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

Yes, quite a bit. The media landscape is ever changing. We have historically spent bulk of our media dollars have been in sort of the broadcast media because we're still a young brand that's trying to fill the funnel, and we still believe that spending the bulk of our dollars trying to fill the funnel of potential new users is the right place for us to be. But we also want to spend that money in a way that goes after the highest potential prospects. Those people who are in the market or have the values and interest in food and pets the way that our existing consumers do, we call them MVPs. So there's this broad funnel with the bulk of our media spending at the top. But as you go down the funnel, there's more and more targeting that happens that's designed to bring these MVPs. People spend about $500 a year with us to move those people down the funnel and into the brand. And so we're increasingly targeting the messaging to that audience, and we're also building a higher share of our media is moving into digital and social from the broadcast just so that we can pull people down through that funnel. We're very data-driven on our advertising and media spend. We've just hired some new folks. We just hired somebody, a new head of our Digital Media Advertising Planning Team. Guy came out of Estée Lauder. We're quite thrilled to get this guy, but he's revisiting the entire plan to help us figure out where do you get the best efficiency? How do you reach your audience, the prime prospects best? How do you pull them down through the funnel? And we're feeling like when we look at the metrics, the metrics need to turn, they need to move to a lower cost of acquisition of a customer, but we feel like we're heading in the right direction, especially with the right message.

Right. Over time, household penetration and growth have proven to be important indicators of brand health. What are you seeing for household penetration in buy rate in terms of growth for -- buy rate growth for the Freshpet brand of late? And which of those metrics, I guess, are you most focused on?

Yes. I mean household penetration is by far the most important metric. When you're a young brand, you want to continue to add household penetration. But we are also very mindful that we want to bring in the consumers who are of the highest value, and that will show up in the buy rate, but household penetration is where our focus has been. And we're particularly looking at that within that at the MVPs, the people that we bring in who are going to be the highest potential spenders. We're today still adding households. We're adding them across all income groups, all age groups, all demographics. So we're adding them at a higher rate than everybody else in the category. We're also bringing in new users at a higher rate than others in the category. It's just not at the levels we were a year ago. We're seeing household penetration gains in the, call it, high single digits overall and in the mid-single -- mid-double digits on our MVPs. The buy rate gains continue to be in the 5% and 6% range overall, which, if you put all that together, gives you a relatively attractive picture compared to most CPG companies today. It's just not where we want it to be, but it's still a healthy overall picture. And if we can manage the capacity, as Todd referred to, and the overhead structure, it's still in a very attractive place for us to be.

I know at CAGNY earlier this year, you spoke about shifting to focusing more on what you refer to as the MVPs, or most valuable pet parents. Can you talk a bit more about the strategic shift you've made there? What drove it? And how you feel it's played out thus far?

Yes. The ultimate goal for us is we believe the best franchise for us to have is consumers who are feeding Freshpet as the main meal every day. And that's what we want to get to. Because if we have a franchise that is a bunch of people who are occasional users or might use this as a mixer or topper, they really haven't bought into the full Freshpet story. And so our goal is to build the biggest franchise we can, but we want it to be an incredibly high-quality franchise. And that's really what the MVPs are. These are people who have committed themselves to feeding their pet in a different way. They're spending $500 a year. And in order to accomplish that, what we need to do is think about the message that we deliver. So the advertising message needs to be really queued in on who they are and what their values are and their relationship with their pet. The media targeting needs to find those people because there are 32 million of those people out there today. There are 32 million households that are in our prime prospect group, but we need to find those people and deliver that. And then we need to make sure that the consumer experience, when they buy the product, they experience the product, they notice or see the benefits that they would expect to get from the product. That is a big, big focus for us. In the end, we will always have some number of occasional users. We'll have -- always have some people who feed Freshpet for their dog's birthday or for Christmas or whatnot. But the franchise we want to build is that loyal base of consumers who buy us every single day as a regimen purchase.

As with any growing segment in our industry, we've seen competition in fresh dog food has recently been heating up. Obviously, later this year, there have been other announced launches into the fresh space as well. Maybe you can talk a bit more about how you think Freshpet compares in light of the increased competition coming to market? Are you losing any shelf space or new fridge placements? And how do you foresee that dynamic playing out over the next couple of years?

