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

Thank you all for coming. I'm Robert Moskow. I'm the senior analyst covering the food sector for TD Cowen. And I want to thank the Freshpet management team for being here with us at the 2024 ICR Conference. Only 17 years ago, Freshpet disrupted the pet food category by introducing the first refrigerated entry and -- for targeting consumers who are looking for fresher, healthier solutions to kibble. It's now a $750 million business, growing 25% a year. Here to tell you about what's coming next is Billy Cyr, CEO; Todd Cunfer, CFO; and Scott Morris, COO. Thank you.

Thanks, Rob. All right. Like everybody else, we have our safe harbor statement. We also always like to start with a very clear picture of what our mission is and what we're trying to accomplish. We are in the pet food business, but we are about strengthening the relationship and the bond between pets and humans. And we think that, that is a very rich place for us to build a very long-standing franchise value. As Rob said, the 3 of us here are part of the current management team, but we also would like to introduce you to the 3 new members of our team we've just added: Rachel Ulsh, who's sitting here somewhere. Where's Rachel, somewhere around here. Rachel's sitting here. Rachel just joined us last week as our VP of IR. She was part of the team at ICR that took the company public in 2014, and so she's very familiar with the story and with our folks. We also just hired a new Head of Food Safety and Quality, [ Nandini Natarajan ]. And we're thrilled to get someone with deep protein experience. She worked in the beef, chicken and in the seafood space, huge add. And we also hired our first General Counsel. Many people are surprised we have a General Counsel. We're using outside counsel. We've now hired our first General Counsel, someone who has experience in big companies, small companies, public and private and a lot of work in the food ingredients space. I'm going to fly through some quick facts so that we can get to the meat of the agenda today. The meat of the agenda is going to be the pieces that Scott and then Todd will be talking about. But I want to make sure everybody's on the same page about what Freshpet is. Freshpet, as Rob said, is a $755 million business. That's our guidance for this year -- or for 2023. We're predominantly a dog food business in the U.S. is the way to think about it. We have a very small cat food business, and we have a very small international business. Both of those remain very big opportunities for us. But today, we're pretty much a dog food business in the U.S. and growing very, very quickly. We have a manufacturing footprint today with 2 manufacturing facilities we own. We also have a third facility that's run by a partner, and we have about 1,100 employees on our team. Freshpet exists at the intersection of 2 very important macro trends. And it's frankly what has driven our growth to date and what will drive our growth going forward. We exist at the intersection, the humanization of pets and people's desire for fresh, fulsome and all natural food. We think this is going to change the way the category is constructed. And so if you think about it, the pet food category is a $40 billion category that has been evolving and changing over time, and we think that fresh food is going to be the next evolution of the category. Everything from back in the 1940s where pet food was basically table scraps, through the arrival of commercial pet food, birth of premium pet food, super-premium pet food, ultra-premium pet food, and now we've moved into the world of real simple foods. Our lineup today includes a range of product forms, everything from rolls, which is about half of our business, the bags, which is basically the other half of the business, and the bags come in multiple forms, everything from little meat balls that we call our roasted meals to shredded meat, which is our "Fresh from the Kitchen" product as well as a product that looks like home cook product and as well as patties. The model that we use to drive the growth in our business is simple and a little bit unusual. The simple part is that we have no trade spend, none of that promotion stuff, discounting as a way to drive people into the business. The model works with basically -- advertising investment is the driver of the growth of this business. There is a very strong correlation between advertising investment and the net sales of the company. The advertising is amplified by the fridges that we place in stores. Today, we have fridges in stores in the U.S., Canada, U.K. and Ireland as well as a little bit of France, and that provides us amplification value. So if the consumer sees our ads, they walk in the store, they see these 7-foot tall, 4-foot wide, lighted, branded company-owned fridges, it becomes a significant extender of the visibility and availability of the brand. And we use product innovation. That -- those 3 pieces are what have driven our long-standing growth. Our core consumer, we call them HiPPOHs, that's a high-profit pet-owning households. These are people who think of their pet as a partner or like a person in their house, probably sleeps in their bed. If not, they've got a quilted bed that they sleep in. This dog is the #1 priority for them. Probably they're treated as a child or their favorite child, and they think that the dog deserves the absolute best. This is what our target audience looks like today. Our franchise is growing very quickly, the number of those consumers. This chart was published in the deck we put out this morning. But actually, we got another round of data this morning and the number of households that Freshpet is in is now up to just under 11.5 million households, growing at a very, very rapid rate. And the buying rate, meaning the average dollars per household has also been growing very quickly. But the reality is we have a long way to go to capture what we would consider our fair share of those households, and Scott's going to talk a lot more about our opportunity to do that. Our retail footprint is very large, 26,777 stores as of the end of 2023, December 31, 2023. Over 20% of those stores contain multiple fridges, 2 or 3 fridges. So we have 1.7 million plus cubic feet of space at retail, very, very strong retail