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

All right. Welcome everybody and thanks for joining us for our fireside chat with Freshpet. So with us today are our CEO, Billy Cyr and CFO, Todd Cunfer. Welcome to you both thanks for being with us here today.

Maybe a good place to start. Freshpet last presented at this conference in 2021. Can you walk through some of which changed in the business. I know, it's been a lot, it's on the improvements you have made. Maybe we will start off with you, Billy.

Yeah. Great. First of all, just so everybody knows, I'm fine. I'm wearing mask, I'm healthy, I'm doing this to protect my wife, who is going through some health challenges. So this is my way of keeping her safe. Good question, it has been a wild ride, for the last 3 years quite a bit of a wild ride. If you think about where we are today, today, we're more than 2x the size that we were back in 2021. It's pretty remarkable. We now have a dramatically more manufacturing capability. We opened our Ennis, Texas facility, which will ultimately be a 1 million square foot production facility producing over $1 billion of Freshpet food when it's done. But we opened that in that last couple of years. And if you look at the scale of the organization or the impact that we have on the market, back then, we had about 7.5 million users. Today, we have over 12.5 million users Today, our organization is 1,300 people back then. We had about 600 people. It's just a dramatically bigger enterprise. But the more important part is I think we're a much better company than we were back then. And if I had to still reflect back on what's changed, what do we do differently to get to where we are today, the first thing is that we got behind in talent. We were behind where we needed to be from organizational capability perspective. And so we've had to bring in talent. People like Todd over here has joined us since then, Rachel over there. We've brought in a ton of talent to the organization, and that has really helped us quite a bit improve our execution. The second thing that's really different is we made a very deliberate investment 3 years ago in stabilizing our hourly workforce. It's not the high glamor sexy part of it, but we realized we needed to attract higher skilled workers. We need to give them a career path, not just a job and training and development to get there. And since we've done that, our turnover rate or our way to think about it is the percentage of our employees who have been with us for a year or longer has gone from -- at that point, it was 18% to now it's over 70% of our workers have been with us that long, and that is showing up in every leg of the P&L and it's driving tremendous improvement in our performance. And as I think about the outcomes that came from all those things, Today, our margin -- our EBITDA margin today is going to be probably about 10 points better than it was in that year. We're generating probably about $100 million of incremental EBITDA this year versus where we would have been -- where we were in 2021. We're on the verge of positive net income for the first time. We'll be cash flow positive -- free cash flow positive in 2026, if not sooner. And the cash flow in that year, I think, was negative $320 million and this year, it would be, what, negative $50 million or something like that, somewhere in that range. So it's a tremendous improvement. And I have to say that we did great things. We feel really good about the work, but it's also obvious the environment is a lot easier. Back then, it was a very difficult time and very challenging time. Workforce materials, reliability of the supply chain much tougher, and I don't want us to sound like we did it all ourselves. The reality is the world got a little bit easier.

Great. Thank you. Thanks for that. You just reported your 24th consecutive quarter of greater than 25% net sales growth. It's been primarily volume driven. So maybe you can talk a little bit about what the key drivers are for that, for those that maybe aren't as close to the story?

Yes. I mean it always starts with we're in a great category. Pet food is still a great category. It's been a great category for more than 2 decades at this point. The humanization of pets is a very real phenomenon. People are having fewer kids and they're replacing them with dogs. It's just a fact of life, and that's good for a business like ours. The second is this is a category that was ripe for some innovation. If you think about it, human food was canned in the first half of the 1900s, dried came along in the middle of the 1900s, but the store, the retailers, if you look at their stores where it used to be a big center of the store, now today, it's all perimeter. It's dairy, produce, Deli, the meat department, and whatnot, that's where all the action is. And yet the pet food market is still stuck in canned and dried. Dry dog food was invented in 1956, canned dogs invented in 1922 and it was time for an upgrade. And so that's changed pretty dramatically and Freshpet food is at sort of generational change that is long overdue. It's -- we're driving it in pet food, but it will probably do the same thing that happened in human food where our consumers given a choice, will choose the fresh alternative to the canned or the dry product that they otherwise would have previously had available to them. And then the last part of it is we have a great business model. Our founders did a phenomenal job creating a business model that delivers an exceptional consumer experience. Our products are noticeably different. They are incredibly good tasting, nutritionally beneficial. Pet parents notice the difference. We have manufacturing technology that we are the only ones who really know how to practice it. We don't do promotion or discounting so the consumer is getting a product every time at the right price every single day. We drive household penetration gains with advertising. The whole model works really, really well. And so we don't have a business that is fluctuates up and down based on promotional intensity or the latest price change in the market or a competitor's pricing action, it's a consumer franchise that is highly loyal to a highly differentiated and preferred product.

