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Chewy (CHWY 2.99%)
Q4 2023 Earnings Call
Mar 20, 2024, 5:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Hello and welcome to the Chewy fourth quarter FY '23 earnings call. My name is Elliott and I'll be coordinating your call today. [Operator instructions] And I'd like to hand over to Jen Hsu, vice president and head of investor relations. The floor is yours.
Please go ahead.
Jen Hsu -- Vice President and Head of Investor Relations
Thank you for joining us on the call today to discuss our fourth-quarter and full-year results for fiscal year 2023. Joining me today are Chewy CEO, Sumit Singh; and CFO, David Reeder. Our earnings release and letter to shareholders, which were filed with the SEC earlier today have been posted to the Investor Relations section of our website 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, 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 annual report on Form 10-K and 8-K filed earlier today 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 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 and letter to shareholders, which were filed with the SEC earlier today. These non-GAAP measures are not intended as a substitute for GAAP results. Additionally, unless otherwise stated, all comparisons discussed today will be against the comparable period of fiscal year 2022.
Finally, this call in its entirety is being webcast on our Investor Relations website. A replay of the webcast will also be made available on our Investor Relations website shortly. I'd now like to turn the call over to Sumit.
Sumit Singh -- Chief Executive Officer
Thanks, Jen, and thank you, all, for joining us on the call today. Before we cover our fourth-quarter and full-year 2023 results, I'm thrilled to welcome David Reeder who joined us in February as our Chief Financial Officer. Dave is a key addition to our leadership team and I look forward to having many of you engage with him in his new role. I would also like to thank Stacy Bowman for her support as interim CFO. Now, let's review our results.
The team delivered a strong finish to the year with our fourth-quarter and full-year 2023 performance demonstrating our ability to deliver market share, gaining growth while simultaneously expanding margins and accelerating free cash flow generation. I will provide an overview of our performance, followed by some perspectives on the pet industry and Chewy's strategic priorities as we embark on 2024. Dave will then discuss our financial results in greater detail and share our guidance for the year. Q4 net sales increased by 4% to $2.83 billion, resulting in full-year 2023 net sales of $11.15 billion, representing 10% year-over-year growth. Our favorable mix of nondiscretionary consumables and health categories continues to be a pillar of strength for Chewy, representing approximately 85% of full-year 2023 net sales. Additionally, our autoship subscription program, which delivered $8.5 billion of autoship customer sales in full-year 2023, continues to provide unparalleled convenience for pet parents while enhancing customer stickiness for Chewy.
Growth in autoship customer sales meaningfully outpaced overall top-line growth, increasing by 8% in the quarter and nearly 15% for the full-year 2023. We continue to deepen our engagement with existing customers and delivered compelling wallet share growth. Net sales per active customer, or NSPAC, grew to $555, a year-over-year increase of approximately 12%. We believe there is significant runway for further NSPAC expansion, particularly as we continue to expand our product and services offerings across our pet platform. Progressing through the P&L, we are incredibly proud of our ability to deliver consistent profitability expansion over time.
Our gross margin exceeded 28% for both the fourth-quarter and the full-year 2023, representing an improvement over the prior-year period. Our performance throughout the holiday season was in line with expectations, including as it relates to promotional activity. As planned, our sponsored ads program also continued to ramp throughout the latter half of the year and increasingly supported our gross margin performance. We achieved an adjusted EBITDA margin of 3.1% for the quarter and 3.3% for the full year, a continued improvement relative to full-year 2022. Our results reflect our ability to deliver improved profitability on a steady and consistent basis even while concurrently investing in planned growth initiatives that we expect will deliver long-term value to shareholders. Finally, expanding margins coupled with disciplined capital spending has allowed us to generate meaningful levels of free cash flow.
We exceeded our 2023 free cash flow expectations and generated more than $340 million of free cash flow, nearly three times our 2022 free cash flow. We have reached an exciting inflection point in this area and expect to generate substantial free cash flow on a go-forward basis. As we close the curtain on 2023, let me now spend a few moments framing our view on the pet industry and Chewy's outlook. We operate in the approximately $144 billion U.S. pet market comprised of pet food and supplies sized roughly $87 billion, pet health contributing roughly 47 billion, and pet services representing roughly $10 billion. On top of that, following our expansion into Canada in Q3 of 2023, we now also participate in the roughly $10 billion Canadian pet market.
The pet category is a recession-resilient, above-GDP-growth industry that is increasingly moving online. Chewy has been and remains a key driver and beneficiary of this trend. As we enter the new fiscal year, it is helpful to characterize 2024 industry expectations in the context of historical performance. Over a multi-decade period, the overall pet industry grew at an annual rate in the mid-single digits. This growth was predicated on low single-digit unit growth in addition to low single-digit pricing growth with further growth supported by a secular premiumization trend. Looking ahead, the pet category is projected to grow at a similar rate over a multi-year forward period.