presence. Our growth has been tremendous, roughly a 35% CAGR over the life of the company. We guided to 25% growth or a little over 25% growth for 2023. And that will be $755 million in sales and our long-term algorithm calls for 25% growth. This company has been through multiple phases. The first phase was figuring out what it is, establishing the idea of fresh. That was up until about 2010. Scott, as one of the co-founders was the key driver of making that happen. Between 2010 and 2022, the job was to accelerate the development of fresh. And we got up to about $500 million of sales in that window. And now we think of it as a fresh future where we are going to be scaling and improving the operations and focusing on increasing consumer and customer intensity. And we're going to talk more about the benefits of that. The model we have used and we are going to amplify as we go along is the model that you see here, first introduced in 2017. And this is a virtuous cycle where we do advertising and innovation, which drives household penetration, increases velocity, retailers respond to that by putting more fridges in stores. We expand our capacity that gives us scale and leverage in COGS and SG&A. We drive further efficiencies and reinvest in the business. That model has worked for us and driven accelerating growth over the last 7 years, feels very good. It's on the way to what our 20 million household target in 2027, $1.8 billion net sales target with an 18% adjusted EBITDA margin is our target. So this model is what's driving us and the way we're thinking about it. But we are also thinking about how we may provide some intensity and concentration within that. And that's what we're going to talk about today, and we call this mainstream main meal and more profitable. I shortened it to Main and More. And it starts with this idea that there's -- at the intersection of becoming a more mainstream brand, by that, we mean in more households, different dog sizes, different dog ages, different income demographics, age demographics, but by making the brand more mainstream. And we're already mainstream today, but making it more mainstream, we create a level of intensity of the business development and a return for that investment that will help drive the profit improvements we need. At the same time, you have the main meal part, which is basically getting the people to use this, not as a mixture or a topper, but use it as the main meal component. The intersection of those 2 drives the profitability and you'll hear more about that. And this is what that model looks like. It basically says the right-hand side of this equation is where we are driving initiatives, advertising, product innovation, marketing that drives the main meal and mainstream. And on the left side, it helps us create more profitability. But to tell you more about it, I'm going to turn it over to Scott, and he's going to talk to you about mainstream and main meal.

All right. Okay. So if you think about it today, we're many, many years in, and we've made incredible progress. We're now at 11.5 million households that use our product today. How do you make your product mainstream, right. How do you continue to mainstream it. And when you think about the idea of going mainstream, you start off with innovators, then you go to these very early adopters and then you go to early majority. We're now entering into that early majority phase. And one of the things that you'll see here is pricing. So we have a wide range of products that kind of appeal to a wide range of consumers. Our pricing goes all the way from $3 a pound, all the way to $9 and $10 a pound. And the other thing that's really been interesting is from a household perspective, you're seeing growth by all different income levels. Next, dog size. You want to make sure your portfolio of products has a range of appeal for dog sizes. So in 2018, we launched a product that was focused on small dogs. That's become one of our top-selling products. Just last year, we launched a product for large dogs, that was specific to large dogs. And now we're seeing great progress with that product. Now if you think about how much a small dog would eat, how much a large dog would eat, the only thing that might be able to eat out -- out-eat a large dog is a teenage boy. Does anyone have a teenage boy or know of one? Yes, me too. So it's pretty amazing, like, the opportunity in front of us. We're going from small to large dog. But overall, we just have to start with a great portfolio of products. I talked about pricing on the first slide. I'm talking about different product types here. And then here's another example of all the product types where we look at life stages, and we have opportunities to really focus on dogs that are on the younger side and even dogs that are on the older side. The other thing we know is that when people start -- many people start feeding Freshpet because their dogs are older. They get finicky. They gain weight. They have different issues with mobility. We're designing products that way. And the other thing is if that large -- that older dog eventually passes away, the most likely person to get a new dog is someone who already had one, so great opportunity to continue to develop that end of the spectrum. But as you can see on the slide, across the board, we do really well with all the different age groups and life stages of the dogs. Younger users, right? So the next thing you want to think about is we do not have a [ view ] problem here. We really do incredibly well with younger consumers. We see them coming into the franchise, and one of our greatest growth areas is with Gen Z. But we do well really across the board. So we're seeing growth, really, across the board, but especially with the younger consumers. Next, we look at what the potential is for the brand. So from an awareness perspective, we took a brand that's several years ahead of us like Blue Buffalo, you can see where their awareness is it's 93%. Well, here we are, we're in the high 50s now after many, many years of advertising. And that's the simplest form of awareness. It basically says to someone, are you aware of this product? Do you actually give them the name and they say yes or no. We have 60%. So, not only do people have to become aware, they have to become familiar and comfortable