Freshpet, Inc. (FRPT) Q2 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to the Freshpet Second 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] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Katie Turner for opening remarks. Thank you. You may begin.

Thank you. Good afternoon and welcome to Freshpet's second 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 to 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 discussed on this call. That presentation can be found on the company's Investor website. Management's commentary will not specifically refer to the presentation rather it's just a summary of the results they will discuss today. Now I'd like to turn the call over to Bill Cyr, Chief Executive Officer.

Thank you, Katie, and good afternoon, everyone. To begin, I will 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 the sales growth and the scale benefits that our Feed the Growth plan delivered in the second quarter. We also delivered record growth in household penetration and our largest increase in ACV distribution in several years, creating a strong foundation for sustained growth. Based on these results and our outlook for the balance of the year, we are raising our 2019 guidance, which Dick will discuss in more detail. It is clear that our strategies are working. At Freshpet, we are attracting a significant number of new consumers, inspiring retailers to expand the amount of space they dedicate to Freshpet and driving significant cost benefits from added scale. That virtuous cycle is the essence of our Feed the Growth strategy, and we are very pleased with our results thus far. Our strategy is enabling us to feed more pets and change the lives of many families, that have invited dogs and cats and Freshpet into their homes. We firmly believe that we are just scratching the surface of the opportunity to change the pet food category, enabling pet parents to feed their pets in a way that is similar to the way they feed the other members of their family. As a result of the planned advertising investments, outstanding retail presence and meaningful innovation we've delivered, our net sales grew 26% to $60.1 million in Q2 and that puts us on track to exceed our original guidance of 24% growth for the year. The growth was broad-based with Mega-Channel Nielsen measured consumption up 27%, behind 35% growth in grocery, 27% growth in mass and 13% growth in big box pet. Same-store sales velocity grew 17% and accounted for more than 60% of the year-over-year growth. Our core dog business, which is the sum of our dog rolls, roasted meals and Fresh From the Kitchen main meal items that accounts for more than 90% of our business was up 28% in the quarter. Our small but rapidly growing e-commerce business, which includes Curbside programs with our key customers, home delivery via services like Instacart and Shipt and fresh e-commerce like AmazonFresh and FreshDirect was up 101% for the quarter and accounts for 2.2% of our business. More than 80% of that business went through our in-store fridge network. Adjusted EBITDA in the quarter was $1.2 million, down $1.3 million versus year ago, largely due to a $4.8 million increase in our advertising investment, in part behind a second advertising campaign that positions Freshpet as the next generation of pet food, one that is consistent with the values you have for the food you feed the other members of your family. This advertising began airing at the end of May and has driven very strong interest in Freshpet. This media spending increase is not incremental to our total advertising investment for the year, it simply increases the amount of spending we placed in the first half, about 80% of our total anticipated spend for the year versus about 70% last year. We continue to expect to get a return for this investment in the second half of the year, as we have experienced historically. You will recall that we set five strategic objectives for 2019. Overall, we made good progress against our goals, but we did experience some transitory operational challenges that impacted our financial results for the quarter. Fortunately, we are pleased that these challenges are largely behind us and they will not prevent us from exceeding our goals for the year. Our specific progress against our goals includes first, expand the Freshpet consumer franchise. As a result of our significant marketing investments and distribution gains, we drove the largest year-over-year increase on record in the size of our Freshpet consumer franchise, and those consumers bought more than they did a year ago. But while household penetration was up 18% versus year ago and the buying rate increased 9%. Our core dog household penetration was up 27% versus year ago. As expected, the rapid influx of new buyers limited the core dog buying rate growth, but it was still up 4% versus year ago. This data shows the effectiveness of our advertising at building a bigger and more loyal consumer franchise, even in the phase of the price increases we took in February, and there are many more consumers, who look very similar to the consumers whom we've already attracted, so the future growth potential is very robust that can strengthen Freshpet's retail presence. The strong first quarter momentum with retailers continued into the second quarter, driving the largest increase in ACV distribution and several years behind another strong quarter of new stores, upgrades and second fridges. We added 361 net new stores in Q2, bringing our year-to-date increase to 915 net new stores and our total store count to 20,414. We upgraded another 160 stores from small or medium fridges to large fridges in the quarter, bringing our total upgrades year-to-date to 363, and we added a second fridge to another 376 stores, bringing our total number of stores with two or more fridges to 747 stores. ACV distribution grew 3.7 points, our biggest increase in years of 48.2% and TDPs grew 8%. TDP growth was constrained a bit by some out of stocks we encountered late in the quarter due to certain supply issues. It's very clear that retailers are responding to our two years of strong growth and then Freshpet is now achieving a level of scale where it can have a meaningful impact on their total category growth. This is also evidence that our Feed the Growth productivity loop, where increased advertising investment drives increased velocity and that drives increased distribution is working as intended. That is driving our strongest distribution gains in several years. In the near term, that will dilute our velocity gains temporarily as it takes new stores some time to become as productive as existing stores. The longer term, it produces strong sustained net sales growth and supports a broader consumer franchise. We expect to see the strong distribution gains continue throughout the year and deliver our annual targets of 1,500 to 1,600 more stores, an incremental 500 fridge upgrades on top of the 1,000 we delivered as part of the plan we announced last year and 800 stores with two or more fridges. This should result in ACV gains in excess of our long term average ACV distribution growth rate of 7% and TDP growth in excess of 10% during 2019. Third, strength in adjusted gross margin and adjusted EBITDA margin. Adjusted gross margin in the quarter was 48.5%, down 290 basis points versus the year ago period. In combination with our strong Q1 adjusted gross margin, our year-to-date adjusted gross margin