Good afternoon, and welcome to the Petco Second Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ms. Tina Romani, Head of Investor Relations and Treasurer. Please go ahead, ma'am.

Good afternoon, everyone, and thank you for joining Petco's Second Quarter 2025 Earnings Conference Call. In addition to the earnings release, there is a presentation available to download on our website at ir.petco.com. On the call with me today are Joel Anderson, Petco's Chief Executive Officer; and Sabrina Simmons, Petco's Chief Financial Officer. Before we begin, I'd like to remind everyone that on this call, we will make certain forward-looking statements, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from such statements. These risks and uncertainties include those set out in our earnings materials and SEC filings. In addition, on today's call, we will refer to certain non-GAAP financial measures. Reconciliations of these measures can be found in our earnings release, presentation and SEC filings. With that, let me turn it over to Joel.

Good afternoon, everyone, and thank you for joining us today. I'm incredibly proud to share the progress we are making in strengthening the foundation of our operating model and improving our retail fundamentals while positioning Petco for sustainable, profitable growth. We are continuing our transformation journey and pleased we have the confidence to raise our earnings outlook. In addition to the progress we are making on our transformation, this month marks the 60th birthday of Petco, celebrating our rich heritage. In our 6-decade history, Petco has been where the pets go for consumables, for grooming, for vet services, for pharmacy and more. I'm honored to be leading Petco along a talented team as we embark on the next 60 years. As I complete my first year on the ground at Petco, it is gratifying to watch Petco regain confidence and relevancy in the pet sector. I will spend a few minutes later in my prepared remarks outlining what this means and where I'm seeing progress. Looking to our financial performance in Q2, sales were in line with our outlook, and we meaningfully improved our profitability, increasing operating income by over $40 million and generating more than $50 million in free cash flow. For the quarter, we delivered $114 million in adjusted EBITDA. This is a true testament to the hard work all the teams at Petco have leaned into. As we enter the back half, we continue to execute on Phase 2 of our transformation and expect to make improvements to our bottom line and overall performance versus last year. It is with this confidence in our ability to deliver improvements that we are able to raise our guidance and at the same time, begin thoughtful reinvestment behind the business as we set the stage for Phase 3 of our…

Thank you, Joel. Good afternoon, everyone. I'm pleased to share our continued progress on strengthening our economic model. As we've discussed with you previously and in line with our goals laid out at the start of the year, we are executing with intention to build a strong foundation from which to grow. This means expanding our gross margins and leveraging SG&A, resulting in improved profit, cash flow and overall returns. Our teams are moving with urgency as we execute against this phase of our transformation, and our second quarter results reflect our continued progress. In line with our outlook, net sales were down 2.3% with comparable sales down 1.4%. As a reminder, the difference between comp sales and net sales is driven by the 25 net store closures in 2024 and the additional 10 net closures year-to-date, bringing our U.S. store count at the end of the second quarter to 1,388. It's worth noting on a 2-year basis, comparable sales improved 130 basis points from Q1 to Q2, driven by improvement in our store performance. Our top line results primarily reflect the decisions we are making to move away from unprofitable sales, shifting instead to disciplined promotional strategy, better retail execution and enhanced customer experience. This work resulted in gross margin expansion of more than 120 basis points versus last year to 39.3%, with gross margin in both products and services expanding once again this quarter. Similar to Q1, gross margin expansion was driven by a more disciplined approach to both average unit cost and average unit retail, including stronger guardrails and the deployment of more disciplined processes to effectively manage our pricing and promotional strategies. It's also worth noting that there was minimal tariff impact in the second quarter. Moving to SG&A. For the quarter, SG&A decreased $36 million…

[Operator Instructions] And the first question will come from Michael Lasser with UBS.

So it sounds like you're moving closer to Phase 3. Joel, when is a reasonable expectation for us to hold the firm accountable for generating a positive comp? Is that by the fourth quarter of this year? Or is that more likely a 2026 outcome?

Thanks, Michael. As -- I think both of us mentioned, Tina went into detail -- sorry, Sabrina went into detail, third quarter is our hardest compare of the year. And so like I outlined earlier, we are smack in the middle of Phase 2, Michael. And while we are beginning to seed ideas and test and learn, as we like to call it for Phase 3, the results will begin to show up in 2026 as it relates to a positive comp, but we will start to work on ideas right now, Michael.

