Freshpet Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 5, 2024

There are 16 speakers on the call.

Operator

Greetings. Welcome to Freshpet's Second Quarter 20 24 Earnings Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded.

Operator

I will now turn the conference over to Tracey Olsh, Vice President, Investor Relations. Thank you. You may begin.

Speaker 1

Thank you. Good morning, and welcome to Freshpet's 2nd quarter 2024 earnings call and webcast. On today's call are Billy Sears, Chief Executive Officer and Todd Comfort, Chief Financial Officer. Scott Morris, President and Chief Operating Officer, will also be available for Q and A. Before we begin, please remember that during the course of this call, management may make forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Speaker 1

These include statements related to our long term strategy, 2027 goals and pace in achieving these goals, prospects for growth, timing of Freshpet Kitchen's expansion and new technology and 2024 guidance. Words such as anticipate, believe, could, estimate, expect, guidance, intend, may, project, will or similar conditional expressions are intended to identify forward looking statements. These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in these forward looking statements, including those associated with such statements. Please refer to the company's annual report on Form 10 ks with the Securities and Exchange Commission and the company's press release issued today for detailed discussions of risks that could cause actual results to differ materially from those expressed or implied in any forward looking statements made today. Please note that on today's call, management will refer to certain non GAAP financial measures such as EBITDA and adjusted EBITDA among others.

Speaker 1

While the company believes these non GAAP financial measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for how management defines such non GAAP measures, why management believes such non GAAP financial measures are useful, a reconciliation of the non GAAP financial measures to the most comparable measures prepared in accordance with GAAP, and limitations associated with such non GAAP measures. Finally, the company has produced a presentation that contains many of the key metrics that will be discussed on this call. That presentation can be found on the company's investor website. Management's commentary will not specifically walk through the presentation on the call, rather it is a summary of the results and guidance they will discuss today.

Speaker 1

With that, I'd like to turn the call over to Billy Cyr, Chief Executive Officer.

Speaker 2

Thank you, Rachel, and good morning, everyone. The message I would like you to take away from today's call is that we are on track to deliver the disciplined growth we committed to achieve this year. As you know, we aspire to deliver category leading growth with outsized improvement in profitability. But as we've learned over the past few years, carefully managing our growth to about 25% enables us to drive operating improvements and manage cash more effectively, making Freshpet an even more attractive business. That is our definition of disciplined growth.

Speaker 2

And if we do that well, consumers will win, customers will win, and our shareholders will win. Our second quarter results demonstrate the strong progress we are making towards delivering that disciplined growth. We delivered our 24th consecutive quarter of net sales growth over 25% and did it within our existing capacity limits, so we maintained exceptional customer service and strong fill rates. That enabled us to operate very efficiently and effectively, so we expanded our adjusted gross margin and an adjusted EBITDA margin. The bulk of the operating improvements came in our key focus areas of input costs, quality and logistics, totaling 7 70 basis points of improved operating improvements.

Speaker 2

Those operating results, specifically adjusted gross margin, input, quality and logistics costs, exceed some of the key elements of our 20 27 goals. As a result, we are in an even stronger position to achieve or exceed our full set of 2027 targets as well as raise our guidance for this year. We still need to prove that we can achieve these results consistently before we adjust our long term targets. However, another quarter of strong performance has made us even more optimistic. These results were driven by broad based strength on the key business fundamentals.

Speaker 2

1st, our growth in the 2nd quarter was entirely driven by volume growth. There was no impact from pricing or mix this quarter. Further, we have been seeing a steady trend towards consumers buying larger pack sizes, which slightly reduces the price per pound, but improves the efficiency of our production lines and our distribution systems. This consumer behavior is a positive indication that value seeking consumers move up to larger sizes of Freshpet rather than reducing the size or amount they buy. 2nd, from a household penetration perspective, our growth rate is where we needed to be to hit our 2027 target of 20,000,000 households.

Speaker 2

We are growing households in the low to mid-20s and increasing the buying rate in the low single digits. That combination results in mid-20s growth rates, which is our targeted level. More encouragingly, our heaviest users are growing even faster than the total user base. 3rd, our media plan is also delivering the way we had hoped. It is driving strong household penetration gains in line with our long term model and at a healthy customer acquisition cost that is comparable to the cost we had prior to the price increases we took over the past 2 years.

Speaker 2

Additionally, by balancing our media investment more evenly across the year, we have been able to deliver strong growth while living within our capacity limits. 4th, consumers continue to believe that Freshpet represents a good value. The desire for value is being expressed as quality for the price, not just price. We believe consumers find value in a truly differentiated product. That is why it appears that much of the category growth is now coming from the fresh frozen segment where Freshpet is a leader.

Speaker 2

Further, our growth is fastest among our heaviest users, another strong indicator of the differentiated value Freshpet represents even in an environment where consumers are looking for ways to stretch their dollars. Finally, taking a step back, our growth continues to be supported by the long term trend towards the humanization of pets. The pandemic created a pet adoption bubble, but we are now back on the same long term pet population growth trends we have seen for more than a decade. And our volume growth comes from expanding household penetration, which is the model that has worked for us since we first launched our Feed the Growth strategy in 2017. Now I'd like to provide some highlights of the 2nd quarter.

Speaker 2

We had strong momentum and made great progress against our long term plan, and you can see that in our financial results. 2nd quarter net sales were $235,300,000 up 28% year over year, all of it being volume driven, as I said earlier. 2nd quarter adjusted gross margin was 45.9%, above our long term target for the 2nd consecutive quarter compared to 39.8% in the prior year period. 2nd quarter adjusted EBITDA was $35,100,000 an increase of approximately $26,000,000 year over year. From a retail perspective, we are having a solid year of retail availability growth.

Speaker 2

Store count growth is in line with our long term rates. More importantly, some of our larger customers are engaging with us on potential plans to add 2nd and third fridges in high velocity stores. That is where we expect to see the bulk of our growth. You will see that in TDP growth exceeding ACV growth as we go forward. Specifically, we placed 7 90 fridges in the 2nd quarter, including new stores, upgrades and secondthird fridges, bringing us to a total of 35,602 fridges at retail or more than 1,800,000 cubic feet of retail space.

