments. We also continue to expect full year capital expenditures in the range of 1.5% to 2% of net sales and free cash flow conversion to remain above 80%.

Finally, we are updating both our share-based compensation and shares outstanding expectations for the year. We now expect full year 2024 stock-based compensation expense, including related taxes, to be approximately $305 million, down from our $330 million guidance at the onset of the year. This reflects the continued discipline with which we are managing our operating expenses. We expect basic shares outstanding at fiscal 2024 year-end to be approximately $430 million. This incorporates the nearly 19 million shares that we repurchased during this quarter and does not incorporate any potential future share repurchases. Notably, due to the timing of our 2024 fiscal year-end, this share count guidance includes an incremental vesting event for our employees for awards granted during 2024.

With that, and in closing, our second quarter results reflect another quarter of strong execution, solid growth against the backdrop of a normalizing pet industry and continued margin expansion as our business benefits from incrementally higher profit flow-through at scale. I'm incredibly proud of the hard work that drove our results this quarter, and I want to thank each of our Chewy team members for their collective efforts.

I will now turn the call over to the operator for questions.

[Operator]

[Operator Instructions] Our first question comes from Doug Anmuth of JPMorgan.

[Douglas Anmuth, analyst]

I have 2. Last quarter, you talked about signs of green shoots with pet adoptions exceeding relinquishments for the first time in about 2 years. So hoping you could talk more about whether those positive trends are continuing based on the data and surveys that you're seeing? And then, Sumit, I know it's early, but just as you think about fiscal '25, is it fair to expect more balanced growth between active customers and NSPAC then?

[Sumit Singh, executive]

So on the first one, household formation trends, at large, we're seeing similar trends this quarter as we did in Q1, albeit with some seasonality impact as Q2 is typically a peak period for pet relinquishments, primarily due to seasonal travel during the spring and the summer months, and January, February are typically peak adoption months in the U.S. and the Middle East. As we've talked about previously, there's no one source of truth for pet household formation growth data.

However, big picture, we believe that in options in the quarter remain up. From our data, we suggest kind of low teens on a year-over-year basis and relinquishments remain down low to mid-single digits on a year-over-year basis, supporting our continued kind of theory on the green shoots. The absolute number still needs to recover. So when you look at overall pet household year-over-year, it's relatively flattish, but the trends are certainly improving.

On your second question, I think it's helpful to understand -- so I would start by saying we're obviously not guiding, but yes, we would certainly hope so, right? As Chewy continues to grow and customers get attracted to the value propositions of various products and services and lines of businesses that we're introducing, NSPAC will continue to remain a prevalent force in our revenue algorithm. And at the same time, we certainly hope and expect to return to active customer growth next year, right?

It's also helpful to understand what it is that drove kind of -- net adds growth this quarter. And we believe it's much more as a result of some of the efforts that we've been driving in the last several quarters rather than the macro turning around. Although there are certainly green shoots and macro, which we're encouraged by, they were -- quarter-over-quarter, that isn't what drove our turnaround. So we're certainly hopeful.

[Operator]

Our next question comes from Mark Mahaney of Evercore ISI.

[Mark Stephen Mahaney, analyst]

Two questions, please. That SG&A being flattish to even slightly down on a year-over-year basis. Just talk about that going forwards. Are you at a basis -- are you at a point in the cost structure where you've -- where it's sustainably -- you can keep it roughly at this level until you get a material reacceleration in revenue growth and decide to reinvest in growth? And then, any quick comments on international markets and particularly in Canada and what you're seeing up in the -- I think, especially in the Toronto area?

[David Reeder, executive]

Mark, this is Dave Reeder. I'll take the first part of that question and then Sumit maybe will just talk a little bit about the Canadian question. With respect to SG&A, look, you're exactly right. We're an at-scale revenue business, roughly 78%, slightly north of that of our revenue flowing through Autoship, so highly predictable. And with that type of revenue profile, we are able to get quite a bit of leverage out of really the 3 parts of that scale portions of our business, the fixed fulfillment centers, the at-scale software and then, of course, our at-scale human capital. And so we did have SG&A, excluding stock-based comp, come down on a year-over-year basis in a relatively meaningful way. Our employees remain incredibly productive, and that is a trend that we expect on a go-forward basis to be relatively flat, albeit we are continuing to make investments.

Sumit, do you want to talk a little bit about Canada?

