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

Hello, everyone. Thanks for joining us today. My name is Brian Holland, senior research analyst at Cowen, focused on sustainable food and healthy living. This past Friday, we launched Phase 1 of our coverage rollout around this theme and published a report on the future of food, where we believe the convergence of the ongoing effects of COVID-19, emergence of Gen Z and rise to sustainable food production poised to bring about perhaps the most dramatic sea change in consumer behavior and generation. One area where these are converging is pet food with perhaps no better company -- no company better aligned, excuse me, than Freshpet. As such, we have installed the company as our top pick here. I'm excited to have from the company, Co-Founder and COO, Scott Morris. Today's event will be a Q&A format. I obviously have a list of my own to get to, but we certainly welcome questions from the audience as well. So at any point in the conversation, feel free to post a question, and we'll work through as many as time allows. I should also point out, I specifically wanted to have Scott on in this forum to talk about the brand, how he and his team have built and cultivated it and how they are positioning for the future? So that will be the focus of today's discussion. Please we will be hosting corporate access with the company later this month. And as part of that, I will be recording a deep dive podcast with CEO, Billy Cyr. So if there are any questions you have that Scott and I don't address today, please feel free to drop me a line, and I will include them in my conversation with Billy. So welcome to the Second Annual Cowen Health, Wellness and Beauty Conference. When I think of Health and Wellness, I think of Freshpet. When I think of Beauty, I think you, Scott, how are you?

I'm good Brian. Thanks. I don't know if most people would agree with you, but I'll take the kind statements.

Let's dive right in, the humanization of pets on the surface. It sounds like a lazy thesis for someone in my seat, but I do think it's underappreciated the extent to which we've migrated pets into our families. It's still, by and large, be them dry kibble or wet can. Can you provide some context on the lack of innovation in this category historically? Why that is? And why we -- where we stand today in that evolution?

Yes, sure. It's interesting because I think it has been one of these conversations that's been very, very talked about. But it's interesting because I think the response in the category has been very, very glacial. I mean I think it's really been very, very slow across the category. So I think it's one of the most talked about stories. But I also think it's -- maybe going all of CPG, all of the humanization of pets. But I think it's the one that everyone knows and then maybe didn't respond to or overhaul their business around. And I actually -- it's probably like most things, quite honestly, in light where people talk a lot about it, but how much do you do about it. And the humanization thing, it is absolutely fundamental to what we're seeing from a consumer behavior standpoint and how it's playing out. And it's been for -- it's literally been, like I said, for basically a decade and it's been across all generations. But if you really want to see it perfectly played out, you look at millennial and Gen Z. And I know that, that's something that we'll probably talk more about in the next like 30 minutes or so we have here. But the way they think about their pets in their lives and the way all consumers think about pets in their lives, it really has changed and it's continuing to change, and they're -- what they're expecting from the companies they buy from and the food they buy is -- really is changing. So I do think it's about humanization of pets, but I don't think the industry has done much better about -- much about it because what the industry has pretty much done is they've taken a kibble and made it better or prettier. They put more meat into it. But basically, it's still a starch carbohydrate-based food, which is maybe not always ideal for dogs. And I think lots of people are doing good work, but I don't think anyone's been willing to kind of pass out their know-how, their manufacturing model to really build a humanized pet food. So maybe another way to think of it is if you have billions and billions of dollars in equity and know-how and capabilities and maybe industrial infrastructure in an organization, and you're growing at maybe 2%, 3%, 4%, 5%, you're feeling pretty good. And I think that most of the time when there's big innovation, it's because of necessity. Like kind of the idea of this necessity is the mother of innovation. So I feel like most of the industry hasn't felt like they've had to innovate as much. They basically have looked at it. And they said, you know what, we're in pretty good shape. We have a good growing business. And this is what we know how to do and doing something very different. Honestly, it's really, really hard. So I think that typically, the most significant innovation doesn't come from the incumbents. It comes from like the new folks. We're the new folks. We had an opportunity to kind of completely start from scratch, reset what the company was about, how we operate, the products we make and what we wanted to build. And I think that's put us in a really, really encouraging position right now. And I think now what's happening is many of the folks are realizing, "Hey, humanization is bigger than maybe we thought. And I think that we're going to need to do more innovation." And I think initially, it was kind of this whole idea of fresh food was written off as a niche. And I think that people are now recognizing that at some point in the foreseeable future, it should be -- could be 20% of the category.

So why don't we go there real quick. For those of you or for those who haven't had the opportunity to meet you, just provide some brief background sort of where you were before Freshpet and kind of the inspiration for developing this brand?