is now 49.4% and in line with where we had expected to be at this point, although the sequence was reversed relative to our expectations. While we continued to execute our adjusted gross margin improvement plan in the quarter and realized most of the benefits, we did experience some production challenges later in the quarter. Recall we converted our fourth line to a 24 hour, 3.5 day production in mid-May. In combination with that conversion, we also experienced some quality issues on inbound raw materials that resulted in both short shipments on a few specific SKUs and higher scrapping costs related to product that did not meet our quality standards. Plus, we incurred incremental processing costs and other products that in total deferred our adjusted gross margin in the quarter by approximately 170 basis points and resulted in constrained supply late in the quarter. That constrained supply resulted in higher out of stocks with our customers for a few weeks in late June and part of July. Those issues are now largely resolved and we're now shipping to our customers demand. These issues remind us that producing fresh, all natural food is not easy and further reinforces the value of our continued investments in training and building out our technical backbench strength. We believe that our manufacturing expertise is a critical advantage we have, and we fully intend to continue to develop and expand that advantage. We strive to make it very difficult for a competitor to match our level of mastery of Freshpet food manufacturing. While some of the higher costs we experienced flowed into July and thus impact a portion of Q3, we believe we resolved the issues and do not expect them to impact our ability to achieve our target of a 50% adjusted gross margin for the year and a 51% adjusted gross margin at the end of Q4. That is because we are continuing to benefit from the margin improvement plan, we put in place this year, which calls for three drivers of margin improvement. First, price increases; second, higher margin innovations; and third, full utilization of our labor in the third and fourth quarter. Recall, we started our fourth line on a 24 hour schedule in the second quarter. The price increases are delivering improved margins and we continue to see very little price sensitivity. Our higher margin innovations are performing well in the market and all the training costs for labor have now been fully absorbed behind our increased production schedule. We also expect to see a significant gain in SG&A absorption this year, increasing absorption by 240 basis points and a cumulative 500 basis points versus where we ended 2016. Due to our heavy advertising investment and the lumpiness of SG&A spending, we expect to see more of that benefit in the second half of the year. As a result, SG&A was basically flat versus year ago in Q2. But when you exclude our heavier media investment in the quarter versus year ago, we gained significant leverage in SG&A, improving by 420 basis points. Year-to-date, we've gained 370 basis points versus year ago on SG&A absorption, excluding media spending. We're confident that our plans are on track to deliver our projected goal for both this year and the cumulative total of 700 basis points by 2020. We also believe that there are additional scale benefits we can accrue beyond 2020. Adjusted EBITDA margin was 2.0%, down 330 basis points versus year ago can be entirely attributed to the planned increase in media spending, which was up 290 basis points versus year ago. The SG&A reduction versus year ago offset the adjusted gross margin issues in the quarter. The good news is that the adjusted SG&A improvements are structural and will continue. And to reiterate, the adjusted gross margin issues are temporary and largely resolved. Finally recall, our adjusted EBITDA will skew towards the back half of the year in line with our plan and as it has for the past two years due to our significant media investment in the first half of the year. Number four, continue measured development in Canada and UK. Our UK and Canadian businesses made steady progress. We front loaded our advertising investment in each market and have seen growth behind those investments that are consistent with the growth rates that we see behind media investments in the U.S. We expect that this will encourage retailers to expand their distribution of Freshpet later this year and next year, and thus, enable us to invest again next year to drive -- further drive velocity and encourage additional distribution. That is the same virtuous cycle that has worked for Freshpet in the U.S. and it seems to be working elsewhere. It will take several laps around that productivity loop to achieve the scale and presence that we have in the U.S. But when it is done, we will have created a strong foundation for a highly profitable business in each of those markets. And everything we've experienced thus far suggest that both of these markets have the potential to be major contributors to our success once we have both the production capacity and distribution to support the development of a larger consumer franchise. Fifth, build capability to support accelerated longer term capacity expansion. As we have said many times, the single biggest limiter to our growth is our ability to add capacity fast enough to keep up with the consumer demand that we know exists for Freshpet. We also believe that our scale and expertise in making Freshpet food is a real competitive advantage, and we plan to invest to continually expand that advantage. That is why, we are investing in both facilities and technical talent this yea. In late June, we broke ground for our Freshpet Kitchens 2.0 on our Bethlehem campus and that project is on track to start up in Q3 of 2020 as planned and within the budgeted cost of plus or minus $100 million. Additionally, we are making good progress in our search for the site of our next production facility and expect to acquire the necessary land this year and hire a site leader in the near future. If we continue to grow at our current rates, that facility would need to be up and running sometime in 2022. We're also making good progress at adding technical bench strength to support improvements in our existing operation and to support further capacity expansions. We expect to announce a key addition to our team within the next few weeks. Fortunately, the rapid growth of Freshpet, our clear and appealing mission and the career growth potential we offer makes Freshpet a very attractive place to work. Even in this tight labor market, we are not having trouble attracting the kinds of talented and motivated team members, who can help us achieve our mission. Though our challenge is not one of attracting talent, but rather one of training and integrating enough employees to keep up with our growth. That is where we are focusing our time and energy. In summary, 2019 is shaping up to be another strong year for Freshpet. Our strong growth is continuing and we are on track to exceed our net sales and adjusted EBITDA guidance for 2019 and meet our longer term 2020 goals. At the same time, we are fulfilling our mission of providing more pets with fresh, all natural foods that enrich their lives and the relationships with their pet parents. And doing so in ways that are good for our pets, for people and for our planet. I will now turn it over to Dick to discuss our Q2 financials in more detail and our outlook for 2019.

