Greetings and welcome to the Freshpet Fourth Quarter and Fiscal Year 2021 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Jeff Sonnek with ICR. Thank you, Jeff. You may begin.

Thank you. Good afternoon and welcome to Freshpet's fourth 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 for 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. That 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 summarize the results and guidance that we'll discuss today. Now, I would like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Jeff. And good afternoon, everyone. The message I would like you to take away from today's call is that we finally have the capacity needed to support our significant growth potential and build upon the momentum that we've created through five consecutive years of accelerating revenue growth. We fully intend to take advantage of that capacity. But we've also learned some hard yet valuable lessons over the past two years. Those lessons are the foundation for the conservative planning that we've undertaken, which we believe is required in this complex and challenging environment. Over the past two years, we've navigated everything from the COVID crisis to labor shortages, to supply chain issues and inflation. Our operations wobbled numerous times along the way. We are keenly aware of the impact those have had on our many stakeholders, most notably our customers and consumers. We learned that in order to deliver a long-term sustainable growth Freshpet is capable of, we need to do a better job preparing for and insulating ourselves from those issues. The environment we are operating in today still has many of the issues we have faced over the past two years, albeit some are less impactful, like COVID, and others are more impactful like inflation. But the more important change is how well we prepared for those issues and plan for new and unknown challenges. We finally have more than enough capacity and have more coming online. We have stabilized, trained and developed our workforce, and we've completed our ERP conversion. Further, we've strengthened our marketing programs, increased our innovation, installed more and larger fridges, and built a broader and deeper management team. We have a rare opportunity to change the way people feed their pets forever and build a truly great company. To do that though, we need to plan and prepare for continued disruption to ensure the reliability of our operations in an uncertain environment while also planning to aggressively maximize Freshpet's growth potential. We believe the plan we are sharing with you today strikes the right balance between the two. Perhaps the most important decision we are making to achieve that relates to how we will manage our capacity. We successfully built enough capacity to refill the trade inventory hole we created during 2020 and early 2021. It took a long time to refill that hole. And to do it we had to both delay our growth and increase our production to a level well in excess of demand. For perspective, in February we produced at an annualized run rate of approximately $600 million in net sales and our consumption run rate was approximately $490 million in net sales. So we are currently producing at an annualized run rate more than $100 million greater than demand. That is the magnitude of the production increase we had to put in place to refill the trade inventory hole. Please note that both the production and net sales numbers I just provided are at the pricing in place in February, prior to our second price increase. We also have more capacity coming online throughout 2022, both in Ennis and Kitchen South. It gives us plenty of headroom to grow, and we plan to use it. We expect to grow at a rapid rate. And we'll invest in marketing early in the year to drive our growth, but it will take time to fill that much capacity. So for a period of time, we will have more capacity than our reasonable and conservative assumptions would indicate we will need. An excess capacity generally means excess cost. We debated quite a bit about the best way to manage that. We analyzed the pros and cons of delaying our capacity additions and scaling back production staffing to deliver more robust margins this year. In doing so, we are mindful of several important risk factors. First, ERP conversion; we just completed our ERP conversion and while it's going well, as anyone who has done one can tell you, there are always bumps along the way. Second, construction and startup of Ennis; we are heavily dependent on the completion of the construction of our Ennis, Texas facility and the successful startup now delayed to early Q3 due to construction material shortages. As we all know, it is very difficult to get construction materials and equipment delays are numerous and lengthy. Further, startups always come with some level of risk. Third, tight labor markets; we're in the midst of one of the tightest labor markets in decades. We've worked hard to build a team of highly skilled employees and have real momentum with our training program the Freshpet Academy. We are seeing the dividends and our labor strategy every day, but the labor market remains a risk. Fourth, supply chain disruptions; up and down the supply chain, we are seeing interruptions brought on by everything from labor shortages to port blockages to material shortages and even mandate and lockdown protests and now avian flu. Liability supply and transportation, something we used to take for granted can no longer be assumed and many of the shortages are unpredictable. For example, who would have thought that a Canadian vaccine mandate protests by truckers would disrupt the care of supply in the U.S. Fifth, COVID; while we all hope that COVID is largely behind us and we can return to some level of normalcy, we would look foolish if our plan required that this virus and the magnitude of its impact on families and the supply chain has constantly surprised people. And we don't want to be in that spot again. And sixth, pricing and inflation; finally, we've taken the most significant price increase we've ever taken and we are budgeting for a reasonable level of price sensitivity. However, if we have less price sensitivity than we have modeled, we do not want to get ourselves in a position where we cannot supply our customers and consumers reliably. Alternatively, while we lock our costs on as many of our ingredients and materials as we can prior to the beginning of the year, some of them continue to flow. The pricing actions we have taken fully address the inflation we saw and anticipated at the time we took the pricing, but we continue to watch the costs. And if we see higher costs persist for any reasonable length of time, we will not hesitate to take the necessary pricing to recover those costs as quickly as possible. Given those factors, we've made the decision to carry buffer manufacturing capacity this year. That is capacity that is more than we theoretically need to meet the guidance we are providing. We view this as a very important strategic decision and the result of our experience over the past two years, we have a unique opportunity to create and define the Freshpet food market and capture the lion's share of it as long as we can reliably supply our customers and consumers. Failing to do so opens the door for competitors and encourages our customers and consumers to look elsewhere, squandering our first mover advantage that is a risk we are not willing to take. The cost of the unabsorbed overhead created with this approach is significant in the short run, costing us approximately $13 million to $17 million for the year, or approximately 225 to 300 basis points of adjusted gross margin, but incredibly inexpensive over the long run. If that investment enables us to capture and maintain a much larger share of the emerging market for Freshpet food for a long time, that investment will look tiny in comparison to the opportunity it created. This approach has already paid dividends for us. In January, we were able to shut down one production line for much of the month to absorb the higher absenteeism due to Omicron and still keep up with demand rather than digging a deeper trade inventory hole and further frustrating our customers and consumers. The result, despite all the challenges of Omicron, our fill rates improved from the mid 60s in December to the high 80s last week, and our year-to-date shipments are up 38% versus the year ago. This approach also allows us to meet demand if it exceeds our projections, which is possible if we experience less price sensitivity than we planned or advertising proves to be more effective than anticipated. Finally, it can enable us to opportunistically expand