Freshpet, Inc. (FRPT) Earnings Call Transcript & Summary

Good morning, and thank you for joining us for our next presentation of Freshpet. Many of you are well aware of Freshpet's performance over the past year. A leader here in refrigerated pet food sold in over 17,000 locations across the U.S. and Canada and now the U.K., including Walmart, Whole Foods, Costco and a pretty diverse list of retailers. And most of you understand kind of the growth the company has had as they've had the convergence of healthy living and pet ownership in the U.S. and really ridden that wave. I think a lot of you have forgotten, 4 years ago, it's pretty remarkable that we were talking about how -- investors are talking about how the company had peaked, how they had really filled out their niche, how they had no real room for growth from here; how they had some mold issues, as you might remember; and how it was really kind of lost in its way. And in that time frame, the existing management team steered the ship right. Billy Cyr, one of our speakers and the CEO, came in about 3.5 years ago and stepped up advertising, improved distribution. They've expanded capacity and now have 3 straight years of 25%-plus growth in addition to last year, also seeing 350 basis points of margin expense. And the stock has rewarded investors, being up 140% last year after being up pretty meaningfully the year before. Now you and I are very excited to hear what the next act is as they continue to expand and strive for their potential. And so today, we have Billy Cyr, who will give the presentation, the CEO; Scott Morris and Heather Pomerantz, the COO and CFO, respectively, who will join us for Q&A. And with that, Billy, why don't you kick us off?

Great. Thanks, Bill. It's always a pleasure to be here at ICR and also to have you hosting the session with us as well. What we're going to do is take you through this presentation, and it has been posted on our Freshpet Investors section of our website. But we want to give you an update on how the business is doing and some exciting news that we have that gives a sense for how big the opportunity is going forward. As always, we have to start with our safe harbor statement. And I also have to start with a reminder of who I work for. This is my boss. Her name is Appa. She's a 2-year-old Samoyed. She's the fourth Samoyed that my wife and I have had since we got our first one as a wedding present 33 years ago. She loves Freshpet, and she reminds me every day why, what I do is very important to families everywhere. Our mission as a company is to awaken the world to a better way of feeding pets. We feel like we're heading in the right direction. I want to run a video for you that gives you a little bit better sense for who we are and what we do. [Presentation]