Yes, sure. So I've been in CPG, it's hard to say, but for 30 years now. And I started off at a large multibillion-dollar Messi Purina, so a large multibillion-dollar company. And I would say it was really classically trained in all areas of sales, marketing, management. But I felt like it was always an entrepreneur at heart, and it's really what I brought. I think all the organizations and companies that I've interacted with over time, I did a stint as a management team in private equity which is really, really interesting and really causes you to think differently about managing a business and a big established business. And then over time, in my kind of personal journey, but also in my business journey, I've become more and more kind of awakened around what was good food, what was good nutrition. And when I saw the opportunity for this idea, you brought out humanization of pets. I saw the humanization of pets. I saw people thinking differently about how they want to feed their pets. And then the trend in human food, in general, and then those things together really kind of coalesced and became an opportunity to create Freshpet, which is fresh refrigerated all-natural food to bring it to market and really disrupt a significant category that didn't have quite the innovation because people had all of that infrastructure tied up and making kibbles that go on to a meat that goes on a shelf, that can sit there for up to 2 years or meat that goes in a can. And so we just don't think there was an incredible opportunity to really change the trajectory of the industry.

You talk about that value proposition that Freshpet has, but -- so within the context of humanization, but sort of -- how do they think the Freshpet brand, the humanization, bringing it together? And maybe -- we'll get to the other part later. Go ahead.

Okay. Yes. Well, let me talk about that a little bit. So if you think about -- I don't want to get too far on pet foods, but I think it's important. People and pets have been living together for 30,000 years, is really the thing that you hear. And it's early on that relationship and -- was primarily functional in many ways. So it was like the pets were there to help us hunt, protect our herd, protect our families, act as a guard dog, no matter what it was. And now it's actually migrated, and this is really important when we get into the value proposition of what Freshpet's bring. Now it's really migrated to helping kind of our physical, our emotional and really the fulfillment of our lives. And what you're seeing out there today, and there's more and more articles about this, if you Google it like living a longer life with dogs, right, you'll see tons of research and tons of different articles on this. But people are living longer, healthier lives with pets. Pets live longer, and we live longer. And there's a lot of reasons for that. So yes, it's because we're out taking them on walks that we feel responsible that it's just caring, that nurturing, they meet you at the door. There's even a microbiome benefit that the diverse bacteria that pets bring into our lives really helps us. And all those things coming together, along with consumers knowing that there needs to be better food, better nutrition, like on the human front, they're thinking about, I want to eat better. I want to eat simpler, more natural and less processed, and they kind of understand that those same ideas can apply into dogs and cats. So we believe good nutrition comes from food, it comes from ingredients and not manufacturing. But it's limited manufacturing, so we make our food as simply as possible with as simple ingredients as possible. We process them as little as possible using basically all natural ingredients and keep them refrigerated to keep them fresh. So we don't just want to basically make a food. We were -- it's almost a mindset in ideology. We want people to live longer, healthier lives with pets and us providing great, healthy, simple natural food for people, pet parents to provide their pets kind of helps pay back the favor of us living longer lives together. So I think that's kind of the core value proposition. So I know it was a really, really long answer. But the short answer is we believe that this human animal bond has changed, this idea of humanization of pets. We live longer lives together. We believe fresh, healthy, natural foods is at the core of that for both people and for pets. And we make that food for pet parents. And we also want to do it in a company that's very thoughtful, sustainable and focused on not only current but also future generations of pet owners.

So as part of the analysis that we did, ahead of putting out our initiation report, was sort of this notion that pets are replacing children in the home, particularly among younger generations as family formation is increasingly deferred. What do you see at a macro level? And aside from simply, they're just being more pets, why does this dynamic present such an opportunity for Freshpet?

Well, it's just -- I mean it's fascinating to see it. And again, this goes across all generations. But if you really want to like illustrate the point and you look at what's going on with millennial and Gen Z, for lots of reasons, which we really won't get into here, they are deferring having children. They're bringing in pets into their lives as their children, and that child really never grows up. That child is always at a toddler phase, if you want to think about it that way. And they're changing their entire lifestyles around their pets. It's -- a lot of times it's where do I live? I mean I hear it all the time, we've seen it in research, they're changing where they live. I need to -- I want to move so I can have a backyard from my dog instead of living in a city, for example. They think about it when they're going on vacation. They think about the jobs, can I bring my dog to work? I mean there's even -- there's different companies now that instead of basically in a condo complex or an apartment complex, instead of having a daycare, there's a dog daycare. So it's changing even where they're living. And we -- fortunately, we significantly over-indexed with those groups. And -- but we're not -- and we've shared some data on it, but we're -- I think if you look over the past year or so, we're at a 200 index on Gen Z, we're at 160 or 80 index on millennials. So significantly over-indexing with sourcing consumers from those groups. But the goal is we've built the right company for them, but really the goal is not what we did today, but what we want to do tomorrow. So we're literally looking at restaging one of our brands significantly, and we shared a little bit of that around Nature's Fresh, but also bringing in many new products that appeal specifically to those consumers because I don't just want to do well with those consumers, I want to win now and I want to win over the next 10 years with that consumer group because they're the ones who will be the pet food category in the future, they're the ones who are getting more pets and they're the ones who have the tightest, closest relationship and they're changing their lifestyles around living with their pets.

