Freshpet, Inc. Q1 FY2022 Earnings Call

Greetings and welcome to the Freshpet First Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Mr. Jeff Sonnek, Investor Relations at ICR. Thank you, sir. You may begin your presentation.

Hello and good afternoon and welcome to Freshpet’s first quarter 2022 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 it is a summary of 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 our Q1 results are an early indicator of how much more resilient we are today than we were one year ago. The investments we made in our workforce and buffer capacity enabled us to overcome the challenges from Omicron, industry-wide supply chain disruptions, and our ERP conversion, and still deliver the strongest quarterly net sales growth rate since Freshpet went public in 2014. That resiliency will enable us to continue our rapid growth and fulfill our mission to change the way people nourish their pets forever. Our team is quite proud of what we accomplished and the results we delivered. We overcame supply shortages and construction delays to design, construct, install, and start up the incremental capacity that has enabled us to not only meet our rapidly growing demand but also fill the trade inventory hole that we dug over the past 18 months. We still have some pockets where our in-stocks are not where they need to be, particularly in pet specialty where we went through a distributor change. But overall, we have our best retail conditions in almost two years, and they keep getting better. We’ve also hired and trained the team members needed to produce enough Freshpet to fill those fridges in one of the tightest labor markets in decades, and we continue to generate incremental demand in the face of the most significant inflation in decades, through outstanding marketing, innovation, and fridge placements. Looking ahead, we are also keenly aware that the operating environment remains extremely challenging. The planning and skills that it took to overcome the obstacles we faced in Q1 will be needed over and over again in the coming months and years, if we are to sustain high rates of growth. To be successful, we will need to continue to plan conservatively and act aggressively, just as we’ve done so far this year. That is what we intend to do. It is in that vein that we have revisited our long-term capacity expansion plan. Since we established our plan about 15 months ago, quite a bit has changed. Some of the biggest changes have been first lead times; lead times for construction and equipment have lengthened significantly, sometimes doubling and tripling. That puts a premium on planning and ordering ahead, but it also puts added strain on the balance sheet because we must start spending capital much further in advance of when capacity is able to begin production. On average, we are spending capital more than six months earlier than before to deliver the same capacity. Second, costs; the cost of construction and equipment has increased significantly. On average, construction materials and equipment costs are up more than 20% over the past year, particularly for those who use a large amount of stainless steel as we do. Third, operating know-how; we’ve learned quite a bit about how to design facilities to operate more efficiently over the past year, particularly since we’ve been operating Kitchens 2 on a 24/7 schedule for a full year. Fourth, new technology; we’ve been experimenting with a variety of new production technologies over the past year, some that support existing products and some that enable new innovations; we are ready to scale up some of those technologies. And fifth, competition; the emergence of a large and growing segment of very high-end fresh and frozen pet foods has reinforced the strategic importance of ensuring that Freshpet always has the best products in the market while presenting consumers with an attractive value proposition. We’re ready to scale up some additional products that we believe will expand our franchise, increase our buying rate, and enhance the Freshpet brand reputation. To address those changing dynamics, deliver the necessary capital efficiency to justify the investments we are making, and to keep up with a significant increase in demand, we established the following guiding principles. First, focus on building where our talent is based and maximize utilization of our technical staff. We will focus our efforts on Bethlehem, Ennis, and Kitchen South, fully building out those sites. This will enable us to maximize the potential of each site with the most efficient use of our talent. This includes innovation, as we will house innovative new products in Bethlehem so that they are connected with our R&D staff. Second, locate and group technology and equipment in the most cost-effective manner. As a small company attempting to meet almost insatiable demand across our product portfolio, we had to pair a bag line and a roll line together each time we expanded. Now we’re adding capacity in larger chunks and can establish buildings and operations that specialize in either bags or rolls. That delivers labor efficiency, better management and maintenance of spare parts, and greater operating expertise. Third, limit fresh pick capital investment to assets of greatest strategic value. While we will continue to selectively build and own some of our buildings, our new plan makes greater use of our partners’ capital to construct and own buildings, where we focus our capital on equipment and technology. And fourth, enable innovation; our capital plan must ensure that we never fall behind on product performance versus any relevant competitor. We believe we have the best-in-class product today, and we intend to keep it that way through a commitment to long-term innovation. Applying those principles, we’re making some changes to our long-term capital plan. The key changes are: first, splitting Ennis Phase II into a Phase II and Phase III. The new Ennis Phase II will be dedicated to roll lines, and we will be pulling forward the beginning of construction as well. In fact, we’ve already begun the site preparation work for that expansion and expect the new Phase II to open in Q4 of 2023. Phase III will largely focus on bag lines and will be slated to open a year later in Q4 of 2024. Second, focusing Kitchen South on bags, we will be adding incremental bag lines to the existing building and eliminating the need to add a new building that would house roll lines. We will ultimately house five bag lines at Kitchen South, some of them using new technology with higher throughput and greater packaging flexibility. And third, adding an innovation of scale facility in Bethlehem. We’re establishing a new 100,000-square-foot facility about one-half mile from our existing campus in a leased building that we will equip with the production lines capable of producing some of our new innovative products. In total, this revised plan will deliver capacity to make approximately $2.9 billion of Freshpet products, up about 500 million or 20% from our previous plan. We will also add new product technologies capable of producing new preferred products that will provide unique benefits to new consumer audiences, and the plan will deliver greater operating efficiency than the previous plan. The accompanying investor presentation provides more detail on the projects and the returns we will get from these investments. But simply, each of these projects will pay back quickly once they are operational and fully utilized. Just as the Bethlehem campus is generating significant free cash flow on a full load basis now that it is fully utilized. We believe this is both an aggressive and prudent plan. It is very clear that the future of pet food is in higher quality foods like Freshpet. Various industry estimates have pegged the size of the category at $4 billion to $6 billion as soon as 2025. We outlined a 25% increase in the size of the total addressable market, or TAM, to 25 million households at the ICR conference in January. We fully intend to capture as much of that market potential as possible. We are the category leader; we have a huge head start, and we have sizable competitive advantages. To maintain that lead, we must always have adequate capacity, and we must always have the best products. Our plan is designed to ensure we always do. So what does this capacity expansion mean for our existing 2025 targets? We are off to a fast start in 2022, and our current growth trajectory is well in excess of the rate we would need to hit our 2025 goal. But with all the uncertainty in the macro environment, we think it is more prudent to maintain our targets while we navigate through this fluid macro environment. That said, we have great confidence in the path forward to build and serve a much larger consumer audience. Simply put, this is a timing exercise. Given the incremental challenges in sourcing and construction, we need to start sooner to ensure that our operational capabilities and capacity keep pace with long-term demand. For investors, we believe this capacity plan is best thought of as both an option for accelerated growth and installation against further challenges in construction or equipment sourcing. We’re also building in some flexibility. While there are long lead times for construction equipment, we have preserved the ability to scale back portions of the plant at various stages along the way to ensure that our capital spend is always optimized and capacity is in lockstep with our latest estimated demand. Further, we are also mindful that the world we are operating in has an unusually large amount of economic uncertainty in it. Given that and the aggressive competitive posture we are taking, we will balance the capacity expansion plan with a conservative balance sheet that is designed to insulate our growth plan from the typical volatility of both a high-growth company and the capital markets. We intend to operate with low leverage until the business is generating strong cash flow capable of funding our capital expansion plans from operations. We believe the plan we’re laying out today is the right one and will allow us to reach our long-term goals in the most efficient way possible, solving for the current environment and leveraging our growing set of capabilities. Our founders bet on the future of higher quality pet food back in 2006 with the creation of Freshpet, and we asked our investors to do that when the company went public in 2014 and again in 2017 when we launched Feed the Growth. We believe our long-term results have shown that those were wise investments. We believe the plan we’re laying out today will enable us to build on those results and deliver the future pet food and have a very bright future for Freshpet. I will now turn it over to Heather to provide a summary of our Q1 2022 results.

