Petco's Q2 2025: Contradictions Emerge on Gross Margin Strategy, Phase 3 Timing, and Inventory Management

The above is the analysis of the conflicting points in this earnings call

Date of Call: August 28, 2025

Financials Results

• Revenue: Net sales down 2.3% YOY; comparable sales down 1.4%
• Gross Margin: 39.3%, up more than 120 bps YOY

Guidance:

• FY25 adjusted EBITDA $385–$395M (~+16% YOY at midpoint).
• FY25 net sales down low single digits; tariffs increasingly impactful in H2.
• Q3 adjusted EBITDA $92–$94M (~+15% YOY at midpoint); net sales down low single digits; Q3 EBITDA seasonally below Q2.
• FY25 depreciation ~ $200M; net interest expense ~ $130M.
• FY25 capex $125–$130M; ~25 net store closures; focus on ROIC.
• Selective H2 reinvestment (e.g., Leadership Summit); maintaining dry powder for opportunities.

Business Commentary:

• Profitability Improvements:
• Petco Health and Wellness Company, Inc. improved operating income by over $40 million and generated more than $50 million in free cash flow in Q2 2025.
• The company delivered $114 million in adjusted EBITDA, reflecting meaningful improvements in profitability.

• These improvements were driven by a reduction in unprofitable sales, a disciplined promotional strategy, and enhanced customer experience.

• Gross Margin Expansion:

• Petco expanded its gross margin by over 120 basis points versus last year to 39.3%, with both products and services gross margins expanding.
• This growth was achieved through a more disciplined approach to average unit cost and average unit retail, as well as effective management of pricing strategies.

• The expansion was supported by minimal tariff impact in the second quarter.

• Digital Channel Focus:

• Petco's e-commerce channel became more profitable by intentionally reducing unproductive sales and promotional activities.
• While the online segment showed a decline in sales, the focus was on improving profitability and setting the stage for future growth.

• The company hired a new leader for its e-commerce channel and plans to address barriers and improve the digital experience.

• Store Performance and Marketing:

• Petco's store performance improved, with positive customer sentiment and engagement around in-store events and experiences.
• The company relaunched its "Where the Pets Go" tagline and introduced new marketing strategies aimed at increasing relevance and customer engagement.
• These efforts were supported by a comprehensive North Star project to reimagine key elements of Petco's business and differentiate its positioning in the market.

Sentiment Analysis:

• Raised FY25 adjusted EBITDA outlook to $385–$395M. Q2 adjusted EBITDA $114M with margin up ~220 bps to 7.6%; operating income increased ~$41M to $43M. Gross margin expanded >120 bps to 39.3% on pricing/promo discipline. Inventory down 9.5% with higher in-stocks; free cash flow >$50M. Acknowledged headwinds: net sales down low single digits and tariffs becoming more meaningful in H2, Q3 toughest comp.

Q&A:

• Question from Michael Lasser (UBS): When should investors expect a return to positive comps—Q4 this year or 2026?
  Response: Positive comps are expected in 2026; Q3 is the toughest compare and the company remains in Phase 2 while seeding Phase 3.

• Question from Michael Lasser (UBS): Were gross margin gains mainly from reducing online promos, and would stores have comped positive excluding e-commerce?
  Response: Focus was on stores while cleaning up heavier promo stacking in e-comm; not disclosing store-only comp, but e-comm cleanup prioritized profitability.

• Question from Steven Zaccone (Citi): How did gross margin perform versus expectations, and how should we think about tariffs and back-half margin?
  Response: Gross margin expanded strongly on AUR/AUC and promo/pricing rigor; tariffs were minimal in Q2, meaningful in Q3, and most impactful in Q4.

• Question from Steven Zaccone (Citi): What are tariff mitigation efforts and how is pricing trending into H2?
  Response: Pricing levers have been used all year and will continue with a consumer-first lens; no major change in approach for H2.

• Question from Jacob Nivasch (Guggenheim): Update on planogram resets and store execution impact?
  Response: Dog/cat resets are complete, improving on-shelf availability, labor productivity, and store profitability; benefits reflected in SG&A leverage.

• Question from Jacob Nivasch (Guggenheim): Any details on the North Star initiative?
  Response: Phase 3 will center on four pillars: superior store experience, services at scale, merchandising differentiation/newness, and winning in omnichannel.

• Question from Kaumil Gajrawala (Jefferies): Status of e-commerce pullback/retool and inventory right-sizing?
  Response: E-comm is more profitable with a new leader driving basics (speed, scheduling, repeat delivery, media/personalization); inventory down 9.5% with better in-stocks and tight governance.

• Question from Kaumil Gajrawala (Jefferies): What’s driving NPS improvement at this stage?
  Response: Broad store-execution and people investments, leadership engagement, and focus on in-store experience are lifting customer metrics.

• Question from Kendall Toscano (BofA): How did transactions vs. AUR/UPT trend in the quarter?
  Response: UPT and basket were solid; transactions lagged and are a key focus to improve via events and marketing to drive traffic.

• Question from Kendall Toscano (BofA): Biggest remaining execution gaps before fully shifting to Phase 3?
  Response: Progress enables reinvestment; margin runway remains with opportunities in sourcing, pharmacy, and supplies; focus turning to growth pillars.

• Question from Simeon Gutman (Morgan Stanley): Trends in pet families and customer behavior; any surprises?
  Response: Industry is roughly flat; Petco prioritized profit while holding share; many one-time and services-only customers—plan to improve omni LTV and cross-sell.

• Question from Simeon Gutman (Morgan Stanley): Any markdown risk from inventory changes and newness?
  Response: No significant risk anticipated; tight processes and fast-turn, seasonal buys to control exposure.

• Question from Justin Kleber (Baird): Can you quantify the comp drag from promo cleanup; is underlying business comping positive?
  Response: Not quantifying; cleanup began in Q4’24; stores are improving while e-comm is about six months behind but progressing.

• Question from Justin Kleber (Baird): What drives the implied Q4 adjusted EBITDA softness—tariffs or reinvestment?
  Response: Q4 tariffs are most impactful; maintaining dry powder for selective investments and prudently managing macro volatility within guidance ranges.