And my follow-up question is, it sounds like the gross margin gains came in part from eliminating some promotional and unproductive activities. Were those mostly online? And is that what drove the weakness in the online segment? And if you were to take away the online channel, would Petco have generated a positive comp in the stores business?

Yes. Michael, I don't want to get into specific segments. But as you can tell from my remarks, we've really been focused on the stores. It is where the majority of our sales are. And so therefore, it was intentional that that's where we start. We see it as the biggest opportunity long-term for us, and we wanted to get that underway. So not only are we pleased in the results the stores are making, but the traction we're getting in e-comm is working as well, but that's been more focused on the bottom line.

And just to add a little bit to that, Michael, I would say everything Joel said about the stores ditto, online last year did have much more promo and stacking that we needed to clean up. So we have -- if you think about -- if you want to think about it between stores and e- comm, there was more cleanup to be done on the e-comm side to be helpful.

The next question will come from Steven Zaccone with Citi.

I want to follow up on Michael's question on gross margin. So could you just dig a little bit more detail there, how that performed relative to your own expectation because it looks like a big beat. And then it sounds like there's some timing aspect with tariffs. So can you just elaborate on that a little bit more, how we should think about gross margin rate in the back half of the year?

Yes. So we have been super focused from our first call together, we've talked about the economic model and how one of the most important tenets of that is expanding our gross margin on a year-over-year basis for the full year to get our business healthy so that when we do regrow sales, it has a nice flow-through on healthy margins. So we've been working every lever AUR, AUC within those, every lever, promo, pricing, clearance, markdown to deliver on that gross margin expansion, and we're really pleased how it came through on both merchandise and services in the second quarter. When you look forward, though, Steve, for sure, tariffs start to impact. So we had almost no tariff impact in Q2. There was some, but it's like, let's call it, rounding. As we go to Q3, it becomes meaningful, and then it becomes even much more meaningful in the fourth quarter.

I guess the follow-up then on that is just how do we think about mitigation efforts? And maybe as it relates to top line specifically, how did pricing perform in the second quarter? And what's your view on pricing as we get into the back half of the year?

Well, we've been doing pricing all year long. So maybe different than a lot of retailers who perhaps are reacting to the second half tariffs. We have been using this vehicle as we came together as a new leadership team from the get-go. So really, there's less of a change in the second half, but will we be using that lever? Of course, we will, but it will be with a consumer-first lens. We are very focused on delivering on a value proposition to our customer. So no change there, but yes, it will continue to be used.

The next question will come from Steve Forbes with Guggenheim.

This is Jake Nivasch on for Steve. So 2 questions for me here. One, I think you guys mentioned last time that you were working on some planogram resets, and I wanted to circle back to see if you could provide some updates on the work there. And then I have a follow-up.

Yes. I think we were specifically talking about our dog and cat reset back then. And so think about my prepared remarks where I talked about on-shelf availability, better in-stocks, making it easier for our store associates to fill the shelves, which therefore makes them more productive, which makes our stores more profitable. So it was very successful. We've completed those resets. You'll continue to see more of those as we move through this year and into next year in other categories. But it's just a great example of the diligence the teams are making to improve the profitability in the stores, improve on-shelf in-stock for our customers and make our stores more customer-friendly.

Yes. Just to tag on to that, as you heard me say, part of our SG&A savings was store labor and operations. And that is exactly what Joel is talking about that we got a lot of operational benefits that are flowing through in our expense savings.

You had a follow-up, Steve?

Yes. Perfect. Yes. Just a follow-up...

Jake...

And I know -- yes, but, you touched on this a little bit, but curious if you guys can share some more detail around the North Star initiative that you guys have been working on. And maybe it's too early, but I'm curious if you have any updates there.

Yes. I think we'll certainly give you a more detailed outlook on that as we get into the specifics of Phase 3 and growth. But I can tell you, as we think about Phase 3, there are really 4 main pillars to it. It's all about delivering amazing store experience. Our partners are pet first, and that's what sets us apart. It's delivering services at scale. Services aren't easy. And in many ways, I think of that as our moat, and that clearly showed up in our North Star work of how important our services were. The ecosystem of interacting between grooming, hospital and center of store is something Petco only can do. Third pillar, merchandising differentiation. I've alluded to that. I gave you several examples in my prepared remarks, but you're going to see more newness out of us, more surprise and delight. We have to be relevant, no more of set it and forget it, seasonal categories, pricing, that all comes into the merchandise differentiation. And then finally, number four is over time, winning with omnichannel. So those are kind of some of the pillars that are coming out of our North Star work that's going to drive our growth down the road.