[Sumit Singh, executive]

Mark, Canada is going as expected in some areas, exceeding our expectations, particularly in the way that customers are transacting through our app business in the way that they're building their baskets in Canada. Assortment continues to grow in Canada. Our service receives very high NPS, and customers are continually asking us when we are expanding mid- to high single -- mid- to high teens traffic is already coming out of Ontario as we build out our awareness in the Canadian marketplace and also that will help us drive efficiencies from a marketing investment point of view because the quicker you can gain kind of the base from an awareness point of view up top, the more it subsidizes direct acquisition cost for us.

So that's been a little bit of our focus in the last few kind of months. We've only been in the market 3 quarters. And overall, results are as planned. We're not planning any incremental or materially incremental investment in Canada as we move through the back half of the year. So all of this is incorporated in the profit guidance.

[Operator]

Our next question comes from Michael Morton.

[Michael Morton, analyst]

I was wondering, as the industry starts to improve from the COVID pull forward and it's getting healthier with net adoption, could you maybe talk through over the last several years, how you've seen the consumer journey change on top of the funnel, maybe to bottom? And then as a result, as pet households start to improve in the last 3 to 6 months, what is the reaction you're seeing in the competitive environment, like specifically in the auctions from your competitors?

[Sumit Singh, executive]

I'm trying to understand the first question a little bit more, how have you seen customer journey change from the upper funnel to the lower funnel? So traffic trends continue -- yes, go ahead.

[Michael Morton, analyst]

Yes. If you just think about a more digitally inclined consumer, right? Like there was the world pre-COVID and then post-COVID, and it's different from walking into like a brick-and-mortar store, but how that's evolved and then how the compensation is evolving.

[Sumit Singh, executive]

Yes, yes, yes, sure. So overall -- look, clearly, if there was any question about the secular growth towards e-com, right, that question is off the table at this point given how rapidly the market shifted to e-commerce. Coming into the pandemic, we were kind of low 20s penetrated for e-com. Coming out of the pandemic, we were almost low 30s penetrated. Now some of that growth has gone back into retail as customers have sort of settled out. But the secular trend towards e-com has very much continued. This quarter, we saw our traffic pick up low to mid-single digit on a year-over-year basis, which we haven't seen for the last couple of quarters.

And like I said, this is, in our opinion, more driven by the efforts that we've made in the last couple of quarters, and I'm happy to talk about that in greater detail. But overall, we are seeing efficiency in the channels particularly on the lower funnel. And at the same time, we continue to invest reasonably appropriately on building awareness because upper funnel awareness is an important trend to us. So overall, I would say the secular trend continues, and we're best positioned to kind of capture a meaningful portion of the share that's moving online as we always have.

And your second question on what are we seeing from a competitive environment? So overall, I mean, innovation, there is not a great degree of kind of product innovation coming to the market at this particular point. Most of the landscape is just trying to understand consumer, predict consumer behavior. The innovations that we brought to market are resonating well, whether it's programs that we've launched around kind of improvement in Autoship or improvement in our segmentation and targeting or the app business or the Chewy Plus paid membership programs, et cetera, et cetera. And so we are -- these are not really things that are effectively competed against because they built sort of a moat around you and the ecosystem. So we're competing very effectively there.

In terms of sort of promo promotionality, the markets overall are relatively stable. And as we expected and as you would expect, moving towards the back half of the year, there was slightly higher promotionality coming into Q2 and exiting Q2, primarily in nondiscretionary categories. So I believe everybody at this point is playing to their strengths. Competitors that are stronger in hard goods, they're really trying to drive elasticity there. Our revenue mix of 85% coming from consumables and health really provides us a solid insurance kind of coverage around volatility in demand. And then, as you heard, 78% of the volume is going through Autoship. So overall, we're playing through the playbook.

[Operator]

Our next question comes from Eric Sheridan of Goldman Sachs.

[Eric Sheridan, analyst]

Following up on your comments in prepared remarks on mobile, maybe a 2-parter. Sumit, I wanted to know if maybe first, you could take a step back and talk a little bit about the journey you've been on and improving the mobile experience for consumers and how that's [ product ] up to this point? And then in terms of what you're seeing from the consumer on mobile, anything you want to call out in terms of how that might be a tailwind for the business beyond just 2024? Any key investments you really need to make in mobile?

[Sumit Singh, executive]

Sure. So I'll start with the second one. If you look at -- we started investing in the mobile ecosystem in the last few years more seriously. We've had an app for several years, but the traffic going through the app, the orders transacting through the app, the conversion, the experience, our focus on retaining customers in the app and closed loop ecosystem hasn't really elevated more than the last several quarters. And so the tailwinds that I -- or some of the early results that I talked about in the script are reflective of the efforts that we've put in that direction. We see the opportunity as large. Less than 20% of our orders currently transact through our app.