Speaker 2

As of June 30, 2024, Freshpet could be found in 27,000 497 stores, 22% of which now have multiple fridges in the U. S. Fill rates continue to be strong and were in the high 90s throughout the quarter, supporting fridge placement and store growth. Now I'll provide an update on KPIs we track for our mainstream, main meal, more profitable plans, what we refer to as main and more. Focusing on the idea of mainstream, Freshpet is becoming increasingly mainstream, but still has a long runway for growth.

Speaker 2

According to Nielsen omnichannel data, which includes e commerce and direct to consumer, as of June 29, 2024, total U. S. Pet food is a $53,000,000,000 category. We only have a 3% market share within the $36,000,000,000 dog food segment, which is the majority of our business today. Within the fresh frozen subcategory in measured channels, Freshpet has a 96% market share.

Speaker 2

Fresh continues to outperform the broader pet food category, and many retailers believe it is the future of pet food. As a result, Freshpet is now in 66% ACV in Nielsen ex AOC, and we continue to add distribution breadth and depth with 2nd and third fridges. Our household penetration gains also demonstrate that we are well on our way to making Freshpet more mainstream. Household penetration at the end of the second quarter was 12,800,000 households, up 25% year over year and on track to meet our target of 20,000,000 households by 2027. Our high profit pet owning households, or HIPPOs for short, are growing even faster, up 31% versus the prior year period.

Speaker 2

In short, the humanization of pets is a mainstream idea, and now it is our job to make fresh food the standard way to feed your pets. Turning to the main meal part of the strategy. Freshpet sales are increasingly concentrated in our heaviest users, Hippos. Currently, 37% of Freshpet users are Hippos, and they represented 89% of our sales in the 2nd quarter. Even more encouraging, about 300,000 of our users or less than 3% of our total users buy more than $1,000 of Freshpet per year, and this group grew 47% over the past year.

Speaker 2

They now represent about 27% of our business. There is a significant opportunity to increase this percentage and grow our total business. The key driver to convert more consumers to use Freshpet as the main part of their pets' meal is advertising. We need to educate consumers on the benefits of fresh food for their pets. Multi packs and larger pack sizes can also help reinforce the idea that our product can be your pet's main meal and will in turn help increase buy rate, which was approximately $100 at quarter end, up 3.3% versus the prior year period.

Speaker 2

Adding unique value added SKUs helps do that. Based on total U. S. Pet retail plus data from Nielsen, we currently have an average of 18.4 SKUs per point of distribution, up from 16.1 SKUs 1 year ago. Since we have a finite amount of space in our fridge, as we increase the number of second and third fridges, we can increase the number of SKUs, amplifying our visibility and marketing impact, widening our product assortment and broadening the appeal of our brand.

Speaker 2

Now to the more part of Main and More, more profitable. We had another strong quarter of margin improvement. Adjusted gross margin improved 60 basis points versus the strong results we posted in Q1 to 45.9%, and we ended the 2nd quarter with an adjusted EBITDA margin of 14.9%. The key items that drove this improvement were: 1st, quality. Our team continues to execute well.

Speaker 2

We still have lots of opportunity for further improvement, but our team has been able to reduce both the number of issues we have to manage and also the size of any issues. 2nd, input costs and yield. We've returned to our historic level of input costs as a percent of net sales through a combination of price increases, commodity cost management and meaningful improvements in our production yields. Further, we believe there is an opportunity to continue to improve efficiency in this area through formulation work, supplier diversification, operating improvements and new technologies. 3rd, logistics.

Speaker 2

We are clearly benefiting from some macro factors on freight, including lower lane rates and fuel costs. But our 99% fill rate in the quarter, the expansion of the service area for our Dallas DC behind increased production in Ennis and new tools we've put in place to more effectively bid our lanes and improve our customer service are the primary drivers of the improved performance. Turning to an update on our capacity. We have a disciplined approach to managing capacity and continue to execute on our expansion plans while also improving throughput and yields on existing lines. In Ennis, the 4th line is still on track to start up by the end of Q3 2024.

Speaker 2

We began commissioning the line in July and feel good about the test run so far. In Bethlehem, the team is focused on increasing capacity utilization or OEE, and our 7th line in that campus will test new technology and is expected to start up in the second half of twenty twenty five. In Kitchen South, we continue to evaluate ways to add more lines and or shifts. We continue to evolve our capacity expansion plans to drive greater capital efficiency. As we have discussed previously, we are intensely focused on: 1, maximizing the throughput of our existing lines 2, maximizing the capacity of our 3 existing sites and 3, developing and implementing new technologies that generate more throughput per line.

Speaker 2

While we've come a long way since our first facility in Quakertown, PA, manufacturing systems to make fresh pet food are still not where we'd like them to be. We've invested and will continue to invest heavily in both technology and talent to make our production more stable, reliable and efficient. We've made tremendous progress, but still believe the opportunities for improvement are sizable. In summary, I think we are making good progress at delivering the disciplined growth we promised at the beginning of this year. We are highly focused on managing the business to live within our capacity and believe this has led to the progress we've made on our profitability.

Speaker 2

We believe our model works very well at approximately 25% growth, generating the right balance of growth, capital investment and cash generation. And we are increasingly confident that we will be free cash flow positive by 2026. I'm incredibly proud of the progress we have made and the results we have delivered, especially since Ennis is still subscale and we have some exciting new technologies under development that could meaningfully enhance the economics of our Bags business. Now we need to continue to execute at a high level and keep raising the bar. Before I turn it over to Todd, I want to point out that the press release announcing our earnings today has a date line of Bedminster, New Jersey instead of our previous home in Secaucus.

Speaker 2

We've outgrown our corporate offices in Secaucus and have moved into a temporary office space in Bedminster, New Jersey, while our new purpose built leased corporate office is under construction right down the road in Bedminster. We expect to move into the new office in the first half of next year. Our new location in Bedminster will allow us to attract and retain the top marketing and finance talent we need while making it much easier for our team members to go back and forth to our technical base in Bethlehem, Pennsylvania, enabling much closer collaboration and planning. Our new office will embody our pets, people, planet mantra, and we look forward to sharing it with you when it opens next year. Now let me turn it over to Todd to walk through the details of the Q2 results and our updated guidance.

Speaker 2

Todd?