Thank you, Billy, and good afternoon, everyone. We had a very strong quarter, both in the absolute and relative to our expectations. We delivered net sales growth of 41.5% for a total of 132.2 million of net sales. That growth rate is the strongest quarterly net sales growth rate since the company went public in 2014. For perspective, our first quarter net sales are more than our net sales for the entire calendar year of 2016, which means we have doubled the business twice since 2016. In fact, we have doubled this business about every three years since it was founded and that trend is accelerating with Q1 of 2022 being 2.4 times the size of the same quarter only three years ago. First quarter net sales growth was broad-based across channels and product forms. The growth was most pronounced in the grocery and mass channels. And from a product mix standpoint, our roll in Fresh from the Kitchen product experienced significant lifts behind improved availability. That improved availability can be seen in the gradually improving TDP throughout the quarter and into Q2. Pricing and mix accounted for about 8 points of net sales growth in the quarter, and trade inventory refill was about 4 points of the net sales growth. The balance of the growth in the quarter came from volume growth. As expected, pricing will play a bigger role in Q2 than it did in Q1, as our second price increase did not go into effect until the middle of March. As a reminder, our two price increases total about a 17% increase in pricing. We saw very little, if any, price sensitivity from the first price increase, but it is too early to tell how much you will see from the second larger increase. It is particularly difficult to determine the magnitude of price sensitivity we are experiencing because of the compounding variables we have, i.e., much better availability, improved distribution, and a significant increase in advertising. We fully anticipate there will be some price sensitivity, and we’ve built that into our guidance for the year. It is just too early to tell how much we are actually experiencing, given the rapid growth. Household penetration grew only 2% versus a year ago on a trailing 52-week basis. That 52-week time period reflects the worst periods in stocks and is why we saw so little improvement. However, when we look at the more recent four-week period, when advertising was on the air and in stocks had improved, we see much stronger growth rates. In fact, the most recent four-week period was up 12% versus the year ago and is accelerating. While there might be a short-term dip due to the impact of price sensitivity, we expect to see steady progress in Q2 on the 52-week measure and get back to more typical household penetration growth rates by the end of the year. As it typically happens, when household penetration growth slows, buying rate growth accelerates due to a smaller number of new households who come in at a lower buying rate during the Freshpet franchise. Buying rate was up 26% in the quarter, well above our long-term growth rate of 7%. We believe that rapid growth will slow considerably once the household penetration resumes its more normal growth pattern in the 20% to 30% range. However, the increase in pricing will provide a step up in buying rates this year and will go beyond our annual target of 7% growth. Net store account grew by 300 to 23,931 net stores. We also upgraded 72 stores and placed second or third fridges in 179 stores. We expect the rate of growth on each of those measures to accelerate as the year goes on. Shifting to margin, adjusted gross margin was 41.9%, down from last year’s 46.7% and up slightly from Q4 2021 at 41.7%. The Q1 performance was also better than our guidance assumed. As we shared last quarter, we had a timing mismatch between the increase in our commodity costs and our pricing actions. That timing difference created an approximate 450 basis points headwind for adjusted gross margin in the first quarter. But we will get much of that back in Q2, driving a slightly better than anticipated adjusted gross margin in the quarter with strong production performance and greater sales leverage. When we gave our guidance at the end of February, we had just converted to our new ERP system. Our guidance assumes that it would take some time to return to our previous level of production as we work through the case in the new system. But as the chart and the accompanying presentation shows, we bounced back quickly and even began to exceed our previous production performance. This improved throughput resulted in increased shipments and enabled our best in-stock conditions in years, helping to drive strong sales performance. We attribute part of that strong production performance to the investments we made in a Freshpet Academy training program and in talent over the past six months, which delivered consistently strong staffing levels and increased operational flexibility. This is a strong proof point that our revised capacity plan will have associated advantages in terms of efficiency and throughput. The strong top line growth enabled us to drive strong G&A efficiency gains that we reinvested in media in the quarter to drive continued top line growth later in the year. Media investment in the quarter was up 420 basis points versus year ago to 16.3% of net sales. And that increase was more than fully offset by reductions in both logistics costs