Great. Thank you. The concept of disciplined growth was a key takeaway from the past earnings call. Can you talk a bit about how you're managing that? And what's different maybe than in years past?

Do you want to take that?

Yes. So look, this is -- we have grown faster than the 25%. We can grow faster than the 25%. But the execution risk of growing above 30% is high for us. We're still a relatively small organization. We've determined the sweet spot for us is to grow around plus or minus 25%. That allows us to execute extremely well. It allows us to increase the margins, which we've got a nice head start on, but we've got a long way to go. And it also allows us to manage CapEx a little bit more prudently and get the free cash flow quicker. So again, it's great growth at 25%. We don't feel bad about that. But again, it's the sweet spot where we feel we can be more disciplined and plan out our business a lot more efficiently.

Got it. Got it. You've talked about reaching an inflection point on profitability. Why now?

This is truly a scale business. It is -- what we do -- what the team does every day is very difficult. And we're really the only people who can make fresh pet food. Again, this is -- it's fresh. There's no preservatives. It's got a 23-week shelf life, but it's very challenging to do what we do. And to have the network that we have with over 30,000 fridges out there. We've reached -- now we're going to be $1 billion this year. We've kind of reached that inflection point, where the scale aspect of it is really starting to kick in. The Ennis facility, where this -- just the next week or 2, we're going to have the fourth line go live. That's going to start. There'll be 10 or 11 lines there. Eventually, that is now starting to reach the point, where we'll be more efficient in that facility. So lots of good things are happening. By the way, we're planning it, but just now that the scale of the business is approaching $1 billion allows us to do a lot of nice things on the margin.

I just want to clarify a point. You said we're going to be $1 billion business, we're not going to have net sales of $1 billion this year. I would have told people that our run rate now would support being in $1 billion and we're already thinking next year. And so that's what that means. But I also want to just add, it's interesting is we've done a lot of our internal strategy reviews. And as you think about the business, if you look at really good category changing, category-creating companies people who redefined what the consumer's expectation should be in a market. So are we going to talk about Tesla and electric cars, Netflix when they're basically creating streaming video, you look at Starbucks, you look at Amazon and you look at what their trajectory was, and they didn't make money for a long, long, long time. They're capital-intensive. They're continually reinvesting capital to build scale and leverage. And when they inflected, their inflection was incredibly fast, incredibly steep, much more than people had expected. And I think we probably fall more into that pattern than the pattern you'd see of a much more gradual slope of a more traditional business. We are creating a new category. It is a capital-intensive business. But when you reach enough scale, adequate scale and you begin to inflect, you start seeing that inflection happen very, very quickly.

Some of your longer-term 2027 targets have already been exceeded or eclipsed, adjusted gross margin, logistics, quality, input costs. Two questions here, where do you see further upside and what's not included in these long-term targets? And then when should we expect you to formally update those long-term targets?

So 18 months ago at CAGNY, we set out targets. By 2027, we'd be at $1.8 billion in net sales, basically tripling the business at a 25% growth rate. We'd have adjusted gross margin of 45% and adjusted EBITDA margin of 18%. Great news is we're well ahead of that target. We gave guidance this year that we would already hit the 45% on adjusted gross margin and we gave guidance and implied we would be close to 15% on EBITDA margin. So that's fantastic news. We are thrilled by that. We are working internally really hard right now to see kind of what -- we're not going to stop at 45%, obviously. So what are the levers that we can -- we still have, and we have several that allow us to get over 45% and what does the 18% look like as well. So we're working on that right now. We're probably going to come back to people next year and relook at those targets more to come. But the good news is we are way ahead of schedule. And we feel like there's more upside.

Would you expect the need to raise any additional capital at this point?

So that's the other good news is, if I was sitting here a year ago, I would have thought, hey, we're going to be free cash flow positive in '26, but we're probably going to need a little bit of debt to get us -- incremental debt to get us over the finish line. Operating cash flow has been much stronger than I anticipated, and that's obviously largely EBITDA driven. We're sitting with over $250 million of cash on the balance sheet right now, we'll end well over $200 million this year. We'll use a little bit of cash next year. And then we think we're going to be self-sufficient going forward. So right now, I do not anticipate any more capital raises, whether it's debt or equity.

