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

Good morning, everybody. We're going to go ahead and get started. My name is Jim Solera. I run the packaged food and beverage practice here at Stephens. Today with us from Freshpet, we have Billy Cyr, Chief Executive Officer; and Todd Cunfer, Chief Financial Officer. Thank you guys for joining us today.

Glad to be here.

I think a good starting point before we really dive into where you guys are going is just maybe give a recap of the year. It's been a very exciting year for Freshpet. You guys have made a lot of headway, especially on the operations side. And so can you just give us highlights of some of the improvements you made this year and really the impact it's had on the business?

Yes. I'll give you a top line, and Todd can add a couple of pieces of commentary. But perhaps the most important thing that we've accomplished this year is we've transitioned back to the model of top line growth is coming from -- largely from volume and mix, less based on pricing. So we survived 27% cumulative price increases over the last couple of years, and we're now back to a place where we'll burn off the last of the price increases on annualizing that this coming February. But we're showing the top line growth that's driven by volume that, frankly, we've historically shown, and that we know that this business can thrive upon going forward. And so that transition is probably one of the most important things that happened this year as we got ourselves to the consumers, they digested the pricing, and we're growing volume. From an operations perspective, we told everybody this year that we would really focus on 3 key areas. One of them is input cost; second is logistics; and the third is our quality costs. And we've made meaningful progress in each of those areas. I will say that the place that we made the biggest progress most quickly was in logistics. It's been a huge step forward for us. About 1/3 of that has come because the market has been favorable, lane rates and diesel costs. The other 2/3, though, has been because of things that we have done, actions that we've taken. But we've made progress in all 3 of those key strategic areas, and I think that we're really realizing the benefit from really focusing on them. And then the last comment I'd make is our business, because of its high rate of growth, inherently requires that we become really good at adding capacity. We have in the -- since the pandemic began, we've added a Kitchens 2. We built Ennis, a facility in Texas that's going to ultimately have almost 1 million square feet to it. Built the facility, started up 2 lines and are operating 2 lines, and the third line is being commissioned as we speak. So we continue to prove that we can bring on new capacity, whether it's a new facility or a new line or new staffing, and do that very reliably. So we think from a top line, from the operating elements and then from the capacity addition, we're hit on all those metrics. I don't know if I missed anything.

No, but I mean the profitability piece was obviously essential this year. We had not great performance margin perspective for 2022. We laid out clearly in CAGNY at the end of February what our long-term targets were, where we're very confident we can get to a 45% adjusted gross margin and 18% EBITDA margin. And we jumped off of '22 woefully short of those numbers with 36% and 3%, respectively. So a long way to go. Good news is we've made a serious dent in those margin expectations this year. We'll have -- we'll probably gain at least 350 basis points of gross margin expansion this year, which is terrific. And we'll go from a EBITDA margin of 3% to about 8%, based on the guidance we laid out last week. So I feel great about those numbers. Still got a lot of work to do. We've got a long way to go, but we have a very clear path to how to get to that 18% EBITDA margin.

That's great. Billy, you touched on just the growth profile of the business. And I think if we look at the pet food category as a whole, Freshpet continues to grow well ahead of peers. What does the competitive environment look like in pet food, maybe broadly speaking, and then in your kind of more narrow product set? And then how do you feel your products are positioned relative to competitors, both in terms of pricing and maybe some in-store positioning?