of approximately 170 basis points and by other G&A costs of approximately 270 basis points for a net reduction in adjusted SG&A of 20 basis points. Logistics cost reductions were due in part to more completely filling trucks than in the year ago. G&A costs were positively impacted by the benefits of scale that we have been gaining over time. Adjusted EBITDA of 5.1 million was as expected down versus a year ago. Had we not had the timing mismatch between competitive inflation and pricing actions, adjusted EBITDA would have been approximately $13 million greater and delivered an approximately 13.7% adjusted EBITDA margin. Capital spending in the quarter totaled 55.9 million, and we expect to spend approximately 400 million in capital this year. This is higher than our prior planned CapEx spend of approximately 300 million that we previously communicated and reflects the updated capacity plan that Billy shared with you earlier. Operating cash flow used in the first quarter was 34.8 million, which was driven by 33.2 million of working capital. This was significantly impacted by the ERP conversion, which resulted in some delays in invoicing and payables that will be reconciled in Q2. We drew 51 million on our revolver in the quarter. At the end of the quarter, we had gross availability of $299 million on our credit line subject to various limits. Looking forward, this strong start in Q1 gives us a great deal of confidence in our plan for the year. Net sales performance in Q1 came in about $5 million better than the 35% growth implied in our guidance and the consumption trends we saw in April continued that momentum. We are still learning about price sensitivity but each week that goes by we get increasingly comfortable that our assumptions are appropriately conservative, with less risk of downside and more opportunity for upside. Despite that optimism, we are maintaining our net sales guidance for the year out of an abundance of caution related to the unknowns of price sensitivity and until we have assurances that Ennis will deliver the roll capacity that we need to stay on track with our plans. At this point, we believe that Ennis is on track to begin producing scalable products late in Q3, but the current construction environment is challenging, and nothing should be taken for granted. Three things need to be in place for a successful startup. First, equipment delivered. We are in good shape on this item, as all the equipment has been delivered and is ready to install. And the equipment is basically the same as the equipment we use in Kitchens 2, so we know how it works. Second, staffing and training; we have hired all the staffing that we will need for the first two lines, and many of them have been trained in our Bethlehem kitchens for up to nine months. We are in good shape on this item. And third, building completed; this is the primary element of risk, and where most of our focus lies. We expect to have dried in the building by next week, but there are still many wiring to run, interior walls to erect, and electronic systems to install. We believe our timetable is realistic. Some material shortages are very real. And until the building is done, we won’t know for sure that we can get every material, electrical component, or labor on the timing we need. Net, we are optimistic but realistic about our ability to start up Ennis and further support sales later this year. While we also exceeded our expectations on adjusted EBITDA, the surge in fuel prices we’ve experienced since our fourth quarter earnings due to the onset of the Ukraine conflict could offset that stronger performance until we either take another round of pricing or the fuel prices roll back. As we set our guidance, diesel fuel has gone from approximately $4 per gallon to approximately $5 per gallon; that impacts inbound and outbound freight costs. We are also seeing higher energy costs to operate our kitchens. If it appears that these costs will be sustained for a long period of time, we will take another round of pricing to cover those costs as we are committed to protecting our margin. That could create another timing mismatch between increased costs and increased pricing, but it would be much smaller than the mismatch that occurred in Q1 when a broader set of commodities were impacted. Additionally, if we continue to deliver strong net sales performance in excess of our guidance, and we have the available capacity, we will selectively reinvest the contribution from the outperformance in additional Q4 media to further accelerate our growth next year. Thus, we are not taking up our adjusted EBITDA guidance at this time. But our confidence in our ability to meet or exceed the target is very strong. We have updated the quarterly guidance cadence charts we provided with our initial guidance in February, to provide color on these items and other items impacting the cadence we expect for the year. In closing, we are very encouraged by the strong start to the year and even more encouraged by what it says about our resiliency. But we also know that we must maintain our focus and diligence. If we do, we believe we have the capability to continue our rapid rate of growth, deliver a strong performance this year, and continue on our path towards fulfilling our mission of changing the way people nourish their pets forever. That concludes our overview. We will now be glad to take your questions.

