Petco's Q2 2025: Contradictions Emerge on Tariff Impact, Inventory Management, E

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%; 2-year comp improved 130 bps from Q1 to Q2
• Gross Margin: 39.3%, up more than 120 bps YOY; minimal tariff impact in Q2; expansion in both products and services

Guidance:

• FY25 adjusted EBITDA raised to $385–$395M (~+16% YOY at midpoint)
• FY25 net sales expected down low single digits YOY, including effects of 2024–2025 store closures
• Tariff headwinds minimal in Q2; meaningful in Q3; most impactful in Q4
• Q3 adjusted EBITDA expected $92–$94M (~+15% YOY), sequentially lower than Q2
• Q3 net sales expected down low single digits YOY; lapping toughest comp of the year
• FY25 depreciation ≈$200M; net interest ≈$130M
• ~25 net store closures in FY25; capex $125–$130M focused on ROIC
• Selective H2 reinvestment (e.g., leadership summit), maintaining flexibility

Business Commentary:

• Financial Performance and Earnings Outlook:
• Petco Health and Wellness Company reported sales in line with their outlook, with an increase in operating income by over $40 million and free cash flow of more than $50 million for Q2.
• Adjusted EBITDA for the quarter was $114 million.

• The improvement in financials was driven by a focus on strengthening operating fundamentals and transforming the business model.

• Gross Margin Expansion:

• Petco expanded its gross margin by more than 120 basis points to 39.3%, with both products and services contributing to this increase.

• This was achieved through a disciplined approach to average unit cost, average unit retail, and pricing strategies, along with minimal tariff impact.

• SG&A Expense Management:

• SG&A expenses decreased by $36 million, leveraging more than 150 basis points.

• The reduction was due to employee benefits optimization and efficient store labor management, despite flat marketing expenses.

• Customer Engagement and Satisfaction:

• Petco observed an increase in Net Promoter Score (NPS) since the end of last year, with customer satisfaction ratings above 90% for partner friendliness and helpfulness.
• The improvement in customer engagement is attributed to new in-store events and experiences, as well as a focus on marketing strategies that emphasize emotional connections.

Sentiment Analysis:

• “We are raising our adjusted EBITDA outlook for 2025.” “Gross margin expansion of more than 120 basis points… to 39.3%.” “Adjusted EBITDA increased $30 million to $114 million and expanded nearly 220 basis points to 7.6%.” Acknowledged top-line pressure: “Net sales were down 2.3% with comparable sales down 1.4%,” but emphasized profitability and cash flow improvement.

Q&A:

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

• Question from Michael Lasser (UBS): Were gross margin gains mainly from online promo cleanup, and would stores be comping positive excluding online?
  Response: Promo cleanup was heavier in e-commerce; focus has been on stores, but management won’t quantify store-only comps.

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

• Question from Steven Zaccone (Citi): What are the mitigation efforts, especially on pricing, into the back half?
  Response: Pricing remains an ongoing lever applied with a consumer-first lens; approach is continuous rather than a one-time tariff response.

• Question from Jacob Nivasch (Guggenheim): Update on planogram resets discussed last quarter?
  Response: Dog and cat resets are complete, improving on-shelf availability, labor productivity, and store profitability; more category resets coming.

• Question from Jacob Nivasch (Guggenheim): Any details from the North Star initiative?
  Response: Phase 3 pillars: elevate store experience, scale services, drive merchandising differentiation, and win with omnichannel.

• Question from Kaumil Gajrawala (Jefferies): Status of the e-commerce pullback/retool and inventory right-sizing?
  Response: E-comm is more profitable with a new leader tackling friction and basics; inventory down 9.5% YOY with better in-stocks; continuous improvement planned.

• Question from Kaumil Gajrawala (Jefferies): What’s driving NPS improvement at this stage?
  Response: Broad store execution and people investments, plus in-store events and marketing, are lifting the customer experience.

• Question from Kendall Toscano (BofA): What were transactions versus AUR trends?
  Response: Basket/UPT were solid; transactions lagged and are the key focus to improve via events and increased marketing.

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

• Question from Simeon Gutman (Morgan Stanley): Trends in number of pet families and shopper behavior?
  Response: Industry is roughly flat; Petco prioritized profitability with limited share loss; aim to convert one-time/services-only users to omni with higher LTV.

• Question from Simeon Gutman (Morgan Stanley): Any markdown risk from merchandise mix changes?
  Response: No significant risk expected; buys will be tight, seasonal, fast-turn, with stronger governance.

• Question from Justin Kleber (Baird): Can you size the comp drag from eliminating unproductive promotions?
  Response: Not quantified; cleanup began in late FY24 and continues; store performance improving while e-comm lags by ~six months.

• Question from Justin Kleber (Baird): What drives the implied Q4 adjusted EBITDA decline YOY?
  Response: Q4 faces the largest tariff headwinds; also maintaining flexibility for selective H2 investments and prudence amid macro volatility.