Freshpet, Inc. Q1 FY2021 Earnings Call

Greetings. Welcome to Freshpet Inc. First Quarter 2021 Earnings Call. As a reminder, this conference is being recorded. I will now turn the conference over to your host, Jeff Sonnek, Investor Relations with ICR. You may begin.

Thank you. Good afternoon. And welcome to Freshpet’s First Quarter 2021 Earnings Call and Webcast. On today’s call are Billy Cyr, Chief Executive Officer; and Heather Pomerantz, 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 SEC and the company’s press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note that 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 on how management defines such non-GAAP measures. A reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP and limitations associated with such non-GAAP measures. Finally, the company has produced a presentation that contains many of the key metrics that will be discussed on this call. The presentation can be found on the company’s Investor website. Management’s commentary will not specifically walk through the presentation on the call, but rather it’s a summary of the results and guidance they will discuss today. Now, I’d like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Jeff, and good afternoon everyone. I want to start by giving you the punch line up-front. The Freshpet Kitchens are delivering the increases in output we had expected and are now producing at a rate that is almost 50% above a year ago. That is enabling us to refill the trade inventory that we had drawn down during the back half of 2020 and satisfy our customers and consumers with much better in-stock conditions. We are not done refilling the inventory on all the shelves at all customers, but we are getting close. We are incredibly grateful to the customers and consumers who have stood by us during the supply challenges we had over the last six months. We know it is frustrating for our customers to not be able to provide their shoppers with high-quality in-stock conditions. They pride themselves on it, and for consumers to have to search high and low for the Freshpet products that their pets have become accustomed to, our team has done everything they could to catch up to demand under very challenging circumstances. I can't say enough good things about the efforts of our production, sales, logistics, and consumer care teams and their tenacity through the challenges of the past year. The progress we've made has allowed us to get back to doing what we do best: change the way people nourish their pets forever. Our advertising is on the air, household penetration is growing, we are launching new items, and our customers are planning to install new fridges, upgraded fridges, and second fridges. As a result of this progress and the strong fundamental trends we are seeing, we remain very bullish on our prospects for both this year and for the next several years. We are off to a very good start in 2021. Despite the numerous challenges we faced, in Q1, we grew net sales by 33%, our strongest quarter of growth since the third quarter of 2015; basically, we sold everything we could make in Q1. We also grew adjusted EBITDA in Q1 at a rate slightly above net sales growth of 35% versus a year ago. Heather will provide you with more detail on those results. I want to focus my comments on a few of the highlights and choices we made that drove the results in the quarter and update you on our expectations for the balance of the year and early next year. I want to begin by discussing the state of our manufacturing operations. Overall, we are doing very well delivering on the commitments we made on both our near-term and long-term capacity projects. As we have previously outlined, we made several additions to our capacity last year, including a two-shift operation at Kitchen South last June and the startup of Kitchens 2.0 in October. Despite those additions, our total output did not go up; we lost just as much output in our existing Kitchens due to COVID testing and quarantine as we gained from those incremental operations. You can see this on the chart on page 36 of the accompanying investor presentation. In December, we made several interventions designed to correct that, and the plan is working. We are now getting the benefits of the incremental production capacity we added last year and adding more. Other than the two significant snowstorms in February, we've consistently produced in excess of Nielsen measured consumption every week since January 1st and have not lost any production shifts due to COVID, and our April production was about 45% ahead of a strong month year ago, and more than 60% greater than what was consumed a year ago. We've now demonstrated the ability to produce at a level that will support the significant growth we are guiding to this year. We've been able to do this because of the work our HR team did to bolster our staffing. We raised the wages for our night shift and recruited a flex pool of talent to both insulate us from any further COVID-related absenteeism and further expand our capacity. COVID still exists in the Lehigh Valley community where the Kitchens are located. So we are still incurring some COVID-related costs. We expect that to wind down in Q3 as our entire team became eligible for vaccines on March 31st. We have strongly encouraged them to get vaccinated, if they can. We have provided incentives to our team members to share their vaccination history with us, offering two incremental days of vacation and a $25 cash incentive if they share their vaccination record with us in the first two months after they became eligible for one day of vacation if they share it within the following two months. Further, while the state of Pennsylvania has not allowed companies to do onsite vaccinations, we hired nursing staff to sit in our break rooms for eight hours per day, working with our team members to navigate the challenges of finding vaccination appointments. They successfully found vaccine appointments for numerous team members at times and locations that worked for them. We were thrilled with the success of this program and our team members are very appreciative that we made it so much easier for them. While not everyone will choose to get vaccinated, we believe enough will choose to be vaccinated to reduce our dependence on most of our COVID-related interventions by the end of Q3. Due to our success in navigating these unusual and dynamic variables, we do not expect further supply interruptions this year due to COVID, and as a result, we anticipate winding down our COVID add-back to adjusted EBITDA by the end of Q3. We are mindful, however, that the future of COVID is uncertain, and there is the possibility of new variants that evade our vaccines, further government-mandated lockdowns, and new unforeseen supply chain interruptions. We will remain nimble, always keeping the safety of our team as our top priority, and we'll communicate any changes to our expectations in a timely manner. Looking forward, we remain on track to add a new production line in Kitchen South later this year and another one early next year, and construction of our largest Kitchen in Texas is making good progress. We remain comfortable with the timetables we've communicated previously in terms of facility start-up timing and the total production capacity each of those facilities will provide. Further, when the NS facility opens next year, it will be another example of our ability to continually improve the manufacturing technology for Freshpet, creating higher quality products at an attractive cost and in a very positive work environment. Kitchens 2.0 was a major step forward for us against those metrics, and that will be another step beyond that. I also want to point out that we are constructing the NS facility with environmental sustainability in mind. For example, we've already poured 3,700 cubic yards of low carbon concrete. That is concrete that uses fly ash to lower the carbon footprint that has saved approximately 100 metric tons of CO2 emissions, so far in the construction of that facility versus ordinary concrete. We can't replace all of our concrete with low carbon concrete, but where we can, we are doing it. We are also installing a variety of measures designed to both