It's pretty cool when you get to work on a business that has such incredibly high level of relevance for all the families that we encounter, certainly for our own personal families. Scott, who is here as our President and COO, is also the Co-Founder of Freshpet; along with Cathal Walsh, who runs our European business. And the vision that they had to create a business like Freshpet is really incredible. Heather who joined us literally at ICR 1 year ago, that was her debut with Freshpet, is now our CFO. And she and I are awfully glad to have had the opportunity to join with Scott and all the other founders who created this business. Our objective today is threefold. First is we want to share with you some of our preliminary 2020 results. We're doing that at the interest of transparency at a time when the external world is kind of chaotic. We have COVID and all the other issues that are going on in broader society. We want to give investors as much clarity as we possibly can about our current performance, those things that might be short-term in nature and those things that might have longer-term, more lasting impact. The second thing is, we want to share with you some new cohort buying rate data. This data is incredibly exciting. And in combination with the household penetration data that we've typically shared, we'll give you a sense for the upside opportunity that we see with Freshpet, and it's probably significantly larger than what we've described in the past. The third is we want to outline our capacity plans. Capacity has been the biggest limiter of our growth over the last year. And so we want to talk about both the near term, what we're doing to manage the capacity, the impact it's had on our business of late, but also some of the opportunities we have going forward and how we might be able to build the potential that we described with the cohort buying rate data and the household penetration data and some opportunities to further grow more quickly. So let me start with a look at the preliminary 2020 results. First, it was our strongest year of growth since 2015, and it was accelerating. We had 30% net sales growth. And that sales growth was less than what actually the consumption growth was, which was 33% growth. So we obviously drew down some trade inventory throughout the year, and I'll talk more about that in a minute. We also saw acceleration, where we ended the year with 38% consumption growth in Q4. So the business has got a lot of momentum behind it. The household penetration and buying rate also grew quite strongly in the year. For the second consecutive year, our household penetration grew 24%, and the buying rate this year was up 7%. Both of those are in line with what our historical averages have been, but they put us ahead of pace for our 5-year goals. And the third is, we believe we've delivered increasing leverage on cost, and that allowed us -- will allow us to deliver EBITDA growth that's in excess of our net sales growth. Obviously, there were a lot of challenges and opportunities that came out of last year. I don't have to go in a lot of detail about the COVID-created challenges, but they are in the supply chain. They're labor-related, cost-related in terms of the cost to keep employees safe, also slowed down our construction of incremental capacity where we lost a month because of shelter-in-place orders. On the other side of the ledger were some significant opportunities we have. Consumers were increasingly focused on their pets in the year, and that attention to their pets has led to increased desire for products like Freshpet. We also saw lower media costs as many advertisers pulled their advertising that allowed us to lower our cost of customer acquisition throughout the year and allowed us to grow our household penetration quite nicely. And the third thing is customers have really discovered the value of Freshpet. We've achieved a level of scale with our customers that is meaningful. Our growth rate has been meaningful for quite some time, and customers decide to lean in. We now have 7 of our top 10 customers who have at least 40 of their stores with multi-fridge tests or expansions underway. And that speaks to the opportunity that we have going forward. But we're also operating in a very difficult operating environment from a labor perspective. Absenteeism is not just an issue that we saw, it's an issue that all manufacturers have seen. But because we are basically a single site -- production site, it did hit us really acutely. And we are also running up against our capacity. So we really had very little room for error. It's also a tight labor market. Between the unemployment compensation that was put out, people's fear of going to work because of people having health risks at home or the risk or the issues that are related to schools, where they had to be at home because their kids were homeschooling or virtually schooling. The labor market was a very challenging market. And when you're growing as fast as we are and is hiring people as fast as we are, obviously, that creates some potential challenges for us. So basically, what happened for us is despite having installed more manufacturing capacity, meaning installing more lines throughout the year, the staffing challenges made it so each time we added production capacity, it was really just filling the hole for the staffing issues or labor issues that we faced previously. So we didn't get all the full benefit of the incremental capacity we've installed. We've made a decision, as you can see on the right-hand side of this slide, that we will now overstaff, in essence. We'll increase our staffing so that staffing is not a limiter of our growth that, in fact, the equipment capacity can be more fully utilized. Despite all that, we had a very strong year of consumption. This chart shows you our weekly Nielsen-measured Mega Channel consumption. Mega Channel is described as basically everything Nielsen measures. So it includes grocery, mass, club, pet specialty, big-box pet specialty stores, natural food stores. And what I can show you is that, yes, we all went through that rapid rise in -- back in March when people stormed the stores and the crash that came behind it in April. But we came out of that and resumed a very strong growth rate until we ran into capacity constraints that were basically created by labor shortages in the fourth quarter. So we're still growing 35% versus a year ago in the most recent week, and we were up 38% in Q4, 33% for the year, but that was well capacity-constrained. We're building a meaningful share. We're not just a fast-growing business, but our share is becoming meaningful. So if you look on the left-hand side, our most recent 4-week shares are generally, across all classes of trade, bigger than what the 52-week shares are, which are on the right-hand side of this. And so we've become a meaningful share of each class of trades business. We're also in a segment that's growing the best. A lot of people have talked about how the pet food category is very recession-resistant. We saw that in the Great Recession in 2008 through 2010. The data for the last 52 weeks bears that out again, where the ultra-premium wet and dry and refrigerated pet food category is up 17%, while the value version part of the category is down 20%. So we're clearly in the sweet spot where when people are challenged or stressed, they tend to pay attention to and care for their pets significantly. Against this backdrop, we're able to add houses -- households very quickly. As I said before, we are up 24% on household penetration to 3.15% household penetration. We're now in 3.96 million households, we'll round that to 4 million a few slides. And our core dog business, which we describe as basically the main meal components, the things that are staples, regimen purchases as opposed to treat or the cat food business, which is a relatively small business for us, the core dog business was up 28% and