Freshpet, Inc. Q4 FY2023 Earnings Call

Greetings. Welcome to Freshpet's Fourth Quarter and Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I'll now turn the conference over to Rachel Ulsh, Vice President of Investor Relations. Ms. Ulsh, you may now begin your presentation.

Thank you. Good morning, and welcome to Freshpet's fourth quarter and fiscal year 2023 earnings call and webcast. On today's call are Billy Cyr, Chief Executive Officer, and Todd Cunfer, 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 Private Securities Litigation Reform Act of 1995. These include statements related to our long-term strategy, focus, 2027 goals, pace in achieving these goals, prospects for growth, and new technologies and 2024 guidance. Words such as believe, could, estimate, expect, guidance, intend, may, project, will or similar conditional expressions are intended to identify forward-looking statements. 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, including those associated with such statements and accuracies in third-party data. Please refer to the company's annual report on Form 10-K filed with the Securities and Exchange Commission and the company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note on today's call, management will refer to certain non-GAAP financial measures, such as EBITDA and adjusted EBITDA, among others. While the company believes these non-GAAP financial measures provide useful information for investors, the presentation of the 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, why management believes such non-GAAP measures are useful, 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; rather, it is a summary of the results and guidance they will discuss today. With that, I would like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Rachel, and good morning, everyone. The message I would like you to take away from today's call is that we believe Freshpet has reached an inflection point on its journey towards becoming not only a sizable, but profitable business in the emerging fresh/frozen segment of the pet food market. We delivered the strong growth you've come to expect from us, but also turned a corner on our profitability and are on our way towards delivering the kind of profitability and cash flow one would expect of a market leader. In 2023, we made significant progress on nearly all the metrics we set out to deliver. And if we continue to execute as we did in 2023, we will prove that with increased scale comes increased profitability and in turn, shareholder value. Our Feed the Growth strategy, which we implemented in 2017, was driven by our dual beliefs that fresh pet food is a scale-driven business, and that it was also important to maximize our first-mover advantage before competitors entered the fresh pet food market. Our transition to a fresh future plan last year reflected our belief that we are at the point where we have achieved sufficient scale and first-mover advantage such that we can begin to pivot to delivering the profitability that should come with that scale. Our 2023 results show the initial indications of our ability to drive that profitability, and we believe there is a significant opportunity to drive further profit improvement going forward. Now, let me walk you through some highlights for the fourth quarter and full year. First, we ended the year with very strong net sales growth and exceeded our expectations with fourth quarter net sales of $215.4 million, up 30% year-over-year, driven primarily by volume growth of 25% and 5% price mix. This strong growth is compared to a very strong quarter last year when we had significant trade inventory refill. The growth was supported by a strong advertising presence and household penetration gains that accelerated throughout the quarter. Second, we continue to see the strong operational improvements our fresh future plans were designed to drive, including sequential improvement in adjusted gross margin, logistics costs and adjusted EBITDA. Fourth quarter adjusted gross margin was 41.1% compared to 40.2% in the third quarter and 33% in the prior year period. Logistics costs came in at 6.3% of net sales, down from 9.4% in the prior year period, and 6.8% in the third quarter. Fourth quarter adjusted EBITDA was $31.3 million compared to $23.2 million in the third quarter and up 67% year-over-year. Fiscal year 2023 was our sixth consecutive year with greater than 25% sales growth with net sales of $766.9 million, up 29% year-over-year, on the high end of our targeted range and above our expectations. Full year adjusted EBITDA was $66.6 million, more than three times what we delivered in the previous year. These financial results demonstrate real momentum, the potency of our plans and the capability of our team. I'm incredibly proud of what you've been able to accomplish. In addition to those financial highlights, we delivered the significant increase in retail presence our retail partners sought as they became increasingly confident in our ability to supply them. Specifically, a record of 5,251 fridge placements in 2023, including new stores, upgrades and second or third fridges, bringing us to a total of 34,274 fridges at retail or more than 1.7 million cubic feet of retail space. As of December 31, 2023, Freshpet could be found in 26,777 stores, more than 22% of which now have multiple fridges in the US. These fridge placements and store growth were supported by continued strong fill rates that ended the quarter in the high 90s. In addition to our strong retail business, we have also built a very strong digital business. Digital orders, which I previously referred to as e-commerce, we define as any time you order on a phone or a desktop, so this includes anything from buy online, pick up in store, to Instacart, Chewy and Amazon. In 2023, our digital sales increased 58% year-over-year, and at this point, we are projecting digital orders to be over $100 million of net sales in 2024. The vast majority of our digital orders today are pickup or click and collect, which leverages our existing fridge network in retail. According to NielsenIQ, pickup is also the fastest-growing segment of online e-commerce in dog and cat food. During our ICR Conference presentation in January, you may recall hearing us talk about the mainstream main meal, more profitable plans, which I'll simply refer to as main and more. We're making the Freshpet brand more mainstream and getting people to use it as a main meal component, and this creates intensity and concentration of the business that we believe will allow us to be more profitable. Diving a little deeper into