Yes. Yes. So first of all, we've been preparing for this moment for the last 10 years. We had very lofty goals a long time ago that we would build a business that would ultimately be so attractive that people would no longer view us as this niche item. They'd view this as the future of pet food. But when we got there, we want to know that we had built as many competitive advantages so that when the day came that people did enter that those advantages would be available to us. We didn't want to get to this day and then say, "Oh, what's the defense plan or what do you do to respond to it?" We wanted to be ready. And we feel like we've made a bunch of really good choices along the way. We've built what we think is the best retail availability and visibility. We have 38,000 fridges. We have a very broad array of products that need a wide range of needs. We spent a very large amount of money building a consumer brand equity, but perhaps the most important barrier that we built and the competitive advantage that we've built over time has been our manufacturing. Manufacturing fresh pet food is not easy and certainly not to the quality that we get. It is very, very difficult to do that. And so we have spent a ton of time building our mastery, building scale against that mastery and then developing new technologies that are designed to better insulate our business and deliver a better consumer experience at the end. And so as the new competitors arrive, there will be people who are going to buy fridges and put them in store or access fridges that people like Walmart own, probably not to the extent that we have, the 38,000 fridges, people will get some number of stores. They won't have as broad a lineup to reach as many consumers as we can reach with as many specific tailored products. But at the end of the day, it's going to be tough for somebody to compete with the manufacturing expertise we have that delivers the best quality at the lowest possible cost. But we'll see. We'll see what happens as the market unfolds and see how that all plays out. We do believe that the arrival of new competition is really good for the category. We've been saying for the last several years that the Farmer's Dog and the $200-plus million a year they're spending in advertising has actually been very helpful to us. We think that it has raised people's visibility that kibble and can may not be the best way to feed your dog, there's something better out there. In 2017, when we launched our plan that we called Feed the Growth, we spent a grand total of $13 million in advertising. It was doubled in the year ago -- year before, and it was the sum total amount of money being spent to drive the fresh and frozen category. I believe based on the data we've seen, in 2026, there'll be somewhere between $350 million and $450 million spent in advertising to tell people that there's a better way to feed your pet than kibble and can. And that can only be good for the segment that we are the market leader in and the segment that we expect to command a very large share of over a very long period of time. So we welcome the competition. We take it seriously, but we're ready for it.

Yes. And as General Mills, as Billy mentioned, it earlier, they think the category is going to go from $3 billion to $10 billion. So there's $7 billion, if you believe that number, which I think is a reasonable assumption, there's $7 billion of growth over the next decade. So there's going to be a lot of competitors trying to get that $7 billion. We strongly feel we are best positioned to get the biggest chunk of that. Will we have the same market share we have today? Probably not, but we have a lot of upside because this subcategory will continue to grow substantially.

Thanks for that. You've been teasing some new technology that you've been testing over the last year or so. Maybe you can share a bit more about what sort of differentiates this technology, what consequences it could have on your product? And maybe when you'd be able to sort of know for sure that it truly sort of works?

Yes. So we're very excited about it. It's the seventh line in our Bethlehem facility is a new technology for the bags. As most of you who've followed the story know, our bag margins are significantly less than our roll margins, kind of high single digits lower than our roll margins. So the goal is to get back closer to parity. This technology, if it works the way we think it's going to work, will bridge that gap significantly. The -- I won't go into the details of the technology, but it's higher throughputs, it's higher yield, it's lower quality costs. And also a nice added benefit is, it gives us more flexibility on new products and to drive further innovation over the next several years. So this line is being commissioned as we speak. We anticipate we'll start running real product off of it probably around November. I'm sure it will take a little while for us to get comfortable with the product coming out of there, but we're really excited about it. And if it works, all future bag lines will be utilizing this technology. Subsequently, what I'm equally excited about is, at the same time, we've come up with a, we call it the light version of this technology, which allows us to retrofit many of our existing bag lines with forms of this technology. It doesn't get you all the way there, but we get about 2/3 of the margin improvement by able to retrofit, to some extent, our existing bag lines. We will test that live and probably go live with it about April, May of next year in 1 of our lines in Bethlehem as well. And again, if it works the way we think it's going to work, we will build that out over the next couple of years. So that is not in the 48% adjusted gross margin guidance we've given for '27. That's why I do believe there is upside. We'll get some of that benefit, if it works, in '27, but it's more of a '28, '29 benefit where we'll really see the upside in margin.

I think it's also important to put in context that half of our business today is in bags, and it's the fastest-growing segment of our business today. And all the competitive entries that we've seen out there, nobody else has been able to do bags. We've seen competitors do rolls. We've seen competitors do stews. We've seen people do a lot of frozen stuff. But to do a bag product, a fresh bag product, it is the most difficult, most complicated product for us to make. And by the time somebody probably figures out how to make what we're making, we'll be producing to this new standard, which has higher quality, lower cost, better opportunities for innovation. And so to the comment that I made earlier about being prepared for this moment, we started investing in this next-generation technology in late 2018 to figure out how you would do it. We wanted to be ready the day that the competitor showed up. We would be in a position where we could take the next leap forward in the manufacturing expertise and the quality of the product that we produce so that it will be hard for somebody to chase us and certainly hard for somebody to undercut us on the cost, and we think we're going to accomplish that.

