Freshpet Inc (FRPT) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Freshpet, Inc. second-quarter 2016 earnings conference call. (Operator Instructions) As a reminder, this conference call may be recorded.

I would like to turn the conference over to Katie Turner. You may begin.

Thank you. Good afternoon and welcome to Freshpet's second-quarter 2016 earnings conference call and webcast. On today's call are Scott Morris, President and Chief Operating Officer, and Dick Kassar, Chief Financial Officer.

Before we begin, please remember that during the course of this call management may make forward-looking statements within the meaning of the federal securities laws. 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.

Please refer to the Company's quarterly report on Form 10-Q expected to be filed with the Securities and Exchange Commission and the Company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

Finally, please note that on today's call management will refer to certain non-GAAP financial measures, such as EBITDA, adjusted SG&A, and adjusted EBITDA. 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 a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP.

Now I would like to turn the call over to Scott Morris, President and Chief Operating Officer.

Thank you, Katie, and good afternoon, everyone. I am pleased to speak with you today about our progress. On today's call I will start with a brief overview of our financial highlights and recent business performance. Then Dick will review our second-quarter 2016 financial results in more detail. Finally, Dick and I will be available for questions.

Our team continued to execute very well against our 2016 plan and we are pleased with our progress to date. We strive every day to provide pet parents healthy, natural foods that their dogs love and that have a positive impact on their pets' lives.

In the second quarter we continued to improve on key metrics, both on sequential quarter-over-quarter basis and compared to Q2 last year. These include: net sales, velocity, store growth in both new and existing accounts, quality, production throughput, and logistics. We are also beginning to see growth rates improve versus year ago in both IRI and POS.

Focusing on our results in a little bit more detail now, net sales increased 16.4% to $33 million, driven by increased velocity per fridge and increased store count. Freshpet fridge store count increased 10% to 15,795 as of June 30, 2016, up from 14,354 in the second quarter of the prior year.

We also have several significant milestones which we would like to make note of. First, our Freshpet Kitchens expansion remains on plan, and beginning in June, we have started to manufacture initial runs of product which are just coming to market. Secondarily, we will surpass 16,000 stores with Freshpet fridges in the next month. These are two significant achievements that the Freshpet team has facilitated through an outstanding level of dedication and determination and we appreciate everyone's contributions.

The first milestone provides us with the ability to further expand sales at a rapid pace and capitalize on future opportunities and the second provides us a greater incremental scale and efficiencies across multiple fronts. We also remain optimistic about the attractive white space opportunity of over 15,000 stores across North America.

As our business continues to make good, steady progress, both operationally and financially, the Freshpet team has done outstanding work to position the Company for ongoing growth and success. Let me review a few of our key initiatives.

As we execute our mission to bring the power of fresh, natural, and healthy foods to pets, we have begun to see the positive impact of our work. And it has been witnessed by many pet parents. We knew the foods that we developed were excellent, but we have had no idea the positive impact they would have on pets' lives.

Each day we hear about the amazing results consumers are seeing in their pets like having more energy, healthier skin and coats, and eliminating digestive issues. We are extremely proud of the products, but are truly humbled by the results that pet parents continue to experience.

What is important about this it first facilitates great consumer loyalty and, secondarily, we are beginning to share these results in amazing stories across all of our communication touch points including TV and digital. We believe this will have a transformative effect on our business over time. You can see thousands of these amazing stories posted on our website on pet parents.

Next, coupled with our improved communication platform, product innovation continued in the quarter with several new products and product capabilities that are currently building distribution across our retail landscape. Many of these new products began shipping in Q2 and will continue to build out into Q3. These include a new dog shredded product, expanding one of our top-selling forms; dog cups; and several cat items that build out our cat portfolio.

We remain highly focused on our fresh food platform and the broad opportunities it provides us for growth through the development of an improved dog portfolio and the start of a more robust cat portfolio. We continue to closely monitor our baked product sales, which have started to level off with distribution gains, along with some losses as expected.

Next on the distribution front, we are making steady progress in expansion across all classes of trade in North America and currently have a small test with one major retailer in the UK. In the second half of 2016 in the UK we anticipate measured door expansion with one retailer and the addition of a second retailer that we'll begin testing.