the idea of mainstream, according to Nielsen Omnichannel data, which includes e-commerce and direct-to-consumer, as of December 30, 2023, total pet food is a $52 billion category. Within that is the $36 billion dog food category, which the majority of our business is today, and we have only a 3% market share, which leaves a vast runway for growth. At the same time, we have created a new segment within pet food, fresh/frozen pet food, that has gained scale and is growing quickly. Within the fresh/frozen subcategory in measured channels, Freshpet has a 96% market share. Our goal is to make fresh even more mainstream since our products appeal to a wide range of income groups, we have products for each stage of a pet's life and are growing our portfolio to better meet the needs of larger dogs. Our household penetration at year-end was 11.555 million households, up 19% year-over-year and accelerating towards our target of over 20% household penetration growth. Our high-profit pet-owning households or HIPPOHs for short, grew even faster, up 28% versus a year ago. Household penetration has grown fastest with younger Gen Z consumers, and we saw growth across all income groups. We are on pace to meet our target of 20 million households by 2027. Overall retail availability continued to grow, with ACV at year-end of 64%, and we see upside in continued distribution gains going forward. We will continue to focus on depth too, not just breadth, increasing the percentage of stores with second and third fridges, I spoke about earlier. Focusing on the concept of main meal, we know that 40% of Freshpet buyers use the product as the main component of their pet's meal, and there is a huge opportunity to significantly increase this percentage even with our HIPPOHs. 37% of Freshpet users are HIPPOHs and they represented 89% of our sales in 2023. We are using advertising to drive pet parents to feed Freshpet as the main meal item by focusing on healthy food, offering products at a variety of price points and expanding specialized recipes. The concept of converting toppers into main meal users will increase buy rate, which was $95.86 at year-end. Broadening availability of a wider range of our items can help drive more consumers to convert to using Freshpet as a main meal item. Adding second and third fridges enables us to do that, and this also drives increased visibility for the brand, amplifying the value of our advertising. Based on mega-channel data, we currently have an average of 18.2 SKUs per store, up from 15.8 SKUs one year ago. Turning to the more part of main and more, more profitable, we are enhancing margins through improved operating performance and leveraging scale and efficiency. We believe increased business intensity and concentration will drive increased efficiency, and we are seeing that play out in our margins already. Fourth quarter adjusted gross margin was up 810 basis points year-over-year to 41.1%, and adjusted EBITDA as a percent of net sales was 14.5% compared to 11.3% in the prior year period. Three key areas we have been most focused on have been input costs, logistics and quality. And we've improved all three this past year, with logistics now only 6.3% of net sales in the fourth quarter, down from 9.4% in the prior year period. In total, we improved those three areas by 390 basis points in Q4 and 560 basis points for the full year. Focusing on capacity. We feel good about where we are today. December was an all-time production record across the system despite the loss of time for holidays, driving very strong fill rates in the high 90s today. And January production topped the December record. All three lines in the first phase of Ennis are operating today, and that site now accounts for 25% of our total system production, and as Phase 2 construction is on track for the start-up of the first roll line by the end of the third quarter of 2024. We've continued to evolve our capacity expansion plans to drive greater capital efficiency. We are very focused on, first, maximizing the output of our existing lines by investing in an operational excellence program designed to increase throughput. We are making good progress on that program in Bethlehem, and just started the plan in Ennis. Second, maximizing the capacity of our three existing sites so that we can avoid the high cost of incremental infrastructure and overhead. This means finding ways to get more lines into each of the three sites. We've already announced plans to add a seventh line in Bethlehem. We believe we found a way to get an additional line or two in Kitchen South, and are also looking for ways to get more lines in Ennis. Third, developing new technologies that generate more throughput per line and per square foot of space. We've been working on this for some time and are making good progress, but are not ready to share any details at this time. Overall, 2023 put us ahead of the pace needed to deliver our 2027 goals and gave us increased confidence in our ability to either meet or exceed those goals. The strong 29% net sales growth in the year was ahead of what we had projected. As we head into 2024, we intend to manage the growth very closely, so that we do not get ahead of capacity or organization capability. Our model works very well at 25% net sales growth over time, generating the right balance of cash generation and capital spending to deliver our financial targets. We do not want to get too far ahead of ourselves and upset that balance. We recovered 400 basis points of adjusted gross margin during the year, ahead of both our target and the pace needed to hit our 2027 target of a 45% adjusted gross margin, and we ended the fourth quarter with an even higher adjusted gross margin at 41.1%, giving us even more encouragement about our ability to deliver our long-term goal. We are well ahead of our long-term logistics target of 7.5% of net sales, delivering the target three years early and ending the year at a rate well below the target. It is clear that we have an opportunity to further improve in logistics and will likely set a new lower target in the future. Operating cash flow of $76 million was also ahead of our plan and increases our confidence in our ability to fund our growth with no need for additional equity and potentially not even needing any new debt. In summary, we had a very good year, and we believe we are on the cusp of profitability with greater scale and efficiency due to increased business intensity and concentration and disciplined capital management. Now, let me turn it over to Todd to walk through the details of the Q4 results and our guidance for 2024. Todd?