And if I could just interject here. Forgive me, everyone and Scott, as I tried to battle Sunrise here in Portland, Oregon and playing picaboo here with the Sunrise coming through and trying not to get too blown away by the screen. I will also tell you, while we're on the subject of Portland, and to your point, Scott, where people in their 20s go to retire. On my walk to coffee in the morning, I pass more dog daycares than children daycares. It's -- and in every direction. It's pretty amazing. You -- let me ask this question. What are the top trends in transforming health and wellness broadly as you see it? And sort of what's the secret sauce to captivating these younger millennials and Gen Z?

Yes. I think that is critical. I mean one of the things that I think we've seen over the past -- this is -- everyone talks about COVID accelerated lots of trends, whether it was work at home or no matter what the trend was. So I think that overall, the world has become much more awoke on this idea of being responsible, being sustainable. Eating well, I think, is something that people have -- I mean I think there's 2 sides to that one. I know people were probably drinking more and snacking more during kind of being locked up in COVID. But I think that people are definitely aware that they want to eat better. But I think this idea of sustainability, and that's a big word that means lots of different things to people. I think that's a core trend that's changed people's mindset. And I don't think they know really how to exactly be sustainable, but I think they aspire to be more responsible and more sustainable in their lives. I think that is a fundamental change. I think it's been very, very broad. I think that it's something that was underlying and coming out with millennial or -- millennial, Gen Z or GenZennials as we started calling them a lot. And I also think that, that is one of those pieces that will drive health and wellness for the next decade forward because it's not just about health and wellness, it's about what the types of companies I'm buying from, the types of products, where the ingredients are coming from, how it's sourced, is it responsible labor practices, is the packaging environmental, how is it made, what's the impact on the environment there? So I think it's a really, really broad, it's not just in it for me. It's what's in it for we, is the term that we like to think about around how these people are kind of shaping really the future of food.

You introduced a new brand, Spring & Sprout. Will launch in 900 Pepco stores this month in front of a broader rollout in 2022. Obviously, as with any brand, line extensions primarily are looking to either tap into a new occasion or consumer base. So what's Spring & Sprout's purpose?

Yes, that's -- it's really important. I think I mentioned a minute ago. So we have multiple brands that are spread across some different retail formats, for example. So we have a brand called Vital that's really focused on pet and pet specialty. Freshpet Select is our more mainstream brand. They're all under the Freshpet umbrella, all the fair to say Freshpet. We bring different features and benefits with each one of those brands. And one of the things that we recognized was we had a significant opportunity to do even more with millennials and Gen Z. I talked a little bit about Nature's Fresh and Vital. We'll be taking Nature's Fresh from where it is today, and we'll be positioning it much more focused on millennial and Gen Z. So Nature's Fresh, for example, it's stage 1, 2 and 3 carbon neutral. We use gap-rated needs. So we've really kind of been thoughtful on that brand. It's been out for many years. It's been in the natural channel, more focus on natural channel, but it's also now expanding, and we're going to be continuing to do more work there. We also recognize that there is a real opportunity to bring another product or another brand or sub-brand out. And we're calling it Spring & Sprout. And there were a couple of things that we noticed. One of them is more millennial and Gen Z are vegetarians and vegans than any other generation by far. It's almost like 2x. So when they're feeding their pet, they're really struggling around using meats as the core and what they need to feed their pet. And we -- but they also recognize my dog is an obligate cornerboard. So it can get meat that needs to be kind of the basis of his diet. So we felt like there were -- that was going on, and we also felt that there were a lot of issues across generations around animal ethics because I think, again, people are becoming more aware of it, and also the environment. So if you think about animal ethics, like how animals are raised and farmed and how they're treated along the way, but then also the environmental impacts of the animal were raising. I don't -- I mean 10 years ago, there was very, very few people that knew that how much -- how many calories or how much water it took to raise animals. And I think now, today, people are becoming aware of wow, the meat that I am eating can have an impact on the environment. So I think it's people come working around that. So millennial, Gen Z or GenZennials more focused on vegetarian and/or vegan. You have this idea of animal ethics that spans everyone that, again, people have really woken up to and then the impact of the environment. You take those 3 factors together and what can we do differently in pet food and be more sustainable and address those things from a consumer standpoint, and that's really was the challenge that we brought out with Spring & Sprout. So it's basically a plant-based protein. We do use egg in the product. So it's an animal product, but it's not an actual animal itself. And we've been able to put together a plant-based or a plant protein-based dog food that follows the same principles that we typically do, which is as simple ingredients as possible, as less least processed as possible and refrigerated to keep it fresh, and it's natural. So we've been able to bring that together in Spring & Sprout. It's launching in a handful of stores this year, and we'll continue to expand our next year. It's -- we think it's a great entry. It's the first -- we're the first people that do anything in the fresh and really even frozen category that's basically a plant-based, protein-based food. And we think that affords us some really significant benefits both in palatability to also visual for consumers, and we're incredibly excited about the product. And this is a product, but now it's going to turn into a brand and a line over time. So we hope in 12 to 18 months, we have an entire portfolio of plant-based protein products that we'll be bringing to market. And that will be one additional piece that helps propel our growth over the next, really, a decade or so.