limit our water and energy usage but also generate clean water and energy on site. We will provide a much more in-depth review of our entire environmental sustainability and broader ESG effort this summer when we release our first ESG report. The second topic I would like to address is the composition of our growth in the quarter. As we said when we provided our guidance in late February, the year-on-year comparisons are not particularly meaningful due to the COVID surge and trough in the base. In the accompanying presentation, we attempt to provide a bit more clarity so that you can understand the various moving parts, including not only the year ago COVID impacts, but also the impact of our out-of-stocks this year. The key points I would highlight are first, the out-of-stock impact was most significant in mid-February when winter storms interrupted both production and distribution. You can see this in the drop in Total Distribution Points (TDPs), monthly net sales versus a year ago in February, and our two-year stack Nielsen consumption growth rate prior to those February storms improved production resulted in strong January shipments and healthy consumption growth. Since the end of the second storm in mid-February, we've seen similarly strong bounce back in shipments, consumption, retail availability, and our production levels, and those trends continued into April with a strong upward trend in the weekly Nielsen consumption through the most recently reported week. We are now running at the consumption growth rate we need to deliver our guidance for the year. Second, we successfully refilled a portion of the trade inventory in Q1 and expect shipments to exceed consumption in each quarter this year. We believe that we refilled about $3 million in trade inventory in Q1 and that contributed about four points to our growth rate. We would have filled considerably more, but we lost $3.5 million of production to winter storms. So virtually all the trade inventory refill happened in March, and it is accelerating while estimating trade inventory levels is always very difficult and imprecise. We believe that leaves another $12 million of trade inventory to fill in Q2, and we have seen a significant portion of that happen in April as we've had very strong production performance. As we indicate in the presentation, our net sales in April are anticipated to be up about 42%, while consumption in April is expected to be up by a similarly strong growth rate. Please remember that we were also refilling trade inventory a year ago. Last year we reported our total Q2 net sales growth rate included 11 points of trade inventory adjustments. We expect that this year's Q2 trade inventory refill may contribute to our growth rate at a level equal to or slightly above last year's adjustment. Looking into the second half of 2021, I'd remind you that in late Q3 and all of Q4 of 2020, we could not keep up with demand. So shipments did not grow as fast as consumption, and we drew down trade inventory. We believe we will have adequate capacity this year to meet the increasing demand, and our shipment growth rate should exceed the consumption growth rate for the second half of the year. Third, despite our out-of-stocks in the first quarter of this year, we continued to successfully build both household penetration and buying rate in the quarter. As you know, maximizing our first mover advantage in the Freshpet food space is a critical strategic priority for us, so our bias is always to lean in to maximize the number of households who become part of the Freshpet franchise. In early November, we delayed the start of our advertising in Q1 2021 to mid-February, in an effort to better match our projected timing for improved retail conditions. The healthy media schedule continued for the balance of the quarter. If we'd known in early November about the production challenges we would face in late November and December due to COVID, not to mention a series of major winter storms that would curtail our production and accelerate out-of-stocks, we would have made a different choice. Needless to say, that was not ideal. Despite that, we were still able to bring in new households at a very strong rate; consumers saw the advertising and were motivated by it, driving household penetration up 25% and exceeding $4 million households for the first time. The efficiency of the spend was likely reduced from our 2020 levels, but early reads suggest that it was in line with our 2019 levels of efficiency, which was still quite positive. We also built the buying rate by 3%, despite consumers' inability to find our items for a good portion of the last six months. Once it became apparent that the retail conditions would not be restored until the end of April, we delayed the start of Q2 advertising until April 19th. Well, that will delay our ramp-up in household penetration gains in Q2, we believe we got the timing right as retail conditions had improved dramatically. By the time the advertising went on the air, we will now be on the air almost continuously for the balance of the year, and that will provide significant momentum, particularly in the back half of the year. The third topic I would like to cover is how our retail partners are thinking about Freshpet today in light of our recent out-of-stocks and the implications for fridge placements later this year and next year. If there's anything that this experience has taught our retail partners and us, it is that Freshpet has become a very important destination for pet parents. When a store is out of stock on Freshpet, consumers are willing to go to a second or third store to find the product, and they will call us asking where they can find it. Freshpet really is that important to our pet parents and their pets, and our retail partners have noticed. Freshpet is now larger than all dry dog food brands in the grocery channel, which is where some of our biggest distribution opportunities lie. Our total dollar sales growth is now larger than the growth of every other wet and dry dog food brand in the Nielsen Mega Channel, while the out-of-stocks didn't always make for the most comfortable conversations with our customers. One clear theme emerged from them: they now realize that winning with Freshpet is very important to their overall success in pet foods. Many of our leading customers are now planning to lean in on Freshpet. In fact, eight of our top ten customers now have significant tests or expansions of dual fridge placements, and many are planning more, but before we place new fridges, we need to be able to supply them. It makes no sense to put lots of new fridges in stores if we can't supply the fridges that we already have. As a result of the out-of-stocks we incurred in Q1, in cooperation with our customers, we delayed many of the new store fridge placements until later this year, early next year, when our capacity could support them. Thus, our net new stores were only up 174 to 22,890 in Q1. However, we had a strong quarter on upgrades, placing 293 of them and a decent quarter on second fridges, placing 121 of them. This pace is consistent with the guidance we provided in February, and we are on track to deliver our full year 2021 goals. We expect to see a steady stream of new placements throughout this year, with the most significant placements occurring in Q4 and the first half of 2022. We continue to expect to have the capacity to support a $590 million revenue run rate business by the end of this year, and about a $1 billion run revenue run rate by the end of 2022. That will give us plenty of capacity to support the aggressive expansion that our customers are contemplating, and we have shared that information with them. So we remain coordinated. Before I turn it over to Heather, I want to personally thank all the investors who supported our recent equity offering. That offering is allowing us to accelerate our pace of capacity expansion, enabling us to build the capacity to support a $2 billion revenue business and helping us achieve our goal of changing the way people nourish their pets forever. While we have lots of work to do, we are well on our way to deliver those projects. Now I will turn it over to Heather to provide the details on our financial results.