Thank you, Billy, and good morning, everyone. As Billy mentioned, we had an excellent fourth quarter and a very strong year. Now, I'll give you some more color on our financials and guidance for the year. Fourth quarter net sales were $215.4 million, up 30% year-over-year. Nielsen measured dollar growth was 28% versus prior year period with broad-based consumption growth across channels. We saw a 15% growth in pet specialty, 30% in xAOC, and over 100% growth in the unmeasured channels. Fiscal 2023 net sales were $766.9 million, up 29% year-over-year. Nielsen measured dollar growth was 27% versus prior year, again, with broad-based consumption growth across all channels, with 18% growth in Pet Specialty, 29% in xAOC, and approximately 85% growth in the unmeasured channels. Fourth quarter adjusted gross margin was 41.1%, up 810 basis points year-over-year. This was driven by leverage on plant costs as well as improvements across our key focus areas, including quality costs. Fiscal 2023 adjusted gross margin was up 400 basis points year-over-year to 40.0% driven by progress on our operational improvement plan. Fourth quarter adjusted SG&A was 26.6% of net sales compared to 22.4% in the prior year period. We spent 6.3% of net sales on media in the quarter, up approximately $10 million from Q4 last year to help us get off to a fast start in 2024. We saw continued improvement in logistics costs, down to 6.3% of net sales, a decrease of 310 basis points compared to the prior year period. Fiscal 2023 adjusted SG&A was 31.3% of net sales, down from 32.9% in the prior year period. Media spend for the year was 11.1% of net sales, up slightly from 10.5% from the prior year. Logistics costs were down to 7.5% of net sales, a 320 basis point improvement over the prior year. Fourth quarter adjusted EBITDA was $31.3 million or 14.5% of net sales compared to $18.7 million or 11.3% of net sales in the prior year period. This improvement exceeded our expectations and guidance and was driven by better-than-expected net sales and strong operating performance and cost of goods sold and logistics. Fiscal 2023 adjusted EBITDA more than tripled year-over-year to $66.6 million or 8.7% of net sales. Capital spending for fiscal 2023 was $239.1 million, in line with our expectations. Operating cash flow was $76 million, and we had cash on hand of $297 million at the end of the year. We continue to believe that we have adequate cash to fully fund our growth through 2024, and we will be free cash flow positive in 2026. We also believe that we will have access to traditional non-dilutive forms of capital to bridge a gap in 2025 if it occurs. Now, turning to guidance for 2024. We expect net sales of at least $950 million driven by volume, and adjusted EBITDA to be in the range of $100 million to $110 million. We expect capital expenditures of approximately $210 million to support the installation of capacity to meet demand in 2025, further fridge placements and ordinary maintenance. It is important to understand that our growth rate directly impacts the capital we need to spend to build capacity. We are closely managing our cash balance, being very disciplined in our media spend and carefully managing sales growth while expanding capacity and increasing profitability. We exceeded our expectations for 2023, which is why the net sales growth rate of at least 24% is slightly below our long-term target of 25%. We do not want to get ahead of the capacity build that we are putting in place. In terms of cadence, we expect a fast start to the year based on strong momentum from 2023, with Q1 being the highest percentage net sales growth rate year-over-year. We expect to see sequentially lower net sales growth rates as we progress throughout the year as we manage our growth to deliver the right balance between growth and capital investment as we talked about earlier. This should not be construed to imply that the business is slowing, quite the opposite. We are rigorously managing the timing and pace of our advertising investments to regulate the growth so that we can live within our capacity plans and carefully manage the cash required to build capacity. We want to deliver as close to our long-term target of 25% net sales growth over time so that we don't get too far ahead of our capacity expansion. We expect an adjusted gross margin expansion of at least 100 basis points, and the absolute gross margin percentage to be slightly higher in the second half of the year versus first half. We will have some start-up costs on the third line in Ennis in Q1, and additional start-up costs on the fourth line in Ennis in Q4. At this point, we have about 70% of our commodity costs locked in for the year and currently expect modest deflation in 2024. We anticipate media to grow in line with sales, and we will pull back as necessary to control sales growth. Lastly, we expect sequential quarterly improvement in adjusted EBITDA. Overall, we are proud of our 2023 results and believe we are in a strong position to deliver on our guidance with our momentum so far in 2024. With the actions we've taken and continued strong demand for our products, we remain confident in our ability to deliver on our fresh future plan and 2027 goals. We believe that when we look back a year or two from now, it will be apparent that 2023 was truly an inflection point for Freshpet in the fresh frozen category, and that Freshpet will be on its way to having a leading share in that segment and delivering the kinds of profits one would expect from the market leader in an emerging high-growth market. That concludes our overview. We will now be glad to answer your questions. As a reminder, we ask that you please focus your questions on the quarter, the guidance and the company's operations. Operator?

Our first question today is coming from the line of Rupesh Parikh with Oppenheimer. Please proceed with your question.