However, in 2024, year-over-year growth for the industry is expected to be lower than historical average. Unit growth is expected to be muted due to pet household formation trends that remain below historical levels. As it relates to pricing, while we are not anticipating a deflationary environment, we expect no material pricing benefit on industry growth in 2024. These inputs will most likely result in a year of modest growth for the industry, setting up the industry for a return to normality in 2025.
Irrespective of the industry environment, we expect to continue to gain market share in 2024. Speaking to our profitability expectations, we expect to deliver continued adjusted EBITDA margin expansion this year irrespective of the macro and industrial growth backdrop. As a foundation, our well-established Chewy retail business is benefiting from economies of scale. On top of this, our fast-growing Chewy health business and important Chewy retail initiatives, such as sponsored ads, are expected to continue to drive gross margin expansion. Additionally, this year, we expect our ongoing automation efforts and opex discipline to positively offset our investments, delivering SG&A leverage in full-year 2024 relative to full-year 2023.
These collective efforts are expected to drive increasing adjusted EBITDA flow-through in 2024. When coupled with our high levels of capital efficiency enabled by the critical mass we have reached with respect to our distribution infrastructure, we expect to generate meaningful and increasing levels of free cash flow in 2024 and the years ahead. Now, let me provide commentary on some of our newer strategic initiatives that we believe will drive sustainable growth and profit in the future years. We are excited about strategic priorities, such as our recently announced Chewy Vet Care clinics, which allows us to expand our TAM by another approximately $25 billion to address the entirety of the $47 billion U.S. pet health market. Chewy Vet Care has the potential to drive both NSPAC and active customer growth over time while also offering a steady-state margin profile materially above our current businesses.
We believe Chewy Vet Care is a natural extension of our ecosystem and that our thoughtfully designed clinics will be unlike anything in the market, thanks to our proprietary first-party health tech platform and the seamless vertically integrated connectivity to all aspects of the Chewy ecosystem. This includes our B2C e-commerce platform for products such as core and veterinary diet, food, pharmacy and supplements; our emerging B2C services such as telehealth and insurance; as well as our B2B solutions for veterinary practitioners to streamline their operations. We anticipate opening four to eight clinics this fiscal year with our first location slated to launch in Florida, close to our company headquarters, and several additional locations scheduled to open in the first half of 2024. We are very excited to share that our first clinic is already accepting appointments from family and friends, and we expect it to be open to the public imminently. Two key leading indicators of success that we plan to track closely include vet hiring and customer demand generation. As it relates to vet hiring, we are encouraged by the early signals around our vet recruitment processes and already have our first sites fully staffed.
We look forward to keeping you informed on our progress around this initiative as we progress through the year. Elsewhere, Canada continues to ramp for our expectations and, overall, will remain immaterial to 2024 financials given that new markets take some time to achieve scale. We are encouraged by the initial customer and supplier response that we have received. We continue to expand our offerings for customers with assortment significantly increasing since our launch only a few months ago. We are further excited by the launch of many customer-facing shopping features such as our mobile app and additional customer-friendly payment and basket-building mechanisms which are forthcoming in the first quarter of 2024. Success metrics that we are tracking closely such, as basket sizes and autoship signup rates, as well as other customer experience metrics such as delivery speed and reliability remain healthy, providing positive indications for the business we are building in Canada. In summary, we remain highly focused on advancing our enduring mission of being the most trusted and convenient destination for pet parents and partners everywhere, and we are incredibly excited about the opportunities ahead for our business.
We believe we are well positioned to continue driving innovation across the pet category while simultaneously creating significant value for our shareholders. With that, I will turn it over to Dave.
David Reeder -- Chief Financial Officer
Thank you, Sumit. Before covering our quarterly and annual results, I'd like to take a moment to explain why I'm so excited to be part of Chewy. First, I am a passionate pet parent and one of Chewy's 20 million loyal customers. We believe that the level of service that Chewy provides to customers is unmatched in the industry, and I wanted to be a part of the company that is the most trusted and convenient destination for pet parents and partners everywhere. But besides being passionate about the Chewy brand, I'm incredibly excited about the company's opportunities.
We have a highly predictable, attractive business model where more than 75% of our approximately 11 billion 2023 sales was driven by autoship customer sales, resulting in a subscription-like revenue stream. With our world-class infrastructure now having reached critical mass, we expect to deliver increasingly higher adjusted EBITDA margins and free cash flow. In summary, Chewy appealed to both my heart and my head. I couldn't be more excited about the road ahead, and I look forward to getting to know many of you over the many quarters to come. Now, let's review our financial results. Fourth-quarter net sales grew 4.2% to 2.83 billion, bringing our full-year 2023 net sales to 11.15 billion, representing 10.2% growth year over year and exceeding the high end of the guidance ranges that we provided last quarter.
