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

Pleasure of introducing Freshpet, who's revolutionizing the pet food industry, selling better for you or better for them pet food for dogs and cats. With us today, we've got CEO, Billy Cyr; CFO, Todd Cunfer. Welcome up Billy to give a formal presentation. Thank you.

All right. I think the thing we have to take away from today is that if you want to be a high-growth stock, you have to have Mark Astrachan as your analysts because then the Celsius guys were obviously doing quite well. Anyway, so thank you very much. I'm going to give you a quick update on the business and answer, I hope, some of the questions that are lingering out there about our performance. But I think you'll find that we're in pretty good shape. So obviously, we have forward-looking statements. All of you have read that many, many times. I always like to start with what is the mission that we have as a company, because it's really important to recognize what we do every day is driven by a very mission-driven company and purpose. And I start with also that's my dog, so that's my boss. Her name is Appa and she's a 4.5-year-old Samoyed. But we are in the business to strengthen the bond between people and our pets that we both live longer, healthier and happier lives while being kind to the planet. So there's a lot of elements in there, but fundamentally, we're all about strengthening the bond between people and their pets and doing it in a way that our audience finds compelling and interesting and we feel good about. Quick facts on us, and I'll spend very little time on the background. But this year, we're projected to $750 million in net sales. The vast majority of that is in the U.S. We do have a small toehold in Canada, the U.K., Ireland and now in France. Our business is almost entirely a dog food-based business. We have a little bit of treats and a little bit of cat food. That's not because we don't have opportunities there, it's entirely because keeping up with the dog food opportunity has been a full-time job for us. And over time, I'd expect that we would build out our proposition much more in the cat food for certain and a little bit more in the treats. Our footprint today in the U.S., we own two manufacturing facilities in Pennsylvania on the same campus. They're Freshpet Kitchens 1 and 2. We employ about 600 people there, and we have just completed the construction of the Phase 1 of our Ennis, Texas facility which ultimately, when it's fully built out, will be able to produce over $1 billion worth of Freshpet, and that's in Ennis, Texas. And so that is a big, big project for us, and we feel very good about having accomplished the completion of the first phase of that. Our product lineup is a collection of rolls and bags and a variety of other smaller but innovative product forms for us. In a lot of ways, our focus is on creating foods that are of the value that you're -- you would feel good about serving to another member of your family. The pet is increasingly a member of your family. We want you to feel like the food that they're getting is not kibble or can, the kind of stuff that sits in a bomb shelter for 50 years. This is good, high-quality fresh food. So we have rolls that we make. We have roasted meals, which are miniature meatballs; shredded meat, which is our Freshpet Kitchens product; home cooked meals, I call it Thanksgiving in a bag; and patties that we make today. Today, Freshpet is in 25,852 stores as of last Friday. Those stores are scattered across the U.S., Canada, U.K., Ireland and France. And those were in Freshpet Fridges that we own. Our growth has been pretty significant. Our CAGR over the last, call it, 15 years or so is about a 35% CAGR. Ended last year at $595 million in net sales. Last year was a 40% growth rate, part of that driven of course by some pricing that we had to take to match our commodity cost. But the bottom line is that we're growing at an incredibly rapid rate. The key question and the thing we want to focus on today is we think about building our business based on the opportunity to expand the size of the household consumer franchise that we have. Early on, prior to my arrival, and I've been at Freshpet for the last 6.5 years, this was a business that was grown based on getting distribution in white space. We split that model around back in 2017 and focused on building a consumer franchise. It's a much more controllable way of growing your business, but it also means that our ability to grow is going to be dictated by our ability to create the right kinds of products and advertising messages that support them. The way we measure this and the way we consistently report this is household penetration. So what percentage of households are we in or how many in total are we in? And what is the annual buying rate of those households? And we're really focused right now on what we're calling the healthy foodie core target. These are people who we think of as being attitudinally predisposed to treating their dog incredibly well. We call them HIPPOHs, high-profit pet owning households. And those households account for about 33% of our current users, but they're 87% of our sales. And that group has a buying rate of about $220 a year. So you think of that as a very attractive audience for us, about 3.2 million -- 2.2 million HIPPOHs today, and we think that we have the ability to grow that at a rapid rate. And you'll see that it's growing very quickly. But the available of the addressable market is much bigger than that. We think that the total target today or the TAM today is about 27 million households or 41 million if you look at sort of an expanded definition, which is those people who answer a top 2 box questionnaire definitely or probably would buy Freshpet amongst people who are in the pet food business. That's a fairly sizable TAM and relatively underdeveloped versus the opportunity