Got it. And again, timing -- remind us on timing to be free cash flow positive.

In '26.

'26. Got it. Got it. Turning to media spend. You frequently talk about customer acquisition cost. Why do you think you've been able to keep that so low as you get further into the TAM?

Yes. It's -- first of all, we're relatively small as a share of the market. And as part of the TAM, the TAM today is roughly 42 million households, who we think would be prime prospects, for Freshpet, we're in about 12.5 million of them. And so at this point, there's still a lot of headroom available to us. And so we think we're just scratching the surface. We're not to that point where the curve begins to bend and create that diminishing returns on the investment. Having said all that, we also think that with the scale of our media investment, roughly $100 million in media, you would normally expect to see some of that, and we don't want to be oblivious to the fact that, that will happen at some point. But we have a counterbalancing benefit that we get, which is we pay to and invest in fridges to put in retail outlets. These are 4-foot wide, 7-foot tall branded refrigerated lighted fridges that not only service our customer and provide the consumer with the products they need, but they act as a billboard for our point of difference with the consumers. So they see this fridge and they understand it. And as we understand why Freshpet is better and different than the dryer -- canned dog food sitting next to it. If you see one of our ads on television and then you walk in the store and the only fridge in the store, is this tiny little fridge in the middle of an aisle, probably not likely to get a conversion of that advertising investment into a sale. But if you walk into a store after seeing the ad, and now there's 2 Freshpet fridges sitting there on end caps, shining at you, you're going feel there's something going on here. Maybe I ought to be looking at this or maybe I ought to be trying this category. And so our conversion on the advertising is influenced by the retail visibility that we've created and that's permanent visibility. It's a big capital investment that we've made. We put this capital investment in. It's to the retailer's benefit, the retailer gets the benefit of having given up this space to create this awareness, but it then drives for us a loyal consumer who will shop that store and buy that product as a result of the advertising and the retail visibility.

And this leads into what's Freshpet's competitive moat? And why do you think others have tried to come into the space and failed largely?

Fresh is very hard. So there's a technical challenge to do fresh. It's very, very difficult. And when I say that it's a technical challenge, you have to be able to produce a product that will go through a refrigerated supply chain to a retail outlet or a warehouse distribution center and then a retail outlet. It has to have a long enough shelf life to go through that supply chain and still arrive with plenty of shelf life left on it for the consumer to be able to consume it at a reasonable rate to not have a lot of product go spoiled. And so doing that without any preservatives in your product is technically very, very difficult and other people haven't figured out how to do that. And so I'd start with it's tough. The second thing about this is fresh is always a scale-driven business. The reality is if you don't have scale in fresh, you can no longer do long production runs, meaning if you don't have enough velocity to justify long production runs, large manufacturing assets, lots of automation, you're going to be doing a ton of really small runs to support a very small business. It's incredibly inefficient. You're not going to be shipping full truckloads to your customer with the frequency that you want. So your freight costs are going to be higher. You're going to have a large amount of your product become unsalable. I mean it goes past this exploration data at retail, and you're going to have to pay the cost for that because the retailer will not want to cover that cost. So there's huge advantages for having a high-velocity large-scale business in the world of fresh, and we've finally gotten to that point. And so that's a huge advantage and somebody comes along behind us, it's going to struggle to keep up with that. Others have tried, others have not done very well. But we continually seek to expand our moats. So people originally thought it was just the fridges. Well, the fridges are nice, but Walmart put fridges in 2,000 stores and they can do that. But it's the manufacturing technology. Well, we keep advancing manufacturing technology to greater and greater levels to give us better products at better costs and an advantage versus people come along behind us. We're now working up into the supply chain. We put a chicken processing operation on-site in our facility in Texas because we believe there is a competitive advantage, if we can get better, higher quality chicken and find a way to do it at a lower cost, we think that delivers a better consumer experience, and it also can deliver a cost advantage to us. So we look across the entire business ecosystem, and we're looking for as many ways as we can create an advantage. And frankly, now we have a first mover. We have scale. We have brand identity, brand association with the category, outstanding products, a very loyal consumer franchise. We feel very good about the position we're in, but we're not going to rest where we are.

Are there other items that you think investors are either getting wrong or maybe not fully appreciating based on what you can see inside with the business? Or in your discussions top-to-top with key customers or what have you.