Our first question comes from Bryan Spillane with Bank of America. You may proceed with your question.

Thanks, operator, and good afternoon, Billy and Heather. I hope you are doing well. My question is about the revised capacity plan and the capital expenditures. I want to clarify what the incremental amount is moving forward and what hasn't been spent yet. With this year's capital plan in mind, is the additional spending expected to be around $700 million to $800 million, as shown on slide 47?

Heather, do you want to take that?

Sure. Yeah. The 900 million that you see there is the total of all those projects that you see under plan for lines. So it includes all of Ennis phase one, Ennis phase two, the Kitchen South, and incremental lines, as well as Ennis phase three. So Brian, Ennis phase one, obviously started expenditures at the back half of 2020, all through 2021 and into 2022. So that number is inclusive of the total of the Ennis phase one project, which, in the latest revision is just over 350 million. And so because of that, it’s a higher number than is reflective of kind of future expenditures, if you will. So you have to net out the total of what’s already spent on Ennis phase one, which is a significant portion of that number, a couple of hundred million.

Okay. With the capital raise, the cash on the balance sheet, and the available credit, there is enough capital to complete this plan. That was my main point.

Yes, there’s enough capital to complete the plan and I think the difference is that, as Billy mentioned, in the prepared remarks, the goal with this is to maintain a low level of leverage. And so we’ll lean in less into the credit facility in order to risk manage and have a healthy balance sheet along the way.

Okay, great. Okay. I’ll pass it on. Thanks, guys.

Thanks, Brian.

Our next question comes from a line of Bill Chappell with Truist Securities. You may proceed with your question.

Thank you. Good afternoon. I wanted to follow up on what Bryan mentioned. Billy, could you elaborate on what prompted this change? Are we trying to avoid the capacity constraints we experienced last year and need to move more quickly, or is there a shift in demand that triggered this decision? I'm trying to grasp why this change is happening now, as it seems significant. I would have thought your initial plans were well considered, so I'd appreciate your insight on the timing.

