Earnings Call Transcript - FRPT Q2 2023

Operator, Operator

Greetings and welcome to the Freshpet, Inc. Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Mr. Jeff Sonnek, Investor Relations at ICR. Thank you. You may begin.

Jeff Sonnek, Investor Relations

Thank you. Good morning and welcome to Freshpet's second quarter 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 with us for Q&A. Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements. Please refer to the company's annual report on Form 10-K filed with the SEC and the company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note that on today's call, management will refer to certain non-GAAP financial measures such as EBITDA and adjusted EBITDA among others. While the company believes these non-GAAP financial measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release on how management defines such non-GAAP measures, a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP and limitations associated with such non-GAAP measures. Finally, the company has produced a presentation that contains many of the key metrics that will be discussed on this call, 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's a summary of the results and guidance they will discuss today. Additionally, we'd ask that your questions remain focused on the performance of the business and the results in the quarter. Management will not discuss the upcoming Annual Stockholders' Meeting or other topics beyond what is being reported here today. With that I'd now like to turn the call over to Billy Cyr, Chief Executive Officer. Billy?

Billy Cyr, CEO

Thank you, Jeff, and good morning, everyone. The message I would like you to take away from today's call is that the Freshpet business has real momentum on both the top line and the bottom line. In both areas, growth and operating efficiency, we believe that we're still just scratching the surface of the enormous opportunity ahead of us and remain convinced that Freshpet food is the future of pet food and we believe that Freshpet is very well positioned to lead the transition to fresh for many years to come. In Q2, we made significant progress on the adjusted EBITDA improvement that we committed to delivering this year, while simultaneously re-accelerating the household penetration and volume growth that supports both our near-term and long-term growth targets. The operational improvements are the result of the intense focus and organizational capability we've built in the areas of quality, logistics and input costs and in improving operating environment. The re-acceleration, household penetration volume growth are the result of our unwavering focus on three foundational pillars that underpin our strategy. The strength of Freshpet proposition, the exceptional support of our customers and our long-standing demonstrated marketing and innovation mastery. I will share a few highlights of our performance and a few thoughts on the outlook for the balance of the year and then Todd will provide more detail on the quarter and an update on our guidance for the year. The highlights are, first, strong net sales growth. We delivered 26% net sales growth in the second quarter and our 20th consecutive quarter with greater than 25% growth. This quarter's growth was in line with the guidance we shared for the quarter that called for mid-20s growth and puts us on track to deliver our 2023 plan and our 2027 goal of $1.8 billion in net sales. What is most encouraging is that unlike many other CPG companies, our volume consumption was strong and the growth is accelerating as the year-on-year benefits of higher pricing recede. Consumption volume growth in the quarter accelerated to 18% up from 14% in Q1 and 12% in Q4 of 2022. Pricing and mix contributed a little more than 7% to our growth in the quarter. Second, household penetration growth. As we had anticipated, household penetration growth re-accelerated in the quarter once consumers adjusted to the higher pricing that we've implemented over the past 18 months. The 52-week household penetration was up 10% versus a year ago and the more near-term metrics such as the 13-week and 4-week measures are up even higher which foreshadows a positive momentum for the annual growth rate. Encouragingly, the rate of growth among our heaviest users, HIPPOs, was higher yet up 17% versus a year ago in the quarter on a trailing 52-week basis. Additionally, the buying rate for our franchise remains well ahead of our expectations and was up 19% versus a year ago. Third, adjusted EBITDA well ahead of guidance. This was a breakout quarter for our operations team. As we discussed on our last call, second quarter adjusted EBITDA was expected to be in line with Q1 and weighed down by the heavy startup costs in Ennis and the start-up of our Dallas DC. We greatly exceeded those expectations due to strong performance across every part of the P&L, with the biggest improvement coming in logistics. Our logistics costs improved by 350 basis points versus a year ago and 130 basis points versus Q1, primarily due to strong fill rates and the successful utilization of our second DC. But we also had a strong performance on input costs, quality costs and SG&A. As a result of this strong performance and the continued improvement we are seeing, we are raising our adjusted EBITDA guidance for the year. Fourth, we proved that Freshpet can grow strongly even when prices reflect the higher commodity costs. We've now taken price increases totaling a cumulative impact of approximately 27% over the past 18 months to reflect the higher input costs we have absorbed. Despite this higher pricing, volume growth continues to be strong and is accelerating. This demonstrates the strength of our brand and the Freshpet consumer proposition. Input costs, as a percent of net sales came in at 34.4%, a 240 basis point improvement versus the year ago. This reflects the full impact of February price increase and a more stable input cost environment. Fifth, the Ennis Kitchen start-up continues to deliver. The Ennis Kitchen is now operating one bag line and one roll line on a 24/7 schedule and the chicken processing operation is up and running, providing large quantities of chicken to our operations as planned. We are also producing the full range of SKUs that were planned for the Ennis facility. These demonstrate the thoughtful execution of our operating team and we remain very optimistic about future gains we can realize as we ramp up to full efficiency to support our long-term growth. We are in the early stages of planning to start up the second bag line in Ennis and expect to be producing on that line in Q1 of next year, which means that we will begin hiring the staff and then commissioning that line in the second half of this year. Finally, construction on Phase 2 is well underway and the steel frame of the building has gone up. The first line in Phase 2 is expected to begin production late in Q3 of next year, which is when we anticipate that we will need that capacity to support our growth.

