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

My name is Bill Chappell. I'm a senior consumer analyst at Truist Securities. And I'm pleased to introduce Freshpet, a leading packaged food company for pets across the U.S., Canada and the U.K. Freshpet as you probably know, sells their refrigerated premium pet food and their company-owned coolers throughout over 20,000 coolers in retail doors such as Whole Foods, Walmart, Costco, among others. About 7 years ago, this company went public with $87 million in revenue. 5 years ago, Billy Cyr, the CEO, who's with us today, joined the company with -- and had about $130 million revenue They'll finish up this year with close to $420 million of revenue, now expanding, as I said before, into Canada and U.K. and into most major retailers throughout the U.S. And have a long runway of growth from here. They've had a couple of hiccups on supply chains like for the rest of the industry over the past few months. And I know Billy will talk to us about that, talk to us about the opportunity and usually brings a few hundred charts and graphs along to demonstrate his point. So with that, Billy, have at it.

Thanks a lot, Bill. It's a pleasure to be here. And I'm going to share the screen and take you through my few hundred charts that we'll get everybody to understand what we're doing, what we're all about. But as Bill said, this is Freshpet. The picture behind me is of my dog, that's Appa. She is the fourth Samoyed that my wife and I have had since we first got married. The first 1 was to hold off having children. The second 1 was to accompany the children, the same with the third. And the fourth 1 was to fill that void in our lives when the children flew the coop. So she is probably the best fed dog in the world. I want to take you through, we have the usual collection of safe harbor statements. If I can get the thing to move forward. Here we go, safe harbor statement. I want to take you through what our mission is and what we're all about as a company. This presentation was published on our website yesterday. And so you can take a look at it. Because of time limitations, I'm going to fly through some of them, but we'd be glad to answer questions about them in the breakout session that happens after this. But our mission is very clear. We're all about nourishing pets, people and the planet. We think that pet without Freshpet can help us strengthen the bond between people and our pets so that they both live longer, healthier and happier lives. And we want to do that while being kind to the planet. And that's been built into the business model from the very beginning. It is the way in which we operate every single day. And it's frankly 1 of the things that makes us very appealing to the younger generation of consumers, millennials and Gen Z, who are getting their first pets or are very active in this category. I wanted to give you a quick summary of what it is that I intend to cover today. Some of the stuff we'll do in more depth. I'm going to start with a summary of 2021. As Bill said, we stumbled. We stumbled in 2021. There's no doubt about it, but we didn't stumble in terms of our ability to generate demand with consumers. We stumbled on the supply side. And what happened was we underestimated the labor market and supply chain difficulties and you've heard from everybody else. But frankly, they were particularly acute for us, because we are growing 35% in the middle of this, and we're a relatively small company. So we had what would be called the growing pains on top of all the things that everybody else felt. But those things resulted in significant inefficiencies, shipment shortfalls and inability to raise prices to offset inflation in a timely manner. And I'll talk a little bit more about that. But despite that, we delivered our fifth consecutive year of accelerating net sales growth, up 33% in the year. We did reaffirm our adjusted EBITDA guidance for the year in the press release we put out yesterday. Our consumption growth is continuing to accelerate. It did slow in the middle of the year due to out of stocks that we had, significant out of stocks, but we ended December with the last 4 weeks being up 29% and accelerating. We have our new advertising on the air. Our highest scoring ad ever, a new advertising campaign. I won't show you the ad itself, because this format tends to not work very well in this environment, but I'll give you some visuals from that. A highlight for us is the total addressable market. It's a sure sign that we are on trend, and I'll talk more about it, but the addressable market continues to expand and it's not a surprise. Our capacity expansion plans remain on track. We're adding significant new capacity to keep up with the demand. And we are also anticipating like everybody else, significant amount of inflation, and we are going to be taking pricing to account for that inflation. For those of you who aren't familiar with Freshpet, before Freshpet, this was basically what your dog's choices were, dry kibble or mystery meat in a can. Those products have been around for a long time. Canned dog food's been around since 1920s. Kibble has been around since the 1950s. But like every other food category, it was due for an upgrade or an update. If I grew up on dried and canned food, but I'm 58 years old. At this point, the category of pet food needed an upgrade, and that's what Freshpet is. So this is a $30 billion industry that's stuck in 1950. And this gives you sort of what the comparison would be. This is what Freshpet, a roll of Freshpet chopped up, looks like compared to kibble. And this is our Fresh from the Kitchen product compared to a can. And obviously, all of us can see the visual difference and understand there's a huge difference. The product is incredibly good tasting, dogs prefer it significantly over all other pet foods. We also have nutritional benefits. There's a