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

Good afternoon, everybody, and welcome back to our next presenting company, Freshpet. Joining us today from the company are CEO, Billy Cyr; and CFO, Heather Pomerantz. We very much appreciate you guys being with us today. And during what continues to be a very dynamic time in the industry, given the extraordinary demand patterns the company continues to see, along with the challenges of inflation and supply chain that are really plaguing the entire group, we look forward to hearing your updated thoughts. And over to you, Billy. Thank you both for being here.

Great. Thank you very much, Andrew. I'm going to share my screen so everybody can see the -- what we want to take you through. What we want to do -- what we want to accomplish today is we want to give those of you who do not know the Freshpet story, we want to give you the opportunity to learn a little bit of the basics and fundamentals, but that will be a really quick study. And then we'll give you an update on the business since we last spoke. So we'll go from there. As always, we have the usual safe harbor statement. I hope that all of you read at least 3 of these by now. Freshpet has got a very simple mission. We're in the business of nourishing pets, people and the planet. We believe we strengthen the bond between people and our pets so they live longer, healthier and happier lives together. And we want to do that in a very sustainable way, while protecting the planet. Until Freshpet came along, a dog's choices were really limited. They can get canned mystery meat or dry kibble. And it's not very exciting kind of food choices. Freshpet came along in 2006. And obviously, what you see on the right is our Freshpet rolls product, sliced up and placed in a bowl, and it was really the first major innovation in pet food since kibble was created back in 1956. Our Fresh From the Kitchen product, which is a shredded meat product, to be found in the right here, came along in 2015. And you compare that to what others consider the other wet pet food of canned pet food, which has been around since 1922. Obviously, this is a category which was ready for some major innovation and Freshpet is that next generation, that innovation. So we sell fresh pet food. It's all refrigerated. It comes in bags and in rolls, a variety of different sizes and forms of products at various price points along the continuum. We are sold out of Freshpet fridges. We are -- we own these fridges. They are company-owned fridges. They're in more than 20,000 retail outlets and multiple fridges in some stores, and they're all the best retailers in grocery, mass, club, natural food channel, pet specialty, you can find us in a variety of outlets in significant numbers of stores. We're also available via the leading e-commerce platforms. So whether it's online ordering for curbside pickup or whether it's buying from a traditional online retailer or if you're using somebody like Instacart to have it delivered to your door, we're available on all of them and that business is growing very, very rapidly for us. We just announced our chewy.com partnership at that began on July 7, so it's not reflected in any of the results that we have reported to date. But suffice it to say, if you're a consumer, we're available just almost any way in which you want to buy the product. So that was my basic introduction into what Freshpet is. I'll now give you a little bit of an overview of the category. Many of you have heard a lot about the pet category and why it's so exciting. I'm going to give you a little bit narrower view of it, but it starts with this concept of Zooeyia. And I think this is why the category has done so well. Zooeyia is a term that was coined in 2012, and it describes the positive benefits to human health from interacting with animals. Everything from the immune system development the kids gets from being around a pet as a child, whether it's the dandruff from the pet or licking -- the pet licking their cheek, as seen in this picture, all the way up through the motivation for regular exercise or psychosocial development, having a pet in your life makes you live a better life. And that, I think, is why we see the dynamic growth in the world of pets. Dog ownership is growing. We've all seen this. This is the statistics from the American Pet Products Association in their most recent pet owner survey. There are now 69 million households that have dogs in them, up from 63 million households 2 years ago, and total 90.5 million households that have any pet, very significant penetration. And the easiest way to think about it now is there are more households with a pet, more households with a dog than there are households with kids. And the number of dogs in each of these households averages about 1.6 dogs per household. So obviously, there are many multi-dog households out there. The category itself, though, is skewing increasingly towards the more premium items. And what you can see is the growth rate for the very high end of the category is in the high double digits. And the very value-oriented part of the category is down almost 20 points. So this makes for a very good dynamics, where we have a rising pet population and a desire to spend more on your pet. The category is increasingly becoming dominated by younger audiences. Millennials are now the largest share of the dog food market today. But as you'll see, Gen Z is now entering into the phase where they're getting a dog. And these are 2 audiences that are very appropriate for us. The millennials, they want pet foods that have human-grade ingredients, they are non-GMO or they're locally sourced. All of those things are the kinds of products that people associate with a higher quality, fresher