Freshpet, Inc. Q2 FY2024 Earnings Call

Greetings. Welcome to Freshpet’s Second Quarter 2024 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. I will now turn the conference over to Rachel Ulsh, Vice President of Investor Relations. Thank you. You may begin.

Thank you. Good morning and welcome to Freshpet's second quarter 2024 earnings call and webcast. On today's call are Billy Cyr, Chief Executive Officer, and Todd Cunfer, Chief Financial Officer. Scott Morris, President and Chief Operating Officer will also be available for Q&A. Before we begin, please remember that during the course of this call, management will 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, 2027 goals and pace in achieving these goals, prospects for growth, timing of Freshpet Kitchens Expansion and new technology and 2024 guidance. Words such as anticipate, 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. Please refer to the company's annual report on Form 10-K with the Securities and Exchange Commission and the company's press release issued today for detailed discussions of 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, why management believes such non-GAAP financial 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 will 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'd 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 are on track to deliver the disciplined growth we committed to achieve this year. As you know, we aspire to deliver category-leading growth with outsized improvement and profitability. But as we've learned over the past few years, carefully managing our growth to about 25% enables us to drive operating improvements and manage cash more effectively, making Freshpet an even more attractive business. That is our definition of disciplined growth. And if we do that well, consumers will win, customers will win, and our shareholders will win. Our second quarter results demonstrate the strong progress we are making towards delivering that disciplined growth. We delivered our 24th consecutive quarter of net sales growth over 25% and did it within our existing capacity limits, so we maintained exceptional customer service and strong fill rates. That enabled us to operate very efficiently and effectively, so we expanded our adjusted gross margin and adjusted EBITDA margin. The bulk of the operating improvements came in our key focus areas of input costs, quality, and logistics, totaling 770 basis points of improved operating improvements. Those operating results, specifically adjusted gross margin, input, quality, and logistics costs, exceed some of the key elements of our 2027 goals. As a result, we are in an even stronger position to achieve or exceed our full set of 2027 targets, as well as raise our guidance for this year. We still need to prove that we can achieve these results consistently before we adjust our long-term targets. However, another quarter of strong performance has made us even more optimistic. These results were driven by broad-based strength on the key business fundamentals. First, our growth in the second quarter was entirely driven by volume growth. There was no impact from pricing or mix this quarter. Further, we have been seeing a steady trend towards consumers buying larger pack sizes, which slightly reduces the price per pound but improves the efficiency of our production lines and our distribution systems. This consumer behavior is a positive indication that value-seeking consumers move up to larger sizes of Freshpet rather than reducing the size or amount they buy. Second, from a household penetration perspective, our growth rate is where we need it to be to hit our 2027 target of 20 million households. We are growing households in the low to mid-20s and increasing the buying rate in the low single digits. That combination results in mid-20s growth rates, which is our targeted level. More encouragingly, our heaviest users are growing even faster than the total user base. Third, our media plan is also delivering the way we had hoped. It is driving strong household penetration gains in line with our long-term model and at a healthy customer acquisition cost that is comparable to the cost we had prior to the price increases we took over the past two years. Additionally, by balancing our media investment more evenly across the year, we have been able to deliver strong growth while living within our capacity limits. Fourth, consumers continue to believe that Freshpet represents a good value. The desire for value is being expressed as quality for the price, not just price. We believe consumers find value in a truly differentiated product. That is why it appears that much of the category growth is now coming from the fresh frozen segment, where Freshpet is a leader. Further, our growth is fastest among our heaviest users, another strong indicator of the differentiated value that Freshpet represents, even in an environment where consumers are looking for ways to stretch their dollars. Finally, taking a step back, our growth continues to be supported by the long-term trend towards the humanization of pets. The pandemic created a pet adoption bubble, but we are now back on the same long-term pet population growth trends we have seen for more than a decade. And our volume growth comes from expanding household penetration, which is the model that has worked for us since we first launched our Feed the Growth strategy in 2017. Now I'd like to provide some highlights of the second quarter. We have strong momentum and made great progress against our long-term plan. And you can see that in our financial results. Second quarter net sales were $235.3 million, up 28% year-over-year, all of it being volume driven, as I said earlier. Second quarter adjusted gross margin was 45.9% above our long-term target for the second consecutive quarter, compared to 39.8% in the prior year period. Second quarter adjusted EBITDA was $35.1 million, an increase of approximately $26 million year-over-year. From a retail perspective, we are having a solid year of retail availability growth. Store count growth is in line with our long-term rates. More importantly, some of our larger customers are engaging with us on potential plans to add second and third fridges in high-velocity stores. That is where we expect to see the bulk of our growth. You will see that in TDP growth exceeding ACV growth as we go forward. Specifically, we placed 790 fridges in the second quarter, including new stores, upgrades, and second/third fridges, bringing us to a total of 35,602 fridges at retail, more than 1.8 million cubic feet of retail space. As of June 30, 2024, Freshpet could be found in 27,497 stores, 22% of which now have multiple fridges in the U.S. Fill rates continue to be strong and we're in the high 90s throughout the quarter, supporting fridge placement and store growth. Now we'll provide an update on KPIs we track for our mainstream main meal, more profitable plans, what we refer to as main and more. Focusing on the idea of mainstream, Freshpet is becoming increasingly mainstream, but still has a long runway for growth. According to