Greetings. Welcome to Freshpet First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I will now turn the call over to Katie Turner for opening remarks. Please go ahead.

Thank you. Good afternoon, and welcome to Freshpet’s first quarter 2019 earnings conference call and webcast. On today’s call are Billy Cyr, Chief Executive Officer; and Dick Kassar, Chief Financial Officer. Scott Morris, 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 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 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. Please note on today’s call, management will refer to certain non-GAAP financial measures, such as EBITDA and adjusted EBITDA, among others. 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 today’s press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. Finally, the company has produced a presentation that contains many of the key metrics that will be still discussed on this call. The presentation can be found on the company’s Investor website. Management’s commentary will not specifically refer to the presentation, rather at the summary of the results they will discuss today. And now, I’d like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Katie, and good afternoon, everyone. To begin, I’ll provide an overview of our financial highlights and recent business performance, and then Dick will provide greater detail on our financial results. Finally, Dick, Scott and I will be available to answer your questions. We are very pleased with our start to 2019. It is very clear that our Feed the Growth plan has generated significant momentum with our customers, with consumers and within our team. And that momentum is enabling us to serve more pets and pet parents, fulfilling our mission to change the way people feed their pets and doing that in ways that are good for our pets, for people and for the planet. In the first quarter, we delivered strong net sales growth, our biggest increase in ACV distribution since the first quarter of 2016. Our adjusted gross margin improvement plan showed early evidence of progress and we delivered meaningful improvement on the bottom line despite continuing to invest for growth. It was a strong and well-balanced performance. We believe this provides us with good momentum for the balance of the year and as we March towards our 2020 goals. The robust net sales growth in the fourth quarter continued into Q1, driving a 27% increase in net sales to $54.8 million, slightly above the 24% growth we projected for the year. The growth was broad-based, with Mega-Channel Nielsen measured consumption up 28%, behind 36% growth in grocery, 24% in mass and 18% in big box pet. Same-store sales velocity grew 19%, and accounted for more than 70% of the year-on-year growth. Our core dog business, which is the sum of our dog rolls, roasted meals and Fresh From The Kitchen main meal items was up 29% in the quarter and now accounts for more than…

Thank you, Billy, and good afternoon, everyone. As Billy indicated, net sales in the quarter were $54.8 million, up 27% versus the year ago period. This strong start gives us confidence that we are on track to meet our – or exceed our net sales guidance of greater than $240 million for the year. Our continued strong growth is the result of the increased investment we made in advertising this year, strong improvement in our retail presence and the continued strength of the innovations we launched last year. In particular, advertising is the single best driver of our growth and consistent with last year’s plan. We’ve committed to invest 11 plus-percent of net sales this year in advertising in the U.S. to continue the strong growth rates we have seen over the past two years. Despite investing at higher levels than last year, the payback we are getting for that investment has improved for the second year in a row. We believe this is the result of the synergy between our compelling advertising, enhanced retail visibility and increasingly relevant product innovation. Each piece makes the other more potent, delivering increased efficiency and greater impact in the market, another meaningful benefit of our increasing scale. Our price increases also contributed about 1 point of net sales growth in the quarter, despite not going into effect until mid-February. We expect that the price increases will contribute about 2 points to our top line in Q2, as we’re seeing very little price sensitivity on the items, where we increased the prices as it has for the past year, a shift in product mix to our higher-priced bags add another point to the top line versus year ago. Adjusted gross margin for the quarter was 50.4%, up 20 basis points for the year ago…

Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] One moment please while we poll for questions. Thank you. Our first question comes from the line of Bill Chappell with SunTrust Robinson. Please proceed with your questions.

Hey, good afternoon.

Hello there, Bill.

Hey, just a couple of clarification questions. First, you talked about, I mean, initiative on mix shift to improve margins. And I’m just trying to get wrap my head around that in terms of other than the impression that rolls were much higher margin than bags and bags are growing faster than rolls. And so help me understand how that works out?

Sure. So you’re right that rolls have a higher margin than bags. What we’ve done not only on rolls and on bags, but we’ve actually come with innovation that has slightly higher margin in both of those areas. And we’ve – in addition, we’ve also done some pricing, which in addition to all of that coming together. So, yes, we’ve basically rolled out a handful of pieces of innovation that have higher-margin in each of the respective forms.

Got it. So this is not a mix between the two, it’s just trading consumers up?

Right, it is. And the mix between the two with the pricing has kind of become more balanced than it has in the past, too.

Got it. And then on the expanded ACV in the new doors, that – that’s all fantastic. I just – I guess, a year ago, we were talking about deemphasizing door growth, it’s more about velocity. Was there something to change where you’re getting a poll from more retailers now that you’ve been so successful? I mean, why such the big jump in ACV per say?

