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

Good morning, and welcome, everyone. Great to be back in person. Obviously, this is fun. I'm Michael Lavery, the Food Analyst at Piper, but I just want to introduce Freshpet. We've got the management team here today, CEO, Billy Cyr; freshly minted new CFO, Todd Cunfer; and COO, Scott Morris. So I'll hand it right over to them.

Thank you, Michael. So we -- I'm going to take you through the review of where we are. Some of this will be new information for you, but we want to get everybody up to speed. Obviously, our safe harbor statement, all of you have seen those before. Our screen how goes long? It's 2 pages. I'll start with a clear view of who we are as a company, but I want to be very clear and grounded in what our mission is as a company. And we are in the business of strengthening the bond between people and pet, so they both live longer, healthier and happier lives while being kind to the planet, and that is my dog. We have 3 of them. As Michael said, there are 3 presenters today. Those are the folks who are here, and here's what we're going to cover. I'm going to give you an overview of what Freshpet is, for those of you who are new to the story. I'm going to talk to you about some of our strategic advantages, a little bit of a view of how we're increasing operating efficiency and scale and just talk about the organizational announcement we made this morning. Todd is very new to us. He joined us on December 1, but he's a long-time veteran of the food industry, and he will give you his initial view, both why he joined Freshpet as well as what he sees today and then give you some expectations going forward. And then Scott will give you all the meat of the party. He will tell you all the stuff that is the interesting things that we're going to do to continue to drive and grow this business. Here's the quick facts for you. So Freshpet is guided for 2022 to more than $575 million in sales in the release this morning and Todd's comments later, he'll comment on that. We're reaffirming the guidance to that. It is largely a U.S.-based dog food business. We do have a cat food business. It's very small. We do have an international business. It's also very small. We view those as investments that we're incubating for future growth. Our footprint that we have as a company is 1,000 employees, who are located in 2 big manufacturing sites and then also our headquarters in Secaucus, New Jersey. We exist as a company at this intersection of the long-term trends towards the humanization of pets and also the desire for fresh and natural food. And the intersection of those two is really what has sustained our incredibly long period of growth. We are in -- competing in a space that is incredibly large industry, a $40 billion industry, but we frankly view it as an industry that's stuck in 1950. Dry dog food, canned dog food in multicolored bags and cans, pretty much is stuck in a time that's gone by. In fact, if you look at the foods, the food that was Freshpet that was created, Scott is one of the co-founders of the company that created in 2006, looks very different than the kibble that it seeks to replace, which was invented in 1956. So it's the first major innovation in the world of pet food. We sell a variety of product forms and brands. Those products are rolls and bags and include patties today. We have a variety of brands that cut across a variety of different channels of distribution as well. We finished 2022, those of you who are familiar with the story, this is new news, with 25,281 stores. That's a major milestone for us. What's even more impressive about it is this means we added 630 net new stores in the fourth quarter. And for the year, we delivered 1,650 net new stores, which is a very significant increase and well above what we guided to at the beginning of the year. Our long-term growth story is pretty impressive. We've now had 6 consecutive years of accelerating growth, including the guidance that we have for this year. But the long-term trend here is for 35% compound annual growth rate basically, the business doubles every 3 years. Of late, we've been focused on building operating efficiency and scale. It's been our biggest challenge when you're growing as fast as we are and also pioneering a new segment, a form that doesn't exist, and there's no suppliers, no employees who we can hire who know how to do what we do or make what we make. So we are pioneering the space. It's created some issues for us, but we're focused on building operational efficiency and scale. One of the best ways to dimensionalize that scale growth that matches our net sales growth is the facilities that we operate. This company was incubated in its early days in a small least part of a chicken processing operation in Quakertown, PA that was 36,000 square feet. And you can see our evolution over time through Kitchens One and then through the expansion of Kitchens 1.0, then Kitchens 2.0, which we opened in 2020 at the size of 140,000 square feet. And now our NS facility where Phase 1 alone is 400,000 square feet facility. And every step along the way, we are seeking to improve the scale and efficiency of the operation. By the time we're all said and done in NS, as you can see in this, we'll have over 1 million square feet of production capability, and it will be our most efficient facility. What you see in that slide is the Kitchens 2.0 is at the top, and down at the bottom is the NS facility with the production facility that is up and operating on the right, a chicken processing operation on the left that will begin operating later this year, as well as all the central utility buildings in the back in the space for expansion that is already underway in the middle. The facility or the capabilities that we've been building over the last 10 years have been really designed to make us a low-cost producer with significant benefits and scale. What we have today is 2 campuses that are producing -- the capability to produce over $800 million of product. We're 29,000 fridges. And we have the sole refrigerated pet food distribution system in North America. By the time we're done, though, we'll have over $2 billion worth of sales capacity. We'll have 40,000 fridges in stores, and we'll have the sole refrigerated pet food system in North America. So it's a really significant scale and leverage advantage that we are creating as a company. Our NS Phase 1, which is -- this is new news for those of you who are following us, our NS Phase 1 is already up and operating with a bag line that is producing virtually the entire lineup. It's as of the end of the year, we are producing 33 SKUs in that facility successfully. Those account for about 93% of our total rolls lineup or the volume representing our lineup. When that facility is fully up and operating, it will be able to produce over $1 billion in net sales, and the bag line in that facility is on track to begin operating at the end of Q1, beginning of Q2. But