Good afternoon, and welcome to Petco's fourth quarter and fiscal 2025 earnings conference call. Joining me on the call today are Joel Anderson, Petco's Chief Executive Officer, and Sabrina Simmons, Petco's Chief Financial Officer. In addition to the earnings release, we've posted a slide presentation on our website at ir.petco.com. 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, I'll turn the call over to Joel.
Thanks, Roxanne, and good afternoon, everyone. Thank you for joining us to discuss our fourth quarter and full year results, where I'm pleased to share that Q4 sales were in line with our outlook and we performed better than our Adjusted EBITDA quarterly goal. Looking back on 2025, we successfully delivered on our robust agenda to strengthen our economic model and improve retail fundamentals, which resulted in significantly higher cash flow and profitability year-over-year. Specifically, for the year, we achieved a 21% increase in Adjusted EBITDA and a 77% increase in operating cash flow. Our healthier EBITDA and opportunistic debt paydown drove a meaningful reduction in our leverage ratio at year-end, allowing us to start the year with greater financial flexibility. This was no small feat, and I'm exceptionally proud of our team.
We collaborated across the organization, we strengthened our culture, we communicated expectations, and we acted with urgency and decisiveness. It's important to note that the majority of our senior leadership team, which is exceptionally well tenured and talented, has only been together for about one year. We enter 2026 with a running start, something we didn't have in 2025. Some of the most recent additions to the team include Sabrina Simmons, CFO, who many of you already know, Michael Romanko, Chief Customer and Product Officer, and Joe Venezia, Chief Revenue Officer. The entire team's work has been transformative, and yet we are just getting started. In addition to strengthening our financial foundation in 2025 and rebuilding the leadership team, we completed our Petco North Star strategy, including a comprehensive customer segmentation and needs analysis.
This work is already shaping how we prioritize assortment, services, and experiences, and it also informed our updated brand positioning, Where the Pets Go to Live their Best Lives. One key takeaway from the segmentation work is the identification of who our most important engaged customers are. That segment we call Passionate Explorers. These are pet parents who are highly invested in their pets and seek innovation, expert support, and a welcoming shopping experience across the full pet journey. In 2026, we are informed by this strategy work and execution will center on four growth pillars, which I will review in detail later on this call. They are, number one, compelling product driven by increased newness, brand launches, and own brand expansion. Number two, services at scale, leveraging our wholly owned vet, grooming, and training ecosystem. Number three, trusted store experience focused on driving traffic, engagement, and basket.
Finally, number four, an integrated omni-channel model, improving convenience, loyalty, and repeat behavior. With that, I'll now turn it over to Sabrina to provide details on our fourth quarter financial performance and our 2026 outlook. Following her remarks, I will discuss the specifics of our growth strategy for 2026, and we'll then open it up to your questions.
Thank you, Joel. Good afternoon, everyone. As we've discussed, our primary goal all year was improving profitability and cash generation through our economic model, namely expanding gross margin rate, leveraging expense, and expanding operating margin. We're glad to report that we achieved this goal each and every quarter. For the full year 2025, we expanded our gross margin rate 66 basis points to 38.7%, leveraged SG&A 124 basis points to 36.6%, improved our operating profit by $113 million, and expanded our operating margin by 190 basis points.
Increased Adjusted EBITDA 21.3% to $408 million with a margin of 6.8%, and we delivered positive GAAP net income for the year. Additionally, free cash flow improved 276% versus the prior year to $187 million. These results enabled significant progress in achieving our goal of lowering our leverage ratio. Our net debt to EBITDA improved from 4.2x when we entered the year to 3x at the end of 2025. Now turning to the fourth quarter results, which reflect another quarter in which we delivered on our commitments while building a stronger foundation. In line with our outlook, net sales were down 2.4% to $1.52 billion, with comp sales down 1.6%.
As expected, the decline reflects our decision to move away from unprofitable sales, which was our strategy throughout 2025. As a reminder, the difference between total sales and comp is driven by the 25 net store closures in 2024 and the additional net 16 closures in 2025. The number of 2025 closures came in a bit favorable to our expectations, driven by a combination of improved store performance and favorable rent negotiations that supported improved unit economics for those locations. We ended the quarter with 1,382 stores in the U.S. Fourth quarter gross profit dollars were $581 million, while our gross margin rate expanded 37 basis points to 38.3%, including the sequential increase in tariff impact, which we anticipated. Moving to SG&A.
For the quarter, SG&A was $549 million or 36.2% of net sales, leveraging 62 basis points. The $23 million decline in year-over-year expenses was partially driven by lapping last year's consulting costs. Marketing expenses increased $7 million in the quarter. For Q4, our expanded gross margin and expense leverage resulted in operating margin expansion of 98 basis points, and our operating profit increased $14 million or 83% in the quarter. Adjusted EBITDA increased 10.6% or $10 million to $106 million, and our adjusted EBITDA margin expanded 82 basis points to 7% of sales. Moving to the balance sheet and cash flow. Q4 ending inventory was down 9.7% versus our 2.4% decline in Q4 sales.
