Freshpet, Inc. (FRPT) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Freshpet First Quarter 2015 Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to your host for today, Ms. Katie Turner. Ma’am, you may begin.

Thank you. Good afternoon and welcome to Freshpet’s first quarter 2015 earnings conference call and webcast. On today’s call are Richard Thompson, Chief Executive Officer and Dick Kassar, Chief Financial Officer. Scott Morris, Chief Marketing Officer, will also be available for Q&A. Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management’s current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements. Please refer to the company’s Annual Report on Form 10-K filed with the SEC and the company’s press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Finally, please note that on today’s call management will refer to certain non-GAAP financial measures such as adjusted EBITDA. While the company believes these non-GAAP financial measures will provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information provided in accordance with GAAP. Please refer to today’s press release for a reconciliation of the non-GAAP financial measures to the most comparable prepared in accordance with GAAP. And now, I would like to turn the call over to Richard Thompson, Chief Executive Officer.

Thank you, Katie. Good afternoon, everyone and thank you for joining us on today’s call. I will begin with an overview of our first quarter financial and business highlights. Then, Dick will review our financial performance in more detail and review our outlook for the full year 2015. Finally, Dick, Scott and I will be available to answer your questions. We started the year off very well and I am pleased to report that we achieved another quarter of strong financial results. In the first quarter, we generated net sales of $27.1 million, up approximately 40% compared to last year. Our net sales growth continued to outpace our distribution growth. Freshpet Fridges increased approximately 21% to 14,019 in addition to increasing velocity per fridge. This increased sales momentum helps us realize scale, efficiencies and increased cost savings from our Freshpet Kitchens. Our solid start to the year has positioned us very well and we believe that 2015 will be another year of strong growth and profitability as we bring the power of fresh food and fresh snacking to more pets and pet parents. Freshpet’s growth is driven by the increased demand for better-for-you pet food products. Favorable consumer trends also continued to benefit us. According to the American Pet Products Association for pet food increased 3.2% to $22.3 billion. Pet parents are increasingly looking for fresh, natural pet food. Luckily for them, our distribution across grocery, mass, club, pet specialty and natural channels continue to increase as we further penetrate our existing and new retail partners. Freshpet is a trusted brand in pet food and our consumer loyalty rates demonstrate our ability to deliver a superior product that is not only nutritionally beneficial to pets, but also tasty and great. As the strength of our business grows, we are well on our way to becoming a leading brand of choice for pet parents and one of America’s fastest growing pet food companies. Our increased sales momentum enabled us to experience cost savings and helped drive profitability increases. Adjusted EBITDA improved $1.2 million to $2 million in line with our expectations for the first quarter. We look forward to benefiting from cost savings in future quarters as we leverage our organization and achieve greater operational efficiencies. Our team is always thinking of fresh ideas and ways that we can bring more fresh and healthy foods to our pets. We have an impressive history of pioneering new products as you know. As we mentioned last quarter, our new fresh shredded and fresh raw products are now being rolled out across certain retailers. The response thus far on each of these products from pet partners and our retail partners continue to keep us very enthusiastic about future growth and potential incrementality to our business as we continue to improve the productivity of our Freshpet Fridges. Ongoing innovation remains a top priority for the company and will be a cornerstone for continued growth. We believe the Freshpet brand is perceived by consumers as delivering high quality, fresh food for dogs and cats, thus giving us a very strong platform for new product development. As you can imagine, delivering fresh food on a national basis is very difficult to do and our team has worked hard over the last several years to build the infrastructure and create a platform for growth that is not easily duplicated. And everyday we find technology or information to make the process even better. We recently launched a test of our fresh baked food. This is a non-refrigerated, fresh-baked ultra-premium pet food now available at Target. This is great news and quite an accomplishment by our team. We are excited to test a shelf stable option to our already diverse portfolio of Freshpet food products. This ultra-premium fresh baked pet food appears to be performing well thus far. Dick will discuss the impact this test has had on our Q1 financial shortly. Let’s keep in mind that our goal is to continue to deliver innovation to the pet food category with fresh food for dogs and cats. Going forward, our team will continue to develop an improved mix of products as we believe will help drive increased velocity. With 14,019 Freshpet Fridges at the end of Q1, we continue to believe we have considerable opportunity to expand our distribution footprint, increase brand awareness and grow our market share. In addition, we are committed to growing our distribution and delivering fresh, healthy and delicious meals with locally sourced fresh meats and fresh vegetables. We operate our Freshpet Kitchens utilizing human food standards where quality and safety are the cornerstone of how we make our foods. All of our recipes, cooking processes and packaging create a healthy and difficult to replicate combination. The keys to the growth of our business remain having the best quality everyday and increasing brand awareness and trial. Marketing continues to play an important role increasing Freshpet’s overall brand awareness and helping us connect with pet parents. Marketing communication efforts have helped us outperform our advertising productivity model and higher growth than anticipated in Q1. In summary, we have started 2015 with positive momentum. We really believe Freshpet is positioned in the right industry with the right products at the right time. We are squarely positioned with the growing intersection of health and wellness. And as individuals look to eat more healthy diets with fresh fruits, vegetables, meats, this naturally translates over to their children, family and of course their pets. Going forward, our team continues to be focused on expansion of our Freshpet foods network and on driving net sales growth. We believe our ability to increase our sales volume will allow us to increase our current capacity utilization. Over the last several years, our team has invested in our corporate infrastructure and we believe we are now at a point in our growth to truly improve our operating efficiencies, drive greater leverage across our business model and in turn enhance shareholder value. With that overview, I will now turn the call over to Dick, our Chief Financial Officer who will review our financial results in more detail. Dick?

