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, Ana.
Sumit Singh: Thank you.
Operator: Our next question comes from Steven Zaccone with Citigroup. Your line is open. Please go ahead.
Steven Zaccone: 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. 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 a little bit more competitive as we get into the back half? Thanks.
Sumit Singh: Yes. There’s a lot in that question, hey, Steve, let me kind of unpack it. So, let’s start with promotional environment. So, Q4 promotional 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 Q1 and Q2 hadn’t picked up and Q4, we did see kind of the 30 basis points 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 silver lining here is that 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 float as a result of kind of either supply pullbacks or just general normal demand generation.
So, all of that is 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 with. 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 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 environment getting into ‘24 and there’s no premiumization trends.
That sort of continues, it’s more of a mainstream kind of focus as we move towards the ‘24 year. And then meanwhile, when you take the $20 billion remaining pet health merchandising category, right, we continue to remain kind of clear winners there and continue to expect to grow kind of both volume and translating into NSPAC expansion coupled with kind of the Autoship trends that we’ve talked about. So, that’s general industry. When you look at, when you kind of further pair 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 here 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 health care and reasonably so in consumables 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.
Steven Zaccone: Okay. Thank you very much.
Operator: We now turn to Nathan Feather with Morgan Stanley. Your line is open. Please go ahead.
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 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 final piece that we’ve spoken about a little bit here and that’s sponsored ads. We really kind of 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 kind of 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.