That's really helpful. You significantly reduced CapEx this year, as you talked about. Now looking for CapEx of about $175 million versus your initial outlook for $250 million at the start of the year. Can you remind us the breakdown of maintenance versus fridges versus capacity expansion? And what are your expectations for next year? And is that level sustainable?

Sure. So we spent about $20 million-ish on maintenance capital every year. We spend $20 million to $25 million on fridges each year and the rest of it is for capacity expansion. So in a typical year, where we're spending $200 million to $250 million [ of investment ], 80% or so of that spend is going to capacity. Now with the business slowing down a bit, we are able to push out to the right that capacity expansion. And it's -- we're going to do it this year. We're certainly going to do it next year as well. And again, we're going to follow the tape. And if we start to accelerate, then we will start to up the CapEx in the out years. If we're at a new normal slower pace, high single digits, low double digits, that amount of capital will be lower for an extended period of time. But as I said earlier, we will be close to free cash flow positive this year. We certainly will be free cash flow positive in the subsequent years after that.

Maybe in our final moments, you've been meeting with investors for the last 1.5 days or so, and obviously, oftentimes before that, but maybe over the last few days, what's the sort of the common theme that you've been hearing from investors that -- or themes that are developing, the key questions that you're getting, how have you responded to them? And is there something or some area that you feel like folks are necessarily missing or maybe not putting the proper amount of focus on as you see it as we're thinking about this equity over time?

Yes. I would highlight to, and Todd can add to these, but the first one is, I think that the -- anybody who is confusing today's slowdown that we've seen this year with the diminishment of the long-term opportunity is missing the boat. The reality is this is a short-term temporary phenomenon. All the data that we have suggests that the long-term opportunity remains there. It's very clear that consumer sentiment that we've seen this year has had a negative impact on our growth rate, but it doesn't change what the long-term opportunity is. And so anybody who is looking at valuing us, I recognize that it's not an easy thing to do to say at what point will it grow faster, and how do I project that? But you shouldn't assume that the current rate of growth is the rate of growth that we're going to have in the years going forward because we are fully intending to realize that opportunity that's ahead of us. The second thing I would talk about is, people try -- they're trying to figure out with not just General Mills, but we have Mars with Royal Canin, we have The Farmer's Dog, we have a whole host of people who are trying to enter this space. And it is going to be a very dynamic environment. It's going to be very interesting. As I said, we're well prepared for it. But I think there's a very good corollary, and there's probably a wide range of corollaries that people can think about. But the way -- one of the things that I recall is, we feel like we're doing to the pet food category what Chobani did to the yogurt category. Around 2005, they entered with Greek Yogurt. Somebody who was outside the category, was an insurgent, came into the business and basically said, "I have a way to make a different and better product." And there were some well-entrenched competitors then. There was Yoplait, there was Danone and whatnot, and they paused, and they waited a long time before they responded to it. And by the time they responded to it, it was too late. The Chobani had built an enormous brand franchise, a lot of manufacturing capability, a lot of manufacturing expertise and it became very difficult for the incumbents to keep up with them. We aspire to do that same thing to this category. We think we've built the moat to do it. We think we've built the expertise to do it. And we think this is going to be a very durable long-term franchise in this space. The next year or 2 will be the test to see whether what we've done, we've made the right bets, but we feel pretty good about the bets that we've made.

Yes. I would say the other thing that with the slowdown of the business, which has been so much of the focus, what's been lost is our plants are running exceptionally well. Ennis, which was our lowest margin facility last year, this year is our highest margin facility. We've made tremendous strides in the last 6 to 9 months. And I get a lot of questions, a lot of concerns about, "Hey, the business is only growing slightly, are your margins going to start to deteriorate?" And no, they won't. If we're still growing, we can maintain the margin structure that we have. It will make it a little bit more difficult to grow the margins to where we want to grow them. But as I said earlier, we were anticipating about 18% EBITDA margin. Even if our business would slow significantly, we can certainly maintain that margin structure. And obviously, our intention is to get above 20%.

Great. Well, I will say, after a couple of days of hearing a lot of packaged food stories, it's fun, always good to talk about one where there's clearly a pretty significant growth track ahead of you, and it's never a linear straight line. So we appreciate you coming here and talking us through sort of the closer in aspects and then making sure we understand the forest for the trees. So thank you both for being here. We're going to cut it here and go over to the breakout. Please join me in thanking Billy and Todd for being here.

Thank you, Andrew.