Thank you, Richard and good afternoon everyone. I will review our first quarter financial results and we will then review our full year outlook for 2015. For the first quarter, consolidated net sales increased 39.8% to $27.1 million. Excluding the impact of the fresh baked test products, net sales for the first quarter of 2015 increased 37% to $26.5 million. This growth was driven by a 20.9% increase in Freshpet Fridges, which resulted in distribution gains across all retail sales channels and velocity gains in existing stores. Gross profit for the quarter increased to $13.3 million, up from $9.3 million during the same period last year. Our first quarter gross margin was up 100 basis points to 49% versus 48% in quarter one of 2014. The increase in our first quarter 2015 gross profit reflects higher net sales and lower manufacturing costs per pound, partially offset by higher depreciation from the use of the company’s new Freshpet Kitchens in Bethlehem, Pennsylvania. SG&A expenses decreased as a percentage of net sales to 58.4% from 59.9% of net sales in the same quarter last year. Adjusting for fair value of warrants and stock-based compensation expense, SG&A expense decreased as a percentage of net sales to 51.3% from 58.8% in the same quarter last year. Looking ahead, we expect to further decrease SG&A as a percentage of net sales as we increasingly scale our operating efficiencies and better utilize our existing infrastructure while growing net sales. Adjusted EBITDA increased $1.2 million when compared to the same period in 2104 to $2 million. Excluding the impact of fresh-baked test product, adjusted EBITDA increased $1.8 million when compared to the same period in 2014 to $2.6 million. As a reminder, adjusted EBITDA is a non-GAAP financial measure. Turning now to the balance sheet, at March 31, 2015, the company had cash, cash equivalents and short-term investments, which were certificates of deposits, of $32.4 million. The decrease in cash is primarily due to expenditures related to the expansion of our Freshpet Kitchens and capital investments to increase distribution through the purchase of additional Freshpet Fridges. In conjunction with our initial public offering, we entered into a $40 million credit facility, of which zero was outstanding at March 31, 2015. We continue to expect to use some of our current liquidity to expand our manufacturing facility to meet growing demand and further grow our distribution network. I would now like to review our full year outlook. For the full year 2015, we expect Freshpet Fridges in the range of 15,100 to 15,600 stores, representing an increase of approximately 13% to 17% compared to the prior year. We project our net sales, excluding Freshpet Baked test product, to be in the range of $112 million to $114.5 million, representing an increase of 29% to 32% compared to 2014 and adjusted EBITDA, excluding Freshpet Baked test product, to be in the range of $16 million to $17.5 million, an increase of $10.5 million to $12 million compared to 2014. As a reminder, our adjusted EBITDA represents EBITDA plus loss on disposal of equipment, new plant startup expenses and processing, share-based compensation, launch expense and warrant expense. We also are investing approximately $24 million to $26 million in capital expenditures of which $4 million has been spent to-date to expand our plant capacity with projected completion date in the second quarter of 2016. We would like to briefly discuss the expected stock compensation expense in 2015. As we mentioned on our last earnings call, the valuation of options increased as a result of the higher common stock valuation during the lead up to the IPO. As a result, we forecast stock compensation for 2015 and ‘16 to be approximately $7.5 million and $8.2 million respectively. After 2016, we expect our stock compensation to normalize at approximately $3.5 million a year. That concludes our financial overview. I will now turn the call back to Richard for closing remarks. Richard?