Todd Cunfer, CFO

Thank you, Billy, and good morning, everyone. As Billy said, in Q2, we continued the strong performance we saw earlier this year and have raised our adjusted EBITDA guidance to reflect that strength. Let me break it down a bit further. Net sales came in at $183.3 million, up 26% versus a year ago. Our net price mix was up slightly more than 7% versus a year ago in the quarter and volume grew around 18%. Total Nielsen measured dollar growth was up 23% versus a year ago in the quarter, but our growth in non-measured channels was much stronger and added about 2.5 points to our measured channel's growth. Adjusted gross margin was 39.8% in Q2, 110 basis points better than a year ago and above our base expectations. This improved performance was due to a variety of factors including improvements in the cost of inputs, quality, better pricing, and a solid start-up in Ennis. All aspects of our operational improvement plan that our team is focused on. We expect these elements will continue to improve as we move forward and drive continued margin enhancement. As we ramp up production in Ennis in both our operations and in chicken processing, we will have some margin dilution due to the less-than-full utilization of our capacity and the cost of incremental staffing as we prepare to start off our next line, but we will grow into that over time. The increasing production in Ennis will also make us a much more resilient company able to absorb the kinds of incidental supply issues that we struggled with in previous years and also lower our total logistics costs. Total adjusted SG&A was 34.9% of net sales, down from 40% in the year-ago quarter. The biggest improvement was in logistics, where we gained 350 basis points due to strong fill rates, the increased utilization of our second DC, favorable lane rates, and lower diesel costs. We spent a healthy 14.8% net sales in media in the quarter, but this was below the 16.4% we spent in the year-ago quarter when we leaned into first-half media to offset the impact of the February 2022, 12% price increase. For the year, we have delivered $12 million in adjusted EBITDA to date, well ahead of the initial expectations we set at the outset of the year. Capital spending in the quarter came in slightly below the most recent expectations at $45 million, largely due to sequencing of some sizable expenses in Ennis related to completion of the first production building, the chicken processing facility and the early stages of construction of Phase 2. In terms of the cadence of our business for the balance of 2023, we expect to continue the strong growth we demonstrated in the first half, but the net sales growth will increasingly be driven by volume growth versus pricing growth. Now, let me turn to our guidance for the balance of the year, given our outperformance for the first half, we are raising our adjusted EBITDA guidance for the year to at least $55 million from at least $50 million. With net sales continuing to build each quarter and Q4 historically being our lightest media investment period, we expect approximately half of our full-year adjusted EBITDA to occur in the fourth quarter.

Scott Morris, COO

Hey, Mark. Good morning. Historically, we have focused more of our total media spend in the first half of the year, but this year, we've allocated a bit more budget to the second half. Considering our year-to-date performance and the timing related to household penetration, we were anticipating an inflection point and started to see it around late February to early March. So if you look at the overall year, we're slightly above our historical on kind of dollars per consumer. So it's cost us a little bit more to get consumers year-to-date, but if you look at the period since that inflection point, it's actually starting to perform well right back in the norm. And I think this goes back to a much broader piece that we're seeing on the business. To be back in stock consistently with full fridges plus the media plus the innovation and all of those things working together, it's what's driving those efficiencies. We've been able to see incredible returns, one we're very, very careful and selective around some of the marketing that we've done around e-commerce. We're really proud of that. The team has done a terrific job and we just love, we love the progress there and we also see the opportunity in that area. We've been a little bit of a laggard in pressing into that area, partially because we just haven't had the inventory for a few years. So we're really excited to see the media respond to really kind of drive the household penetration and the thing I think we're most excited about is to be able to see that it's not just driving dollars that we're seeing really, really great progress on a pounds and units front, which I think is pretty unique based on the category and also across CPG. And you asked a little bit about cohorts, you asked about media mix. So the thing that I would probably celebrate is both our marketing team and our partners have done year after year after year have done an amazing job continuing to evolve our mix of media to make sure that it's productive as we spend more and as we get deeper into our total addressable market. They've been able to do that consistently and I think it gives us incredible confidence in what we, what the potential of the business is over time.