So we’ve had retailers who are now starting to express a little bit of this FOMO, their fear of missing out, because they’ve seen the incredibly rapid growth that we’ve had for two years in a row. So we’ve had a lot more pull from the retailers and that’s what you’re seeing. So whether it’s new doors or whether it’s upgrades towards getting second fridges put in. So that’s what that’s all about. We are all about ACV. ACV is the key driver here. Doors is the metric that we provide, so folks can benchmark versus where we’ve been in the past, but it’s all about getting the maximum out of ACV and we have a lot of momentum right now.

Got it. Last one for me. Just as I’m looking on quarters, kind of the cadence of advertising, this was a big quarter I would expect it, I guess, to come down next quarter and then pick back up in the third quarter. Is that the right way to think about it?

So I think, historically, what we’ve done is, we’ve talked about kind of the splits over the course of the year just on kind of first-half and back-half. And then this year, our advertising spend will be about 70% in the front-half and about 30% in the back-half of the year. So – and then the first two quarters are going to be fairly evenly split. So, yes, a definite weighting towards the front of the year. And the thing that, I think, we’re very, very excited about and I know Billy mentioned it in the script and Dick also mentioned it is the return that we continue to see on the advertising is incredibly strong and it’s exactly as the model has predicted.

Got it. That’s it for me. Nice to see a gross margin improvement quarter.

Great. Thanks.

Thank you. The next question is from the line of Mark Astrachan with Stifel. Please proceed with your question.

Hey, afternoon, everybody. Wanted to ask sort of related question to Bill’s and just maybe give an update on where you are in the roll out of your largest customers, you don’t want to name names, maybe just kind of broadly talk about the ACV and some of those and what the opportunity might be in converting more of those into adding Freshpet fridges versus some incremental retailers out there? And maybe just broadly, how you think about the whitespace between existing and new retailers?

So there are definitely some new retailers out there for us. The way we like to think about it is, we’re in nine of the top 10 pet food retailers across the country. There are – in the top 10, there’s really only a couple that we have significantly low distribution in. And what we’re starting to see is, we’re starting to kind of close the distribution in those. With the ones that are kind of closer in line in that top 10, we typically range from about 40% – and we have some that are now approaching 70%, 80% and 90% distribution. So some of them there’s not a lot of distribution left, but there are a lot of very, very big players that we have kind of in the 40% and 50% distribution range. And the thing that we continue to see is, every single year, we continue to grow distribution in every single one of those. We know that we’re comfortable in saying that we will probably not be at a 100% distribution at any point in the near future, but we see a very, very long runway across not only the existing retailers, but also some of the new retailers starting to come in.

Got it. That’s helpful. And then maybe switching to the split between dog and cat. So dog up 29 implies cat, obviously, a bit weaker down. Maybe just talk about how you prioritize that, obviously, some of that relates to second fridges or multiple fridges and stores, but maybe talk about just priorities there and then what that opportunity could potentially look like and when you potentially start to realize that you’re focused on it?

So one of the things that we do is, we try and being incredibly agnostic when we plan out the fringes and think about how we’re allocating space. And we try and look at the highest productivity on a dollars per literally linear inch and also gross profit and we kind of planogram the fridges out. So what we were seeing was we were getting better return on many of the dog items that we were putting in versus the cat items. Now there are core set of cat items that are really important for us to have. And right now, we’re kind of retrenching leaving those cat items in. And as we expand second coolers over time, we plan to continue to expand the cat portfolio. And as we have more and more space that will continue to build into that. There’s tremendous opportunity in cat for us. As you are aware, I mean, there’s – around 5% of our total sales are in cat food. There’s no reason why at some point in the future, it couldn’t be 30% out into the future. But going back, again, I think the way we’ve built the plan that we’ve communicated to everyone is that, it is a U.S. dog-based plan that we’re communicating over the next couple of years. And as we really kind of figure out the opportunities in cat or in the UK or Canada and some of these other initiatives that we’re working on, those will hopefully be incremental growth opportunities.

And I’d just add to that. I think, as Scott described, there’s a very important set of priorities that we have to set here, because we do want to manage the resources that we have, the capacity we have, the fridge base we have to generate that consistent and steady and very strong growth that we’ve demonstrated. And right now, we’re getting the best return for focusing that on the U.S.-based dog food business. But it does not mean, there’s not significant opportunity to grow the cat business longer-term. It’s just as we’re at this stage of our life, we have to make priority choices.

Yes, understood. Thanks, guys.

The next question is from the line of Jason English with Goldman Sachs. Please proceed your questions.

Hey, good evening, folks.

Yes.

Congratulations on another strong quarter.

Thanks.

