Freshpet Inc (FRPT) 2022 Q1 法說會逐字稿

Greetings, and welcome to Freshpet's First Quarter 2022 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn this conference over to your host, Mr. Jeff Sonnek, Investor Relations at ICR. Thank you, sir. You may begin your presentation.

Hello, and good afternoon. and welcome to Freshpet's First Quarter 2022 Earnings Call and Webcast. On today's call are Billy Cyr, Chief Executive Officer; and Heather Pomerantz, Chief Financial Officer. Scott Morris, Chief Operating Officer, will also be available for Q&A.

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 annual report on Form 10-K filed with the SEC 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.

Please note that on today's call, management will refer to certain non-GAAP financial measures such as EBITDA and adjusted EBITDA, among others. 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. A reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP and the 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. The presentation can be found on the company's investor website. Management's commentary will not specifically walk through the presentation on the call, but rather it's a summary of the results and guidance they will discuss today.

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

Thank you, Jeff, and good afternoon, everyone. The message I would like you to take away from today's call is that our Q1 results are an early indicator of how much more resilient we are today than we were 1 year ago. The investments we made in our workforce and buffer capacity enabled us to overcome the challenges from Omicron, industry-wide supply chain disruptions and our ERP conversion and still deliver the strongest quarterly net sales growth rate since Freshpet went public in 2014. That resiliency will enable us to continue our rapid growth and fulfill our mission to change the way people nourish their pets forever.

Our team is quite proud of what we accomplished and the results we delivered. We overcame supply shortages and construction delays to design, construct, install and start up the incremental capacity that has enabled us to not only meet our rapidly growing demand but to also fill the trade inventory hole that we dug over the past 18 months. We still have some pockets where our in-stocks are not where they need to be, particularly in pet specialty, where we went through a distributor change. But overall, we have our best retail conditions in almost 2 years, and they keep getting better.

We've also hired and trained the team members needed to produce enough Freshpet to fill those fridges in one of the tightest labor markets in decades, and we continue to generate incremental demand in the face of the most significant inflation in decades through outstanding marketing, innovation and fridge placements.

Looking ahead, we are also keenly aware that the operating environment remains extremely challenging. The planning and skills that it took to overcome the obstacles we faced in Q1 will be needed over and over again in the coming months and years if we are to sustain high rates of growth.

To be successful, we will need to continue to plan conservatively and act aggressively just as we've done so far this year. That is what we intend to do. It is in that vein that we have revisited our long-term capacity expansion plan.

Since we established our plan about 15 months ago, quite a bit has changed. Some of the biggest changes have been, first, lead times. Lead times for construction and equipment have lengthened significantly, sometimes doubling and tripling. That puts a premium on planning and ordering ahead, but it also puts added strain on the balance sheet because we must start spending capital much further in advance of when capacity is able to begin production. On average, we are spending capital more than 6 months earlier than before to deliver the same capacity.

Second, costs. The cost of construction and equipment has increased significantly. On average, construction materials and equipment costs are up more than 20% over the past year, particularly for those who use a large amount of stainless steel as we do.

Third, operating know-how. We've learned quite a bit about how to design facilities to operate more efficiently over the past year, particularly since we've been operating Kitchens, too, on a 24/7 schedule for a full year.

Fourth, new technology. We've been experimenting with a variety of new production technologies over the past year, some that support existing products and some that enable new innovations. We are ready to scale up some of those technologies.

And fifth, competition. The emergence of a large and growing segment of very high-end fresh and frozen pet foods has reinforced the strategic importance of ensuring that Freshpet always has the best products in the market while presenting consumers with an attractive value proposition. We are ready to scale up some additional products that we believe will expand our franchise, increase our buying rate and enhance the Freshpet brand reputation.

To address those changing dynamics, deliver the necessary capital efficiency to justify the investments we are making and to keep up with a significant increase in demand, we established the following guiding principles: first, focus on building where our talent is based. To maximize utilization of our technical staff, we will focus our efforts on Bethlehem, Ennis and Kitchens South, fully building out those sites. This will enable us to maximize the potential of each site with the most efficient use of our talent. This includes innovation as we will house innovative new products in Bethlehem, so that they are connected with our R&D staff.