Yes. I mean there's obviously a lot of attention has been brought to the pet food market. Of late, there's been Wall Street Journal story, USA Today story, and people are trying to take a look at, geez, there's this pandemic boom and then there's this -- maybe there's a little bit of a bust on the backside, and looking for some proof points for that. Fundamentally, we believe that the category has got a lot of tailwinds and it's going in the right direction. People care more for their pets. They're replacing kids in many households. It's a fundamentally very, very good category. Within the category, what we're seeing is the growth has kind of become bifurcated. If you have a highly differentiated, really good proposition, consumers are buying good, increasing rates. The 2 fastest-growing parts of the pet food market are our business and the DTC business, largely Farmer's Dog. And so you think about it, people will talk about consumers trading down. The reality is these are the 2 of the more expensive propositions in the category, and consumers are increasingly acquiring pet food at a higher and higher price point. And it points out the importance of the pet in their household. But the people who aren't doing that are finding relatively undifferentiated propositions in the kibble and can business. And so they're starting to become a little bit more value-oriented in those segments. But we're not seeing any indication that, that's having an impact on our business. We're not seeing trading down in our business. What we're seeing is consumers are adopting us and at rates that are similar to what we've seen in the past, based on the spending that we've done. There's also been a lot of conversation about what happens now that all the pet food companies that are the traditional kibble and can businesses have all spent a lot of money in adding capacity. And just as that capacity is coming online, they're starting to see a slowdown in their volume. Well, it remains to be seen. But from what we can see from the data that we've got is there's not a lot of trading between our business and the other pet foods, in part because it's really hard to compare the forms. I mean how much Freshpet replaces how much kibble? How do I figure out the price, price per day? It's a very complicated exercise. And also inherently, the pet food market is a very loyal business, meaning consumers acquire pet food, a brand, they stick with that brand for as long as it works for them. And only when it stops working for them do they start looking for another alternative. So our base of users is pretty well locked in. The incremental users, the new people we've got to get in are either going to be new to the category or somebody who's had a problem with their existing pet food. So if there's a price issue, it's not on our existing business, it's on what does it take to get in a new user to in essence, get them to trade up in value to -- or up in price to a higher cost product. But so far, we're not seeing any indications that, that is slowing.

You touched on there's really not an apples-to-apples comparison between Freshpet and kind of traditional dry dog food or canned dog food. Do you feel that there's kind of a relative price gap that needs to exist between those formats and your product? Do you have a lot of flexibility and kind of what the price gap can be between those?

Yes. I -- the answer to the question is, we don't think there's necessarily a price gap. The only place that we've seen evidence that there's price gaps that mean anything are if you are one of our lower-volume users who use us as a mixer or a topper, so it's not the main meal, where you may look at the price of a Freshpet item versus a canned dog food, which has a similar purpose for many consumers. And you would recognize there's, okay, there's a price value there. But if it's looking at the mean meal item, we don't see a whole lot of discussion about the price gap because, frankly, it's almost impossible to calculate it. So you can't do it in your head. You need a spreadsheet. And people just aren't going to -- aren't willing to do that. We are much, much more responsive to absolute price points. We do not engage in downsizing of our packaging because the consumer buys a bag or a roll expecting it to work this many days or feed their dog for this many days. We don't want to have them get home and find out, oh, I thought this is going to feed my dog for 6 days, and it only feeds them for 5 days. Inherently, they now realize they got less, and they also get pissed off because they run out of dog food. And so in our world, absolute price point means everything. But when we take pricing, the consumer is going to see it's a bare naked price increase, and we have to have a good value that justifies that. And so far, 27% price increases later, we feel like we're in a good place.

That's great. Kind of continuing on that train of thought. In your conversations with your retail partners, have they given you any thoughts on pricing, pushback on pricing, maybe indicate that they want more promotional spend, anything like that kind of to support the category, especially given your volume trend versus kind of the broader category volume trend?

Yes. So forever, retailers have asked us for promotional support. And we always tell them that's not our model, that's not in your best interest. It's not in our best interest. And while we were small, you could get away with that pretty easily. As we get bigger and become a more important part of the category, they have this bucket on the side where they have to fill this bucket with trade promotional dollars because that's how they make their money, and we keep trying to convince them that they'd be better off making money on full revenue products and purchases every single day at full margin. And so far, that's worked. And they've kind of gotten used to it, but I will say it will always be a challenge. We'll always face that challenge.

But to be clear, we are the -- in brick-and-mortar, we're the fastest-growing brand and we have some of the highest margins for retailers. So it's working for us. It's working for them. I think we can continue with this model for a long, long time.

Yes. That's great. Why don't I pause there and see if there's any questions from the audience? We can go right on. As of your most recent update, your total store count was just north of 26,000 stores, I believe, but only around 20% of those have multiple fridges. Do you have a sense for how high that number could get? And maybe what's the value proposition look like when you're speaking to your retail partners about getting that second or third fridge?