Thank you, Billy, and good afternoon everyone. As Billy indicated, net sales for Q1 of 2021 were $93.4 million, up 33% versus a year ago. Actual Nielsen Mega Channel consumption was up 24%. So after accounting for one less day in the quarter this year, we see a continued improvement in the reduction of spoils and the trade inventory reduction from a year ago. We estimate that four points of our growth came from our efforts to rebuild trade inventory and refill the fridges, which amounts to about $3 million of our net sales in the quarter. We believe we have another $12 million of trade inventory that we will refill in Q2, and we are on track to do that. We believe we could have sold more in the quarter if we could have produced more; we lost about $3.5 million of production to the two major snowstorms that occurred in the quarter. While winter snowstorms should not surprise anyone, these storms had a disproportionate impact on us because of the magnitude of the storms in our production facilities. The fact that we had no excess capacity and neither we nor our customers had any inventory to buffer the impact led to this. The growth in the quarter continued to be led by strong performance in the pet specialty channel, with Nielsen measured big box pet specialty consumption up 43% in the quarter. Our e-commerce business also performed well, growing 156% in the quarter, and now accounts for 6.3% of sales. Additionally, we had very strong performance in our international market; our international business grew 36% in the quarter, and we continue to see strong momentum in those markets behind the advertising investments we have been making. Clearly, the Freshpet business model works outside. Thus, adjusted EBITDA for Q1 was $7.8 million, up 35% versus a year ago, slightly outpacing sales growth. The profitability would have been greater except we incurred significant freight cost increases in the quarter. Part of this was due to the freight inflation we saw coming and communicated on our February call, but a larger portion of the increase was due to our low order fill rate. Due to limitations in our current ERP system, we don't have the ability to consolidate loads very easily when we are shipping less than a hundred percent of a customer's order. Thus, when customers gave us very large orders to meet both weekly demand and refill their inventory, and we only had limited inventory to satisfy the order, our fill rates dropped significantly. The result is that we shipped trucks that were half empty, driving up our freight cost per pound. I have provided a chart in the presentation that describes how this happened and the impact. This problem will be remedied as we rebuild our inventory, both ours and our customers, and customer orders better reflect actual weekly consumption. We expect that to happen gradually throughout Q2. However, the fill rate will only improve modestly until we rebuild our internal inventory on the vast majority of SKU. In other words, we anticipate refilling trade inventory before we are able to completely solve the fill rate inefficiency, which we expect will likely occur sometime in Q3. Our new ERP system will also have the capability to allocate inventory to orders before shipment, allowing for order consolidation, which will be of immense value should we ever face this problem again. That new system is targeted to go live at the beginning of Q4. Until the remedies are put in place, we believe we can offset these higher costs elsewhere in the P&L and still deliver our adjusted EBITDA guidance for the year, but they will reduce our opportunity for SG&A leverage gains until that is completed. Adjusted gross margin improved modestly from Q4, up 90 basis points to 46.7%, but it was well below the year ago of 49.5%. We continue to incur higher beef costs and higher wages, which were anticipated, but we also incurred higher unabsorbed fixed costs due to lost production caused by the storms in February, in addition to expanded production at Kitchen South, which drove higher processing costs. We believe that the investments in both the higher night shift wages and the expanded production at Kitchen South are paying significant dividends in terms of strong and steady production that is enabling us to refill the trade inventory. Because there was much discussion about cost inflation in the market today, I want to comment on how we are seeing that today and outline what you can expect from us. As many of you know, chicken is our single largest ingredient expenditure, and we locked that price for the year in December at prices that are flat versus a year ago. I have already mentioned that we are experiencing inflation in beef and freight, both of which we planned for this year with those increases being in line with our expectations. At this point, we are beginning to see some inflation in resin-based materials, such as packaging. The total impact appears to be modest and manageable within the context of our guidance. We are also beginning to see evidence of labor cost inflation, but we are not expecting a significant increase this year. We will continue to watch these costs as the year progresses before making any determinations about whether we need to take any action. Although if we did, it would not have any impact until 2022. Media investment in the quarter was in line with our long-term rate at slightly above 12% of net sales, but below the 16.7% we had a year ago. Recall we delayed the start of advertising in Q1 to give us some time to rebuild trade inventory. First, excluding