Nielsen Omnichannel data, which includes e-commerce and direct-to-consumer, as of June 29, 2024, total U.S. pet food is a $53 billion category. We only have a 3% market share within the $36 billion dog food segment, which is the majority of our business today. Within the fresh frozen subcategory in measured channels, Freshpet has a 96% market share. Fresh continues to outperform the broader pet food category and many retailers believe it is the future of pet food. As a result, Freshpet is now in 66% ACV in Nielsen XAOC and we continue to add distribution breadth and depth with second and third fridges. Our household penetration gains also demonstrate that we are well on our way to making Freshpet more mainstream. Household penetration at the end of the second quarter was 12.8 million households, up 25% year-over-year, and on track to meet our target of 20 million households by 2027. Our high profit pet owning households, or HIPPOHs for short, are growing even faster, up 31% versus the prior year period. In short, the humanization of pets is a mainstream idea, and now it is our job to make fresh food the standard way to feed your pets. Turning to the main meal part of the strategy, Freshpet sales are increasingly concentrated in our heaviest users, HIPPOHs. Currently, 37% of Freshpet users are HIPPOHs, and they represented 89% of our sales in the second quarter. Even more encouraging, about 300,000 of our users or less than 3% of our total users buy more than $1,000 of Freshpet per year, and this group grew 47% over the past year. They now represent about 27% of our business. There is a significant opportunity to increase this percentage and grow our total business. The key driver to convert more consumers to use Freshpet as the main part of their pet's meal is advertising. We need to educate consumers on the benefits of fresh food for their pets. Multipacks and larger pack sizes can also help reinforce the idea that our product can be your pet's main meal and will in turn help increase buy rate, which was approximately $100 a quarter end of 3.3% versus the prior year period. Adding unique value-added SKUs helps do that. Based on total U.S. pet retail plus data from Nielsen, we currently have an average of 18.4 SKUs per point of distribution, up from 16.1 SKUs one year ago. Since we have a finite amount of space in our fridge, as we increase the number of second and third fridges, we can increase the number of SKUs, amplifying our visibility and marketing impact, widening our product assortment and broadening the appeal of our brand. Now to the more part of main and more, more profitable. We had another strong quarter of margin improvement. Adjusted gross margin improved 60 basis points versus the strong results we posted in Q1 to 45.9%, and we ended the second quarter with an adjusted EBITDA margin of 14.9%. The key items that drove this improvement were: first, quality, our team continues to execute well. We still have lots of opportunities for further improvement, but our team has been able to reduce both the number of issues we have to manage and also the size of any issues. Second, input costs and yield. We've returned to our historic level of input costs as a percent of net sales through a combination of price increases, commodity cost management, and meaningful improvements in our production yields. Further, we believe there's an opportunity to continue to improve efficiency in this area through formulation work, supplier diversification, operating improvements, and new technologies. Third, logistics, we are clearly benefiting from some macro factors on freight, including lower lane rates and fuel costs. But our 99% fill rate in the quarter, the expansion of the service area for our Dallas DC behind increased production in NS, and new tools we've put in place to more effectively bid our lanes and improve our customer service are the primary drivers of the improved performance. Turning to an update on our capacity, we have a disciplined approach to managing capacity and continue to execute on our expansion plans, while also improving throughput and yields on existing lines. In Ennis, the fourth line is still on track to start up by the end of Q3 2024. We began commissioning the line in July and feel good about the test run so far. In Bethlehem, the team is focused on increasing capacity utilization or OEE, and our 7th line on that campus will test new technology and is expected to start up in the second half of 2025. In Kitchen South, we continue to evaluate ways to add more lines and/or shifts. We continue to evolve our capacity expansion plans to drive greater capital efficiency. As we've discussed previously, we are intensely focused on: one, maximizing throughput of our existing lines; two, maximizing the capacity of our three existing sites; and three, developing and implementing new technologies that generate more throughput per line. While we've come a long way since our first facility in Quakertown, PA, the manufacturing systems to make fresh pet food are still not where we'd like them to be. We've invested and will continue to invest heavily in both technology and talent to make our production more stable, reliable, and efficient. We've made tremendous progress but still believe the opportunities for improvement are sizable. In summary, I think we are making good progress at delivering the disciplined growth we promised at the beginning of this year. We are highly focused on managing the business to live within our capacity and believe this has led to the progress we've made on our profitability. We believe our model works very well at approximately 25% growth, generating the right balance of growth, capital investment, and cash generation. And we are increasingly confident that we will be free cash flow positive by 2026. I'm incredibly proud of the progress we have made and the results we have delivered, especially since NS is still subscale and we have some exciting new technologies under development that could meaningfully enhance the economics of our bags business. Now we need to continue to execute at a high level and keep raising the bar. Before I turn it over to Todd, I want to point out that the press release announcing our earnings today has a dateline of Bedminster, New Jersey instead of our previous home in Secaucus. We've outgrown our corporate offices in Secaucus and have moved into a temporary office space in Bedminster, New Jersey, while our new purpose-built leased corporate office is under construction right down the road in Bedminster. We expect to move into the new office in the first half of next year. Our new location in Bedminster will allow us to attract and retain the top marketing and finance talent we need, while making it much easier for our team members to go back and forth to our technical base in Bethlehem, Pennsylvania, enabling much closer collaboration and planning. Our new office will embody our pets, people, planet mantra, and we look forward to sharing it with you when it opens next year. Now, let me turn it over to Todd to walk through the details of the Q2 results and our updated guidance.