Thanks, Dick. We are pleased with the start to 2015 and appreciate all of the hard work and dedication from our valued Freshpet team members. Our team remains committed to our core values. Everyday, we challenge ourselves to find new and better ways of delivering the benefits of fresh, real food to our pets. We work to be transparent and honest in every facet of our business. And finally, we strive to do what’s right for pets, people and the planet. We appreciate the support of our pet parents, retail partners, vendors and shareholders. We would now like to open up the call and take your questions. Operator?

Thank you. [Operator Instructions] Our first question comes from the line of Jason English of Goldman Sachs. Your line is open. Please go ahead.

Hey, Jason.

Hey, guys. Good evening.

Good evening.

I wanted to talk a little bit more about the dry product. It sounds like it has or it seems like it has the potential to be a fairly big idea. I want to get a better sense of how many stores you are in today. What does early read of performing well mean? Do you have any sense of cannibalization? And then I will follow up with Dick in terms of the profitability, the cost and what the forward looks like on that?

Okay, thanks for the question, Jason. I will let Scott kind of answer that for us. Scott?

It is quite early. We are in a significant number of the Target business, the majority of them in the test. At this point in a new product launch, I typically kind of refer to it as kind of either red, yellow or green, meaning it’s either going very – it’s either going well, kind of maybe I am not so questionable or it’s not going well. And I would say everything is pointing us to green at this point in the launch, but again I want to stress it, it is quite early. From that cannibalization standpoint, the read seemed to be consistent with the initial in-home testing that we did and the quantitative testing that we did and we are seeing very, very low cannibalization rates, low single-digits cannibalization rates at this point.

That sounds good. That sounds great. In the preannouncement, you broke out some of the profitability contributions, there wasn’t a lot of gross margin tied to it and there was a lot of R&D expense tied with it that drove it pretty deeply into negative territory, is what played out in the quarter consistent with the preannouncement. And if so can you talk about how much of that’s sort of transitory, what does the ongoing cost structure look like for this business and what kind of margins look like on the longer term?

Well, we are looking at margins, it’s a co-packed product. We are looking at margins in the mid-30s and then – and the logistics expense coming out of that. So that’s basically where we are if we continue – if the test goes well and we continue expansion. We would – we have our people on site there. So we have a chance to optimize margins as we go forward. But right now we are kind of in the mid-30s.

Okay, thanks. One last one, a short one then I will pass it on. There has been some press reports recently, it looks like more noise around some old issues, it seems small, seems inconsequential seems like sort of normal course of business, but I want to make sure you guys sort of agree with that view and kind of weigh in on your perspective of the implications?

Yes. Jason, for sure, we are not making Hostess Twinkies over here that last on the shelf for years and years, is that we are making fresh real food and fresh real food on a national distribution basis is hard to do. And once in a while, if the package is not treated correctly, you will get mold. But let me have Scott address a little bit more. Scott?