Our Freshpet Kitchens continues to make outstanding, quality products as measured by our consumer experience monitor. We are pleased to report that our plant expansion remains on schedule and on budget. We have completed the installation of our new bag line and have been making salable product for the last six weeks.

Next, our roll line is on schedule and will be completed this month. It is important to keep in mind that it will take several quarters for us to ramp up capacity, line utilization, and train the new personnel on these lines. Overall, the team has done an extraordinary job to bring this vision to life and more than doubled the capacity of the only Freshpet food facility in North America.

Now that our expansion is nearly complete, our annualized capital needs will be reduced significantly over the next several years. Going forward, we will be focused primarily on the support of fridge growth and maintenance CapEx.

The execution of our strategic initiatives has enabled us to generate increased adjusted EBITDA and positive operating cash flow during the past seven quarters, while growing net sales and store count at a double-digit rate. We expect the team's efforts to drive greater leverage across our business model and improve profitability as we progress through 2016.

Before I turn the call over to Dick, I would like to take a moment to welcome Billy Cyr to the Freshpet team as CEO. He will officially start with us on September 6, 2016.

I have personally had the opportunity to spend time with Billy, both before he was hired and since. I know he is a leader whose entrepreneurial spirit fits well with our strong culture of growth. He joins us as an accomplished consumer packaged goods executive with strong experience and a passion around our mission. I welcome his future leadership, expertise, and partnership as we continue to realize the potential of Freshpet.

With that overview, I would like to turn the call over to our CFO, Dick Kassar, to review our financial results in more detail.

Thank you, Scott, and good afternoon, everyone. I will now review our second-quarter 2016 financial results.

For the second quarter, net sales increased 16.4% to $33 million. This growth resulted from both distribution and velocity gains, including a 10% year-over-year increase in Freshpet fridges. Gross profit for the quarter was $14.9 million, compared to $13.7 million during the same period last year. Gross margin was 45.2% for the second quarter of 2016, compared to 48.2% in the second quarter last year. Planned startup costs for the hiring and training of our new associates lowered our gross margin for the period by approximately 130 basis points. The remainder of the decline was due to product mix and new product introductions.

For the full year, we continue to expect gross margin of approximately 46%, which will include additional depreciation and personnel required for our plant expansion, along with incremental costs for our product launches, including cat and Vital whole Blends. The 2016 margin projection captures the $1.5 million startup costs of ramping up the new production lines at our Freshpet kitchens prior to realizing higher production volumes, along with additional $1.2 million of depreciation on the new equipment.

After adjusting for stock-based compensation and leadership transition expenses, SG&A expense decreased as a percentage of net sales to 44.4% from 47.3% in the same quarter last year. Looking ahead, we expect to decrease SG&A as a percentage of net sales as we increasingly scale our operations and better utilize our existing infrastructure while growing net sales. Adjusted EBITDA was $3.5 million for the second quarter compared to $2.8 million in the second quarter of 2015.

Turning now to the balance sheet. At June 30, 2016, the Company generated cash of $3.4 million from operations compared to $2.1 million during the same period in 2015. As compared to December 31, 2105, our cash and cash equivalents decreased to $1.7 million, primarily due to expenditures related to the expansion of our Freshpet Kitchens and capital investments to increase distribution through the purchase of additional Freshpet fridges.

As you may recall, we are expanding our plant capacity to provide for sales of up to $400 million, which represent an increase of 130% from historical capacity levels. Part of our 2016 plan previously communicated was to borrow approximately $8 million to $10 million from our credit facility by the third quarter of 2016. At June 30, 2016, we have borrowed $8 million from our credit facility and we expect to repay this indebtedness by the first half of 2017.

As you may know, in conjunction with our initial public offering, we entered into a $40 million credit facility. Each quarter in 2015 we generated positive cash flow from operations and the first two quarters of 2016 this trend continued.

Finally, we are reiterating our guidance for 2016. We expect Freshpet Fridges of over 16,600, an increase of approximately 10%; net sales of over $137 million, an increase of approximately 18%; adjusted EBITDA of $18.5 million, an increase of approximately 67%.