Thank you, Billy, and good afternoon, everyone. As Billy indicated, quarter two net sales were $60.1 million, up 26% versus the year ago period. As a result, we are raising our net sales guidance from greater than $240 million to greater than $244 million. This represents net sales growth of 26% for the year and puts us within striking distance of our $300 million goal in 2020. If we deliver $244 million in net sales in 2019, we would have to deliver 23% growth in 2020 to achieve our $300 million goal. We believe that this is very achievable. Our continued strong growth is a result of the increased investment we made in advertising this year. Strong improvement in our retail presence and the continued strength of our product innovations. In particular, advertising is the single best, biggest drive of our growth and consistent with last year's plan. We have committed to invest 11 plus percentage of net sales this year in advertising in the U.S. to continue the strong growth rates we have generated over the past two years. This year, we have added the second message to our advertising program, and it began at the end of May, as Billy mentioned. One of the benefit benefits of the increased scale we are generating is that our media budget can now support a second message that is equally compelling and its depth to the Freshpet story. Our new advertising message which is run in conjunction with our existing Letters campaign is a powerful reminder to pet parents that as they embrace more natural and fresh food for their families, they need to consider changing the food they feel - they feed their pets as well. The pre-marketing tests on this advertising campaign was very strong and it is powerful complement to our more emotional Letters campaign. As a result of the heavier Q2 spending behind these two messages and the front loading all of our media spending in Canada and the UK in order to drive distribution gains, we have now invested 80% of our total media budget for the year. We believe we have gotten an exceptional return for that investment, as evidenced by the record increase in household penetration and related growth in distribution. And we expect it to drive net sales growth over the balance of the year into 2020. In fact, we believe the return we've gotten on our advertising has improved each year since we began our Feed the Growth strategy. The price increases we took in quarter one are now fully in place and contribute to the expected 200 basis points of net sales growth in the quarter and we are seeing very little price sensitivity on the items where we increase the prices. We believe this further demonstrates the power of the Freshpet proposition. It is also important to note that our fastest growing portion of our business is also our highest price per pound item, our Fresh From the Kitchen line. Further, while it is difficult to quantify the loss of sales precisely from the added stock that Billy mentioned, is likely that they hurt our sales growth by 1 to 3 percentage points in the quarter, but it will not impact our ability to exceed our current projected net sales for the year. Adjusted gross margin for the quarter was 48.5%, down 290 basis points from the year ago period. All three elements of adjusted gross margin improvement plan contributed positively in the quarter, but those actions are more than offset by some production challenges we experienced later in the quarter. Billy described those challenges and their impact on our adjusted gross margin as well as how they contribute to our out of stocks. As we continue on our path toward this, fully developing our technical bench strength, we remain committed to ensuring our pet parents and pets have the best experience possible, which at times will create bumpiness on our way to our 52% adjusted gross margin. As Billy indicated, the production issues lingered into July, but are largely behind us and we're now able to meet customer demand. We remain confident we'll average a 50% adjusted gross margin for this year and deliver a 51% adjusted gross margin in quarter four on our way to 52% of adjusted gross margin in 2020. Our confidence is supported by the fact that our pricing has delivered the intended margin benefit with very little indication of lost volume. Our product innovations are performing well and contributing to margin improvements. Combination of pricing and mix contributes 60 basis points to adjusted gross margin in the quarter versus quarter one, bringing the total improvement from pricing and mix this year to 140 basis points versus quarter four 2018. In addition, our growth will better allow us to absorb our fixed costs and all of our new labor is now trained and productive. Adjusted SG&A in the quarter was $27.9 million or 46.4% of net sales flat versus the year ago period. That includes an increase of more than $4.1 million versus last year's media investment. Excluding media spending, which we will hold roughly constant as a percentage of sale this year versus the year ago, SG&A improved by 420 basis points versus year ago. Recall our goal is to deliver another 240 basis points of SG&A improvement this year, taking us to a total of 500 basis points, since we began the Feed the Growth plan at the end of 2016. Please note that although we have already exceeded our goal of 240 basis points during the quarter, the leverage will decrease during the second half due to the timing of variable compensation. Even with the expected decrease, we believe we were on track to deliver this year's goal and that will position us well to deliver the final 200 basis points improvements we will need next year to deliver a total of 700 basis points of SG&A improvement by 2020. This meaningful benefit from scale is an essential part of the virtuous cycles embedded in our Feed the Growth plan. Adjusted EBITDA in the quarter was $1.2 million, down 1.3 from the year ago period, driven by the increase in media investment. Based on our strong net sales growth to date and our current net sales guidance, we are raising our adjusted EBITDA guidance from greater than $28 million to greater than $29 million to partially reflect the increased flow through over the higher net sales. That means, we expect to increase adjusted EBITDA this year by 43% versus year ago, a rate of bottom line growth in excess of our strong top line growth. Another sign we are beginning to capture the benefits are increasing scale. Our ability to do this should also be an indicator that incremental sales begin flowing to the bottom line as we approach 2020 and provide support for the $60 million adjusted EBITDA bridge we outlined at the end of quarter one. So to summarize, we are increasing our net sales guidance from greater than $240 million to greater than $244 million and our adjusted EBITDA guidance from greater than $28 million to greater than $29 million. We drew $28.5 million on our credit facility here today to cover the normal seasonal variations in our cash flow, funding of working capital and investments in our Kitchen 2.0. We invested $11 million of capital against 2.0 this year and our total spending on that project today is $13 million. We continue to expect to produce positive annual cash flow from operations. We finalized our new credit agreement early in the quarter, the new credit agreement results in lower cost and has the capacity to be the base agreement and is accordion feature to meet all of our capital needs through 2024. In conclusion, we expect 2019 to be another strong year for Freshpet. Our continued growth is delivering numerous strategic and financial benefits that will help us realize our financial goals and will also enable us to fill out the mission of changing the way people feed their pets. To grow a company and changing industry is a once in a lifetime opportunity that our team relishes. And we get to do that while helping people feed their pets fresh and natural food. That concludes our overview. We will now be glad to take your questions. Operator?