The next question will come from Kaumil Gajrawala with Jefferies.

I guess, a couple of things. The first is just where we sort of are in the process of the e-commerce sort of pullback and eventual retool. Is that sort of complete? And exactly the same question, I guess, on the inventory side, inventories came down nicely. And so are inventories where you sort of intend them to be now? Or is there still more work to do? But really, like are those 2 projects kind of mission complete and time to move on or still more to get done?

Yes, Kaumil, let me take e-comm and then Sabrina, if you want to chime in on inventories. Look, as I said earlier, it was our intentional focus to start on the stores first. In a unique way by us reducing sales in e-comm, our e-comm channel is actually more profitable today. But the work we've been doing is just getting started and is ongoing. We hired a new leader, he's already making a big impact. We're reducing friction. And quite honestly, we're just improving basic retail one-on-one operating principles like speed, page load time, appointment scheduling enhancements, improving repeat delivery. Our loyalty program will come in '26. We think we've got plenty of media buying optimization to do and really improve our targeting and personalization. So those are just several examples, but I would say we're in the phase on e-comm of identifying and now we'll focus on implementing. And then, Sabrina, on inventory.

Yes. With regard to inventory, I mean, yes, we're so proud of the work the teams have done even in the face of tariffs to get the inventory dollars down so far. So we're big on continuous improvement. I believe there's always opportunity, but we don't want to push it too far. We pulled off, as I said, down 9.5% with improving in-stocks at the same time. So our goal is to always have a tight relationship between sales and inventory and inventory below sales to me is always a great thing as long as it's not hurting the customers, and that's what we'll be focused on continuing to deliver.

Got it. And if I could ask about your commentary on the increasing NPS scores. Sort of postmortem, what's behind that? Is it just the marketing? Is it what's happening in store? It just feels given the way you've laid out the phases that it's something that you'd expect when you're much further along Phase 3 than at this stage. So just curious if there's anything behind that.

Well, nothing specific. It's a whole host of a lot of improvements. Joe Venezia, who leads our stores organization of the new leadership team, has probably been here the longest. And he's made traction in many different areas. We've already had one leadership meeting with the leaders of the stores organization. We've got another one I talked about coming up next month with all our store general managers and above. And those are just examples of us reinvesting back in our people and really putting effort into the store experience. And it's clearly beginning to resonate with our customers. It's showing up in the metrics I shared with you. And I really believe it's really important for Petco to have a great store experience. And so that's why we've really leaned in initially with our store partners.

The next question will come from Kendall Toscano with Bank of America.

First thing I wanted to ask was just on the comp, if you could comment on any of the transactions versus AUR trends that you saw during the quarter.

Sure. Overall, we're pleased with UPT and basket. Transactions is a place we are very focused on improving. So that's really the biggest opportunity for us. And you heard Joel talk about how we're starting these great efforts on events and making the store fun and doing much more marketing. So we're looking forward to improvement there, but that was the one that held us back in the quarter. Joel, do you want to...

No, I think that really covers it nicely. And as we get towards growth, the real focus will be on starting to invite customers back into Petco, and we shared with you some examples of that with the store experiences.

Okay. That's helpful. And then the other question was just -- so it sounds like there's been a lot of progress in key areas like inventory and in-stocks. And curious just where the biggest remaining execution gaps are that you're working to address before you'd be more confident to shift fully into Phase 3.

Well, I think as I alluded to in my prepared remarks that our back half begins to contemplate reinvesting back in the business. So I think it's less about the gaps, and it's more about how pleased we are with the progress we've made to date. And that progress gives us the confidence that we will continue to make progress. Sabrina talked about inventory. There's always opportunities there. But the teams made such progress that we're beginning to invest. So it's now the shift starts to be talking about those 4 pillars of growth that I alluded to on a couple of questions ago, that's where our focus is.

And just to elaborate on what Joel said, we just think there's such a nice runway here, even if you just think about margins alone. So we've been really focused, like we said, on AUC and AUR levers, including inventory management and pricing and promo and markdown and clearance. But what's kind of yet to come that we're in the early stages of is we think there's a lot of opportunity in sourcing, we think there's a lot of opportunity in expanding categories like pharmacy in regrowing over time, our supplies business. So we still have a lot of levers left in front of us, which makes us very excited.