significant improvement in the amino acid, essentially amino acid bioavailability, because of the way the product is cooked. Rather than overcooking it to death, we lightly cook it and pasteurize it. And as a result, you get significant essential amino acid bioavailability advantages and that is a published clinical study. We also have a higher percentage of our calories that come from proteins. About 50% of our calories come from proteins, and that's much different than where most of them come from the dry dog food comes from grains. Consumers notice this difference. They noticed that after they've been feeding their pet -- Freshpet for a period of time, they see physiological differences in their pet. They see a higher energy levels, shinier coat, firmer stools, healthier skin, fresher breath, less stinky breath, a whole host of benefits. And so there are confirming aesthetics, not just for the dog, but for you as the pet parent that feeding and Freshpet is delivering significant benefits. And there's also a very high level of satisfaction with the product. The consumers give us a sense that the product does meet their needs quite well with very, very high-level satisfaction. This is what our product lineup looks like. This is just representative examples, but we sell rolls and bags. We also sell some patties in our home sale creations lineup, but a ride variety of products. The products are sold in our Freshpet owned fridges that you can find in a wide range of retailers from grocery to mass to the natural channel to the pet specialty channel to the club channel. We're even available now on chewy.com. We built a business that has significant barriers to entry every step of the way and they get stronger, the bigger we get. And it starts up in the top left there with a highly differentiated product, and we continue to add to that. With very high brand loyalty, driven by the product quality and the product experience, with the Freshpet fridges that we own and maintain in the -- as Bill said, there are now over 25,000 Freshpet fridges in stores across the U.S., Canada and the U.K. We're in the best retailers. We're 9 of the top 10 pet food retailers in the United States. We're building significant scale and distribution, refrigerated distribution, which is unusual in the pet food aisle and in manufacturing. We have $2 billion worth of capacity that is under construction at this point. And it's going to give us a significant advantage, not just in the scale and leverage it provides, but also the expertise that we have. This is the business model that we've been operating against for the last several years. We call it feed the growth. And it's pretty basic, simple business model that it's a virtuous cycle. Starts at the top, where we invest in advertising and innovation that drives household penetration gains at a very consistent and reliable rate, which turns into increased velocity for the retailer. The retailer tends to respond to that by increasing the amount of visibility and availability of Freshpet by putting in more or bigger fridges in their stores. So they go from a small fridge to a big fridge, a big fridge to 2 fridges. They put 1 on the end cap, 1 in the aisle. We even have 3-fridge islands in a meaningful number of very large grocery retailer stores. That then creates the volume and the velocity that causes us to expand our capacity, because of scale on our COGS and SG&A lets us drive efficiencies and then reinvest in advertising and innovation. And 1 of the things that I think was probably missed when we first rolled this model out in 2017 was most people view this as a racetrack that you get on this track and you go around and you go to 200 miles an hour and just keep going. What they missed was that it actually is more like a flywheel, where it accelerates every time you go around. So each trip around this track gives you the momentum that allows you to go faster the next time. And that's why we've had 5 consecutive years of accelerating growth with the most recent year coming in at 33% growth. But despite all that success in that strong business model that our founders built into this business, we had a little bit of a stumble in 2021, where, as I would describe it, we underestimated the challenges of doubling capacity during the pandemic. We underestimated the hiring challenges that we would face and we are far too vulnerable to the supply chain challenges. We had to hire 200 people in the middle of this pandemic. And we also got in a position where we ended up with underskilled talent that resulted in higher levels of costs, and we lost significant production efficiencies as a result, and that showed up in our costs. That also resulted us getting behind on our customer service and that had more significant consequences than we had projected. When you're not supplying your customers well, it's hard to take pricing even though inflation demands that you do. It also meant that we were shipping trucks that were less than full, mostly half full, and that had significant inefficiencies in freight. So the conclusion in the learning for us was we need to do a much better job matching the growth rate with the ability of supply chain and labor to supply to meet the demand, in essence, build a buffer between expected demand and available supply to absorb any delays or expected -- or unexpected shortfalls things that we used to take for granted prepandemic, we can't take for granted any longer. I'm not going to take you through this. This is in the deck, but if we had it to do over again, this is lessons that we would have -- we learned and what we could have gotten out of it. But the impact for us, as we think about 2022 is we've got to do a better job matching demand to proven capacity. And the concept we've been talking about is basically putting a 15% buffer between our expected capacity and what we're going to drive to create demand