distribution or launch innovative new products if any of those generate upside volume that would help us absorb the overhead investment we are making. We were also convinced we will need that capacity by late Q4 of this year and believe it would be counterproductive to scale back the capacity only to have to ramp it back up in less than six months. This is especially true with regard to labor. As we've worked hard to recruit and train the talent needed to overcome the pandemic challenges, it is imperative that we strategically build upon our talent and labor pool, not diminish it. I suspect there are some of you who wish our capacity would be more elastic, so do I. When we have the only production capacity capable of producing our best-in-class products, the only flex is within our network. Unlike so many other fast-growing companies that can turn on and turn off co-packers, we can't do that. We're building the largest, most efficient and most highly capable Freshpet food manufacturing base capable of supporting the business of $2 billion or more. We view that as a strategic advantage and we will need all the capacity we are operating now by the end of this year, and we'll need even more next year. To help you understand the impact of this choice, we'll be providing a margin and profit illustration at the end of each quarter and for the year that dimensionalizes the cost. As I said, it is sizable. But against the scale of the long-term opportunity we are seizing, it is a small price to pay. We will be able to continue and accelerate our momentum, restore our credibility with customers and consumers, and insulate ourselves from the volatility that may be ahead of us. With that context, let me outline some of the key points of our plan for 2022. First, we are guiding to greater than $575 million in net sales for the year. If we deliver that, we will have generated 35% growth for the year, our sixth consecutive year of accelerating growth. That net sales target is inclusive of a blended pricing impact of approximately 15%, i.e., the fiscal year impact of the two price increases we've announced and implemented and an assumption of some price elasticity due to the magnitude of the price increases. While we believe our brand and pet food in general are relatively inelastic, our projections assume that net sales growth will be about 10 points greater than unit movement growth. Our guidance also includes an understanding of the headwind we have due to the trade inventory refill in the year ago, partially offset by the more modest rate inventory refill we are completing on bags in Q1. A 35% growth rate might not sound like a conservative assumption. However, our year-to-date Nielsen's are up approximately 35% and accelerating with the most recent weeks up approximately 40%. And that is before we get any benefit from the second price increase. Further, we will be lapping an extended period of out of stocks and delayed marketing in the year ago for most of the first half of 2022. To deliver those net sales, we will lean heavily on our advertising program. Our advertising investment is approximately 12% of net sales and more heavily front loaded consistent with the way we did our media planning in years prior to the pandemic. If those investments put us ahead of our plans by mid-year, we would add more media later in the year to keep the momentum going and utilize the buffer capacity we have. We are also watching the impact that the higher pricing will have on our household penetration and buying rate. We believe that we will have a short-term setback on household penetration when the higher pricing first appears on the shelf, but it will quickly turn positive as we afford distribution, a heavier media plan, and increased fridge placements. The buying rate will likely benefit from the higher pricing even if a small number of consumers choose to use less Freshpet and make our long-term target more achievable. However, there will be some offset due to the rapid influx of new buyers as the year progresses. At retail, we are expecting our customers to lean into more distribution this year, now that we have ample supply to support them. We're expecting approximately 1,300 net new stores and approximately 1,775 upgrades in second fridges this year. We will be introducing a variety of new products this year with many of them launching towards media or later; stay tuned for formal announcements down the road. Based on our success in the U.K. and Canada, we are going to invest further in those markets through increased media to support expected distribution gains. We're also beginning phase one of our launch in France. We've been testing in about a dozen grocery stores in France for much of the past year and are ready to move to the next step there, expanding into a larger number of stores and beginning the media investment in several markets. Our goal is to not only make this market a success, but to also validate that our process for qualifying and launching into a new country can be done more efficiently than we've done in the U.K. So far, we feel good about the progress we are making there, and it began to prospect for our next country. To support this anticipated growth, we'll be starting up several new lines this year. As I mentioned earlier, the capacity we are operating today proves that an annualized run rate of approximately $600 million in February at the pricing in place. However, as we grow, we will run out of capacity on some specific items by midyear. So we need to bring on new capacity to support them. In simple terms, we will have excess roasted meals capacity for much of 2022. But we'll need to add rolls capacity mid-year and fresh from the kitchen capacity by Q4. In total, we'll have installed capacity with operations ramping up that could support almost $1 billion in net sales by the end of 2022. As we get a better idea of the actual demand and mix we will have in 2023, we will make the necessary plans to scale the capacity to better fit the demand. That will come through the pace of adding staffing and startup timing. However, it is important to note that we will also be doing as much to create demand to fill the capacity as we can reasonably justify. We have a unique first mover advantage and we want to convert as many pet parents to the Freshpet regimen as possible before any meaningful competition arises. As significant as that capacity is, we know that we will need more in 2023 and beyond. The significant increase in lead times for capital equipment and construction are causing us to revisit our capacity addition plans; we are taking a prudent approach, balancing our projected growth, the new lead times, and the significant inflation in the cost of materials. The bottom line is that we aim to be as efficient with our capital as possible to meet our rapidly rising demand. And we are amending our credit agreement to provide the necessary flexibility. Let me be clear, the fundamental strategy and goals have not changed. However, we will be putting added emphasis on projects that build on our existing infrastructure and resources and enable us to scale our production more quickly and in smaller increments. Those adjustments to our capacity planning do not impact our 2025 goals to deliver 11 million households, $1.25 billion in net sales and a 25% adjusted EBITDA margin. Rather, they ensure that we can reach them in this more fluid and complex operating environment or being as efficient as possible with shareholder capital. We remain very committed to those goals and believe the plan we are laying out today will put us well on our way towards achieving them. Before I turn it over to Heather, let me briefly summarize the key points I want you to take away. First, we have finally refilled the trade inventory and have ample capacity to support reliable and consistent retail availability. This will allow us to get back to doing what we do best, i.e., drive the growth of Freshpet. Second, we have developed a conservative plan that is designed to insulate the business from the numerous external factors that have impacted us over the past few years, and others that we may not have encountered yet. So that we can maximize our first mover advantage in this uncertain environment. Third, we've put in place the necessary building blocks to rebuild our margins, including the new ERP system that is now operating, the higher pricing to offset inflation, and a more stable workforce that can drive productivity improvements. In total, I believe we are very well positioned to deliver the growth and profitability that Freshpet is capable of delivering. I will now turn it over to Heather to provide a summary of Q4 of 2021 and the details of our 2022 plan.

