Freshpet, Inc. (FRPT) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for your patience. You've joined the Freshpet Incorporated First Quarter 2016 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Ms. Katie Turner. Ma'am, you may begin.

Thank you. Good afternoon and welcome to Freshpet’s first quarter 2016 earnings conference call and webcast. On today’s call are Richard Thompson, Chief Executive Officer; and Dick Kassar, Chief Financial Officer. Scott Morris, President and Chief Operating 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 the actual results to differ materially from those described in these forward-looking statements. Please refer to the Company’s Quarterly Report on Form 10-Q which is expected to be filed with the Securities and Exchange Commission 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 on today’s call, management will refer to certain non-GAAP financial measures, such as EBITDA and adjusted EBITDA. While the Company believes these non-GAAP financial measures 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 presented in accordance with GAAP. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. Now, I'd like to turn the call over to Richard Thompson, Chief Executive Officer.

Thank you, Katie, and good afternoon everyone. To begin, I will provide a brief overview of our financial highlights and recent business performance. Then Dick will review our first quarter 2016 financial results in more detail. Finally, Dick, Scott, and I will open up the lines for questions. We're pleased with our start to 2016 as we execute on our mission to bring the power of fresh real food to dogs and cats. We strive everyday to give pet parents products that their dogs and cats love and having positive impact on the pet's lives. We see the results of our work in thousands of happy letters we've received from pet parents all across America which you can view on freshpet.com. In the first quarter several key metrics showed improvement as compared to the prior year. These include net sales, velocity, store growth, quality, production throughput, purchasing and logistics. Our first quarter 2016 net sales increased 16.3% to 31.5 million driven by increased velocity per fridge and increased store count. Freshpet fridge store count increased to 15,429 as of March 31, 2016, up from 14,019 in the first quarter of the prior year. Product innovation continues to be a key area of focus for our team and we made good progress on this front in the first quarter with the launch of our Vital Whole Blend products at pet specialty and expanding our cat portfolio starting in March. Whole Blends is a meal enhancer that is being offered in the pet specialty category while our expanded cat portfolio will be offered across all retail sales channels during 2016 and 2017. Over the year we will see expanded distribution on these products in addition to the innovation as our Kitchens’ capacity and capabilities come online. From the manufacturing standpoint our planned expansion remains on schedule and on budget. We're on track to have the expansion completed in the second quarter of 2016. We continue to train our plant personnel and expect commercial production during July and August on our two new production lines. On the completion of this expansion our annualized capital needs will be reduced significantly over the next several years to support Fridge growth and maintenance CapEx. We remain focused on the execution of our strategic initiatives, which have enabled us to generate increased adjusted EBITDA and positive operating cash flow during the past six quarters while growing net sales and store count at a double-digit rate. We appreciate the hard work and dedication by all of our team members we expect our efforts to drive greater leverage across our business model, improve profitability and enhance long term shareholder value as we progress through 2016. With that overview, I would like to turn the call over to Dick Kassar, our CFO, and to review our financial results in more detail. Dick?