Yes. Look, it's interesting. As we've done very, very well this year, I think the conversations are getting a lot more clarified over the last quarter. People are starting to get it. I think early on, it was like this business is never going to be that big. And now people started a year or 2 ago, okay, this is a legitimate business. And then it's going to be big, but probably can't ever be profitable. So now that we've made some really nice headway in the profitability. Again, we're not all the way to bright. We have a long way to go. But we now have people believing that, that is achievable to make this a very profitable business. The capital intensity is the last piece of it where people are like, great top line, yes, I see potential for margins, but boy, this is still a capital-intensive business and where is the free cash flow. So we're going to prove I think pretty quickly that this is going to be a free cash flow positive business, and the scale of this thing will start to really move up very, very quickly. The other thing I would say is from a brick-and-mortar perspective, we are so important to retailers. This is a category where 30% of the business is online. So Chewy and Amazon, there's a ton of -- ton of business that goes through those channels instead of why am I going to go buy a 40-pound bag of kibble at the store and lug it home? I'm just going to have it sent to me every 4 weeks on auto ship. This is a product you have to go in the store for. You have to go in and visit one of our fridges, you have to go down the aisle. And not only are you going to buy it Freshpet in the store. You're also going to buy a bunch of other things in there. And the type of customer that we bring in is extremely valuable to that retailer. And so as they plan their business every year, they've lost a lot of market share over the last 5 or 10 years. They realize if they're not winning with us, it's going to be a very difficult -- way, difficult means for them to grow. And so look, we're in a great position. We think there's a lot of upside. Again, we have 3% of the dog food share at this point. There's no reason this can't be at least 10% share, if not even more over time. So this is early innings. There's a ton of runway.

Yes. One other thing I would add is that when we talk to the investors in our meetings last 1.5 day, it's kind of interesting is because I've been in the food business for basically 40 years at this point. And virtually everybody in this industry expects that your products can be co-packed by somebody that there's somebody else out there who can make -- because the reality is the technology has not evolved that much across the vast majority of the categories. So you can find somebody who can, bottle, bag, box, whatever it is in the vast majority of the businesses. And so we get these people asking us, like, can't you guys go get this co-packed. And it means that they're not really understanding how difficult it is and how limited the manufacturing capability is to produce this. And then when I say to people, the technology to make fresh pet food is in its infancy, I don't think people know what that means. And it's not that they're not capable of understanding, it's just we haven't been able to really define what that looks like because if you think about the history of food and how food develops, the technology has evolved, but they evolve at a glacial pace. And so what's being done to make foods today or beverages today is dramatically different than what it was done 30 years ago, but most people don't remember 30 years ago. They don't know what 30 years ago look like. We think of this as very early innings in manufacturing technology. That's why we've invested in the talent and the technology to advance it to produce superior products. But people look at it and say, like, so when -- how fast is that going to happen and what is that going to mean? And we can't really tell them because we're walking into unexplored area. And that's not really well understood in this space because it doesn't happen very often in this space.

Right. Yes. On Tuesday, we announced the appointment of a new COO, Nicki Baty, I think, I pronounced that right. Can you share a little bit about her background and sort of the strategic rationale behind the move?

Yes. Well, first of all, we're thrilled to have Nicki join us. She's an absolutely fabulous person. She's a great talent. We are excited to get her going on our business. She does have some restrictions on what she can do. She came to us from Hill's. And so she can only work on the grocery, mass and club channels until next May at which point then the restrictions will be gone. But between now and then, there's a lot for her to learn about this business. She's a tremendous leader. She's a very, very bright mind. She's got tremendous capability. We love the fact that she's got experience internationally. That's an opportunity for us. We love that she's got experience across basically every class of trade. She's passionate about animals, understands this space and she's frankly going to be a good complement. Within this, what this does is it allows us to get Scott Morris, who was previously our COO, President and Co-Founder, to spend time in doing things that only he can do. He is the consummate entrepreneur. He is the kind of guy who will see a problem and find 15 different ways and we'll knock down walls to get the problem solved. And we're thinking about the world as we're expanding the ecosphere. I kind of described a little bit earlier, but we're expanding the ecosphere that we're operating in and we want to move further up into the supply chain to find ways to get strategic and competitive advantage on the ingredients that we buy, the cost, the quality and whatnot, we want to work on the technologies that we use to cook our product and get strategic advantage there. We want to move downstream into retail to make those fridges even more valuable to us, to our consumers and to our customers through the use of technology, and there's nobody better to take on that ecosystem and find a way to build an even more robust business. When I think about the CPG industry, there are most good CPG companies make good products and they sell great brands. But the truly winning companies build an ecosystem that delivers an exceptional consumer experience. Coca-Cola's bottling system delivers within an arm's reach of desire. We want to be in that case, where we build an ecosystem that delivers the exceptional consumer experience and Scott is going to be leading that work for us.