Thank you, Billy, and good afternoon everyone. Let me begin with a quick summary of 2021. As we announced in January, we delivered $425.5 million of net sales in 2021, an increase of 33.5% versus 2020 and our fifth consecutive year of accelerating growth. In Q4, our net sales grew 37.1% to $115.9 million. The adjusted gross margin for the year was 44.5%, a decline of 380 basis points. In Q4, our adjusted gross margin was 41.7%, a decline of 410 basis points. Those reductions were largely due to inflation and temporary operating inefficiencies we incurred as we rapidly scaled the business with outdated systems in a turbulent environment. Those issues coupled with higher freight costs due to inflation and our temporary inefficiencies flowed through to the bottom line and resulted in adjusted EBITDA for the year of $43 million, a reduction of 8.5% versus the prior year. Adjusted EBITDA for Q4 was $9.7 million, a decrease of 25% versus the year ago. That decrease was due to the same factors plus a higher marketing investment in the quarter than in the prior year, which was 11.9% of sales, up 620 basis points from the year ago. We are not happy with those results and know we can do much better. We have taken the necessary actions to remedy the problems, but they will take time to flow through our P&L. The actions we have taken are, first, increased pricing; we announced two price increases that in total will increase our pricing by 17.2% when fully in effect. The first price increase went into effect at the end of November and the second price increase went into effect today. The impact in fiscal 2022 will be approximately 15%. Those price increases were designed to cover the margin impact of inflation in our input costs, freight, and labor. However, I caution that we are operating in a very dynamic environment and those costs, particularly freight, remain volatile; if further pricing is needed, we will take it. Second, implemented our new ERP system. This system will enable us to plan full truckloads rather than ship half-full trucks creating greater leverage on our freight spend. They will also enable us to implement a pricing system later this year that rewards customers who order efficiently, i.e., in full truckloads and full pallets. Third, invested in training and retention; the wage investment we made last year is designed to drive higher quality operations through increased skills of our workforce, and we are seeing signs that it is working. Fourth, invested in automation and equipment upgrades; we shut down our lines last year to install some new automation and to also upgrade some of our older equipment. We have seen the benefits of those upgrades, and fifth invested in new technology capable of increasing throughput and reducing costs. As time goes by, a higher and higher percentage of our capacity will be comparable to the equipment we have in Kitchen 2 which requires fewer people to produce more product. And we will start up our next manufacturing technology innovation in March. Each of those efforts are underway and will gradually begin rebuilding our gross margin to historic run rates. While we will still encounter some unevenness in costs associated with rapid growth in the addition of new capacity, the overall trend should be very favorable. Turning to our guidance for 2022, Billy outlined our net sales guidance of $575 million and the rationale for it. I will instead focus on the cost and profitability. Our first priority is to fully support our growth via a significant increase in our media investment. We expect to spend about 12% of sales and media in the U.S., and it will be front-loaded to begin filling the excess capacity Billy described. This is important so that we can jumpstart our household penetration increases again due to the massive out of stocks we had last year and the delays in marketing investments. We only increased household penetration by 6% last year, well below our long-term rate of approximately 24%. We are quite confident that our media program will restore that growth rate even in the face of higher pricing, but it will take a little bit of time. As you also heard, we are increasing our media investment in Canada, the U.K., and for the first time in France. Those efforts are part of a long-term plan to develop a robust international business and eventually have the scale to justify European sourcing. Until then, those markets are an investment for us with the cost well in excess of the contribution we generate. But the total cost is very manageable within our P&L and is not big enough to justify breaking it out separately yet. We are also investing in our organizational capability so that we are prepared to support a much larger business and can continue the kinds of innovation our customers and consumers expect from us. We are adding talent, but it will be at a rate that puts us on track to deliver the 1000 basis points of SG&A leverage we committed to as part of our 2025 plan. Adjusted gross margin has lots of moving parts this year, we are squarely focused on two important measures of our success: the run rate adjusted gross margin of the fully utilized Bethlehem campus, and the overall run rate adjusted gross margin of the business before we incur the usual startup inefficiencies in Ennis. It is important to note that the Bethlehem campus will be operating very close to full capacity this year and can provide a reasonable view of the profit and cash generation potential of Freshpet at scale. We believe that is a very important proof point for the long-term value of the Freshpet