Autoship customer sales came in at 2.16 billion in Q4 and 8.49 billion for the year. Growth in autoship customer sales outpaced overall top-line growth by 390 basis points in Q4 and by 450 basis points in full-year 2023. Autoship customer sales represented 76.4% and 76.2% of our total net sales in Q4 and full-year 2023, respectively. Chewy continued to consolidate share of wallet with NSPAC reaching a new record of $555, representing a $59 increase and 11.9% year-over-year growth rate. Active customers declined slightly on a sequential basis in Q4, in line with expectations, ending the year at 20.1 million. Moving down the P&L, we've reported Q4 gross margins of 28.2% and full-year 2023 gross margin of 28.4%.
On a sequential basis, Q4 gross margin decreased by 30 basis points, reflecting of the promotional calendar and peak surcharges typical for the holiday period. Gross margin for the year expanded by 40 basis points aided by our newly launched sponsored ads initiative which had its strongest contribution in the fourth quarter of 2023. We expect continued growth from sponsored ads throughout 2024. Moving to opex, please note that my discussion of SG&A excludes share-based compensation expense and related taxes. SG&A totaled 565.4 million, or 20.2% of net sales in the fourth quarter.
SG&A in the quarter included approximately 14 million of severance-related expenses associated with the corporate restructuring actions taken in the fourth quarter. For the full-year 2023, SG&A represented 19.7% of net sales. Fourth-quarter advertising and marketing expense was 194 million, or 6.9% of net sales. For fiscal year 2023, advertising and marketing expense was 742.5 million and represented 6.7% of net sales. Fourth-quarter adjusted net income was 80.3 million, and full-year 2023 adjusted net income came in at 296.2 million. We reported an adjusted EBITDA margin of 3.1% for the quarter and 3.3% for the full year with 30 basis points of margin expansion relative to fiscal 2022.
We continue to be proud of our ability to invest in strategic growth initiatives while concurrently delivering higher adjusted EBITDA margins. As Sumit noted earlier, Chewy has reached an exciting inflection point as it relates to free cash flow generation. In the fourth quarter, we reported free cash flow of 67.2 million, and in fiscal year 2023, we exceeded our free cash flow expectations and generated 342.9 million of free cash flow, representing nearly three times our free cash flow generation in 2022. Our full-year 2023 free cash flow reflects $486.2 million of net cash provided by operating activities and 143 million of capital expenditures. Capital expenditures for the year were primarily driven by automation-related investments made across our fulfillment center network and ongoing technology projects. We remain highly disciplined with respect to our capital spending and with 2023 capex representing approximately 1.3% of net sales, slightly below our target range of 1.5 to 2% of net sales. We ended the year with 1.1 billion in cash and cash equivalents and marketable securities, over 450 million higher than our ending balance in 2022.
We continue to remain debt free and maintain a strong liquidity position of 1.9 billion. Now that I have concluded our fourth-quarter and full-year 2023 recap, I'd like to discuss our first-quarter and full-year 2024 outlook. Let me start by saying that we have a high degree of confidence in our ability to deliver on the strategic road map and the long-term financial model that the team outlined at Chewy's Investor Day in December. We continue to manage Chewy for the long term and are focused on executing through the near-term macroeconomic environment. In December, we detailed our pathway to continue delivering market share gain and growth, margin expansion, and meaningful free cash flow generation. We expect to make progress across all three of these areas in the coming year as we did in 2023.
With that, we anticipate first-quarter net sales of between 2.84 billio#n and 2.86 billion, or approximately 2% year-over-year growth; and full-year 2024 net sales 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. As it relates to the components of our net sales growth, we believe our 2024 growth will be primarily driven by NSPAC expansion. In light of the continued macro headwinds and subdued pet household formation trends, we expect active customers to be approximately flat in 2024. Moving to profitability guidance, we anticipate full-year 2024 adjusted EBITDA margin of approximately 3.8%.
This will be driven by both continued gross margin expansion as well as SG&A leverage. We continue to expect capital expenditures in the range of 1.5% to 2% of net sales. Taken together, with our increasing adjusted EBITDA flow-through, our collective efforts are expected to result in meaningful cash flow generation in 2024 with free cash flow conversion remaining above 80%. As you update your models for 2024, also keep in mind, we expect full-year 2024 share-based compensation expense including related taxes to be approximately 330 million and basic shares outstanding for the full year to be approximately 440 million. Before we open the call to questions, I'd like to conclude by saying that the team continues to execute and innovate across our key strategic vectors, and we remain incredibly optimistic about Chewy's role in shaping the pet industry. Strategic initiatives, such as Chewy Vet Care, are expected to, over time, unlock both top and bottom-line benefits, as well as broader cross-selling opportunities throughout the Chewy ecosystem. Our operating discipline and many efforts across margin-accretive verticals are producing attractive and increasing levels of profit flow-through, expanding margins, free cash flow, and ultimately positioning us to deliver increasingly attractive returns for our shareholders.