it is going to be our most efficient facility. It's going to be the most environmentally sustainable and huge quality improvements. Our key operational improvements, we've talked about these in September. We recognize that the operational performance of the business was not what it needed to be. We made a very significant intervention beginning in the [ end ] of the summer, focusing on quality, logistics and commodity cost management. I won't take you through all the things on this slide, but we'll be glad to cover them in the breakout sessions, other than to say that we've already started making progress in each of those areas. And we're expecting to see the benefits of those in some part in Q4 and certainly as we head into Q1 of 2023. One of the biggest improvements we made is we invested in our what we call the Freshpet Academy, which is our solution to the labor challenges. And since we made that investment last August, in August of 2021, our turnover has dropped by 45%, and it's given us the skilled workforce that we need to successfully produce the product that we need at scale. We've also bolstered the capabilities of our team. We've added Todd, as you heard, Dirk Martin, our VP of Logistics. And earlier today, we announced the appointment of Jay Dahlgren, a long-time veteran of the pet food industry, to be the EVP of Manufacturing Technology and Supply Chain and someone we're very happy to have on board. He's been consulting with us. He's now coming on board as our leader of our supply chain. I will now turn it over to Todd, and he's going to take you through his initial impressions at Freshpet.

All right. Thank you, Billy. Good morning, everybody. First of all, I'd like just to say I am more than thrilled to be joining this incredible organization. It's really thrill and pleasure for me. I'll go through, first of all, why did I join the company? I've been watching this company actually pretty closely for the last several years. And I've just been -- I've never really seen a business model, creative has so much upside potential. I mean the manufacturing capabilities are fresh, never done before, a one-of-a-kind go-to-market capability with, as Billy just mentioned, over 25,000 fridges out there. A very, very unique situation. Obviously, the growth opportunity is unparalleled. And now that we have the capacity online, the sky is the limit for growth as well. And I truly believe I can add value. I've had the pleasure of working for 2 tremendous companies over the last 25 years, really well-managed companies. I have learned a lot. And I think I can bring a lot to the table to understand what to focus on, what the priorities are, and I'm really excited to be part of that journey for us. Initial observations. So I've been -- as Billy pointed out, I've been here for 5 weeks now. So pretty early in my career. The opportunity is as real as I thought it was. I mean the size of the prize is enormous. I feel more confident now than I did a couple of months ago when I agreed to sign on, it really is an incredible business. The problems need to be solved, and they are solvable. Look, it's understandable, the last couple of years with tremendous growth adding or expanding 3 new facilities during the middle of the pandemic. And by the way, let's throw an ERP implementation on top of that, just for fun. A lot of things going on, but these are all solvable with hard work and focus. So I'm very, very confident of that. The focus areas, the commodity management, the logistics, the quality, those are absolutely the areas to focus on, and we're already starting to see some progress there. I'm really, really confident those are going to be solved in the next couple of years. And we have just lots of basic blocking and tackling, just put some processes in place. I'm very, very confident we're going to make significant improvements over the next couple of years. So what am I focused on right now? First of all, improving forecast reliability. Obviously, again, when the business is growing as quickly, these are the types of business -- businesses that are difficult to forecast, but that's no excuse. We have to do better. I'm also spending a lot of time right now on analyzing what does this business look like at scale. With the NS capacity coming on, we're going to create capabilities of well over $1 billion capacity. We're not going to get the margin structure on day 1, but we will absolutely get it. So I'm doing a lot of work right now, trying to figure out what that looks like and from a timing and a phasing perspective. Obviously, ensuring liquidity to reach our goals, I know that's a concern from the investor base out there. We are sitting on a fair amount of cash right now, which is terrific. I will be redoing our credit facility in the next couple of months. It's likely we will need to do a little bit of debt financing by the end of the year with some of the capital requirements that we have. But we're -- I'm very confident we'll be in a good liquidity perspective. No intention in the next year or so to do another equity raise, but at some point in time in the next few years, it may make sense for us to do that, but nothing -- certainly nothing in the near future. Looking at the capital spend and the timing and the phasing of all that, obviously, with the pandemic, with all the supply chain issues, with all the inflation and all the price increases that have occurred across consumer products companies, a little bit painful, but the good news is by the time we take our next price increase in February, another 5% price increase, that cumulative pricing over the last 18 months is 27%. I look at that as 27% of free capacity that we've just created in our infrastructure, which I'm very excited about. And most importantly, deliver on our promises, do what we say we're going to do is incredibly important. Guidance, we are reiterating the guidance we gave at the end of Q3, so greater for the full-year net sales, greater than $575 million, adjusted EBITDA greater than $15 million. We're in the process of closing books right now. We'll come back to at the end of February with all the specifics, but we're still affirming that guidance that we gave last quarter. And lastly, from a communication plan, we're obviously here at ICR. We're talking about the new organization. Scott will come up and talk about the TAM and some of the initiatives that we're working on right now. We've been invited to speak at CAGNY on February 22. We're super excited about that. And we will, at that time, give some long-term -- updated long-term guidance. That's what I -- as I mentioned earlier, I'm focused on that significantly right now and how much capacity and capital that will require over the next couple of years. So more to come on that on February 22. And lastly, Q4 earnings call probably will be February 27. We'll obviously go through Q4 and the full year's results and then give you guidance on FY '23 as well. So with that, I'll hand it over to Scott Morris.