Speaker 3

Thank you, Billy, and good morning, everyone. As Billy mentioned, we are very pleased with the 2nd quarter results, particularly our ability to deliver on profit improvement. Now I'll give you some color on our financials and updated guidance for the year. 2nd quarter net sales were $235,300,000 or 28% year over year. Nielsen measured dollar growth was 24% versus the prior year period with broad based consumption growth across channels.

Speaker 3

We saw 26% growth in XAOC, 24% in U. S. Food, 9% growth in Pet Specialty and over 100% growth in the unmeasured channel. It is important to note that Nielsen IQ has expanded their coverage beyond what we previously called the Nielsen Mega Channel to a new U. S.

Speaker 3

Pet retail plus channel that adds online sales via Amazon Chewy, neighborhood pet retailers and farm and feed stores. Wherever possible, we will use the expanded definition to provide the most comprehensive view of our business and the category. We estimate that this new channel covers more than 85% of our U. S. Business today.

Speaker 3

2nd quarter adjusted gross margin was 45.9%, up 6 10 basis points year over year. This was driven by improvement in input cost, yield, throughput and quality cost. Specifically input cost as a percent of net sales improved 4 60 basis points with better yields, throughput and lower commodity costs, while quality cost improved by 90 basis points. 2nd quarter adjusted SG and A was 31% of net sales compared to 34.9% in the prior year period. We spent 12.2% of net sales on media in the quarter, down from 14.8% of net sales in the prior year period.

Speaker 3

Total media investment was up 6% year over year. Recall, our media plan is less front loaded this year than in years past so that we can manage our growth to live within our capacity limits. Logistics costs continued to improve and were 5.8 percent of net sales in the 2nd quarter, a decrease of 2 20 basis points compared to the prior year period. Like Billy stated, the majority of the improvement was due to strategic actions we have taken to increase bill rates, reduce miles driven by increasing the number of states served by our 2nd distribution center and negotiate with vendors with the remainder being macro driven with more favorable lane rates. Other SG and A, which was 13% of net sales, increased 90 basis points driven by higher incentive compensation.

Speaker 3

Please note that our GAAP P and L includes an $11,100,000 true up of non cash share based compensation based on multi year share based awards granted in fiscal year 2020. This year's unexpectedly strong profit performance has increased the likelihood of greater vesting on those awards. Excluding this charge, we would have generated $9,400,000 of net income. 2nd quarter adjusted EBITDA was $35,100,000 or 14.9 percent of net sales compared to $9,000,000 or 4.9 percent of net sales in the prior year period. This improvement was primarily driven by higher gross margin as well as improved logistics costs.

Speaker 3

Capital spending in the 2nd quarter was $48,300,000 Operating cash flow in the 2nd quarter was $42,400,000 and we have cash on hand of $251,700,000 at the end of the quarter. We continue to believe that we have adequate cash to fully fund our growth through 2025 and will be free cash flow positive in 2026. Our strong improvement in adjusted EBITDA this year also makes it unlikely we will need additional capital. Now turning to guidance for 2024. We are updating our outlook to reflect our outperformance in the second quarter as well as our conviction in our ability to execute in the second half.

Speaker 3

We are raising our net sales guidance from at least $950,000,000 to at least $965,000,000 or growth of at least 26%. We are able to do this because of the strong improvements in our operating efficiency, particularly in Bethlehem and Kitchen South that will allow us to sell a bit more this year and still maintain strong customer service. However, we still need the new roll line in Ennis to start up by the end of September and ramp up production in order to have the supply we need to meet demand. We are also keeping in mind the capacity needed to support next year's growth and do not want to get too far ahead of our original plans. As far as cadence, we continue to expect net sales to have sequentially lower percentage growth throughout the remainder of the year as we intentionally manage our growth rate while expanding capacity.

Speaker 3

Our more balanced first half, second half media investment this year has been critical to delivering the growth we have experienced while also living within our capacity constraints. As the first half media really dictates the demand we have in the second half of this year and the second half media investment will drive the demand we experienced in the first half of next year. For this reason, our second half media investment will be significantly larger than the investment we made in the previous year. For adjusted EBITDA, we are raising guidance from at least $120,000,000 to at least $140,000,000 to reflect the over delivery in Q2. We now expect adjusted gross margin to expand by approximately 500 basis points for the full year compared to 300 basis points previously.

Speaker 3

Capital expenditures are now projected to be approximately $200,000,000 compared to approximately $210,000,000 to support the installation of capacity to meet demand in 2025. The modest reduction is due to the timing of certain expansion projects. In summary, the 2nd quarter results demonstrated disciplined growth and our ability to execute the strategy we laid out. We are very pleased to see our investments in capacity and organizational capabilities are paying off and we are gaining significant scale advantages. That concludes our overview.

Speaker 3

We will now be glad to answer your questions. As a reminder, we ask that you please focus your questions on the quarter, guidance and the company's operations. Operator?

Operator

Thank Our first question is from Ken Goldman with JPMorgan. Please proceed.

Speaker 4

Good morning. Thank you. Good morning. When it comes to the outlook for 20 27, I think you're skating about as close as possible to raising it without officially doing so, if that's fair. Can you just please remind us on or update us rather on the guideposts you're looking for that will allow you to, I guess, proverbially pull the trigger?

Speaker 4

I guess I'm also asking what gives you pause today that makes you maybe think that you can't necessarily deliver some of these results consistently? I think some people are hoping that within the next couple of quarters you'll raise that outlook is kind of what I'm getting at.

Speaker 2

Yes, Ken, thanks. The way we're looking at it is we feel really good about the progress that we've made, particularly on the operations side. And at the same time, we're very mindful that we operate in a fairly volatile environment. So what we'd like to see is we'd like to see us deliver the full year at the rates that would be embedded in our 2027 targets. And we get to that point, we'll take a look at it and say what makes sense going forward.

Speaker 2

But we'd like to see the see us deliver the full year in a consistent way and ways that could support those 2027 targets. And that particularly is on the operations side. On the net sales side, we feel really good about where we are. We're as we said in the comments, we're trying to drive our growth to live within the capacity limits and plan capacity. We plan capacity out 18 months to 24 months.

Speaker 2

So you should expect us to be very, very close to the guidepost as we go from here through 2027 and expect that on a long term basis that it's going to our growth rate is going to be driven by our ability to add capacity and the rate at which we want to add capacity.