for. We'll start the year with more of a buffer than 15%, just because we've been building capacity for the past 2 years, and we'll build the demand up to meet that. But our goal will ultimately be to always have a 15% buffer to in essence handle all those things that happened to us that we just hadn't planned for in the past. We've announced 2 significant price increases to more quickly recover our inflated costs. The total -- sum total of our price increases is about 17% between the 2. And that's going to handle the inflation that we've incurred since Q4 of 2020. We're also implementing a new ERP system, part of our growth curve and that will give us some efficiencies on the way in which we schedule and plan our freight. And the last part is we've got to really pay attention to our ability to acquire the talent that we need. We did make a significant investment starting back in September in the labor, and we call it the Freshpet Academy, and we just need to keep doubling down on that. Because in a very tight labor market, bringing in higher-caliber people, training them well is that you get a significant return for that rather than hiring the lowest cost people you can come up with. And so that's the focus of ours. Where do we stand today? Today, we're producing in excess of the demand, even though we have been shutting down a line every day due to Omicron-related absences this month. We expect that to end as Omicron fades heading into February. But at this point, even with that line shutdown, we are producing in excess of the demand that is going across the scanners, and that's enabling us to complete our refill of the trade inventory hole that we had dug over the last 1.5 years. Retail conditions are improving. They're improving quite significantly. We're basically to the point where our rolls products, which is about half of our product lineup. We are shipping that in full and have been since October. So retail conditions are pretty good. We are starting to see the total line that total distribution points or TDPs, are now up to better than they were for the last 16 months, and we expect to be pretty much complete by the end of the first quarter and getting everything in stock in a good position. And we also have built significant inventory of the products in which we have had the available capacity and that will allow us to weather some bumps along the way. We do want to be very clear that we expect significant downstream supply chain disruption during January and maybe into February due to Omicron. What we've been hearing from across the industry is that the freight system is struggling to keep up with demand as truckers are out with COVID. Same thing is true of warehouses and warehouse workers, and we're certainly seeing that in the warehouse system that we access, where they just can't handle the capacity of the loads that they're being asked to handle. We expect that to abate sometime in February. And when it does, the available production inventory that we've created will then move through the system. But we're clearly expecting that, that problem will be there for much of the first quarter. Retailers, though, have seen this story and they're now convinced that Freshpet is the future of the pet food category. And as a result, they are planning on making significant investments in incremental fridges. They basically have seen our rapid growth and the scale that we have been able to create and are making the bet that this is the future of the category, it's a strategic advantage for them. And as a result, they're putting in more fridges, and we expect to see significant fridge placements this year. And the last part is that we decided, though, even though we were still building the trade inventory to invest in media in Q4 to get -- ramp up this engine of growth, so that when the trade inventory is refilled and we have the capacity that enabled us to refill that trade inventory that we'll be growing into it. And so we're seeing very dynamic growth. The growth rate accelerated throughout the fourth quarter. We expect to see that continue heading into the first quarter, and the 29% growth was the December growth rate, but I expect to see us beat that as we head into January. The 2021 results we published yesterday. Our final net sales will be published the adjusted EBITDA at the end of February. But as I said, it's our fifth consecutive year of accelerating growth, up 33.5% to $425.5 million. We did affirm the adjusted EBITDA guidance at $42 million, and we'll post those results, as I said, at the end of February. Where is the consumption growth? It's a very reliable and consistent story. This shows -- this chart shows you the Nielsen Mega Channel, so that's basically every channel that we compete in. The consumption by week for each of the last 2 years. The yellow line is 2020. The green line is '21. And you can see other than that hiccup that happened during the pandemic surge and trough, the consistency of the consumption is very, very significant. And even though we had significant out-of-stocks in 2021, you can see that line is moving up at a very, very rapid rate. Over the last 4 weeks, up 29% for the year, we were up 25%. And you can see what the -- it was a tale of 2 cities. The first half of the year, while our supply was not keeping up with the demand, our growth rate was decelerating. It was also a function of the strong growth in the year ago. And then basically we got to the middle of August, and it turned around and started going up again, and you can see the accelerating growth towards the back half. I cautioned that the last couple of periods of the oddities of Christmas and New Year's and the movement of those from year-to-year. So the week-to-week trends are a little bit different, but the overall trend is very clear, heading in the right direction. And the 2-year stack on this business is now clearly broken 60% on a consistent