that's ahead of us. The interesting thing is people would perceive that this is a very premium product. And our household income, advertising old income is above $80,000, but it's not a whole lot above that. And as you'll see a little bit later, you'll hear us say that our growth amongst lower-income households is actually very rapid. And many of those lower-income households are younger households with a single wage earner in the household, [ 1 wage earner ] and 1 dog. Here's the audience that we talk about, the audience we talk about and is our core consumer. These are people who are, the pet is their partner. They treat the dog like it's a person. The dog is their -- a #1 priority. So if they're constrained from an economic perspective, they will end up making a priority to feed the dog or treat the dog well. If they're tight on time, the dog is an important priority for them. The dog deserves the best, and they eat fresh food. They're a food lover, they appreciate good food, and the same is for the pup. And that's what brings them to the Freshpet franchise. So it cuts across a wide variety of ages and incomes, so it's much more a psychographic benefit. This ad, let me show you, kind of typifies that. This is our current advertising. [Presentation]

That's pretty much the psychographic of our franchise. You'd rather have the dog as your friend than the girlfriend. So we also have a mother-in-law version of that ad. As you might imagine, it's got similar humanity to it. But that's us. It's not dog food, it's food food. That's what we're all about, and that's the message that we're driving. And we find this advertising is incredibly compelling to the audience that we're talking to. As we think about where our business is going, advertising is, by far, the biggest driver of our growth. And as you can see on this chart, over time, this goes all the way back to 2017 when we really started to double down on our advertising investment. Our cumulative advertising investment against our net sales, incredibly strong correlation. R-squared is 0.99. You don't oftentimes see R-squared is that strong. And it makes basic sense because at the end of the day, then when you don't do pricing or discounting, you should expect that your growth is going to come from the advertising investment that you make. And that's leading us to that very loyal household franchise that we have. People see the ads. They make an initial purchase based on the ads. They buy at full price. So they know what they're getting, they know what it's going to cost and they stay loyal to the franchise after that with a very high repeat rate. We've been talking a lot about household penetration, how we've grown it over time. And as you can imagine, during the pandemic when everybody is at home spending time with their dog and paying attention to their dog, we grew our household penetration incredibly rapidly. We report this data very regularly. This is -- shows that we passed 10 million households as part of the Freshpet franchise in the most recent period that came out for May 7 of this year. And the 9% growth rate, while it is -- looks slow compared to the previous years, that shows that we've begun the reacceleration that we needed to do. We had dropped down to as low as 7% in the data that we reported at Q1 earnings. But you can also see the buying rate because we've had higher pricing, so these consumers are buying at a higher rate, continue to go up quite nicely and it's up 22%. So the same consumers that we've got are spending more on Freshpet. We feel very good about the progress, but this is the area we're focusing on. We need to see the inflection continue and end this year with household penetration gains north of 20%. What's really most encouraging is that super heavy users, those HIPPOHs that we talked about, I'm describing before, were up to 3.4 million of those households in the latest data, with their buying rate now up to $237. So there's very strong growth that's occurring there. In fact, the growth rate for the HIPPOHs is in excess of the growth rate for the total franchise. In a way, that makes a lot of sense because the consumers who are most committed to the franchise, who bought into the idea are going to grow fastest as opposed to the people who view this as sort of an occasional or discretionary purchase. If they find themselves economically distressed or under economic pressure, the discretionary purchases go first. The absolute mandatory purchases are the last thing to go. How is our current business trends? How are they looking? Well, this chart, I think, describes our history. And if you look -- go back -- this goes all the way back to the beginning of '22, but you could see a similar history if you go back to '16 or '17 as well. And it basically shows a series of stair steps as we go along. In the beginning of '22, and the yellow line on here represents our 4-week rolling average Nielsen-measured dollar sales. And what you can see is, at the beginning of '22, we had -- even though we took a price increase, we had a strong media investment and improving in-stocks. We got to the summer last year and we've got $5 gas, which was a real hit to the consumer as well as a little bit of the summer doldrums that occur in the pet food category. It came back in the fall, had strong media investment for the, call it, August, September window, a little bit of October. And we had improving in-stock conditions. We've been out of stock for quite some time. Built the business again. We were off the air in the fourth quarter. You can see it went flat then. We've been back on the air with a full advertising program, full innovation program, full fridge placement program, and you can see the businesses continue to grow. And all that is in -- despite having three pricing actions in that window, we've actually had four pricing actions in the last 18 months, totaling a 27% price increase. We