Second, locate and group technology and equipment in the most cost-effective manner. As a small company attempting to meet almost insatiable demand across our product portfolio, we had to pair a bag line and a rolls line together each time we expanded. Now we are adding capacity in larger chunks and can establish buildings and operations that specialize in either bags or rolls. That delivers labor efficiency, better management and maintenance and spare parts and greater operating expertise.

Third, limit Freshpet capital investment to assets of greatest strategic value. While we will continue to selectively build and own some of our buildings, our new plan makes greater use of our partners' capital to construct and own buildings while we focus our capital on equipment and technology.

And fourth, enable innovation. Our capital plan must ensure that we never fall behind on product performance versus any relevant competitor. We believe we are the best-in-class product today, and we intend to keep it that way through a commitment to long-term innovation.

Applying those principles, we are making some changes to our long-term capital plan. The key changes are: first, splitting Ennis Phase 2 into a Phase 2 and a Phase 3. The new Ennis Phase 2 will be dedicated to rolls lines, and we will be pulling forward the beginning of construction as well. In fact, we've already begun the site preparation work for that expansion and expect a new Phase 2 to open in Q4 of 2023. Phase 3 will largely focus on bag lines and will be slated to open a year later in Q4 of 2024.

Second, focusing Kitchens South on bags. We will be adding incremental bag lines to the existing building and eliminating the need to add a new building that would house rolls lines. We will ultimately house 5 bag lines at Kitchens South, some of them using new technology with higher throughput and greater packaging flexibility.

And third, adding an innovation scale-up facility in Bethlehem. We are establishing a new 100,000 square-foot facility about 0.5 mile from our existing campus in a leased building that we will equip with the production lines capable of producing some of our new innovative products.

In total, this revised plan will deliver capacity to make approximately $2.9 billion of Freshpet products, up about $500 million or 20% from our previous plan. We will also add new product technologies capable of producing new preferred products that will provide unique benefits to new consumer audiences. And the plan will deliver greater operating efficiency than the previous plan. The accompanying investor presentation provides more detail on the projects and the returns we will get from these investments. Put simply, each of these projects will pay back quickly once they are operational and fully utilized, just as the Bethlehem campus is generating significant free cash flow on a 4-wall basis now that it is fully utilized.

We believe this is both an aggressive and prudent plan. It is very clear that the future of pet food is in higher-quality foods like Freshpet. Various industry estimates have pegged the size of the category at $4 billion to $6 billion as soon as 2025, and we outlined a 25% increase in the size of the total addressable market, or TAM, to 25 million households at the ICR Conference in January.

We fully intend to capture as much of that market potential as possible. We are the category leader. We have a huge head start, and we have sizable competitive advantages. To maintain that lead, we must always have adequate capacity, and we must always have the best products. Our plan is designed to ensure we always do.

So what does this capacity expansion mean for our existing 2025 targets? We are off to a fast start in 2022, and our current growth trajectory is well in excess of the rate we would need to hit our 2025 goal. But with all the uncertainty in the macro environment, we think it is more prudent to maintain our targets while we navigate through this fluid macro environment. That said, we have great confidence in the path forward to build and serve a much larger consumer audience. Simply put, this is a timing exercise.

Given the incremental challenges in sourcing and construction, we need to start sooner to ensure that our operational capabilities and capacity keep pace with long-term demand. For investors, we believe this capacity plan is best thought of as both an option for accelerated growth and insulation against further challenges in construction or equipment sourcing. We are also building in some flexibility. While there are long lead times for construction and equipment, we have preserved the ability to scale back portions of the plan at various stages along the way to ensure that our capital spend is always optimized and capacity is in lockstep with our latest estimate of demand.

Further, we are also mindful that the world we are operating in has an unusually large amount of economic uncertainty in it. Given that and the aggressive competitive posture we are taking, we will balance the capacity expansion plan with a conservative balance sheet that is designed to insulate our growth plan from the typical volatility of both a high-growth company and the capital markets. We intend to operate with low leverage until the business is generating strong cash flow, capable of funding our capital expansion plans from operations.

We believe the plan we are laying out today is the right one and will allow us to reach our long-term goals in the most efficient way possible, solving for the current environment and leveraging our growing set of capabilities. Our founders bet on the future of higher-quality pet food back in 2006 with the creation of Freshpet, and we asked our investors to do that when the company went public in 2014, and again, in 2017, when we launched Feed the Growth.