Thank you, Richard and good afternoon everyone. I will now review our first quarter 2016 financial results. For the first quarter, net sales increased 16.3% to 31.5 million. This growth was resulted from both distribution and velocity gains, including a 10.1% year-over-year increase in Freshpet Fridges. Gross profit for the quarter was 14.9 million compared to 13.3 million during the same period last year. Gross margin was 47.3% for the first quarter of 2016 compared to 49% for the first quarter last year. New product introductions lowered our gross margins for the period by approximately 120 basis points, while the hiring and training of our planned expansion is scheduled for commercial production during the second and third quarter impacted our gross margins by another 76 basis points. As a reminder for 2016, we expect the gross margin of approximately 46.7%, which will include additional depreciation and personnel required for our planned expansion. Along with incremental costs for our product launches including cat and vital whole blends. For 2016, margin projection captures the 1.5 million startup cost of ramping up the new production lines at our Freshpet Kitchens prior to realizing higher production volumes, along with 1.2 million of depreciation on the new equipment. After adjusting for stock-based compensation fair value warrant expenses SG&A expense increased as a percentage of net sales to 49.4% up 51.3% in the same quarter last year. Looking ahead, we expect to decrease SG&A as a percentage of net sales, as we increasingly scale our operations and better utilize our existing infrastructure while growing net sales. Adjusted EBITDA was 2.5 million for the first quarter compared to 2 million in the first quarter of 2015. Turning now to the balance sheet, at March 31, 2016 the company had cash and cash equivalents of $300,000. The decrease in cash was primarily due to expenditures related to the expansion of Freshpet Kitchens, capital investments to increase distribution through the purchase of additional Freshpet Fridges. As you may recall we are expanding our plan capacity to provide for sales of up to $400 million which represents an increase of 130% from current capacity levels. We continue to be on track with this project and estimate completion for construction in the current quarter. As a result, we expect our operations to begin in June as we estimated part of our 2016 plan was to borrow approximately 8 million to 10 million from our credit facility by the third quarter of 2016. And we expect to repay this indebtedness by the first quarter of fiscal 2017. As many of you know when conjunction with our initial public offering we entered into a 40 million credit facility of which zero was outstanding at March 31, 2016. Each quarter in 2015, we generated positive cash flow from operation and in the first quarter of 2016 this trend continued. Finally, we are reiterating our guidance for 2016. We expect Freshpet Fridges of over 16,600, an increase of approximately 10%, net sales of over 137 million, an increase of approximately 18%, adjusted EBITDA of over $18.5 million, an increase of approximately 67%. From a seasonality perspective, we expect our net sales growth to be more weighted to the second-half of the year, as we realize the full benefit of our distribution, media, and new product. And we continue to expect adjusted EBITDA to more heavily weight to the fourth quarter as our expenditures lighten considerably due to the timing of our planned media program. As a reminder, our adjusted EBITDA represents EBITDA plus loss on disposal of equipment, new plant startup expenses, share-based compensation, launch expenses, and warrant expense. We see strong growth for our products across our distribution network and we will continue to maintain a strong balance sheet and liquidity to meet demand and further grow our distribution network. That concludes our financial overview. Richard, Scott and I are now available to take your questions.

Thank you, sir. [Operator Instructions] Our first question comes from the line of Peter Benedict of Robert Baird. Your line is open.

Just wanted to start off with few a questions nice quarter by the way, Scott, can you speak to some of the channel strategies you guys have began putting into place this year to focus the organization around fridge growth, the first quarter came in nicely above our models, anything that you are seeing as far as early traction there? Perhaps any new developments related to some of the channel partners you had delayed with last year?

So from a service standpoint, we had talked about it at the end of last year. And really into the beginning of this year, that we were basically kind of reassessing what many of the opportunities were that we had from a store growth perspective and how to kind of capitalize on those and really accelerate them as much as possible. I would say at this point we are starting to see some modest impact around that but we really anticipate those coming kind of more in the back of the year which is the way, we have really budgeted. We talked about it that had it in the notes a second ago. But we see kind of the strongest store growth in Q3 and then really that work is a foundation for this year but also puts us at a strong point for the next several years out on how we are looking at different opportunities, developing great portfolio of products, the right fridge mix and also really the right communications in addition to in incentives that we put across our sales organization and some of our external partners in order to make sure we are grabbing those stores and adding them into our distribution next. So I don’t think I mean we are really happy with the way the quarter developed but we think it's something that we are going to see more benefit from kind of further out at this point.

Okay, that’s great. And then Dick, just on the logistics opportunity and the model that you have spoken to before, did you see any incremental leverage on that line item in the first quarter here? And then remind us what type of savings do you expect in the second half of 2016 from the new contract that you guys were negotiating?

Yes, historically we will Titan has been a great partner has done a great job for us and we have been running at about 10% of net sales for logistics and in 2015, the first quarter we came in around 9.5%, we expect to pick up a half to a point with our new logistic supplier. And we'll start seeing those numbers creep in more in the second -- late second quarter and in the third quarter. But we feel good about though what's happened and how it's progressed thus far.