are facing the consequences of having rolled off the last -- the 12% price increase that happened last February, so the Nielsen growth rate doesn't look the same as it had before. It's got to become much more volume- and unit-driven than it does pricing-driven, but we're starting to see that turn up in the units in the volume as well. Here's what it looks like on a 2-year stack. I've done 3-year stack and 4-year stacks. And I think we're back to the point where 2-year stacks actually make some sense again, and the growth is very, very consistent over a long period of time. This shows by week, the 2-year versus -- the 2-year stacks, very strong consistent rate. It's a little bit more skewed to the previous year in the latest periods, but you'll expect to see it flip around in the back half of the year. The other thing you should note about the Nielsen data is that the Nielsen data is slightly less representative of our business this year than it has been in years past. And it's important to know that when you're looking at the Nielsen data, because the -- what this chart shows is what we've actually had for our shipments of pounds versus the pounds that are measured going through Nielsen scanners. And what you can see is that there's been about a 3-point shift. And the reason for that is pretty straightforward is that we've gotten more growth in unmeasured channels, and this is Costco and online than we've had in historical periods. So we're expecting about the -- the Nielsen to underrepresent us by about 3 points more than it has in previous periods. That's not unusual. The panel data that we have, the household panel data, says something similar. This shows the units that are being bought on a rolling 13-week basis on a change versus a year ago. And what you can see, in particular, is that our club business has taken off. And it's pretty straightforward. We're now in about 1/3 of the Costcos. We've been in the BJs forever and done well there. We're not in any of the Sam's. But Costco is such a high-volume outlet. Now that we're in 1/3 of them, you can see it's actually having a big impact on our overall growth rate there. We expect to be in half of the Costcos by the end of this year and continue to grow from there. You also should know that pricing, which has been the topic for sure for the last 2 years. And if you think about the Freshpet -- how pricing has impacted us for the long haul, a lot of people have asked, "Geez, how much pricing can the consumer absorb in this category, in this brand? At some point, are you priced out of the market? What this chart shows, this goes back to August of '21. And what it shows in the green line at the top there is what our measured consumption was for every one of those periods -- weekly periods, and it's pretty strong and consistent, despite the yellow line which is showing the pounds going up and then a little bit down. And the pricing, which is the orange line, you can see there have been some steep price increases relative to the year ago, which drove down the pounds, but the net sales just kept motoring on. And I take a lot of confidence out of this. It says that we might get in on pricing and some periods where we might get in on pounds at other times. But the bottom line is the net sales of this company grows at a very strong and very consistent rate. When you think of it, also look at -- the other way to look at it is consumer digesting the price per unit. This shows in the green line at the top, the buying households that we had and the yellow line shows the spend per unit. So as the consumers are spending more per unit, again, there's slight variation in these curves as they go along. But the reality is, going all the way back into -- this goes back as far as 2019, I believe, you can see the consumers pretty consistently digested pricing and kept motoring along and adding households to the consumer franchise for Freshpet. So again, pricing has been an issue. It has had short-term impacts. I don't want anybody to downplay that, but we think that we've now taken the pricing that we need to take to get to our margin structure that we need for the long haul. And the consumer has shown a remarkable ability to, over time, digest the pricing. I think people need to understand that over time, this model, remains very much intact. The other piece I want to highlight in the current business performance is our fridge placements. We told people at the beginning of this year that this would be a banner year for Freshpet fridge placements. We expect to place about 5,000 fridges this year, and we're well on track to delivering that. You can now walk into some of the highest velocity outlets in the country and find 3-fridge islands or double fridges on end caps because customers have decided that this is the way to win in the pet food market. If they want to win in pet food, the highest value shoppers are buying Freshpet, they need to be known as the retailer who has the product constantly in stock, the widest array of products, and this is the way to draw consumers into the pet aisle. Those are highly valuable shoppers. So as you can see, what we're projecting for this year is 1,200 new stores, 3,000 second and third fridges and 1,000 upgrades from smaller to larger fridges. And we are very much on track for delivering that. And that's one of the ways to measure that is these are TDPs, that's total distribution points. It's the product of the amount of ACV that you're in times the average number of SKUs in the store which is, in essence, is a measure of how in-stock you are and also how many phasings that you have. And you can see that since our -- the depths of our out of stocks that occurred during the depths of the pandemic, we've come out of that and we are now achieving all-time record highs. And that's a measure of really, really good in-stocks shipping at a very high fill rate. And secondarily, it's