We believe our long-term results have shown that those were wise investments. We believe the plan we are laying out today will enable us to build on those results and deliver the future of pet food and a very bright future for Freshpet.

I will now turn it over to Heather to provide a summary of our Q1 2022 results.

Thank you, Billy, and good afternoon, everyone. We had a very strong quarter, both in the absolute and relative to our expectations.

We delivered net sales growth of 41.5% for a total of $132.2 million of net sales. That growth rate is the strongest quarterly net sales growth rate since the company went public in 2014. For perspective, our first quarter net sales are more than our net sales for the entire calendar year of 2016, which means we have doubled the business twice since 2016. In fact, we have doubled this business about every 3 years since it was founded, and that trend is accelerating with Q1 of 2022 being 2.4x the size of the same quarter only 3 years ago.

First quarter net sales growth was broad-based across channels and product forms. The growth was most pronounced in the grocery and mass channels. And from a product mix standpoint, our rolls and Fresh From the Kitchen products experienced significant lift behind improved availability. That improved availability can be seen in the gradually improving PDP throughout the quarter and into Q2.

Pricing and mix accounted for about 8 points of net sales growth in the quarter, and trade inventory refill was about 4 points of the net sales growth. The balance of the growth in the quarter came from volume growth. As expected, pricing will play a bigger role in Q2 than it did in Q1 as our second price increase did not go into effect until the middle of March. As a reminder, our 2 price increases total about a 17% increase in pricing.

We saw very little, if any, price sensitivity from the first price increase, but it is too early to tell how much you will see from the second larger increase. It is particularly difficult to determine the magnitude of price sensitivity we are experiencing because of the confounding variables we have, i.e., much better availability, improved distribution and a significant increase in advertising. We fully anticipate there will be some price sensitivity, and we've built that into our guidance for the year. It is just too early to tell how much we are actually experiencing given the rapid growth.

Household penetration grew only 2% versus a year ago on a trailing 52-week basis. That 52-week time period reflects the worst periods of in-stock, and is why we saw so little improvement. However, when we look at the more recent 4-week period, when advertising was on the air and in-stocks had improved, we see much stronger growth rates. In fact, the most recent 4-week period was up 12% versus a year ago and is accelerated. While there might be a short-term dip due to the impact of price sensitivity, we expect to see steady progress in Q2 on the 52-week measure and get back to more typical household penetration growth rates by the end of the year. As typically happens when household penetration growth slows, buying rate growth accelerates due to a smaller number of new households who come in at a lower buying rate, entering the Freshpet franchise.

Buying rate was up 26% in the quarter, well above our long-term growth rate of 7%. We believe that rapid growth will slow considerably once the household penetration resumes its more normal growth pattern in the 20% to 30% range. However, the increase in pricing will provide a step up in buying rate this year and will go beyond our annual target of 7% growth.

Net store count grew by 300 to 23,931 net stores. We also upgraded 72 stores and placed second or third fridges in 179 stores. We expect the rate of growth on each of those measures to accelerate as the year goes on.

Shifting to margins. Adjusted gross margin was 41.9%, down from last year's 46.7% and up slightly from Q4 2021 41.7%. The Q1 performance was also better than our guidance assumed. As we shared last quarter, we had a timing mismatch between the increase in our commodity costs and our pricing actions. That timing difference created an approximate 450 basis point headwind for adjusted gross margin in the first quarter. But we will get much of that back in Q2, driving a slightly better-than-anticipated adjusted gross margin in the quarter with strong production performance and greater sales leverage.

When we gave our guidance at the end of February, we had just converted to our new ERP system. Our guidance assumes that it would take some time to return to our previous level of production as we work through the kinks in the new system. But as the chart in the accompanying presentation shows, we bounced back quickly and even began to exceed our previous production performance. This improved throughput resulted in increased shipments and enabled our best in-stock conditions in years, helping to drive strong sales performance. We attribute part of that strong production performance to the investments we made in the Freshpet Academy training program and in talent over the past 6 months, which delivered consistently strong staffing levels and increased operational flexibility. This is a strong proof point that our revised capacity plan will have associated advantages in terms of efficiency and throughput.