Yeah. Bill, it’s a very good question. The reality is, as you saw, we put up the growth in the first quarter, 41.5%. We’ve got 35% growth for the year when we put out our plan for 2025 and the capital plan before, the growth rate that we were expecting at the time was in the high 20s. So we’re running way ahead of that plan. And so we want to get ourselves in a position where we’re never leaving the customer a reason to go look for somebody else to supply them. And so we want to make sure we get ahead of this. I will tell you, it’s a little bit like chasing your shadow though, because it seems like the more capacity we bring on, the faster we grow and so we just want to push that as far as we can, organizationally, and as quickly as we can to get as far out as we can. But it’s also important to note that lead times have taken increased fairly significantly. So we now have to take action much sooner to build capacity, that’s going to come on a little bit later, so that’s really the biggest driver here. The accelerating rate of growth and then the longer lead times, once you make the decision that you have to take action based on those two phenomena, then you recognize that there are some things that we’ve learned whether it’s new technology, new innovation, or better ways to organize our facilities. Putting rolls lines in single places and bag lines in other places makes an awful lot of economic sense. But those come on after you recognize and you’re growing faster, and lead times are longer.

Okay, that helps. Heather, I understand that it's early in the year and there are many variables at play, but I’m trying to grasp how we can maintain full-year guidance, particularly regarding EBITDA. Can you confirm that there is still more inventory to backfill for refilling stores in the second quarter, and that it wasn’t all completed in the first quarter? Also, I believe you mentioned that the EBITDA margins could have reached 13.7% if pricing adjustments had been implemented fully by January 1. Is this impact completely overshadowed by the additional costs from the Ukraine conflict, or is this a more cautious approach as we begin the year?

When we discussed the impact of Q1, any pricing changes made during that quarter are already included in our Q2 margin expectations. We achieved a gross margin that exceeded expectations for the quarter, as our growth was stronger than our previous guidance suggested, which contributed positively. It's important to note that because we had buffer capacity to accommodate additional revenue, our labor and overhead costs have already been accounted for in our figures. While there are costs associated with inputs, they came at a significantly higher margin, which contributed to the improved gross margin this quarter. Additionally, we have increased our inventory levels. Looking at the full year, we anticipate that our pricing adjustments will carry into Q2 and beyond. We are taking a cautious approach, considering potential impacts, especially with diesel fuel prices rising to $5 per gallon from $4. We need to monitor this closely, as it may lead to pricing mismatches like we experienced in Q1. There is some risk going forward. Another key point from an adjusted EBITDA standpoint is that if we see accelerated growth and the potential for further margin improvement, we would aim to reinvest and ensure a strong start to 2023.

Okay, great, thanks so much.

Bill, I want to add that we are being cautious. As Heather mentioned, we were caught off guard by several factors last year, and we need to proceed carefully at this early stage of the year. It's essential to acknowledge that there are many uncertainties ahead, including issues related to diesel fuel and price sensitivity, as well as other factors we aren't yet aware of. This caution is driving our approach. We are optimistic about the start to the year and the underlying trends, but we don't want to get ahead of ourselves again.

Now thanks. I totally appreciate that.

Our next question comes from the line of Brian Holland with Cowen and Company. You may proceed with your question.

Yeah, thanks. Good evening. I wanted to ask, when you talk about reviving the long-term capacity plan. I feel like, on some level, whether its lead times, costs, operational expertise, technology, you’ve talked about a lot of these in one form or another. I was curious about the competition angle, though. I guess I asked this question two ways; one, are you either aware of something new that’s coming within the last few months? Or are you seeing increased adoption of direct or indirect competitors that maybe increases the sense of urgency? You’ve talked about competition before; I appreciate that, but I just want to sort of clarify the tone there and what that sort of entails.

Scott, you want to take that?

Yeah, sure. So, Brian, I think the best comment that Billy made a few minutes ago was, every time we build capacity, we grow more. And I think that’s really like a key part of our focus when we’re thinking about what we’re doing. When we look across, there’s a lot of activity; there’s a ton of activity going on, more in the pet food category than I feel like I’ve ever seen, that’s been in a really long time. When we look across what competitors are doing, I think it’s really terrific, but we really are confident that we deliver a much more compelling portfolio of products, brands, forms, variety, at a significantly better value proposition at every single one of them, in addition to having new and forward-leading innovation. So I think we’re looking at a group of people that are coming to the category that are going to raise awareness around fresh and frozen, that’s going to help us educate consumers. And we think we’re in by far the best position to take advantage of that consumer change, and that’s really leading the way we’re thinking about building out the ability to meet the demand.