products. But Gen Z is now the future of the category. Gen Z, just to remind you, the oldest Gen Z-er is 24 this year. So that means if the generation is 18 years in length, that means there's a dozen more years that are under the age of 18 that are waiting to get their first apartment or to get married or have their first relationship. And oftentimes, each of those comes with a pet. Roughly 50% of Gen Z-ers will, between the age of 18 and 24, will get a dog. So if you think about it, there's 4 million people who are in that generation each year, that means there are 2 million of them will have a pet in their household. So it's a fairly significant increase in the number of pets that's coming from Gen Z. And one of the things that you can see, as we're seeing in the data, is that these are people who love Freshpet. Their propensity to try Freshpet is double that of what you would have seen in the previous generations. And this is why we think that Freshpet not only has had a great run, but it has a very long runway ahead of it. our opportunity for amongst millennials and Gen Z to continue to grow and expand the category and expand with an extending pet population is very significant. So what have we been able to accomplish and what has been our strategy to do that? First owner highlight that we have a very strong and fortified business model that we think provides very significant barriers to entry. Not that any one of these individually is the thing that would protect our position, but collectively, they are all very, very difficult to duplicate. And they provide the foundation for a very long and sustainable runway for growth. Our manufacturing capability, we are right now in the process of constructing capacity that will take us from a $300 million business last year to a $2 billion business, meaning we have $2 billion worth of capacity under construction or on the plan on under -- being planned. Our supply chain, we're building significant scale in the supply chain, mostly the refrigerated supply chain, where scale and leverage becomes critical to getting an effective cost structure and to having products that -- reducing the product consumables. We have retail partners. 156% ACV today, growing that very consistently, but we're in the best retailers and in the best stores. And in many of them, we have multiple fridges. Our Freshpet fridges. We aspire to have 40,000 fridges out there. There's about 25,000 in total fridges that we own. It's over $115 million worth of an installed base of fridges that are company-owned company maintained heavily branded, and they reinforce our product point of distinctivity. Our goal is to get into 11 million households. We're in 4 million households today, and we have incredibly strong brand loyalty. Ultimately, the biggest barrier to entry, the biggest piece of protection that we're going to have is a highly loyal consumer audience because people don't change their pet food very frequently. Once they've adopted a pet food and if it works for them, they like to stick with it. And we have a very differentiated product lineup that we continue to expand. We keep coming out with new items that are designed not to deepen within an existing household, but to bring in new households. Products like a small dog product that is perfect for households who have a small dog. Where if you have a dog that had sensitive skin or sensitive stomach, we launched a product for them this year. We have products that are designed to expand the household penetration and deliver that to 11 million households. Our business model that we announced -- our strategy, our operating model that we announced back in 2017, we call Feed the Growth, and it's a very basic productivity loop that assumes that we start with advertising, increasing our investment in advertising, which we did in 2 steps starting in 2017 to the current level of about 12% of net sales is what we think is the right place for us to settle in. If we do that well, that -- what that serves to do is it increases the trial of the product. The product is so good that our repurchase rate has been very consistently in the 70% range. That succeeds at creating velocity for the retailer. The retailer responds to that by putting Freshpet in bigger fridges or in more stores with second fridges and third fridges. What that enables us to do is get higher visibility and availability, which amplifies the value of the advertising, means if we spend $50 million in advertising and we have small fridges in the middle of an aisle, that's less effective than having $50 million of advertising where we are in large fridges on end caps or second fridges in the highest velocity retail outlets. That allows us to then expand our capacity, which gives us scale and leverage on our cost structure, particularly on our SG&A, allows us to drive more efficiencies in our operations, and then we repeat. What most people didn't understand when we first launched this strategy back in 2017 is they thought that this was sort of like a racetrack where you get on the track, you get up to speed, you go around the track each time at about the same speed. Really, what this is about is the ability to accelerate. Each time you go around, each lap builds on the previous lap. So our rate of growth is continually accelerated as we've gone around this track, picking up momentum each time. We've gotten meaningful scale now. We now are a very sizable brand in the grocery channel, much smaller, if you look down at the pet superstore channels, but we now have meaningful scale and it is growing. In fact, if you look in the grocery channel, our total brand in the last 13 weeks is on par with Blue Buffalo and Pedigree against their total dog food business. And our velocity -- because we're not