accounts for over 90% of our total business today. Our buying rate continues to grow. But as you can see from this chart, the buying rate growth has been less consistent over time. We've historically described that as a function of the number of new users we bring in. So rapid greens and household penetration. Those new users are coming in at a lower rate of spending in their initial year. And so it pans down to buying rate. What we're going to show you in a minute is some more detail on what the buying rate looks like. But for 2020 -- for the year 2020, our buying rate amongst all households was up 7% and amongst the core dog users was up 5%, making fairly significant progress and in line with our 2025 goals. Distribution growth, as you can imagine, was a little bit stressed during the COVID year as retailers refocused on taking care of the safety of their shoppers and of their employees and doing a lot more on keeping their stores clean and well stocked. So our household -- our distribution, as measured as ACV, hit 55.5% in the most recent period. But you can see our rate of growth slowed this year. We don't think that's a lack of retailer enthusiasm. We think, frankly, the retailers are very enthusiastic. It just is a reflection of their limited capability, and that will resume a more normal path as we go forward. But it also should tell you that we have significant upside opportunity in new distribution. We're only at 55.5%. We think we can be in 75%, 80%, 85% as the brand continues to grow and demonstrate success in wider classes of trade and in broader demographics. Our store count growth, which would match that, was up. We increased stores by 1,146 net new stores in the year. But the more important story is the number of retailers who chose to put a second fridge or even a third fridge in the store. In the year, 1,640 stores ended up with a second or a third fridge and a total of 2,477 now have a second or third fridge. That rapid rate of growth really speaks to the tipping point that we think Freshpet has achieved in terms of customer importance and relevance. It's also part of a longer-term trend that we've seen. This chart shows our installations between 2017 and 2020. And where back in 2017, more than half of our fridges that we are installing were small and medium fridges, in 2020, only 12% of them were. And instead, what you're seeing is now we have 48% or 53% of the stores are double or triple stores and large -- when you add large to it, you're basically up at 89% or 88% of all of our stores are getting a large fridge or a second or third fridge. So a real testament to the confidence that retailers have in Freshpet. And it's not a surprise when you see the velocity. We've been gaining velocity, measured as dollars per million ACV, so a rough proxy for dollars per store per week. The -- that has been growing consistently. But in the space of COVID, it grew even more significantly. We have seen a little bit of a distribution erosion in the most recent quarter, and that's what this chart shows you. And by that, I mean, it's not that the retailer has not authorized the distribution, it means that the items are out of stock. This is total distribution points. It's a rough proxy for out of stock, says that an item has been scanned in the last week or so. We pushed up against our capacity so close, we short-shipped quite a bit in the fourth quarter. So we have a fair number of out of stocks. We're in the process of remedying that. I'll talk about that in a little bit. But you can see, though, the long-term trend here is towards more SKUs and more stores on a long-term basis. We also have an e-commerce business. Our e-commerce business is described as anytime you order the Freshpet online or via your phone, it can be delivered at curbside. It could be delivered by a company that does fresh traditional e-commerce like AmazonFresh or FreshDirect or it can be by a service like Instacart or Shipt. It was about 6% of our sales, went that way in Q4, up 192% versus a year ago. Over 85% of that is going through a Freshpet fridge, though, meaning the product is ordered by our customers, stocked in the Freshpet fridge, and then it's either going curbside or via Instacart or Shipt to the end consumer. This is a big opportunity for us, but the growth has been truly tremendous in the last year. We also have a business in Canada. And while Canada has gone through the same COVID challenges that we've gone through in the United States, our business there has accelerated quite a bit. The long-term trend, this is the one customer we have data for in Canada, and you can see it's a very strong long-term trend. Our most recent week, which is reflective of the performance we've had recently, was up 44% versus a year ago. Freshpet has also been in the United Kingdom for the last several years, and we are also seeing very strong progress there. We have data for 2 of the larger retailers in that market. And you can see the long-term trend has been very healthy with most recent weeks up in -- very significantly. Our business in the fourth quarter in the U.K. was up -- its growth rate was well in excess of the total company's growth rate. So I now want to shift gears and take you a little bit through what our 2020 results are. Obviously, it's still very early, and so we won't be able to give you actual EBITDA results. But we do have the other elements finalized. We want to give you an update on that in the interest of transparency. First, let me start with Q4 net sales. They were up 29% versus a year ago at $84.5 million. You'll recognize that the net sales number is basically flat with where we were in Q3. It's because of supply constraints. We actually had more capacity come online in terms of equipment, but what we had was staffing challenges. Literally, the ability to get people and then the number of people out for testing and quarantine related to COVID. We also had an issue with the -- very late in the quarter where we have a largest -- our single source of production in Bethlehem, Pennsylvania, a large Nor'easter blew through here on December 16, the afternoon December 16 through December 17 and dumped a foot of snow, became a state of emergency. That picture on the left is a 55 semi pile-up on I-80 in Pennsylvania. So it's narrowed the traffic system or the transportation system. And we, as a result, lost production and shipping days with really no time to recover in the rest of the year. And so what I'm showing you in this chart is we literally gave an update to our guidance on December 15 before the market opened and then snow started the afternoon of 16. We lost 2 days of production, cost us, call it, $1.3 million of production. The good news is though, the incremental staffing that we've now put in place beginning on January 1 is, now has our production on the right-hand side of the slide, running about 20% in excess per day what we were running in the month of December. So the incremental staffing against the same equipment is giving us the capacity that is allowing us to actually produce in excess of what's going across retailer scanners for the first time in several months. That snowstorm also did have an impact on our shipping with so few days left in the year. We lost 2 days of shipping, it's about $1.7 million. So when we had given guidance of greater than $320 million, the reality is that those 2 days hit us, and we dropped slightly below that. We are, as a result of all this, carrying a very large backlog of orders into Q1 2021. Think of this chart as showing you what the Nielsen consumption has been across what they call xAOC, that's the green line; what our shipments have been on a sort of rolling 4-week basis, that's the yellow line; and what the orders have been, which is the gray line in a rolling 4-week basis. And that gap was a very small gap on a weekly basis, but it grew like a snowball over time. And we added an incremental $7 million to $8 million of trade