With that, I will turn the call over to the operator for questions.
Questions & Answers:
Operator
Thank you. [Operator instructions] Your first question comes from Doug Anmuth with J.P. Morgan. Your line is open. Please go ahead.
Doug Anmuth -- JPMorgan Chase and Company -- Analyst
Thanks so much for taking the questions. I have two. First, Sumit and David, can just talk about the '24 revenue growth, obviously, starting with 2% outlook in 1Q, but perhaps you can talk about what drives the confidence and acceleration as you go through the course of the year? And if there's anything else you can add just around the cadence in terms of the quarters going forward. And then, on active customers, you know, you're talking about flat for '24. Can you give us any insights into dynamics between gross ads and what's happening with churn or attrition on existing customers? Thanks.
David Reeder -- Chief Financial Officer
Yeah. So, hi, Doug. It's a pleasure to meet you virtually. Look forward to meeting you in person as we work through the coming quarters.
With respect to the growth for the year, you know, I think as Sumit outlined in his portion of the script, we're expecting an environment where pricing is relatively flat, and so most of the growth will be off -- of volume as we progress through 2024. And that's certainly the trend that we kind of saw in fourth quarter. And we're extrapolating and extending that trend into 2024 given that we're not expecting a lot of inflation. With respect to first quarter versus the remaining three quarters as we progress throughout the year, first quarter, we've guided to 2% year-over-year growth. And so, we feel pretty good about that number as we -- as we roll into this first quarter.
For the remainder of the year, we've got the benefit in the fourth quarter of the extra week. If you do the math on that, we're given the high percentage of recurring business that we have through autoship, as well as consumables. And you would do the math on that and get about 2% growth for for the year from -- from that particular extra week, about $220 million. So -- so, the second half of the year, we do believe we'll have not only seasonality as we typically do, but also the benefit of the extra week. Sumit, anything that you would add to that?
Sumit Singh -- Chief Executive Officer
On customers, Doug, the situation is quite -- quite similar, actually. So, when you look at kind of the discretionary environment is essentially holding back on our side, it's impacting roughly kind of 300,000 to 400,000 active ads. I've kind of not size that for you directly. I figured we'd come out and kind of size that for you so you get a sort of sense for how much of this is being held back.
Our cohorts coming out of the pandemic have fully stabilized. So, we're not seeing, you know, any kind of further deterioration in -- in cohort behavior. 2022 cohorts continue to settle out and -- and we're continuing to see kind of low single-digit, you know, higher kind of churn from them, just like we did from the pandemic cohorts. Our reactivation rate remains impressively high, actually. So, we've improved reactivations, you know, from a year-over-year point of view, and we will add roughly 15% more reactivated customers this year than we did last year.
So, on the balance, I think we're -- we're -- we're sort of getting into the year with a -- with a little bit of, you know, wait-and-watch approach. We are not expecting hard goods category or the discretionary to improve materially, so we're holding that into our forecast. And then, as of right now, we're not expecting, you know, the Canadian business to contribute meaningfully in 2024 as the script sort of outlined. In addition to that, I think two more points I would add is our -- all of our premium businesses, whether it's premium consumables, premium health, supplements, etc., you know, acquisition remains strong and customer participation remains strong, as well as kind of participation into autoship, you know, signup rates are actually also pretty healthy.
So, hopefully, that gives you some color on -- on -- on customer cohort analysis.
Doug Anmuth -- JPMorgan Chase and Company -- Analyst
OK. Thank you both. I appreciate that.
Sumit Singh -- Chief Executive Officer
Sure.
Operator
We now turn to Mark Mahaney with Evercore ISI. Your line is open. Please go ahead.
Mark Mahaney -- Evercore ISI -- Analyst
Hey, I just wanted to ask about the advertising revenue opportunities. And I know you talked about what you've seen so far in your outlook seems relatively constructive for the year. Can you peel that back a little bit more? And where do you think you are on kind of ad load versus where you could be? Where do you think you are in terms of endemic and maybe non-endemic advertising in terms of where you could be in any, you know, clear lessons that you've drawn so far that, you know, make you reasonably confident about the outlook for the year? Thanks a lot.
Sumit Singh -- Chief Executive Officer
Hey, Mark, this is Sumit. I'll take that one. So, we're all coming out of last year, you know, we fully ramped into search product. We have recently launched branded product, and you know, we are currently, you know, ramping up the on-site portion of the ad revenue.
We have the off-site portion of the ad revenue that starts ramping up toward the back half of this year. And so, what you'll see is, essentially, you know, the ad load is split between kind of 70% on the on-site, 30% on the off-site. And, you know, the blended margin flow-through is obviously pretty high that we're taking to the bottom line here, but more so on the on-site and less on the off-site. And then, you know, supplier participation rates are pretty healthy. Our ROAs are pretty healthy as well. You know, we're continuing to comp on an LTV basis, not on a per transaction basis, which is, you know, appreciated given kind of the power of the autoship and the business itself or the recurring repeat revenue.