Thank you, Billy, and good morning, everyone. As Billy mentioned, we are very pleased with the second quarter results, particularly our ability to deliver profit improvement. Now I'll give you some color on our financials and updated guidance for the year. Second quarter net sales were $235.3 million, or 28% year-over-year. Nielsen measured dollar growth was 24% versus the prior year period, with broad-based consumption growth across channels. We saw 26% growth in XAOC, 24% in U.S. food, 9% growth in pet specialty, and over 100% growth in the unmeasured channel. It is important to note that Nielsen IQ has expanded their coverage beyond what we previously called the Nielsen mega channel to a new U.S. pet retail plus channel that adds online sales via Amazon, Chewy, neighborhood pet retailers, and farm and feed stores. Wherever possible, we will use the expanded definition to provide the most comprehensive view of our business in the category. We estimate that this new channel covers more than 85% of our U.S. business today. Second quarter adjusted gross margin was 45.9%, up 610 basis points year-over-year. This was driven by improvement in input cost, yield, throughput, and quality cost. Specifically, input cost as a percent of net sales improved 460 basis points with better yields, throughput, and lower commodity costs, while quality cost improved by 90 basis points. Second quarter adjusted SG&A was 31% of net sales, compared to 34.9% in the prior year period. We spent 12.2% of net sales on media in the quarter, down from 14.8% of net sales in the prior year period. Total media investment was up 6% year-over-year. Recall our media plan is less front-loaded this year than in years past, so that we can manage our growth to live within our capacity limits. Logistics costs continue to improve and were 5.8% of net sales in the second quarter, a decrease of 220 basis points compared to the prior year period. Like Billy stated, the majority of the improvement was due to strategic actions we have taken to increase bill rates, reduce miles driven by increasing the number of states served by our second distribution center, and negotiate with vendors, with the remainder being macro-driven with more favorable lane rates. Other SG&A, which was 13% of net sales, increased 90 basis points driven by higher incentive compensation. Please note that our GAAP P&L includes an $11.1 million true-up of non-cash share-based compensation based on multi-year share-based awards granted in fiscal year 2020. This year's unexpectedly strong profit performance has increased the likelihood of greater vesting on those awards. Excluding this charge, we would have generated $9.4 million of net income. Second quarter adjusted EBITDA was $35.1 million, or 14.9% of net sales, compared to $9 million, or 4.9% of net sales in the prior year period. This improvement was primarily driven by higher gross margin, as well as improved logistics costs. Capital spending in the second quarter was $48.3 million. Operating cash flow in the second quarter was $42.4 million, and we have cash on hand of $251.7 million at the end of the quarter. We continue to believe that we have adequate cash to fully fund our growth through 2025 and will be free cash flow positive in 2026. Our strong improvement in adjusted EBITDA this year also makes it unlikely we will need additional capital. Now turning to guidance for 2024. We are updating our outlook to reflect our outperformance in the second quarter, as well as our conviction in our ability to execute in the second half. We are raising our net sales guidance from at least $950 million to at least $965 million or growth of at least 26%. We are able to do this because of the strong improvements in our operating efficiency, particularly in Bethlehem and Kitchen South, that will allow us to sell a bit more this year and still maintain strong customer service. However, we still need the new roll line in Ennis to start up by the end of September and ramp up production in order to have the supply we need to meet demand. We are also keeping in mind the capacity needed to support next year's growth and do not want to get too far ahead of our original plans. As far as cadence, we continue to expect net sales to have sequentially lower percentage growth throughout the remainder of the year as we intentionally manage our growth rate while expanding capacity. Our more balanced first-half, second-half media investment this year has been critical to delivering the growth we have experienced while also living within our capacity constraints. As the first-half media really dictates the demand we have in the second half of this year, the second-half media investment will drive the demand we experienced in the first half of next year. For this reason, our second-half media investment will be significantly larger than the investment we made in the previous year. For adjusted EBITDA, we are raising guidance from at least $120 million to at least $140 million to reflect the over-delivery in Q2. We now expect adjusted gross margin to expand by approximately 500 basis points for the full year, compared to 300 basis points previously. Capital expenditures are now projected to be approximately $200 million, compared to approximately $210 million to support the installation of capacity to meet demand in 2025. The modest reduction is due to the timing of certain expansion projects. In summary, the second quarter results demonstrated disciplined growth and our ability to execute the strategy we laid out. We are very pleased to see our investments in capacity and organizational capabilities are paying off, and we are gaining significant scale advantages. 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, guidance, and the company's operations.