the higher freight and lower media costs in the quarter, SG&A was down 160 basis points versus a year ago, giving us the confidence that our long-term roadmap towards 1000 basis points of SG&A leverage by 2025, excluding media spend, is on track. We incurred $950,000 in COVID-related expenses in the quarter and have added those back. We expect to complete our COVID add-backs in Q3, as we anticipate enough of our teams have been vaccinated by then to roll back some of the incremental provisions we have put in place. Our net cash used in operations was $5.5 million in Q1. Our cash flows and operations were driven by accounts receivable and inventory working capital needs due to strong net sales growth and production. In the last month of the quarter, we successfully completed our equity offering in the quarter, netting $332.5 million. Our cash on hand at the end of the quarter was $341 million. We spent $49.3 million in cap backs in the quarter. The NS facility is entering some of its highest investment quarters, as all of the site preparation is complete. Foundations have been poured and steel has been going up for about a month now. Additionally, our project at a second line at Kitchen South is on track to produce product by the end of Q3, and the third line there will come online at the beginning of 2022. We are also taking advantage of the incremental capacity that is coming online to make some upgrades in our existing Kitchens. We expect to have that work completed by the end of the year. That work will improve quality and reduce some of our labor costs on one of the existing lines. I also want to comment on the productivity we are seeing from the new lines in Kitchens 2.0. You will recall we raised our throughput expectations for those lines when we provided our updated long-term capital plan in late February. In that plan, we acknowledged that the higher speed lines and greater automation we placed in Kitchens 2.0 could deliver higher output than we included in our original projection. We are continuing to see that level of productivity as we increase the hours of production on those lines, and we are also seeing outstanding quality. We are not done expanding the shifts in that facility yet, so we have significant incremental production capacity yet to come, but it's very exciting for us to realize the benefits of the manufacturing expertise we have been investing in. We believe we have created a new standard for Freshpet production and look forward to sharing it with you when the world opens up and we can host visitors again. Turning to our guidance for 2021, we are reiterating our guidance for the year that calls for net sales of greater than $430 million and adjusted EBITDA of greater than $61 million. In the presentation, you will see some of the many assumptions that go into that guidance and also some details on the cadence we are expecting. As we have said, the unusual nature of last year's consumption patterns and our short shipments will make the year-on-year comparison a bit odd, so we are doing our best to clarify as many of the moving parts as we can. In particular, as we look to Q2, please take into account the following: in the quarter, we expect to complete the refill of the trade inventory hole we created in the back half of 2020. However, we did something similar a year ago, so we will not necessarily experience a significantly higher shipment growth rate than the consumption growth rate reported by Nielsen. But based on what we are seeing so far, the consumption growth rate has been robust, so we are projecting continued strong shipments. We expect to see sequential improvement in adjusted gross margin as we continue to produce at a very high level and expect to exit 2021 with a fourth quarter gross margin run rate higher than our full year 2020 results. We are still on track for the average adjusted gross margin to be flat to 2020. We will continue to experience higher freight costs due to our depleted inventory levels for most of Q2 and potentially part of Q3. This will diminish our leverage gains and adjusted SG&A including media this year, but we expect those increased costs to be gone by Q4. We will have a very strong advertising investment in Q2 as we ramp up our growth to catch up to the increased production capacity. We have created that investment will continue through the end of 2021 with comparable spending in absolute dollars landing each of the three remaining quarters. In closing, our guidance for 2021 continues to call for net sales greater than $430 million; up 35% versus a year ago, and adjusted EBITDA greater than $61 million; up 30% versus our rebel. We believe our strong performance in Q1, particularly in manufacturing, has positioned us well for the balance of the year. We are producing about 50% more than we did a year ago and we have more capacity coming online. Our advertising is driving household penetration gains, and we have a strong continuous media presence for the balance of the year. Retailers recognize the value that Freshpet brings to the category and are planning more and larger fridge placements, and our innovation pipeline is deep. We have not had the luxury of all those conditions being in place all at the same time in a long time, and we look forward to taking advantage of the momentum that provides, accelerating our growth towards our 2025 goals of 11 million households, $1.25 billion in net sales, and a 25% adjusted EBITDA margin. That concludes our overview. We will now be glad to take your questions operator.