And if you look at like-sized businesses, we should be north of 60% of owners going through our app. Now that's a healthy aspiration, but it's something that we believe should be achievable over time. We see higher AOV. We see greater Autoship penetration. We see our ability to keep the customer in a closed loop ecosystem. So you're not spending on external marketing to be able to maintain these healthy relationships and drive conversion. You're -- they're one step away from letting you discover -- letting them discover your best features that are launched. It delivers the personalization journey much more effectively. So broadly speaking, I think the effort makes a lot of sense to us, and we're early, at the same time, rapidly innovating in the area.

[Operator]

Our next question comes from Rupesh Parikh of Oppenheimer.

[Rupesh Parikh, analyst]

So my first question is just on monthly trends. Just want to get a sense of the cadence of trends during the quarter, and then maybe what you're seeing quarter-to-date? And then my second question is, hard goods growth actually outpaced consumables. So just curious more color on what you saw in hard goods and just confident in being able to sustain that positive momentum.

[David Reeder, executive]

Rupesh, with respect to monthly trends, look, I would say very much as we expected, when you have such a large percentage of your business flow through consumables and even perhaps more importantly, the highest loyalty program that Chewy has Autoship. And you have a pretty regular cadence from a monthly perspective. And so I would say both the months through second quarter as well as kind of what we've seen entering third quarter, I would say, very much as we've expected and very much in line with our guidance.

With respect to hard goods, from a hard goods perspective, we would characterize hard goods as having kind of stabilized and be broadly flat on a quarter-to-quarter basis. I think the positive signals that we're seeing from hard goods is that we've reached a level of stability, which, to us, indicates with active customers growth sequentially Q1 to Q2 for the first time since Q1 of '23. With some of the pet household formation that Sumit highlighted earlier, we feel like hard goods broadly flat, stabilized at this stage and very much in line and consistent with what we see as a normalizing market in 2024, with perhaps a full return to industry normality in '25.

Sumit, anything you'd add to the hard good side?

[Sumit Singh, executive]

No. That's good.

[Operator]

Our next question comes from Trevor Young of Barclays.

[Trevor Young, analyst]

Two questions here. First, on the improvement in net adds for sequential growth in more than a year, how much of the contribution there was from Canada and where net adds in the U.S. may be flat or even up at this point? And then second one, back to the mobile app discussion, what portion of orders are from mobile web at present? And are you able to funnel those users towards the app install more quickly at this point? Or do we still have more work to do on the app before you'd be willing to really push that app install?

[Sumit Singh, executive]

So let me add some additional color on how active customers are trending at Chewy, looking at your question here, improving the how -- Canada was -- Canada is -- was and is and remains kind of relatively immaterial to the scale of the customer base, given that the business is only 3 quarters in. And it's meeting our expectations, but the curves are reasonably balanced there, so overall immaterial. So let me add some additional color into how active customers are trending. So new to customer -- new to Chewy customers exceeded our internal expectations and remain a larger proportion of the overall gross adds. That indicates to us that there remains a large pool of prospective customers we have yet to introduce to our ecosystem.

Additionally, we're reactivating customers at an accelerated pace and are seeing improvements. I've talked about CRM improvements in the past around personalization and customer segmentation bear fruit. Specifically, we're taking advantage of our ability to segment and target customers, who visit our website and drive purchase conversion. This isn't ability that we did not have last year, hence, kind of my comment to tying back to the recent trending is more us than kind of the change or the rate of change in the macro.

Third, we've also materially stepped up our efforts on retention with a greater focus on areas such as onboarding and settling customers post their first order purchase as well as an enhanced focus on post-purchase experience, whether it is through direct communication with customers or continued improvement in delivery experience or keeping them in the locked app ecosystem, et cetera, et cetera. What this does is, it helps reduce churn and improve second order purchase rates for these customers. So we're seeing an improvement in each of these 3 areas, which is sort of the internal trending at Chewy.

Your last question is around -- or your other question is around mobile web. So I'll disappoint you by not sharing the specific details. But yes, I mean, as you would expect from the sources of traffic, mobile app is a healthy proportion. And yes, we have the ability now to be able to funnel these into the app. We're not predicting or providing guidance on the rate of this migration. Customer behavior needs to be understood. And there's a certain kind of organic trend that customers take regardless of your efforts. So it's a focus area for us, and we'll continue to shine some light here as we move forward.

