Executive Summary / Key Takeaways

• Petco is executing a multi-phased transformation focused on restoring profitability and strengthening retail fundamentals before pivoting to growth, demonstrating early success with a Q1 2025 Adjusted EBITDA beat.
• The company's differentiated services offering, particularly owned vet hospitals and grooming, continues to show momentum and is viewed as a key competitive moat, supported by operational technology improvements.
• Strategic initiatives centered on merchandising excellence, cost discipline, and operational efficiencies are driving gross margin expansion and SG&A leverage, evidenced by improved profitability metrics in recent quarters.
• Despite a challenging macroeconomic backdrop and modest top-line pressure (Q1 2025 net sales down 2.3%), management reaffirmed its full-year 2025 outlook, signaling confidence that internal operational improvements can offset external headwinds, including current tariff impacts.
• Key areas for investors to monitor include the continued execution of Phase 2 initiatives, progress towards the debt leverage target, and the successful identification and testing of growth levers in Phase 3, expected to begin in late 2025.

A Transformation Underway: Rebuilding Retail Fundamentals

Petco Health and Wellness Company, Inc. stands at a critical juncture in its 60-year history. What began as a single pet store in 1965 has evolved into a vast omnichannel ecosystem spanning over 1500 pet care centers across the U.S., Mexico, and Puerto Rico, complemented by a robust digital presence. This extensive physical footprint, coupled with a deep-rooted mission to improve the lives of pets and pet parents, forms the foundation of Petco's business model in the large, fragmented, and resilient pet care market. However, recent periods have highlighted the need for significant operational and financial improvement amidst a dynamic consumer and macroeconomic environment.

Under new leadership, Petco has embarked on a multi-phased transformation strategy aimed at reinventing its iconic brand and regaining market share. The initial focus, Phase 1, centered on stabilizing profitability, enhancing the leadership team, and restoring foundational retail practices. With Phase 1 complete, the company is now deeply engaged in Phase 2: implementing and executing the identified work streams to strengthen retail fundamentals and drive structural cost out. This phase is about putting strategy into action and demonstrating tangible results.

The Competitive Arena: Navigating a Fragmented Market

The U.S. pet care market is intensely competitive, featuring a mix of pure-play online retailers, mass merchants, grocery stores, and other specialty providers. Petco's primary direct competitors include online giant Chewy (CHWY), e-commerce behemoth Amazon (AMZN), and major physical retailer PetSmart (privately held). Mass merchants like Walmart (WMT) also compete on price for basic supplies.

Petco positions itself as a differentiated "holistic pet wellness ecosystem," aiming to be the single source for all pet needs through its integrated physical and digital channels. This contrasts with Chewy's dominant online-only model (holding ~41% of the online market share) and Amazon's broad marketplace approach (~35% online market share). PetSmart, with a physical footprint comparable to Petco's (~1600+ stores), also offers supplies and services, focusing on areas like sustainability.

Financially, Petco's revenue growth (around 8% in 2024) has lagged Chewy's (15%) and Amazon's overall growth (12%), reflecting the challenges in its core retail operations. While precise, directly comparable market share figures for all niche competitors are not publicly detailed, Petco holds an estimated 15-20% aggregate market share. Petco's gross margins (TTM 38.08%) and operating margins (TTM 0.66%) have generally trailed the higher margins seen at more digitally-focused players like Amazon (gross 48%, operating 10%) or even PetSmart (estimated gross 35%, operating 6%), partly due to the higher costs associated with maintaining a large physical store network. Petco's Return on Invested Capital (ROIC) at 6% also lags the estimated industry average of 10%, indicating operational inefficiencies that the current transformation seeks to address.

Petco's strategic response to this competitive pressure involves leveraging its unique strengths: its physical store network and its integrated services offering. While Chewy and Amazon excel in e-commerce efficiency (Amazon's automated warehouses offer estimated 30% lower operating costs per unit), Petco's stores enable in-person services like veterinary care and grooming, which offer higher margins and stronger customer retention. The company's focus on optimizing these services and enhancing the in-store experience is a direct play to differentiate itself and capture wallet share that online-only players cannot easily access.

Operational Technology: Enhancing Efficiency and Service Delivery

While not defined by a single, breakthrough hardware technology, Petco is strategically investing in and leveraging operational technology to enhance its business model and competitive position. This includes a suite of digital tools, software systems, and process automation aimed at improving efficiency, customer experience, and service delivery, particularly within its differentiated services segment and omnichannel operations.