inventory gap in Q4 on top of the roughly $7 million to $8 million trade inventory gap at the Q3. So we believe there's about a $15 million trade inventory pull that we will need to fill in Q1 of 2021 and maybe drifting into a little bit of the month of April. Our updated 2020 net sales and adjusted EBITDA guidance. The actual result on net sales is $318.8 million, up 30% versus a year ago, slightly below the guidance that we had given because of the snowstorm and the impact on our shipping and production. The adjusted EBITDA, we're not done with that. We had been calling for greater than $46 million. We're calling it about $46 million. And the reason for that is the shortfall in the net revenue side is obviously going to have a flow-through impact the EBITDA, but we're pretty comfortable that we're in that ballpark of $46 million. That will be up 58%, and it demonstrates fairly significant scale benefits that we're getting as we have increased the net sales from the business. I would also highlight in Q4, all those staffing challenges that we had will have an impact on the gross margin that we had in Q4. Basically, we're carrying the cost of a larger organization against much lower production that we expect to be remedying in Q1 as we increase our staffing and get the throughput up pretty considerably. So the long-term look at what our net sales looks like is it was another year of accelerating growth, up 30% to $318.8 million and a long-term CAGR of 25%. And assuming that the guidance we're providing for the EBITDA is right, obviously, that curve is an accelerating curve as well and up 58%. So a very, very good long-term picture. But we think the opportunity is much bigger than that going forward, and I'm going to frame this in the context of penetration and buying rate. Many of you have seen before this chart, which is a complicated way of describing how innovations are diffused into the market. The bottom line is, though, we think that Freshpet at that point, which is called takeoff, where everything starts to work better. You grow faster for the same amount of effort, and you start acquiring a significant number of new users. And that's where Freshpet is on this chart today. Demographic trends are helping drive that. Millennials and Gen Z love the idea of Freshpet. We saw this year in the middle of COVID, they were the consumers most likely to join the Freshpet franchise, very high propensity. And that bodes well for us for the long-term health of our franchise. We described earlier this year, I guess last year now, that the opportunity in the addressable market was at least 20 million households based on data we've done at the -- gathered at the end of 2019. And we say that everything has shown us that, that number is probably conservative and that the number of households that we have as an opportunity is significantly larger. Recall, I said that we're up to 4 million households today and that our goal is to be in 8 million households by 2025. That still leaves you -- us a lot of room, even at the low end of the curve, and we think that the upside is significantly higher than that. So we laid out a goal to be in 5 by 2025, 5 million more households by 2025. And if you recall what I told you about where we are at the end of 2020, you can see we're well in excess of the 3.5 million that we talked about being at the end of 2020, and we're just short of where we thought we would be at the end of 2021. So at 3.96 million, our goal for a year from now is to be at 4.15 million. We were well ahead of the pace we had expected. We have a very strong demonstrated track record of driving household penetration via media. This is that -- this chart shows the household penetration gains correlated with our cumulative media investments since 2016. And obviously, that r-squared of 0.983 is quite impressive. This is the primary vehicle that we use to drive our -- to drive household penetration, and it's working incredibly consistently. It's also working against all sorts of households with dogs. If you have 1 dog or 2 dogs, we've seen penetration gains across both groups over the last 3 years and no matter what size dog you've had. We saw small dogs, medium dogs, large dogs, giant-size dogs, penetration gains amongst all audiences. So we're now at halfway to our 8 million household goal by 2025. Buying rate remains a very significant opportunity. If you fed Freshpet to your dog every day and you had a 30-pound or average-sized dog and you bought our average product, you spent $630 per year. And the buying rate on average is $117 a year. So we have a huge opportunity to increase that buying rate. In our long-term goals we laid out, we described it as going from $106 to $162 million -- not million, $162 by 2025. And we thought that at the end of 2020, we'll be at a little over $112. We're at $117. So we're well ahead of pace there as well. So the next, the big driver for us is the very strong consumer satisfaction. Consumer satisfaction is helping us quite a bit and helps drive that buying rate. I want to take you through the journey quickly on -- the journey of the consumer goes through when they are entering the Freshpet franchise. So the advertising brings them in. They now consider what they're going to buy. And as you might expect, when they're buying completely new dramatically different product form, they're a little bit tentative. They tend to buy a smaller size, probably a lower total dollar commitment. So they buy more likely are buying rolls than our bags because rolls are less expensive, and they buy a smaller size. But what happens is as they get exposed to the product and they have the very high satisfaction, what you can see is 54% of them become some form of a regular user, with 17% of those becoming what we call super-heavy users. And the progression that they go through is pretty predictable. This shows you when you look at 30 purchases for a consumer from their first purchase out to the 30th purchase, their increase in the pounds per household per trip is pretty consistent. They move into larger sizes and at a higher price per unit, and there's a steady increase in the dollar spent per trip. So you see the steady increase in the buying rate. For the first time, we have this new data we gathered that helps us understand, what is the magnitude of that increase and how long does it last? And the reason that we really are focused on this is because we are adding household penetration so quickly as we are building the business, we are obscuring the value of the existing users because the new users were typically coming in at a lower level. And so we wanted to get a sense for if somebody was part of the franchise, what did their purchases really look like. So we had Nielsen create a panel for us going back -- using their panel data, going back to 2016 and identifying people who entered the franchise for the first time in 2016 and then track their purchases each year for the next 5 years. Did the same thing with a group of people who entered the franchise for the first time in 2017 and tracked them through 2020 and so on through 2020. And this became an incredibly insightful way to screen out the impact of new users diluting the value of the existing users. And there's a couple of important conclusions we've reached. First, the new users each year were entering at a higher buying rate in their first year than the cohort that preceded them. So you can see, every cohort was 10% or better than the previous group, and they tend to be in the 13% increase year-on-year. That's really a testament to the value of the innovation that our team has done. Because if you look at the group that joined in 2020, 35% of the products that those people bought on their first purchase were not available, meaning they did not exist prior to 2016. So the innovation that was done between 2016 and 2020 created products that were appealing to a new audience and brought them into the franchise. And it came