So, as you would expect, we're leading with consumables followed by hard goods and health. We have to be a little more -- a little more, you know, careful, making sure that we're -- we're completely respecting regulatory kind of constraints there per se. What else can I tell you about the ad business? Overall, we're -- we're pleased with the -- with the progress and response there.
Mark Mahaney -- Evercore ISI -- Analyst
OK. Thank you, Sumit.
Sumit Singh -- Chief Executive Officer
Sure.
Operator
Our next question comes from Dylan Carden with William Blair. Your line is open. Please go ahead.
Dylan Carden -- William Blair and Company -- Analyst
Appreciate it. Sumit, back to that kind of cohort analysis on the churn side, I wonder if you could kind of speak to it on the NSPAC side. And I guess the broad question would be how relevant some of your historic cohort spending metrics are. And just whether or not there's any impact from higher levels of autoship if those customers kind of set it and forget it and don't yield up in the same fashion because they don't visit the site with the same frequency.
Any detail there would be helpful. Thanks.
Sumit Singh -- Chief Executive Officer
So, you know, the NSPAC side of the house will be continued to be driven by both the health as well as, you know, participation in autoship. Those are the two primary drivers of NSPAC expansion that we see in '24. And the -- you know, so those are the pluses. The minuses are obviously you don't get the pricing benefit in NSPAC that you saw last year. So, if you average out NSPAC benefit over the last four years, you know, we essentially have 80% of the NSPAC growth that came since the time of the IPO in 2019 on the back of organic, you know, work that the team has done like Improvement in autoship, improvement in health, lots of pharmacy, growth in the supplements business, etc.
And, you know, 20% or less has come from inflation. But if you look at last year, right, the weight on inflation was higher as NSPAC kind of grew. So, this year -- we're not expecting -- this year, as in '24, we're not expecting the impact of pricing or inflation in this. And so, NSPAC's going to grow, you know, on the back of pure autoship and health.
On the health side, if you look at cohort analysis, we're likely going to add, you know, north of 1 million customers to pharmacy. And, you know, that is a direct expansion of NSPAC in addition to, you know, the -- the usual subscription rate growth that we will drive toward in the autoship business. So, those two will be a combination. We just don't get any pricing benefit this year.
Dylan Carden -- William Blair and Company -- Analyst
Got it. Thank you.
Operator
Our next question comes from Anna Andreeva with Needham and Company. Your line is open. Please go ahead.
Anna Andreeva -- Needham and Company -- Analyst
Great. Thanks so much for taking our questions. We have two. On the adjusted EBITDA, I think the guide implies a slightly less than the 15% incremental margins you guys outlined during the Analyst Day.
And you mentioned the guide doesn't buy some opex leverage. So, should we expect more muted gross margin gains for the year? Just any color there would be super helpful. And then, secondly, capex, as you mentioned, came in a little lower than the guide for '23. Should we expect it to stay at similar 1.3% of sales or below for '24? Any thoughts on initiating a buyback just given this ramping free cash flow generation? Thanks so much.
David Reeder -- Chief Financial Officer
Sure. Hi, Anna. Let me -- let me -- let me take that one and let me -- let me speak a little bit more broadly perhaps and philosophically about profitability. First, you know, we -- we outlined at Capital Markets Day our philosophy and our path to 10% EBITDA margin and the corresponding free cash flow that would, of course, come from that. And so, when we think about profitability within 2024, we are expecting to get leverage, not only on the gross margin line, but also on the operating expense line as well.
And specifically, within gross margin, let me call out a few areas. You know, given our -- our infrastructure and the fact that it's reached critical mass, we're actually able to flow through incremental volume at a much higher accretive rate for the company. So -- so, as we get more volume, given the infrastructure we've built out, we have moderated capex on a go-forward basis, the fall-through is higher for that incremental volume, fixed cost absorption, if you will. In addition to that, we also have product mix. So, we're mixing up from a product perspective as we continue to grow into healthcare, into pharmacy.
That also averages up or increase up our gross margin. And then, finally, within the gross margin line, we also have sponsored ads that we've already spoken about a little bit. We expect sponsored ads. We ramped those in the fourth quarter. We expect to continue to grow those quarter to quarter to quarters sequentially throughout 2024.
And so, that's the accretion that we expect to occur on the gross margin line. With respect to opex -- and, you know, we are making some investments on the opex side. We expect our core opex to continue to scale, but then of coursem we're thoughtfully entering Canada as we expand into Toronto. And of course, we're also investing in our long-term initiatives around vet care.