I would like to note that we are not providing guidance on GAAP net income or GAAP EPS and only on non-GAAP adjusted EBITDA because we have not yet finalized our calculations of several factors necessary to provide the corresponding GAAP measures as discussed in our earnings release.

From a seasonality perspective, we continue to expect our net sales growth to be more weighted to the second half of the year as we realize full benefit of our distribution, media, and new products. We continue to expect adjusted EBITDA to more heavily weight to the fourth quarter as our expenditures lightened considerably due to the timing of our planned media program.

As a reminder, our adjusted EBITDA represents EBITDA plus loss on disposal equipment, new plans startup expenses, share-based compensation, launch expenses, leadership transition expenses, and warrant expense. We see strong growth for our products across our distribution network and we will continue to maintain a strong balance sheet and liquidity to meet demand and further grow our distribution network.

That concludes our financial overview. Scott and I are now available to take your questions. Operator?

(Operator Instructions) Rupesh Parikh, Oppenheimer.

Thanks for taking my question. I just wanted to start with the housekeeping question first. On the gross margin guidance for this year, I'm not sure if I heard it properly or not. Is it -- last quarter I believe it was 46.7% for the full year. Is that still the expectation for gross margin for this year?

No, we're expecting approximately 46% for the year based on new products that we brought into the marketplace more recently in the second and third quarter.

Okay, great. Then maybe a question for Scott. If you can maybe provide more color in terms of the type of velocity trends you are seeing in the different channels, pet specialty and some of your other channels as well.

Sure. As we have seen historically, mass continues to kind of percolate along well and really be a leader. What we are seeing that is a little bit of a transition is where pet -- the pet retailers are not performing quite as well in general, so we are seeing a little bit more softness there. And some of that actually being picked up in grocery and what I would call maybe alternative formats, that including natural and club and a handful of others.

Then, obviously, the online piece is something that everyone is very, very aware of and is closely tracking. Just a couple of percent of growth on the online piece is where it can cause some significant softness. We think that's probably most impacting the pet class of trade.

Okay, great. Thank you for all the color.

Joe Edelstein, Stephens.

Scott, I know that the new CEO was just only announced last week and Billy isn't going to be joining, as you said, really till after Labor Day. Since you have spent some time with him, can you just talk a little bit more in depth around what you think he's going to bring to the table? What areas of the business that you may have already discussed and if there's any big opportunities that may have already been outlined at this point?

I think Billy obviously has -- he has been a CEO for many years and he has some very methodical approaches to building out an organization. If you look at where the Freshpet organization is, we have made incredible progress, but in some ways we still -- we're in our adolescence in a way. And I think Billy can help us attain what really the future potential is of the organization.

He has been a CEO of a $500 million company for many years. We think that he has a lot of strength and very, very heavy from an analytical standpoint. He is classically trained in marketing and sales. I think he can contribute there.

And the reality is we really have a long path in front of us and so much opportunity in front of us that I believe that Billy can help us capitalize on that. And, again, realize what the potential of this organization is and what we've built here.

He definitely has -- his entire mentality is really very entrepreneurial. He has a great spirit. He really believes in the mission and what we've built here as an organization.

The way we are looking at it, too -- again, I haven't spent a lot of time with him, but when I have we like to think of it as when you've got a great team everybody on the team brings some different assets. And we really feel like Billy will contribute and bring some really strong assets to the team to help us build everything out here.

I appreciate that, Scott. You did mention the marketing efforts, even during some of your prepared remarks. Our latest survey that we have done has still shown some pretty low brand awareness. And I realize a lot of the marketing is going to be second-half weighted here.

I was hoping you could just remind us, just on the total spent that you are allocating into the second half and what specific products are really going to get that marketing support. Then lastly, just curious if you are seeing any meaningful competition from look-alike products at this point.

From an awareness standpoint, we track awareness primarily on an annual basis and every year for the past several years we have seen significant progress on building our awareness. Now we use aided brand awareness in what we are tracking. I'm not sure if you use aided or unaided. I can't speak necessarily to your study, but I can speak to what we've done.