Key technological initiatives and their benefits include:

• Services Software Upgrades: Enhancements to grooming software allow for greater flexibility in online appointments, crucial as over 40% of grooming appointments are booked digitally. This aims to improve appointment availability and customer convenience, directly impacting service utilization and revenue. Similarly, the vet scheduling system has been enhanced to ensure better coverage and optimize hospital productivity.
• Inventory Management Systems: Implementation of a new inventory management system in 2024 has been instrumental in improving in-stock levels, particularly for essential consumable products. This operational improvement directly addresses a fundamental retail challenge and supports sales by ensuring product availability.
• E-commerce and Omnichannel Optimization: Efforts are underway to reduce the cost per order and the number of split shipments in e-commerce, increasing overall shipping efficiencies and speed. Leveraging automation in pet care centers for online order fulfillment also aims to reduce in-store tasking and free up partners to interact with customers, while improving click-to-delivery time and order tracking visibility for omnichannel customers.
• Tele-health Platform: Petco has rolled out a tele-health platform, providing faster consultations (estimated 20% faster) and differentiating its veterinary offering against more generic online options. This leverages technology to improve accessibility and efficiency in pet health services.
• Data and Analytics: The company is increasingly using data and analytics, including vet customer data, to understand purchasing patterns, inform customer engagement, and drive wallet share. The comprehensive "North Star" project, expected to complete in the back half of 2025, is leveraging qualitative and quantitative analysis to understand customer segments and identify white space for growth, informing future strategy and customer engagement.

The "so what" for investors is that these technological efforts, while perhaps less visible than a revolutionary product, are foundational to improving Petco's operating model. They directly support the goals of gross margin expansion (e.g., supply chain optimization, service productivity), SG&A leverage (e.g., labor model efficiency, procurement professionalization), and enhancing the customer experience (e.g., appointment booking, order fulfillment). By improving the efficiency and accessibility of its services and omnichannel offerings, Petco strengthens its competitive moat against players lacking integrated physical and service capabilities, potentially improving profitability and setting the stage for future growth.

Financial Performance: Progress on Profitability

Petco's recent financial performance reflects the early stages of its transformation, showing progress on profitability despite ongoing top-line challenges.

For the thirteen weeks ended May 3, 2025 (Q1 2025):

• Net sales decreased 2.3% to $1.49 billion, compared to $1.53 billion in the prior year period. This decrease primarily reflects lower transaction volume and a lower pet care center count (driven by 25 net closures in 2024 and 5 in Q1 2025), as well as a greater focus on profitability over chasing low-margin sales.
• Comparable sales decreased 1.3%. The difference between net sales and comparable sales is largely attributable to the net store closures.
• Gross profit was $569.97 million, down from $578.66 million in Q1 2024. However, the gross profit rate expanded to 38.2% from 37.8%, primarily due to improved utilization of the services footprint, effective inventory management, supply chain optimization efforts, and channel mix impacts.
• Selling, general and administrative (SGA) expenses decreased to $553.61 million (37.1% of net sales) from $595.44 million (38.9% of net sales) in Q1 2024. This decrease included lower payroll and other compensation costs, advertising expenses, and store occupancy costs, also benefiting from lapping disposition costs related to the Pupbox business in the prior year.
• Operating income improved significantly to $16.36 million, compared to an operating loss of $16.78 million in Q1 2024.
• Net loss attributable to Class A and B-1 common stockholders improved to $11.66 million ($0.04 per share) from $46.48 million ($0.17 per share) in Q1 2024.
• Adjusted EBITDA increased $13.8 million to $89.45 million, expanding the Adjusted EBITDA Margin to 6.0% from 4.9% in Q1 2024.

These results demonstrate tangible progress on the company's key financial priorities: gross margin expansion, SG&A leverage, and ROIC improvement. The Q1 2025 performance builds on momentum seen in the latter half of FY24, where Q4 2024 comparable sales were up 0.5% and Adjusted EBITDA was ahead of expectations, and Q3 2024 results came in slightly ahead of expectations with revenue up 1% and gross margin expanding 130 basis points.

Liquidity remains a focus, with $647.9 million available as of May 3, 2025, including cash and cash equivalents ($133.3 million) and ABL Revolving Credit Facility availability ($514.6 million). While net cash used in operating activities increased in Q1 2025 ($15.5 million vs $8.4 million in Q1 2024) primarily due to higher incentive payouts, the company ended Q1 2025 with a higher cash balance ($139 million vs $91 million in Q1 2024) and improved inventory management (ending inventory 5% below prior year). Free cash flow was negative $44 million in Q1 2025, driven by the incentive payout. The company achieved positive free cash flow of $49.7 million in FY24 and aims to achieve a debt-to-EBITDA leverage ratio below two times over time, which is contingent on continued profitability improvement.