business. In today's investor presentation, there is a chart that demonstrates that potential. The chart shows that now that Bethlehem is operating at scale, it is generating approximately $145 million of cash before media investment and the adjusted EBITDA before media is 29.2%. As a mature business, we would expect to incur some media investment. But nowhere near the 12% sales we are investing now to drive a 35-plus percent growth on mature business would expect to spend much less. And even if you charge the full 12% of net sales in media investment to the now full Bethlehem campus, the cash the campus has generated would pay for the entire capital spent to build that site in approximately two years. We believe that view provides greater clarity on the ultimate profit potential of Freshpet at scale and justifies continued investment in new capacity. And, as I indicated, we believe we have significant room for further improvement by driving production efficiencies, lowering our freight costs, and gaining the benefits of scale in our corporate overhead. Within this year, we expect to drive improvements in our adjusted gross margin via pricing and increased mix of production on our higher speed line and elimination of the temporary operating inefficiencies through the systems and training investments. Headwinds we will face will be production plant mix, product mix and any further inflation beyond what we have covered with our pricing. The adjusted gross margin cadence will be lowest in Q1, as we have very little benefit of the pricing and systems improvement and virtually all of the higher costs in the quarter. In fact, if we had the benefit of the higher pricing for the full quarter, it would add approximately $10 million to $15 million in adjusted EBITDA in the quarter. We also incurred the unabsorbed capacity costs resulting from shutting down one production line in January due to the staffing issues caused by Omicron. In total, that means that we will produce very little if any adjusted EBITDA in the quarter. Margins will improve significantly in Q2 as the pricing is fully reflected in our systems and talent increases efficiencies. We expect Q3 to retreat sequentially due to the impact from the Ennis startup where we will be generating smaller volumes in advance of ramping up. With respect to Q4, we are expecting even greater margin headwind as we will have two new lines operating at reduced capacity as they ramp up, but it should be better than Q1. We will also begin to more fully utilize our new Dallas distribution center as the year unfolds. For most of the year that DC will be a cost headwind, as we will have to ship products from Bethlehem to that DC in order to have the full complement of products available for our customer orders. By the end of the year though, it should be a more efficient way to distribute Freshpet to a significant portion of the country. In total, we are establishing guidance of greater than $55 million in adjusted EBITDA for the year. However, as Billy indicated, that result is negatively impacted by several factors. They are one: excess capacity; we are carrying approximately $13 million to $17 million in buffer capacity cost this year. That capacity is designed to insulate us from any disruptions and prepare us for the increased demand we expect by Q4. This represents approximately 225 to 300 basis points of adjusted gross margin. Two: temporary pricing versus inflation mismatch; our second price increase just went into effect with orders today while our higher costs began flowing through our P&L in January or earlier. We believe that this mismatch creates an approximate $10 million to $15 million headwind to our adjusted EBITDA in the first quarter. Three: adverse mix impact; all of the trade inventory refill we did this year was on bags, which have a lower margin than our rolls. The trade inventory refill was largely completed in February, so Q1 will have a disproportionate mix of bags. After that, our mix should normalize. And four: plant mix; this year, we will have a disproportionate amount of production at our partner at Kitchen Style until Ennis is fully operational late in the year. That plant mix will flip-flop for self-produced products in 2023 as Ennis gets up to scale. Taken together, these variables are creating an adjusted EBITDA headwind of approximately $25 million to $30 million and an adjusted gross margin headwind of approximately 400 basis points. Due to the size of the number, we will call out the impact of the buffer capacity in our communications this year so that you will have a better visibility on it as we grow into our scale. We are providing the balance of the information for perspective but do not plan on updating it on a regular basis. In closing, we believe we have constructed a plan that prudently balances the need to restore the consistency and reliability of our operation, the need to demonstrate the potential profitability of the business as it grows, and also maximizes the size of the opportunity in front of us. As challenging as the past few years have been, we arrived at the place we are today with the resources and tools to fulfill Freshpet's potential. We remain very confident in our long-term goals of 11 million households, $1.25 billion in net sales and the 25% adjusted EBITDA margin, and we believe we have the ability to change the way people nourish their pets forever. That concludes our overview. We will now be glad to take your questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Anoori Naughton with JPMorgan. Please go ahead with your question.