in with those products were usually at a higher price per pound, so a more premium product. The second conclusion you reach from this data is cohort data is that the second year is about more than double the size of the first year. Now that's not a surprise because there's a calendar phenomenon. They may have joined us only halfway through the first year, so we didn't get a full year's worth of purchases. But there are other elements at play, too. One is they may have moved into more premium items as they tried a smaller size, less premium item, they might have moved to a larger size and a more premium item; or they may have moved into products that they use on a more frequent basis. So they went from mixing their topping with a dry dog food to using us as the full replacement. But year 2 is double size of year 1. This also helps validate the theory that the year 1 users are diluting the buying rate that we've seen -- buying rate gains that we've seen because you see they're coming in at half the level of the people who've been part of the franchise for just 1 more year. The third important conclusion is that by year 4, the buying rate is more than 3x what it was in year 1. And the fourth conclusion is that the rate of growth in buying rate or buying rate continues to grow for all 5 years. All of this is in excess of what we had expected. This basically presents a picture of a higher rate of underlying buying rate growth than the 7% that we had modeled, and it also shows it going on for a longer period of time. That's very, very encouraging as we think about our ability to achieve our longer-term goals. It's also very interesting, if you take a look at -- and this is a separate data source that comes from Numerator. But we looked at it across the buying rate over the last 3 years by the size of the dog to see if this was a phenomenon that may have been unique to only people who have small dogs. But what you can see is regardless of the size of the dog, we saw buying rate increases with the exception of the toy dogs, where they actually got to a very high level of buying rate and it stayed there very quickly. But we saw buying rates across all different sorts of dog sizes. So what do we conclude from all this? First, we have a strong and increasingly efficient ability to drive household penetration. We're driving it in mid-20% range. And frankly, we think that understates what our ability is because we had to constrain our advertising investment to fit within our capacity this year. We also have a lower cost of consumer acquisition every year for the last 5 years. And so we are getting increasingly efficient as we're driving household penetration. Second is buying rate is growing strongly, but it's obscured by the number of new buyers. We think the rate of growth is more in the mid-teens, and that really speaks to the very big, significant long-term opportunity. Combining these 2 pieces of data suggests that the Freshpet long-term opportunity is much larger than previously projected. I want to be very clear, though, we are not revising our 2025 target at this time because a part of that target is a function of our ability to add capacity and execute against the opportunity. But what we are saying is the opportunity is probably significantly larger than what we described previously. So that turns into the question of what are we doing about capacity? Well, first, I feel very good about our ability to add capacity. And the best example of that is the Kitchens 2.0 that we started up in Q3 of this year, and we are now running today. This is a project that we have been constructing for the last 2 years, very sizable technology increase in improvement, lots more automation than we used in the past, higher throughput, better efficiency. And it gives us great confidence that we know how to add capacity. That line is up and running in our Bethlehem campus. So that facility is running on our Bethlehem campus today. As we look at 2021, a lot of folks have asked, "If you're capacity-constrained, you're tight on capacity in Q4, what will it look like as we go through the quarters this year?" And what you can see is we have installed manufacturing capacity that covers $590 million of sales today. It's really just about adding staff. We have capacity -- staffing capacity of $390 million in Q1, growing to $490 million in Q2, $540 million in Q3 and $590 million by the end of the year. And we plan to overstaff this year so that if we do have absenteeism due to COVID, that we'll be able to insulate our throughput by having incremental staffing. We'll gladly carry higher cost of staffing in order to meet customer and consumer demand this year. We also have our next kitchen under construction in Ennis, Texas. We began construction back in August of this 2020. And we expect to have that up and running in mid-2022. But as the footnote at the bottom highlights, and I'll show you in a second, we do have the opportunity to pull that forward by a quarter through an increased investment, basically paying for construction to go round the clock in order to meet higher levels of demand sooner. The base plan that we laid out last year had us creating $1.3 billion in total capacity, spending somewhere between $800 million and $900 million to build that capacity. And we're calling that now our base plan. But that base plan has the opportunity for us to add more capacity sooner. And the 2 call-outs on this slide are the opportunity of capacity both that I described and the opportunity to add additional capacity at Kitchen South between Ennis Phase 1 and Phase 2. In total, that would take us to somewhere between $1.7 billion and $1.8 billion of capacity, or bring $1 billion of capacity sooner into late 2023 or into 2024. You should rest assured, though, that this incremental capacity investments do drive increased profitability. This is a chart that Heather provided in her talk that she did last month, and it shows how the incremental EBITDA we get for incremental dollars of CapEx grows as we go through our various stages of capacity expansion. We are doing this. Right now, we have a clean balance sheet. But we will, as we spend all -- a lot of money on this capacity, we will use the line of credit that we have, the credit line that we've got, and we will keep our leverage to reasonable levels. And we will only use equity if we have accelerated growth opportunities that are going beyond the current plan. So that is a possibility, but it depends on what our actual capability is to expand capacity much more quickly. So in summary, we think we have huge opportunities to grow, increasing the awareness, expanding into more households, expanding the buying rate, expanding the distribution, very significant. We get the 5 million new households that we've described, we get to $1 billion in net sales by 2025, and that's a 27.2% CAGR versus where we were at the end of '19. We already show we can grow faster than that while capacity-constrained and limiting our investment in 2020. So we're optimistic that we can accelerate from here. All of that serves to build and reinforce our business model that has strong, competitive insulation. So every piece of scale that we add creates another brick in the wall that better protects our business, where there's more manufacturing scale and leverage, efficiency in the supply chain and distribution, greater retail presence, more fridges, lowering the cost of operating the fridge network, more loyal consumer households and a broader line of products that appeals to a broader range of consumers and it's harder for someone to replicate. So we're building the foundation for a business with a potential to be greater than $2 billion in net sales. We're building all the systems and infrastructure to do that. So with that, Appa says, "Thank you for your attention." And we're glad to take any questions, and obviously, you'll have questions. But we are on the path to 5 by '25 and beyond.