Yes. So how high could it get? It's -- it can get much higher. And obviously, there has to be enough room in the store for it to make sense. There has to be enough foot traffic in the store for it to make sense. But what's the conversation with the retailer look like? It's really a strategic conversation. It's what role do we play in the category? What role do we play in the store? So I'll give you a couple of examples. So for Kroger, who has got unbelievably good loyalty card data, they made a strategic choice a while ago to invest in 3-fridge islands in their stores and build their pet department around it, so really, a fridge that's facing 3 different directions. So the consumer could be drawn in and they would see 3 distinctly different propositions from us on each of them. But this was where they recognized that the Freshpet proposition was bringing into the store, the entire store, not just to the pet department, to the entire store, the kind of shopper who is of most interest to them, high value, they shop the produce department and the meat department and whatnot. And so we became not just a good first or second fridge because of what we did on pet food sales, we became a very valuable proposition to the entire store. If you look at Target, when Target went big on Freshpet back in 2015 and they put Freshpet on the end caps, the reason they did it is because people didn't think they sold pet food, and they wanted to make a very clear message that they were in the pet food business and that they were in the higher quality premium pet food, which sent a message about the whole store. In other words, if we're going to be in pet food, it has to look better than other guys did. And so the answer to the question is it's every retailer will have their own strategy and how we fit in with what that strategy looks like. But if they're interested in pet, which most of them are increasingly interested in, if they're interested in -- sorry, if they're interested in pet and if they're also interested in building out the higher-value consumer base that they have in the store, then we become a very good strategic tool for them to use. And the only question is, are they going to add more items or are they going to try to get higher velocity on the core items. And that's a choice they make.

And you guys touched on recently a couple of new product additions, large dog and some entry price point offerings. Does that also build into the value proposition to get a second or a third fridge, just allowing kind of a broader SKU offering?

We talk about it as fridge bait. To get these items, you need to put a second fridge in. But we don't do that unless we think that, that would add real value to that retailer's outlet. So we have Homestyle Creations, which is a product that replaces home cooking. We have the large dog, which is for people who have a large dog. And each of those items is designed to enhance the value of the total portfolio that we've got and make them more efficient. But some people will use the second fridge for a different reason. I mean there are some retailers out there who view the second fridge as a way to increase the holding power so that they can get the velocity that they need without having to restock constantly. There are some people who will use it to carry unique SKUs, SKUs that their competitor doesn't offer, which is part of their value proposition to their shopper. So at the end of the day, it's a delicate balance, and we have to find a way to make the Freshpet portfolio marry up with what their proposition is to their shoppers.

As you expand the number of second and third fridges, does that really deepen your competitive moat because there's a finite amount of kind of visible real estate in the stores? And I imagine as your fridges occupy more of that, that means that there's, therefore, less for competitors. How do you guys think about that? And if you can maybe offer some commentary on stores where you have multiple fridges or stores where you only have one fridge and kind of how that helps?

There's plenty of space in the store for somebody to put another fridge in. That's if they want to put more fridges in, there's a lot of space in the pet food section to put in multiple fridges from if other competitors want to go down that path. So that's not the limiter. What is the benefit for us is if we put in multiple fridges, it supports the entire infrastructure, everything from our marketing investment to the manufacturing scale to the distribution system and the logistics that we get to the buying power that we get. So the benefit of multiple fridges is sort of the front end or the visible part of a system that gets much, much bigger barriers to entry for our competitor or competitive advantages that we'll have versus somebody else who comes in. But the fridge space itself, the expertise in managing the fridge is a barrier to entry, but people with deep pockets can go out, buy fridges and convince somebody to put them in a store. That's -- but that's just one piece of the puzzle.

Yes. You guys have also seen strength in the club channel. Talked on Kroger and Target, but in club, it's a little bit of a different shopper, a little bit of a different shop. Can you give us a sense for what you guys have seen there and maybe the opportunity to expand your presence in club?

Yes. So we've been in BJ's for a long time. And if you think about BJ's, BJ's is a retailer who really is more of a grocery store on steroids. They are less of -- they're not like a Costco. And so we've done very well there, very, very well. If we're part of your fresh shopping purchase, if your fresh buying is at BJ's, you shop for our product there. Costco has been the big home run for us last year. We've been in Costco for quite a long time, but it's store by store, region by region. In the last year, we've had a bit of a breakthrough. So we're now in something like 390 of the, call it, 550 Costcos they have in the U.S., but it's been growing very rapidly. Our proposition there is like it is in many -- for many other people in Costco, which is a value proposition. You buy a package that has multiples of rolls or a large size of our bags. And Costco takes a low margin, relatively low margin, so it becomes a very good value opportunity to buy large scale, and the velocities are phenomenal, I mean absolutely phenomenal in there. So that's a really good proposition. We're not in Sam's today. We talked on our earnings call about that's a possibility in the future, but we're not in Sam's today. At some point, we'll find the proposition that works for them and for their shopper and their strategy. And once we do, that's upside opportunity for us.