And so, the rate and pace of those investments will be, you know, thoughtfully -- thoughtfully managed as we proceed throughout the year, but we're expecting to get benefits in profitability from both gross margin as well as -- as well as opex. On the capex side of the house, we've guided long term a point and a half to two points of net sales. You're correct, last year, in '23, we were slightly below that. I think a good midpoint would be take the midpoint of that guidance between 1.5 and -- and 2%, and think about the midpoint of the guidance we've given you on the top line. That'll put you in a good spot from a -- from a capital expenditures perspective.
We do expect to generate meaningful free cash flow as -- as we mentioned in our script.
Anna Andreeva -- Needham and Company -- Analyst
All right. Thank you so much. Best of luck.
David Reeder -- Chief Financial Officer
Thank you, Anna.
Sumit Singh -- Chief Executive Officer
Thank you.
Operator
Our next question comes from Steve Zaccone with Citigroup. Your line is open. Please go ahead.
Steve Zaccone -- Citi -- Analyst
Great. Good afternoon. Thanks for taking my question. And, Dave, congrats on the new role.
Sumit, I wanted to ask about the broader pet industry. You know, we've heard about some higher promotional activity and then some trade-down activity in terms of the pet food space. What are you seeing in your business? And I guess, as you think through the year, do you think we're in the worst of it now, or could the space get a little bit more competitive as we get into the back half? Thanks.
Sumit Singh -- Chief Executive Officer
Yeah, there's a lot in that question. Hey, Steve, let me kind of unpack it. So, let's start with promotional environment. So, Q4 pro environment was rational and in line with our expectations.
It was modestly higher than 2023, but we'd been signaling that, you know, all the way through 2023. And so, you know, '21 and -- Q1 and Q2 didn't -- hadn't picked up. And Q4, you know, we did see kind of the 30 to 50 basis point incrementality and promotion pickup that we were forecasting throughout the year. You know, obviously, we were able to absorb it given that we were planning for it.
So, the good -- the -- the silver lining here is that, you know, we've sort of returned to normality from a promotional standpoint, in our opinion, from a pre-pandemic, post-pandemic world, right? Post-pandemic, we sort of -- through the pandemic, we got this benefit of sort of, you know, float as a result of kind of either supply pullbacks or just general -- normal demand generation. So, all of that has normalized. We don't expect promotional environment to remain more volatile or to become more volatile as we move through 2024. That's sort of the assumption that we're making in this. Generally, when you look at the industry -- so, let me kind of shift to industry trends.
So, generally, when you look at the industry, if you take the 90 billion pet food and supplies category, over the past decade, unit growth has been driven by mostly supplies and treats. So, that's all discretionary. And pricing growth has been driven by premiumization trends, right? So, you know -- so, when you put that in context in today's macro, it helps you understand why the industry is expecting kind of modest unit growth in '24 and limited pricing benefit given that we're coming out of the inflationary environments getting into '24 and there's no premiumization trends. That sort of continue, it's more of a mainstream kind of focus as we move toward -- toward the '24 year. And then, meanwhile, when you take the $20 billion, you know, remaining pet health merchandising category, right, where we -- we continue to remain kind of clear winners there and continue to expect to grow kind of both volume and translating into NSPAC expansion, you know, coupled with kind of the autoship, you know, trends that we've talked about. So, that's -- that's general industry. When you look at -- when you kind of further pare that down into inputs and you look at adoption data, so pet adoptions were down 30% year over year coming out of Q4.
Search for new pet and new pet interest was down 16% coming out of the year. And that has further degraded by somewhere around 6% to 8% year-over-year rate. So -- so, coming into the year, trends haven't picked up yet, and of course, there's a lot more here to play. We continue to, you know, be a little bit protected or insured, given that 85% of the business is coming from consumables and health, both categories where we continue to gain share, meaningfully so in healthcare and reasonably so in consumables, you know, with hard goods as the lagging category. So, that's how I would characterize it. Happy to take a follow-up if I left anything out.
Steve Zaccone -- Citi -- Analyst
OK. Thank you very much.
Operator
We now turn to Nathan Feather with Morgan Stanley. Your line is open. Please go ahead.
Nathan Feather -- Morgan Stanley -- Analyst
Thanks for taking my question, everyone. So, thinking about the 50 basis points of EBITDA margin expansion guided to for the year, you know, can you help us walk through the key drivers to get there and what could really drive upside for that? And then, anything you can share on how much international expansion is weighing on margins? Thank you.
David Reeder -- Chief Financial Officer
Sure. Let me -- let me start with the EBITDA expansion of 50 bps that we guided. Look, it's really when you think about -- when you think about the growth there, let's -- let's talk about the -- the gross margin line first. It's really the three items that I mentioned before.