The strong top line growth enabled us to drive strong G&A efficiency gains that we reinvested in media in the quarter to drive continued top line growth later in the year. Media investment in the quarter was up 420 basis points versus a year ago to 16.3% of net sales, and that increase was more than fully offset by reductions in both logistics costs of approximately 170 basis points and by other G&A costs of approximately 270 basis points for a net reduction in adjusted SG&A of 20 basis points.

Logistics cost reductions were due in part to more completely filling troughs than in the year ago. G&A costs were positively impacted by the benefits of scale that we have been gaining over time.

Adjusted EBITDA of $5.1 million was, as expected, down versus the year ago. Had we not had the timing mismatch between commodity inflation and pricing actions, adjusted EBITDA would have been approximately $13 million greater and delivered an approximately 13.7% adjusted EBITDA margin.

Capital spending in the quarter totaled $55.9 million, and we expect to spend approximately $400 million in capital this year. This is higher than our prior planned CapEx spend of approximately $300 million that we previously communicated and reflects the updated capacity plan that Billy shared with you earlier.

Operating cash flow used in the first quarter was $34.8 million, which was driven by $33.2 million of working capital. This was significantly impacted by the ERP conversion which resulted in some delays in invoicing and payables, which will be reconciled in Q2.

We grew $51 million on our revolver in the quarter. At the end of the quarter, we had gross availability of $299 million on our credit line, subject to various limits.

Looking forward, this strong start in Q1 gives us a great deal of confidence in our plan for the year. Net sales performance in Q1 and came in about $5 million better than the 35% growth implied in our guidance, and the consumption trends we saw in April continued that momentum. We are still learning about price sensitivity, but each week that goes by, we get increasingly comfortable that our assumptions are appropriately conservative with less risk of downside and more opportunity for upside.

Despite that optimism, we are maintaining our net sales guidance for the year out of an abundance of caution related to the unknowns of price sensitivity and until we have assurances that Ennis will deliver the roll capacity that we need to stay on track with our plans. At this point, we believe that Ennis is on track to begin producing salable products late in Q3, but the current construction environment is challenging, and nothing should be taken for granted.

Three things need to be in place for a successful start-up. First, equipment delivered. We are in good shape on this item as all the equipment has been delivered and is ready to install. And the equipment is basically the same as the equipment we use in Kitchens 2, so we know how it works.

Second, staffing and training. We have hired all the staffing that we will need for the first 2 lines, and many of them have been trained in our Bethlehem kitchens for up to 9 months. We are in good shape on this item.

And third, building completed. This is the primary element of risk and where most of our focus lies. We expect to have dried in the building by next week, but there is still lots of wiring to run and carrier walls to erect and electronic systems to install. We believe our timetable is realistic, but material shortages are very real. And until the building is done, we won't know for sure that we can get every material, electrical component or laborer on the timing we need. Net, we are optimistic but realistic about our ability to start up Ennis and further support sales later this year.

While we also exceeded our expectations on adjusted EBITDA, the surge in fuel prices we've experienced since our fourth quarter earnings due to the onset of the Ukraine conflict could offset that stronger performance until we either take another round of pricing or the fuel prices roll back. Since we set our guidance, diesel fuel has gone from approximately $4 per gallon to approximately $5 per gallon. That impacts inbound and outbound freight costs.

We are also seeing higher energy costs to operate our kitchens. If it appears that these costs will be sustained for a long period of time, we will take another round of pricing to cover those costs as we are committed to protecting our margin. That could create another timing mismatch between increased costs and increased pricing, but it would be much smaller than the mismatch that occurred in Q1 when a broader set of commodities were impacted.

Additionally, if we continue to deliver strong net sales performance in excess of our guidance and we have the available capacity, we will selectively reinvest the contribution from the outperformance in additional Q4 media to further accelerate our growth next year. Thus, we are not taking up our adjusted EBITDA guidance at this time, but our confidence in our ability to meet or exceed the target is very strong.

We have updated the quarterly guidance cadence charts we provided with our initial guidance in February to provide color on these items and other items impacting the cadence we expect for the year.

In closing, we are very encouraged by the strong start to the year and even more encouraged by what it says about our resiliency. But we also know that we must maintain our focus and diligence. If we do, we believe we have the capability to continue our rapid rate of growth, deliver a strong performance this year and continue on our path towards fulfilling our mission of changing the way people nourish their pets forever.

That concludes our overview. We will now be glad to take your questions. Operator?