with your product, and that takes a long time. You have to develop that. It's really important to have great trust from consumers. So we think that there's a lot of opportunity to just get awareness, but we also look at the opportunity to, really, from a penetration standpoint as we were talking about a minute ago, where we have 11.5 million households, you look at a brand like Blue Buffalo, they're at $30 million. But you look at our category or I mean a segment like wet dog food, and they're almost 40% of consumers are buying wet dog food. We believe where we're going is we're developing a whole new segment in pet food, right? There's dry, there's wet and then there's fresh. So we think that, that's a really good target for us over time, that there should be almost 40 million households buying, basically, fresh food over time. And that all helps it really kind of go mainstream. All right. So this talks about distribution. So today, we're at about 73% distribution. We know there continues to be upside in our distribution. But the biggest piece of the opportunity that we have is not just more distribution, it's what I refer to as depth of distribution. So right now, we have 73% of stores that have a fridge. The fastest-growing area for us is the second fridges and even third fridges. So sometimes we're better off putting a second fridge in a high-performing store than we are putting a first fridge in kind of the store towards the very end of the [ 2 ]. But a tremendous amount of opportunity, not only on total distribution, but also depth of distribution. Next thing is how do we make it a main meal, right? So in the very beginning, when people would try us, we were the weird thing at the end of the aisle that the innovators will go down, take something out of the fridge and they start using it for their dog, right? So we've really started to kind of mainstream it, but now not just mainstream, we want it to be the center of the plate. We want it to be the center of the meal. Just like food for us, you shouldn't eat -- the center of your plate, shouldn't be cereal 3 times a day. Same thing for a dog. We want fresh food to be the center of the plate, center of the meal. So how do you kind of make it the main meal? Well, the first thing is we want to -- we know that we're growing loyal consumers. And when we see our -- the households, the people that are most loyal to us tend to be growing the fastest, which is terrific. That's exactly what you want to have, and that's really demonstrating our opportunity to do that. The light users are the ones that are -- we've seen a little bit of declines in that group. But the core is it's loyal households. Those are the ones that are the important ones. We refer to those as HiPPOHs, the high-profit pet-owning households, and in some cases, we want those people to, not only be small dogs, but also the larger dogs I was mentioning earlier. Now the thing that's really interesting with that group is that 37% of our households are super heavy, heavy. They actually represent 89% of our total business. So you kind of see that really typical 80-20 rule that you'll see on many brands, and we're definitely seeing it here, and it kind of leads us to really be encouraged about the opportunity to develop more and more consumers in that direction and to be super heavy, heavy buyers. As I mentioned earlier, those are the group that's growing absolutely the fastest. So a little bit more about how we do it. Billy talked about our advertising. We've literally created our advertising today, where now we're literally telling people that they're actually choosing, basically, their dog over someone in their life, whether it was a potential girlfriend, a sister in law, a mother in law, et cetera, that they've actually chosen the dog, and you guys may have seen the commercials or not. But we're not going to play them today, but go check them out. They're a lot of fun. So advertising is basically -- we're picking a point of view. We're basically saying dogs are important in our lives. And those are the people that we really want to focus on. The next thing is the portfolio, and I mentioned that earlier. So we talked about pricing. We talked about a range of forms, convenience, varieties being available, not only at Walmart and Target, but also Whole Foods and grocery stores and even pet stores, right? So we're available over the place, and we're available consistently. That's also really important. We've been more and more consistent over the past year about our availability. But the other thing with the portfolio is we're developing case packs where we actually have large packs and that creates a real message point or a communication point for consumers. If you use a 6 or an 8 pack of a product, it's not something you're mixing in. This is your dog's food. So you'll start to see those come from us. And then also, we'll continue to offer different specialized recipes and offerings for consumers, too. So overall, all of these things together create the idea of this is a main meal. This is the core of your dog's food. And it's really kind of starting to see that change that we created years and years ago, really kind of be -- really change the category forever. So one of the things you'll see also, for us, is a lot of people still mix us. So within all the data that we shared, 40% of the people use this as a main meal where 60% is still mixing. And what we see is, over time, that people are mixing mix more and more and more fresh pet every year. And hopefully, those people become more of those HiPPOHs, those high users, those heavy users, those loyal consumers. And lastly, if you think about the average number of items, there's a tremendous opportunity for us to bring more and more of our products that we already make today into the store, put them in the second and third fridge. And we know it creates incremental sales. It creates incremental visibility. It changes the dynamic and the look in the entire aisle and creates an expectation of consumers that this is a main meal or a core food. So we can add more items that appeals to a wider group of consumers. And we're doing all of that by actually simplifying our portfolio, so it's easier for the operations team, too. I'm going to pass it on to Todd, and he's going to talk about being more profitable.