And there's -- I mean with Costco, there's also upside internationally. They have a very large Canadian business which we could fit into quite easily. We actually have a very nice U.K. business, and we're in the U.K. So there's some opportunity in the U.K. as well. So feel great about that club opportunity over the next couple of years.

Yes. Actually, Todd, just going off of your comments there. Is there a different value proposition for an international consumer versus a U.S. consumer? Or is it largely the same?

Largely the same.

Yes. Very, very similar proposition.

When we're looking at the household penetration growth that you guys have seen, it's surprisingly strong among younger consumers who have less spending power. This is obviously a premium product. Can you just give us an overview of kind of your customer composition in terms of age? And then how that gives you confidence about kind of the long-term success of the business moving forward as your consumer [ changes ]?

Yes, it's interesting. Our -- still our largest group of consumers is going to be in the Gen X and in the millennial group because that's where you tend to have the largest households and they're most likely to have a dog in the household. The waning end of it is the baby boomers who still have dogs and still getting new dogs, and they're still very interested in the Freshpet proposition. But the real opportunity for us has been the Gen Z crowd. If you're an 18-year-old male in the United States today and you think about what's going to happen to you in the next 6 years, you're going to graduate from high school, you might go get some higher education, whether it's college or a trade school or whatever it is, you going to get your first job, you're going to get an apartment or your first house or whatever it is. There is a 50% chance that you're going to get a dog, and there's only a 25% chance you're going to get married, okay? So just think about the priorities that you've got. And that's the reality. That's what's happening. And those consumers in that audience are twice as likely to choose Freshpet as the first -- as the pet food they feed their dog as somebody who would have been in the baby boomer generation or in the Gen X generation. So we feel very good about the long-term viability, but it's an up-and-coming group. So in terms of the share of our business today, it's still on the small end, but it's also the fastest-growing part of our business. The other thing that's really interesting, when you look at the -- a lot of people are very fixated in this economy on, well, how are you going to do amongst consumers who are economically stressed? And what's funny is we have this sort of odd curve where we have low-income consumers who are growing at a high rate, high-income consumers are growing at a higher rate, and the lowest rate of growth, still growing at a good rate, is the sort of middle income group. And that's kind of disguising what's really going on because the group that's in that low income group is either retirees who don't have many fixed costs or discretionary costs that they're having to absorb, or young people who have no car, no house, no mortgage payment, none of that stuff. And so their income might be relatively low but their discretionary spending or where they're going to spend it is much more focused on things like their dog. If you have 3 kids in your household, that's the household that's most economically stressed. So their income might be higher than the Gen Z-ers, but they're spending it on 3 kids or 2 kids or whatever it is and all the costs that go with that. So we have this odd distribution of growth by income. But that's -- we view that as a good thing because as each of those groups mature, they're bringing along the Freshpet habit.

And it sounds like based on that, that these households that don't have kids or maybe only have one kid or married with no kids, it's really not a discretionary purchase for them. I mean it's a core staple item in their basket.

It very much is. And we always say Freshpet is replacing -- or dogs are replacing kids. And I tease my kids that Freshpet -- or our dog, Appa, Appa is not just one of our children, she's my favorite child. And I think a lot of people are feeding their pets with that same kind of mentality. It's -- and it's good. It's good for our business. It's good overall. The kids don't think so.

Recently, you guys have had more kind of visible prime time ad campaigns tying into maybe some of the themes that you just touched on. Can you just speak to the kind of the theme of the ads, early kind of signs of success that you've seen from that? And what we should expect from kind of the messaging there?

Yes. I mean we've been blessed. Our advertising team, the advertising agency that we've been doing business with for many, many, many years have done a phenomenal job. We rigorously test every piece of advertising we put on the air. Long before it goes on the air, we always are queued up with a campaign, the next campaign, or the pool out of the existing campaign. The advertising that we had on the air last year was doing incredibly well, but we thought we could go better. And the current campaign that we have on air, it says, It's Not Dog Food, It's Food Food, has sought to basically create a distinction between the person who thinks of their pet as that member of their family and should be fed like their member of their family or one of their treasured children, and the people who don't think that way. So you've seen our ads that show a mother-in-the-law showing up and questioning why her daughter-in-law has got pet food in the refrigerator and she gets kind of bounced out and -- the same thing with the buddy in the man cave, garage watching the football game. If you don't think that feeding your pet food that's good enough to be in your refrigerator, then you're probably not a friend of mine. So -- and that's worked incredibly well for us. It's really tapped into the psyche of our users.