(Operator Instructions) Our first question comes from the line of Bryan Spillane with Bank of America.

So first, my question is really just around the revised capacity plan and the CapEx. I just want to make sure I understand, is the -- so what's incremental from here, so what's not yet spent and is still to come, balance of this year in the future, is that number -- I'm just looking at Slide 47. Is that roughly $700 million to $800 million of additional spending from here including this year's CapEx plan?

Heather, do you want to take that?

Sure. Yes. On Slide 47, the $900 million that you see there is the total of all those projects that you see under planned, core lines. So it includes all of Ennis Phase 1, Ennis Phase 2, Kitchens -- the Kitchens South of incremental lines as well as Ennis Phase 3.

So Bryan, Ennis Phase 1 obviously started expenditures at the back half of 2020 all through 2021 and into 2022. So that number is inclusive of the total of the Ennis Phase 1 projects, which in the latest revision is just over $350 million. And so because of that, it's a higher number than is reflective of kind of future expenditures, if you will. So you have to net out the total of what's already spent on Ennis Phase 1, which is a significant portion of that number, a couple of hundred million.

Okay. So the capital raise plus the cash you have on the balance sheet and the credit, you have enough -- there's enough capital to complete this plan? I guess that's what I was really getting after was just that.

Yes. There's enough capital to complete the plan. And I think the difference is that, as Billy mentioned in the prepared remarks, the goal of this is to maintain a low level of leverage. And so we'll lean in less into the credit facility in order to risk manage and have a healthy balance sheet along the way.

Our next question comes from the line of Bill Chappell with Truist Securities.

Just kind of following up on Bryan's -- Billy, maybe just a little bit more of what pushed this change? Was it a thought that we don't want to ever run into capacity constraints as we did last year and we need to get faster? Or is there something on the demand curve where you felt like -- just trying to understand why the change now because it's obviously a big -- and it seems like a very positive change, but it's also from -- I would have thought your original plans were pretty well-thought-out as well. So just help us understand why now.

Yes. Bill, it's a very good question. The reality is, as you saw, we put up for growth in the first quarter at 41.5%. We've guided 35% growth for the year. When we put out our plan for 2025 and the capital plan before, the growth rate that we were expecting at the time was in the high 20s. So we're running way ahead of that plan. And so we have to -- we want to get ourselves in a position where we're never leaving the customer a reason to go look for somebody else to supply them. And so we want to make sure we get ahead of this.

I will tell you, it's a little bit like chasing your shadow though because it seems like the more capacity we bring on, the faster we grow. And so we just want to push that as far as we can organizationally and as quickly as we can to get as far out as we can. But it's also important to note that lead times have taken -- have increased fairly significantly. So we now have to take action much sooner to build capacity that's going to come on a little bit later. So that's really the biggest driver here, the accelerating rate of growth and then the longer lead times.

Once you make the decision that you have to take action based on those 2 phenomena, then you recognize that there are some things that we've learned, whether it's new technology, new innovation or better ways to organize our facilities. Putting rolls lines in a single place and bag lines in other places makes an awful lot of economic sense, but those come on after you recognize that you're growing faster and lead times are longer.

Okay. No, that helps. And then Heather, just understanding that it is early in the year and there's a lot of moving parts, but with the quarter in kind of your commentary, trying to get my arms around maintaining kind of full year guidance, especially on the EBITDA line. And I think what you had said was -- and I just want to confirm that there's still more kind of backfill of inventory to refilling the stores that go in 2Q, so it wasn't all done in just 1Q. And also, I think you had said that you could have 13.7% EBITDA margins had pricing already been put in place fully at January 1. So is that all really just kind of wiped out by the incremental Ukraine conflict costs? Or are we just -- is this still being conservative to start the year?

So when we talked about the Q1 impact, as pricing was in the quarter, that is already reflected in our Q2 expectations of margins. We did have an overdelivery in gross margin versus expectations in the quarter and that we did have obviously a stronger growth in the quarter than our guidance implied. And so that did flow through.

Remember, because we have the buffer capacity and when we had incremental revenue, the cost -- the labor to overhead cost is already reflected in the numbers that we had. And so you don't get it for free, you still have to pay for the input cost, but it comes at a much higher margin. And so that was a big part of the overdelivery of gross margin in the quarter. The other [assets as] we did build a little bit more inventory.