I appreciate the information, Scott. I would like to ask about the rollout of Ennis and the mention of construction delays. How might these delays impact the opening of phase one of the facility? How should we consider this in relation to buffer capacity? It seems there’s a chance that the timeline could be pushed back. Would a delayed start at Ennis consume or exceed our buffer capacity? I want to ensure I understand the implications of Ennis starting on time for your full-year outlook. Thank you.

Yes, Brian. Ennis provided some of the buffer capacity, and any delays there do impact that capacity since we're already covering the staffing costs. It's primarily a rolls issue rather than affecting the entire line. We really need the rolls capacity at Ennis to come online to sustain that segment of the business. We have sufficient bag capacity available this year, so if there's a mismatch, it's on the roll side. Additionally, we can scale up much quicker. Many in the Ennis production team, the hourly laborers starting up that facility, have been in Bethlehem since last June, allowing them to learn and practice on the same equipment they'll use in Texas. This means we can transition from startup to a 24/7 operation very rapidly. Although there's a risk of some delays, once we begin operations, they will proceed quickly. We feel confident in our ability to execute once construction wraps up.

Our next question comes from the line of Robert Moskow with Credit Suisse; you may proceed with your question.

Hi, Billy. Maybe you should clarify that last comment a little further about what’s in the assumption for buffer capacity and what’s not. Where the inefficiencies at Ennis already contemplated in that $12 million to $17 million estimate, correct? Is this new plan here? Incremental, different from what you saw a few months ago, and therefore it’s going to eat into it? And then my follow-up is, are you talking about relocating people like people who were trained in Pennsylvania, you want them to move to Texas to work on that line? And, you know, this is a very tight labor market; asking people to move around might be complicated.

Let me take the second one then Heather will take the first one. But the second one is we actually hired people in Ennis, Texas, so native to that area or living in that area. And we then transplanted them to Pennsylvania to be trained, so we were housing them, feeding them, transporting them while they worked in the Freshpet facilities in Bethlehem and they’ve been a phenomenal team to have and really, really good effort and highly-skilled people. So we will be returning them home. In fact, we already sent a few folks back in the last week, I guess it was, and more will be returning later this month. But this is sending people back home, not trying to transplant people from Pennsylvania back to Texas. Heather, do you want to take the first question?

The buffer capacity is fairly evenly distributed throughout the year. In the first quarter, we used just under half of it due to some disruptions, particularly the Omicron-related shutdown of a production line for three weeks in January and the start-up of our new ERP system, which also caused some production downtime. The remaining portion was consumed by building up inventory and additional sales. Overall, it remains quite consistent across the quarters, though there was a slight decrease in Q3 and Q4 as sales increased quarter-over-quarter, followed by a rise again with the addition of Ennis. Therefore, it is best viewed as evenly allocated throughout the four quarters.

Okay. So there’s no change to the $12 million to $17 million estimate, correct?

Correct.

Okay. And also, this new plan, does it require unwinding any capital that you’ve put into place or anything like that, or is it really just like you’re at stages and gates and this is the stage where it makes sense to move in this direction?

This was the right moment where we were being forced to make decisions. I think we had to like slightly undo a little bit of planning that we had done on Ennis when we decided to split it into phase two and phase three and put the rolls together in phase two. We had already done a little bit of planning work, but there’s no steel in the ground, no concrete poured or anything like that. Other than that, I think everything is pretty much gone. This was the right moment to make the decision. And frankly, I described earlier in one of the questions that the rapid rate of growth and the extension of lead times created the need to do it, but this was also the time to do it because of some of the significant choices we’re making some of the investments we’re about to make.

Can you clarify if the 20% increase in capacity is entirely related to price, or is it a combination of half price and half volume?

What we did in telling you 20%, we took the old capacity plan and we updated it for the current pricing, and then it’s 20% more on top of that. So, the old plan was 2.1 billion; that we rolled it up to 2.4, and so it’s 20% on top of that 2.4.

Got it. Alright, thank you.

Yeah.

Our next question comes from the line of Mark Astrachan with Stifel. You may proceed with your question.