Good morning, everyone. Good to see everybody. Todd, thank you so much. We are thrilled, thrilled to have Todd. It's only been a month, but it's been a tremendous month. And you can see the skills that he's bringing to the team. He's going to make a tremendous difference and really help our business continue to grow and scale. In addition, we're really excited about the manufacturing talent that we brought into that Billy mentioned. All right. I'm going to talk about the consumer opportunity, and I'm also going to talk a little bit about like what we're doing from a growth standpoint and how '23 is going to be an amazing year for us, really exciting year. Let me start off and say when we started the business in 2006, it was hard to look at something out there, some other example out there and realize that after 16, 17 years, we would still have 96% of the category out there. So if you look at fresh and frozen pet food, we're 96% of mega channel. That includes pet, mass, grocery, et cetera. So it's really, really extraordinary accomplishment. I will say we set out to do this, and we constructed the business model in order to take advantage of this as much as possible and build as many barriers to entry as possible. The other thing I think that was hard to imagine when we first started the business a long, long time ago was to take a look at the TAM. So every year or so, we take a look at what the opportunity is around our TAM. And what we're seeing is that there's 41 million households that are now interested in fresh and frozen pet food. It's an extraordinary number, and that equates to a $5 billion opportunity. That's not a $5 billion opportunity in the future. That was measured at the end of '22. It's not exactly the best time to go to the market and say, who wants to potentially pay a little bit more for their pet food? But there's tremendous, tremendous interest. And I think it shows the potential that we have today. If you think about that TAM, think about that TAM and then you think about it from a household standpoint, there's 70 million dog-owning households out there. Of that, there are 41 million, the number I just shared, that are interested in fresh and frozen pet food. Of that, there's 27 million that are part of our target group, what we're calling healthy foodies. And I'm going to talk to you on the next slide a little bit what a healthy foodie is. And today, we are not -- there are 9.5 million consumers in our business, from a penetration standpoint. So there's tons and tons of room. Okay. Let me talk about what a healthy foodie is. First and foremost, and it'd be interesting if you think about this for yourself, healthy foodies are people that realize food is important. Food and nutrition is important for our health and our longevity. We've done it on the human side. People -- the way people eat in the last 5 and 10 years has changed dramatically than the way people were eating 20 and 25 years ago. It's amazing. So that's the first kind of test for this group. They are focused on eating good, healthy food. The next thing is they think of their pet as truly a partner that it's really like someone that they think of as a child and a partner and someone that really has priority in their family and that deserves the best. They are literally willing to sacrifice themselves to basically get something for their pet, which is a pretty strong motivation. Now, I want to talk more so about even a tighter group. These are basically what we call our HPPOHs, our high-profit pet-owning households. They actually represent 33% of our total consumers, but 87% of our sales. These are the people that have made a complete switch in the way they think about pet food. Their buy rate's $220 a year, and their household income, importantly, is $80,000. We're comfortable that what we've seen with this group, they have basically consistently come in and consistently bought our products, even though we have had price increases and some of the economic challenges we've had over the past year. So this is the group that we're going to continue to focus our business around, going forward. If I look at -- one of the best ways to get those consumers and more of those consumers in, we're going to tailor the entire business even more and more towards this healthy foodie or these HPPOHs, again, high-profit pet-owning households. If you look at -- and we did a chart where basically, if you look over time in our quarterly revenues and our media spend over time, there's an incredibly high correlation between us spending media and basically the growth of the business. We know it works. The thing that we've been able to do is not just grow the business, we've been able to help consumers think differently about pet food. Remember the change I was talking about just a few moments ago, where we're eating differently. We're trying to enlighten the pet consumer to think, "I have to feed my pet differently. I have to feed them a food that's good, healthy and fresh." And what we've been able to do, I call it, flip the bowl or fresh first are those strategies. We've been able to get those consumers to think very differently. Kibble is not the way to nourish your pet. And that creating a movement with all the media that we spent all those years, that is an extraordinary achievement and accomplishment. The next group that's thinking really differently about pet food is the retailer. For years, we went in and we talked to retailers about adding Freshpet Fridges into the aisle. And