[Operator]

Our next question comes from Dylan Carden of William Blair.

[Dylan Carden, analyst]

I'm curious if there's any nuance to margin as active customer growth returns to the model? And particularly, Autoship now 78 plus percent, presumably, that's in large part because you have more mature customers making up the balance of the business. Should that come in as active customer growth accelerates? And will you spend on marketing and how much into sort of a better demand environment would be the 2 ones that I'm most focused on, but anything you can add there would be helpful.

[Sumit Singh, executive]

I can start quickly and Dave can add as he sees fit. The customers that we're acquiring are, in our opinion, higher-quality customers than what have -- what we've picked up in the last couple of years. We've stopped and are not keen on picking up customers just for velocity. So the quality of customers as we interpret them, particularly through metrics like repeatable category penetration, Autoship subscription rates and three, their second order purchase or their overall kind of third order purchase settlement rates. These are sort of indicative metrics on customer quality.

Secondly, we're -- the NSPAC curves in these customers has remained healthy. And given the efficacy of the operation at this point, helps us sort of achieve a higher flow-through even if we have to attract or bid competitively up in the funnel when acquiring them. Third, as you sort of just heard me share, there is a healthy level of traffic that visits our website given our high brand awareness, right, that we didn't have the ability to convert. If we have the ability to pick up appropriate signals from this customer, then we should also have the ability to convert them effectively at a much lower CAC than going out and fishing for these customers out in the marketplace. So I feel like we're appropriately focused here, appropriately disciplined and appropriately bullish.

Dave, anything to add?

[David Reeder, executive]

Yes. If I could just build on some of what Sumit said here. When you think about nuance -- Chewy's nuance to margin, if you extract out, you start with that scale revenue, you start with the amount of recurring revenue that we have driven through Autoship. That then flows down into product categories and the expanding product portfolio that Chewy is now offering everything from kind of core e-commerce ecosystem all the way flowing through health care now flowing through services as well as additional improvements like sponsored ads.

And so not only do you have the ability to retain existing customers in the Chewy ecosystem, providing better service, better products, more capability in terms of care for their pet within Chewy, but your value proposition then to new customers also continues to expand. And so when you look at our increasing flow-through for the second quarter, something like $56 million on $77 million of revenue, those are year-over-year numbers. And what you're really seeing is you're seeing more existing Chewy customers spend more in the Chewy Active Ecosystem. And then you're also seeing new customers that are coming to Chewy, you're seeing them exposed to more categories and spending more time as a new customer also in the ecosystem.

So we're very pleased with the value proposition that we're providing to our customers. We continue to have a very, very high brand score with very satisfied customers. And the trajectory to us in the backdrop of a normalizing pet industry is quite pleasing right now.

[Operator]

Our next question comes from Anna Andreeva of Piper Sandler.

[Anna Andreeva, analyst]

Great. And we have 2. First off, just a follow-up on the positive net adds, and congrats on that. So it sounds like the segmentation and the targeting initiatives that you guys have been working on are still early on and continuing, and Sumit, I think you said 2Q tends to be the peak for relinquishments. So are you expecting net adds to be positive again for the third quarter? I know you've reaffirmed flattish for the year?

And then secondly to Dave. Really strong gross margins, can you rank the biggest drivers within that, just again, looking at sponsored ads, the mix and promotionality? And how do you feel about sustainability of those?

[David Reeder, executive]

Sure, let me actually start on both of those with net adds first. When we started and guided for this year, what we spoke about was that we expected net adds to be flat to slightly down in the first half of this year, and that we expected net adds to be flat to slightly up in the second half of this year, largely kind of becoming equal to where we finished fourth quarter of 2023. We haven't really changed that guidance. We do believe that we performed better in the first half than what we initially expected. And we do believe that we're seeing some signals of a normalizing pet industry. We believe that the actions that we are driving specifically at Chewy are resulting in better than at least internally expected expectations or forecasts at the beginning first half of this year.

But at this point in time, we're not really changing our guidance on net adds for the year. So we feel like it's a little early to be doing that. Pleased -- I would characterize it as pleased with the first half, pleased with our efforts. We believe we're going to take share irrespective of what's happening in macro, but we'll continue to enter the second half of the year with kind of the guidance that we gave at the beginning.