That's great. Why don't I pause one more time and open up to see if there's any questions in the audience?

[indiscernible]

Yes. So the most direct competition that we've had has been Mars entering into Walmart stores almost 2 years ago at this point with rolls. And then earlier this year, General Mills launched the Blue Buffalo Fresh product in Walmart stores. They went into about 200 stores. The Mars item ultimately got up into as many as 1,600 stores. Both those items have been discontinued. They might still be in distribution in some of the stores, but they've been discontinued. They won't be on the planogram. They're not on the planogram going forward. And it's a very good reason for that. In those stores, they were selling $30 or $40 per store per week for the CESAR item, same thing with the Blue Buffalo item. In those same stores, we were selling $1,250 per store per week. So it wasn't even close. So those items are gone. So we don't have a really strong direct competitor in broad distribution as a fresh product today. There are some people who are launching frozen versions, so you're seeing freezers show up in some stores. And those products are -- they're getting closer in form but they're still frozen, because doing fresh is really hard. Nobody has figured out how to do fresh like we do. The other part of the category is the DTC business, which there's obviously been a lot of action in that area in the last couple of years. The breakout winner in that category has been Farmer's Dog. We think that based on everything we're hearing, they're a business that in a net sales perspective is about the same size as ours. They are -- we hear they are not profitable. We don't know that. We -- as we look at that business and think about that segment, we believe fundamentally that there's a limit to how big that business will get based on it's frozen, based on its DTC model and whatnot. So we don't want to go chasing rainbows and whatnot. But from where we sit, we think there's a very, very long runway for fresh, and we're the best at it and we're going to do the best we can with that and make it as big as we can. That doesn't mean we're not paranoid, not watching all these other things and may consider to do things that are competitive with those items, but you should expect that the vast majority of our focus is going to be winning with fresh.

Do you have a sense for Farmer's Dog, where they [indiscernible] how much their cost is on a count basis versus your Texas facility?

So they're co-packing. They're coming out of a human food manufacturing facility. So it's -- and it's a hard thing. They're selling price is about twice the feeding cost of what ours is. I can't tell you what their actual operating costs are.

But you still think -- I think when you were raising money for Texas, you were saying Texas would be the lowest cost dog food production.

Fresh food, fresh food. Yes, and we're pretty convinced that's the case.

And then just another one on Costco. So I think you said about 65% of the households coming in are new?

They're new to our franchise based on data we get from the numerator, yes.

I mean how are they different than what your existing customers?

The demographics are very similar to existing customers. Remember, we only have 50% awareness on Freshpet today. So it's not unheard of for us to find people whose primary shopping is somewhere else who still haven't heard about Freshpet.

And then the other 100 or so that you don't have, do you have the right to [indiscernible]?

Independent decisions. Yes, they don't buy at a corporate level. So they just kind of roll out when they want to roll it out. So we're confident we'll get most of them over time. And we're kind of picking off 15, 20 every couple of weeks, but those are individual decisions.

And do you have an ability to move from back of the warehouse where it sits now and move it to the front?

Those are their decisions. I mean obviously, we try to influence it as much as we can. But at the end of the day, I have a bigger issue, which is they use a different header card on the fridge. It's our fridge. I don't like the header card. But right now, I'll live with it while we're selling $5,000 per store per week in those stores. But at some point, I'd love to get it to be the Freshpet header card.

[indiscernible]

My first sales call when I joined Freshpet 7 years and change ago was to Sam's. And since then, I think there are 4 different pet food buyers there. I don't think that -- they had other issues to solve first. And now I think it's gotten to the point where there's so many -- only so many of those things they can solve where they now have to face the obvious of the biggest thing that's going on in retail pet food is us, and they've got to have some point of view on how they can play and how they can win. And we need to decide what that's going to look like. They, like many retailers, when they decide to get in, they want to know what makes them distinctive. And oftentimes, if you're in the club channel, you want that to be all about price, and we're not interested in creating that kind of a pricing dynamic in the market. So if you take that off the table, it's going to have to be something else.