basis. And I wouldn't be surprised if not just the 1 period of 70%, that we're above 70% as we head into next year. Retail conditions, as I mentioned, this chart goes back to 2018, so you can get a sense for what the curves look like, but we're clearly on the upswing. The green chart bar at the end is the most recent week. It's not a 4-week number. It's a 1-week number, and it reflects holidays and all the confusion that goes with holidays, but the overall trend is moving in the right direction, and we expect to see ourselves in a good position by the end of the first quarter. Our fill rate. This has been an issue. We provided this data with people over time, just so you can understand how we're doing it, meeting our customer needs and the fill rates are now up into 70s. That doesn't feel like anything to write home about. But for us, we've been in the 30s, 40s and 50s, at points in this year, that is a significant improvement, and we expect to see that continue to go up. Even though we have shut down the line due to Omicron this month, we're still producing the items that we've been cutting at a significant rate and then will drive the fill rates up. As I mentioned earlier, we launched a new advertising campaign. The evidence suggests very clearly that having a pet in your life is a way in which you can extend the longevity of your life. And so this campaign focuses on that unique relationship between a pet parent and their pet and in essence, how you can both live longer and healthier lives together and what Freshpet role in that is. The ad campaign is set to the song from Sonny & Cher, I got you babe. And it's a very endearing and it's the highest scoring piece of advertising that we have ever produced and tested. So it's a phenomenal piece of advertising. We did want to update people on the addressable market, the total addressable market. This is a -- we think is 1 of the key reasons why people want to invest in Freshpet, because this is the future of the category. Yes, we are growing very quickly, but the category that we compete in or the segment we compete in is also growing very quickly. So there is not just the share opportunity, but there's also the market opportunity. There's an underlying idea here. This concept that was created in 2012 called Zooeyia, which basically speaks to the same thing the ad campaign speaks about, which is the benefits to humans of having a pet in their life. And it's all sorts of things from immune system development to catalyzing social interactions, to motivating you to exercise. Those are very real phenomenon, really -- very real benefits. And that's what's driving people to recognize that having pets in their lives is important. In 2016, we went out and assessed the size of the market, the addressable market, and we've determined it was about 7.5 million households. We repeated the exact same study in 2019 and the market had expanded to 20 million households. And we did it again just a few months ago, and it's now up to 25 million households. And that kind of makes sense when you think about it. Because that's where the overall trends in the market are going, which is younger consumers, millennials and Gen Z have values and attributes that look like what makes them a perfect Freshpet consumer. They want to have products that are made the way they want them made, made by local independent farmers, made using environmentally responsible techniques. They want to have products that are made by companies, who have the similar values and beliefs that they do. And if you think about it, those are the future pet owners. The millennials and Gen Z now are becoming the largest share of pet owners in the country. And they are also, by heavily skewed towards the prime prospects. In other words, the millennials and Gen Z, who are getting their pets, are also having values that are much more likely to make them Freshpet buyers than the previous generations would have been. Production capacity has been the limiter of our growth for the last 2 years. You could pretty much write in your estimate of our net sales by quarter based on what our capacity was. That's changing in 2022. Demand will drive our net sales, because we've built so much capacity. But this gives you a sense for the progress that we've made. The yellow line in this case is 2021 heading into 2022, which you can take away from it is basically since the middle of the 2021, we've been producing in excess of demand every week other than when there was a holiday or a snowstorm and that's allowed us to refill the trade inventory. But the hole was very, very deep that we had to refill. So as we look ahead to this year, this is what our rated capacity is by quarter. We would then take a buffer on top of this. We would plan to be at something less than this to allow us to absorb a significant disruption in production and still service our customers, still service the consumers and deliver the net sales that you would expect from us. We are also trying to improve pricing and margin. We've had significant inflation across the portfolio. When your protein base as we are, that's where there's been enormous inflation in the market, and we have now taken pricing to cover that. Our competitors have as well. So the consumer who goes into the category is seeing significant price increases from us and from everyone else. And this is the grit of things that we're doing because it's not just pricing, but we also have to drive efficiency to get ourselves there. And that's it. That's the Freshpet story. That's where we are, and we'll be glad to take questions at the breakout session afterwards.

Thanks so much, Billy. Appreciate your time. I think the breakout is in just a few minutes. So we will save all questions from there. And thanks so much for the detailed presentation and the walk-through and look forward to hearing more in the coming weeks and months.

Thanks, Bill.