With respect to gross margins, we've been very pleased with our gross margins, as you would probably expect. We guided full year gross margin now at about 29% for the year. Obviously, we posted higher than that in the first quarter as well as the second quarter. The biggest drivers on a year-over-year basis with respect to increasing gross margin, one would be the increase in sponsored ads. We've spoken about sponsored ads having the capability to reach kind of 1% to 3% of net sales at a quite high margin. And we're at the low end of that range, I'd say towards the low end of that range, and we think that by the end of this year, we'll be at the low end of that range in 2024.

So continuing to make good progress on sponsored ads. We characterize that as kind of growth quarter to quarter to quarter to quarter throughout 2024, and that is what we're seeing. We're seeing that value prop resonate with our vendors as well as with our customers.

Secondarily, in terms of the gross margin, we're continuing to mix up the business. We're continuing to expose more customers at Chewy to our full product portfolio. That includes health care. And so as we continue to do that, we continue to mix up that business. So sponsored ads, health care and then, of course, all the scale that we're getting out of our fixed fulfillment centers.

[Operator]

Our final question comes from Curtis Nagle of Bank of America Merrill Lynch.

[Curtis Nagle, analyst]

Two for me. Just, one, I wonder if you could talk a little bit more in terms of competitive trends, particularly from the larger online platforms. I think you mentioned this is consistent with other calls that maybe you were seeing, I don't know if it's pressure or just some ramping up on hard goods. But just generally speaking, from the larger platforms, what are you seeing there?

[Sumit Singh, executive]

Competitive trends quarter-over-quarter haven't really changed. We see secular trending towards e-com continue. We see us picking up a healthy portion of that growth that is moving online. On hard goods, we've stabilized coming into the year. I mentioned hardgoods is an opportunity for Chewy and our teams have rallied behind that. We've added assortment. We've sharpened conversion without really incrementally driving up discounting too much. So it's not like we've actually overspent on our promotion side to drive the elasticity. So the results are more kind of organic inputs of conversion. So hard goods, we consider as not declining more towards kind of stabilizing at this point.

On consumables and health, we are competing very effectively, outcompeting in several areas across those type of lines of businesses. Chewy Plus paid membership has been trending as per expectation. Our rate of customer acquisition is exceeding internal forecasts. Our rate of conversion from free to paid is exceeding our internal forecast. Engagement remains high. So broadly speaking, I would characterize competitive trends as fairly stable on a quarter-over-quarter basis.

[David Reeder, executive]

Do you have a follow-up, Curt?

[Curtis Nagle, analyst]

Understood. Yes. And then just a quick one on clinics. Just it sounds like in terms of, I guess, acquiring vets, things are going well. Maybe dive into a little bit more in terms of what's resonating? Is it compensation, it strengthen the brand? Where are you recruiting that's primarily from?

[Sumit Singh, executive]

Yes. So I would characterize the effort as broad-based. So it's 2 things. It's, a, the halo of the Chewy brand that has always been known, and we wanted to be known for customers-first mentality that carries over to our partners. So it's not just a customer-first mentality, it's a partner-first mentality as well. Number 2, we've really tried to understand the inputs of what drives vet satisfaction and vet retention. Some of these are as simple as picking up vets from the right stages of their career stage: vets that are looking for growth opportunities, vets that are looking to spend more of their hours treating patients versus their hours solving back-office challenges or entering data.

So we've taken these type of dissatisfaction drivers or satisfaction drivers, dissat drivers and turn them into satisfaction drivers, right? So we've our tech allows us to reduce the amount of work that a vet spends in back office by over 50%, making them more efficient and also more available to spend time in the front office or treating their patients, which is what they like to do. We are spending time and building relationships with kind of sources of recruitment going all the way back to universities, associations, showcasing them the power of technology, the power of experience combined together.

So I think it's early days, but our approach to the market has been one that kind of works backwards from the veterinarians and tries to solve an experiential gap via kind of mentality and technology both and that's resonating. So happy to take a follow-up.

[David Reeder, executive]

And Curt, if I could just build on Sumit's comment with respect to the brands. About half of the customers that have visited our clinics have subsequently placed orders at Chewy on our e-commerce site. And so not only are we resonating with our vet community as well as our technician and kind of nurse community on the veterinarian side, but that service offering that has historically been very good at Chewy is flowing through, not only on the vet care side, but then also it's synergistically flowing back to the e-commerce side as well.

[Operator]

We currently have no further questions, and this concludes today's call. Thank you to everyone for joining. You may now disconnect your lines.