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

Good afternoon, everyone. Thank you so much for joining us. My name is Brian Holland, Sustainable Food and Healthy Living analyst here at Cowen. Pleased to be joined today by Freshpet. Here from the company are Co-Founder and COO, Scott Morris; and CFO, Heather Pomerantz. Unfortunately, CEO, Billy Cyr, unavailable today. His youngest is graduating from college. So congrats to him if he's listening in his ear phone right now, somewhere, I'm sure he is. But Scott wanted to make a presentation today. So we will kick off. With that, Scott, I'll turn it over to you.

Great. Thank you. Thank you so much. Brian and everyone from Cowen. First of all, thank you so much for having us. It's -- really appreciate having us here. And I do appreciate you guys' time today, too, as we go through everything. So I'm going to talk a little bit about Fresh and share a little bit of our story. I'm actually going to back way up on a few aspects. There are decisions that we made literally like 10 years ago that, in some cases, make us look brilliant. And I promise you, we are not brilliant. We are very, very good, but there are things that we did a long time ago that are really important for the business today, but also the business kind of going forward into the future. So of those things, there were some that gave us massive competitive advantage. And I think that's what's really important that we'll focus on through the conversation. So again, not perfect. We're good. We're hardworking. And we've, in some cases, and especially with even product development, we, in some cases, have failed our way into success as we figured things out. So I'm going to start -- when I talk about Fresh, I'm showing you some peaches here, which one looks better? Which one do you think is more nutritious, right? I think most of you are going to choose the one on the right. You think same thing with frozen orange juice or oranges, right? You're probably going to choose the fresh orange. Now this is a real product on this next slide. Roast Beef -- canned Roast Beef from Kirkland or the Roast Beef on the right, which one do you think looks more appealing, more nutritious, healthier, pretty interesting. So we all know that like less processed food is better. Sometimes we have to really reach across the table and make sure we're not reaching for the processed foods and going for the less processed foods because we do know that they're healthier. So people know that fresher and less processed is better, and we will convincingly tell you day in and day out that so do dogs. And overall, because Fresh is better tasting, it is healthier and it is more nutritious. If you look at study after study on the human side over the past 20 years, it shows you and demonstrates that the idea of a fresher, healthier, less-processed diet is better. It's just better food. And we've taken that as inspiration for when we started the company, and what we continue to build out today, and it's really where our focus is. That's why we built our own company on an entirely Fresh platform. And to overuse that insight, I'm going to take you through the different things that we've done where we've taken a very, very fresh and new approach. So first one is Fresh, like literally the whole like meaning behind the pet parent bond and the human relationship, we think we really have a lot of really fresh insight around that. Fresh food. We're the first ones in North America to being fresh, refrigerated food, and it's healthier for pets. Fresh ingredients. We'll talk about our food ideology as we get further into the presentation, but it starts with as fresh, simple ingredients as you can possibly have, as least processed as possible, very different than other products. Fresh preparation. We cook everything at incredibly low temperatures to preserve the nutrients. We talk about that as bioavailability. Fresh looking. It looks and smells fresh. Sometimes people will go, well, why does it matter? It's for a dog. Well, the people that buy it or the pet parents, right? It's important for them. We'll touch on that also. Fresh delivery. It goes from our kitchens to our refrigerators that are owned at stores. Fresh portfolio. We have the widest range, widest portfolio of products, widest range and variety of products that pet parents could be interested in buying. Our mission. We're committed to nursing that pet parent bond. We think it's really a fresh idea. And then from a purpose standpoint, in 2014, we trademarked pets, people and planet. And it's because when we founded the company in the very, very early days, we really felt like we had a really, really clear and differentiated mission than most packaged foods companies and then really also people and pet. We were trying to do all those things across the board. Now the last piece, which is clearly important, obviously, is the team, the people. So the purpose is that critical component. If we have great purpose that makes our people passionate about it and that helps the power the potential that we have in the organization. So really important to have a great purpose. I think a lot of people talk about that today. We did literally stand the company with much of that in mind. So we feel like we've created an entirely new category. And I will tell you, I started my career early on and not everyone thought this was a good idea. I started actually at a company called Purina many, many years ago. And I remember winning a sales contest and the winner of the sales content have to go to this NASCAR Driving School because we were sponsoring a NASCAR at the time, a long time ago. So we're at this driving school. And as you can see here, I got to put on my cool sunglasses. This is as close as I was ever going to get to a top gun, my fancy driving suit, et cetera. And there was an executive there from the company. And at a driving school, he started calling me and