Speaker 4

Thank you. And then a follow-up, Billy, you haven't really talked, I think, in specifics about where your capacity will be next year in a little while and where you expect sales to exactly be, although I think people still expect kind of a 25% increase there. Can you just give us a little bit of an update perhaps on the path ahead for the next year or 2 as you see it in terms of capacity versus confuses investors a little bit, and there's not much confusing about the story right now given how well everything is going, is just try to kind of think about those pads ahead in terms of capacity versus expected sales and how they may track each other in general?

Speaker 2

Yes. Historically, we've talked about it in the context of total capacity, but we're at the point now where it really is driven by capacity for bags versus capacity for rolls. So for example, this year, the capacity limitation that we've had to work with has been on our rolls lines. And as we're starting up another rolls line in Ennis in this quarter, we had to keep our total business or total net sales underneath the limit that that rolls capacity implied. As soon as that line is up and running, we flip it over and then the next capacity limit that we'll run into probably in the first half of next year is bags.

Speaker 2

And so we have new bags lines coming on in the Q1 of next year. And so I don't think of it in terms of total capacity. I tend to think of it in terms of the limitations that we have on bags or rolls and we kind of flip flop back and forth between the 2, but in a very steady cadence. And if we keep adding capacity at the steady rate that we planned, we keep improving capacity utilization on the existing line and operate really well, we feel very comfortable about our ability to deliver the net sales growth that's embedded. I think people who look for us to go way above that are missing the fact that we're trying to stay very disciplined and very close to the guidepost that our capacity provide.

Speaker 2

That's really where we're focused.

Speaker 3

But Ken, just to be clear, we had next month the new line coming up in Annis. We have a line a bag line coming up at our Kitchen South facility in Q1. We're also going to add some shifts to some existing lines in Kitchen South and then we're anticipating better performance and a ramp up in Ennis across the entire facility. So we feel very good about the amount of capacity we will have for next year. But as Billy pointed out, we're not going to get too far ahead of our skis.

Speaker 3

We're trying to manage cash flow, capacity, earnings, top line all together and that's the trick. But we literally review this every month and we have a clear strategy and path to get to our $1,800,000,000 in $27,000,000

Speaker 4

Thank you very much.

Operator

Our next question is from Bill Chappell with Truist Securities. Please proceed.

Speaker 5

Thanks. Good morning.

Speaker 2

Good morning.

Speaker 6

Hey, just want to follow-up on

Speaker 7

your kind of comment about the consumer buying more bulk or larger sizes. And trying to understand, we hear so many mixed signals over the past 3 months of what the consumer is doing. Are you seeing a real change? Or is that more reflective of just your recent expansion in the club channel with naturally they're buying much bigger bolt?

Speaker 2

Clearly, there's some piece of that in it, but we do see it across the board that there is a migration towards the slight migration towards the larger sizes. The way I think about it, if you're taking a step back on the macro market, if you have consumers who are value seeking and you are in the staples business, meaning consumers want to buy your product in every day, they need to keep it in their pantry or in inventory, you should expect to see them migrate to larger sizes because that's the way they exercise value seeking behavior. If on the other hand, you're in the impulse purchase business, you should expect to see consumers moving to smaller sizes as a driver. But in our business, we view ourselves as a staple. We're part of the everyday diet of the dog.

Speaker 2

And so we see consumers moving up into larger sizes. It's not a huge shift, but it is enough of a shift that is noticeable.

Speaker 7

Got it. And then just bigger picture, so we hear a lot of noise from the direct to consumer new players in the market, mainly it's frozen direct to consumer. And frozen has been fairly stagnant category since even before you started to exist. And so I'm just trying to understand, are you seeing anything new? Is it a threat?

Speaker 7

Is it an opportunity? Just as you look at the other players that are certainly making more noise from the advertising front, I'm not sure if on the sales front if they're having much impact.

Speaker 5

Hey, Bill. So look, we're always keeping a really close eye on everything that's going on in the market and kind of where the new entrants are coming in, how it's playing. We're testing basically different types of direct to consumer in 3 and 4 different ways. We think it's really interesting. We love our model and long term we really feel positive about the way our model is developing and progressing.

Speaker 8

Okay. Thanks so much.

Speaker 2

Thanks.

Operator

Our next question is from Robert Moskow with TD Cowen. Please proceed.

Speaker 9

Hi. Thank you. Bill, you might have kind of answered this question already, but I wanted to fast forward beyond 2027. I mean, if your growth rates continue at a rapid pace, what's the implication for capital deployment and therefore cash flow? Could you foresee like having to take a step backward on your cash flow momentum in order to fund another tranche of significant growth?

Speaker 9

What's the appetite for that? And then secondly, I had a question about the buying rate in the numerator data. It looks like last year got restated. It's not by a lot, but compared to Q1, it's down a little. And then your buy rate growth this year is 3%.

Speaker 9

I think last quarter it was 5%. So small numbers, but I want to know if you're watching that and if you have any reason for those changes.

Speaker 2

Yes. Rob, we do on the first question, we do look at the capacity planning out through in fact we go out to 2,030 and beyond and we pay very close attention to it. We have construction and line installation projects going on right now on all three of the campuses that we operate and we're very comfortable that we have adequate capacity to meet the demand that we can reasonably project through 2027 beyond on those sites. The thing that we've been spending a lot of time trying to figure out is at what point does our existing footprint require us to go and add a new site, which would be a fairly sizable capital expense. And at this point, we don't see that happening inside of the 2027 window and probably out to the 2,030 window where we would not require it because we can get enough capacity through technology improvements and adding lines to the existing sites.

Speaker 2

So we feel very good about it And as a result and Todd can comment on the cash flow that comes from that, but we feel pretty good about the cash generation capability of the business and more than able to meet the needs of the capacity planning expansion we have. Let me just jump to the numerator piece for a second. On the numerator piece, numerator restates the data literally every month. And so they readjust their panel. So you should always expect the numbers to move a little bit.

Speaker 2

And that's why the previous periods will change. What you can also expect is that a year ago we had some pricing that was in the 52 week numbers. This year there's no pricing in the 52 week numbers because we've lapped all that pricing. So you should expect that the buy rate is not benefiting from anything other than consumers migrating to higher value products or their increased purchases of the products. It is not benefiting from pricing.