Good morning. Thanks for taking my question, and also congrats on a strong quarter. So maybe to start out, just on the gross margin line, very strong performance in Q4, and it sounds like you guys are guiding for at least a 100 basis point improvement this year. So maybe, Todd, if you can just walk through the puts and takes that you see on the gross margin line for the year?

Are you talking about '24?

Yes, correct.

Yeah. So as I mentioned in the opening remarks, we are going to see a little bit of deflation, that's our expectation right now in commodities. Obviously, we'll have some inflation on our labor and overhead. But we're fortunate enough to lock in a fair amount of our commodities at really nice rates right now. So we will see a reduction in our input costs. We anticipate quality costs, which we've made great progress on in '23, will continue to see some improvements in '24. Those are kind of the fixed cost, labor and overhead because we're still building out a couple of new lines in Ennis, we're not going to see any progress for '24 there, that's probably more of a '25, '26 improvement timeframe. What's really going to become lower input costs and improved quality are the main drivers.

Great. Thank you. And then maybe just one follow-up question. So it sounds like you guys are going to manage to your longer-term algorithm for the top line. Is there a way to help frame what your capacity is today and where you expect to end by the end of the year?

Yeah, Rupesh. The way to think about this is that we have to be mindful, not just of overall capacity, but we also have to be mindful of capacity by form. In this case, what we're really managing to is the Ennis Phase 2 first line is a roll line. So we'll be tight on capacity until that line comes up on the roll segment of the business. We're doing really well on the bag side, and so we're really trying to guide ourselves so we don't end up short shipping anything on the roll side prior to that line coming up and being able to give us the capacity. Once that's in place, we have a pretty good runway until sometime in '25, when it will flip around and the tightness will come on the bag side. We're working diligently to make sure that we have enough capacity to accommodate the growth that we've got. But we're literally managing ourselves between each of these projects—rolls and bags—so we can sustain the growth rate that we've got, but we don't want to get too far ahead of ourselves.

Yeah. So right now, we have about $1 billion of total capacity. But as Billy mentioned, there's a little bit of a mismatch. We've got more capacity on the bag side versus the rolls. And then obviously, we need to get well above $1 billion as we get into '25. So it's really the rolls right now causing us a little bit of an issue.

Great, thank you. I'll pass it along.

Our next question is from the line of Brian Holland with D.A. Davidson. Please proceed with your questions.

Thanks, good morning. Quickly on media. Number came in higher than I was projecting in Q4, so I'm assuming that maybe it was a little bit higher than what you had communicated and maybe planned for prior to the quarter. So just curious if there's anything there that you can speak to with respect to an opportunity that you saw? Or just any logic behind to the extent that you increased that number in Q4? And then also, just want to understand the variability of the media spend as we look out to fiscal '24, with what sort of time horizon can you pull back on that spend if needed?

So I'll start off and I'll let Scott answer. Internally, we planned that number for a while. We kind of hedged our bets a little bit. We weren't sure where the costs would come for the year. So we kept some dry powder back. But as we saw the gross margins and the sales perform very, very well in Q4, we released that money. So internally, we planned that amount, but externally, we hedged our bets a little bit.

It's unusual that we spent that much in Q4, but this is a year where we actually had capacity, so we ended up spending a little bit more in Q4 than we have historically. That gave us good momentum into Q1. We're seeing that come through both in consumer penetration and overall top line growth, especially in units and pounds. Regarding how far out we can manage media, we can make small adjustments within 30 days. We can make more significant changes and modifications about 90 days out, which is typically how we think about it.

Thanks. And then just a follow-up on that. I guess the reason for the question is a lot of people asking about your ability to sort of run counter to the trends in premium pet food that we've been seeing for quite a while now. And what might be behind that? Is there a lag effect? Does it ultimately catch up to you? So you're going to be at, I guess, north of or around about $100 million of media spend. I believe another big visible competitor in the space, the fresh frozen space is spending roughly the same, if not more. And I'm just curious if there's anything anecdotal that you are seeing or any data points you can refer to that might sort of crystallize whether we're at— and you talked about 2023 being an inflection point for the business. And I'm wondering if it's been an inflection point for this subsegment of fresh/frozen in food as sort of redefining premiums. So I'm just curious what you've seen or what you can speak to that end.

Let me answer in two parts. First, there has been a change in the overall category, but we have not seen the impacts other parts of the premium category have seen with consumers changing their buying behavior. We're not seeing consumers trade down. We're seeing consistent consumer growth, and you see that in penetration and HIPPOH growth and in our media productivity. One of the first signs of trouble would be slowing penetration and media becoming less productive. We're not seeing those signs. I don't anticipate the broader category disruptions to have a significant impact on us this year. Second, are we at an inflection point from a consumer standpoint? We've been trying to change long-standing behaviors around dry and wet food, and people are becoming more aware of fresher, healthier diets. People may not do it for themselves, but many will do it for their pets. Everything we're doing—making the brand more mainstream, more visibility in retail, broader availability, our advertising—supports this shift. We believe we're moving into the early majority, but we're not even halfway through that group yet. We do believe it's an inflection point and that it has been developing for years.