referring to me as Turtle Morris, well, it's stuck for a very, very long time, not exactly the term you want to be kind of known as at a driving school. So Turtle Morris was forever burned into people's memory. So it's pretty funny. So years later, I met a pet industry show, big show, we had a 10 by 10 booth in 2010. We had a 10-by-10 booth, a big deal for us. We had our fridge setup. We had a big cutting board, setting everything up. I'm there, and I hear in the background. Turtle Morris, Turtle Morris, Freshpet Food. I wish I had thought of that. And it was a gentleman. He's a great guy, a really, really great guy. But at the time, he thought it was completely ludicrous that we were thinking of fresh pet food. And today, I don't think it's anywhere near as funny to anybody. I think people think it's like really a force to be reckoned with in transforming the category. So we really did think about transforming and developing an entirely new category. And also as we were doing it, building in barriers to entry. So one of the first things that we built in to keep us out front was we decided to go and develop several different brands. And not just because we wanted to develop all these different brands, all under the Freshpet umbrella, but those brands were all at different channels, okay? So Freshpet select as a grocery, vitals in the pet stores and Nature's Fresh is in the natural channel, right? Now in addition to that, we came up with different forms and different varieties. And then importantly, we actually developed a whole range of price points across each one of these. Now what's important about that? So the important thing is that we've now staked out the territory from good, better, best across. We've staked out the territory to own the refrigerators and own the space in each one of these channels, right? So we basically conquered every one of these channels and taken it. And we've also come up with a wide variety of foods. Every one of those, it wasn't just a channel strategy. It was really to meet the emotional and the rational needs that pet parents have, right? That was the goal is to make sure that we're appealing to them in an aspect in a way that they want to be spoken to. So we have lots of brand propositions and varieties and flavors and all the places where pet parents might shop, but we needed to make the right product. And we went and we talked to human food suppliers, we talk to pet suppliers and no one could make what we wanted. So of course, what everyone wants to do in the very beginning of starting a company, we literally built our own facility. So this is just a graphic example. If you take a 2,000 square foot house, which is kind of a smaller house, our first facility was in Quakertown, Pennsylvania, not far from our Kitchens in Bethlehem. And it was equals about, I think, 18 houses, 18 2,000 square foot houses. And it was a great facility. There was a lot of learning, and we developed incredible competitive advantage in how we make our products there. We quickly grew into what is our platform as of today, which is kitchens 1, Kitchens 2 in Bethlehem and also Kitchens South. And you can kind of see where that is. It's about 360,000 square foot. Now the thing that's going to happen in literally just a few months to give you guys a perspective on the scale of it is Ennis is going to come online. In September, October. It will start really coming out in October. That alone is 480,000 square feet. It is enormous, okay? So we'll be -- this year, we'll be at 840,000 square feet. It's an enormous, enormous scale and project that we're undertaking. All of this is obviously designed to meet the demand that we currently have, and we are developing and anticipating is coming over time. And then by the end of next year, we'll start to add the rest of it. Where we're going in the not distant future, we'll have 1.5 million square feet of manufacturing, okay? It's a lot from a -- not storage, not warehousing, but manufacturing. It's a lot of square feet. In addition to that, we've now invested $1 billion in that technology that we literally pioneered that the pet people couldn't make and the human food people couldn't make that we developed in Quakertown. We'll have $1 billion invested in it. Where is everybody else? They're starting from 0. So we feel like this is an incredible competitive advantage. In addition, that technology delivers better palatability and better bioavailability. Now this is all going to make even more sense in a minute when I talk about what's important from a pet parent and a pet standpoint. But that technology is different than the way it's done today in other fresh foods. In addition, our approach allows us to have several months of refrigerated life versus even human food products, typically, you're talking weeks, 6 to 8 weeks for a human food product. After we make our products, then we obviously deliver them and we bring them into our owned fridges, right? And one way to think about those fridges, we talk about the number of fridges a lot. So it's in 27,000 fridges and 24,000 stores but it's 1.3 million cubic feet of space that we own at retail that our products go into that are displayed in FreshPet fridges. It's pretty interesting piece that we developed there. Now what's important about that is all of that is to satisfy this next piece, which is what the consumer is interested in. So it starts with our food ideology, which again starts with fresh ingredients that are gently cooked, less processed as much as possible. That are then in a stay-fresh package. Some people will look at our package. It really like, oh, it's a plastic package. There are sometimes in some of our packaging, there are up to 8 layers to make sure it keeps fresh. It's pretty amazing technology actually, which refrigerated and delivered to stores and then obviously put into our fridges at the stores. But this food ideology is important because it delivers