We've got the opportunity given our fixed infrastructure to get some fixed cost absorption out of the model. So, if volume grows faster than we expect throughout the course of the year, then that's going to be a benefit to us. It's going to flow through at a higher rate given that we don't have to correspondingly make the same level of investment to ship that incremental volume. And so, we're going to get some nice fixed cost absorption to the extent that volume picks up throughout the year. In addition to that, we have been product mixing up the business as we expand into healthcare, into pharmacy, into services. All of those are accretive to us from a corporate margin perspective.
And so, as those become a larger part of our business over time, which they have, then that margin will fall all the way through the P&L to the bottom line. And then, of course, the -- the final piece -- piece that we've spoken about a little bit here in that sponsored ads, we really kind of ramped that up in a -- in a bit more meaningful way in the fourth quarter of '23. And as I mentioned, we expect sponsored ads to grow throughout 2024, you know, Q1 to Q2 to Q3 into Q4. So, that's an area of growth for us that -- that is accretive as well. On the -- on the opex side, I'll just kind of reiterate that, you know, the rate and pace of those investments will be the rate and pace at which the business needs those investments to be made.
So, we have committed to profitable growth at Capital Markets Day. We do believe that we are going to deliver that profitable growth, but we also want to continue to invest for the future. And so, we -- we feel like this business plan that we've kind of outlined for you today for the full year, irrespective of the macro environment, it is -- it is a plan to continue to take share. And then, of course, it's also a plan to deliver profitable growth and meaningful free cash flow, I would add.
Operator
Our next question comes from Alex Steiger with Goldman Sachs. Your line is open. Please go ahead.
Alexandra Steiger -- Goldman Sachs -- Analyst
Great. Thank you for taking my questions. First one on -- on competition. So, how would you characterize the competitive landscape as we enter 2024? And what gives you the confidence in continuing to gain market share this year? And then, one follow-up on -- on the Q4 EBITDA outperformance.
So, can you maybe just help us understand the contribution from the various initiatives you've laid out versus some of the efficiencies you're seeing on automation and/or opex discipline? Thank you.
Sumit Singh -- Chief Executive Officer
Sure. I'll take the first one. It's Sumit. So, in terms of competitive intensity, it's not elevated from our point of view.
Promotional intensity was obviously higher coming out of Q4. Ad intensity and ad competition remains high. If you look at CPCs, CPCs were up roughly 14 to 16% in Q4, but they were met with demand given that supplies had recovered in Q4 of this year. So, we were anticipating higher CPCs given kind of bidding -- bidding intensity was higher coming into the holiday season. That has pared back some as we've come into Q1.
Some part of that is naturally expecting -- some part of that is, you know -- when you look at across the industry, we believe, you know, three -- there's at least -- from what we can tell, there's kind of three, you know, companies that are taking share. Chewy's clearly gaining share in the market. You know, Walmart and Amazon are the next two competitors. You know, from a -- but each of -- each -- each of the portfolio has kind of different strengths, in my opinion, where, you know, someone like Chewy kind of being able to sort of sustain the entire gamut here. So, what I mean by that is, you know, our performance -- I mean our performance continues to be supported by nondiscretionary categories which make up 85% of our sales. And so, we excel in many pockets in that 85%.
In the current environment, you know, some of these other companies that I'm mentioning have been likely, you know, primarily winners in that -- in -- in the discretionary categories where we are not winning. So, that lower mix of hard goods is both a strength and an opportunity to Chewy given that it shields us from, you know, the discretionary impact that you've seen, you know, announced in some other -- other places. And then, Walmart has unsurprisingly shined in the value segment amid the current macro backdrop, you know, including kind of outside successes that -- that have been seen in areas like private label, where, you know, as we were candid in the Investor Day presentation, we do not have kind of like-for-like assortment. But it's part of our strategic plan to come out and provide strategic like-for-like assortment there. So, if you kind of summarize it, what we -- what is important to, I think, note is we believe Chewy, you know, remains differentiated from both these players or the industry generally through our comprehensive offering that we provide to the pet parents, the type of relationships, and the loyalty that we build. The autoship subscription business and the strength of that -- that -- that ecosystem -- the pet health ecosystem, which is first-party proprietary that extends both through product and services across our -- our -- our retail offerings, all of it positions us well to compete in 2024.
Alongside that, we've made several investments in future categories, which are both top-line growth and margin-expanding categories. So, we feel bullish about our ability to compete through '24, as well as accelerating pace as we come out of '24 into '25 and '26.
David Reeder -- Chief Financial Officer
Thank you, Sumit. Let me -- let me address the -- the EBITDA question that was posed. Let me -- let me speak a little bit more broadly about -- about the year first. When you compare 2023 versus 2022, you know, we did expand gross margin by roughly 40 bps on a year-over-year basis.