Thank you. At this time, we'll be conducting a question and answer session. One moment, please, while we poll for questions. Your first question comes from the line of Ken Goldman with JP Morgan. Please proceed with your question.

Hi, good afternoon. Thank you. You know, I know there's some year-on-year lumpiness or there's some lumpiness of the year-on-year numbers, but the way I see it, you've guided to annual run rate capacity in one Q of $390 million in potential sales, you've got it to $490 million in Q2 for the run rate. So I guess we just average those out and it kind of gets you to a quarterly run rate of about $110 million in dollar sales capacity this quarter. I apologize for doing the math on the call, but it just feels like you're sort of saying to us, you know, you should probably get close to that $110 million number in dollar sales unless you under ship consumption, which seems unlikely. So I just wanted to make sure my math there is not totally inaccurate and how to think about, you know, implied guidance for Q2 revenue?

Hi Ken, I'm sorry, I was talking on mute. I apologize. No, I thought I was someone for the first time in history. Yeah, no, sorry. Thanks for trying to jump in. So Ken, your math is right. But I caution that there's a couple of assumptions that are built in there. The first assumption is that we have at the end of the quarter and that the demand is fully utilizing all the capacity. We're filling the trade editorial hole now. So it assumes that at the end of the quarter, the Nielsen consumption is using all of it up. The second assumption in there is as we continue to ramp up production, the assumption is that what we produce and what is in demand is a dead match. So as you can imagine, we're going to start doing longer production runs and try to refill some of our inventory to improve our customer service. Because we know as we have more inventory in house, our ability to fill trucks goes up. So we may end the quarter with higher inventory as opposed to necessarily selling everything that we make. It's not the ideal way to do it, but it's ultimately what could end up happening. But other than that, your math is right.

Okay. So just to clarify, and I'm not, I don't want to pin you down on an exact number here, cause I know things are so fluid right now, but $110 million seems like the maximum you can produce, but there are some caveats to that that could bring it, so potentially slightly below that. And I'm not holding you to that. I'm just trying to get a sense of what you're saying?