Our next question is from the line of Ken Goldman with JPMorgan. Please proceed with your question.

Hi, good morning and thank you. I just wanted to get a little bit better sense of how to think of CapEx between now and sort of your target year, I guess, longer term of 2027? I think previously, you'd sort of guided to maybe $250 million a year in '25 and '26. I don't know if you've officially kind of addressed or updated those numbers since maybe CAGNY of '23, if I have—or if you have, I missed it. I'm just trying to get a better sense as you kind of think of the rollout of certain plants and demand and some efficiencies you've created, whether those are kind of rough numbers to factor in, in light of the $210 million this year so.

The numbers continue to be fluid. We try to optimize consistently how we're spending and the timing of it all and where we're putting the investment. Right now, we have not given official updates. The way I think of it is it will be over the next several years somewhere in that $200 million to $240 million range per year. It's still too early to talk about exactly what the '25 number is. We're still making some final decisions, but that $200 million to $240 million is probably a pretty good estimate at this point.

All right. Thank you for that. And then just a follow-up. I wanted to get a better sense of the maximum flexibility you had this year and the balance you have between building the brand over the long term and also not getting ahead of yourself on capacity and organizational capability. Is there kind of a minimum media number you'd want to spend for the year in terms of dollars? Or is that not really the right way to think about it?

We typically guide to increasing our media in line with sales. Our long-term target is to be ultimately at 9% of sales. As we see situations where growth is running a little hot and we need to manage within capacity, we would meter ourselves back, heading toward that 9% to see how quickly we can get to that level. I don't foresee a circumstance in this year or next year where we would drop below 9%. That's really the guidepost—sort of a 9% to 11% range is where we're trading in.

Great. Thanks so much.

Our next question is from the line of Peter Benedict with Baird. Please proceed with your questions.

Hi, guys. Thanks for taking the question. Maybe, Scott, back to you on the consumer behavior. You said you hadn't seen much change at all. But maybe tilt back a little bit—within your portfolio of products that you have, how consumers are responding to innovation, to the additional SKUs that you guys alluded to per store. Just curious on that and how pricing—next year's growth is going to be mainly volume. But how do you think about pricing and more about mix as you think about 2024?

It's been an interesting period in the industry where others have seen impacts around changes in the portfolio and people trading down. We really have not seen that at all. We haven't seen any significant effect in our business around that. On the new product front, we have products at both ends of the spectrum—from higher cost-to-feed-per-day products to more cost-effective products. Both are performing and growing well. Some products perform better in different formats. In mass, we're seeing a bit more growth on the more cost-effective products, and those are margin neutral for us internally. We're also seeing good growth on higher-end products. That dynamic is encouraging and aligns with consumer behavior we're seeing.

No, for sure. That's good color. And then just a question on the broader category. You guys have 96% of the measured category. Maybe give us a sense of where you think the broader fresh/frozen category may be today? What kind of growth you would expect out of that category over the next few years? And just the competitive dynamics—there's a lot of folks that have been coming in and then they start to cycle out. So just curious your broad view of the category. Thank you.

We set out to build Freshpet many years ago and have maintained around 96% of the total fresh/frozen sold in brick-and-mortar measured channels. There's also a direct-to-consumer segment, which is a different model and has not inhibited our ability to grow. When we look at our model and opportunity, we discuss a TAM of 43 million households. We're currently at almost 11.7 or 11.8 million households. There's a long way to go on penetration. For buy rate, we believe there's an opportunity over a long period to roughly double our buy rate. Within 2027, we've penciled in a buy rate target of $127; today we're at $96. We expect to move toward that number. We're focused on HIPPOH consumers and believe there's scope to improve buyer rate over time. On both fronts—penetration and buy rate—there's significant opportunity. The category is changing, and it will be interesting to see how it plays out over the next few years.

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

Hey, good morning, guys. Hope all is well. Firstly, on HIPPOH growth. It's exceeded household penetration now the last couple of years, especially in '23—nearly 30% versus overall household penetration just under 20%. Maybe talk about the life cycle and conversion of those HIPPOH consumers from first consumption of the category or from the brand into a HIPPOH, and how do you think about the opportunity of those that are casually using today? Can you accelerate that adoption? Do you need to bring in more consumers to the category? What do you see around those that really become HIPPOHs and those that drop off?

Thanks for that question. Last year we added about 1.8 million households, and HIPPOHs grew by over 900,000. Growing our best consumers by a significant amount is notable. HIPPOHs are becoming a large piece of the business. We facilitate that growth by getting fundamentals right—being in stock consistently, delivering high quality, good consumer experiences, continuing innovation, broader availability and online ordering. We see HIPPOHs come from two groups: some consumers become HIPPOHs within three to six months and make Freshpet their dog's primary food immediately, while others start using Freshpet as a topper and gradually shift the mix until fresh becomes the main meal. It's a different mindset because with fresh you can be the core main meal rather than just a topper. We see HIPPOHs evolving from both paths, and continuing to improve fundamentals will help accelerate that conversion over time.