Thank you. Our first question is from Ken Goldman with JP Morgan. Please proceed.

Good morning. Thank you.

Good morning.

When it comes to the outlook for ‘27, I think you're skating about as close as possible to raising it without officially doing so, if that's fair? Can you just please remind us on or update us rather on the guideposts you're looking for that will allow you to, I guess, proverbially pull the trigger? I guess I'm also asking what gives you pause today that makes you think you can't necessarily deliver some of these results consistently? I think some people are hoping that within the next couple of quarters, you'll raise that outlook, is what I'm getting at?

Yes, Ken, thanks. The way we're looking at it is we feel really good about the progress that we've made, particularly on the operation side. And at the same time, we're very mindful that we operate in a fairly volatile environment. So what we’d like to see is deliver the full year at the rates that would be embedded in our 2027 targets. And when we get to that point, we'll take a look at it and say what makes sense going forward. But we'd like to see us deliver the full year in a consistent way and in ways that could support those 2027 targets. That particularly is on the operation side. On the net sales side, we feel really good about where we are. We're trying to drive our growth to live within the capacity limits and plan capacity. You know, we plan capacity out 18 to 24 months. So you should expect us to be very, very close to the guideposts as we go from here through 2027 and expect that on a long-term basis our growth rate is going to be driven by our ability to add capacity and the rate at which we want to add capacity.

Thank you. And then a follow-up, Billy, you know, you haven't really talked, I think, in specifics about where your capacity will be next year in a little while and where you expect sales to exactly be, although I think people still expect kind of a 25% increase there? Can you just give us a little bit of an update perhaps on the path ahead for the next year or two as you see it in terms of capacity versus sales? Is there a rough utilization rate we should think about? I think one thing that kind of confuses investors a little bit, and there's not much confusing about the story right now, given how well everything's going, is just trying to think about those paths ahead in terms of capacity versus expected sales and how they may track each other in general?

Yes, historically we've talked about it in the context of total capacity, but we're at the point now where it really is driven by capacity for bags versus capacity for roles. So for example, this year the capacity limitation that we've had to work with has been on our roles lines. And as we're starting up another roles line in Ennis in this quarter, we've had to keep our total business or total net sales underneath the limit of that roles capacity implied. As soon as that line is up and running, we flip it over, and then the next capacity limit that we'll run into probably in the first half of next year is bags. And so we have new bags lines coming on in the first quarter of next year. And so I don't think of it in terms of total capacity. I tend to think of it in terms of the limitations that we have on bags or rolls, and we kind of flip-flop back and forth between the two, but in a very steady cadence. And if we keep adding capacity at the steady rate that we plan and keep improving capacity utilization on the existing lines and operate really well, we feel very comfortable about our ability to deliver the net sales growth that's embedded. I think people who look for us to go way above that are missing the fact that we're trying to stay very disciplined and very close to the guideposts that our capacity provides. That's really where we're focused.

But Ken, just to be clear, we have next month, and you know, the new line coming up in Ennis, we have a line, a bag line coming up at our Kitchen South facility in Q1. We're also going to add some shifts to some existing lines in Kitchen South, and then we're anticipating better performance and a ramp up in NS across the entire facility. So we feel very good about the amount of capacity we will have for next year, but as Billy pointed out, we're not going to get too far ahead of our skis. We're trying to manage cash flow, capacity, earnings, top line altogether. And that's the trick. But we literally review this every month, and we have a clear strategy and path to get to our $1.8 billion in '27.

Thank you very much.

Our next question is from Bill Chappell with Truist Securities. Please proceed.

Thanks. Good morning.

Good morning.

Just want to follow up on your comment about the consumer buying more bulk or larger sizes and trying to understand. We hear so many mixed signals over the past three, four months of what the consumer is doing, right? Are you seeing a real change? Or is that more reflective of just your recent expansion in the club channel, which naturally, they're buying much bigger bulk?