Advertising spend continues to ramp, as you said it would, it’s driving sales growth as you foreshadowed that it would, all great to see. With the spend ratio you mentioned, I think, 11% of sales, it looks like you’re on track to spend roughly 50, maybe a little bit north of $50 million this year? Behind one brand, that’s a big budget. At what point, do you think you hit critical mass start to see diminishing returns on that? And at that point, I mean, I guess, there’s two implications, one, the P&L leverage, that could flow through it, but also the impact on continued sales momentum?

So the way we have – the way we’ve planned, the – I think I answered the question a little earlier on kind of on the split and in the productivity of the media. The way we have the media plan this year is actually about a $26 million, $27 million total spend is what we’re planning out. And obviously, we – we’re always reviewing that to see if it’s the best place that we want to spend at. But that’s really kind of how we’ve been thinking about that spend for this year. And then I think when we’re starting to talk about, we want to keep it at that 11% level and then we’ll continue to monitor that and the productivity as we look into the following years and also the capacity constraints that will come into in 2020.

And, Jason, if you think about it at the spend rate that we’re spending this year at the 11%, the payback we get on that advertising investment is within one year. When we started this, it was at year-and-a-half, it’s now down to within one year payback. And so as we head into 2020, we’ll probably have to glide the spending down to 9%, which is what we guided to when we set the 2020 plan just so we can make sure we manage within the capacity. But when we get excess capacity, when we open Kitchens 2.0, we have every interest in increasing the investment that we make back up into the 12% range. And the reason we do that is, because the payback we’re getting is so good and we’re also finding that the payback is improving, as Dick said in his comments, that the payback is getting better each year and it’s a combination of the impact of the advertising, plus the increased retail availability and visibility you get and the more relevant product innovation that we have. So as long as we see those dynamics in place, I think, we’re inclined to continue to invest, and we think we’re getting pretty good payback for it.

Understood. And sorry, I mixed up a couple of numbers there. But the core of my question was…

I wish – hey, Jason, I wish I had $50 million.

Yes.

No, I hear you. And give it a few years, you’ll have the revenue and probably the media there, too, if you keep this momentum going. But one key question is, whether the EBITDA is going to be there. Looking at your bridges in terms of the – how you’ve build on incremental margins, contribution margin is clearly a key enabler, which I think you define as gross margin, less brokerage fees, less logistics cost…

Yes.

…given that that’s a core kind of driver. Can you give us an update on where that’s coming in at in terms of the incremental margin on those two components combined?

Yes, we’re around 41% right now.

Got it.

…gross margin.

So roughly in line, if not modestly ahead of your 40% target?

Yes.

Yes.

Good stuff. Thanks, guys. That’s all I have.

All right. Thanks, Jason.

All right. Thanks, Jason.

[Operator Instructions] The next question is from the line of Peter Benedict with Robert W. Baird. Please proceed with your question.

Hey, guys. My first question is just around the market response to the traction you guys are seeing, I mean, obviously, the revenues are there. But just the retail partners and the second fridge initiative for this year, you’re at 341 right now. I think you said, you expect maybe another 500 over the balance of the year. Can you help us understand maybe the cadence of that? And then is this coming across all of your channels, or is there any particular channel that’s showing the most interest there?

So on the second – I think that, Billy used the term earlier that we’ve been using internally the idea of FOMO, which is the fear of missing out. And I think retailers are looking around and they’re recognizing that we have consistent growth cadence coming in. It’s been really positive for a very long time. We’re starting to see a little bit more scale in our business. We’re still very small, but there’s a little bit more scale coming, then they’re looking at kind of their same-store sales metrics, which is really – continues to be really, really positive and growing. And I think they’re looking around and recognizing that there’s – as they continue to grow the category, this is a tremendous opportunity for them and it’s a really strong way for them to continue to keep shoppers in their store buying fresh items. So I think they look at that and then there’s a handful of people across multiple different formats that are testing the second fridges. So we have grocery, we have some mass and then we also have pet that’s been testing it. So we’re starting to see that rolling out in grocery and mass earlier this year. I think, we’re going to see pet coming in with additional – significant additional fridges in the back in addition to a couple of other grocery retailers. So it seems like it’s being well received. The results that we’re getting are consistent with what we had anticipated and what the retailers had anticipated. And I think with the media spend and the improvements in overall growth rates, I think that over time, more and more people are going to become more interested in what we’re bringing to market and adding either larger or second fridges into the – into their aisles.

And then, Peter, I would add. If you’re a retailer who has decided to make the pet food category a strategic priority for you that you view this is a signature category or one where you’re trying to make a statement as you’re watching, trying to compete with other forms of commerce, those are the folks who tend to be leaning in the furthest and they’re also the ones who probably already have a fairly good share on our business today. We’re adding a second fridge delivers for them an added assortment and significantly higher revenue because of that added assortment.

That’s great, and that’s helpful. Thank you, guys. My other question, just as around kind of related to the response you’re seeing in retail and some of our channel checks with people suggest that there’s kind of a rising demand or interest from some of these guys to do some private label. I mean, is this the category that’s obviously starting to take off? Can you talk about what’s going on with you guys with that respect, and what you’re kind of seeing in the market? Thank you.

