Q4 2023 Chewy Inc Earnings Call
Participants
Jennifer Hsu; VP, Head of Corporate Development (M&A) and Investor Relations; Chewy Inc
Sumit Singh; Chief Executive Officer, Director; Chewy Inc
David Reeder; Chief Financial Officer; Chewy Inc
Doug Anmuth; Analyst; JPMorgan
Mark Mahaney; Analyst; Evercore ISI
Dylan Carden; Analyst; William Blair & Co
Anna Andreeva; Analyst; Needham & Co Inc
Steven Zaccone; Analyst; Citigroup
Nathan Feather; Analyst; Morgan Stanley
Alexandra Steiger; Analyst; Goldman Sachs
Rupesh Parikh; Analyst; Oppenheimer
Presentation
Operator
Hello, and welcome to the Chewy fourth-quarter FY23 earnings call. My name is Elliot, and I'll be coordinating your call today. (Operator Instructions)
Now, I'd like to hand over to Jen Hsu, Vice President and Head of Investor Relations. The floor is yours. Please go ahead.
Jennifer Hsu
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's CEO, Sumit Singh, and CFO, David Reeder. Our earnings release and letter to shareholders, which were filed with the SEC earlier today, has 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
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. David is a key addition to our leadership team, and I look forward to having many of whom engage with him in his new role. I would also like to direct 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 non-discretionary 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 continued 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 level those 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 quarter and 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 US pet market, comprised of pet food and supplies sized at 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. A 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 strength.
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 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 industry 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 clinic, which allows us to expand our TAM by another approximately $25 billion to address the entirety of the $47 billion US 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 died 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 them informed on our progress around this initiative as we progress through the year.
Elsewhere, Canada continues to ramp per 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 assortments 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 sign-up 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
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'm a passionate pet parent and one or 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 Chevy 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 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 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, or 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 [$415 million] higher than our ending balance in 2022. We continued to remain debt-free and maintain a strong liquidity position of $1.9 billion.
Now that I've 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 roadmap and 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 in 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 billion 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.
Question and Answer Session
Operator
Thank you. (Operator Instructions) Doug Anmuth, JPMorgan.
Doug Anmuth
Thanks so much for taking the questions. I have two. First, Sumit and David, can you 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, I know you're talking about flat for '24. Can you give us any insights into the dynamics between gross adds and what happened with churn or attrition on existing customers? Thanks.
David Reeder
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, 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 of volume as we progress through 2024. That's certainly the trend that we kind of saw in the 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 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, you would do the math on that and get it about 2% growth for the year from that particular extra week, about $220 million.
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
On customers, the situation is quite similar, actually. So when you look at the discretionary environment, it's essentially holding back on our side. It's impacting roughly 300,000 to 400,000 active ads. I've not sized that for you directly. I figured we'd come out and size that for you, so you get a sense for how much of this being held back.
Our cohorts coming out of the pandemic have fully stabilized. So we're not seeing any kind of further deterioration in cohort behavior. 2022 cohorts continue to settle out. And we're continuing to see low single-digit, higher, churn from them, just like we did from the pandemic cohorts. Our reactivation rate remains impressively high, actually. So we've improved reactivations from a year-ago 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 getting into the year with a little bit of wait-and-watch approach. We are not expecting our 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 the Canadian business to contribute meaningfully in 2024, as the script outlined.
In addition to that, I think two more points I would add is that all of our premium businesses, whether it's premium consumables, premium health, supplements, et cetera, acquisition remains strong and custom participation remains strong as well as participation into Autoship sign-up rates are actually also pretty healthy. So hopefully, that gives you some color on customer cohort analysis.
Doug Anmuth
Good. Thank you, both. Appreciate that.
Sumit Singh
Sure.
Operator
Mark Mahaney, Evercore ISI.
Mark Mahaney
Hey. I just wanted to ask about the advertising revenue opportunities, and I know you talked about what you've seen so far, and outlook seems relatively constructive for the year. Can you peel that back a little bit more? And where do you think you are on ad load versus where you could be? Where do you think you are in terms of endemic and non-endemic advertising in terms of where you could be and any clear lessons that you've drawn so far that make you reasonably confident about the outlook for the year? Thanks a lot.
Sumit Singh
Hey, Mark. This is Sumit. I'll take that one. So overall, coming out of last year, we fully ramped into search product. We have recently launched branded product and we are currently ramping up the on-site portion of the ad revenue. We have the off-site portion of the ad revenue that starts ramping up towards the back half of this year.
And so what you'll see is essentially the ad load is split between 70% on the on-site, 30% on the off-site. And the blended margin flow-through is obviously pretty high. That's particular to the bottom line here, but more so on the on-site and less on the off-site.