Clearly, there's some piece of that in it, but we do see it across the board that there is a migration towards the slight migration towards the larger sizes. The way I think about it, if you're taking a step back on the macro market, if you have consumers who are value-seeking, and you are in the staples business, meaning consumers want to buy your product and every day, they need to keep it in their pantry or an inventory, you should expect to see them migrate to larger sizes because that's the way they exercise value seeking behavior. If, on the other hand, you're in the impulse purchase business, you should expect to see consumers moving to smaller sizes as a driver. But in our business, we view ourselves as a staple. We're part of the everyday diet of the dog. And so we see consumers moving up into larger sizes. It's not a huge shift, but it is enough of a shift that is noticeable.

Got it. And then bigger picture, because we hear a lot of noise from the direct-to-consumer new players in the market, mainly it's frozen, direct-to-consumer. And frozen has been a fairly stagnant category since even before you started to exist. And so I'm just trying to understand, are you seeing anything new? Is it a threat? Is it an opportunity? Just as you look at the other players that are certainly making more noise from the advertising front. I'm not sure if on the sales front, if they're having much impact.

Hey Bill, so look, we're always keeping a really close eye on everything that's going on in the market and kind of where the new entrants are coming in, how it's playing. We're testing basically different types of direct-to-consumer in three and four different ways. We think it's really interesting. We love our model. And long-term, we really feel positive about the way our model is developing and progressing.

Okay. Thanks so much.

Thanks.

Our next question is from Robert Moskow with TD Cowen. Please proceed.

Hi, thank you. Bill, you might have kind of answered this question already. But I wanted to fast forward beyond 2027. I mean, if your growth rates continue at a rapid pace, what's the implication for capital deployment and therefore, cash flow? Could you foresee like having to take a step backward on your cash flow momentum in order to fund another tranche of significant growth? What's the appetite for that? And then secondly, I had a question about the buying rate in the numerator data. It looks like last year got restated. It's not by a lot, but compared to first quarter, it's down a little. And then your buy rate growth this year is 3%. I think last quarter, it was 5%. So it's small numbers, but I want to know if you're watching that and if you have any reason for those changes?

Yes, Rob, we do look at capacity planning extending to 2030 and beyond, and we pay very close attention to it. We have construction and line installation projects currently underway at all three campuses we operate, and we feel confident that we have sufficient capacity to meet the projected demand through 2027 and beyond at those sites. We are focused on determining when our existing footprint will require the addition of a new site, which would involve a significant capital expense. At this time, we do not foresee this occurring within the 2027 timeframe, and likely not until 2030, as we can achieve adequate capacity through technological improvements and adding lines to the existing sites. Overall, we are optimistic about our cash generation capabilities and believe we can support our capacity planning expansion. Regarding the numerator piece, it is adjusted every month, so you should expect some fluctuations in the numbers, which is why previous periods may change. Last year, we experienced some pricing in the 52-week numbers, but this year there is none as we've eliminated that pricing. Therefore, the buy rate is not benefiting from pricing increases, but rather from consumers shifting to higher-value products. There has been a rise in product purchases, contributing positively to our performance. We are pleased with the growth in household penetration and our current buy rate, which is running slightly above our expectations. We anticipate maintaining penetration in the low 20s and buy rate in the low single digits, which will drive our overall growth rate. I don't know if Todd wanted to add any further comments concerning cash flow.

Yes, that's a great question, Rob. We're quite optimistic about the growth of this business over the next several years. While I don't anticipate a 25% growth rate in 2035, that scenario could be achievable. Even if growth is slower, we expect to generate significant EBITDA and ample operating cash flow to manage potential capital expenditures related to year-over-year growth. We're also focused on improving operational efficiencies at our plants, which is why we're exploring new technologies to enhance the return on invested capital for new capacity moving forward. We recognize the need for a new facility in the future and are considering all options, including a greenfield project like Ennis. We are comfortable partnering with others to reduce capital expenditures, and we will carefully monitor the cash flow impact.

Thank you.

Our next question is from Brian Holland with D.A. Davidson. Please proceed.

Yes, thanks. Good morning. I guess just to start with media spend, which looks like still projecting to grow in line with the top line. I know year-on-year higher in the second half than it was prior year. Trying to square that with the consumer acquisition costs, which once again down sequentially this quarter, continued progress there back to pre-price increase levels. I guess maybe there was a part of me that was anticipating sort of a lower revision of media and if that's out there, and I missed it, forgive me. But just help me think about the cadence for media as we start to think about 2025 and how quickly we can kind of come in line that seems to be the one metric that we're still a bit off from what your 2027 target is?