Thank you. [Operator Instructions] Our first question comes from Bill Chappell with SunTrust Robinson Humphrey. Please state your question.

Thanks. Good afternoon.

Good afternoon.

Couple, - well I guess, one housekeeping, what was the percentage of marketing spend in the first half of last year versus the 80% spent this year?

Yeah, last year we spent 16 of 22.

Yeah, and we said 70%...

That's 70%.

Got you. So - and the - trying to understand on the gross margin hit in the quarter and then kind of coupling that with your raised EBITDA guidance for the year. I mean, I understand it was out of stocks, but do you expect to make up those sales or you just had more cushion to the full year EBITDA number that now -- that you're not be able to layer through all of that cushion as we go to the back half?

So there are a couple of pieces in what you just described. So let me first start with the out of stocks at the end of the quarter. As Dick said, we lost -- we believe we lost somewhere between one to three points of sales. We did have a very strong July. So we feel very good about the effect or our ability to recoup what we might have lost on the top line, and that's part of getting to the top line guidance. In terms of the adjusted gross margin, as we said in the script, we had a -- probably a little bit better than expected first quarter and not quite a strong second quarter. But on balance, we are about where we thought we would be at the halfway point to the year. And so - and as we said, we think we pretty much have these issues behind us, so it'd be a little bit of a tail into July, as we've seen a little bit of that. But we believe that we have more than enough room then to then deliver on the raised guidance that goes with a higher net sales target.

So just to understand maybe it seems like the out of stocks are kind of lost profit, but because somebody - pet owner bought something else from somewhere else, just trying to understand how it pops back in the next quarter?

Well. So first of all, the out of stocks is -- it starts with -- we short shift a little bit, so we're capturing some of that back. Obviously, if the consumer had any pantry inventory, they drew it down or had to go somewhere else to go buy the product, if that's where they were very loyal to it. It's hard to say exactly how that -- how big that was. That's why we gave a range of 1% to 3%. We can tell you as we had a very strong July. So we feel like we got back and we feel very comfortable with where the run rate is today, getting to the $244 million in sales, if we hadn't had the out of stocks, we would be higher than that, I can't tell you, it's not that precise. But we feel very good about the $244 million, that we gave guidance on.

Got it. And then my other question is just, help me -- the first time we really heard about out of stocks. And so as I look with your growth going to accelerate and increased capacity just coming online, I mean, how do I get comfortable that you have a soft landing that we don't have -- that the growth or demand doesn't outstrip supply over the next couple of quarters?

Yeah, so first of all, you need to know that we are shipping to demand today with customer service. It's in high 90s. So we -- the issues that we had at the end of the quarter and the very beginning of the second of the third quarter, we're now back to the customer service levels that our customers have come to expect from us. And we tend to have a very high standard for that. The second piece is that we did say that we would be taking our final line of 24/7 from 24, 3.5% at the end of this year. So between now and the time that we bring on our new facility in the third quarter next year, we have that one more increment of capacity that becomes available to us. We also are working pretty diligently to restore our previous turnaround time on our line. Fundamentally, the more uptime that you have on your equipment, the faster you turn it around, the more productivity you have. And we have to get about 5% back that we had lost. And we feel very good about our ability to get there. If we do those things, that gets us back -- gets us the capacity to meet our needs before Kitchen 2.0 come on next year in the third quarter. But you should also know that we don't ever live with just plan A, we're working on a plan B in case we have demand had outstrips our capacity and we will not be caught short.

Got it. Thanks so much.

Thank you, Bill.

Thanks, Bill.

Our next question comes from Brian Holland with D.A. Davidson. Please state your question.

Yeah. Thanks, good afternoon. Starting with - just going back to the EBITDA outlook here for a second. Is it fair to say just quick back of the envelope math, which is admittedly dangerous for me? I sort of get to maybe like $4 million more that you spend above plan maybe or the big shift into Q2. Is that fair or is that too high?

Yeah. It's about $2.9 million. That shifted to the back half of the year from the front half of the year…

From the front - from back to front.

Yeah from the back half of the year. In EBITDA, it went - it's going into the back half of the year, another $2.9 million. We had a $29 million plan. We spent 80% of it early on before we had this new media plan, we were thinking of spending 70% of it. But the new media was kind of exciting and we decided to spend an additional $2.9 million in the quarter.

Okay. So - and that $2.9 million is a pull forward, right? So if I look at the EBITDA relative to consensus shortfall, you miss the EBITDA by about $2 million, you raised it by a $1 million, but $3 million moved into the second quarter. And you've got the fastest household penetration bump that you've had on record. So you can have confidence going into the back up and the top line. And then the media spend is just a $3 million shift and that's why -- that's where we get the EBITDA bump. So that's the first part. The second part is just to make sure that we're clear. Because obviously, optically, as Bill implied, it looks strange that you would miss on gross margin to the magnitude that you did and still take it up. But really, this isn't as much about you're comfortable with the gross margin, but really what it is -- you've had a mix shift in EBITDA and you've got a big revenue bump on it, therefore, there's the confidence. Is that fair to frame it that way?