Got it. That's helpful. And then going back to Ken's question on CapEx. I was surprised CapEx guidance remained the same. You talked about maximizing output of existing lines, adding capacity to existing sites, and developing new technologies. With all that, why are you still spending the same on CapEx? Is the plan to get more output than originally expected, or is it less costly? Bridge that for me, please.

Mark, there's a timing difference. The capital spend we do in '25 and '26 impacts sales levels in '26, '27 and '28, so there's a lag. Second, the technology we referenced—we're bullish on it—but we have not assumed any benefits from it in our long-term plan. We have the spending for it, but we didn't guarantee the higher throughput per dollar of spend. If those benefits materialize, it's upside to the economics. Similarly, improvements to operating effectiveness are upside if they happen. We're being cautious about planning capacity; if the improvements occur, they provide additional benefits, but we haven't built that into base planning.

Our next question is from the line of Jon Andersen with William Blair. Please proceed with your question.

Hey, good morning, everybody. Thanks. Quick question on the sales outlook for 2024. We talked about 24% growth, largely volume-driven. How should we think about the mix a couple of different ways? You haven't really referenced your expectations for fridge placement growth or store growth. If you could talk about expectations for distribution growth through additional fridge placements. And then from a channel perspective, non-measured grew substantially faster than measured in '23. Is that a dynamic you would expect to persist in 2024 and why?

Let me address several points. In grocery, we're at 72% ACV and by far the number one brand, while other number-one brands are typically in the 90s ACV and often have 4 feet of space. Across grocery, we have around 2,000 double coolers. There's upside in ACV and especially in adding double coolers in grocery, which would allow more SKUs, greater aisle presence and better visibility. In mass, we have around 200 double coolers across Walmart and Target; the opportunity there is also significant. While ACV opportunity exists, the majority of our model is driven by same-store sales, where we typically see high teens up to low 20% same-store sales growth. That's the core of our growth, driven by advertising, but there's additional upside from ACV and extra coolers. Regarding channels, adding digital and unmeasured channels has been an important part of growth and will continue to be.

Jon, on unmeasured versus measured, we expect unmeasured growth to add about three points to our growth in 2024, at least three points. It was heavier in the fourth quarter, and we're in a lot of Costcos at this point, which helps especially in the first half. It won't be quite as strong in the second half of the year as we lack some of the performance we had in the second half of 2023.

Okay, great. That's helpful. I'll leave it there. Thanks.

The next question is from the line of Bryan Spillane with Bank of America. Please proceed with your question.

Hey, good morning guys. I wanted to follow up on out-of-stocks on key SKUs. Can you update us on where you stand on in-stock levels on a regular basis? Are out-of-stocks still impacting sales growth—are you leaving some sales on the table because you're out of stock on key SKUs during key periods?

If there are out-of-stocks at retail, it's a function of the high velocity in that store and the store's inability to keep the fridge stocked at an adequate level. Our actual shipments to our customers have been running at 98% to 99% fill rates consistently since the beginning of this year and in the latter part of Q4. So there's not an issue with our shipments or supplying the customers; it's about how well stores execute replenishment of the fridges.

Our next question is from the line of Bill Chappell with Truist Securities. Please proceed with your questions.

Thanks, good morning. Billy, Scott, why isn't CapEx going to be greater over the next year or two? Back at IPO, the thought was you'd build out Bethlehem, add one in the Midwest, maybe another facility on the West Coast as demand grows. You just talked about an inflection point, mainstreaming, large household opportunity. Why aren't we talking about another facility or a West Coast presence now?

Bill, first, as I described earlier, we're focusing on three things to maximize throughput on our existing footprint: increasing operational excellence on existing lines, finding ways to add more lines within each existing site to avoid duplicative infrastructure costs, and investing in new technologies. Based on what we know today, that existing infrastructure and planned technologies could allow us to meet growth goals until almost 2029 if we maintain a 25% growth rate. The question of why not grow faster is about execution: at around 25% growth over time, we execute well—engineering, staffing, organizational capability, hiring and training—so pushing faster risks executional problems. We prefer to stay at that sustainable rate. If we do, our existing footprint should meet needs until about 2029, at which point we'd evaluate adding a new site unless further technology changes alter that plan.

Got it. And does that put international on the backburner? You've said Canada and the UK are opportunities, but if you're capacity constrained to meet US demand, is international deprioritized?

I should clarify: my comments were focused on the North American business. Our European business is robust and a good opportunity, but supplying it from the US isn't the most reliable. It's more a reliability issue than a cost issue. We're developing alternatives that would provide a more reliable supply source in Europe, but we would not pursue a greenfield operation on our own; we'd look for a partner. If we go down that path, it would be much lighter on capital than building greenfield operations in the US.

Our next question is from the line of Michael Lavery with Piper Sandler. Please proceed with your question.