It just recognize that there's a human component. Yes. I mean, let's put it this way. Ken, can we get in that direction? Yes. There's the human component. We're adding staffing. We have to produce well every time every week; you get the idea, but we're in that ballpark.

Understood that. That's helpful. Thank you for that. And then you spoke last quarter about a major expansion in e-commerce; obviously e-comm is doing great for you still. I think we hear, though, another mention of that major expansion today unless I missed it. I just wanted to know, are you still on schedule with those partners? Or maybe you have your production challenges temporarily delayed some of the bump-up you might've expected? Just hoping for an update because that was such an important part of the story last quarter.

Yeah. Hey, it's Scott. So no, everything is running on schedule. I wish everything was running as tight as this. So I think what you're going to see from us over the course of this year is a lot of expansion in e-commerce in general. We've actually had to shut down a lot of the marketing and advertising that we've done over the past year just because of some of the capacity issues. So you'll see expansion with many of the folks that we currently work with where the majority of it goes through our existing fridge network. And you'll also see some additional e-commerce partners come in where you'd be able to order different things. We are going to increase the marketing. We anticipate it will continue to increase our overall share of the business. We're getting a ton of inbound requests from consumers from a subscription standpoint. We think we'll be able to solve that this year. So we're very excited about that and we're really planning on working with the right partners to make a major impact in e-commerce over the course of this year.

Thanks, Ken. Your next question comes from line of Steph Wissing with Jefferies. Please proceed with your question.

Thank you. Good afternoon, everyone. I have a question for you, Heather. It's just on the overall cost structure. So you talked about chicken being locked in, beef seeing a little inflation, some packaging inflation, and then freight separately in the selling expense. Can you just help size up each of those to your overall cost pool? So we can just understand a little bit about the impact in each of those big buckets?

Sure. Just to sort of dimensionalize how to think about our input costs and where they show up: the cost of goods when you split up the input costs are about 40% of our cost of goods. And just as a reminder, freight costs are in SG&A. So, when you're thinking about margin impacts, that's the split there. So, yeah, we touched on it, but I'll go into a little bit more detail. We anticipated inflation in beef, which is on track in terms of what we've gotten for guidance. We also anticipated packaging inflation mainly in corrugate, and that's also reflected in our plans. The only new one that's really emerging is around resin-based materials, and right now kind of the resin impact appears to be pretty modest in terms of how that will impact our packaging costs overall. So, not a major driver; something that we're comfortable that we can absorb within the overall P&L structure and overall guidance. In freight, we touched on it, but I'll just go into a little bit more detail. We are ending the beat in freight inflation, both in carrier inflation, as well as fuel surcharge, and those assumptions haven't changed versus what we had in guidance. The bigger driver is the issue that I talked about around the cost and vocation of our low fill rate. That's a pretty meaningful cost. If you look in the presentation, you'll see that, when you look at a 50% fill rate versus a 90% fill rate, that's about $0.07 a pound, so it's pretty meaningful. The impact in Q1 on a margin perspective is about 200 basis points. So we had 300 basis points versus our planning and logistics, of which 200 is driven by that fill rate issue versus prior year. So it's pretty meaningful, but we do expect that as fill rates improve, it'll naturally come down as we improve.

Okay. That's great. And if I could just have one follow-up, this also relates a little bit to e-commerce being about 6% of your business. But as you're thinking about deploying more dollars in advertising, can you share with us a little bit about the digital versus traditional mix? And then as you see e-commerce continue to climb higher, do you shift more and more towards digital activation and conversion?

It's a really interesting question. It's something we've tested our way through over the past five years on how we go to market. We make sure that the dollars that we're spending, we keep an incredibly close track on, and we do an incredible amount of analysis to make sure that there is productivity as possible. The vast majority of our spending continues to be on television. We are finding that there's some great places in connected TV and OTT that we can spend dollars in that are really productive. We have nice spending in digital, but it's definitely not the majority of our overall spend. As we do a little bit more e-commerce with what we've done over the past year, we get really, really good return on ad spend when we're advertising specifically in the dollars going to a partner that allows consumers to order it directly. So there are some areas where we're getting really good return on ad spend, and we're going to continue to press into that area until we see any diminishing returns. So I don't think it'll cause a dramatic shift in what we see overall because it's still a very small piece of the total pie for us. But over time, we definitely anticipate potentially moving some dollars into that area.

Your next question comes from the line of Rupesh Parikh with Oppenheimer and company. Please proceed with your question.