Sure. That's absolutely right.

Yeah. And I would say going back to your first point, Bryan, the fact that we are exiting the second quarter with an incredibly large consumer franchise, which as you know, as that the high repurchase rate and then they go through the process of becoming loyal users. That gives us a lot of encouragement about the top line part of the equation. And so the myths on the EBITDA is a marketing spending myth more than anything else. And as I said to Bill, the gross margin, we're about where we thought we'd be at the midpoint of the year, just came in the reverse order that we thought it would come.

Okay. Thanks, that's helpful. Just curious on the distribution front, obviously continued nice gains. But if you look at some of the -- you look at the landscape, even just the conventional grocery, which is where your strongest growth outside of e-commerce is coming from. A lot of the sort of legacy core dry kibble brands really struggling, obviously Blue Buffalo moving into Walmart there has been a catalyst as well. But what are retailers telling you about their ability to maybe further accelerate your pace of distribution growth as you kind of shift the real estate in that aisle towards faster growing sub-segments? Certainly you being one of them. I mean, is that something that can accelerate even faster as we look out? I know obviously there's a capacity constraint on your end to some extent. But as we look out over the next two or three years, can you continue like the 2019 pace of distribution gains or accelerate that going forward? Do you have any line of sight just kind of conversationally?

Hey, Bryan. It's Scott. So pretty much what we're seeing and what we're planning is to kind of continue that cadence of 1,500, 1,600 stores a year from a new distribution standpoint. And every conversation that we continue to have with retailers demonstrates that they're interested in the proposition and the concept. And I think every quarter that goes by, when they see the growth and they now start to see a little bit of scale behind it. I think it positively predisposes them to doing more. And so there's obviously the new store piece which gives us ACV. But the second chiller piece and the upgrades are really an important component of that. And we think over time that's going to be a significant amount of kind of our ACV or revenue growth component over time that I'll kind of continue to contribute more and more. Obviously, the advertising is the anchor tenant on our growth, the advertising communications media. But that piece from an ACV standpoint and depth of distribution, as I like to refer to it with retailers, will continue to kind of climb up and contribute more over time. So I think that we're seeing a lot of people that are really interested in growing their Freshpet business.

Thanks, Scott. Last one from me, just curious what you've heard from your customer or consumers about some of the recent press around grain-free diets and links to heart disease as I'm not only an analyst, as you know, I'm also a client. Our vet knows what we feed our dog and as you know made the same comment to us similar to what we heard. So even though you weren't mentioned in The New York Times article, I'm just curious sort of what you're hearing from consumers as far as any blowback, any concern and sort of what your view is about some of that research that's surfaced in the past couple months?

So obviously, it's always greatly concerning from an industry standpoint. The fortune thing is we've done internal testing prior to the FDA's most recently release. We were mentioned once in 560 complaints and it was a very tertiary comment -- passing comments. And it wasn't even a grain-free product. So really no mention at all at Freshpet there were 16 brands that were mentioned. It tends to be -- from a consumer standpoint, they're focusing a little bit more on the brands that were mentioned. This is just my kind of take from what's going on the industry. Secondarily, they're thinking grain-free because it's not all grain free, and I think what vets are kind of telling their clients slowly over time is we're not exactly sure. And to be safe maybe step away from grain-free. So that's really what's happened. We have seen no impact whatsoever that we've been able to track. We've actually even kind of diagnosed and really looked at our grain-free items. We have not seen any kind of skip whatsoever. The only skip that we've seen has been when we actually shorted some of those products in that kind of June-ish period, that where we had some shorts on some of the gain-free products, but from a retail takeaway, we really have not seen any impact whatsoever. You know, it's always unfortunate, but we feel really good about our nutritional approach. I think the testing that we've done has validated that, they're not really being any at all consumer complaints around it. We've gotten very, very low numbers of calls compared to what I've heard from some other companies. I think if -- I don't even know if we had a double-digit number of calls around DCM concerns with Freshpet. So I think we're in really good position and it's obviously unfortunate to hear and causes a lot of consumer concern. But I think we've been able to really bypass and not be part of that foray.

Thanks. Appreciate the color. Best of luck, gentlemen.

Thank you.

Our next question comes from Jason English with Goldman Sachs. Please state your question.

Hey. Good afternoon, folks.

Hey, Jason. How are you?

I'm excellent. Thank you. You're going through earnings season and enjoy a little bit of summer. Well, there's still some left. Congrats on the continued sales momentum. Obviously great to see. It's -- the sales strength kind of a year-after-year has come on the back of pretty aggressive, not only distribution expansion, but marketing effort. As we think about going forward, how do you balance the risk of pulling back on that media spend and keeping the sales momentum because quick back at the envelope math, we take 30% of last year's spend and put it over 20% of planned spend this year, looks like media spend will be down modestly in the back half of the year. And I know that 9% ratio that your fiscal '20 guidance is predicated on suggests pretty modest, if any, sort of media growth next year. So it looks like we're going to run through a period over the next six quarters where we've got little to no media spend growth, but anticipation of continued sales momentum. How do we fit those two?