Yeah, thanks. Afternoon, everyone. I guess two points of clarification maybe on the new plan and maybe it’s building off of one of the earlier questions. So am I right, looking at this, if I total the CapEx for what’s already there and what’s now planned? Is it not a couple hundred million or so more than what it would have been previously, so I guess yes or no around that. And then you touched on productivity relating to the new plan. I’m curious, what does that mean; are there potential cost savings in housing bags and rolls kind of together? It would seem sort of intuitive if that’s the case. Do you also get some benefit in terms of revenue synergies from this as well, in terms of the same sort of thinking like you don’t have to obviously shut down lines to convert over to do other things that you were planning on doing, so if you can touch on that? And then I just had a follow-up for Scott around how to think about the accelerating household penetration in terms of the more recent stuff? Is it folks that lapsed consumers that couldn’t find the product? Is it new consumers kind of coming in and finding Freshpet, anything you’ve seen there would be helpful? Thank you.

Heather, do you want to take the first question?

Yes, in 2022, we mentioned that we would spend around 300 million, but now we expect that figure to rise to approximately 400 million, which marks the first increase. In the following years, we anticipate an additional increase of about 300 million for future projects compared to the previous plan.

So that’s 400 total.

That’s right, exactly.

Got it, okay.

Scott, you want to take the penetration kind of question?

Yeah, absolutely. We’re starting to make progress, and we believe that a significant part of that is due to having a more consistent product supply than before. We’ve noticed that some customers are very specific about the forms or even individual products. We think we’ve lost some occasional users over the past year; they will come if the product is available, but they might not go to another store if it's not. The good news is that this group is the easiest to win back, and they represent the smallest volume. We’ve been able to grow significantly by simply increasing household rates. We believe that people are starting to return as occasional users, and we are beginning to attract new customers to our brands. Once we achieve a more stable stock availability along with advertising and innovation, we expect to see growth in household penetration. One thing to note is that it’s common to experience a temporary dip after a significant price increase; however, it seems we have already moved past that dip and are beginning to recover. Some customers may be deterred by a large price hike, but we believe we are on the upswing now.

Our next question comes from the line of Jon Andersen with William Blair. You may proceed with your question.

Hi, good afternoon, everybody.

Hello, Jon.

My first question is on in-stock levels; you commented that you’ve made much improvement there. Can you give us a little bit more detail around that? Where you think in-stock levels are today, what you would ultimately want in-stock levels to be at, just give a sense for how much more room for improvement there may be? And I think you commented on one area where there’s more room for improvement is pet specialty, so a little more color around why that is and how quickly that can be remedied. Thanks.

Scott, do you want to take that?

Sorry, I was on mute. Sorry about that. So Jon, we have seen some, I would say, very slow, steady progress, where we’ve had kind of one step or two steps forward, one step back at some times. You can see it in some of the data that’s in the presentation on slide nine, when you look at production, but we go through an ERP conversion, it’s a little challenging; not only to produce, but it also sometimes challenging to get as many trucks out the door as we would like, and we do see some hits in product availability at retail. So we have made overall steady progress. Our fridge inventory or conditions continue to improve other than for some small backwards motions, but we have a long way to go. I think we’re probably a couple of months away from being where we would be really proud and happy to have very high service levels and really good in-stocks at retail. The best in-stocks we have right now are up into the 90s but for the most part, we’re still seeing into the 70s and 80s, and in pet we’re seeing into the 50s and 60% in stock rates at retail. So a lot of opportunity and just having it there consistently for consumers builds confidence, and it also lets retailers get more and more comfortable with continuing to kind of move forward and expand out. So we’re making progress; we have a ways to go. We really have a ways to go at this point but slow, steady progress, production is moving forward. We’re getting more and more trucks out the door. We had a really significant record on the number of cases we got out the door last week, so really nice work by the team there. But I would say we have a couple more months so we’re in great shape.

In some ways that makes the 43% revenue growth in the quarter even more impressive. Second question is on gross margin; I think last quarter, you talked a little bit about some puts and takes in gross margin throughout the year. I think Q2 stronger than Q1, given pricing catching up with costs, but then maybe a little bit of a sequential decline in Q3 with capacity coming online. Maybe Heather, could you talk about your expectations for the kind of the movement or cadence of gross margin as we move through the year? Thanks.