Thanks, Billy. I'm -- this is Bill Chappell again. You don't see my smiling face because I've learned that my technology in my basement office is not quite as good as I thought it was. So I want to jump in with some few questions. And I guess right -- I think I understand the message you're trying to say is, what the surprise has been the buy rate from existing customers as they've extended their tenure as customers. I mean you have a strong recurring revenue base in terms of customers who keep coming back, oh, no, but you've been surprised. And it gives greater confidence going down the road about how much they're spending in year 2, year 3. Is that the right way to look at it? And is that kind of the basis of why it sounds like you think you can exceed your goals over the next few years?

That's the essence of it. I would say that we were willing to sacrifice buying rate in the early years to add household penetration at a more rapid rate. What we were missing and didn't see was that the buying rate was growing more like 14% or 15% of the underlying existing users. And that gives us a higher level of confidence that the opportunity is as big as we thought. But I'd also point out, though, that we are ahead of the rate that we projected for household penetration and buying rate at the end of year 1 of the 5-year plan, and it's not by a small margin. We're pretty far ahead. And we did that despite being constrained on supply and constrained on the amount we could actually invest in advertising because of the constraint on supply. We came nowhere close to investing at 12% of sales that we would like to.

Got it. And then talk to a little bit alluding to the overstaffing. I mean I understand you're not giving 2021 guidance at this point. But you've wildly exceeded on kind of the top line expectations, but there's also a goal to get to a certain margin by a certain amount of time. I imagine the term overstaffing means that there's some pause on that while you focus on growth. But help us understand what that means.