So let me just start with sort of the broad overview. The way we think about the media investment and the role that it plays in our business is that the advertising is out prospecting for new users. And then the product converts those folks into repeat customers and builds out the buying rate that supports the business. We don't need or we don't expect that advertising investment supports the existing business. The product carries that and the in-market results support that, we go off the air, as we have from time to time throughout the last several years, we don't see an erosion in the business. So when we put advertising on the air, it's purely out prospecting for new users and it converts -- the advertising spend converts to new users at an incredibly reliable and predictable rate. And so what we see is that the dollars that we're going to spend over the back half of this year, whether it's more than or less than last year, whether the same as last year and the same for next year, whatever it is it's all in the business of bringing in new users to our franchise and building on the existing base of consumers that we have. And we've -- as you might imagine have modeled it out and said if we spend this much and bring in this many users and the existing users are moving out through the product acquisition curve, will we be on track to deliver our goals? And the answer we feel very comfortable is yes. In fact, as Dick said in the prepared remarks, we're growing 26% this year. We only need to grow 23% next year to hit the $300 million number. So we feel that it's very achievable, especially if we exit this year with a run rate on the business, they call it, $260 million run rate range. The number of new users that we need to add is very easily doable with the media investment that we're talking about making.

Okay. And second question from me and then I'll pass it on with only two. The operational challenges that you experienced this quarter, I heard kind of a lot of puts and takes, some on the incoming raw material. Those sound more transitory. But can you help me understand what went wrong with the processing cost side because I've kind of thought about operational risk is low right now, until we get into sort of ramping up the new facility. So I was caught a little bit flatfooted by having some operational issues and what I would consider is still a low risk period for you.

Yeah, so let me start with -- Freshpet is a phenomenally good product, but it's also the way in which we make it is a technology that is still, I would say, relatively immature technology. That's one of the reasons, why we continue to invest in bench strength or in capability. And as I said in the prepared remarks, we will announce a meaningful new hire in the next couple of weeks that will help further develop our strength and our capability there to advance the technology, because long term, we want to have not only the best product, we want to have it be very difficult for anybody to keep up with us. Now, what happened in this quarter? You referenced a couple of things. First of them was some inbound raw materials. You're right, very transitory, we stopped that, we've moved on. We learned a little bit in the process, things that we need to tighten up our specs on, but we now feel much better. The other part of the issue is that as you're growing as quickly as we are and you're having to go from a five day shift operation to seven day operation, and to around the clock operation and then do that on multiple lines, you start pushing the limits of just about every one of your systems. And you also -- we saw a little bit of erosion in our efficiency, in our effectiveness, that we need to get back. And that's really what was the issue -- the issue is that we just weren't turning around our lines from one day's production to the next day's production that's effectively or as efficiently as we needed to and as a result, we didn't have quite the throughput or the quality that we needed to have. But it's not like we have to go to a new higher level, we need to get to a level that we've been at before. And that's what we're working to do.

Great. Thanks a lot.

Great. Thank you, Jason.

Our next question comes from Mark Astrachan with Stifel. Please state your question.

Thanks. Good afternoon, everybody.

Hi, Mark.

I wanted to go back to that last question kind of ask it a different way to. So by my math, it seems like you're actually getting incremental leverage on media dollars spent in terms of what the cost is to acquire an incremental household. So I guess A, do you kind of agree with that and B, what is driving the leverage that you get in kind of purchasing the additional households so to speak? And kind of how do you think about that opportunity over a longer period of time as you think about the media spend, meaning that I know next year supposed to be a year where you are not spending more, if you're going to kind of get into lower levels of growth because capacity constraints, but as you go into kind of the out years, how do you think about the ability to leverage the media spend and what is the -- and kind of the right rate and how does that fit into the household penetration longer term?

Hey, Mark, I think you're exactly right. We've added consumers over the past six months faster than we've ever added them before and actually more cost effectively. We think part of that has to do with the way we're planning and buying our media, but also some of the messages that we're communicating out. In addition, what's very helpful is when we have great visibility, bigger fridges and more fridges, that retail are a big kind of contributor to that. So that -- all of those components have gotten us to a kind of a lower consumer acquisition costs, if you want to think about it that way, which is really where the advertising is directed. And as Billy mentioned earlier, once people come into the franchise, the thing we'd love is that when people come in, our repeat rates continue to be at these incredibly high level. So once people experience the product and are using it, we get these great repeat rates, which encourages people to buy it again. So the advertising is constantly in the hunt to contribute to more and more people over time and quarter by quarter. So we're really happy with the first six months results. I don't want to harp on it, but quite honestly, if we had had and actually it's in the script too, Dick talks about it in his section. But if we had had slightly better in stock rates, and that those in-stocks go all the way to retail, we would have actually seen some even better growth during the period. The good news is we've gotten a lot of people into the franchise and that will continue to repeat and continue to grow our business.

I would add to that, one of the things that several of you have asked us about is the sort of what is the long term beyond 2020, sine we haven't provided explicit guidance beyond 2020. And so how big can this business or the Freshpet market be? And we're out doing a very good piece of research that'll help us define that for our investors sometime early next year. But one of the questions that we've asked the research firms that we've talked to in this process is, it helps that other brands that have gone through this curve. What does it look like? What kind of dynamics do we see in the consumer acquisition and what we hear over and over again, if you look at, that if you look at categories, where there's been really rapid growth and really rapid acquisition of new users, you find this phenomenon of it getting quicker and more efficient because you get the benefit of higher visibility, higher availability, you get a word of mouth benefit. So somebody else has used the brand, now you feel like it's a more trusted brand or you're intrigued to try it because somebody else has had a positive experience. But there's this snowball effect that occurs. And so whether you're talking about the adoption of bottled water or the increased frequency of the use of Uber or any variety of other things, where you saw that's sort of early in its life, people didn't know about it and didn't really adopt it. But later on people adopted it a much more rapid rate than you could account for based on the marketing investment that was made, you can see a very significant growth rate. And we think that that's still ahead of us. We think that opportunity exists for us over the next five years and we'll significantly expand the opportunity and while media will be a big driver, it won't be the only driver.