And then supply participation rates are pretty healthy. ROS is pretty healthy as well. We're continuing to comp on an LTV basis, not on a per-transaction basis, which is appreciated given power of the Autoship and the business itself or the recurring and 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 careful, making sure that we are completely respecting regulatory constraints there per se. What else can I tell you about the ad business? Overall, we're pleased with the with the progress, response are all good.
Mark Mahaney
Okay. Thank you, Sumit.
Sumit Singh
Sure.
Operator
Dylan Carden, William Blair.
Dylan Carden
Appreciate it. Sumit, 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 said 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
Yeah. So the NSPAC side of the house will be continued to be driven by both the health as well as participation and Autoship. Those were the two primary drivers of NSPAC expansion that we see in '24. And the -- 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, we essentially have 80% of the NSPAC growth that came since the time of the IPO in 2019 on the back of organic work that the team has done like improvement in Autoship, improvement in health, launch of pharmacy, growth in the supplements business, et cetera, et cetera.
And 20% or less has come from inflation. But if you look at last year, 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 is going to grow on the back of pure Autoship and health.
On the health side if you look at cohort analyses, we're likely going to add north of 1 million customers to pharmacy, and that has a direct expansion of NSPAC in addition to the usual subscription rate growth that we will drive towards in the Autoship business. So those two will be a combination. We just don't get any pricing benefit this year.
Dylan Carden
Got it. Thank you.
Operator
Anna Andreeva, Needham and Company.
Anna Andreeva
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 16% incremental margins you guys outlined during the Analyst Day, and you mentioned the guide that implies 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
Sure. Hi, Anna. Let me take that one and let me speak a little bit more broadly, perhaps, and philosophically, about profitability first. 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 a few areas.
Given 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 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 health care, into pharmacy. That also averages up or accretes up our gross margin. And then finally, within the gross margin line, we also have sponsored ads we've already spoken about a little bit. We expect sponsored ads -- we ramp those in the fourth quarter. We expect to continue to grow those quarter to quarter to quarter sequentially throughout 2024. So that's the accretion we expect to occur on the gross margin line.
With respect to OpEx, we are making some investments on the OpEx side. We expect our core OpEx to continue to scale up. And then of course, 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 thoughtfully managed as we proceed throughout the year. But we're expecting to get benefits and profitability from both gross margin as well as OpEx.
On the CapEx side of the house, we've guided long term a 1.5 to 2 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 2% and think about the midpoint of the guidance we've given you on the top line. That will put you on a good spot from a capital expenditures perspective. We do expect to generate meaningful free cash flow as we mentioned in our script.
Anna Andreeva
All right. Thank you so much. Best of luck.
David Reeder
Thank you, Anna.
Sumit Singh
Thank you.
Operator
Steven Zaccone, Citigroup.
Steven Zaccone
Great. Good afternoon and thanks for taking my question. And Dave, congrats on the new role. Sumit, I wanted to ask about the broader pet industry. We've heard about some higher promotional activity and then some trade down activity turns in 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
Yeah. There's a lot of that question. Hey, Steve, let me unpack it. So let's start with promotional environment. The Q4 promo environment was rational and in line with our expectations. It was modestly higher than 2023, but we've been signaling that all the way through 2023. And so, '21 and -- Q1 and Q2 didn't -- hadn't picked up, and Q4, we did see the 30 to 50 basis point incrementality and promotion pickup that we were forecasting throughout the year.
Obviously, we were able to absorb it, given that we were planning for it. So the good part -- the silver lining here is that we've return to normality from a promotion standpoint, in our opinion, from pre-pandemic, post-pandemic world, right. Post-pandemic, we -- through the pandemic, we got this benefit of float as a result of can -- 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 the assumption that we're baking in that.
Generally, when you look at the industry, so let me 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 when you put that in context in today's macro, it helps you understand why the industry is expecting modest unit growth in '24 and limited pricing benefit, given that we're coming out of the inflationary environment getting into '24. And there's no premiumization trends that continuous and more of a mainstream focus as we move towards the '24 year.
And then meanwhile, when you take the $20 billion remaining -- that health merchandising category, right, we will continue to remain clear winners there. And it can continue to expect to grow both volume and translating into netback expansion, coupled with the Autoship trends that we've talked about. So that's general industry.
When you look at -- when you further prepared 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 coming into the year, trends haven't picked up yet. And of course, there's a lot more year to play. We continue to 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, with hard goods as the lagging category. So that's how I would characterize that. Happy to take a follow-up if I left anything out.
Steven Zaccone
Okay. Thank you very much.
Operator
Nathan Feather, Morgan Stanley.