on the right side of this, which is starts off with consumers look at fresh food for their pets. 15 years ago, they might not have thought this. But today, they're looking at it going, "I think this is better for my dog. It's fresh food. It's fresh healthy food." That's what I'm supposed to eating. It looks like food versus where pet food is. And even many -- most of the other products in the market today that are even similar to us. It smells good. Our stuff smells good. Because the first thing the pet parent does open it up and looks at it and they smell it. It smells like real food. Dogs love the taste. That's the palatability chart. So that's the next reaction that pet parents make or see. Then I know it's like right after lunch. I'm sorry, but actually, you see better poop, okay? That is reason to believe -- so a dog eats the product, they love it. Then all of a sudden, it's basically a smaller firmer poop and the pet parent goes, "Oh my god, it's more digestible. It must be better food from my dog, he is adjusting it well. And then it's actually more nutritious, the bioavailability piece that I talked about earlier. And then consumers see a visible difference in their dog's health. And then finally, the pet parent feels like a hero. Now let me ask you this, who has kids here? Okay. If you were able to bring home, whether it was great, natural, healthy food, and your kid was banging on the table going, "This is awesome, I love it, give me more." And then soon after, they had a shinier hair and coat, and they had more energy. How would you feel? Would you feel like you did a good job as a pet parent. Absolutely, right? You bring-in your home -- it's not like you bring it home an M&M, you're bringing only good stuff, good healthy food, and they're loving it and actually acting better. This cycle is critical. And this is why we developed the entire food ideology to start with because it's that emotional motivation that a pet consumer has. So this is all cool, and it's gotten us to a really interesting platform to continue to build on, but let me talk to you about how it's doing today. Pet parents and the dogs absolutely love us. And I want to put up a handful of these stats that we talk about periodically in one place, 92% brand satisfaction, industry-leading, 70% repeat VP purchase, industry-leading. #2 on Net Promoter Score. This is -- we just got this reading. This is in a situation where we haven't had enough food for most of the people that want to feed our products for the past 18 months, and we still have a #2 Net Promoter Score. It's unbelievable. Price value perception, which is one of the biggest challenges typically we have. We're considered #3 in the industry. 94% of people see a positive change in their dog. That goes back to, if you're the parent, you're bringing home that great food for that toddler, you're fur kid, right? You can feel really good about it. And then dogs preferred, I talked about the palatability earlier. So one other thing, how you're doing. So I went way back. And I think it's an interesting perspective. If we go way back to literally 2010, we've been delivering a 35% CAGR since 2010. It wasn't because it was baked up in the front. It's been pretty consistent, except for a couple of years all along. And again, we're just finished the year where we finished 33% growth, right? Pretty amazing. And we were also product supply constrained in the last 18 months, the end of 2020 and also into '21. So really good stats. Now let's look in the more recent period, right? So we actually are demonstrating not only great share. This is share of dry and wet dog at food, xAOC, mega and then pet stores. Look at the growth rates across the bottom in the last 13 weeks. Now there is a little bit of tailwind, there is tailwind from pricing, but the pricing is going incredibly well, too. And what this is demonstrating is we see terrific growth across all these channels, the channels that we originally staked up the territory in with different brands, and we're continuing to see incredible growth, and we're seeing growth in our fridges, continue to expand not only our total store count, but the number of fridges we have, the second and third fridges. Retailers are liking the proposition and expanding it forward. And in addition to all this is the addressable market year after year that we test this has been expanding. When we first tested it, we thought the market was 7.5 million households, then we went to 20 million, and now we're at 25 million households that we believe are really -- excuse me, it's top 2 box, I believe, interested in a fresh or frozen proposition. So it's really, really fortunate to be in a situation like this where the market is moving in your direction. What we've seen in addition to that is we have great tailwinds. People are getting dogs. They're having incredibly tight relationships with those pets. And we've seen our market size expand from what we initially thought was where we are today at $1 billion total market, up to $4 billion to $6 billion into 2025 and slightly beyond. Now this is not a number -- that $4 billion to $6 billion. There are 3 different studies out there in the industry. We have done 1 -- there are 2 other people that have started to share data and information on what they think the marketplace is for fresh and frozen food. So we believe it's easily that $4 billion to $6 billion number in the not distant future. Now one of the things people will bring up is that we are definitely not alone anymore. We're not doing this alone. But I want to put in perspective what some of the people, some of the competitors have been doing. And I think it's an interesting perspective. So I actually looked back a few years. Some of you that have been with us for a while, you'll see the original launch, it was by a $400 million Australian pet food company that they know fresh pet food really well. They dominate in Australia