Sure. So as Richard said, it is fresh food. If in anyway the bag gets compromised, whether it’s bumped or poked or cut at retail or through the supply chain and air reaches the food, it could – you could get mold. But to put it in perspective, this is the same level of mold complaints that we have had over the past 2 years. In fact the number is about 30 per 100,000, 30 complaints per 100,000 bags, so you can kind of put that in perspective. Right now we are selling about 390,000 bags per month and it is growing at 52%. So our bag business is growing significantly. Even though it’s a small number, we are very focused. We were – before we knew this conversation was coming out, we are focusing on quality and improving quality. And we are working not only on package strength, but also changing the case configuration around to get that number – we would love to see at zero obviously. But if a bag does get compromised, you could run into an issue.

So just to ensure everybody that we are focused on quality everyday and to do it better and better and so we – I don’t believe we will ever get to zero, but we certainly everyday work to get at a lower rate.

Great. Thanks a lot guys. And I will pass it on.

Thanks.

Thank you. Our next question comes from line of Robert Moskow of Credit Suisse. Your line is open. Please go ahead.

Hi there, how are you doing?

Good Rob, good.

Just wanted to make sure I understood the adjusted EBITDA guidance $16 million to $17.5 million, did you say that excluded the expense of the tests?

Well, it excludes all of Baked, so to the extent that the early results of the tests are negative because we had trials during the first quarter, production trials in R&D. If in fact the test is successful, any margin, the 35% margin I just alluded to previously on future revenues is also excluded from the range of $16 million to $17.5 million. So yes, the expense is excluded in this period, but any positive margin going forward assuming the test is successful is also excluded.

So is it the expectation that the test will be successful and this will be positive EBITDA for the year?

If the test is successful, then it would be positive EBITDA for the year.

And we try to do a lot of things around here that are positive, so – but we are still always looking for new opportunities, new ideas. And you have to go out and you have the test them. And that’s what we are doing.

I mean the other thing Rob is if in fact it is positive EBITDA and we want to generate more awareness, it’s possible that with that margin that we have on the product that would reinvest in further growth of that product.

Yes. I mean most tests or at least first year launches maybe not tests, but first year launches can be negative EBITDA just because you are investing more in marketing to increase awareness, but in this case that’s not the plan, right, the plan is that if it’s successful it would be positive EBITDA, that’s the plan for the test?

Well, no, basically, the plan for the test is if it’s positive EBITDA and it’s a successful – and if it’s a successful test, we may elect to reinvest those positive funds back into developing that brand further.

Yes, as Rob was mentioning.

As Rob was mentioning.

Okay, okay. Yes, go ahead, Richard.

No, that’s I just want to – it’s still a test and in the next kind of 30 days, we will know a lot more.

Okay. And then just to – I wanted to check on – there is a couple of major customers of yours that you thought might be kind of dragging their feet a little bit in terms of getting new merchandising and just being able to execute the way they normally execute. Any changes in that timing or anything like that? Are they still kind of in the throes of rethinking their broader strategies? And is that still kind of slowing things down, I guess?

I think the information that we can definitely share is that we feel – we do feel consistently good about the range in stores that we – the guidance that we gave on the last call, the 15,100 to 15,600 and Dick just reiterated it. There are a handful of retailers that have had some challenging times this year. There always are. And we are waiting on a couple of reasonable size opportunities that are kind of pending for Q3. And I think that will – depending on how those come through, it will put us at different places in the range.

Right, okay. So, yes, I mean, a couple of months ago, I think you kind of – that’s what you said, so there is no new news on that front in terms of that?

No, but we keep – well, I can assure you Rob we keep working hard everyday and everyday, we make more and more contacts and everybody loves what we are doing.

Just like sell-side analysts, work hard everyday, make more contacts.

I can’t speak for them, but I can speak for my team.

Okay, thank you very much.

Thanks, Rob. Appreciate your calling.

Thank you. Our next question comes from the line of Peter Benedict of Robert W. Baird. Your line is open. Please go ahead.

Hey, Peter. Thanks for calling in.

Hey, guys. It’s Matthew Larson on for Peter. How are you doing?