Outlook and Strategic Horizon

Petco's management remains focused on executing its transformation plan and is confident in its ability to deliver improved financial results in 2025, independent of a significant market recovery. The company reiterated its full-year 2025 outlook, which assumes tariffs remain at current levels and no higher, indicating that internal operational improvements are expected to offset these external pressures.

Full-year 2025 Guidance:

• Net sales expected to be down low single digits compared to last year. This includes the anticipated impact of 20 to 30 net store closures in 2025, building on the 25 net closures in 2024.
• Adjusted EBITDA expected to be between $375 million and $390 million.
• Depreciation expected to be approximately $200 million.
• Net interest expense expected to be approximately $130 million.
• Capital expenditures expected to be approximately $125 million to $130 million, with a greater focus on ROIC-enhancing projects like optimizing existing vet hospitals rather than significant new builds.

For the second quarter of 2025, the company expects net sales to be down low single digits versus the prior year and Adjusted EBITDA to be between $92 million and $94 million, representing approximately 11% year-over-year growth at the midpoint.

Management's rationale for this outlook is grounded in the "self-help" nature of the 2025 plan. The focus is on driving gross margin expansion and SG&A leverage through disciplined execution of Phase 2 initiatives. This includes continued work on merchandising excellence (assortment optimization, pricing, vendor partnerships), services productivity (utilization, software enhancements), and broad operational efficiencies (supply chain, labor model, procurement). The planned store closures, while impacting the top line, are expected to contribute positively to EBITDA by removing unprofitable locations.

Looking beyond 2025, Phase 3 will focus on a return to profitable growth. This will involve leveraging the strengthened foundation to seed and test revenue growth initiatives, including product innovation, evolving marketing messages (more solutions-oriented), enhancing the digital experience, scaling the membership program (new program expected 2026), and further investing in services. The North Star project will inform customer segmentation and engagement strategies for this growth phase.

Risks and Challenges

Despite the positive momentum in profitability, Petco faces several risks and challenges that could impact its trajectory:

• Macroeconomic Headwinds: Ongoing macroeconomic pressures, including potential inflation, interest rates, and shifts in consumer spending patterns, could continue to pressure discretionary product sales and overall transaction volume.
• Competition: Intense competition from online players like Chewy and Amazon, as well as physical retailers like PetSmart and mass merchants, puts pressure on pricing, margins, and market share, particularly in the product segment. Petco must effectively articulate and deliver its differentiated value proposition.
• Execution Risk: The successful execution of the multi-phased transformation plan, particularly the complex operational and merchandising initiatives in Phase 2, is critical. Failure to effectively implement these changes could hinder profitability improvement and delay the pivot to growth.
• Tariff Uncertainty: While the company believes current tariff levels are manageable, changes in trade policy could increase costs and impact profitability, requiring further mitigation efforts with vendors and supply chain adjustments.
• Debt Levels: While the company is focused on improving its leverage ratio, high debt levels could limit financial flexibility and investment capacity if profitability or cash flow generation falters.
• Services Utilization: Despite progress, achieving full utilization and structural margin improvement in the relatively new fleet of vet hospitals requires consistent staffing, marketing, and operational efficiency.

Conclusion

Petco's Q1 2025 results, marked by an Adjusted EBITDA beat and significant operating income improvement, signal that the company's multi-phased transformation is beginning to yield tangible results. The focus on strengthening retail fundamentals, driving operational efficiencies, and leveraging the differentiated services offering is the core of the current investment thesis. While top-line growth remains challenged by macroeconomic factors and strategic pruning of unprofitable sales/locations, the progress on gross margin expansion and SG&A leverage demonstrates management's ability to execute on its profitability goals.

The company's integrated physical and digital model, underpinned by strategic investments in operational technology, provides a competitive moat, particularly in the high-growth services segment. The reiterated full-year guidance, absorbing current tariff impacts, reflects confidence in the "self-help" nature of the 2025 plan. Investors should view this year as a crucial period of implementation and execution (Phase 2), laying the necessary foundation before a potential pivot to profitable growth (Phase 3) in late 2025 and beyond. Key factors to watch will be the sustained improvement in profitability metrics, progress towards debt reduction, and the successful identification and scaling of future growth drivers in a highly competitive market.