in as many doors as they are, our velocity is in excess of what theirs is. So if you're a retailer, you look at this business, it's now got scale and it's got velocity, and it's growing very, very quickly. We also have an international business. It's very much in its formative stage. We are in Canada. This chart shows what our business in Canada has done. We're using exactly the same model, company-owned fridges, branded products, advertising driven, we turned on advertising 2 years ago in Canada. And what we've seen is the market has responded just as it has in the U.S. And so in the last 4 weeks, our business has been up 44%. In fact, our international business is not dilutive to our total company growth. The U.K., it's a very similar phenomenon. They were in 2 of the leading retailers as well as in Ocado, and we have a very small direct-to-consumer business for an e-commerce play there, and our business the last 4 weeks is up 49%. We view both of these as the starting points for what could be a very significant long-term business. They're not meaningful to our total economics today, but they are seeds that we've planted for future growth, and we'd expect to develop very meaningful businesses outside of the U.S. This has all led to a very strong financial performance. As you can see, since 2017, we launched Feed the Growth, we've generated very consistent rate of growth, and we've guided this year to $445 million in net sales, up 40% versus a year ago. Last year, we were up 30% versus the year ago. The prior year, we were up 27%. So it speaks to this accelerating rate of growth that we get from that Freshpet productivity loop. EBITDA has come along with it. There have been times where it's grown faster than the sales growth and a little bit slower depending on where we're choosing to make the investments and what some of the headwinds we see along the way, but we fully expect to see an expanded margin over time. That's led us to our goals for 2025. Our goal is to go from 4 million households in 2020 to 11 million households in 2025, and that's the primary focus of all of our efforts, is expanding households. All of our advertising, all investment is geared towards that. And if we do that, our products will take care of the buying rate if the product is so good, and we'll see the buying rate go up from $117 to $162. Both of those growth rates, 23% CAGR on the penetration and 7% of the buying rate are consistent with our past 2-year performance. What will that result in? It will take us from a $318 million company last year to $1.25 billion company in 2025 for a 31% CAGR and it'll take our EBITDA margin from 14.7% to 25% with the bulk of the gains coming from SG&A leverage. So where are we in Q3? Obviously, we reported our results for Q2 at the beginning of August. So I'm going to update you on where we are versus then. Here's the quick summary though, the increasing rate of consumption growth that we had predicted would happen in August has begun to happen. We have reached that inflection point, and I'll show you what the data looks like. Our retail in-stock conditions began to improve. We had a hiccup in July, and I'll show you the data on that. The hiccup was related to downstream issues in our third-party warehouse, a labor-related issue, which they have since resolved. Our production and capacity plans are all on track to consistently expand the capacity of operations. We're up this year. Our capacity this year is up 40%, 47% in production in August ahead of a year ago. And we are starting up another line next week, going to a 24/7 operation next week on our rolls line and lots of other capacity projects are on track, including our new facility we're building in Ennis, Texas, which will be dried in next week, which means we are in control of our destiny, and we expect to start that up in Q2 of 2022. Our media is now on the air and will be continuously on the air through the balance of the year. It will be the first year that we've had significant media in Q4. In fact, we will spend significantly more in Q4 than every other quarter this year. It will be our biggest investment, and we expect that will give us a strong head start on where we go in 2022. It will also skew our growth this year more towards the Q4 then Q3 than we've seen in years past. Years past, those quarters have been roughly comparable. You should expect to see Q4 being significantly larger than Q3 this year. We are expecting that the back half of the year, though, will show 44% growth. Roughly 44% growth with it skewed towards Q4. There's obviously been a lot of inflation. We've all talked a lot about it. We have announced a price increase to our customers, effective with orders on 11/29. It's a 4.8% average price increase, but there's no item that goes up 4.8%. There are some items that aren't going up at all and some items that are going up considerably more than that. We expect a minimal impact on our financials this year, but it will help us with our margins next year. We've talked a lot about costs. Everybody is talking about it. We're no different. We're not immune to the issues of cost. We're seeing them in all of the same places everybody else is seeing them. And we believe that the price increase is in combination with some efficiency improvements that we're working on, we'll be able to offset that inflation next year. So what are the consumption trends? First, I'd start with this. A lot of folks were wondering when we were going to start to see the turnaround and we kept saying it would happen in August. Well, it has. You can see this is weekly Nielsen data. It's the growth versus year ago in the green bars. And what you can see is in the last 2 weeks, our growth rate has started to accelerate again, going from 13% in the second