Yes. I mean club versus -- I mean Sam versus Walmart, if you have a good proposition, Walmart will probably take you and have hundreds of SKUs in the pet category, okay? Club probably only has 20. So whatever that buyer is or whatever the strategy is with timing, they're going to have a point of view on what limited number of SKUs they're going to put in. So it's just -- it's a different buying phenomena. Look, we're having a conversation, and I'm very confident at some point in time, we will get into Sam's because we have a terrific proposition. I'm sure they're seeing what's going on at Costco. Obviously, we're doing incredibly well at their sister company, Walmart stores. So we'll get in there at some point of time.

[indiscernible]

Well, essentials messaging is the product offering. So like in -- so for example, in Costco, the brand name on the product is Deli Fresh. It's Freshpet's Deli Fresh product. So it has a-- it's just like we do in the pet specialty channel. We sell Freshpet Vital in the natural channel, we sell Freshpet Nature as fresh. In Costco, we do Freshpet Deli Fresh so it's got slightly different characteristics to it. We do it in a box that is a multipack box of rolls, moving from a 4-pack to a 6-pack in order for us to get more efficiencies in doing that. Those kinds of degrees of flexibility exist when you're dealing with customers as big a Costco or a Sam's.

Look, they're a great operator. We'd love to get in there. I'm sure it's -- confident at some point in time we'll get in there. They sell a lot of pet food. So we're optimistic.

Great. I think one of the more impressive feats that you guys have delivered is your resilient volume trends even in the face of higher pricing. How should we think about the composition of your sales growth moving forward? Kind of what's the contribution that you expect from price mix versus volume?

So if you're shooting for 25% annual net sales growth, we would expect that you would see, from a poundd perspective, call it, in the low to mid-20s. We reported in Q3, it was up 23% on volume. In the most recent weekly Nielsen's, so remember, the Nielsen's do not include the Costco business, but in the most recent weekly Nielsen's, we're up 22% on volume. You'd add the Costco gains to that. We think that kind of in the low to mid-20s on volume and then the rest of it coming from consumers migrating up the franchise into higher value per pound items is a pretty sustainable model over the long haul. There will be years where it's skewed a little bit more towards volume and a little bit more -- or more towards mix depending on what innovations we've launched, which customers have invested in double fridges, that kind of thing. But that's sort of the sustainable model for us.

Recently, you guys have talked about managing your growth to make sure that you don't overextend the network. Obviously, a very high-quality problem to have. Can you walk us through kind of some of the levers that you have to manage growth to make sure that you don't have excess demand kind of beyond what you want to put in the network?

I mean it starts with advertising. I mean our business is so closely correlated to our advertising spend that if we set the advertising spend number, you can get yourself to what the net sales number is going to be pretty darn close and dial it up, dial it down based on that. There is the amplification value of incremental fridges and the visibility that, that provides. And there is also the variable of who or what new items do you launch that year and what impact do those items have, because some items are bigger than other items. But over the long haul, as we think about what tools do we have to control the growth rate, it's literally control the advertising spend. Yes, we spend 99% of our time thinking about it that way.

Okay. If you do have excess demand and you pull back on the ad spending, but given like you said, you have kind of this greater in-store visibility, do you feel like that gives you a little bit more leeway to maybe be more aggressive on pricing if you have the volume trends you haven't really seen [indiscernible]?

Pricing is a very difficult or a sensitive topic for us because the pricing decision is not just ours, it's also the retailer. You have to -- they're not pushovers on just take more price. And the other part of it is that we still think that this category is in its infancy. And we do not want this to become a niche category because the products got so expensive. We really want this to become ultimately the mainstream of the pet food market. Now we think the market's mainstream is going to move up to meet us. But we can't have it be so high up that the consumer ultimately always pigeonholes us in, you're that thing over there that's only for certain kinds of people. We want to be in the mainstream. So we are very respectful to the margins that we have to get, and we have to recover the commodity cost and input costs that we've had. We have to justify the capital we're spending. So we're very, very mindful of that. But we don't want to be the brand that pushes the prices so high that we limit the kinds of consumers we can bring into the franchise.

That's helpful. We talked a lot about the top line, so maybe we switch gears a little bit and drill down on some of the operational improvements that you guys have made this year, which, as we mentioned before, are significant. How does Ennis Kitchen help support the improvements that we've seen this year? And maybe what should we think about as kind of the next shoe to drop at Ennis?