And I'll build one more thing on top of that because I think it's really is important, if you have to remember kind of where we are. So we're excited that we add a lot of consumers. Our penetration is now at 2.2%. So we have fairly low aided awareness. We have very low unaided and we have very low penetration. So we're making great progress, but there's incredible opportunity behind us or in front of -- I'm sorry, in front of us, I mean, and I think that the new advertising and the work that we've done is going to allow us to tap a much greater and larger group consumers.

Thanks. That's helpful. It's actually a good lead into another follow up I have. So correct me if I'm hearing something strange, so you had a goal previously of something like $500 million, it was an unofficial sales goal by 2023. But didn't you just say in the script too that you're talking about needing to open the new facility by 2022 to hit your longer term $500 million targets?

We said that we could need the new facility as soon as in 2022. You have to remember that our capacity comes on walls and on bags. And so this new facility will start up next year as wall line and a bag line. We could be out of the capacity for the bag line in 2022 and need to add incremental bag capacity in that year. Would we be at $500 million? We may be at $500 million, maybe at more, depends on the mix of our business. But we don't think that's a stopping point. We frankly think the growth potential is significantly beyond that.

Got it, okay. Thank you.

Our next question comes from Rupesh Parikh with Oppenheimer & Company. Please state your question.

Good afternoon. Thanks for taking my questions. So few key topics that I wanted to cover, so first on double fridges, I was hoping to get an update in terms of what you guys are seeing from a live perspective and whether your performance is consistent across different channels?

So we're -- it's in some of the data, we're at 747 second fridges. We have an 800 -- target 800 store, double fridge target for the year. So we're on track for that. What we continue to see is that these are paying back within a three year period. That's been - how we've been talking about it. I'm -- I think we're -- at this point, we're seeing very good increases. I think it's well below the potential of what the second fridges can do. So if you go back in history, six or eight years, eight years ago, all we made were rolls. So we fill an entire fridge with rolls because that's what we had. So the plan for the second fridge is to continue to fill out the portfolio and really optimize the products that are in that fridge. At that point, we will get much, much more productivity out of that fridge into the future. So we're seeing nice returns. The retailers that have done it typically have been very happy with the results. We continue to talk to more and more retailers about expanding second fridges and we're seeing uptake on that conversation. And we anticipate to continue get more and more of those. But I think we won't really know exactly what the potential is until we see kind of the full portfolio filled out into that second bridge.

Can I add a point to that too, which is part of what Scott is emphasizing is the value the second bridge -- the product portfolio expansion? If you think about building barriers to entry over the long haul, having a broader portfolio mobile fridges in-store insulates our consumer franchise from a potential competitor even more strongly than the existing opportunity does, because if somebody wants to compete with us you have to make a multitude of product forms, they're going to have to get a multitude of fridges put in a store and we become much, much less of a target or it's harder to target our users if somebody comes along.

I mean -- and the second fridge becomes kind of the minor league for Freshpet in a way, too. In addition to filling out the portfolio and expanding brands, it allows us to take things and test them in a second fridge that potentially can graduate up into the first fridge into 20,000 stores, instead of being in 1,000 stores, at some point in the not terribly distant future. It can go from the 1,000 to 20,000, so we can have the most productive first fridges too, which will basically give us the opportunity to have even more second fridges also.

Okay. Great. Thanks for the color. And if I can sneak in one more question, so Blue Buffalo has obviously gone to more and more locations. I was just curious if you guys have seen any impact on your business as they've got in WalMart, BJ's and some other retailers as well?

Yeah. It's interesting. I know a lot of people have seen major, major impact. I think first it's because of distribution losses and secondarily because they've actually had an impact on their consumer franchise, especially in the beginning, we are in and versus or purchase. So as Blue Buffalo comes into more and more retailers, where we have distribution, we've actually seen some acceleration because they're bringing in more consumers potentially on a more frequent basis into some of the retailers. So it's actually been a slight help to us in many cases. We have really not lost that I'm aware of any distribution whatsoever anywhere. And I think, like I said, I think it's and purchase. I think the retailers think about it that way. And then over time, when people do start buying Freshpet, as you know, over time, they buy more and more every single year. That's what we continue to see. And so we have more consumers coming in and more consumers every year buying more Freshpet. That puts us in a good spot. And I think it helps demonstrate the numbers that we see from not only penetration increases, but also the buying rate piece that we can see it continue to see year after year even when new consumers are coming in, and we see buying rate increases of 6%, 8%, 10% over time.

And Rupesh, I drew a chart that had the WalMart weekly sales -- that weekly sales at WalMart for the last year and put it down in front of people without dates on it and asked them, can you tell me where the inflection point is that Blue Buffalo entered into WalMart and nobody could find it? You can't see the line change the further line; the trajectory of the line moves at the same pace.

Great. Thank you for all the color.

Our next question comes from Robert Moskow with Credit Suisse. Please state your question.