Thank you. Good morning. You've touched on ways you're improving throughput, such as longer run times and reducing changeovers. How much opportunity is there from longer run times and reducing changeovers? How achievable is that?

That's an interesting point. When we started up the second bag line in Ennis in Q4, it's already showing the benefit you described because we no longer have to produce the entire bag lineup on a single line, which forced extensive changeovers. The second line is much more productive. We expect a similar benefit when we start the second rolls line in Ennis. In Pennsylvania, where we have six lines, high-speed lines run long, deep runs and smaller lines handle more changeovers. As Ennis becomes more built out and lines can be more specialized, we expect significant benefits from longer run times and reduced changeovers. Those benefits are not modeled into our forecast yet, but early indications are promising based on the second bag line start-up.

Today we have 12 lines in operations—six in Bethlehem, three in Ennis, three in Kitchen South. Fast forward a couple of years and we'll have over 20 lines. With more lines, some will be dedicated to one or two SKUs and others will handle changeovers. The efficiency we expect from that structure is substantial. We're constantly looking at SKU mix to optimize portfolio efficiency. We're seeing early signs of benefit from the extra capacity and believe more is to come.

And that benefit is not yet modeled into your forward targets?

No, not yet.

And then just to follow up on the Complete Nutrition launch—how is that going? Is it playing the role you expected?

Complete Nutrition is doing a bit better than we anticipated. We designed it to be a slightly more accessible, cost-effective product while maintaining quality. It's margin neutral for us and has brought in new consumers as intended. We're seeing good sales and trial, and it's performed exactly as we designed. We're also planning to reduce the long tail of SKUs over the next 12 to 18 months to improve production efficiency.

Our next question is from the line of Robert Moskow with TD Cowen. Please proceed with your questions.

Hi, thanks for the question. Two quick things. You mentioned that your buy rate is now at $96 a year and your household penetration is approaching your target. Doesn't that mean buy rate will have to increase substantially this year to hit your overall growth assumptions? Do you have a number internally where it needs to go? Quick follow-up after that.

Rob, the long-term algorithm is that you have penetration growth rates around 20% to 22% and buy rate up in the mid-single-digit range, and together that gets us to the target growth rate. So yes, we need buy rate to grow in the mid-single-digit range. A big part of buy rate improvement comes from increasing the number of HIPPOHs, which pull the portfolio up. So we expect buy rate to grow in those mid-single-digit percentages.

And on repeat data—this is a year where there was a lot of trial due to advertising. What do you look at internally to ensure first-time triers are repeating at the rates you hope?

We haven't talked about repeat rates much recently because there's been a change in data sources and it's confusing to compare the two. In either source, repeat rates are continuing to be strong and growing. We need to get comfortable that the new metric is consistent, but across sources, repeat rates are in line with or a bit higher than historical levels.

If repeat rates weren't strong, you would see it reflected elsewhere—the HIPPOHs wouldn't be growing as they are.

Our next question is from the line of Kaumil Gajrawala with Jefferies. Please proceed with your question.

Hey, guys. Good morning. Lots of conversation on managing growth to that 25% number. Can you talk about how you do that practically? Beyond media spend, how are you dealing with retailers and their commitments? How do you pull that figure in practice?

By far the single biggest driver of our growth rate and the main lever to manage growth is controlling media spend. We look across the year on a month-by-month and quarter-by-quarter basis. We know when we spend, like we did in Q4, the impact is felt in Q1 as consumers go through a purchasing journey. To avoid short shipping—especially before our new rolls line in Ennis is live—we must manage media in Q1, Q2 and Q3 carefully. We don't typically regulate plans with customers because those take time. So we manage demand through our media investments.

Our next question is from the line of Tom Palmer with Citi. Please proceed with your question.

Good morning. On logistics, it's been running lower than your long-term outlook assumed. As we roll into 2024, how should we think about logistics progressing? Is 2024 embedded in guidance a reversion to the long-term target?

Year-over-year, we'll see a decline in logistics cost as a percent of sales. We're benefiting from shorter miles, the opening of the second DC in Texas, fuller trucks due to higher fill rates, and generally lower diesel and lane rates. Those factors drive current favorability. Long term, 7.5% was our previous target, but we are very confident we can do better than that going forward. Market rates can move, but with current steady rates, we see further favorability.

And on volume growth cadence, given capacity rollouts, is there a quarter where we might see a bigger step-up sequentially in one quarter versus another?

We guided capacity to match normal sales patterns. The cadence for the year will be fairly normal, but we'll start hot in Q1 because of media spent in Q4 and will moderate spend to align with capacity limits—especially on the rolls side—until the new Ennis roll line comes online. That's the main cadence driver this year.

Sequentially, every quarter the absolute dollar amount should increase. Growth rates will differ and likely slow as the year progresses due to capacity management, but absolute dollars increase each quarter.

Our next question is from the line of Connor Rattigan with Consumer Edge Research. Please proceed with your question.