Yes. I mean Nicki is going to be unbelievable. I probably spent time with her 3 or 4 times before she's come on board. I still can't believe we convinced her to come. She's incredibly talented. She's a true general manager. She understands the P&L. She is going to be amazing. So we're so happy to have her.

Great. Are you able to comment on the recent 8-K filing related to severance, change in control and noncompetes? And does Nicki's appointment have anything to do with that?

Yes. No, Nicki's appointment had nothing to do with that. It did look like in the dark of night on a Friday before a holiday weekend, we snuck some stuff out there and hope that nobody pay attention. That really wasn't the goal. In fact, that the timing was driven by the fact that the original FTC new directive on noncompetes was -- had an effective date of yesterday and any agreements that were completed prior to yesterday would be grandfathered in. Even though the courts have now put that on hold for a while, our work was well underway, and we wanted to get them done to make sure there's no chance. The real motivation for doing what we did was that we realized that over the last decade, we've built an enormous amount of intellectual property that is essential for our success in fresh pet food. And it all exists in the minds of our key leaders, technical leaders as well as commercial leaders. And if we look back, we were -- 10 years ago, we were an $86 million company, and we had noncompetes that had varying scopes, varying lengths all kinds of things that, frankly, didn't give us the protection that we needed to guarantee that we were going to be able to own the intellectual property we created. So we set out to create much better, stronger non-competes for the company. But in order to do that, you can't go to an existing employee and say, "Oh, by the way, we're putting a tighter news on you on your non-compete, you actually have to offer them something as an accommodation" and the accommodation that we could offer was, if there was a change in control, you would get a richer severance than your previous agreement allowed you to do. So you basically are bartering one for the other, and we were able to do that. So we think the shareholders win because they get much better protection on the intellectual property and the leaders of the organization get the confidence in the security that, for some reason, somebody showed up they'd be well taken care of. So it was a really good move. It was done on Friday because we had to get it done before September 4, and we were going to be out of town. So we wanted to get it done. But that's what drove the timing. It was not in the dark of the night exercise.

Great. Thank you for that. We've got a couple of minutes left. Maybe we take a step back and just talk about the overall pet food category. Just a couple of trends. What are you seeing in terms of either trading up, trading down, channel, right, specific moves that you're seeing? And just kind of what your expectations for the overall category as we move through the back half of this year?

So I think the way to think about it is that we went through 4 years of hell. Those 4 years are done. We're back to a more normalized environment. There's -- every environment has good employment might be good or bad, economy might be good or bad. But the reality is we're back to a more normal period. And I think the trends that we saw in 2019 are now continuing on. So we had a big adoption boom, a bust this kind of normalization. And what we see now is we see the pet adoptions continuing at roughly the same rate that they were going for the last decade before the pandemic. And we see that as a good healthy thing. We also see the move towards the premiumization of pet food just continuing. The 2 fastest-growing pet foods right now are our Farmer's Dog, which is a very expensive DTC brand and Freshpet, a very expensive fresh brand. And so the reality is for people to say that the consumer is tightening up, when the fastest-growing items are the most expensive is kind of -- it's an odd piece. Within our business, we see 2 signs that there's some economic strain out there. One of them is our consumers are moving from smaller sizes to larger sizes because that's where they get the most efficient cost per pound. So every time I look at the Nielsen's, the pounds are up more than the units are, which is a healthy thing for us and it's good for the consumer. The other thing is more of our business has moved into value-oriented channels. So channels like Walmart, which are known for value are getting better foot traffic. So we see a higher rate of growth in those kinds of channels than we do in the channels that are less known for value. Beyond that, in our business, we're not seeing a whole lot of other changes. I will say what we're hearing from our -- from the competitors in the pet food broadly, is that they are seeing a little bit more shifting and shuffling between the brands. There's a little bit more of a value orientation. I would just argue that what that's masking is the fact that there's a lack of differentiation between some of those products. And so they are more substitutable for each other.

Good. Good. All right. I think that's a great place to leave it here. Hopefully, you can join us in the breakout session next door. And please join me in thanking Billy and Todd for being here.

Right. Thank you.

Thank you both.

Thank you.