We have seen nice progress. We typically see that progress behind two major components of our growth. One of them is chiller placement. So the more chillers we have out there, the more visible we are and the higher our awareness.

Then secondarily, on advertising. We see very, very strong correlation from our advertising that correlates not only into sales, but it also -- we do know that it helps build our awareness over time. So we're making good progress.

Our spend levels and our share of voice are significantly lower than what you are going to see across many of the big brands in the category. As we continue to progress and as we grow, we continue to invest in advertising and see steady progress. As you are well aware, this year we had to be very measured in our approach to investing behind communications because of our capacity constraints in the kitchens.

Now, in future years, we may reassess the allocation and rethink on how we are doing some of the communications and then you will see more progress from an awareness build standpoint. So that is how we look at it. We have made, again, really nice progress on aided awareness, but we do have a small share of voice.

From a competitive standpoint, which was the second part of your question, there is a fair amount of competition out there. We are seeing a lot of activity from an innovation standpoint: more innovation coming to market, more differentiation coming to market. The thing that is -- obviously, we are so unique in the category and so differentiated that although there is competition, we tend to not get caught in the fray on the competitive activity that's going on.

Fortunately, we haven't seen a lot of pricing activity which could potentially have an impact on us. Most of it has been around innovation. There's a little bit of pricing, a lot of advertising and investment in the category, but it really doesn't have as much of an impact on us. It could impact, over time, store growth, but from a day-to-day velocity standpoint, we feel like we are executing well on our plan. And that's really how the year has been developing.

I appreciate that again. If I could just ask one more, maybe a question for Dick. You did talk to the kitchen expansion and it sounds like that's largely on track and largely done with really the bulk of the CapEx spend.

I was hoping you could just remind us what the actual expected CapEx would be for this year and if you could give us even just a ballpark range as to where it drops down to into the out years from here. Thank you.

Sure. First of all, in 2016 we obviously finished our phase two of the expansion of the plant. In addition to that, we were adding about 1,600, 1,700 stores and that CapEx for the year is around $26 million, $27 million.

In addition to that, we have about -- within that $27 million we have about $2.5 million left on our current plan expansions. Going forward, we expect about $2.5 million of maintenance CapEx on our current facility and about $3,500 per additional store added. So in a year then we would add -- in 2017, we haven't focused on it or finalized our plans yet, but if we're in the 1,700 to 2,000 store range it would be somewhere around $7 million for fridge acquisition.

Okay, thanks and good luck.

Bill Chappell, SunTrust.

Thanks, good morning or, sorry, good afternoon. It's that kind of day. Just any update -- maybe I missed it -- on dry and kind of where that's going. And then also on the -- I'm trying to understand on the new product launches what kind of permanent impact they have on gross margin in terms of how long of a drag will they be?

Bill, it's Scott. On the dry front on baked, so it's not unexpected. We are seeing -- we are continuing to see gains and we have saw some distribution losses. Net-net from a store count standpoint, baked is going to end up being fairly neutral from a distribution perspective.

We are seeing some modest dollar growth in places, but as we mentioned in the beginning of the year, we wanted to spend this year really retrenching on fresh, making sure that we got our growth rates really accelerated again on fresh. We are starting to see that develop; we like that. And then kind of refocus on what the opportunities are from a baked standpoint.

So we feel baked will be a contributor for this year and we're making some progress, but it definitely has not been a key focal point for the organization this year. Does that get you (multiple speakers)?

Yes, definitely. Then in terms of the margin compression from those and -- well, other new products launched?

The back half of 2015 our margin was about 45.6%. In the first half of 2017 (sic) we are at 46.2%. Included in the 46.2% we charged-off around $670,000 for planned startup expense. So outside of the planned startup expense, which is basically training our employees on their new lines, our margin would have been 47.3% in the first half of 2016.

Additionally, we have some CapEx that we are spending in the back half of this year for products that are currently co-packed that we'll be bringing on our equipment, which should add about 70 to 80 basis points, to take us to approximately 48%. And then the other side of that, Bill, we are going to have depreciation on this equipment as we go forward for the new plant expansion of about $200,000 a month.