And so on a full year basis, though, the expectation of that pricing was built into, of course, Q2 and beyond. And I wouldn't say -- there is obviously -- I wouldn't say from a -- we're being conservative in that we are looking at the impact that potentially will come. We're sitting on risk already with, as I mentioned in the script, that with diesel fuel at $5 a gallon versus $4. So we're watching it closely. There's likely -- if we have to end up pricing, is going to be a price in mismatch there like we had in Q1, and so there is some risk in the future.

I think the other thing that's important to note from an adjusted EBITDA perspective is that if, in fact, there is an accelerating growth and an opportunity to over-deliver from a margin perspective, we would look to reinvest behind having a fast start into 2023.

Bill, can I just add? I want to just add a comment on that, which is you asked if we're being conservative. We are -- I think, as Heather indicated, we are very mindful that we got blindsided by some things last year, and we need to be very cautious in this early in the year. It's important for us to recognize that there's a lot of unknowns ahead of us, whether it's diesel fuel or whether it's the price sensitivity or the things that we don't even know about yet. And so that's really what's driving us. We feel really good about our start to the year. We like all the underlying trends. We just don't want to get out ahead of ourselves again.

Our next question comes from the line of Brian Holland with Cowen and Company.

I wanted to ask, when you talk about revising the long-term capacity plan, I feel like on some level, whether it's lead times, cost, operational expertise technology, you've talked about a lot of these in one form or another.

I was curious about the competition angle, though. I guess I ask this question 2 ways. One, are you either aware of something new that's coming within the last few months? Or are you seeing increased adoption of direct or indirect competitors that maybe increases the sense of urgency? You've talked about competition before, I appreciate that. But I just want to sort of clarify the tone there and what that sort of entails.

Scott, do you want to take that?

Yes. Yes, sure. So Brian, I think the best comment that Billy made a few minutes ago was every time we build capacity, we grow more. And I think that's really like a key part of our focus when we're thinking about what we're doing.

When we look across -- there's a lot of activity. There's a ton of activity going on, more in the pet food category than I feel like I've ever seen and I've been at it a really long time.

When we look across what competitors are doing, I think it's really terrific. But we really are confident that we deliver a much more compelling portfolio of products, brands, forms, variety, at a significantly better value proposition in every single one of them in addition to having new and forward-leading innovation.

So I think we're looking at a group of people that are coming into the category that are going to raise awareness around fresh and frozen that's going to help us educate consumers. And we think we're in, by far, the best position to take advantage of that consumer change. And that's really leading the way we're thinking about building out the ability to meet the demand.

I appreciate the color, Scott. And then if I could just ask about the rollout of Ennis, and sort of the callout here on construction delays generally speaking and potential impact on Ennis as you get towards opening up that facility Phase 1. How does that -- how do we think about that in the context of buffer capacity? It sounds like you -- it sounds like you're not -- that there's some possibility that, that could get pushed out further. Does that eat up all -- the delayed start of Ennis, does that eat up all and then some of the buffer capacity? I'm just trying to make sure I understand how much is sort of riding on Ennis starting on time in the context of your full year outlook?

Yes. Brian, the buffer capacity, Ennis did provide some of the buffer capacity, and so any delays on Ennis do eat into the buffer capacity because we already have the staffing that we're carrying the cost for that.

But what I'd also encourage you to think about is that, one, is it's really a rolls issue, not necessarily an entire line. We really need the rolls capacity in Ennis to come online in order to keep that part of the business growing. We've got plenty of bag capacity this year. So if there is a mismatch, it's on the rolls side.

And the second part of it is we also have the ability to scale it up much more quickly because I think as we've said before, and most people know, we brought the Ennis production team. So the hourly laborers who are going to be starting up that facility to Bethlehem, some of them have been in Bethlehem since last June, so they could learn and practice on the exact same equipment that they'll be starting up in Texas.

So we're going to go from start-up to a 24/7 operation very, very quickly in that facility. So while there is the risk of any -- some sort of delay, once it gets going, it goes really fast. And so we feel very good about our ability to get things done once construction is completed.

Our next question comes from the line of Robert Moskow with Crédit Suisse.