week of August to the 17% in the third week and 18% in the fourth week. I would caution that Hurricane Iota will fall in the next week that's reported when we get the data next Monday. And we expect that Hurricane Iota will slow that growth, might actually reverse it by a couple of points. just because of the stores that were closed for that 1 week or 10-day period. We do expect to see sequential consumption growth based on the data that we're seeing, but there will be a little bit of short-term hiccup due to Hurricane Iota, but the long-term trends are exactly what we thought they were. And this inflection point that we're seeing is exactly the inflection point that we have told folks was coming, and we are glad to see that it has arrived. And I'd point out that last year, we hit a brick wall on our demand because we ran out of capacity. So beginning in the second week of August last year, we basically flatlined on consumption as measured by Nielsen. With the exception of the 2 holiday weeks of Thanksgiving and Christmas and the troughs that came behind them, we were basically flatlined because there just wasn't any more product available. This year, we have ample capacity, significant marketing investment, much better in-stock conditions, and you should expect to see us continue to grow. And we expect to exit this year with north of 30% Nielsen mega channel growth versus year ago. It won't be the measure for Q4. It will be where we expect to exit at the end of Q4 and gives us a lot of momentum heading into Q1 of next year. Part of the issue with -- as people are looking at the data in the market, most of the publicly reported Nielsen data does not include the pet specialty channel. The data that we reported that Nielsen mega channel does, it includes xAOC plus the pet specialty channel. And the pet specialty channel has been our fastest-growing channel all over this year. And so all the publicly reported data has understated the growth that we are actually seeing and experiencing. This shows you the last 4 weeks in the last 13 weeks in Nielsen consumption data with the green bars are what's happening in big box pet. And you can see we're seeing growth in the 40% range there. This is part of why our numbers are consistently higher than what you'll see publicly. We expect to see the 2-year growth, a 2-year stack break 60% in the coming weeks. It was there actually last week. This week, the year ago, it was a little soft. But as the numbers get back into the high 30s and low 40s in the year ago, and we get to growth in the 20-plus range this year, we'll be north of 60%. We'll exit the year with a 2-year stack north of 70%. Penetration and buying rate are what we're all about. As we've had significant out of stocks this year, we've seen a slowdown in the penetration gains that we're making below our historic rates, but we've seen an increase in the buying rate because what's happened in the past has been the penetration gains that we've been making have diluted down the buying rate increases of the existing users. And so as you add fewer users because of the out of stocks, the existing -- the benefits that we see on the existing users are amplified. So our most recent period, we're up 13% on penetration amongst our total sample, up 18% amongst, what we call, core dog users. Core dog users are people who buy our main meal items, not our cat items, not our treats. So again, significant household penetration growth, but below what our long-term trajectory has been, frankly, because we've gone for a year now with significant out of stocks. The buying rate, on the other hand, has responded to this because the people who were buying our products are no longer being diluted at the same rate. So the buying rate is now up to $130, up 15% in the latest period, up 11% on the main meal buyers. How are retail conditions coming as we've tried to improve our conditions? We had short shipments in July, very significant. It was not a production issue. We actually produced very strongly in the month of July other than the 3 days we took for maintenance of our operation. But you can see in the chart on the left here, a very significant drop in our gross sales, which is a measure of our shipments, and that was entirely due to labor challenges at our third-party warehouse. They had solved those, and we've seen the bounce back that you see in the green line on the chart on the left. But the consequence of that was significant out of stocks that are reflected in the chart on the right. That data takes you through the middle of August, August 14, which we believe, based on our own internal data, and that chart I'll show you in a second, that's the bottom. That's where it ended. And they have since improved fairly considerably. We know that because of our own internal tracking of retail conditions, but also this data, which reflects consumers calling us and asking where they can find the product or telling us that it's out of stock. You can see the ramp-up that happened when we had the issues in July. You can see it's now come back down as we've headed into September. So we're very comfortable that the surge of production that we've been making and the improvement in the warehouse labor conditions have restored retail conditions to where they were before July. And we still have a ways to go to get back to exactly where we want it to be on total retail conditions, but it's moving in the right direction. How are we doing on visibility and availability? As you might imagine, when you short ship customers for a year, they're a little bit slow to add more stores or frankly, we encourage them not to put fridges in stores where it's discretionary in the plans until we can supply the existing stores well. So while we continue to add stores, we're