Good Matthew. How are you doing?

Good, good. Well, hey, you called out the solid performance of the continued consumer marketing initiatives in the release, could you provide some additional color on that? And then what sort of lift are you seeing from the Made to Matter feature at Target here in the last couple of months?

So, basically, what we are referring to is if you look at the results – you know how we have that advertising model that we have talked about over time that we established really in 2011 and we have been able to carry it through where per 100 GRPs, you get around a 1% increase in the business? In Q1, we were able to outperform that pretty significantly and it was centered around the advertising in that period or in Q1. We hope that it continues to outperform, but we are not going to – we don’t want to budget it that way. We just don’t want to budget it that way. So, hopefully, it does continue to outperform. We are spending slightly less in Q2 on advertising than we did in Q1 and that’s very typical. We typically spend the most in Q1 and a little bit less in Q2 and Q3 in our typical years. And then on the Made to Matter piece, I think it’s still early. The Made to Matter – there is a whole series of activities that are centered around Made to Matter. So, it’s terrific that we have the display tied in with the dry food and they have recognized us as Made to Matter on our Fridges. There are many, many opportunities out the year for us to interact with Made to Matter consumers, events and different things. In fact, over the course of the year, we will be handing out significant numbers of samples to hopefully continue to get consumer trial. So, we – I don’t think we have seen a lot at this point, but I would say it’s very early on the Made to Matter execution. They are literally layered in between now and I am sure Target has some information out of this, but they are laid in basically between now and the end of the year at different Made to Matter activities.

That’s great to hear. We will stay tuned. Just one additional one, could you speak to the – to what you are seeing as far as velocity gains kind of across your footprint, any additional color by channel where you are seeing the strongest growth?

Typically, where we see the most significant increases in velocity are the channels that are outperforming the category. So, you kind of start at the top, in pet specialty, we typically get a little bit better performance or stronger kind of same-store sales growth. Right under that, you kind of have mass and then grocery. And that’s very – if you look at kind of the growth rates across those channels, it’s pretty similar. What I mean by that is if you look at the growth rates in pet, those are going to be the highest, mass is going to be second, and then grocery is going to be slightly lower. So, outperforming in pet and mass and then grocery is kind of the last on the list. And Whole Foods and natural is a clear outlier for us. We are seeing in terrific numbers coming from them.

That’s great. Well, thanks a lot.

Thank you, Matthew.

Thank you. The next question comes from the line of Scott Van Winkle of Canaccord. Your line is open. Please go ahead.

Hey, Scott.

Hey, guys. It’s Mark Sigal for Scott. Wanted to come back to the fresh baked. One, I am wondering should test prove successful, the longer term appetite to bring that product in-house, what type of investment that might necessitate and how that product potentially would slot in with your existing distribution network?

Well, first of all, it’s way too early to even talk about that. And it would not fit with our fresh distribution at all and it wouldn’t fit in our fresh manufacturing facilities, because that’s completely different opportunity and operation. So, it’s just way too early to think about that. We have got to get through the test and then even when we get to the test, we would have to roll it out of ways and see how it performs in more of a general market before we would even think about it.

Okay. And then can you talk a little bit about this year your visibility, your comfort level, realizing that there is a variance from the low end to the high end in your Fridge guidance and maybe not so much versus last year, because it was a heavy year in the first half of the year in terms of new Fridge adds, but historically versus the last couple of years, where you feel your comfort level is at this point in the year on progress towards your full year Fridge objective?

Yes. I think that the numbers that we gave the guidance around from a Fridge standpoint really are – we do feel good about those. And I think we made the comment last time that we want to guide on what we know and not what we think to come into that 15,100 to 15,600 range. The other component that I think is really important to keep in mind is that velocity is outpacing expectations. So, even though Fridges may be slightly lower than if they came in somewhere in kind of the lower end of that range, we still feel good about the velocity and the dollars projection for the year. And then I think the most important point around all of this is if we continue to outgrow category growth rates at the level we are, I mean, if you look at our – we are still kind of – even – pick a chain, pick a class of trade, we are into the high 30% growth rate. We are dramatically outgrowing the category. All the stores will eventually come that we have planned on. It’s just a question of timing and our timing aligning with the retailers’ timing depending on what dynamics are going on in the marketplace.