Thank you for giving us some of the details into the risks considered in your guidance. But what gives you confidence that the 575 is conservative enough to encompass all of the one-time type events that have challenged you and others in the industry lately? And then, what do you see as the potential upside drivers for the near outlook as well?

Yes. Let me just talk about the risk profile. And then, Scott might just give a commentary on where the upside part of it is. But unlike most companies where demand is really the big question for them, our big issue over the last two years has not been, in fact, over the last many years has not been the absence of demand. It's been the absence of supply. And so our entire risk mitigation approach has been focused on how do we get ourselves enough supply that we can let the demand rise to where it needs to be. And as I said in the comments, we're already running at the rate that would support the 575. So we feel very good about the underlying growth rate here. Our big challenge is, are we going to have enough capacity? And that's what we've laid out as a plan that we have significantly more capacity than the 575 would require. I think the proof in the pudding was in January, where we were able to take down a line, still keep up with the demand and not take a trade inventory hold. So we feel very good that we're managing the right element of risk here. The element of risk is not the demand side; the element of risk is on the supply side. Scott, you want to comment on the demand drivers and the upside.

Yes, I completely agree with Billy. Over the past two years, we have struggled to provide customers with the specific products they wanted. However, in the last month or two, we are finally seeing those inventories return, and our presence in retail is significantly improving. We wonder how much growth we could have achieved in the past years if we hadn't faced these challenges. The latest Nielsen data shows some impressive numbers. We're confident that our media performance and current advertising is the best it's ever been, and we know that there's a strong link between media efforts and both penetration and revenue. We are optimistic about our innovation and are seeing steady progress in distribution. Everything seems to be aligning for our business now that we have sufficient inventory.

Anoori, I just want to emphasize that we are in a unique position compared to many other companies. Managing risk means overseeing our net sales through demand. We believe that demand is our strength and a key driver for us. Therefore, we are focused on managing risk by ensuring we have ample cushion and flexibility on the supply side.

Thank you. Our next question is from Mark Astrachan with Stifel. Please proceed with your question.

I guess just directionally following up on that. You talked about I guess what mid-teens 15% or so benefit from pricing this year? Yes, even at 35. So that implies volume trends of, a lot weaker than where they were running. A year ago, you talked about elasticity having not a huge impact. And obviously, everybody else in Pet is taking price. So maybe if you could kind of parse those two pieces out there. And why this number couldn't I guess be potentially bigger? I mean, I get wanting to guide conservatively, but the price is obviously a much bigger piece of the puzzle this year relative to what it's been historically. So how do you think about that? And then, theoretically, I guess you talked about in the presentation staff capacity, which is still, 100 million plus above what you guided do for revenue? So is that something that you can potentially meet, if demand is there, again, potentially, to what Scott was talking about in terms of kind of the perfect storm here of advertising spend and innovation, et cetera. So there's a lot but anything there will be helpful.

Let me address the first part of your question regarding the 15% pricing. We mentioned in our comments that we anticipate unit movement to be approximately 10 points below the net sales movement. This means we are expecting about a 10-point benefit instead of the full 15 points from pricing. That is the assumption we are using in our plan for price sensitivity. If the actual price sensitivity is less than expected and benefits our bottom line directly, it could lead to an additional five points of growth solely from pricing. Scott, could you discuss the potential upside based on the demand side?

Let me briefly discuss our current understanding of pricing. For dry products, we are observing an increase of 8% to 12%, while wet products are expected to rise between 12% and 30%. We are concerned about a combined increase of 17% from the two price hikes, with the first one already implemented and the second one taking effect today. We have noted some specific changes in a few items due to the initial price increase, which is around 5% to 6%, and so far, it appears to have had minimal impact. This assessment is complicated due to various factors, including improved stock levels and changes in product mix. However, some high-demand items have already seen price adjustments; for instance, our six-pound chicken roll has experienced a 15% price increase, reflecting the majority of both price hikes, and it has surged 86% in sales at a particular retailer during February. While interpreting these trends is challenging, the movement in pricing seems positive, although we remain uncertain about future outcomes. Demand indicates that consumers are eagerly anticipating our product restocks.

Thank you. Our next question comes from Steph Wissink with Jefferies. Please proceed with your question.

I wanted to just pull on the common thread here again and try to stress test your plans for distribution. So you talked about demand and what your anticipation is for maybe a little bit of household penetration destruction and then revival in the back half. But talk a little bit about the retailer conversations and how your commitments are in terms of project expense. And I think you also mentioned some larger refrigerators to help us reconcile that the guidance with what portion is unit growth, demand growth versus incremental accessibility growth with distribution? Thank you.

Yes, indeed. Most of our growth this year will come from increasing penetration and buying rates, with penetration being the largest contributor. We anticipate that about 80% of our overall growth will result from our advertising and marketing efforts. The remaining growth will be driven by distribution and innovation. While we are expanding our store count, as highlighted in our presentation, we've provided details about over 1300 new stores and significant upgrades, including nearly 1000 fridge upgrades and the addition of around 900 secondary fridges. It’s important to note that we have been open with retailers throughout this process, despite not being flawless. We've communicated a lot of tough news but have also outlined our plans from early last year. We are now able to demonstrate our tangible progress, such as with Kitchens 2 and the projects in Ennis and Kitchen South. We're beginning to ship products at various levels, which has fostered a strong sense of confidence among retailers to collaborate with us in expanding this category.

Thank you. Our next question comes from Bill Chappell with Truist Securities. Please proceed with your questions.

I would like to clarify two points. First, regarding absorption—are you essentially creating a safety stock? Even if demand exceeds your expectations, is the goal to maintain a high level of safety stock that could potentially become outdated throughout the year? Alternatively, could that figure decrease significantly if demand increases? Second, concerning revenue and filling the channel—last quarter, your initial projections were much higher than the growth in consumption as you were restocking the channels, but that didn’t materialize due to supply chain challenges. I anticipated that you would experience a considerable increase in this first quarter as you finally replenish the fridges. Is that not happening? Is the replenishment occurring more gradually throughout the year, or am I misunderstanding the situation? Please help me understand how absorption works for the year and the flow of revenue as you restock the shelves. Thank you.