And then just one final one, could you quantify the baked sales and EBITDA impact in the first quarter and then just any related thought on that business? Thanks.

I don't know if we've -- what we said for 2016 is we would -- we estimated about $6 million worth of sales for the year and what we've said is anything we earn beyond that we will reinvest in developing baked. The first quarter our sales were approximately $1,500,000 million in baked. So, anything we earn on it whether we earn it in this quarter or we earn in the next quarter, we're going to give back to marketing to further develop the product line.

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

Can you help me on velocity trends Scott? Just, I think you gave us a pretty good look at that in the fourth quarter, I think you said that things have slowed little bit by design, because you were off air. Did your velocity trends improve in the first quarter as you came back on air?

Yes it's actually kind of come along exactly as predicted. We take a real close look at it in both POS and IRI. So, we're not seeing all of it yet in what we're seeing from a revenue and net revenue standpoint, but we really are seeing kind of really nice progress from a velocity standpoint. The thing we're running up against Bob which you may see is we had an incredible kind of early Q1 last year. In fact about 40% of our growth for the year last year was in Q1, so we made a tonne of progress there and we're kind of moving right into that. But when we were looking kind of worst prior periods, we're seeing really consistent nice upward trends on velocity, on every kind of period this quarter, so, every four week period or so. So, it's really responding exactly to how we kind of planned on the business and we're really happy with the results, they seem to be right in line with exactly how we budgeted.

You're telling on the new -- on the pace of new store adoptions, just in the last question, just sounded a little bit less comfortable than you did last quarter, just wanted to make sure that your -- you haven't changed your guidance. Is something changing with respect to the timing versus three months ago in terms of how quickly you can get those locations?

No, no not at all, in fact when we were at the ICR Conference, we were starting to kind of communicate that and message that out. And we had always planned on that you are kind of coming in at this pace, Q1 was really like right on what we planned. We knew some of the bigger opportunities were really developing in Q3 this year. Which is why we -- the way we kind of paced out the year and then close to the year. So, there are two [indiscernible] kind of [indiscernible] this year, there's more stores coming in the Q3 period and then once the capacity comes online with the Kitchen there's going to be more innovation contributing to the business growth in that kind of Q3, Q4 period. But no, no changes at all, maybe it was my first question Rob and I used to thank I have gotten one job. But there's -- we feel really great. We feel really great about where we are from the store standpoint we are right on for Q1 and we're looking at the number for the back of the year and we feel like we should be coming in right on plan.

If you need Richard to turn up the energy level, he's right there. So, he could dial [Multiple Speakers].

Thank you. Our next question comes from the line of Joe Edelstein of Stephens. Your question please.

I had a question about the marketing and the strategy that you guys have been using, maybe just some color on what's been working, what hasn't, and some future strategy like that you're going to look to implement going forward?

We use kind of three prongs to our growth obviously and then I'll talk a little bit about the marketing in a second, but obviously stores is a key component and then marketing around communication and education and I'll talk about that more specifically in a second. And the last one is innovation and we really have -- from the innovation we've been able to bring the market we're seeing nice incrementality on that. When you specifically look at the marketing piece around education and communication, TV has been kind of the anchor tenant in that piece. When we're talking about our marketing we continue kind of stick with our TV model, it seems to respond really almost exactly as planned. There is always other variables that are going in the market but responds very-very in sync with our plans and our spending. We're still continuing to see really nice response around that. And the area that we're continuing to be more and more work in as you're probably hearing from all packaged goods companies is everything around the area of kind of digital social media etcetera. So we think that we have some actually absolute best in class processes in digital and social media and how we are working with our consumers and we are continuing to really push that ahead as we really see the future and a big piece of the future of marketing as communicating digitally and socially and TV won't be as much of an anchor tenant in the next kind of couple of -- multiple years out. So -- anyways so that’s really how we are like we focus on it and we are thinking about it. Does that answer your question?