Brian, what's really exciting about this is that our growth model remains strong. You've been observing it for many years. We track the number of new consumers joining us and the costs associated with acquiring them. This is right in line with where it was last year, three years ago, five years ago, and even further back. It's important to highlight that this showcases the potential of our concept and the changes we're making in the category. As we delve deeper into our total addressable market, we aren't experiencing increased customer acquisition costs, which is remarkable. This sets us apart from others entering the fresh and frozen markets. We're very optimistic about it. Regarding our media spending this year, it has been designed to keep us aligned with our growth targets. While the overall media spend for the year will see a notable increase, the first half will show a much lower rise compared to last year, which had about a 16% increase. In the second half, we expect a significant increase in media spending. This is aimed at ensuring we are well-positioned for another successful year in 2025. If you speak with our team, you’ll find that our current focus is on preparing ourselves over the next six months for a strong 2025. We're fortunate to be in a position where we can plan and allocate our resources effectively.

Appreciate the color, Scott. And then maybe, Todd, just thinking about what's implied in the guidance over the second-half of the year, if we set aside the top line, the biggest driver of upside was obviously the gross margin over delivery in the first half. Anything to be mindful of in the second half that would compress the kinds of gross margins we've seen in the first half? Is there any reason they couldn't be mid-40% or better mindful that we've had six consecutive quarters of sequential gross margin improvement?

Yes, we have a few challenges ahead, but we're optimistic about the beginning of the year. We hope to achieve similar gross margins in the second half as we did in the first half, and we'll strive to meet those goals. However, there are some legitimate expenses that will impact us in the latter part of the year. For instance, the launch of the fourth line antennas will incur costs at very low production volumes. Additionally, we're increasing shifts at Kitchen South to prepare for next year's growth and to support capacity, which will also raise costs. We did not reduce our inventory levels, and while that provided a significant benefit in Q1, there was no impact in Q2. We might see inventory adjustments in the second half, so we'll keep an eye on that. Overall, we feel confident about the start. We're about 90% covered on commodities, and we don't anticipate major changes there. However, the new capacity coming online in the second half may pose some slight challenges.

Appreciate it, thank you.

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

Yes, thanks, and good morning, everybody. I wanted to go back to this larger pack size comment and then try to understand it a little bit better. So price/mix was flat, but you're selling larger packs in Costco at a higher price point. So how does that factor? And I guess what you're selling has a lower average price per unit, but I suppose what the consumers buying would just be bigger dollar amounts and bigger volumes. And obviously, you have more sales in Costco today than you did 12 months ago. So would that be mix accretive in terms of contribution to the top line? That's the first question.

Mark, I think it's important to view our portfolio as we continue to develop and promote larger pack sizes since Freshpet is increasingly seen as a main meal option. About a year ago, we acquired a product called Complete Nutrition in a 1.5-pound size. We also made some intentional adjustments to our pricing, tightening it a bit because we were starting to hear concerns about value from consumers. On one end, we have customers purchasing smaller items and the Complete Nutrition product, which serves as an attractive entry point with good margins. On the other hand, we have larger packs available in various retail channels, including mass and club stores. Interestingly, our largest growth is occurring in our large bags, which are also our most expensive items. There’s a lot happening, and it involves various components. As we strategize for the market, we aim to ensure our products cater to a wide range of consumers and their different preferences for use and perception of our brands. We offer a variety of sizes and prices, appealing to customers from low to high price points. Overall, we've built a strong portfolio that consumers appreciate, leading to significant activity and movement. Some of this growth relates to larger sizes and trade-ups, while we’re also seeing many new customers entering at the 1 and 1.5-pound size, which is currently the fastest growing segment for us.

Got it. So it's just a lot of moving parts, I guess, beyond just that point. I had another question, but as a follow-up to that, is Costco still attracting new consumers? I mean, is the larger pack size leading to more people consuming more of the product? Is that the right way to think about this?

Yes. We are seeing a lot of new consumers coming in not only through club but also with our larger sizes across all retail. It's interesting to note that some customers are starting with a six-pound roll. We are definitely observing that trend. Additionally, we began offering multipacks not just in club but also in regular retail, and these are starting to gain some early traction. We anticipated a slower start, but this is part of a long-term strategy to establish our product as a core meal option.

Hey Mark, one other thing, as we said in the comments, that if you think about where our fastest growth has been its amongst the HIPPOs, so the heavier users, and then we also mentioned the ultra-users, so people buying over $1,000 a year. They're growing at an even faster rate. So we are seeing an increasing number of consumers who are moving up into that higher purchase amounts, and oftentimes, it comes with buying larger pack sizes.

Got it. Okay, that's super helpful. I'll leave it there. Thank you.

Thank you, Mark.