also getting a lot more second and third fridges in the stores. This is less driven by new stores and much more driven by second and third fridges. So as we think about where we are today on the growth side of the equation, we are expecting that we're going to see acceleration in the periods ahead. Right now, the Nielsens are growing in the, call it, 21%, 22% range if you're looking at the Nielsen mega-channel. Remember that understates our growth a little bit because of the unmeasured outlets. But the leading indicators for our growth are going to be household penetration acceleration, buying rate growth, fridge additions, fill rates that are above 95% so you know you have the in-stocks you need to have and a media investment in the balance to go period and versus a year ago. And all those are heading in the right direction, and we feel very good about it. And you should see that show up as Nielsen measured growth acceleration in the coming periods. I frankly expect to see that showing up in, call it, the July to August window. So if you take a long step back and say where are we today, we've been through a lot of stuff with pricing and out of stocks and all the issues that come with that supply chain challenges. The reality is where we sit today for this year, we're spending more than $70 million in advertising this year in 2023 and more than 40% of that remains to go. Fridges, we're going to get 5,000 fridges this year. There are about 3,500 of those to go that will help us build out retail availability. And the bottom line is that, that creates significant momentum for us, accelerating pound and unit growth. Pound shipments, that would be above 20% versus a year ago and household penetration accelerating. And the bottom line is it means that the model is still working as it has since 2011. This is a very simple model that continues to work. I want to give you a quick update on competitive environment because there's been a lot of focus as we built this category and establish that fresh pet food is the future of pet food, we've finally drawn the interest of all the big incumbent pet food players. The first of those is Mars CESAR product. They launched rolls, competitive roll product with the help of Walmart in about 1,600 Walmart stores now. What you can see in this chart at the bottom is the weekly sales volume per store for the Mars product, which is running at about $46 per store per week. And in the same stores, we're running at $1,210 per store per week. So we feel very good about our strength and our performance and the growth even in the face of Mars deciding to enter the category. Obviously, they're not getting anywhere near the traction they probably would have hoped. And then Blue Buffalo, General Mills recently launched Blue Buffalo Fresh. It's still relatively early on, first started showing up in stores in February, late February, but it seems to have sort of plateaued at a level of about $35 per store per week. Again, we do about $1,200 per store per week. They're in 200 stores. So the bottom line is that the work that we did to build the competitive mastery, the scale, the brand equity, the product innovation to create this category seems to be holding up in the face of two of the category giants with well-established brand names trying to compete with us with the help of the world's largest retailer. I also want to focus on increasing operational efficiency and scale, really just touch on this briefly, but this is a real strong focus point for us this year. We've demonstrated to all of our investors that we know how to grow, and we can grow quite nicely, but they all have questioned whether or not we have the ability to deliver the profitability and the margins, the cash generation we need to generate. We did host an investor event back in April in our Ennis facility. This is what that site looks like. This is a 70-acre site, about 45 minutes south of Dallas. The part on the right is the main production building that is already up and operating. You can see we have essential utilities building in the back. We have a chicken processing operation on-site. It's the first time we've done that, operating that with a partner that will start up later this month. And we have already stopped broken ground and started construction on Phase 2, which is in addition to the building to house incremental production lines. So this is our biggest investment to date. It will be the most technologically advanced, most efficient facility and also the most sustainable facility that Freshpet has ever built. And we view this as the anchor for our competitive advantage in the manufacturing of fresh pet food. Nobody else knows how to do fresh pet food, certainly not the way that we do it. And certainly, we'll not be able to do it at the scale that we do it. This is the timetable and the milestones for this year. Our rolls line, the first line is up and operating 24/7 and producing very high-quality product very consistently. The bag line is up and operating and been producing salable product for a couple of months now, and the chicken processing is starting up now and the bag line will switch to 24/7 operation within a month or 2. We feel very good about that progress. It is very difficult to greenfield and operation, especially in the middle of a pandemic, and we managed to pull it off. We're also very proud of our labor, how we've managed the labor situation. We decided that labor was going to become a strategic advantage for us instead of a constant challenge. And so we created a program 18 months ago, or a little more than 18 months ago now called the Freshpet Academy, where we deliberately refocused and changed the equation on labor, where we focus on higher skill employees and investing very heavily in training and development, and it's working. And that's part of our operational turnaround. The operational turnaround that people saw in Q4 and in Q1 