The overstaffing comment is really more about in the COVID environment. It's -- we can't tell what next week is going to look like in terms of the infection rates in the broader community and thus, the number of people who we have to have send home or send for testing or quarantine. In the month of December, there were days that -- in a facility that has a little over 300 production workers, we were having 40 people out for testing or quarantine in a day. And that caused us to have to shut down a line. We shut down the line virtually every single day in the month of December for some period of the day, whether it was just for the night shift or for the whole day. And we don't want to do that. We have pet parents who depend on us. We have retailers depending on us. And so as long as this condition exists, we're willing to invest in the people so that we're better insulated against that. It also, though, does say that we will train ahead. We will hire people -- as we get past the COVID period, we will train ahead. So that if the growth does run ahead of us, we have the people to continue to add shifts as we need to add the shifts. And is that going to be a big hit? It will be a little bit of a hit, but you should make up for it on the revenue side.

Okay. That's great. And then talking about advertising and hitting the levels that you want. I mean as you said, you're getting growth from existing customer base probably faster than expected. And it seems like you're acquiring new customers, as expected. I think I asked this question every year. Do you need to spend as much in marketing and advertising as you plan? Or are we getting a diminishing returns level?

Well, we're certainly not getting diminishing returns. So our customer acquisition cost is going down. And we view this as a first-mover opportunity. We have a first-mover position. And it's in our interest, our shareholders' interest for us to maximize that opportunity. So as long as we can do it efficiently, there's no reason for us not to continue to pursue as big a business as fast as we can execute in a high-quality fashion.

Got it. And then on the capacity front, I actually have one question online and one kind of with that is, one, where there was a question on -- for Kitchens 2.0. What's the expected capacity utilization for '21? How many lines will be up? And what's expected over the year? The second question is, as you talk about bigger numbers down the road, what's the risk to overbuilding? I mean -- and how do you prevent from, hey, we're focusing on $5 billion in sales, and we're only going to get by a certain year and we only get to $3 billion? I mean help us understand how you mitigate that risk as well.

It's a fair question. Let me start with the first one. So Kitchens 2.0, bag line is up and operating. It's operating on a, call it, 5-day, 12-hour schedule at this point. So we obviously are going to add a second shift there in Q1 or end of Q1, beginning Q2. Our rolls line is going to come up this month, producing salable product probably next month. And then we'll be adding shifts to that later in the year. We'll come -- we'll give you a little bit better sense for what the total capacity utilization is when we lay out the guidance for the year. But I did include in the deck, as you saw, what our total capacity from a staffing perspective would be by quarter. And we will not have maxed out that facility until the bag line will probably be getting close to max capacity at the end of the year. The roll line won't have maxed out capacity until sometime in 2022. In terms of how do you avoid overbuilding, I mean first of all, we have to be really good at sensing where the market is and what the market opportunity is. Right now, we're this big in an opportunity that is significantly larger. So I think the risk of overbuilding is very, very small. We know there's demand out there. There's no sign of slowing of the demand for the business. The second piece is we add capacity in chunks. It's not like we're going to go out and build, call it, another -- after Ennis, another $500 million, $700 million in capacity all in one shot. We look at it as adding lines at a time at a site. And so I think the bigger we get this business and the more infrastructure we have, the more flexibility we have to add increments that are reasonable in their expense relative to the size of the total business. By that, I mean, adding a line on a $700 million business is a lot less significant than adding a line on a $200 million business. And we'll be able to do that in a much more measured way. And the lead times on adding lines versus adding sites is a lot shorter. So I think we're going to get to a point where our ability to be not having to commit as far ahead is going to get better over time.

No. That's helpful. And looking to the distribution from -- again, we're talking a lot about increased buying rates and existing customers and stuff like that. But several years ago, the focus was how many doors we can get into. And you've got a -- when you came in, kind of pulled that back and really focus on velocity, which has proven to be very successful. But I've got to think, part one, that a lot of your distribution gains maybe were put on hold or some of the distribution gains were put on hold because of COVID and the messiness at retail over the past 9 months; but two, that with the retailers are seeing your growth, and there's probably an increased demand to have more coolers in their doors -- in new doors and not just second door, third fridges per door. So kind of talk about what the demand level is, how you see that whole part of the story as we move into '21 and '22.

So Scott, why don't you take that?

Sure. So Bill, what we're -- what we anticipate this year is we will get back to a little bit more of a normal cadence of adding kind of primary distribution kind of first fridge in the store, where we should see -- and we -- the typical number we've used is around 1,500 fridges over the course of the year. We think that we can kind of achieve that this year. There are a fair number of retailers that are saying that they want to continue to expand distribution. The thing that I think is really important is we're better off, in many cases, adding a second fridge in the higher-velocity stores, which is really where we anticipate a lot of our additional fridge placements coming from. We've been able to demonstrate that it's incredibly productive that we get an immediate 25% to 40% increase in the velocity that's going out of that store. And that continues into the second and third year when we have those second and, in some cases, third fridges. All that being said, I think we pointed it out, the primary growth for the organizations to come from advertising that's driving velocity in the existing stores, we want to be more available and not just at the brick-and-mortar retail. We want to be more available. But the biggest component is going to be driving more consumers into the franchise is the -- that's going to be over 70% of our growth, we anticipate coming from penetration and then eventually layering in the buying rate, as we were talking earlier.