fresh pet food. They said, "Hey, the U.S. market is huge, let's come here. Let's go to the U.S. market." Well, they came here. They launched H-E-B, a major retailer in the Texas marketplace, but they're one of the top 10 retailers in the U.S. from a food standpoint. We have sold them 7 to 1 after 4 years of trying, and they tried everything when I tell you. Then the same company came in, in 2018 to PetSmart and we have sold them 10:1. And now Caesar, which is owned by Mars, obviously, they came into Walmart months -- over 6 months ago, I believe it is, we're selling them 12:1, okay? In addition, just as another fact, our dollars per store per week in Walmart has increased 31% since they've come in. So there really hasn't been much impact from the competitors at all. In fact, most -- the first ones have gone away. I don't know where the future is for what Mars is doing, we'll see. Another one in PetSmart, another company that Mars bought was Nom Nom, and PetSmart launched with Nom Nom, we're selling them 12:1, okay? So it's a little bit more prospective. The company that is doing reasonably well is in Petco. Now they have publicly come out and said this just food for dogs, they've probably come out and said, we're committed to being in Petco brick-and-mortar only through 2024. It was a press release that 2 companies put out. On the dollars per store per week, we have actually grown 107% since then. So massive growth in our dollars per store per week. They are doing well. They do a similar dollars per store per week that we do in those stores. However, they are in massive sections. They have brand ambassadors in the stores and it's the only place they're distributed. If I was only in 1 store, they wouldn't be able to keep the fridges full ever. So it's just another piece of perspective. So importantly, when I look at everything all the way back to 2014, all the way through now, all fresh and frozen competition stacked up, that's the little light colored bar at the top. It's 3.6% of total sales. So competition is coming. They're probably going to expand. We never said we're going to own 100% of the $5 billion, but I'd sure like at least 90. I will settle for a little bit less. But that's our goal. So today, it's 3.6, it's going to continue to expand from there. Stores that sell fresh pet food that we think this is an important aspect. The people that sell fresh food on the human side we believe will be the ones that drive fresh pet food into the future. So if you look at our share on the left side, you'll see basically where grocery is and where mass is. And you see that they have a well outsized share in fresh pet food. Grocery is 51%, it's 22% of total sales. So what do we need to do to continue to stay ahead? Well, obviously, building out, taking the technology that we developed and building out $2.9 billion in potential. We want to continue to build that piece out. We're also focused on millennial and Gen Z consumers. We over-index with them, but we're continuing to build out our company and our innovation around that group. And part of that is building great innovation. So we've shared a little bit about Spring & Sprout. We probably haven't talked much about Nature's Fresh. That's a brand we have in our natural channel today that's expanding out. We're now taking all of that to regenerative farming. All of that -- all the ingredients will be coming from regenerative farming for Nature's Fresh over time. So we're really kind of continuing to transform that brand in addition to the things we're doing at [indiscernible]. So it's now turning from a know-how game to a scale game. So we have all those components in place. We want to leverage our advertising, our availability, our visibility and then finally, our innovation. And we know we have tremendous opportunity. Aided awareness is low. We have a long way to go. It's a very basic level. Our households are low. Our buying rate is low, and our percent ACV distribution also has a long way to go. So we want to continue to kind of push forward our 2025 targets, 11 million households, $1.25 billion in sales and 25% EBITDA margin. And I know that over time, a lot of people have talked about all these barriers for the past 10 years of, wow, fresh food, maybe people won't like it. Do they want to keep it in their fridge. They want to cut up their dog food. All of these challenges over time, the more recently, our penetration is not increasing, which it is now, you'll see it. And our competition is coming. And all I can see -- all Turtle Morris, can see is that we have 1.3 million cubic feet of retail space. We have the know-how that we developed in 15 years, the power of what we've done in the past. We have 1 million square feet of manufacturing on its way going to 1.5 million square feet. We have $1 billion invested in manufacturing, $250 million invested in our advertising over the past several years to the end of this year. So it's an extraordinary number. We have consistently grown the company. We've doubled the company every 3 years since our founding, and we anticipate continuing to be able to do that. In conclusion, we built this great company all around fresh ideology. Our execution was really focused on pet parents. We think that we're now finally realizing some of that. Our continuous planning for the future has led us to continue to build forward and expand what we're doing as a company, build on that technology and build our manufacturing base and that we believe everything is better from a Fresh standpoint, and the health benefits are there and that really taps into what consumers are interested in doing. So fresh food does have an expiration date, but fresh thinking doesn't at Freshpet. And I do want to thank you for the time. I know I went through a lot of material, but happy to chat with anyone at any of the meetings later today, et cetera. And I know Brian is going to ask some questions. So thank you very much.