Speaker 2

We feel really good about the combination of household penetration growth in our buy rate. I mean in fact it's running slightly hot right now versus where we would have expected to be. We feel very, very good about it. You should expect that we will always run-in the call it low 20s on penetration and low single digits on buy rate that will get us our total growth rate. I don't know Todd wanted to give you any more commentary on the cash flow.

Speaker 2

Yes.

Speaker 3

I mean, look, it's a really valid question, Rob. Look, we're very bullish on this business growing nicely over the next several years. Do I think we're going to grow a 25% clip in 2,035? Probably not. It's possible.

Speaker 3

But even under that scenario, we will be generating enormous amounts of EBITDA that will come into fruition and plenty of operating cash flow to cover what could be a lot of CapEx based on those kind of growth in dollars year over year, which is I think where you're getting at. But it also goes to we're spending so much time. We know we have to get better on operating efficiencies at our plants. That's why we spend so much time looking at new technologies to make the ROIC on new capacity better and better as we go in the future. And look, we will need a new facility at some point in time.

Speaker 3

We are not averse. We're looking at every possible scenario, whether it's another greenfield like Ennis. We're very comfortable with working with partners that could minimize the amount of capital out there. But we will manage that cash flow impact very, very closely.

Speaker 9

Thank you.

Operator

Our next question is from Brian Holland with D. A. Davidson. Please proceed.

Speaker 10

Yes, thanks. Good morning. I guess just to start with media spend, which looks like still projecting to grow in line with the top line. I know year on year higher in the second half than it was prior year. Trying to square that with the consumer acquisition costs, which once again down sequentially this quarter, continued progress there back to pre price increase levels.

Speaker 10

I guess maybe there was a part of me that was anticipating sort of a lower revision of media and if that's out there and I missed it, forgive me. But just help me think about the cadence for media as we start to think about 2025 and how quickly we can kind of come in line? That seems to be the one metric that we're still a bit off from what your 2027 target is.

Speaker 5

Hey, Brian. So the thing that's I think really exciting about this is the way we like to think about it, the growth model is really, really well intact. I know you've watched it for many, many years. We focus on it like the number of consumers that are coming in, what it's costing to get us those consumers. It is definitely right within band of exactly what it was this year, a year ago, 3 years ago, 5 years ago and even longer than that.

Speaker 5

So I think one of the things that's really important to communicate is it demonstrates the potential of this idea. It demonstrates the potential of the change that we're making in the category. And the deeper we're getting like further and further we're getting into our TAM, we're not seeing increased costs on our CAC. I mean, and that's extraordinary. And I think that's incredibly unique from what else we're hearing from other people trying to come into kind of fresh and frozen.

Speaker 5

So I think that we feel really terrific about that. If you look at our media spend this year, it was literally constructed to make sure that we stayed within bounds for the growth that we wanted for the year. It is lower. If you look at the overall year, it will be a fairly significant increase in overall media spend, but the front half will be a much lower increase versus year ago. It was about a 16% increase versus year ago.

Speaker 5

In the back, you're going to be see a significant increase, but the back half media is all about making sure that we're in a great spot and setting ourselves up for another terrific year in 2025. And if you ask if you think about talk to people in the company and the work that we're doing now, it's all about what do we need to do over the next 6 months to put ourselves in a terrific position for a 25. And I think we're incredibly fortunate that we have the ability to plan in that way, think that way and kind of put our resources against that.

Speaker 10

Appreciate the color, Scott. And then maybe Todd, just thinking about what's implied in the guidance over the second half of the year. If we set aside the top line, the biggest driver of upside was obviously the gross margin over delivery in the first half. Anything to be mindful of in the second half that would compress the kinds of gross margins we've seen in the first half? Is there any reason they couldn't be mid-forty percent or better mindful that we've had 6 consecutive quarters of sequential gross margin improvement?

Speaker 10

Yes. I mean, look, there's

Speaker 3

a couple of headwinds. We're feeling great about the start of the year. Obviously, we'd like to replicate the gross margin that we had in the first half and the second half, but we're going to do our best to hit those marks. But there are some a couple of expenses that will hit that are legitimate here in the second half. Obviously, the start up of the 4th line antennas that will add cost on very low volume coming out of that new line.

Speaker 3

We are adding some additional shifts at Kitchen South to prep us up for next year's growth and reliance on bag capacity that will add some cost there as well. We did not de load any of our inventory. Obviously, that was a big Q1 benefit of about 100 basis points. No impact in Q2. We could see that happen still in the second half of the year.

Speaker 3

That's still a watch out. But look, we're going to we're obviously feeling great about the start. We are about 90% covered on commodities. We don't see much happening there at this point. But it is the new capacity coming online in the second half that will be a slight headwind.

Speaker 2

Appreciate it. Thank you.

Operator

Our next question is from Mark Astrachan with Stifel. Please proceed.

Speaker 5

Yes, thanks and good morning everybody. I wanted to

Speaker 11

go back to this larger pack size comment and then try to understand it a little bit better. So price mix was flat, but you're selling larger packs in Costco at a higher price point. So how does that factor? And I get that what you're selling has a lower average price per unit, but I suppose what the consumers buying would just be bigger dollar amounts and bigger volumes. And obviously, you have more sales at Costco today than you did 12 months ago.

Speaker 11

So would that be mix accretive in terms of contribution to the top line? That's the first question.

Speaker 5

Hey, Mark. So I think the way to think about this is, if you look across our portfolio, we have we are definitely developing and pushing larger pack sizes as Freshpet becomes more of a main meal feed. The other thing we did, you may remember a year or so ago, we brought a product called Complete Nutrition in a 1.5 pound size. And we also got really sharp before the value was as much of a discussion, we got really sharp on our 1 pound pricing. Like we actually tightened it

Speaker 2

up just a little bit.

Speaker 5

And we did that intentionally because we started hearing a little bit of storm clouds where people were concerned about value. So you have people coming in on one side and buying some of the smaller size items and the complete nutrition, which is a good opening price point, but very solid margins. And you have the other side where we have these larger packs at some of the not only in mass, but also in the clubs etcetera. The things that it's interesting that we're seeing the largest growth in. If you look across our developed items, the things that are growing the fastest are our large bags, which are the most expensive items we have.