But are there any capacity constraints if a big retailer says we want to get into 500 new doors tomorrow?

Tomorrow would be hard. But later -- I mean from a -- so there's a good slide in the deck, I don't remember which slide it is. But from a fridge standpoint, we're in a good position. We have fridges, and we have the ability to expand there. We have the resources to place the fridges and set them. It really comes down to product availability, and that should be kind of diminishing. That challenge will be diminishing over the course of the second quarter. And we won't be restricted really in any way once we get into that second quarter. So it's pretty much imminent.

Got it. And just switching gears, Scott, Billy. You talk a little bit about innovation. I mean you can make a case that your product, just even the rolls, is a major innovation versus everything else that's on the market. And so just trading to that is something new and different. But I know you've added from bags to the meals, to some extent, treats. How important is innovation? How robust is the pipeline over the next couple of years? Or is it really just, we're continuing to work on household penetration and introduce new households to your existing offering?

The innovation has been kind of fundamental to everything we've done, really since the beginning of the organization. And it's not just innovation and product, but I will talk specifically more about the innovation on the product piece. It's great to innovate. A lot of organizations innovate to try and grab shelf space. We make sure we're innovating where it's really a focus on how do we add incremental consumers into the franchise. And we've been able to demonstrate time and time again is when we do add the innovation, we see increases in penetration. We see, many times, increases in buying rate, some of that's because they are somewhat more expensive products. So innovation is really, really helpful to us to the overall proposition. It actually ends up being a kind of a multiplier effect. So when we do run our advertising, if we have good innovation in the marketing, advertising is actually more productive. So it is going to be continually important to come with innovation. I am confident in saying that over the course of this year, there will be some innovation that will be some, oh, wows. Like I'm surprised that there is something that is this big a leap forward. So we're -- we continue to kind of keep the focus on innovation and bringing new and innovative products to the market. We want to focus on making as much of the great quality existing products we have, but innovation is a key. If there's anything that we can possibly think of that is a better, fresh product that could be out there, we want to be delivering it to consumers.

Great. And then one question from online, which I'll kind of merge with one of my questions. There's a question of what percentage of revenue comes from mom-and-pop retailers versus big-box pet stores? And kind of tying with that, maybe you could also help us understand, how do you see the channels playing out over the next few years? I mean certainly, the -- even the big-box pet retailers have struggled and lost some share to the bigger players. Now there's a question of -- certainly, as Chewy gets bigger and more online is there -- and your product doesn't necessarily lend itself to be an online product versus dry. Help us kind of understand how you see the channel mix over the next few years, but also if you could break out kind of mom-and-pop versus big box.

The mom-and-pop piece, I don't have an exact number, but I would say it's less than 3% of our total sales. We have -- our pet specialty is a little bit less than about 15% of our sales today. And of that, mom-and-pop is a vast minority of it. So it's a small piece. We know that there's real pressure on that piece of the pet specialty channel. So there is potentially some liability there over time. We do -- hopeful that they continue to exist, but we do know there's pressure there. Over time, we definitely anticipate that there is going to be increased migration. I mean it's been a dynamic pet food business over the past several years, where it's exciting, the shifts that are happening. We feel we're well positioned across every single format that you can imagine, whether it's PetSmart, Petco, all the pet retailers, Whole Foods, the big box and grocery. But we also recognize there's a significant opportunity to partner with someone and make sure that we're getting more food delivered to people's homes in a more direct manner. We've done a good job on e-commerce. We've made a lot of progress. It's still a small piece of our total sales, but it's growing very rapidly. There's also a piece in the deck that talks about that. I would say that we've done a good job. I hope by the end of this year, we can say that we've done an exceptional and great job in e-commerce. And we anticipate some new opportunities coming forward over the course of this year that were somewhat delayed due to COVID.

Great. And Billy, just kind of last one. A year from now, what are we talking about? Are we talking about new competition coming in? Are we talking about capacity constraints? Are we talking about -- is there something that you see on the horizon that we're not talking about today?

I hope that the things we're talking about, the innovations that Scott described and the new capacity additions that we're making and what those -- and the technologies that underpin them because we are also working on new technologies to make Freshpet higher quality at a lower cost, more efficiently, more capital-efficient manufacturing processes. So I hope those are part of the conversation in the year.

Well, great. I think that's all our time today. Thanks to everyone for being on the line. And look -- hopefully, we'll have a more prosperous year for everyone.

Thank you. Thanks, Bill.

Take care, everyone.