We haven't done new 2017, but I know, based on our capacity early on in 2017, we will never have a full line running 10 hours a day on one of our new lines, because we just don't have the business at this point in time. But we are prepared for the growth.

We obviously -- we started we had two lines, a chub line and a bag line. We are currently running the bag line several hours a day, the second bag line. The chub line will probably start running in the back half of this year, but neither one will be taking a whole shift because we just don't have the volume at this point in time.

But when you are looking out long term, come late 2017 or early 2018, you will start to bounce off those barriers of 47%, 48% and move forward.

Okay. And then kind of the same question on SG&A. You are talking about continuing to see some pretty good leverage in the back half. How should we look at the drivers of that and where should that be going?

Sure. In SG&A, year-to-date we were $34.4 million and included in that was $2.2 million of leadership expenses. SG&A has some variable costs associated. In SG&A we have logistics which, as you know, we changed providers and we are seeing a nice reduction in logistics costs, but it is variable with revenues.

We also have brokerage expense which is variable with revenues. In addition to brokerage expense, we have chiller expenses, which is kind of -- moves in the same relationship as additional chillers hitting the fields.

So not all SG&A is fixed, but a predominant amount is fixed. And if you look at each quarterly release, you will see a lower and lower percentage of adjusted SG&A to revenues as a percentage of revenue. We expect that to continue to come down, but the variable pieces, which represent about 16% or 17% of sales, they will continue to grow. And the balance of SG&A, as a ratio to sales, will continue to decline.

Okay. Then last one on store count, just your goal of -- I was under the impression that most of the stores are added in the first half of the year; kind of your line of sight to getting to the full-year goal in the back half.

We have been executing right on how we have budgeted the year. We actually see pretty strong growth in Q3 and actually last year we had really strong store growth, even in the Q4 period. So we do anticipate like continued store growth through Q3 and Q4.

Typically the way we talk about it is we have about 60% of the total number about six months out. So if you look at it, we can kind of start to see the vast majority of it towards the back of the year and that's where it's coming from. There is obviously always variables in there, but we are tracking on pace.

Okay, great. Thanks so much.

Peter Benedict, Robert W. Baird.

It's actually Justin Kleber on for Pete. Thanks for taking the questions. Wanted to start by asking on gross margin as well, particularly the sales mix pressure you are seeing. Is that primarily related to the shredded product?

No, it's really related to kind of all our new products coming out. We have a cat product coming out. We had a single-serve dog product hit the marketplace. Our shredded is moving in the right direction, as we indicated in the prior year.

Our production on shredded on a per-hour basis is up nicely from the prior year. And as you know, we just launched our large-size shredded in June to some retailers and the balance of the year they will be going to a good percentage of the marketplace.

Then also, on the pricing on shredded, the pricing of shredded for consumption of one pound is about 50% higher than one pound of rolled. So it throws off not only a fair margin, but it throws off a nice gross profit from a penny standpoint.

But where it is is it's transitioned in the plant, going from a plant that was kind of running full speed with two lines to now kind of embracing the third and fourth lines. And experiencing slower movements because we have to staff the line, but we don't have 10 hours worth of production on those lines. So we are going to -- we will be in this range, in the 45% to 47% between now and then the latter part of next year and kind of move north of that as we attain more volume by getting more distribution.

Thanks for that color, Dick. Then maybe a question for you, Scott. Just on SKU productivity, you guys have a good track record of innovation; example being the shredded product. You still also see a lot of fridges, a lot of rolls in the fridges.

So I'm just curious how you view the importance of new products versus existing top-performing SKUs as you think about driving velocity and margin. And is there maybe an opportunity to better optimize the assortment in the fridge as you go forward? Thanks.

Sure. We actually done a major project this past year that we just finished up and we are now really in the process of implementing. We actually -- we're calling it space maximization.

We, literally, look at every inch of that fridge and we look at it on sales on a per linear inch and then longer-term gross profit expected from those individual items. Then we will actually make fridge assortment decisions based on that. So it's, literally, just like a retailer thinks of their store, we think of our fridge in the same respect.