Thanks, Scott. All right, Heather, well Turtle only left us with time to ask about the offering. So we'll just go there. I'm just kidding, but we will start there. Stocks underperformed. First quarter results you reported earlier this month were quite strong, right? But stock has responded more so, I think, to the equity offering. So 2 questions. One, why did you feel it was necessary to issue equity now? And two, you're talking about capacity of $2.9 billion. You've got a 2025 target of $1.25 billion. It's obviously a pretty wide gap. So help us understand how that gap gets filled, and why we need to add this much capacity now.

So when you look at our expansion plans, our plans this year were to spend $300 million in capacity expansion. With the backdrop of macroeconomic environment, putting a lot of pressure on both inflationary cost of construction and building, as well as lead times. So when we started looking at our plans and thinking about what that meant, we had the need to pull forward and it's Phase 2, which we had planned to start spending in 2023, coupled with, at the same time, an opportunity to launch an innovation manufacturing facility. And it was an opportunistic time to do that. Both of those triggered a need to increase the investment this year from $300 million to $400 million. We could have actually made a decision to defer those things and slow down growth. But as you just saw with the presentation and what's possible, that's not something that we're willing to do. We actually had prepared all the way up to 2:00 the day of earnings, a scenario where we were going to go ahead with the [razor knife]. So I could assure you that the decision to do it was -- it was not an easy one. We understood the potential impact, but it was a decision that we felt given the volatility of the market, and not necessarily having the ability to raise money in the future, which we would have had to do eventually that it was the right time to do it. So we went ahead and did it. I will say that when we look at our positioning now, we actually -- we're not happy with the stock price. We're not happy with where we had to raise money, but we feel very, very good about where we are now in terms of our financing to be able to meet basically the potential of where we think this business is headed. There is a disconnect when you look at the $1.25 against the $2.9. We're well aware of that. We have -- we are going to look at our long-term targets, and we will come back by the end of this year with a revised view of where we think that should be. The reason why we didn't do it at the same time is because we just had -- we just put in place our second price increase. So cumulatively now, we've got 17% in the market to offset the inflation that we face. And so the impact of that is still very fresh. We want to make sure when we come out with revised targets that we have a view on what does it mean in terms of household penetration, what does it mean in terms of buying rate and really the underlying complexion of what drives that revised target. We may, in fact, come out with a view of what it might be a 2027 target instead of just 2025. So more to come, but we are committed to doing that to make more sense of how much of that 2.9 we think will be utilizing and we get to that point.