Good afternoon. Thanks for taking my question. So as you look at the April data, clearly consumer mobility has increased. I was just curious if you guys are seeing any changes in consumer behavior or where they're purchasing. Have you seen some changes with the increased vaccinations, etc.?

First of all, in the deck, we show our estimate of what April's consumption is, or our sales were, and then also you see the Nielsen data for the month. You can see we're seeing an upward trend in consumption as well as the shipments that we're doing. The thing that's tough for us to tell is we have two things going on at the same time: advertising went on the air for us on April 19th, and our in-store presentation has improved consistently throughout the month of April. So with those two factors, we'd expect to see continued strong upward trends in consumption. So it's hard to separate that out from anything else, like vaccinations and people having more mobility. The attitudinal data we've seen suggests that the consumer comments indicate that behavior is very similar, but I have to believe that psychologically, consumers are feeling a little more liberated.

Okay, great. And then maybe just one follow-up question. So clearly you have some cost pressures in your business. It seems like this year you'll be able to manage through. How do you think about the pricing lever going forward? Is that something maybe you revisit later this year for next year, or just curious on pricing and how you guys think about that going?

Yeah, Rupesh. Heather had made some comments in the prepared remarks that basically said, we'll take a look at that, but probably later this year. We'll look at it and see what the cost picture looks like. Frankly, we have to restore our customer service and get ourselves in a good position with both our retailers and our consumers before we even think about that. And then we'll take a look at it and see what the cost inflation is that we have?

That being said, we have done pricing in the past. We've been able to manage it very well. The business has responded incredibly well to it, so we do know it is a lever. But it's not something that we're looking to apply in the near-term.

Okay, great. Thank you.

Your next question comes from the line of Bill Chappelle with Truist. Please proceed with your question.

Thanks. Good afternoon. Hello there, I guess, first question, trying to understand kind of the out-of-stocks and how we see the retail. I mean, doing a fair amount of sort checks, you can find some pretty bare fridges. You can even, even as recent as the past couple of weeks, and historically, it's always rare where you could find a fully stocked fridge, just because it was either growing so fast or just because of customer service or getting it to the fridge levels. Should that change over this year? I know you said you're going to have production up to make your sales goals, but I didn't know if the out-of-stocks would still be an issue throughout the year where you may be leaving some sales on the table?

Let me take a shot at that, and Scott might have some comments to add on it, but the out-of-stocks were at their very worst shortly after the snowstorms we had in February. And whether you measure using TDPs, which is sort of a publicly available way of identifying our out-of-stocks, or we do some of our own internal audits, the bottom line is we've seen consistent improvement week on week since that deck in February to the point that as of the most recent week, you know, there are still some fridges out there, and it's in certain places and certain customers and uncertain SKUs, you'll see some spotty conditions. But we fully expect to see much better-looking fridges in the next several weeks. And if you take a look at the PDPs as a sort of a benchmark of it last August, mid-August, when we were just the first time we sort of ran out of capacity, that was our high-water mark. And we had a lot of very full fridges back then. I'd expect us to be back at that level within the next six weeks or so. And at that point, yes, you'll find some fridges that don't have all the SKUs all the time, but you'll find a largely well-stocked fridge. Scott, do you have anything to add to that?

Yeah, I feel we touched on it in the past, and sometimes we look at it and I think everyone in the organization sometimes does scratching their head on how we're putting up the numbers we're putting up with some of the in-stock conditions that we have. I think it's a good signal; we have in-stock conditions at some retailers that are as low as 30%, 40% all the way up to 80%, but we have a lot of opportunity, a ton of opportunity. I think as we continue to get the rest of the portfolio, people want to buy certain things. If we get the rest of the portfolio filled out, I think there's really nice upside for us over the course of the year.

Got it. You talked about kind of pushing out some of the new store openings, and I might've asked this before about innovation and skew count expansion. Have you done any near-term adjustments with everything that went on in the quarter where you need to push that out even further just to increase throughput for the most popular SKUs?

What we've had, Billy, you want to go ahead? Yeah, no, in about a lot of our innovation this year was actually centered on lines that were not our high capacity lines. We have a handful of smaller, lower capacity lines that enable us to get some of that newer innovation out. We've been able to utilize those. So it didn't take away from a lot of the capacity that we needed to put towards our base items. So we were fortunate with that. We did get some of that innovation out. There was a little bit of it that did kind of slide, and some of it will even go to next year at some retailers, but the majority of the innovation will go out as scheduled and as planned throughout the year.