So I mean we're very early stages in Ennis. We have 2 lines running currently. The third line is going to come up here right at the end of the year, beginning of January of '24. And even the 2 existing lines are not running the throughput, they're not still at full capacity. They're still ramping up. We have conservatively said that the Ennis production will be at a similar cost of Bethlehem. We actually obviously feel we can do better than that over time. We have chicken processing on site, which ultimately will give us better cost structure. Labor rates in Texas are a bit lower than they are in Pennsylvania. So there is -- and the lines are a little bit more advanced, bigger. There should be ultimately more throughput there. We're very pleased with trying to start up a greenfield. It's very, very challenging, especially in this environment. So it's going very well, but we have a ton of upside at Ennis. Obviously, it's going to bring on a lot of capacity over the next couple of years for us. The line just mentioned coming out at the end of the year, we have a rolls line coming on probably at the end of the third quarter. But we're just at the beginning of starting to really leverage that facility. Both from a direct cost perspective, but just from a fixed cost overhead leverage perspective, there's a lot of upside in that plant. So we feel great about the footprint we have between Bethlehem, Ennis, our Kitchens South facility, we're good for the next several years. There's enough capacity in the footprint that we have to get us through at least 2028. We will need to start working on what's next in the next couple of years because the lead times are long, but we're in pretty good shape right now.

That's great. Can you maybe just remind us where you guys think you'll be at for capacity at the end of this year and then kind of year by year?

With the third line coming on here we'll be a little over $1 billion of capacity. And the good part about that is it allows us to have a little bit of flexibility of how much -- how many of those lines we are actually staffing so we can turn on the staffing a little bit on and off. That's -- we had some of that this year as well, and that gives us some extra flexibility. But we'll get to over -- by 2027, we'll be at over $2 billion worth of capacity, the way we've laid out our plan. And again, with the existing footprint we have, we have another line in Bethlehem that we're actually going to put in. We're going to use a dry storage facility there. We've got 8 more lines coming on at Ennis. We probably have 3 more lines we can put in, in the Kitchens South facility, so a lot of upside in the capacity plus some new technologies that we're working on, and we haven't -- we're not far enough along to count on them yet, but they potentially could add some more efficiencies and capacity with the same footprint.

Jim, I just -- I would add to that. The one thing we're spending a lot of time on right now is also capacity at the macro level is nice. But at the end of the day, we have to have rolls capacity and bag capacity. And so keeping them both in balance because you bring on a bag line, at Ennis we now have 2 bag lines and one roll line, it gets you a little out of balance, and that's not just from a demand perspective but it's also from a logistics perspective. We want to have balanced production of rolls and bags at Ennis and in Pennsylvania so that they go to their DCs and get distributed to the customers to meet the demand. Right now, we feel really, really good about the bag capacity. We have a roll line that comes up next at Ennis sometime at the end of the third quarter of next year, and that's critical for us. So even though we tell you we got $1 billion of capacity at the end of this year, we really need that roll line to come on next year in order to meet the demand.

And the other thing, this really is such a scaled business. The one thing about Ennis right now where we're unfortunately penalizing them right now with 1 bag and 1 roll facility is, and we have a distribution center right near that facility and we want to utilize that distribution facility for the Western states, is we're forcing that facility to produce a lot of SKUs. And so the changeovers are very high right now on those 2 lines. Once we get the second of each lineup, it gives a lot more flexibility to have the 1 bag line cranking out 1 or 2 of the power SKUs, and the other 1 kind of feeds in the smaller runs. So that will create a lot of efficiency once we have 2 and 2 up. And you can only imagine when you have 5 and 5, ultimately, you're literally going to have a line where it's just producing 1 power SKU all day long. And the efficiencies and throughput efficiencies we can get from that will be tremendous.

The $8 billion, is that the 8 lines [indiscernible]?

Yes, it is. Yes, 8, correct, it is.

Todd, you mentioned your DC that's near the Ennis facility. I think logistics is an area that you guys have made really a ton of headway on this year and really kind of outperformed our expectations, certainly, but even I think your own expectations. Can you just give us some color there on what you think the logistics costs look like moving forward?