Great. Appreciate the rundown on that. I believe I've seen Freshpet copy on TV personally, no more than whatever. It would be fair were cord cutters. But in the past few months, I've actually heard your spots on a few different sports podcasts I listened to first-time ever. So that's new. How has the media strategy evolved? Who are you targeting? And where are you looking to find them?

Sure. So we're very, very proud of what we've done from a media, investment and return standpoint. So I think we've shared some information around this over time. But typically, our consumer acquisition costs or CAC is around $50. Now most packaged goods companies, you will not hear them talking about CAC. That's typically more of an online method. But we do think about our business that way, we think about it from return on ad spend, we think about it from a CAC perspective and we think about how do we spend our dollar across every different channel to reach our consumer. Historically, we've been a very heavy cable buyer, and we've also tested OTT, Connected TV and all types of digital advertising, marketing, social marketing, social advertising and influencers, et cetera. And I always like to say we're completely media agnostic. It all comes down to where we get the best return to the mix. So we've been able to keep that model consistent. Really since 2010, we started testing, and we were able to show that for every 100 GRPs that we run, we get a 1% increase in same-store sales. And we've been able to hold that model all the way through and those returns all the way through, which has made our business as we invest media very predictable on a growth standpoint. There's been times when we've done better, and we've had great innovation or a lot of retail visibility. And we've gotten -- we've overperformed and there's times where we slightly underperformed, but the model stayed very, very tight over a very, very long period of time, almost 10 years. So as we continue to grow and target out to -- in 2025, where we're targeting to have 11 million consumers in the franchise. One of the things that we started recognizing was there was a significant opportunity to widen our target and not just go after kind of a female, and we used to be 35 to 54. We've since stretched that down to younger women, especially the millennial, the GenZennials as we -- I referred to them earlier. But we also now start to expand that into a male target because what we started recognizing over time was it used to be primarily a female household or a female-driven household that find the products. And now we're starting to realize it's almost a 60-40 mix of female-male purchasing the pet food in the house. So how do you reach male? So we have tested sports, NFL, a lot of football. We just advertised a little bit in the U.S. Open, but not as much as we had planned based on some of the supply constraints. And we've gotten incredible return. And we think it's another area to open up to a broader group of consumer. So the television is -- really works for slightly older. We fill it out with digital to get to younger, and now we're moving into sports to really target more younger male audience.

Yes, so...

You're going to be in that younger male audience, right?

Yes. As far as you know, yes. So let's expect the current capacity constraint dynamics. So Billy provided an update last week at a competitor conference. Among the highlights, pounds produced in August grew at the highest rate so far this year and perhaps some very early evidence that scanner trends that folks have been sensitive to may have troughed. Certainly, that's encouraging because it -- as your supply situation improves, you could spend more on advertising and resume fridge placements. So talk about the amplifying effect of bringing your various drivers of awareness and visibility together? And your confidence that as these activities resume in force later this year and into early 2022, that we'll continue seeing the same kind of momentum that folks have been used to?