Speaker 5

So there's a lot going on. There are a lot of pieces to it. And when we set the strategy forward going into the market, we intentionally want to make sure we cover basically products for as many different people on how they want to use it and how they think about our brands and our products. So there are sizes, there's price points that go from low to high as you know. And I think what we've done is we've done a nice job developing a really good portfolio and consumers appreciate it.

Speaker 5

And there is a lot of action. There's a lot of movement all through that. Some of it's on sizes and some of it's on trade up to the larger sizes, but some of it's a lot of new people are coming in on this 1, £1.5 sizes. We see that that's the single fastest area where people are coming into the business.

Speaker 11

Got it. So it's just a lot of moving parts, I guess, beyond what sort of sort of related to that then, because I had another question, but just as follow-up to that. So is Costco still incremental consumer? I mean is the larger pack size more people just consuming more of the product? Is that the right way to think about this?

Speaker 5

Yes. So we are the interesting thing is we are seeing a lot of new consumers come in through not only club but also even our larger sizes in all retail. I mean, it is interesting. We do see some people go for it and actually you'll start up with a 6 pound roll. So we definitely see that dynamic going on.

Speaker 5

And then what we started to put out these multi packs not only in club, but we're also starting to see these multi packs that are starting to go into regular retail and they're starting to get a little bit of early traction. We knew it was going to be slower, but part of a long term plan to make sure people are using us as a main meal product.

Speaker 2

Mark, one other thing is we said in the comments that if you think about where our fastest growth has been is amongst the Hippo, so the heavier users and then we also mentioned the Ultra users, the people buying over $1,000 a year, they're growing at even faster rate. So we are seeing an increasing number of consumers who are moving up into that higher purchase amounts and oftentimes that comes with buying larger pack size.

Speaker 11

Got it. Okay. That's super helpful. I'll leave it there. Thank you.

Speaker 5

Thanks, Mark.

Operator

Our next question is from Peter Benedict with Baird. Please proceed.

Speaker 8

Good morning guys. Thanks for taking the questions.

Speaker 9

First one is just around, I mean, a

Speaker 8

lot of talk about capacity, what might be needed going forward. You did mention the new production technologies seem to be proving out here, I think you said second half of twenty twenty five, where you might have that fully up and running. Can you kind of remind us what's going on there and kind of what the plan would be to, I guess, retrofit your existing lines with those technologies, just thinking of ways to improve or continue to improve your output without a new facility that type of thing? That's my first question.

Speaker 5

Hey, Peter. I think the way to think about this is there's 3 major pieces to us improving the capacity on our lines. The first one is basically just like OEE improvement and we have a long way to go and a lot of opportunity and the team is doing extraordinary job there. I mean like hats off to the guys and the work that they've done. And they're significant that that will be significant and that will change the cadence that we need to open these lines and it will improve profitability from the existing network.

Speaker 5

Okay. That's the first one. The second one is, I'll call it kind of updating and like minor modifications to the existing lines with some new technology and new equipment. We've been able to start proving that out and we're seeing pretty significant we're not going to share anything at this point, but we're seeing significant progress in that area. We're really we're excited and enthusiastic about the potential that just by making some small improvements and some investments in the lines that the amount of upside there is.

Speaker 5

And the third one is basically I would call it almost it's not an evolution, I would say it's somewhat of a revolution of our bag technology. And it is a kind of more developed future state of where we believe the bag production will be. Now we'll start to see that next year, but it will be very small and the intent is that that will take as we prove that technology out, it will start taking the place as we expand our lines in the future. But at this point, that's really far out and that's not something that like we can get too far into. It's just like we can't predict exactly the future.

Speaker 5

I will say we are confident that that technology will work. The question is exactly when and then the exact impact on kind of our expansion and our capacity across our network.

Speaker 8

Well, fair enough. Thanks, Scott. That's good perspective. And then my follow-up question, look, you guys have made enhancements to the management team over the last couple of years. You're obviously executing very well.

Speaker 8

Billy, you talked about the new corporate headquarters in Bedminster, New Jersey. I think you mentioned marketing and finance as maybe some areas where you'd be looking to attract additional talent. Just wondering if you could expand on that, your thoughts around the organization, who you might or what areas you would be focused on maybe continuing to build as you support the growth in the business? Thank you.

Speaker 2

Yes. Peter, as we're growing,

Speaker 5

obviously, we have growth opportunities and

Speaker 2

needs in behind on adding talent. So you can see us leaning into acquiring behind on adding talent. So you can see us leaning into acquiring the necessary talent in the places that will make a biggest difference and you'll see it in a wide range of areas. And as you've seen in the last 18 months, the amount of talent that we've hired has been fairly significant. I don't want to get into any specific areas other than to just say that you should think about as we add scale to the company, it gives us opportunities to add capability in areas where we may have been a generalist before and we can become a specialist, where we can get higher level capabilities in an area where we've previously been operating, but probably haven't had the sophistication and capability that's needed for a business that's $1,000,000,000 or $2,000,000,000 or $3,000,000,000 in sales.

Speaker 2

So you're going to see us continue to add people to add bench strength to help us grow the company and it's just going to be an ongoing part of our process.

Speaker 5

All

Speaker 8

right. Good to hear. Good luck, guys. Thank you.

Operator

Our next question is from Rupesh Park with Oppenheimer. Please proceed.

Speaker 12

Good morning and thanks for taking my question. So maybe just to start out with the EBITDA cadence, just any more color how you guys are thinking about Q3 versus Q4? And then I have one follow-up.

Speaker 3

Yes. Obviously, don't give specific guidance, but just big picture, we'll have more EBITDA in Q4 than Q3 just because of the amount of media spending. We'll see a similar as we pushed media from the first half to the second half this year, You'll see a similar amount of media spend in Q3 as you did in Q2. That's unusual for us. But then there will be a drop off in Q4.

Speaker 3

So a very sizable increase versus prior year, but there will be a drop off and that will allow additional EBITDA in Q4. Great.

Speaker 12

And then one follow-up question just on the category. So one of your retail customers highlighted they're seeing green shoots in the pet category on the pet adoption side. Just curious what you guys are seeing right now from a pet adoption perspective?