Yes. So first of all, we brought a -- we did not have good logistics expenses in '22 for lots of reasons. Some of those were market-based, diesel costs, lane rates were very high because of our capacity constraints, trucks weren't full. And so we had a lot of issues with logistics last year. We brought in a new team who are just doing a tremendous job. And we kind of laid out at our CAGNY presentation that, what, 2027, we'd get to 7.5%. Well, we're below 7% now in year 1. So we really screwed up that projection big time. And I think we still have some more room to grow. But about 1/3 of the big decrease this year is market-based. I mean to be fair, one -- everyone is enjoying it. Diesel rates are down, lane rates are down, so we're benefiting from that. But the other 2/3 are things that we've done internally. So now we've got capacity, we've got full trucks. We put bracket pricing in to encourage customers to order very, very efficiently. We are negotiating much better lane rates besides just market-based advantages, just we have multiple people bidding against each other right now. So the team has just done a tremendous job. And so look -- and with that second facility in Dallas now, the number of miles that on average that we're traveling to get to a customer is way down as well, and that will continue to build over the next couple of years. So a lot of progress, still got a lot more room to grow, and obviously, we feel like we can get well below 7.5%.

My favorite stat that we quoted on the earnings call about the logistics in the third quarter was we had 23% more pounds that we shipped, but we had 28% less freight miles. Think about that. That's pretty remarkable. And it just is all the reasons that Todd described. It was a lot of things that we did, second DC, higher fill rates, bracket pricing, all those things that drove that.

That's great. Maybe one more question on the margin side. Just give us some color around the commodity basket. What does that look like? And any sense you have for costs moving into 2024?

Yes. Look, I think we feel pretty good. I definitely don't see any inflation in '24. I've been saying kind of flattish. If we get lucky here, we're going to kind of lock in a good portion of it in the next 30 days, just the way chicken prices are purchased. If we get lucky, maybe we have a little bit of deflation, but we're going to -- we'll see how that plays out, but feeling fairly confident at this point.

Okay. Great. Maybe open it up one more time for questions. And then I have one final question. Great. So I think it's a final question as we wrap things up. Just given the progress that you've made in 2023, what do you guys view as kind of the next set of opportunities as we move into 2024 and beyond?

Do you want to take that?

Sure. Look, we feel great about the 25% CAGR that we've kind of laid out. Look, it's not -- that's not simple. It's not easy, but we've proven we can grow this business and the media works, and there's so much upside and the consumers really recognize the value proposition of Freshpet food. So we feel great about that 25% will continue. Still, like I said earlier, we've made some really nice progress on margins, but we've got a long, long way to go. We've got 10 more margin points on EBITDA that we've got to get over the next few years, half of it very controllable below the gross margin line. We'll slow down media in the out years. We'll be able to grow G&A at half the cost of net sales and get a tremendous amount of leverage, and then obviously, the logistics that we talked about. The harder part is the gross margin. We've still got about 5 or 6 points of gross margin that we need to get over the next few years. But we have very clear building blocks of how to get there, just leveraging the footprint that we have, reducing the quality cost, which we made some nice impacts this year. So it's there. We have, again, very clear building blocks. We just got to go execute, it's as simple as that. And I tell people all the time that we have a 2027 target of 45%. And I'm very comfortable with that target and we're not going to take that target up. But if I'm sitting here in 2027 and we're only at 45%, I'll actually be very disappointed because I think there's upside to that number. But we got a long way to go, but we feel great about the head start we got in '23.

And Jim, I would just add one thing to it, and so it's part of the organization maturing. I mean we -- during the pandemic, we got behind on our organizational capability and we've had to do a lot to fill it out. The thing that we're really focusing in on right now, is while we're doing all this capacity addition and we have to do it well, and while we're focusing on each of those 3 focus areas, we also know that we need to get operations that are more mature to operate as if they're more mature. And so we've invested a lot of time and energy in the last year into building operating effectiveness into our Bethlehem Kitchens. And so while Ennis is focusing on doing all this work to ramp up capacity and start up operations and learn how the thing works, Bethlehem needs to recognize that there are 6 lines there. They're operating at full capacity. They need to be more efficient. And that's what good manufacturing operations do. And we've hired the people do it. They're making good progress. It's a long runway of opportunity ahead of them and I feel really good about it, but that's part of the maturing of the company. We're really good on the top line. We've always been good on the top line. We've gotten good at adding capacity at the right time at the right pace. We now need to demonstrate that we can do the things that mature companies do and execute really well on the operating cost side in the existing facilities where they're not dealing with those new challenges of capacity additions.

Great. Well, thank you, everyone, for your time today. Billy and Todd, thank you for joining us, and I think we'll leave it there.

Great. Thanks, Jim.