Nathan Feather
Thanks for taking my question, everyone. So thinking about the 50 basis points of EBITDA margin expansion guided to for the year, 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
Sure. Let me start with the EBITDA expansion of 50 bps that we guided. Look, it's really when you think about the growth there, let's talk about 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 investments 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 health care, 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 final piece that we've spoken about a little bit here and that's sponsored ads. We really ramped that up in a bit more meaningful way in the fourth quarter of '23. And as I mentioned, we expect sponsored ads to grow throughout 2024, Q1 to Q2 to Q3 into Q4. So that's an area of growth for us that is accretive as well.
On the OpEx side, I'll just reiterate that, 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 feel like this business plan that we've outlined for you today for the full-year irrespective of the macro environment, 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
Alex Steiger, Goldman Sachs.
Alexandra Steiger
Great. Thank you for taking my question. First one, 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 the Q4 EBITDA outperformance. So can you maybe just help us understand the contribution from the various initiatives you have laid out versus some of the efficiencies you're seeing on automation and/or OpEx discipline? Thank you.
Sumit Singh
Sure. I'll take the first one, this is 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 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 when you look at across the industry, we believe three, there's -- at least from what we can tell, there's three companies that are taking share. Chewy is clearly gaining share in the market. Walmart and Amazon are the next two competitors. From a -- but each of the portfolio has different strengths, in my opinion, with someone like Chewy being able to span the entire gamut here.
So what I mean by that is our performance I mean our performance continues to be supported by non-discretionary categories which make up 85% of our sales. And so we excel in many pockets in that 85%. In the current environment, some of the other companies that I'm mentioning have been likely primarily winners in the discretionary categories where we are not winning.
So that lower mix of hard goods is both a strengthen an opportunity to Chewy given that it shields us from the discretionary impact that you've seen, announced in some other places. And then, Walmart has unsurprisingly shined in the value segment amidst the current macro backdrop, including outside successes that have been seen in areas like private label, where as we were candid in the Investor Day presentation, we do not have 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 summarize it, what is important to I think note is we believe Chewy remains differentiated from both these players or the industry generally through our comprehensive offering that we provide to the pet parent, the type of relationships and the loyalties that we build, the quasi-subscription business and the strength of that ecosystem, the pet health ecosystem which is first-party proprietary that extends both through product and services across 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
Thank you, Sumit. Let me address the EBITDA question that was posed. Let me speak a little bit more broadly about the year first. When you compare 2023 versus 2022, we did expand gross margin by roughly 40 bps on a year-over-year basis. And so, when you look at how that flowed through from an EBITDA perspective, I think what you saw us do, what 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 and the EBITDA margin line. And 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 fourth quarter, we did grow gross margin slightly on a year-over-year basis in fourth quarter 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 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
I would just add that when we started the year, we carved out a bunch of growth initiatives that we were impact, that we'd 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 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 you.
Alexandra Steiger
Very helpful. Thank you.
Sumit Singh
Sure.
Operator
Rupesh Parikh, Oppenheimer.
Rupesh Parikh
Good afternoon. 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
Thanks for the question, Rupesh, and look forward to meeting you all in person. This is my fifth week at Chewy and I think one of the things that I am most pleased to report is that the business performance trajectory, the opportunity set, all of the things that went into my diligence thesis when I was joining Chewy, all of it seems very much in-line with what my expectations were.
And specifically, the consistency, predictability, the repeatability of the revenue stream was high on my list of items to test as build with Autoship and consumables. The infrastructure is world class. The build out 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 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 meaningful. And then finally, when you think a little bit longer term, some of the opportunities that we have to penetrate direct vet care, expand international, add incremental services, I think all those thesis that I had about the business, about Chewy, as well as of course the loved brand all of those things are as built and I'm incredibly excited to be here. Did you have a follow-up, Rupesh?
Rupesh Parikh
Yeah. And I guess just my follow-up question. So it sounds like this year, a 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 pet household formation? Is that the key ingredient at this point?
Sumit Singh
That is definitely one of them, but that's not the only one. I mean, we continue to pick up customers at a pretty healthy clip. All of the other categories that we're performing within continue to resonate loudly.
In pharmacy, I mentioned north of a million customers migrating over, which is obviously not showing up in the active customer file, but you show that in the NSPAC number and the amplifying revenue growth number.
And then, all of the newer innovations that we're looking at, whether it's 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 customer acquisition, bolt acquisition and retention type verticals. So yes, there is the macro, but we're also focused on what is controllable on our side and making sure that no stone goes unturned per se.
Rupesh Parikh
Great. Thank you.
Sumit Singh
Sure. Thank you.
Operator
Ladies and gentlemen, this concludes our Q&A and today's Chewy fourth-quarter and full-year 2023 earnings call. We'd like to thank you for your participation. You may now disconnect your lines.