every once in a while, we would get one. Well, I'm here to tell you that like it's completely changed. Now retailers are not talking about adding one, they're talking about adding seconds and thirds. We've gotten them incredibly excited because we have got really strong margins. We've got consistent category-leading growth year after year, and we drive tons and tons of traffic into the aisle. Next year is going to be a great opportunity for us. We look at next year as a really potential breakout year. This past year was strong, this next year could be even better from what we're seeing. So we're actually anticipating about a 17% growth in the total amount of cubic feet we see at retail. That's going to be 1.7 million cubic feet of Freshpet refrigerators at retail. Think about what that number means and what the opportunity is there. And not only are retailers putting in 1 fridge, but I mentioned seconds and thirds. So it was potentially like a dream off into the future when we thought retailers were putting this in. We're seeing in mainstream grocery retailers putting in 2 and 3 fridge, sometimes even islands that are basically the focal point of their Fresh section. It's because they realize that they can make a difference and really have a point of difference there. Next, we're going to tailor more and more of our innovation over time to that healthy foodie, those HPPOH consumers. And you're going to see things around tailored nutrition, real food, things that look literally like food that I could feed to my kids or I could eat myself. We're going to see some great innovation from an e-comm perspective. I'm going to cover that in the next slide. And then finally, we're going to talk a lot about quality and value that we're creating for consumers within our existing portfolio. So this is an example of some of the products that we're going to be coming with this next year. We're really excited about them. I believe that this is really, really kind of category-leading innovation that we have set up. Let me talk a little bit more about the e-com innovation that we're bringing to market this year. So what we have realized is there are consumers that really want two aspects. They don't just want to order it online. They want to customize food for their dog, specifically customized for dogs. So does your dog have -- does he like these types of products? Is he a picky eater? Are there [ skinning code ] issues? Are there digestive issues? What are the things? Tell us about your dog. So we ask them to go through a very brief literally a handful of questions, answer what's specific about your dog, and we will give them a specified product delivered to their home with specific feeding guidelines for their dog to keep their dog healthy. We think this is an extraordinary advancement in e-commerce. It's going to be customized, as I mentioned, and it's also going to be convenient. It's going to be delivered on a subscription basis and scheduled to consumer's house. So they'll go through that questionnaire. It will get delivered, and fresh meals will be coming to their door on a scheduled 3-, 4-week basis, every 3 or 4 weeks. We know that there's a real opportunity in the marketplace. Everything we're doing in this case is going to be leveraging all the benefits and the scale that we have in our manufacturing, in our products, our portfolio, some of our brands, our supply chain and even our existing partners. We think we really, really will have a great advantage in this. So if you look across these 3 things that I covered, advertising, changing the consumer mindset to fresh first, advertising is going to grow over 25% next year compared to what we did this year. Availability and visibility of our fridges is going to grow about 17% versus this year, going to that 1.7 million cubic feet. Our innovation, I would argue that it is the best innovation we've had in 5 years and potentially forever. We'll see how that plays out. We've been pretty successful with most of the things we brought to market over time. And I think this is giving us really an incredible growth path going forward. So if you think about TAMs expanding, consumers are thinking differently about the way they're feeding their dog. That change is happening. We're now moving into that early majority phase and maybe even slightly beyond that. Retailers are thinking differently about their pet aisle, and we've got tremendous innovation to take advantage of what we've done. So we're very, very excited about the opportunity. We do recognize that this -- everything we're doing -- and this is what we call our value creation platform and how we build value and create really a competitive kind of moat and competitive advantage in our business, every single one of those has to be focused in our operational improvement plan. We have to operate better. We have to manufacture better. We have to have better quality. We have to have better products day in and day out. We've got to do a better job in that area. That's the work that the team has taken on over the past 6 months, and that's the talent that we've added into the organization. So we're incredibly excited about really delivering on that plan over the next several years. We're happy -- we're looking forward to talking to everyone more through the conference. We have 2 different breakout sessions later today. And look forward to seeing everyone there. Thank you very, very much for hanging with us for the 25 minutes. Hope everyone is doing well. Take care.