Bill, I'll address the second part of your question, and then Heather can respond to the first part. Regarding the second part, we have essentially completed the trade inventory refill as of this week. We're experiencing strong shipments and as I mentioned earlier, our net sales year-to-date are approximately 38% higher. Last February was weak, but last March showed significant improvement as we recovered from the storms in February, so we expect to see some benefits there. Our projections for the first quarter align with our expectations. However, I want to emphasize that while we have completed our ERP conversion and feel confident about our position, we are being cautious and allowing some buffer time for any potential glitches or logistical issues, similar to what we encountered in Q4. Nevertheless, the trade inventory refill is nearly finished, with Fresh from the Kitchen being the last item we needed to restock. We haven't reduced inventory on Fresh from the Kitchen in three weeks, indicating strong shipments. Heather, would you like to address the first part of the question?

Sure. Bill, it's important to understand that this isn't just a safety stock; we refer to it as buffer capacity. This represents the extra capacity in our cost structure. We're planning for this extra capacity to handle a business that could potentially be 15% larger. If there are no supply chain issues and everything runs smoothly, this fixed cost structure can support an increase in demand of up to 15%. However, in instances where we face operational disruptions, like we did in January due to Omicron when we had to shut down a line, this enables us to meet existing demand without affecting customer service. While this may diminish the buffer, it allows us to manage disruptions without falling short of our sales targets, which also mitigates any negative impact on margins in case of increased demand.

So just to be clear, as we move to the fourth quarter, you would expect kind of the run rate of that absorption to be kind of low single-digit millions. Is that right? I mean, you're starting high, and then you're kind of growing into it; you won't hold this kind of level forever.

I believe we will always aim to maintain some buffer capacity due to our growth. The financial impact will depend on how things unfold. We might face margin pressure that we cannot absorb if we encounter operational challenges each month, similar to January, although we do not anticipate that happening. However, we can also accommodate increased demand, which is why we are investing in media to support that growth. By the end of the year, this could either help us meet higher demand and achieve better margins, or it could maintain our guidance without affecting margins because of the buffer capacity we have in place.

Thank you. Our next question is from Robert Moskow with Credit Suisse. Please proceed with your question.

I was hoping for a little more clarity on slide 37, where you show the profitability of Bethlehem campus when it's 535 million in sales. And I guess that's where I'm questioning is, your total company is not at 535 yet. So what's the sales basis for this scenario? And how do you come by these numbers that shows the cash generation?

Heather, you want to take that?

The 535 represents the capacity of the Bethlehem campus. It reflects the facility's capacity alongside revenue and related cost structure, which is not fixed as we will keep implementing efficiency and cost-saving initiatives to enhance it. Currently, the net sales capacity for Bethlehem, based on its cost structure, indicates a margin of 50.2%. This is our initial assessment. We have also taken a portion of the SG&A expenses into account to evaluate the facility's contributions. We are actively working on improving our SG&A expenditures through increased scale, growth leverage in G&A, and logistic efficiencies, which are expected to enhance our position further. This margin is indicative of our current worth, with the understanding that improvements will continue.

Rob, just to clarify one point, the footnote mentions total company sales of 600 million. This suggests that if we were to utilize all the capacity in Bethlehem while sourcing the remainder of the stock needed to reach the 600 million figure, that stock would come from other locations. Depending on the product mix we sell this year, we might decide not to source all of it from Bethlehem; some might come from Kitchen South or Ennis based on the type of products and their locations. However, with the capacity and staffing plan we have demonstrated and proven, this is the expected delivery at the current pricing, assuming a full year of the pricing in place as of today.

So it also assumes all the pricing goes through as well.

Yes, that's in the footnote full year benefit is 228 ‘22 full price increase.

Thank you. Our next question is from Brian Holland with Cowen. Please proceed with your question.

Yes, thanks. Good evening. So just to clarify here on the guide, and the $13 million to $17 million, you are front loading your media spend, I think, Billy, you mentioned potentially leaning heavier into the media spend as we go through the year. So is the thought process here that as long as the risk factors that you laid out, that are supporting the why you would want to have that buffer capacity in place. So and it comes online on time or no further delays than what you've currently projected, everything else is okay, and you're seeing the correlation between your media spend and your sales, you would lean into those, you would lean into that excess buffer capacity in the second half of the year through increased media spend that would close the gap between your buffer capacity, which is $660 million and we would lose the absorb cost. Assuming that's what you chose to do, is that the way to think about that?

Conceptually right, there's a timing issue in all those in that scenario that you laid out where as we said, we're front loading the media to like 65%, first half 35%. In the second half, if we found ourselves running towards net sales that were well in excess of what our plan is, we would have the opportunity to add more media in the second half; you wouldn't get as significant a benefit. It was more carrying you towards the next year. But you would have that opportunity. But there are lead times both on the media commitments as well as on the making sure you ramp up all the right staffing the right places. We will have plenty of staffing to support a significant part of that. We just want to make sure they're also reflecting whatever the risks are that are out there, whether there are transportation risks, whether they're ingredient risks, whatever, there could always be some of those other elements that can constrain us. And we just want to make sure that we have the capacity before we lean into the higher level of media.

Understood, and then just on the media spend. You mentioned International and you're tackling France into that mix now and leaning heavier into that. Maybe I don't know if it's possible to dimensionalize between kind of like media spend behind North America or U.S. specifically, and the rest. But if we think about that, how much are we spending on the U.S. relative? Are we leaning in heavier there?