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

Good morning, everyone. Thank you for the questions. My first inquiry is about capacity and what might be required in the future. You mentioned that the new production technologies appear to be progressing well, with a target for full implementation in the second half of 2025. Can you provide an update on this? Additionally, what plans do you have for retrofitting your existing lines with these technologies? I’m interested in how you might continue to enhance your output without building a new facility. That's my first question.

Hey Peter, I think it's important to consider that there are three key areas where we can enhance capacity on our lines. The first area is operational efficiency improvement, and we have significant work ahead of us along with many opportunities. The team has been performing exceptionally well, and their efforts will have a meaningful impact, helping us speed up the opening of new lines and boosting profitability from our current network. The second area involves making some updates and minor modifications to our existing lines through new technology and equipment. We are starting to see promising results in this area, although we won't disclose any details for now. We're genuinely enthusiastic about the potential for improvement through small upgrades and investments in our lines. The third area I would describe as a significant transformation in our bag technology. We envision a more advanced future state for bag production, which we expect to begin seeing next year on a small scale. As we validate this technology, it will gradually replace our existing lines as we expand in the future, but that's still quite a ways off, and we can't provide a precise timeline. We are confident in the technology's effectiveness, but the timing and its overall impact on our network's capacity remain uncertain.

That's a good perspective, Scott. For my follow-up question, I noticed that you have made improvements to the management team over the past few years, and you're clearly executing well. Billy, you mentioned the new corporate headquarters in Bedminster, New Jersey, and talked about marketing and finance as potential areas for attracting more talent. Could you elaborate on your thoughts regarding the organization and the specific areas you plan to focus on as you continue to support business growth? Thank you.

Yes. Peter, as we're growing, obviously, we have growth opportunities and needs in virtually every area in the company. That's what happens when you're growing at the rate that we're growing. And the most important lesson we've learned in the last couple of years is you can't get behind on adding talent. So you can see us leaning into acquiring the necessary talent in the places that will make the biggest difference. And you'll see it in a wide range of areas. And as you've seen in the last 18 months, the amount of talent that we've hired has been fairly significant. I don't want to get into any specific areas other than to just say that you should think about as we add scale to the company, it gives us opportunities to add capability in areas where we may have been a generalist before, and we can become a specialist, where we can get high level capabilities in an area where we've previously been operating but probably haven't had the sophistication and capability that's needed for a business that's $1 billion or $2 billion or $3 billion in sales. So you're going to see us continue to add people to add bench strength to help us grow the company, and it's just going to be an ongoing part of our process.

All right, good to hear. Good luck, guys. Thank you.

Our next question is from Rupesh Parikh with Oppenheimer. Please proceed.

Good morning, and thanks for taking my question. So maybe just start out with the EBITDA cadence, just any more color on how you guys think about Q3 versus Q4? And then I have one follow-up.

Yes. While we can't provide specific guidance, generally speaking, we expect to see higher EBITDA in Q4 compared to Q3 due to increased media spending. We will experience a similar level of media expenditure in Q3 as we did in Q2, which is not typical for us. However, there will be a decline in media spending in Q4, although it will still represent a significant increase compared to the previous year, and that will contribute to additional EBITDA in Q4.

Great. And then one follow-up question just on the category. So one of your retail customers highlighted they're seeing green shoots in the pet category on the pet adoption side. Just curious what you guys are seeing right now from a pet adoption perspective?

Rupesh, I believe the best way to approach this is to recognize that the category typically experiences ups and downs. Currently, there is a slight post-COVID decline, but we anticipate it will return to a more stable rate. However, there are numerous challenges in the category at the moment. When growth is in the low single digits, it's crucial to pay attention to both the challenges and opportunities present. Fortunately, we've managed to focus less on these trends and more on our strengths. For most retailers, it's about evaluating the entire category, different segments, and brands. We've clearly emerged as a leader, which opens up more opportunities for collaboration and business development in the future. Regarding your question about adoption rates, it's important to note that when we analyze this data quarterly or over six-month periods, fluctuations are evident. While there is a slight dip now, this is part of a significant societal shift where people are increasingly treating pets as family members and opting for pets over children. We believe this trend will continue in the long run.

Great, thank you for the color.

Our next question is from Bryan Spillane with Bank of America. Please proceed.

Thank you, operator. Good morning, everyone. I just have one question. I believe you entered this year with a more cautious approach to growth, aiming to avoid overstressing your manufacturing capabilities. Given the strong demand this year, I'm curious if, hypothetically, capacity wasn't an issue and you could produce as much as needed, would your sales figures be higher? Is there more interest from retailers and consumers than what we're currently witnessing in the results?