Yes, that’s good color. And then do you guys have any annual or quarterly the update to market awareness or brand awareness or how often do you guys get that data that feedback from people?

We really look at it annually. We will get some snapshots over the course of the year, but at the -- you see volatility kind of in the quarters and you can you need to look at multiple quarters of the trend. I mean based on the sales that we are seeing, I mean what we are seeing for every year and really anytime that we’d looked at it even quarters and half years we will see consistently growth from a penetration standpoint meaning we are more consumers into the brand and we are increasing kind of our loyalty and repeat rates. And we are seeing that consistently for several years now and based on the response of the business, we went on air on TV we are seeing growth based on almost exact correlation to the TV spending which typically means we have grown penetration and at the same time we have been able to hold on our network potentially usually grow our loyalty rates too. I don’t have the data in front of me but I would assume based on history that it would be really in line with what we are seeing.

Yes, that’s good. And then maybe just a real quick response to how the store conversation is going to the retailers Target had an issue but if that has been resolved, or how is all, the store talks going?

So every retailer has unique circumstances that it can potentially get in the way over the course of the year. The way we budget this is recognizing that we may run into some of those situations, so I don’t want to really get into the specifics around any one specific retailer but the conversation are still very strong. They are still seeing really nice growth, we are seeing significantly better growth than whether same store sales or whatever metric a retailer typically wants to look at we are seeing really strong growth versus what they are seeing in that category which they love. We are continuing to deliver super strong margins, typically category leading margins for them, and then in addition we are driving a lot of traffic into the stores and that’s what a Fresh product does versus some of the other products that they are selling. So we think we can be a real contributor to their category. The more people are educated and the more data and analysis they look at typically the more positive the conversations are with the retailers. So we are continuing to make slow, steady progress across every single trade group retailer very positive conversations in general and looking real positive for the year.

Thank you. Our next question comes from the line of Mark Astrachan of Stifel. Your line is open.

I wanted to ask about the split of fridge growth between existing and new customers if you could please, in terms of what's your expectations are here.

Sure. So we -- the thing that is always very encouraging is we are seeing growth and we can kind of look at the -- I don’t know if we have the exact number in front of us. But what we can say is we are continuing to see store growth, from new retailers, brand new retailers or what we call white space opportunity. We are also seeing growth from the existing customers and that’s kind of a perfect combination. If you can have your existing customers who are growing deeper and deeper into their distribution in the stores but also we are adding new customers in so in the last 120 days, we have added four new retailers into our kind of portfolio so that’s very positive. And we continue to believe we will see several more come throughout the rest of this year. But we are also again seeing nice consistent distribution growth from existing customers. And I think that that’s one of the things that is a great indication and speaks volumes to the success of the business and their perception of it and would they see longer term.

That’s great, and then shifting a little bit, the growth rate between pet specialty and figured math so it still seems like pet specialty is a bit weaker maybe you could a talk a bit about what's you are seeing there, sort of how that rolls to your expectations for the year please?

Yes, so we have been seeing in the back of last year on and off, we kind of defiantly saw some peaks of that and I think we may have mentioned it. And we are defiantly seeing at this where we are seeing a little bit of a softening in growth rates in the pet specialty channel and that’s not really just us, I think that they are seeing that in general and I think the data seems to support that. Where they are not seeing the high single-digit numbers that they have kind of traditionally seen and I think there are several different aspects of that. One is that I think that many retailers are really sharpening their pencil to compete against pet specialty. Secondarily you will hear commentary around traffic and online sales I think is another component. So we kind of went this year in knowing that was the case. We knew for the most part where a lot of stores are coming from and also had expectations around our velocity increases in timing, we're doing a lot of work across kind of going back to the original question on channel strategy, it's not just about gaining stores, but it's about getting as much velocity out of each channel as possible. And we've done a lot of work to really mixture that we're seeing velocity and the nice thing is we're staying ahead of pace for what any of these channels are seeing so. But I think that pet specialty piece is the one area where we are seeing a little bit more softness in the market. I don't think it's exclusive to us.