Speaker 5

Rupesh, I think the way to think about this is, I mean the category always goes through ebbs and flows and there is definitely a little bit of a post COVID trough. We think it's going to come back to much more normalized rate. But I think that there's look, if you look at the category, there are tons of headwinds going on. And I think when you're kind of dealing in single like light single digits, you're going to kind of really focus on some of those either headwinds or tailwinds. We've been very fortunate that we haven't had to really focus on those trends and that we're winning within.

Speaker 5

If you're I'd say almost any retailer, you're kind of looking across the category and you're looking across segments and then you're kind of looking across brands and we have really been like the absolute clear winner and it creates even more opportunity for us into the future to work with them and develop the business. So I know your question was specific around adoption rates. I would say, look, when we're looking at this stuff on quarterly and 6 months basis and things are ebbing and flowing, yes, it's off a little bit. I mean, look, this has been a significant trend, a large societal trend where people are treating pets more like people and people are having less kids and more pets. And they're becoming an important part of our lives and we think that that's going to continue over the long term.

Speaker 12

Great. Thank you for the color.

Operator

Our next question is from Bryan Spillane with Bank of America. Please proceed.

Speaker 13

Thanks, operator. Good morning, guys. Just one question for me. I think you started this year or went into this year with a plan to be more measured, I guess, right, in terms of growth and not wanting to overheat your manufacturing network. And so I guess is just curious this year, right, given how good the demand has been, if you had if capacity

Speaker 11

was not a question, right, if you could make as much

Speaker 13

more interest there more interest from retailers and consumers than maybe what we're seeing in the results?

Speaker 2

I would say if we would spend at the sort of comparable growth rate on media to what we had last year, in other words, grow media in the first half at the same rate of sales growth, you would have seen more demand. But we knew we couldn't supply that. And for us it's really, really important to keep the growth within the capacity limit and also to execute our capacity expansion plan in a very measured and orderly fashion. And we feel good about it. Our team has gotten really good at designing, constructing and starting up lines.

Speaker 2

We want to do that reliably. We want to provide very high level of customer service because we know we provide high level of customer service. Our costs are lower. Our fridges are full, the sales are better, customers are happy, consumers are happy. So I think for us it's really important that we measure or manage the growth to live within the capacity.

Speaker 2

We add the

Speaker 5

Thanks.

Speaker 2

Thanks.

Operator

Our next question is from Michael Lavery with Piper Sandler. Please proceed.

Speaker 12

Thank you. Good morning.

Speaker 5

Good morning.

Speaker 14

You talked about adding shifts at Kitching South. I guess maybe 2 part question. How is the relationship with Kitchen South like if there's better overhead absorption or efficiencies from that kind of at least in an operating leverage way, do you benefit from that on the cost? And then guess the other part of it is do you have opportunities on any of your own lines to add ships as well or at least produce changeovers and maybe do extended runs? How should we think about that as part of an opportunity for you?

Speaker 3

Sure. The Kitchen South relationship is terrific. They're performing exceptionally well. We could not be more pleased with performance coming out of that operation. They've been terrific this year.

Speaker 3

There is a little bit of leverage as we add some shifts there. It's not dramatic. Just the way the arrangement is set up, we do get a little bit of leverage. So we'll continue to lean in there, just not on shifts. But as I mentioned earlier, we have another line coming in Q1 and then we have room for a few more lines if both partners choose to go that route in that facility as well.

Speaker 3

So we look forward to many more years of great performance and additional capacity coming out of that facility.

Speaker 14

And is there room to add, extend runs or add shifts on any lines at Ennis or Bethlehem?

Speaker 3

Bethlehem is pretty tight at this point. Ennis, yes, there is room and we will not we'll add more shifts, we'll get the efficiencies in the Ennis facility ramped up over the next year or 2. So there is some capacity there.

Speaker 2

Michael, think about it as our operating model is that when we install a line, we ramp it up by putting on one shift or in essence half capacity utilization for a period of time. And then as the demand grows and the production efficiency on that line grows, we ultimately take it to a 20 fourseven operation. And that happens typically before you bring on the next line. So at the same time we're doing all that, we are working as we increase the number of lines in our system to make some

Speaker 5

of those

Speaker 2

lines more specific or specialized and it reduces the number of changeovers that we have to do and allows us to deliver higher throughput or higher output per hour of operation and also extend some of our runs depending on what some of the products are and where they're being produced. So there are significant benefits that we gain in each of our operations as we gain scale.

Speaker 14

Okay. That's helpful. And just a follow-up. You mentioned in the prepared remarks, the Dallas DC, I think the way you phrased it was it's expanded its coverage area. I guess I hadn't realized it maybe wasn't stripping all of what it could or was meant to.

Speaker 14

Is that now optimized or is there room for even more could it expand further to get to a more optimal service area?

Speaker 2

Right now, the Dallas DC exists to take the product that's produced in Ennis and ship it to the states that it can serve. So as we add production in Ennis, the Dallas DC is able to supply more states. So for example, we're right now in the process of converting the states of like Utah and Colorado over to being shipped out of the Dallas DC. Ultimately, when Ennis is up and running to its full ten lines of production, the Ennis or the Dallas DC should be supplying more than half of the United States. Think of it as everything west of the Mississippi and probably parts of the Southeast.

Speaker 2

So we will continue to get freight efficiencies from the Dallas DC, but they're 100% connected or linked to increasing the amount of output from the NS facility. Okay. That's helpful. Thank you. Thanks.

Operator

Our next question is from John Anderson with William Blair. Please proceed.

Speaker 15

Good morning, everybody. Thanks for the question. I just have one. I wanted to come back to an earlier comment on distribution. I think, Bill, you mentioned that we should expect to see PDP growth exceeding ACV growth moving forward.

Speaker 15

I guess, my question is, are you now seeing that your the brand is represented in the stores that you need to be in from a coverage perspective? And at the same time, are you seeing more of your large accounts, particularly in FDM proactively moving to add second and third fridges? I'm just trying to understand of little bit more context around that comment. Thank you.

Speaker 5

Hey, John. So I made a brief mention of it before, but I think as retailers are looking and they're starting to think about like their growth in the category not only this year, but next year, I think they are clearly recognizing that Freshpet is delivering on not only our growth, but now we actually have nice scale behind it.