And so, when you -- when you look at how that flowed through from an EBITDA perspective, I think what -- what you saw us do where you saw us execute in 2023 was you saw us execute with long-term investments in the business but still return a good portion of the gross margin expansion to the bottom line, in the EBITDA margin line. And so -- so, we were quite pleased by our ability to take gross margin as it expanded and then push it all the way through the P&L to the EBITDA margin line on a year-over-year basis. With respect to -- to fourth quarter, we did grow gross margin slightly on a year-over-year basis in fourth quarter by -- by 10 bps. We did have some timing issues with respect to expenses. And so, on a year-over-year basis, adjusted EBITDA did decrease from 3.4 to 3.1%.
I would characterize again many of those as the investments that we were making throughout the year to be able to support both our international expansion as well as -- as well as Chewy Vet Care as the primary reason for that. But again, for the full year, quite pleased with our ability to deliver profitable growth.
Sumit Singh -- Chief Executive Officer
I would just add that, you know, when we started the year, we sort of carved out, you know, a bunch of growth initiatives that we were impact -- that -- that -- that we had sized for you. And as we move through the year, we increasingly found the ability to self-fund a lot of these initiatives ending the year strong. And as you've seen us kind of provide guidance for 2024, we continue to invest in growth initiatives for the future and are self-funding a bunch of that, alongside the EBITDA expansion that we're providing here.
Alexandra Steiger -- Goldman Sachs -- Analyst
Very helpful. Thank you.
Sumit Singh -- Chief Executive Officer
Sure.
Operator
Our final question today comes from Rupesh Parikh with Oppenheimer. Your line is open. Please go ahead.
Rupesh Parikh -- Oppenheimer and Company -- Analyst
Good afternoon and thanks for taking my question. So, a question for Dave. So, you've obviously been there a few weeks now, so it's still early, but just curious if you see any new opportunities in the business.
David Reeder -- Chief Financial Officer
Thanks for the question, Rupesh, and look forward to meeting you all -- all in person. You know this -- this is my fifth week at Chewy. And I think one of the things that I am -- I am most pleased to report is that the business performance trajectory, the opportunity set, all of the things that kind of went into my my diligence thesis when I was joining Chewy, all of it seems very much in line with what my expectations were. And specifically, you know, the consistency, predictability, the repeatability of the revenue stream was -- was high on my -- my list of of items to kind of test, you know, as build with autoship and -- and consumables.
The infrastructure is -- is world-class, the build-out of our -- of our infrastructure and the critical mass that we have there and our ability to ship some significant incremental volume through the same footprint as that volume becomes available for us to tap in the -- in the industry, I do believe we're going to get, not only moderating capex, but increasing free cash flow. The margin opportunities, as we mix up the business from healthcare, are -- are meaningful. And then, finally, when you think a little bit longer term, you know, some of the opportunities that we have to penetrate, direct vet care, expand international, add incremental incremental services, I think all of those thesis that I had about the business about Chewy, as well as, of course, the -- the Love brand, all of those things are as-built. I'm incredibly excited to be here. Did you have a follow-up, Rupesh?
Rupesh Parikh -- Oppenheimer and Company -- Analyst
Yeah, and I guess this is my follow-up question. So, you know, it sounds like this -- your house -- household formation is likely going to be weak. So, if you guys think about a return to positive net active customer growth, is that essentially you just need a better macro and a return to stronger household formation? Is that the key missing ingredient at this point?
Sumit Singh -- Chief Executive Officer
That is definitely one of them, but that's not the only one. I mean we continue to pick up, you know, customers at a pretty healthy clip. All of the other categories that we're performing within, you know, continue to resonate loudly. You know, in pharmacy, I mentioned, you know, north of a million customers migrating over, which is obviously not showing up in the active customer file, but we showed that -- we showed that in the NSPAC number and the amplifying revenue growth number.
And then, you know, all of the newer innovations that we're looking at, whether it's, you know, introduction of new marketing channels that we might be experimenting with at any given point or launching of new verticals such as services, these are all, you know, customer acquisition -- both acquisition and retention-type verticals. So, yes, there is the macro, you know, but we're also focused on what is controllable on our side and making sure that no -- no stone unturned per se.
Rupesh Parikh -- Oppenheimer and Company -- Analyst
Great. Thank you.
Sumit Singh -- Chief Executive Officer
Sure. Thank you.
Operator
[Operator signoff]
Duration: 0 minutes
Call participants:
Jen Hsu -- Vice President and Head of Investor Relations
Sumit Singh -- Chief Executive Officer
David Reeder -- Chief Financial Officer
Doug Anmuth -- JPMorgan Chase and Company -- Analyst
Mark Mahaney -- Evercore ISI -- Analyst
Dylan Carden -- William Blair and Company -- Analyst
Anna Andreeva -- Needham and Company -- Analyst
Steve Zaccone -- Citi -- Analyst
Nathan Feather -- Morgan Stanley -- Analyst
Alexandra Steiger -- Goldman Sachs -- Analyst
Rupesh Parikh -- Oppenheimer and Company -- Analyst