Peter Benedict, Analyst

All right, guys, good morning. I was hoping maybe you can expand a little bit more on the unmeasured channel growth, how strong that's been. Just some more color on what's driving that and how you see kind of the durability of that above average growth?

Scott Morris, COO

Hey, Peter. Good morning. So we have continued to see a really, really nice expansion and when I say expansion, just continued strong and leading growth in the non-measured channel, and those that centered around both club and e-commerce, the e-commerce is still on the smaller side of our business, but we're recognized and I was just mentioning a lot about the marketing performance that we've seen. The other thing that's I think important to note, in those unmeasured channels is we've done a pretty significant amount of work and been able to identify that the consumers coming in on those non-measured channels seem to be incremental to the kind of the overall business. So we really, really like that aspect of it.

Bill Chappell, Analyst

Thanks. I guess I was hoping you could comment on behaviors you're seeing across your price points, across your assortment, and maybe how you feel about how that set right now. Are there any adjustments that you think you might want to make given demand elasticities across your portfolio?

Billy Cyr, CEO

Yeah, we feel very good about where we're sitting right now. Obviously, the consumer had to digest 27% pricing in 18 months, and there were some bumps along the way, but we've come out the other side and we feel like we're in a really good place today, the value relationship looks pretty good. The only piece of shift that we've seen is we've seen a little bit more of rolls consumption than bags, but it's very small in the grand scheme of things. For the most part, the consumers have digested the pricing quite well. It's a little bit hard to see some of the details because our in-stocks have been improving quite a bit since where we were a year ago and that masks some of the price sensitivity you might see. But overall, we feel like we're in a pretty good spot. And frankly, we like where we sit, because the commodities seemed to be somewhat stable, consumers have adopted our pricing. So we feel like we've got fairly clear smooth sailing for at least the foreseeable future at this point.

Michael Lavery, Analyst

Can you just unpack a little bit and help us make sure we understand what drives the volume acceleration in the second half and just how much of the EBITDA guide is tied to that pickup as well?

Billy Cyr, CEO

I'll talk about the acceleration and let Todd will talk about the EBITDA pickup, but what's driving is the consumers have digested the pricing and the in-stock conditions look good. We're getting lots of second fridge replacements and the media is on air and working the way it worked historically, as Scott outlined in the earlier question. So it's the, basically, the return to the business model, getting to work without all the bumps and out of stocks and media not necessarily being on air.

Todd Cunfer, CFO

Yeah, back half is pretty simple, it's really two aspects. One is, as you know, we spent more heavily in media in the first half, almost two-thirds of our spend happens in the first half versus second half, so that delta between first half and second half in absolute dollars is almost $25 million, that's a huge chunk of the EBITDA second half weighting there and then just sequentially every quarter, we're anticipating revenue will be larger. And we'll obviously get a variable margin off of that.

Rupesh Parikh, Analyst

Good morning and thanks for taking my question. So just going back to the Ennis facility and the ramp so far, just curious, any positive or negative surprise as you continue to ramp that facility?

Billy Cyr, CEO

I guess I would say that, as you can imagine starting up a greenfield facility is always got ups and downs in it, and we've had our fair share of ups and downs as we've gone along. What I'll tell you is where we are today is we feel very good about the progress we made on the roll side of the business and it's going very, very well and the chicken processing is doing very well. The bag side of the business took a little bit longer and steeper to ramp up than what we would have hoped. We are now producing all the items in the lineup, we feel very good about that, but it took a little bit longer to get to the production levels that we wanted in qualifying all the items, and in part, that's why we've begun to do the staffing for the line, the next bag line.

Robert Moskow, Analyst

I guess one last question. Todd, I think you mentioned that you won't be committing capital to volume until you know for sure that the volume's there. Is there any way to quantify what kind of volume growth you'll need in 2024 to hit that threshold?

Todd Cunfer, CFO

Yeah. So, as you know, the algorithm for us over the next five years is to grow the topline on average 25%. And for '24, I mean, we don't anticipate any additional pricing. So we'll have a little bit of a wrap-around on that last price increase that we took in February. But for '24, it's going to be almost all volume, so close to 25%.

Billy Cyr, CEO

We have not made any commitments for the second part of Ennis Phase 2, Ennis Phase 3 or additional lines at Kitchen South. We will only make those commitments when demand justifies it.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Cyr for any final comments.

Billy Cyr, CEO

Great. Thanks, everyone, for your interest and your time. I'll end with a thought for you from the author Karen Davidson. She said, a dog can express more with his tail in minutes than an owner can express with his tongue in hours. To which I would respond feed them Freshpet and their tail won't stop talking until it's time for the next meal. Thanks, everyone. Thanks for your interest.