Definitely 90% U.S. is the way to think about it.

And Brian, strategically and conceptually, we sourced the U.S. to where we think it needs to be before we put the revenue into the other markets. But to the media and to the other markets, we have more than adequately funded the other markets, but we do not put media money into those countries at the expense of the U.S.

Thank you. Our next question is from Peter Benedict with Baird. Please proceed with your question.

I have two questions. First, can you maybe talk about the CapEx budget, how you kind of see that this year, and maybe next? And how kind of the bigger the borrowings are going to flow? That's my first question.

Heather, you want to take that?

Yes. So I know we've touched on in the prepared remarks that we're looking at our plans. And we are doing that, but from a 2022 perspective, from a spend perspective, it's largely in line with what we've shared. So just from a financial perspective. And we're reviewing plans, as we said, of course, as you know, from a marketplace perspective, there's longer lead times and inflation that we're facing. But our focus in looking at the refined plans is really around taking an opportunity to look for capital efficiency and ways to optimize. And so, one of the things that we are doing is looking at our existing infrastructure and how we can continue to expand on our existing infrastructure, as well as, increase capacity in smaller increments. So it's all in the works. And what you should know from a funding perspective is consistent with what we shared at ICR is that we're looking to amend our credit agreement at this point to provide the flexibility to support those plans.

Okay. And then, just wanted to clarify the kind of a cost view. That's, I guess, embedded here with the inflation. Are you just assuming that the costs that you exited the fourth quarter with are kind of what's going to persist for the rest of the year? Is it more what you're seeing today, you're assuming continues the rest of the year? Or are you assuming either any relief on the inflation front or incremental headwind, and I understand that cost inflation is commodities, it's on freight, it's on a whole variety of things, but just trying to understand how you built this plan from that perspective.

This reflects what we know as we exited 2021, along with the terms of our chicken contract, which is significant. It includes our expectations of inflation for the full year. Currently, much of our purchases are under contract, but there is variability in the cost structure, as we experienced in 2021. The margin impact shown is based on our anticipated inflation, but there is a discrepancy between price and inflation, as the second price increase that we mentioned started today. This results in about two and a half months of a mismatch between price and inflation.

Thank you. Our next question comes from Bryan Spillane with Bank of America. Please proceed with your question.

I have two quick questions. First, concerning the $660 million in staff capacity for Q4, does that figure include both price increases? We're trying to assess the available capacity for '23. How much of it has been increased purely in pounds compared to dollars, given that pricing has changed since last year? I'm trying to determine if there is actually more pound capacity available and if there's a risk that over-delivering on volume could create additional tightness in capacity.

So it's a little bit complicated because there's a lot of moving parts in there. First, we actualized all of the capacity numbers based on what our one experience has been, the efficiencies we're seeing the yields we're seeing. That $660 million number that we had been sharing before had been prior to the assumptions for price increases. So theoretically, there's increased value of the price increases that would flow through. There are some mix differences because those different items, the capacity doesn't necessarily all match up with the same size of the price increases. So there's some moving parts that are in there. If the broader question is, is there some risk that we're going to be tight on pounds capacity in this plan. We think we've got plenty of headroom and we have the ability to flex the headroom quite a bit.

Okay, now that's helpful. And then maybe just one second question, Billy is just, can you just give us a sense or your perspective on, just how competitors in the fresh segment coming into the market have impacted the demand for fresh? And I guess we've seen a lot of advertising for the Farmer's Dog and their social media following right, as followers have increased substantially in the last six months. You've got, I guess, just food for dogs now in Petco with distribution there in frozen. So just trying to understand, as you see more competitors coming into the market, is it actually just expanding awareness of fresh? It's just good for the segment in general? Or are you concerned at all about just the competitive dynamics heating up?

I would say that with a world of exploding in our case, and it's just making the opportunity that much bigger, but Scott can give you a lot better color on it.

We are closely monitoring the market situation. To begin, when we consider the future of fresh and frozen food, we see it as a substantial segment worth about $6 billion, although estimates vary. This segment represents a significant opportunity for growth. Our objective is to maintain our strong position since we believe we have developed an excellent portfolio and business model. Over time, we have observed many new entrants in the market. For example, not long ago, there was a notable Margo product and a farmers market product. The frozen direct-to-consumer brands that started around 2014 or 2015 have since grown to over $200 million in retail sales. Throughout this period, we have managed to achieve growth rates of 25% to 35% in different years. Therefore, we recognize a large total addressable market, and we have successfully navigated it. As we have seen these competitors enter various market channels, our performance at retail locations has remained unaffected, and we often outperform them substantially. There is clearly a portion of the market that we expect to dominate, while others may compete for a smaller share. We have also been attentive to the innovations and consumer insights these competitors have introduced. We are currently working on our own innovations which we believe will significantly disrupt the direct-to-consumer market later this year. I feel confident about our positioning; while competition will progress, we anticipate that our scale, expertise, and commitment to freshness will lead us to a favorable outcome.

Thank you. Our next question comes from Jason English with Goldman Sachs. Please proceed with your question.

Congrats on the capacity for getting that right sized. You mentioned the step up in media to 12% of sales. Can you tell us where you finished 2021 out?

Heather, do you have that?

Yes, I do. We finished 2021 a little over 10.5%.