Hi, thank you. Hey, Billy, I was wondering have you asked consumers what percent of them say that the advertising was what introduced them to the brand or brought them to the brand? And the reason I ask is in the grand scheme of things, the dollars you spend are not very big. I'm very impressed that they are breaking through. I haven't seen an ad and I have a couple of dogs. So I'm wondering, if is it like the majority of people see the displays and that's what brings them to the franchise. And then the advertising is kind of complimentary on top of it. And then how do you make -- how do you think about that as you think about your longer term advertising strategy?

Well, Rob, I am really glad to know that you don't watch Jeopardy?

Jeopardy?

A real fortune. How's that? Just kidding. So we actually have done kind of what -- what's made people aware of the product and how people come in. So part of it said, that's self-reported. So it's a little bit challenging but we do see about half of the people come in, specifically reporting that they've seen the advertising and the other half through, not only seen the refrigerators, but word of mouth and other types of social marketing, et cetera, some of the other things that we do. But what we can't see and we have a very, very direct correlation is when we run the advertising during certain periods even on really tight periods, we can actually see not only the revenue growth, but also the consumer growth during those periods. Now revenue growth, you can say, oh, well, you're encouraging some people to buy more. But we've actually seen really consistent for like five years now, when we run advertising, we know basically what the correlation is between the advertising spend, the GRPs that it represents and the actual number of consumers and then the actual cost per consumer that comes into the business. So the reality is, you're right, it is an incredibly small marketing budget compared to what's spent on the total category. Our share of weaves is a little bit above average. So you can make a pretty strong argument that we should be spending maybe even lot more. And I think what we're doing is we know we can grow this business well beyond what it is. And the major governor on the entire business is the capacity that we have. We can sell more than we can make at this point. So we're going to continue to kind of have a really kind of consistent cadence on the marketing spend, bringing new consumers in, but also working really hard on the retail presence piece, which I think is what you're referencing. And that gets into the upgraded fridges and also the second fridge strategy.

Got it. And then one little follow-up. Are you still on track to spend that $2 million investment internationally for this year?

Yeah, we spent it in the first half of the year.

It's already done. Okay, right, great. Thank you.

And it was a very good investment too.

Yeah, we're seeing the response rate, that we had anticipated that we had seen here in the U.S. and it gives us encouragement that as we spend some type of media dollars into both those markets, mostly it's Canada and UK, at this point, that will get really strong return and it creates incremental distribution opportunities over time and really kind of completes the entire model in those markets.

And have you said what your sales are internationally?

No.

I mean, they're quite small -- very small at this point. But it's, I mean, there's a significant -- we demonstrated, there's significant potential in both those markets, where they can be a growth accelerator for the business.

Okay. All right, thanks.

Thank you. Your next question comes from James Allen with JPMorgan. Please state your question.

Just thinking about the preliminary results for your longer term study, if you've seen them. I'm wondering if they still endorse expectations for a ramp in media spend up to 12% of sales for longer time or if the more effective customer acquisition rates that you had is causing like -- might tamper that all?

So and can -- we don't want to get into what we're going to share because we're in the very preliminary phases. We'll have that at the beginning of next year. But what I can tell you is that we believe fundamentally that we are in the business of changing the way people feed their pets that there is a significant tailwind behind us between the humanization of pets and people feeding themselves and other family members, fresher food. And we think the opportunity is much bigger than the $300 million we gave as guidance for 2020. And as I said, we think we're going to need capacity beyond 2022. And we told folks that it is in our best interest to fill capacity as fast as we have it available to us and we will do that. As you take a look at this quarter, what you would take away from it is, that if you do it a little bit too fast, you kind of -- can experience little bit of growing pain, so we've got to be very careful about managing that rate. But beyond 2020, I'd expect us to be spending in the 12% range because we've proven that that's rate, that we can both grow at and as well as there's significant opportunity for us to expand Freshpet and fill capacity, as it's available.

Great. And then just on commodity costs. We had Tyson talk this morning about higher meat prices kind of across the spectrum and ASF, African Swine Fever related exports have already starting to materialize. So just curious on your exposure, timing of your contract resets, how long they last, margin sensitivity, and if there was a big cost increase, what your pricing strategy would be?

Yeah, so first of all, the bulk of our single biggest cost on proteins is chicken and we price chicken once a year. So we're protected for this year and we would price that again at the end of the year for 2020. Obviously -- the chicken supply can expand very, very quickly to replace any export production. It's also true, though, that what is actually exported may not be the part of the chicken that we use. And so there's a possibility that as more chickens are grown for the export opportunities, that it actually creates an increase in supply of the parts that we use. And it may help give us some favorability. So it's hard to say, exactly where it's going to end up, there's lot of murkiness in the markets. But as it relates to pricing, if we have a need to take pricing, the industry as a whole is taking pricing, we certainly would consider it, what we saw from the pricing that we took this year is we saw there was very little, if any price sensitivity. And we also know that our fastest growing item in our line is all our highest price for pound item. So it indicates that we have a little headroom above us. But having said that, we really don't want to take pricing, if we don't need to because we think that we like the position that we're in. And we would like to not let price be a barrier to consumer adoption. So we would look at it very carefully and make a decision on it. But at this point, the picture is a little bit too murky.

Thank you very much.

Thank you. Ladies and gentlemen, there are no further questions at this time. I'll turn it back to management for closing remarks.

Yes. The Advice Columnist Ann Landers once said, don't accept your dog's admiration as conclusive evidence that you're wonderful, to which I would add, but if you feed your dog Freshpet, you've a much better chance of getting close. Thank you for your interest and we look forward to talking to you again in next quarter.

Thank you. This concludes today’s conference. All parties may disconnect. Have a great day.