Hey guys. Good morning. You mentioned increasing household penetration, converting users to HIPPOHs and converting toppers to main meal users. Stepping back to consumer LTV, where do you see the greatest opportunity? If forced to rank adding an incremental user, converting a user to a HIPPOH, or converting a topper to a main meal user, which is most valuable?

When you're in the early innings of developing a category, the highest priority is adding households. That's the focus of much of our media. As the category matures, we shift attention toward increasing buy rate within households. Today, household penetration remains the number-one driver, and over time we'll migrate more toward buy rate improvements.

Makes sense. And on digital orders—you noted an expectation of around $100 million in 2024. Did you quantify current digital sales? Is continued growth primarily incremental new digital-only consumers, or will it cannibalize brick-and-mortar?

We want to be as available as possible for how consumers want to buy. Making it easier to shop increases overall penetration and everyday usage. Digital growth mainly makes it easier for consumers to include Freshpet in their existing grocery shopping, often as click-and-collect, and increases convenience. It both brings in new consumers and supports main meal usage without materially cannibalizing our brick-and-mortar presence because much of digital is pickup that leverages our fridge network.

Our next question is from the line of Jim Salera with Stephens. Please proceed with your question.

Hi, good morning guys. Maybe to start, you highlighted that about 22% of stores now have second or third fridges. Do you have a sense for how big that percentage could get as you continue to add second and third fridges? Also, you said SKU count was up to around 18.2 SKUs per store from 15.8. What are those incremental SKUs typically, and what could that SKU number be as you increase second and third fridges?

Every year we see more opportunity for second fridges in many stores. In grocery, we have 72% ACV today and about 2,000 double coolers; there's no reason we couldn't push ACV into the 80s or even 85% to 90% over time. Double coolers allow a wider variety of SKUs, more visibility and more holding power. In mass, we have far fewer double coolers, and there's significant opportunity there as well. That said, the core of our growth is same-store sales, often mid to high teens. As we add second coolers, it's important not to over-SKU. We aim for the right portfolio that consumers appreciate—maybe up to 25 SKUs in the average store with double coolers to maintain holding power without diluting efficiency.

Okay. And then Todd, on margin—there's still a lot to do to get to the 2027 targets. When should we expect margins to inflect more significantly?

If you do the math, we need roughly 10 points of additional EBITDA margin from today's levels to hit 2027 targets—about 5 points in gross margin and 5 points below the line. We're expecting at least 100 basis points of gross margin expansion this year and some progress below the line. If we can pick up a couple of hundred basis points of EBITDA margin each year, that moves us toward the target. There is upside potential if our efficiency work pays off, but we're not promising more than our current targets.

Our next question is from the line of John Lawrence with Benchmark Company. Please proceed with your question.

Good morning, thanks for squeezing me in. Regarding retailer growth in mass and grocery, what continues to be retailers' objections to expanding your footprint? You've proven the model, it works, same-store sales are strong. What determines whether they expand or not? For example, when Walmart expands and builds new units, are you part of that?

Great question. The feedback from retailers has shifted dramatically over the years. Today, we generally don't hear the objections we heard a decade ago; retailers are supportive because the category is productive. The main practical constraint is timing—putting in a fridge is straightforward for one store but complex at scale. Retailers prefer to add fridges during major category resets or store remodels to avoid repeatedly moving electrical and shelving infrastructure. So it's more a timing and logistical cadence than objection to the category. We see steady rollout plans with retailers rather than resistance.

Great. Thanks, guys. Good luck.

Our final question is from the line of Marc Torrente with Wells Fargo. Please proceed with your question.

Hey, good morning. Building on the media discussion, can you talk about media efficiencies and what's working best? And on operating cash flow progress in 2023, how are you thinking about leverage levels and progress toward free cash flow targets as you grow through 2024?

We use a mix of mass TV, targeted placements, OTT, connected TV, digital and social. Over the past 18 to 24 months, we've expanded our targeting, including younger and male demographics and sports placements like football, which have shown strong productivity and reached new consumer groups. Our media buying is highly analytic and professional; we plan 6 to 12 months forward and test messages before scale-up to ensure productivity. We'll also expand PR over the next 12 to 18 months. We focus on mass and targeted approaches that drive penetration and household acquisition.

From a cash flow perspective, we were pleased with operating cash flow of $76 million in 2023. Part of that was EBITDA improvement and working capital normalization after ERP-related disruptions in 2022. For 2024, a reasonable expectation is around $90 million of operating cash flow because we won't have the same working capital benefit. We're spending about $210 million in CapEx, so given our cash balance of roughly $297 million at year-end and the expected spend, we project ending cash around $180 million. That positions us well for 2025 and beyond.

At this time, we've reached the end of the question-and-answer session. I now turn the call over to Bill Cyr for closing remarks.

Great. Everyone, thank you very much for your interest. I'll leave you with this thought. This is from Helen Thompson: 'A well-trained dog will make no attempt to share your lunch. It will just make you feel so guilty that you cannot enjoy it.' To which I would add, feed your dog Freshpet, and all your guilt will disappear as fast as the Freshpet. Thank you very much.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.