So we have gotten requests – many, many requests over the years. And what we’ve basically asked everyone to think about is, what’s the incremental contribution of having a private label product. So as we’ve looked at that, we’ve found one opportunity very recently, where we felt like it was a good match with the portfolio and we’re trying it out in the handful of stores to kind of see what the productivity of those SKUs are. But I think that, as retailers think about this, I think, they’re really committed to the segment and the growth, and they recognize that it’s a very, very tight amount of space. So I think, they’re going to want to develop in a way that has the highest level of productivity for that chiller. And if over time, private label becomes, there’s a role for it and literally overall for it. I think that that’s something that we’ll continue to talk about and think about and kind of assess specific opportunities that we want to pursue.

And then our work has shown that at least the initial past year, the private label product is actually being priced at a premium to the Freshpet product. Is that – are we accurate?

Yes, yes, you are accurate. And I think that’s a case where there was an opportunity to bring some incrementality to the existing portfolio and it was something that worked for the retailer and worked from a consumer standpoint and was productive for us. And that’s something we thought might be a fit and again, it’s in a small number of stores, it’s a test. And we’re kind of evaluating, as an organization, that is this is a good path to make us get as many dollars out of a refrigerator as we possibly can.

And to develop the category the way we think the category should be developed. We don’t want to turn this into a price-driven category, so that’s why that kind of an opportunity might fit.

Yes. Okay, now makes sense. Thanks very much, guys. I appreciate it.

Take care, Peter.

Thanks.

[Operator Instructions] The next question comes from the line of Chase West with Consumer Edge Research. Please proceed with your questions.

Hey, good afternoon. Thank you for the question. Quickly just want to touch on Bill’s question from earlier. With the apparent shift back to ACV, how should we think about buyer growth through the rest of the year? Do you guys you think you can maintain the current growth throughout the year?

So we – the thing we like most about where the business is. And I don’t – I know we ended up talking a little bit about ACV, but we are very, very confident in the way we move this business is through adding more consumers in and – which is penetration and then adding – continue to have growth in the buying rate. So ACV is kind of like the extra whipped cream with the cherry on top…

…it’s a byproduct of that.

Yes, it really is, it’s a byproduct. So the major focus is to continue to add consumers and add buying rate, and that’s the focus of all the advertising that we do, which is where we’re spending the most money. It’s also the focus of the innovation that we bring. And the thing that we love about what we’re seeing with the way the business is developing is the growth is so broad-based. Meaning, if you look at almost any retailer in any geography, domestic or international, if you look at any form for us, whether it’s rolls or bags, every single aspect is growing. And when you kind of look at the growth drivers, which is communications, as we mentioned, innovation, the idea of depth of distribution or second coolers, every one of those is really contributing very positively. So the growth is very, very broad, it’s across every single aspect of the business and things are performing really, really well. But I do want to kind of reinforce that ACV is an important contributor. It’s probably – it’s less than 20% of the overall growth of the business and that advertising innovation are the 80% of the aspect, and that’s driven by getting more people in penetration and the buying rate piece.

So, Chase, also very specific to your question, we think that the biggest driver for us of the penetration gains is the advertising investment. And so the penetration gains will fall in line with the advertising investment. And what will happen is, it will be a trail fit. So the advertising ones, the consumer does, the consumer doesn’t want to buy it that day or that week, but over time, it’s a cumulative benefit. And I think if you look back at history, what you’ll see is, we kind of start getting off to a – you get off to a little bit of a start in the beginning of the year and then we kind of ramp it up and we continue to grow household penetration as all the way through the end of the year and then we go off here in the fourth quarter and take a little while to get it started back up again in the next year. But fundamentally, we follow the media spending, because the household penetration gains follow the media spending.

Got it. Yes, that’s very helpful. And then just quickly switching gears slightly. I know second fridges are the main initiative here, but Billy, you called out third fridges in some stores. How should we think about the trajectory of third fridges going forward? Maybe are they like in different area of the store than the original fridge?

I think that third fridges right now are relatively few of them, but they’re only in the very high velocity stores, where you need it for the holding power and to have the fullest range of assortment. I would think that in the near-term, it’s really going to be the – that’s going to be the case, where you get yourself in a situation where you need it to have accommodate the full assortment and to have enough – and the holding power for the velocity you see in a store.

Got it. Thank you for the questions.

Thank you.

Thank you. At this time, I’ll turn the floor back to management for their closing remarks.

Yes I’d like to leave you with a thought. the humorist, Will Rogers, once said, if there are no dogs in Heaven, then when I die, I want to go where they went to which I would add and wherever that is, we hope you find a Freshpet fridge there. Thank you, and have a good night.

Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.