Sure. We've included an updated version of that chart in the presentation on slide 57. As I mentioned previously, we achieved slightly better adjusted gross margin in Q1 than expected due to higher revenue and a bit of an inventory build. We finished Q1 with some momentum, but the significant change in Q2 stems from experiencing a full quarter of the larger price increase, which is why Q2 shows the most substantial effect. We expect to maintain improved margins into Q3, though they will decrease slightly as we start up Ennis, which will have an impact on margins in that quarter, and then continue into Q4. Although we have a planned startup, we want to clarify that once we commence production, we will not add back until we have saleable products. Initially, we will have a facility and production lines that are underutilized, and this will affect margins, with the most considerable impact occurring in Q4. Additionally, while the increase in fuel costs primarily affects outbound logistics, we are closely monitoring the impact on inbound freight and energy costs to operate the facility, particularly regarding natural gas, which is a key factor. There is some near-term impact that we are observing carefully. Consistently, as we've stated, we would consider pricing adjustments if we believe the situation will persist, and we are assessing that closely right now. More details will follow regarding where that impact might occur and how long it may last, but the overall trend is similar to what we previously discussed, with added risk concerning fuel.

Our next question comes from one of Anoori Naughton with JPMorgan; you may proceed with your question.

Hi, good afternoon. I just had a hypothetical clarification question. You talked about some occasional users may be slipping. I was curious, do you have a sense of what percent of the business are actually the topper users? Of those lost users? Do you have any sense of maybe where they’re going instead?

Scott, you can take that one?

Yeah, sure. So it when we get into the break, I can tell you at an overall level on the business, our heavy users represent about half of our total dollars today, okay? The occasional users are in kind of 30% to 40% of our business and then the last group are very, very occasional. So, there is a group of occasional that have left. We don’t have as much detailed statistics as we’d like, especially for short periods of time on this, but we can see some of that kind of in the data. So it’s hard to answer the exact specifications and exact detail around that, to be quite transparent.

Understood that the sizing is possible. Thank you for that. And then my question is, in your new CapEx plan, when do you target having the chicken processing facility operational? And then does this change the way you’ll be procuring chicken on a go-forward basis? I guess, more broadly, can you just provide more details on what you think the expected benefits in savings will be from having a chicken processing facility on site? Thanks.

Yeah, Anoori, the reason for the chicken processing on site is actually to deliver higher quality. While it’s likely it will give us some lower expenses because you don’t have to transport the product as much, but the reality is we want to use the freshest chicken possible, and so by having the processing operation on site at our largest site gives us the opportunity to bring in the chicken, process it, and then feed it directly into our manufacturing operations immediately or as quickly as we possibly can, close coupling the production or the processing the chicken and the production of the Freshpet. That’s really the driver. We don’t have the ability or the room to do that in Bethlehem, although the facility that does process our chicken is only about 20 miles away, so it is very, very close and we’re getting locally sourced chicken there. But we like this as an operating model. We feel very good about that as an ongoing benefit. We would do it for the quality; the cost would be an added benefit.

Our last question comes from line of John Lawrence with Benchmark; you may proceed with your question.

Thank you. Congratulations, guys, on the progress. But can you talk a little bit about the ERP system getting installed, getting it up and running, what had been the positives and the negatives of the system at this point, and what do you expect over the next couple of quarters?

Heather, you can take that.

Yeah, sure. Well, thank you. So we are revived successfully in our new system, so we’re really thrilled about that; it’s a big milestone. In that, we fully converted to a new ERP system end to end, so the scope of it was all processes. And our goal was to ensure that we could run our end-to-end business on the new system, and we successfully are. I would say, the positive coming out right now is really not production; and we shared that in the prepared remarks, but the production is going quite well. And you had your expected, call it just getting folks trained, having the change management on but the production floor is running really well. In fact, they’re running more favorably now than they were prior to the conversion. It was just a learning curve. We are running, like I said, the full end-to-end processes. We’re still, as you’ll see in some of our working capital figures, you’ll see a quarter on impact in our working capital with receivables number that is higher than we would expect just based on growth. And that’s a function of the ERP and having to get some of those sort of the process of invoicing and all the way through on a timely basis. But again, it’s all growing pains but we do feel confident and good about being converted to the new system, and it was coming along quite nicely.

Great. Thanks and good luck.

Thank you.

Ladies and gentlemen, we have reached the end of today’s question and answer session. I would like to turn this call back over to Mr. Billy Cyr for closing remarks.

Thank you and our apologies to those whose questions we’re not able to get to today. We’re obviously on a very tight schedule with the news we put out earlier today. I’ll leave you with one thought; the author John Grogan said, that short little lives our pets have to spend with us, and they spend most of it waiting for us to come home each day. And I would add to that: serve them Freshpet when you arrive, and it will have been worth the wait. Thank you very much. We appreciate your interest and attention.

This concludes today’s conference; you may disconnect your lines at this time. Thank you for your participation during the rest of your day.