What we do is, as we are coming out with innovation, we are making sure that the innovation is incremental to what we have in the fridge and that we are able to remove things and see incremental sales out of it. And we really have been very successful in that. If we look historically, we have been able to take our base products and continue to grow what we are calling our base products year after year in same-store sales. But we've also been able to add a lot of sales for -- through innovation, because it's differentiated and it really does open up the market to new consumers.

So we are actually kind of in a major transition right now. You're starting to see in July, August, and you'll see the final changes into the September period with a handful of retailers -- some may be straggling into October -- where we feel very good that that will deliver significant incremental growth out of the fridges for the next year forward after that change.

And I think it's a continuing evolution where we look at the lowest-performing items in the fridge and we basically move them out and we are moving more productive items in. We think there's continued room to optimize there, but we are very cognizant. We are not coming out with a new flavor just to put it out there. We're making sure that it provides incremental sales.

The items that we have been able to put out there have been successful and the ones that we are putting out now look very, very encouraging from the results we've already seen in some of the lead accounts. So sorry for the long answer, but --.

No, that's great. Thanks for all the color. Best of luck, guys.

(Operator Instructions) Dominic Ruccella, Wedbush Securities.

Thanks for taking the call. I'm actually on the line for Phil today. I was wondering if you could give us a quick update from last quarter and what you are seeing on the cat product.

How is that progressing? How many fridges do you guys have that in now? Anything you guys can provide on that would be helpful. Appreciate it.

Sure. On the cat product, we are now in several thousand -- we are approaching over 6,000 fridges we have cat products in today that we have added since the beginning of this year. So I want to be really clear on that.

Now secondarily -- so we are continuing to expand on our cat portfolio and it's really on two fronts. The first front is within existing fridges we are expanding out and building out what the right mix of cat products are.

From there, we are continuing to take that learning and we are applying that model to dedicated cat fridges. Right now there's 250, 248 cat fridges across the US that are independent cat fridges and we are recently seeing some real significant improvements in the velocity that we are getting out of those cat fridges.

We are actually -- over the course of the next six months, we are actually going to be doubling the number of tests. The tests don't give us a lot of stores, but what they do is they give us a lot of seeds that we have implanted that should grow into additional stores.

So we are kind of getting -- again, we are in an early stage here, but the dedicated cat fridges around 248. We'll see several other tests developing and we are starting to see some expansion from the existing tests. So this is going to be something that will have a major impact or more significant impact on the business next year and this is kind of a developmental year for us in cat.

But encouraged with the results; those results are really kind of sales-related and we have several new items that are coming in a cat portfolio that will build it out, so we have several items in a dedicated cat fridge. But I would say we are still in the figuring out stage. It's a promising development and a nice opportunity for us next year.

Got you. And then just to follow up on that, I know you mentioned that you are working on the mix. It's obviously still early. Is there anything you could -- color you could provide in terms of what the velocity is you guys are seeing, though?

Is that similar to the dog fridges? Is it similar to how the dog fridges were in the earlier days of their release? Any other color you can provide on the velocity you are seeing?

Sure. I think the best way to think about it, because it's so varied across all the different retailers and formats that we are in, so right now we are seeing about 40% to 50% of what we are seeing out of a dog fridge. But there's two major factors. One of them is it's in its infancy and it's kind of like the early days of the dog fridges. So there's a little bit of like a way in as we figure it out piece of it. That's obviously highly important so we are seeing that.

The other thing is these fridges are much smaller than the dog fridges. We are typically seen waist-height fridges, so they are smaller. They take up less space and then demand less space from the retailer. So obviously that's a consideration.

Again, we kind of like the results we are seeing. We have a little bit of ways to go to figure out the full model. Once we get the rest of that portfolio out there and we have established this is the model, this is exactly how it is, from there it will allow us -- when we can take those results and share them with many retailers, it will -- we will get a lot more buy-in a lot faster once we have that model really solidified.

Got you. Understood that was helpful. Thank you.

Thank you, I'm showing no further questions at this time. I would like to hand the call back over to management for any closing remarks.

Thank you for everyone joining us. We really appreciate your participation, your questions, and your interest in the business. And look forward to continuing to work with everyone. Good evening.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may now disconnect. Have a great day, everyone.