Okay. Thanks, Scott. So to bring it home on why the scale advantage of mainstream and main meal, at the end of the day, drive shareholder value, it's the profitability of our business. All of these things enhanced long term, the scale and the profitability of our business, and we're really excited to talk about that. So 15 months ago, we set out a profit improvement plan, which had 4 factors. One was to get ample capacity. We brought -- and it's online. There's now 3 lines running up Ennis. We have $1 billion of capacity as we head into '24, so that's a huge win for us. More efficient logistics, trucks. Our pipeline fill was low. Trucks were empty or only 50% to 60% capacity. Logistics costs went through the roof. We're in a much better situation right now. The -- we have a new facility outside of Dallas, which is driving huge efficiencies. Our trucks are full once again, so we're really excited about that 300 basis points of improvement in logistics this year. Improved quality. Again, when you have ample capacity, good things happen from a quality perspective, and we're seeing about a 100 basis point improvement. We have time to fix things when they occur, and that's a huge advantage for us. And then commodity costs, everyone faced huge commodity costs over the last couple of years. We've caught up largely with pricing, 27% of price increase over the last 18 months. The last piece of that is 5%, which will burn off in February. And our outlook, as we talked about in the Q3 conference call for '24 is benign issues with -- we're not seeing inflation in '24. We've got a little bit more pricing as we get into '24 as well. And so we're going to -- we should finish '24 pretty much caught up from the huge commodity increases we've seen in the last couple of years. So here's 2 charts here showing kind of how our adjusted gross margin has been realized by quarter and then kind of a trailing 12-month EBITDA. And you've seen -- you see the trough as we ended 2022. So we had all those issues we talked about, logistics, the supply issues that we had, the quality issues that we faced because we were running so hard. And then Ennis came on beginning in Q3 of last year. That's the good news. The bad news, a lot of fixed costs came on to the P&L as well. And as you can see, we're back on track as we got into '24. So a huge increase in our adjusted gross margin. Again, we have ample supply. The logistics costs have come down 300 basis points. Quality has come down 100 basis points. And now we're starting to leverage the scale of Ennis and our other facilities. And then what that results in is significant improvement in adjusted gross margin, trailing 54 months -- $54 million over the last 12 months, and we gave guidance of $62 million for the full year. And what this results in is just a huge flywheel effect for our business. So think about it, we're basically -- as Billy pointed out, we're basically one brand in one country. We're spending over $80 million this year in media. We'll probably spend about $100 million next year, hugely effective. We have lots of fridges. We had over 5,000 new fridges in stores. That just amplifies the effect of the strong advertising we have out there. Again, the focus on one country, the consumers that are coming in large numbers, the buy rate, as you're seeing with the main meal perspective of it is, again, creating a huge flywheel effect for us. And the end result of that is higher operating margins, and we're seeing a huge improvement in '23, and we anticipate another really strong year in '24 as well. Update on the Ennis facility, Here's a picture -- a recent picture of it. So we now -- the building is in 3 phases. The first phase has been up and running for a while. We now have the third line in Ennis as of December, running. You see, to the left of that picture, the second phase. The building is largely complete. But to the first 2 lines, there will be 4 lines in the second phase. Those first 2 lines are being installed right now. The first one of those new lines will come in on September. And then lastly, guidance. So we're reiterating our guidance that we gave at the end of Q3, net sales around $755 million, adjusted EBITDA around $62 million. And just a couple of -- we feel great the way we finished the year. Obviously, we haven't closed the books yet. We're a couple of weeks away from doing that. So we're not going to update any guidance. But we ended where we wanted to end. We have very strong measured growth of 28% growth in measured channels. In fact, on the nonmeasured piece, which is largely Costco, that's enhancing it by an additional 5 points. So we ended the year very, very strong. And from a measure perspective, 22% of that is pure volume. Add the 5 points from the nonmeasured, we ended the fourth quarter with about 27% volume growth, which is exactly where we wanted to be. Adjusted EBITDA, again, we feel great about the $62 million. The quality cost, logistics cost continue to be terrific, we're making great enhancements at. And from a '24 perspective, we'll continue to be very prudent. We talked on the Q3 conference call, gross margins will improve. We'll give more color on that in February. Operating margins, EBITDA margins will grow even faster as we start to leverage the P&L, and we'll give a full color of that at the end of February. Now I'll pass it on to Billy.

I will close it out real quickly for you, which is basically, we think that Freshpet is one of those very special, very unique opportunities. We are the future of pet food. We have a large addressable market. We've got great products. We've got incredible distribution broadly available and growing, great marketing. We have state-of-the-art capacity that's coming on place, and we're adding to it this concept of, basically, business intensity and concentration that will help us drive increased profitability. So thank you very much.