of this year can directly be tied to the improvements that we made in this. It was a big, hard investment and well thought out, but the chart on the right shows you what our turnover looked like in August of '21 versus where we are in March of '23. And basically, we now have 68% of our people have more than 1 year's experience versus 19% before, and the less than 6 months crowd is down to 5% versus 46%. This was a huge improvement for us and a big driver of our success. Our guidance for this year, there's really -- there's no change in our guidance for the year. Progress is very much focused on the same building blocks we mentioned before. You noticed checkmarks and all these things on the left, except for leverage scale in COGS. We're still working on getting the leverage out of that. We expect that to happen when Ennis is brought up to scale, but we're getting the improvements that we expected to get in the other areas. We're really focused on having enough capacity, getting logistics efficiencies, improve quality and commodity costs in line with pricing. We're reaffirming our guidance today for about $750 million in net sales and greater than $50 million in EBITDA. We feel very good about it. You can read in the deck. It's on our Investor Relations section of the website, the details behind that. And as we talk about Q2 expectations we reinforced, we expect to have similar kind of mid-20s net sales growth versus what we had in Q1. Advertising investment remains very heavy front-loaded. We expect to have some extra logistics costs in Q2 versus Q1 just because we're starting up a Dallas DC, and you can read the rest. But the bottom line is we feel like Q2 is heading in the right direction. I do feel obligated. It's the sort of the elephant in the room. It's not the thing that we like to spend time on or talk about, but just give a quick update on where we are on governance. We have what I would describe as highly unusual shareholder-friendly governance plan that we put in place long before we saw our friends, the activists, show up. In 2020, we determined that we were going to transition from an emerging growth company that was basically a very small-scale private equity-backed company that had gone public to a fully mature company by the time we're $1 billion in net sales. And so we laid out the road map to do that. Back in 2020, we put it to a vote of the shareholders. The shareholders have endorsed every single piece that we've asked them to endorse, and we've taken every action that we laid out. To my knowledge, no other company has done this, where they laid out 5-year governance transformation road map and has followed through and done every element of it. Included in that was broad shareholder support for our plan to de-stagger the Board by 2025, including 97% support for that plan. It also included a mandatory retirement for directors, which prevents our Chairman, Charlie Norris, from standing for reelection. That's been public information since 2021. Obviously, some folks didn't notice that, and we've implemented every part of that plan. We're also strengthening our Board quite considerably. Spencer Stuart has been helping us with that. We added recently, Dave Biegger, the former Chief Supply Chain Officer for Conagra and Campbell Soup, to our Board. Huge win. He's unbelievably a talented supply chain guy. He's already been working with our team and learning what we do and providing expertise on that. And we're frankly willing to work with the activists to figure out what's the right way to govern them. We gave them the opportunity to interview our top two nominees, one of them being Dave Biegger, and they supported their appointment. We also offered to interview their candidates to see if they would be appropriate. At this point, they have not accepted our offer to interview their candidates. I also want to point out that we announced significant organizational changes and structure before we knew that JANA was involved in our stock. On September 7 last year, after working at it for a couple of months, we announced a significant refocusing and some organizational changes. We announced those on September 7. That included the departure of the CFO and the hiring of -- we ultimately ended up hiring Todd, who's here today, a proven CFO for that role. And we also announced the plans to hire additional operations talent and have hired that talent. We're going to announce some additional hires later this month. Since those changes, we have met or exceeded expectations every quarter and reduced the capital spending commitments of the company. We've also demonstrated improved operating performance. We got the Freshpet Kitchens Ennis up and operating on time and on target. We opened a second DC, and our cost for quality and logistics have improved significantly year-to-date and are continuing to improve. So I want people to take away that our Board and our management recognize we need to do some things to improve. We took action without somebody coming in and telling us to do it, and we feel very good about the progress that we're making. We remain very open to having amicable conversations. But as any of you who have read all the press, you can recognize that, that's not always the easiest thing to do. So that's where we are. We feel very good. We think the future for Freshpet is incredibly bright. We think we are changing the world for pet food and the world of pets. We think that, at the end of the day, that fresh will be what the future of pet food looks like. When you walk in a store 5 or 10 years from now, you kind of wonder whoever bought that canned or kibble stuff because you're going to see fridges lining the aisle, and that's the future of Freshpet food. So I appreciate your attention. Thank you very much. Todd and I will be here for a few minutes more if there are any other questions, but I appreciate your time and attention. Thank you.