Thank you. [Operator Instructions] Our next question comes from the line of Dominic Ruccella of Wedbush. Your question please.

My first question was in regards to the cat product, I know last quarter you guys were still in the task, but I was wondering if you have any further updates in terms of how that's going, any feedback you are getting from the sale right now?

From a cat standpoint, we had actually mentioned it I think it was in the script last quarter that we expect it to see it in over 2,000 stores by the end of May. We anticipate it to be right on track there. The cat food products that have gone into market appear to be performing kind of at the levels and at expectations that we're seeing. One thing that is really nice on the cat food products obviously as they're highly-highly incremental to existing fridges, when we have an existing fridge. And we also have it in standalone fridges too. So there's a couple of hundred standalone fridges out there. Those continue to progress and what we're doing is we're continuing to prove out that model in existing fridges and utilizing that as a stepping stone in order to have more and more independent cat fridges out there overtime. And as you can imagine there's obviously tremendous opportunity for the organization as that starts to develop over the next couple of years. So, really good progress, seems to be in sync how we have budgeted. And we'll continuing to keep a close eye on it and support it in every way we can and it looks to be kind of on track and successful and kind of later in the year when we have kind of a little bit more settled in, from a distribution perspective we'll start to support that and hopefully see nicer even more incremental growth coming out of it.

And then I am following up on that. Are you guys working with the retailers, are you guys seeing -- are you guys feeling any hesitation to put a second fridge in versus just having to bring into the dog fridge, or is that even acting as a like as a dog fridge have to get the test to possibly bring in cat fridge later on, down the road, do you guys have any color to offer on that?

Yes it is actually a really good and I think if you kind of rewind back even what we expand for the dog food fridges, there are retailers that automatically see it, understand it and think about it as a way to help grow their category and add incremental consumers in. And a very sticky traffic into their category and there's a handful of retailers that have raised their hand and we're moving forward with them and that's terrific. But there's others that really do want to ladder in slower and in those cases, that's where we are taking the cat food products, we're putting them into the existing dog food fridge proving out the sales that we can get from that and then eventually like I was mentioning we will use that as a stepping stone. So, it's one of the things, that it's not going to happen real fast, but the nice thing is, it's a very-very large significant opportunity for us over many-many years to come.

Last one kind of switching gears a little bit, on the competitive front, are you guys obviously you guys are running into more competition in the pet specialty channels that is due to maybe higher concentration of healthy alternatives versus what consumer is finding in the grocery stores if we are talking mass channel. How do you guys see you're progressing, how is it going so far, are you guys seeing changes on the competitive front there?

So, pet specialty is always a very-very -- I mean if you walk into a pet store, you can recognize that it's a highly fragmented and very diverse category and more so than many-many packets with categories and the fortunate thing is we've been able to develop the vast majority of our distribution across pets [indiscernible] so we're highly developed that at those retailers and in the larger big box type specialty accounts and many of the other regional. So, we're really fortunate there, and the other thing that we're really fortunate around is we have our own merchandizing unit as you recognize it, it is our refrigerator. So, there is a lot of activity in stores, we're very-very unique and we're going to continue to bring really strong consumer grabbing innovation and communications and we kind of have the benefit of having our own unit and it does put us in somewhat of a competitive advantage, we have obviously a long way to go and a tremendous amount of opportunity to increase sales in pet specialty. But although there's some more activity and a lot of brands out there, a lot of competition, we've been able to maintain really nice growth rates there and retailers tend to be quite happy with the performance, so.

Thank you. At this time I'd like to turn the call over to CEO, Richard Thompson for any closing remarks. Sir?

Thank you very much. I'd just sort of like to thank you everybody for calling in this afternoon and participating in today's call. And we look forward to continuing growing our business and I wish everybody else a great evening. Thank you.

Thank you, sir. And thank you ladies and gentlemen for your participation. That does conclude your program. You may disconnect your lines at this time. Have a wonderful day.