Yes. So it is interesting because I think that we're -- I mean obviously, it's really important to have great performance in all periods. But we were facing kind of a unique year ago period where there was a massive acceleration up, and it caused the Nielsen's to get a little tighter in growth rate, but now we're seeing them in the last several weeks, we've seen consistent expansion back into the growth rate, from teens into the early 20s. We expect it to grow into the 30s. And then for the second half of the year, overall, we should be up about over 40% for the back half of the year. And really where -- like what this transition -- the transition, if you think about it, initially, this was a -- we didn't have enough infrastructure and lines to run. 6 months ago, 8 months ago, we didn't have enough lines finish to run before we opened Kitchens 2.0. And then what happened is during COVID there -- I mean obviously, just like everybody else, we're facing labor and people, team member for challenges where some people left the work for us, some people moved jobs, some people retired early, no matter what it was. So we turned it to now we had lines available, but we didn't have all the people trained to run the lines to meet the demand that honestly is actually a little bit above where we had budgeted in the beginning of the year. So I think in the near term, that will rectify itself. It's -- we're solving it because we just -- we're opening that we're adding shifts, we're adding another line in the September into October period, we'll we get another line in a brand new line, and then we'll continue to open up lines over the course of next year and building up to analysts which should be in kind of the first half of next year. And from really -- once we get to -- I mean in this period, it's starting to open up where there will be a lot of capacity. But when I get to the middle of next year, we will have almost unlimited capacity. And now the challenge will be how do we grow faster to fill the capacity. And so there will be no constraints whatsoever. So I always like to look at what's happening now and what's happening in 30, 60, 90, and even within the next kind of 6 months. It's hard to truly impact that on these really long-term things, capacity, for example. But if I look out to the back of next year, it's truly we're going to be in a unique position almost like we've never seen before. We'll be able to grow as fast as we can possibly grow. And you'll see us kind of really pulling out all the stops. You'll see more innovation coming from us. You'll see more advertising than ever before that we spent, especially in the back of the year and over the course of the total year. And you'll also see continued expansion across retail.

Perfect. Consumers and customers and I doesn't like to see out of stock. It's been the topic investors have been most keen to talk to me about the past couple of days. And it feels like [indiscernible] linger for some time, so let's take this in 2 parts. First, what are consumers doing when they can't find the Freshpet product where they're accustomed to? And do you have any handle on how much this has impacted either attrition among existing households or hindered your ability to convert new households?

That's -- it's very important. We track it very, very closely. And what we have seen is that we've been pleasantly surprised at the number of new households that have continued to come in, and we have -- we'll share penetration data over time. It's continued to grow nicely. It's up into the over 20% versus a year ago. So it's growing very nicely and really been kind of showing significant growth. And I think the thing that's important when you look at something like this is we're disappointed to not be able to make enough product for everybody. We're always disappointed in that. We want to move through that and get everyone as much as they possibly want. So I think it's -- what's important to recognize is if you look at this business, and I've been in since 2006, right? When we started the business in 2006, we have faced over time adversity over time. And there's -- whether it's been supply constraints or availability early on, I couldn't find it in my store or things have changed. We've had years and years past, we've had some quality issues. And the thing that this business has demonstrated time and time and time again, because we built such a compelling product, we've worked hard to do the right things with great products, make it accessible to consumers really a fair value, create palatability, extraordinary attrition. If you look at all those aspects, it's been very quick to bounce back in every way. So I think that where we've had to kind of -- we have not been able to grow as fast as we would like and consumers would have liked. Typically, the first thing they do is they look for the role is not available that they want, they look for another role. If they can't find that, they maybe go to another flavor. If they can't find that, they might go to a bag or the other thing is some people will skip a purchase or so, but because over time we've seen this a few times, we've seen people come back to the business very, very quickly because they like the product and their pets like the product and they really see the difference it makes in their pet. So I'm very confident that if we disappointed people along the way, I know we have disappointed some, I did the apology tour, if you've seen my notes and also a video that I put out on Facebook earlier this year, in Instagram. We put out messages to explain to consumers where we are. The outpouring of support was extraordinary. I don't know if you looked at any of that, but the outpouring of support from consumers was amazing. They were cheering for us. They want us to get better. Have we missed some purchases with some people? Absolutely. Were we growing at an amazing rate over the course of the year? Yes. And do we see the business responding to the media we started to put back on in the very near term? Absolutely. We've started to do a little bit of media as we've had a little additional capacity in the past couple of weeks. We've seen immediate bounce back in the business. And I expect it to be 6 months from now, we'll look at a slight maybe hiccup for a short period of time, and we'll have grown -- we'll grow right through it.

All right. Great. We'll have to leave it there. Scott. Thank you so much for joining us. I really appreciate the time. As always, I thank everyone online for joining us as well. I hope you found this to be a great use of your time. Scott, best of luck to you and the team going forward, look forward to watching your progress.

Thanks so much, Brian. I appreciate the time. Nice to see everyone.