The next question will come from Simeon Gutman with Morgan Stanley.

Can you talk about number of pet families? Can you talk about growing, declining? And then Joel, what are you learning about the families as far as the departments they're shopping, the services they're using for -- using you for? Anything that's surprising you from when you started?

Yes. Simeon, good question. I would say our industry data is showing that the pet space is relatively flat right now. And in fact, for us, as we've intentionally focused on the bottom line rather than the top line, we're really pleased with our performance as we're not giving up that much market share and at the same time, making significant improvement on the bottom line. As far as the observations we've made from -- that I've seen, I've been surprised at how many onetime customers we have. And I think that's probably some areas where we were too bottom of the funnel focused on our e-commerce channel as opposed to being more focused on omni customers, lifetime value of customers. So those are some of the changes we'll make. And we also have a significant amount of customers that shop us for our services only, and we've got an opportunity really there to grow that share of wallet with our customer into some of our other categories, merchandise, improve our repeat delivery capabilities so they use us. So those are just a couple of examples, Simeon, of things we've observed through all our North Star work.

Okay. And then you mentioned like just toggling some inventory, bringing some new stuff in. Is there any -- and I'm sorry if this was asked, is there any inventory movement markdown risk associated with changing merchandise mix going forward?

Nothing significant, Simeon. I mean, obviously, when you change inventories, optimize inventory, you can tell, as Sabrina said, our inventory was nearly down double digits, and that didn't come with a huge inventory risk at all. So look, we got to be disciplined about it, Simeon, and go at it methodically, but I don't see any big inventory risk on the horizon.

And just to underscore that, the teams are really focused on improving the governance and processes around inventory and buys. And we absolutely need more newness for our customers, and we're excited to bring it in. But those buys will be tight and well controlled and seasonal and fast turning. So we intend to manage it with a lot of good process and governance.

And the last question for today will come from Justin Kleber with Baird.

So first off, Joel, you've been talking about cleaning up these empty calorie promos for a handful of quarters. I'm curious if you could help us size the drag to the comp from this activity. If we normalize for what you're doing, I mean, is the business comping up kind of excluding the cleanup of these promotions?

Well, I don't know that's a little probably too specific to get into. I think it's more important to look at it of where we're at with the progress. And both Sabrina and I commented that Q3 is the toughest compare. So what you can glean from that is we started in on this progress in Q4 of last year. We identified more in Q1 and so on. So as we continue to find opportunities where there were empty calorie sales, we are offsetting those with some of the growth initiatives that are starting to take place, but we still need to get through especially this Q3 and the beginning of the holiday season.

The only thing I would add to that is -- I was just going to add, Justin, what Joel already said in his remarks, which is -- what we see under the covers is improvement in our store performance, and that's really important to us because that's the vast majority of our sales. So just to reiterate, that was our first area of focus, and it's just great to see the improvement there. And e-comm is probably 6 months behind because new leader just started, and as Joel said, identification phase. So we will get there because we know all the levers we need to work, but we're very pleased with what's happened in our stores.

And then just a follow-up on the implied fourth quarter adjusted EBITDA guide. It looks like at the midpoint, if you'd be the midpoint of your third quarter guidance, you'd be down 2% year-over-year. So just trying to understand what is driving the decline? Is it more about the tariff headwinds building or more about your intentional investments back into the business as you set the stage for a return to growth?

Yes. I mean we gave ranges. So it kind of depends where you model it and end up. But what I will reiterate about the fourth quarter is definitely tariffs have the most meaningful negative impact in Q4. Secondly, we're excited because of our strong performance in the first half. We're excited that we get to keep some powder dry in the second half for areas of investment should we deem them worthy of investing. The only thing we have committed to, by the way, is the Leadership Summit that Joel talked about, but we want to keep that dry powder. And then finally, I think it's good to just protect against volatility because I don't think the macro is completely out of the woods. We live in times where there's big news cycles nearly every day. So we feel like we've taken a prudent approach to the back half.

This will conclude our question-and-answer session. I would like to turn the conference back over to Ms. Tina Romani for any closing remarks. Please go ahead.

Perfect. Thank you so much, Joel and Sabrina, and thank you, everyone, for your time and your questions. We're looking forward to seeing many of you next week. And with that, that concludes our call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.