Great. And then sticking near term, right, one of the issues that you faced last year was obviously supply constraints trying to add the lines. Obviously, the world we're in right now, almost impossible to be adding capacity. We see that on a number of fronts. But certainly, the timing of that adding, I think, 2 lines in the second half of this past year. Even just pushing those back a couple of weeks, you missed Q3 and then Q4 gets kicked out into Q1 of next year. As we think about the guidance for this year, can you just help us tie as we start to think about Ennis, which I think Scott said October, expect that to come online. You've introduced buffer capacity. How do we tie, what is it, 570, 575?

575.

575 Of revenue this year to Ennis, meaning how reliant is that 575 number on Ennis as opposed to how much staff capacity do you have today? I guess, is the right way to say.

Yes, it's a good question. So let me start by saying that we have -- we're in really good shape on Ennis. So one of the things that obviously, the proof point in terms of what you just said, you struggled last year and how do you have conviction this year. We had a lot of lessons in terms of coming out of launching Plant 2 last year. And so -- as well as the Kitchens South constraints that we had. So when we think about Ennis, there's really 3 main factors that matter in terms of readiness. One is that the building is built; two, is that the equipment and lines are in place; and three, is that we have the labor to staff up those lines. And so we're pretty much fully there. It's pretty much check, check, check. All of the equipment is in. It's all -- had been ordered in time is either actually in the facility or in storage. So we have no issue with equipment. All of the labor that we need to start at the first line is -- has actually been -- we got way ahead on labor, hiring ahead and brought them to Pennsylvania. Some of them have actually been training for 9 months in Bethlehem side-by-side with folks and are trained very, very well. So readiness of labor is not an issue. And the last piece on the building. The building was the one that was call it, the most impacted in terms of lead times and some allocations on materials and things of that nature. But we're closed in now. We're in very good shape in terms of the building. So it's really around just getting everything in place, tested and up and running. So we really risk managed that. We feel that could there be a couple of weeks delay, potentially. There's always that type of risk, but we're not talking about any sort of extraordinary delay. And then in terms of what does it mean, the buffer capacity was a really good decision that we made this year in terms of both even near term, things that happened in Q1 that we were protected on, we had to shut a line down for 3 weeks in January because of labor being out due to Omicron and it wasn't an issue. So the buffer capacity is there. We will have pressure on rolls. So the first line to come up is rolls. Having said that, we've refilled trade stock fully. We have inventory on rolls on our own inventory side. And so could it put pressure on reducing inventory positions throughout the supply chain? Yes. But having said that, that would be the only sort of main constraint that we're watching closely. But from an overall guide perspective, we're not concerned.

And I'll just ask in closing, obviously, folks increasingly worried about rising inflation and a lot of moving parts there. As you think about your margin story, obviously, you took a hit this year to carry the buffer capacity. That should create a margin inflection for next year. How we covered over the rest of this year? Where are the weather exposure to spot markets, et cetera that we need to be watching for?

Sure. The main risk really comes around fuel and what's happening with fuel and energy costs. We've got contracts in place for about 70%, 75% of our input cost. So it's really the impact to outbound logistics to a certain extent, inbound logistics and fuel. We are contemplating, if needed, a potential third price increase. If we do that, it will be small in nature, a lot smaller than the cumulative 17%, low single digits. And more of, as Scott described it as a nip-and-tuck really price points where there's maybe a little bit of room, and we don't see -- we feel confident in the price sensitivity impacts of that. But we're in good shape. We're -- the cumulative price increase that we put in place of 17%. The elasticity is fairly benign. As far as we see it right now, our volumes are growing in the low to mid-20s, and we're in a strong place in terms of the success of that.

Great. We'll leave it there. Scott, Heather, thank you so much for joining us.