Okay. So this was the biggest year-on-year increase in media spend, I think in the company's history. But you're pointing to as a driver of the slowing penetration growth? How do I put those two?

Jason, I believe this is a crucial point. Our biggest challenge has been experiencing periods where we are entirely out of stock on cat food, whether it's bags or rolls. Throughout the year, you can see that these stock-outs occurred on specific items that customers really prefer, such as forms, which is typically their first choice. This leads to losing those customers temporarily. However, when those products return to stock, the growth rate is remarkable and significant. I can provide item-specific data. Once we have all our products available again, I anticipate a substantial increase in our market penetration. Although it’s an interesting perspective, having faced adversity this past year while still achieving strong growth primarily from increased buying rates reflects the commitment many consumers have to our products. They have remained loyal to us despite the frustrations caused by stock issues. We are closely monitoring the situation, and it seems like we are off to a strong start. The business is responding positively to media initiatives this year, which is evident in the growth rate. While penetration tends to lag behind as an indicator, it appears we are on track to see improvements in our penetration growth.

Thank you. Our next question comes from Rupesh Parikh with Oppenheimer. Please proceed with your question.

And I'll be quick here. So just in terms of the guidance, the $13 million to $17 million on absorbed expenses. So we see higher sales during the year, would the flow-through be higher than normal for the sales?

Heather, do you want to take that?

Rupesh, can you just clarify what you mean on flow through?

Yes. So you already have these costs built into our base of $13 million to $17 million. So if you end up seeing higher sales in your guidance, would the flow-through on those incremental sales be higher than normal?

Yes, you will only have the variable costs associated. This means we will improve margin for each dollar, as there won’t be an increase in the plant costs related to that. This is also reflected in our slide deck, where you can see the adjusted EBITDA impact on the flow-through.

Thank you. Our next question comes from a John Andersen with William Blair. Please proceed with your question.

Most of my questions have been asked and answered. Just one quick one. The new fridges for 2022 step up, sounds like more than 3000 whether that be new stores or upgraded second fridges? Can you talk about first the cadence that you expect through the year? And second, a little bit of color around where these placements and upgrades are going to be concentrated? And what that typically does for you, does it drive household penetration? Does it drive buying rate? What's the kind of the benefit as reflected in your primary drivers of your business? Thanks.

From a cadence standpoint, we anticipate that placements will be fairly evenly distributed throughout the year, perhaps more so than in previous years. It could end up around a 60:40 split, but it will be quite close to an even distribution. Most of these placements are with existing customers, with a few being new ones as we expand distribution in stores where we currently do not have a presence. Regarding the second fridges, they are going into stores that are performing well and are either being remodeled or have been identified as needing a second fridge due to sufficient demand and velocity. We view both new and second fridges as a way to enhance our marketing and advertising efforts. This year features exceptional advertising, influencing our approach to consumer acquisition. We generally evaluate this based on customer acquisition cost. Currently, it ranges from $45 to $55, depending on various factors. In a year with significant placements, excellent advertising, and strong innovation, we might see a lower customer acquisition cost, around $45. In contrast, if those elements are lacking, the cost might rise to $55 or slightly higher. Last year was unique due to out-of-stock issues, but this is our overall approach to understanding how these factors contribute to business growth. Again, about 80% of the growth is driven in marketing, the marketing is slightly more effective because we get a lot more fridges, they're higher visibility fridges, and we have really good innovation. So that's really kind of how we typically kind of think about building the revenue model for the business.

That's helpful. If I could squeeze one follow-up in on innovation. Billy, I think you mentioned a good slate of innovation mostly mid-year. I know you're not going to talk about specific items, I'm not asking you to talk about specific items. But can you talk conceptually about the size of the innovation pipeline? And maybe the focus of it, type of dog, occasions, different forms, just to give us a sense for what we may be opening up here in terms of incremental TAM? Thanks.

I don't think we have enough time for Scott to answer that question.

So Jon, it's another one of these things where we spend a lot of time thinking about. I think we've gotten to a point where we know when we're adding innovation, innovation is going to improve our business performance because like some people have unlimited shelves, right? Or the potential of unlimited shelves, we don't; we have our fridges, and we sometimes have second fridges. So we want to be very, very prudent and thoughtful on the innovation we're bringing to market. So when we're testing innovation, it has to be more successful than what we already have out there. And it has to bring incremental consumers into the business into the portfolio. So that's really how we evaluate it. So we continue to always identify where there are gaps and where there are opportunities. One of the things we've seen is there is a lot of opportunity around size-specific items, certain sizes of dogs and certain aspects around sustainability, people are really interested in, we're going to do more and more around sustainability, you'll see different things that we're doing on our lines and our businesses and our products. You're also going to see more and more plant-based items continue to come. We think there's a tremendous area of opportunity. And then finally, we know that convenience and customization is really, really interesting to a subset of consumers. And that's really what we want to tackle and we think that we have an opportunity from a fresh perspective, to do an amazing job customizing and creating a very convenient product for consumers that feel very specific to their pets. So there's a pretty broad array. Probably I think late this year, we'll probably do a very extensive sharing session with the investor and analyst community and we'd love to kind of share more details at that point.

Thank you. There are no further questions at this time. I would like to hand the floor back over to Mr. Cyr, for any closing comments.

Great, thank you. Let me just leave you with one thought from American humorist, Corey Ford: Properly trained, a man can be a dog's best friend. To eliminate any doubt, properly training means that you know to feed Freshpet every day. Thank you for your interest and attention. Good night.

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