We continue to manage inventory with discipline, which is one of the drivers of our improved cash flow profile. For the year, free cash flow was $187 million, an increase of $137 million or 276% versus last year. Our ending cash balance was $257 million, an increase of $91 million versus last year, including having voluntarily paid down $95 million of debt. As many of you have heard me state, our approach to our debt refinancing was opportunistic, and we're pleased to have executed the refinancing with favorable terms. We replaced a fully variable debt structure with a more optimal mix of fixed and floating, and extended our maturities to 2031, providing us ample flexibility.
On our first call together last March, we stated our goal of reducing our leverage ratio to 2x or less. We are thrilled with the progress we've made in just one year. As we said, we started fiscal 2025 at over 4x, and in just a single year, we have reduced that to 3x, enabled by our focus on driving improved profitability and cash flow. With our retail and financial fundamentals strengthened, we are well-positioned to turn more of our focus to regrowing top line and driving sustainable, profitable growth over the long term. Now turning to our outlook. We are starting the year from a position of strength while continuing to navigate a bumpy macro backdrop. Of note, our guidance assumes that fuel prices normalize by the end of the quarter.
For the first quarter, we expect net sales to be down 1% to flat versus the prior year, with comp sales roughly flat at the midpoint of the range as we begin to build into the growth initiatives Joel will outline in a minute. We expect Adjusted EBITDA to be between $92 million and $94 million. Now, turning to the full year, we expect net sales to be flat to up 1.5% growth versus last year as our growth initiatives take hold and build over the course of the year. Of note, similar to 2025, we expect net store closures between 15 and 20 in 2026. As is typical, store closures are weighted toward the back half of the year. We estimate the full year spread between total sales and comp sales to be about 50 basis points, though it will vary somewhat by quarter.
This expectation implies positive comp sales for the year. We expect Adjusted EBITDA to be between $415 million and $430 million, with an overall goal of delivering on our economic model for the full year. To provide additional color on other line items, for the full year, we expect net interest expense to be about $125 million. Capital expenditures of about $140 million, with an ongoing focus on ROIC, which we improved in 2025 by 3 percentage points. Depreciation and amortization to be about $200 million, similar to last year. Finally, to be helpful with your models, we expect stock comp to increase by a low double-digit % versus last year. As a reminder, stock comp will remain well below years prior to 2025.
In closing, I wanna thank our teams for executing on our transformation with great discipline, resulting in our significant growth in profitability and cash flow. Now I'll turn the call back over to Joel.
Thank you, Sabrina. With our foundation firmly in place, I'm energized to walk you through the specifics of our 2026 strategy that will drive our expected growth. As you know, we outlined a three-phased approach to our turnaround. We laid the foundation in phase one and phase two, and we are now entering phase three, which is about driving sustainable top-line growth. Internally, this phase three strategy is called Reach for the Sky, which is all about looking up and driving forward, leveraging our competitive advantages and capitalizing on the growth opportunities we see across our business. It is also about the opportunity I see for Petco to be reimagined and broadened beyond primarily being a commodity-driven business. It is about the blue sky opportunities Petco has to engage with pet families through the ups and downs and the real-life experiences of raising a pet.
Our team has tenaciously driven cost savings, and now we'll continue with that same rigor while driving sales and reaching for the sky. Petco is the only national, fully integrated and comprehensive pet care ecosystem. Our vision for the Reach for the Sky strategy is centered around leveraging our differentiated store-based model to bolster our competitive positioning, increase relevance, and improve store productivity. We plan to fuel our growth by offering product newness and differentiation, as well as further strengthening our community of pets and their humans through our unique store experiences, integrated omni-channel model, and wholly owned services. We are in the early innings of capitalizing on the significant opportunities that we see to gain share of wallet across all our businesses. The groundwork in 2025 has served us well. We expect these initiatives to grow sales and become more impactful as they materialize throughout 2026 and beyond.
Now, I'll outline the detailed framework of our Reach for the Sky plan to drive sales within each of our four pillars. I'll begin with our compelling product offering, specifically within consumables. This is roughly half of our business today, and in the U.S. alone, it's a $54 billion market. I'll talk about four key catalysts within consumables to jumpstart growth beginning this year. First, fresh food is one of our biggest opportunities. We've been a primary destination for fresh food for a long time and are continuing to build on that foundation by expanding the assortment. This category at Petco experienced healthy growth in 2025, and we expect the momentum to continue in 2026. This is an example of a category that exemplifies the significant advantage our store ecosystem brings.
Beginning in Q1, we're adding additional freezers, amounting to over 1,000 incrementally over the course of the year, which will enable us to expand our range of offers meaningfully. Our focus on driving share of wallet in the fresh food category is intentional. Of note, those that buy fresh food from us make over four more trips per year and spend over 50% more annually than dry food-only dog customers. Secondly, we will launch new national brands. This area starts with communication. I have personally met with the leaders of several of our key consumables partners. They are aligned with our goals and objectives and excited about the renewed energy and focus of growth at Petco. At the center of our strategy, we'll be infusing a high degree of newness, including a significant number of new brands and flavors being added this year.