I would say if we would spend at the sort of comparable growth rate on media to what we had last year, in other words, grow media in the first half at the same rate of sales growth, you would have seen more demand, but we knew we couldn't supply that. And for us, it's really, really important to keep the growth within the capacity limit and also to execute our capacity expansion plan in a very measured and orderly fashion. We feel good about it. Our team has gotten really good at designing, constructing, and starting up lines. We want to do that reliably. We want to provide a very high level of customer service because we know when we provide high levels of customer service, our costs are lower, our fridges are full, sales are better, and customers are happy. So I think for us, it's really important that we measure or manage the growth to live within the capacity. We add the capacity at a very disciplined rate. And if that all works together, we think everybody wins. And you should expect to see that from us going forward.

Okay, thank you.

Thanks.

Our next question is from Michael Lavery with Piper Sandler. Please proceed.

Thank you. Good morning.

Good morning.

You talked about adding shifts at Kitchen South, I guess, maybe two-part question. How is the relationship with the Kitchen South, like if there's better overhead absorption or efficiencies from that, or kind of at least in an operating leverage way? Do you benefit from that on the cost? And then I guess the other part of it is, do you have opportunities on any of your own lines to add shifts as well or at least reduce changeovers and maybe do extended runs? How should we think about that as part of an opportunity for you?

The relationship with Kitchen South is excellent, and they are performing exceptionally well. We are very pleased with the results from that operation this year. We are gaining some leverage as we add shifts, although it's not significant. Given the structure of our arrangement, we do experience a bit of leverage, and we will continue to focus on that area, not just on shifts. Additionally, we have another production line scheduled to come in during Q1, and there is potential for more lines if both partners agree to that approach at the facility. We anticipate continued strong performance and increased capacity from that location for many years to come.

And is there room to extend runs or add shifts on any lines at Ennis or Bethlehem?

Bethlehem is currently quite limited. At Ennis, there is available capacity, and we will add more shifts. We will improve the efficiencies in the facility over the next year or two, so there is some capacity there.

Michael, think about it as our operating model is that when we install a line, we ramp it up by putting on one shift or, in essence, half capacity utilization for a period of time. And then as the demand grows and the production efficiency on the line grows, we ultimately take it to a 24/7 operation. And that happens typically before you bring on the next line. So at the same time we're doing all that, we are working, as we increase the number of lines in our system, to make some of those lines more specific or specialized, and it reduces the number of changeovers that we have to do, and allows us to deliver a higher throughput or higher output per hour of operation. And also extend some of our runs depending on what some of the products are and where they're being produced. So there are significant benefits that we gain in each of our operations as we gain scale.

Okay, that's helpful. Just a follow-up on the Dallas distribution center. You mentioned in your prepared remarks that it has expanded its coverage area. I didn't realize it might not have been utilizing its full potential. Is it now fully optimized, or is there still an opportunity for further expansion to achieve a more optimal service area?

Right now, the Dallas DC exists to take the product that's produced in Ennis and ship it to the states that it can serve. So as we add production in Ennis, the Dallas DC is able to supply more states. So for example, we're right now in the process of converting the states of like Utah and Colorado over to being shipped out of the Dallas DC. Ultimately, when Ennis is up and running to its full 10 lines of production, the Ennis or the Dallas DC should be supplying more than half of the United States. Think of it as everything west of the Mississippi and probably parts of the Southeast. So we will continue to get freight efficiencies from the Dallas DC, but they're 100% connected or linked to increasing the amount of output from the Ennis facility.

Okay. That's helpful. Thank you.

Thanks.

Our next question is from Jon Anderson with William Blair. Please proceed.

Good morning, everyone. Thank you for your question. I wanted to revisit an earlier point about distribution. Bill, you mentioned that we should anticipate PDP growth to surpass ACV growth in the future. My question is whether you are currently seeing that the brand is available in the necessary stores for adequate coverage. Additionally, are you noticing that more of your large accounts, especially in FBM, are taking the initiative to add second and third fridges? I'm looking for a bit more context regarding that comment.

Hey Jon, I briefly touched on this earlier, but as retailers evaluate their growth in the category for this year and next, they are acknowledging that Freshpet is not only growing but is also achieving significant scale. Over the last 26 weeks, we've contributed $100 million in growth to the category, which outpaces any other brand, making it very exciting. As they look ahead to next year, they realize the need to optimize the mix of products in existing fridges. We are also having very productive discussions about adding second fridges and expanding distribution, not only in stores where we currently don't have a presence but also with additional fridges and in some cases even third fridges. I believe that’s the direction we’re heading in. There are also rare instances where some retailers have purchased their own fridges, and we could be entering that space as well over time.

We have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

Thank you. Thanks, everyone, for your interest. I'll leave you with one thought. Dogs teach us a very important lesson in life; the mailman is not to be trusted. That's from Sean Ford, to which I would add, but if the mailman carries fresh fat turkey bacon treats, he will be the most loved and anticipated visitor you could have. Thank you very much for your interest.

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