Okay. And then we have heard some recent commentary around some macroeconomic sensitivity in some of the food retailing channels. I am just wondering if you are picking up on any instances of that from your customers?

No, we really haven’t at all. I think that there are some – some of the dynamics that you are referring to, I don’t think are directly applicable to us. I think that if you are referring to maybe some of the more natural channels, I think it’s because consumers are being spread across other channels that are entering in kind of that natural and organic space. We are in a little different situation. We are not seeing softness in our business. You can see it – we kind of moved right through Q1 quite well as you can see by the numbers. So, we are not recognizing that.

Alright. Thanks, guys.

Alright, thanks for calling in, Mark.

Thank you. [Operator Instructions] Our next question comes from the line of Bill Chappell of SunTrust. Your line is open. Please go ahead.

Hey, Bill.

Hey, thanks for taking the question. Just anyway to kind of characterize the doors to-date, the new coolers to-date kind of between mass and specialty and what have you just as we kind of look on the velocity going forward for this year?

To-date through Q1, about two-thirds of the stores – yes, right around two-thirds of the stores in Q1 were mass and the vast majority of the rest of them were in grocery. And we anticipate the mix shifting more towards grocery and mass throughout the back of the year. Most of the time – or basically what we are expecting to see is we will see those numbers or the stores that we are adding being consistent with our kind of average run-rate across mass and grocery. We don’t expect the mix of those stores to have any significant impact either way.

And just as I look at kind of the door count in your kind of guidance for this year, I would imagine with kind of a 6-month, 9-month lead time for orders, I mean, do you have a pretty good idea of where we are going to fallout at this point? I mean how much upside potential can there be?

Hey, Bill, we are just going to stay with the guidance we got. So, that’s where we are at. We appreciate the question, but we are very confident we will be in our guidance range.

And then last one for me, just kind of an update on, and I might have missed it, on raw and shredded?

Oh, no, that’s a good question. Scott, why don’t you handle that?

Yes. So, actually, that is good. So, we are seeing – and if I were – mentioned this in the past, we have seen between 4% to 10% incrementality on the raw business that we have launched. We are right now in all the PetSmarts and we anticipate it continue to expand out through pet specialty over the course of this year where we will be in the majority of pet specialty in – kind of by the middle of the year. So, it’s going quite well. We are happy with the results and again going very well. On the shredded, we are in about 50% of our total universe or closer to 65% or 70% – around 70% of our grocery and mass at this point on the shredded product. And that will fill out a little bit further through the course of this year where raw and shredded over the course of the year will end up being in the vast majority of our appropriate channels. So, the raw is in pet specialty and the shredded is in grocery – across grocery and mass.

Okay, great.

The one other comment on the shredded, we are seeing 72% incrementality on the shredded piece of business. So, we are – those are kind of in line with the projections and we are very happy with the lift that, that’s driving and we are anticipating that will help be a nice velocity driver in the back of the year.

And Bill, my dog has been eating shredded for several months and he loves it.

I believe it. Just one on that, when you say 72% incrementality, I mean, what does that mean for kind of same-store sales for a cooler?

That’s a good question. So, we are seeing overall Fridge sales, where it’s been fully tested, increase by – I will put a number somewhere between 5% to 7% when we introduced the shredded product in.

That’s great. Thanks for the color. I am glad to hear Potters [ph] is enjoying the shredded.

Yes, he has. He says hi.

Thank you.

Thank you. And I am showing no further questions in the queue. I would like to turn the conference back over to Mr. Richard Thompson for any closing remarks.

Thank you very much everyone for being on the call today. We appreciate your support. And anything that we can do for you, you know where you can find us, and if it’s not a blackout period, we are more than happy to talk to you. So, thank you very much and all have a good evening.

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Have a great rest of your day.