Okay, great. And then let's sneak one last update on kind of sense of how much U.S. pet ownership has spiked over the past 12 months.

We've seen so many numbers on that, just like you have as well. I will tell you I've seen numbers that were as low as 2%, and I've seen numbers in the high, mid single digits. The best number I've seen, which suggests that the pet ownership, and I'm now speaking mostly about dogs, was up like 3%, maybe a bit more than 3%. There was a big pull-forward last year, but I don't believe the numbers that said it was a whole lot more than you know, if you got me to four, I'd be surprised.

Okay. Hey Bill, I appreciate one thing. The other on the pet ownership piece, I saw a study done recently that was really encouraging that not only was there some increase in pets, there's only so many types to go around, but there's still pent-up demand. It seems like it's continuing. I think, hopefully, people are realizing it's pretty awesome to have a dog or a cat or a pet in your family. So I don't think it's going away and it may continue to grow over the next year or so.

Your next question comes from the line of Peter Benedict with Baird. Please proceed with your question.

All right, guys. I guess I have one question on production. One of the slides you had in here had about GBP 519,000 a day as the average in April. And I think during the presentation or the call here, you spoke to some improvements coming from some of the Kitchen 2.0 lines, some increased coming in Kitchen South, trying to get a sense for where you think pound production per day could be as we look out over the second half of the year or the end of the year, benchmark, or however you want to frame it?

Yeah. I don't think I haven’t mapped it out in terms of pounds. One of our manufacturing guys might've done that. It's also very, we have to be careful because when we use pounds, we bring in a lot of ingredients, and that's the way we measure throughput, but it turns into cases and it turns into meals that we feed pets. What I can tell you is the chart that we've also included in the deck shows what the revenue would be in each of the quarters is probably the best indicator of what we think we're going to get because one of the things that's going to happen as we expand capacity, one of the lines that we're expanding capacity on the most and where we're shortest right now is on our Freshpet Kitchen line. Freshpet Kitchen is the highest price per pound of our mainstream items. So when we start producing that, the pounds won't be as big as some of the other items, but the dollars will go with it. I just caution that using pounds is the only metric to think about our capacity could become a little misleading as we get further into the year. But suffice it to say that we're going from where we are today, where we have all of our equipment running. We're now adding shifts. As we add shifts, we pick up capacity first on our bag, then on our roll lines, and then ultimately start up another line of Kitchen South, which will be another bag line. So we'll see more of the mix moving near term into roles, longer term into bags, and that will impact both the pounds and the dollars.

That's helpful, thanks, Billy. The P&L, you know, how the loss on equity investment line in there, not sure if you guys are willing to speak a little bit more about that, apply some color into that, but in the P&L, I figured I'd ask Scott. You want to talk about that?

I can grab that; Heather. Sorry, we went, we went on mute. Sorry about that. The loss there is representative of our percentage ownership in the investments that we've made reflective of that business's Q4 performance. That's basically all that we could share.

Okay. All right. That's all right. And then I guess last question for Scott with your social media video today, it's approaching 2000 views across Instagram and Facebook. How's that trending relative to your expectations?

Yeah, well, we launched it around 11 o'clock, and I was quickly told that I have no chance for any type of award from the bio, so I'm a little concerned, but I'm going to work harder next time. I mean, look, I think it's been pretty well received. If you kind of go through the comments, I think very, very well received, honestly. You actually see some people in there like, 'send me a subscription kind of thing,' or 'I waited for you.' I think it's been really supportive; it's been great to see over the next couple of weeks. This will have a long tail on it, and we will be putting a little bit of spend behind it to communicate it out because it's not about vanity; it's about really trying to be transparent and communicating with our consumers and making sure that people see it. So I think we'll see some numbers grow, and the people that want to hear about it will get a chance to see what we're talking about. But so far, so good. I think if Andrew Cuomo got an Emmy for his COVID press conferences, Scott should get an Oscar for that.

All things, I'm not acting; there's no acting going on. It's just the real deal. Well, listen, well done on that night; I think all you've been doing with the letters and now the video, it's great because obviously, it's a tough situation for some consumers, but I think it goes over well. So anyway, just wanted to flag that way.

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

Thank you everyone for your attention. I want to just leave you with one thought. This is from Aldous Huxley: 'To his dog, every man is Napoleon; hence the constant popularity of dogs', to which I would add: 'If you feed them Freshpet and your dog thrives, you deserve to be called Emperor Napoleon.' Thank you for your interest in Freshpet, and we look forward to talking to you again at the end of the next quarter. Okay. Thank you.