Speaker 2

I mean, if you look at

Speaker 5

the last 26 weeks and measured, we've added $100,000,000 in growth to the category, which is by far the leader of any of the I think any brand by far, which is really exciting. So now they start looking forward and thinking about next year, what do you do? We know we need to tighten the mix of the products that we have in existing fridges, but we're also having, I would say, really productive conversations about second fridges and expanding distribution not only in stores we're not in, but also in second fridges and even some cases where it's 3rd fridges. So I think that's what we'll see going forward. There's also a couple very few scenarios where there's some retailer or so that has bought some of their own bridges and we may be going into some of that space over time too.

Speaker 15

Okay. If I could squeeze one more in. On the media front, can you talk a little bit about how not the level of spend, but maybe how you're changing or evolving the type of media that you're aiming and using and the messaging and is it working? Because I think you've taken some different approaches over the past 12 months or 18 months maybe than you have in the past, but an update on that

Speaker 5

would be helpful. Thank you. Yes. Hey, so I think the let me start with like great work by the marketing team and overall across the entire marketing team. And the work has been done not only on creative, but also packaging.

Speaker 5

It's not dog food, it's been a tremendous campaign for us. It's producing incredibly well. We're seeing great performance from the creative. We're seeing also great performance from the buying and how we're planning our media and we continue to expand opportunities to place it in different spots that are like actually on the face more expensive, but the productivity has been so strong that's where we can deliver on that really consistent CAC range that we're talking about earlier. So we're seeing visits to the site up, we're seeing conversions up.

Speaker 5

Every metric that we track is performing really, really well and it really goes back to the work that the team has done across both the creative and also the media buying. So yes, we continue to kind of expand out different targets. We've also recognized that we've pushed into sports. You're seeing us kind of push into sports a little bit more. Every one of those has worked really well.

Speaker 5

And the way we typically think about it is we want to test now and then we really want to see the productivity of that and then we want to buy that in the future. So the next quarter or next year is when we're getting into a bigger buy on that. So we're constantly in that mode.

Speaker 2

Thank you.

Operator

Our next question is from Tom Palmer with Citi. Please proceed.

Speaker 6

Good morning and thanks for the question. Wanted to first just follow-up on the fridge count discussion. As we look at the next couple of years, it sounds like you have kind of some visibility both for maybe new stores and adding these 2nd units. Which one becomes the bigger driver here over the next couple of years?

Speaker 5

Yes. The clear driver longer term is going to be second fridges. If you it's actually an interesting point, but if you look at the productivity that we get out of the first four feet now, we are one of the most productive 4 feet in the pet food aisle. And when you can demonstrate that and have category leading margins that's really great cocktail for expansion into a second fridge. And we get into 2nd fridge, the number we typically quote is within 6 months.

Speaker 5

It's running about 60% of the first fridge. It's really productive for us. The capital investment is great. The sales is great. And then once that levels off, now you have an ongoing annuity that typically will increase on a double digit sales growth into the next year years going forward.

Speaker 5

So the retailers that move with us earlier are seeing a compounding effect on the growth that they're seeing on Freshpet.

Speaker 8

Okay. Thanks for that.

Speaker 6

And then on this year's sales guidance, you did note the new line in Ennis this quarter, but also opening this quarter, but then also the continued ramp in prior lines and the added shifts. I guess just thinking about this year's growth, how reliant if at all is that new Ennis line to hitting your guidance that we just updated today?

Speaker 2

I mean, we've in order to continue to support the growth that we already have, we need that Rolls line in Ennis to come online. We're very confident that it's going to come online. The qualification is going very, very well. But if for some reason that didn't happen, we would be very short on rolls for the balance of the year. We're very comfortable with our bags production capacity right now and our ability to meet the bags demand for the balance of the year.

Speaker 2

Bags becomes an issue at our current rate of growth as we head into the Q1 next year, which is why we're bringing on new shifts and new lines at Kitchen South later this year and then the new line actually starts up in the Q1 of next year. So we are constantly in a position where we're growing into the existing capacity.

Speaker 5

We need to bring on a line

Speaker 2

in a reliable fashion on time. It's a really nice cadence that we're developing, but we've got to execute well.

Speaker 5

Okay. Thank you.

Operator

Our next question is from Mark Torrent with Wells Fargo. Please proceed.

Speaker 6

Good morning. Thank you for the questions. Just one for me. Non track channels continue to grow over 100%. How much of total does this represent now?

Speaker 6

What area is here most incremental? And any other new distribution white space starting to gain traction for you guys? Thanks.

Speaker 5

Hey, good morning. So yes, we are seeing really nice growth in some of the untracked channels. And it's a lot of it is work that's been going on for multiple years that's now coming to fruition. You're going to see longer term continued growth there and we're hoping to see like really great performance from both Canada and the U. K.

Speaker 5

Next year albeit small. We think there are tremendous opportunities to continue to expand there also. And then the other thing that we have a tremendous opportunity in, we are and you may have heard us talk about this in the past, but from a kind of a digital standpoint where someone could sit down at a computer and buy us, we are very, very underdeveloped. Approximately 8%, 9% of our sales are through some type of digital and that includes click and pick etcetera. We think that the opportunity there is tremendous and we would like to see really leading growth in that area over the next kind of 12 to 18 months.

Speaker 5

There's a lot of our focus is there. We're just not as developed as many brands in digital or in e commerce in any way.

Speaker 3

Mark, just one call out. Obviously, that non measured growth has been tremendous in the first half of the year, added about 5 points in Q1, 4 points in Q2. As we start to lap some of the store growth that we got last year in the second half, we anticipate that growth will probably only add about 2 points in the second half of the year, still tremendous growth. And as Scott pointed out, we're seeing some really nice gains here in the econ world, which we think is going to really flow into 'twenty five as well. But that growth on non measured will still be really, really strong, don't get me wrong, but it will slow in the second half.

Operator

We have reached the end of our question and answer session. I would like to turn the call back over to management for closing remarks.

Speaker 2

Thank you. Thanks everyone for your interest. I'll leave you with one thought. Dogs teach us a very important lesson in life. The mailman is not to be trusted.

Speaker 2

That's from Sean Ford. To which I would add, but if the mailman carries fresh pet turkey bacon treats, it will be most loved and anticipated visitor you could have. Thank you very much for your interest.

Operator

This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.

Remove Ads
Powered by Quartr
Earnings Conference Call
Freshpet Q2 2024
00:00 / 00:00
Remove Ads