Billy, maybe you could clarify that last comment a little further about what's in the assumption for buffer capacity and what's not. Were the inefficiencies at Ennis already contemplated in that 12 to 17? Or is this new plan here incremental or different from what you thought a few months ago, and therefore, it's going to eat into it?

And then my follow-up is -- are you talking about relocating people, like people who were trained in Pennsylvania, you want them to move to Texas to work on that line? And this is a very tight labor market, asking people to move around might be complicated.

Let me take the second one, then Heather will take the first one. But the second one is we actually hired people in Ennis, Texas, so native to that area or living in that area. And we then transplanted them to Pennsylvania to be trained. So we were housing them, feeding them, transporting them while they worked in the Freshpet facilities in Bethlehem. And they've been a phenomenal team to have and a really, really good effort and highly skilled people. So we will be returning them home. In fact, we already sent a few folks back in the last week, I guess it was. And more will be returning later this month. But this is sending people back home, not trying to transplant people from Pennsylvania back to Texas. Heather, do you want to take the first question?

Yes. So the buffer capacity, the way to think about it, it's actually spread quite evenly across the quarters of the year. It was large -- if you think about Q1 delivery, we consumed about half of it -- a little bit less than half of it due to some of the interruptions that we had. And remember, in January, we had interruptions due to Omicron where we shut down a rolls line for 3 weeks. And then we also had the start-up of our new ERP where we took down production for a period of time. And so about half of it was consumed via inefficiencies and then the other, more than half of it came through in building of inventory and as well as the incremental sales.

So when you look it spreads fairly evenly. The phasing of it came down a little bit in Q3 and Q4 as sales grew quarter-over-quarter and then increased back up with Ennis coming on. But again, the easiest way to think about it is fairly even across the 4 quarters.

Okay. So there's no change to the $12 million to $17 million estimate, correct?

Correct.

Okay. And also, this new plan, does it require unwinding any capital that you've put into place or anything like that? Or is it really just like you're out of stages and gates and this is the stage where it makes sense to move in this direction?

It was -- this is exactly at the right moment where we are being forced to make decisions. I think we had to like slightly undo a little bit of planning that we had done on Ennis when we decided to split it into a Phase 2 and Phase 3 and put the rolls together in Phase 2. We had already done a little bit of planning work, but there was no steel in the ground, no concrete poured or anything like that. Other than that, I think everything is pretty much gone. This was at the right moment to make the decision.

And frankly, I described earlier in one of the questions that the rapid rate of growth and the extension lead times created the need to do it, but this is also the time to do it because of some of the significant choices we were making and some of the investments we were about to make.

Okay. Last clarification. The 20% increase -- maybe you answered this already, but in capacity, is that all related to price? Or is there -- is it like half price, half volume of -- versus the new plan?

No. What we did in telling you 20%, we took the old capacity plan and we updated it for the current pricing, and then it's 20% more on top of that. So the old plan was $2.1 billion. We rolled it up to $2.4 billion, and so it's 20% on top of the $2.4 billion.

Our next question comes from the line of Mark Astrachan with Stifel.

Yes. I guess 2 points of clarification maybe on the new plan and maybe building off of one of the earlier questions. So am I right in looking at this, if I total the CapEx for what's already there and what's now planned, is it not a couple of hundred million or so more than what it would have been previously? So I guess, yes or no around that?

And then you touched on productivity relating to the new plan. I'm curious, what does that mean? Are there potential cost savings in housing bags and rolls kind of together? It would seem sort of intuitive that's the case. Do you also get some benefit in terms of revenue synergies from this as well in terms of the same sort of thinking? Like you don't have to obviously shut down lines to convert over to other things that you were planning on doing. So if you could touch on that.

And then I just had a follow-up for Scott around how to think about the accelerating household penetration in terms of the more recent stuff. Is it folks that are lapsed consumers that couldn't find the product? Is it new consumers kind of coming in and finding Freshpet? Anything you've seen there would be helpful.

Heather, do you want to take the first question? Heather?

Sorry. Sorry, Mark. Can you just -- sorry, I got a little bit -- had a little bit of a troubled time hearing you. Can you just repeat a little bit of the first question. Again, apologies.

Yes. I was just asking about trying to go back in my model and add up CapEx in terms of everything through '21 and looking at what we had from '22 on, it would seem like it's a couple of hundred million or so more than what we had been expecting prior. Is that a good way to think about it, I guess, through 2020 assuming there was more that sort of way to think about it?