The majority of these are launching in the first half. We expect these to generate excitement and customer interest, and we look forward to discussing these with you in future quarters. Third, we are increasing the frequency of product drops. Historically, we set consumables merchandise annually with one big cat and dog food reset. As you can imagine, this didn't provide our customers with multiple reasons to see what's new at Petco, and often we were the last to roll out a new innovation or flavor. We are changing this approach meaningfully by continuously layering in product newness throughout the year, both in consumables and supplies. This is designed to create excitement and freshness of product and will entice our customers to walk our aisles more frequently. Fourth, we are ramping our own brands business. This is within consumables and supplies.
Own brands account for about 20% of our sales today and have the potential to become more meaningful over time. As part of our own brand strategy, we will anchor our focus on our strongest seven private labels, which already account for a significant percentage of our own brand sales. Therefore, leveraging the strength of these brands and increasing their presence and relevance. This focus on own brands is intended to allow us to go faster and fill in voids our national partners don't have visibility to. In terms of key initiatives, in consumables, we plan to offer new formulas and packaging in dog food. In supplies, we'll expand our own brands business across categories and offer newness and innovation more broadly, such as in beds, bowls, collars, leads and toys. As we've mentioned prior, the margins of own brands are significantly above that of national brands.
In the supplies and the companion animal category specifically, we are introducing new assortments that we believe will further differentiate us from competitors. An example is newness in insects, such as jumping spiders and tarantulas, which we see as a newer pet trend in the United States. This customer basket is also likely to include ancillary supplies and consumables. Additionally, we launched Gardening with Your Pet this month, a new category for us in nearly all of our stores. It includes gardening products and plants that provide customers with pet-friendly options. Moving on to our services pillar. We also see abundant opportunities to continue growing our wholly owned services business, which is a key aspect of our differentiated model. Services include vet hospitals, vaccination clinics, grooming and dog training. This business was a strong performer in 2025, and we are expecting continued growth in 2026.
While we took a purposeful pause in constructing new vet hospitals last year, we've been laser-focused on improving productivity of our existing locations. In 2025, we optimized a significant number of our approximately 300 hospitals, and we'll work on increasing the productivity of the still roughly 25 underutilized locations this year. Know that even after we complete these, there is still a sizable runway for driving higher sales and productivity improvements from these 300, and we will be focused on maximizing their potential. Bottom line here is that we are committed to the vet business as a key growth engine and are in the early innings of assessing the longer-term opening cadence and growth opportunity. That said, you should expect us to start growing our hospitals in 2027. We will keep you updated on plans as they come together.
I'd like to emphasize that our key competitive advantage in this space is that our vet hospitals are wholly owned and are part of the store. We uniquely have the opportunity to capitalize on retail traffic and to share customer information. As we've discussed prior, the opportunity is twofold. Grow the vet business as well as become a full-service pet needs provider by cross-selling food, prescriptions, and supplies. I'm pleased to announce that we are adding technology and functionality beginning later this year and into 2027 to better enable this. The goal is to drive incremental trips and increase sales per customer. We are now operating on a scale that gives us the depth of expertise, breadth of coverage, and overall respect of the industry to be a desired employer of choice for veterinarians and vet techs to grow their careers at Petco.
The third pillar of growth opportunity I want to discuss is our key competitive moat, our differentiated high-touch store ecosystem. Our stores represent a significant portion of our total sales, and so they remain a key focus for us. We have changed leadership, reorganized how we operate, and unified our center-of-store operations with our services. We have also physically brought our stores and services leadership together three times in less than 12 months so that communication can be cascaded with one voice and expectations are clearly aligned. Our goal is to leverage stores to build community, excitement, and customer loyalty through frequent newness, higher levels of customer engagement, such as holding fun events for families and pets, and through wholly owned services that promote repeat visits. The end goal is to drive both traffic and basket.
Our marketing efforts will be centered around driving traffic to our stores by building awareness for our product newness and in-store experiences. We will also capitalize on a more engaged customer in stores by focusing on increasing basket size. Specifically, we launched a major training initiative in February for all district and regional managers to promote cross-selling opportunities. This initiative is being cascaded to all stores this quarter. We estimate that successful cross-selling can drive one to two additional trips, as well as a higher sales per customer over a six-month period. An example of this is a focus on converting grooming customers to purchase merchandise by giving groomers access to a customer's purchase history across the store. To give a sense as to how impactful this initiative could be, about half our dog customers currently don't buy dog food from us.
You can imagine the opportunity to capture a much greater share of their wallet. What backs our confidence in the long-term viability of the store model is that shopper demographics are also on our side. Industry data tells us that 34% of Gen Z customers shop exclusively in stores. Interestingly, this group's preference for an in-store experience is much higher than Gen X or Millennials and is virtually in line with Boomer preferences. We see this as a huge long-term opportunity, with the Petco model well-positioned to capture Gen Z's desire for experiences and connections. Our field leaders are excited about these opportunities, and we will have more to share with you as the year progresses. The final pillar of our Reach for the Sky's initiative is centered around integrated omni-channel.