up to 23,000 stores, the reality is that it's just not the same rate of growth that we've seen in years past. We do expect to see that accelerate again next year as our supply situation gets better. Another metric for us is fridge upgrades and second fridges. And it's, in fact, a very important priority. And we've exceeded our guidance for the year in both of those categories already. So the customers who were determined to put up a larger fridge in or a second fridge have already done that, and we're making good progress on that. How are we doing on production? We are now producing on average about 44% more pounds than we were in the year ago period, and that's enabling us to refill this trade inventory hole that we had. It's -- we are now bringing on also more capacity beginning Monday, we bring on another line at our Kitchen South facility with a 2-shift operation. And we're also taking our rolls line in our kitchens to a 24/7 operation on Monday. So you should expect to see this gap get even bigger. So our capacity is delivering the expected increases in throughput. We've also been producing in excess of demand basically this entire year. So we've been refilling the trade inventory hole all year other than when we had snowstorms back in February, and we've had holidays this year. So this measures our production versus Nielsen reported consumption. You can see what our production has looked like on a monthly basis, July was a little low because we took 3 days of much needed maintenance time, but we were up 47% versus a year ago in August, and we'll be ahead of that in September. We're adding lots of capacity which you can see as the chart on the right hits on the key drivers this year of the capacity additions that we're making. We've hit every one of the milestones that we've talked about. The next 2 on there, we will hit this coming Monday. And then there's another line that will start up between Christmas and New Years of this year but not produce sellable product until sometime later in January of next year. But all of those projects are on track on timing, and we're very encouraged by the increases we're going to get. This is the first time we're sharing with folks what our capacity is going to look like next year. This shows our roles in bags capacity by quarter so that you can do a better job of projecting what our theoretical potential is. Our expectation, though, is that we will have more capacity than we will have demand for the first time in a long time, and that will allow us to restore our inventories, make sure our customers are in good shape, give us the buffer for some overruns if we end up growing at a little faster rate than you would have otherwise expected. But we feel very good about these increases. You can see it's a very sizable step-up in capacity per quarter. We're also putting in more efficient capacity. We have significant work underway to increase the throughput of each of the lines and then find lines that are more capital efficient, meaning to take up less space and produce more product. per square foot. And each of those initiatives is well underway, and we can take you through those in more detail at the right time. Additionally, we've had only 1 DC, which kind of constrains our logistics efficiencies we just opened a second DC on an experimental basis. It's a -- shipping only to a small number of customers in Oklahoma. The DC is in Dallas. But once we're up and running with our facility in Texas, having a second point of distribution will enable us to lower our logistics costs and improve our service reliability considerably. We do expect to see continued improvements in margins from technology, but there will be some variability as some of the manufacturing is done by our partner in a facility that they own, they operate, but it includes our technology, our equipment. We own the equipment, it's exclusive to us. So the mix effect between self-manufactured and manufactured by our partner will have an impact on the margins over time. But there will also be impacts from forms. So bags versus rolls, there's different margins and there will also be the technology improvements. each line that we put in, it's more efficient than the line that preceded it, and that's giving us a very significant improvement in the operating efficiencies of our operations. Ultimately, we expect to add $2 billion in capacity, have gross margins that are in excess of 51%. In total, we'll have $2 billion in capacity by the time we finish the second phase of our Ennis project, which would be in 2025. So if you think about it, we've set out a goal of $1.25 billion, but we're building $2 billion in capacity, and that's frankly because you can't arrive at $1.25 billion and then say, let's start building the next increment. You have to have it ready to go, and also gives us the ability to flex into increased opportunities as they come along. But it's a very significant increase in capacity because we think the opportunity is that big. And that's what Freshpet is all about. We want to get to 11 million households by 2025 under our Feed the Growth strategy, $1.25 billion in net sales. So with 31% CAGR in the growth rate from where we ended 2020 at a 25% EBITDA margin, we think it's a very compelling story. We feel really good about it. But even better than that -- that's my dog Oppy you see you over my shoulder. She likes that we're making more food all the time as well. So that's the Freshpet story. So thank you, Andrew.

Billy, thank you very much for that super informative presentation, and I think a lot for people to really think about and process there. So, that's a great place to leave it. We appreciate your time, and I look forward to tracking your progress going forward. Take care.

Thank you.