Yes, sorry about that. Yes. So in 2022, we had shared that we were going to spend approximately -- expected to spend approximately $300 million, and now that's going to be approximately $400 million. So that's the first increase. And then the subsequent years, the increase is about $300 million incremental for the future projects versus the prior plan.

So that's $400 million total?

Right, exactly.

Got it. Okay.

Scott, do you want to take the household penetration question?

Yes, absolutely. So -- yes. So we're just starting to turn the corner, and we really believe that the majority of that has to do with just having product supply in at a more steady rate than we've had. What we find is that there are people that are very either form-specific or even down to the product -- the individual product level or SKU-level specific.

The biggest group that we believe that we have kind of lost some of is the occasional users over the past year. They'll come, if it's not there, they're not going to -- they may not go to another store. Now the good news is of that group, they're the easiest to come back in, and they are the people that represent the least amount of volume. So we've been able to obviously grow significantly with just expanding household buy rate, basically.

So what we believe is happening, and it's hard to tell exactly, is that people are starting to come back in, the occasionals, and we are starting to add new users again into the business in our brands. We think that once we're back in stock in a more consistent and steady basis and you add the advertising plus the innovation, then we should be back nicely to seeing some household penetration growth.

The one caveat on all that is, it's very typical to see when you take a significant price increase that there is a short-term dip. It looks like we've already turned from that dip, and we're already kind of starting to build on the other side of it. But we do see -- you're going to turn some people off when you have a significant price increase. But we believe we've already kind of turned from that dip, as I mentioned.

Our next question comes from the line of Jon Andersen with William Blair.

My first question is on in-stock levels. You commented that you've made much improvement there. Can you give us a little bit more detail around that, where you think in-stock levels are today? What you would ultimately want in-stock levels to be at, so we have a sense for how much more room for improvement there may be? And I think you commented on one area where there's more room for improvement is pet specialty. So a little more color around why that is and how quickly that can be remedied.

Scott, do you want to take that? Scott?

Sorry, I was on mute. Sorry about that. So Jon, so we have seen some, I would say, very slow, steady progress where we've had kind of 1 step or 2 steps forward, 1 step back at some times.

You can see it in some of the data that -- in the presentation on Slide 9, when you look at production. But when we go through an ERP conversion, it's a little challenging, not only to produce, but it also sometimes challenging to get as many trucks out the door as we would like. And we do see some hits in product availability at retail.

So we have made overall steady progress. Our good fridge inventory or conditions continue to improve other than for some small backward motions. And -- but we have a long way to go. I think we're probably a couple of months away from being where we would be really proud and happy to have very high service levels and really good in-stocks at retail.

The best in-stocks we have right now are up into the 90s. But for the most part, we're still seeing into the 70s and 80s, and pet we're seeing into the 50s and 60% in stock rates at retail. So a lot of opportunity and just having it there consistently for consumers builds confidence and it also lets retailers get more and more comfortable with continuing to kind of move forward and expand out.

So we're making progress. We have a ways to go. We really have a ways to go at this point. But slow, steady progress. Production is moving forward. We're getting more and more trucks out the door. We had a really significant record on the amount of cases we got out the door last week. So really nice work by the team there. But I would say we have a couple more months until we're in great shape.

In some ways, it makes the 43% revenue growth in the quarter even more impressive.

Second question is on gross margin. I think last quarter, you talked a little bit about puts and takes in gross margin throughout the year. I think Q2 is stronger than Q1, given pricing catching up with costs. But then maybe a little bit of a sequential decline in Q3 with capacity coming online. Maybe Heather, could you talk about your expectations for the kind of the movement or cadence of gross margin as we move through the year?

Sure. We've included an updated version of that chart in the presentation as well on Slide 57. And so as I shared before on a prior question, we did deliver slightly more favorable adjusted gross margin in Q1 than anticipated with the higher revenue as well as a bit of an inventory build. And so we come out of Q1 with a little bit of momentum.

But having said that, the big shift in Q2 comes from having a full quarter of the bigger price increase. And so that's why we get the biggest impact in Q2. We maintained that improved margin into Q3. It comes down slightly, and that's really as we start up Ennis. That's the impact in Q3 that brings down the margin slightly and then into Q4.

And while we have a plant start-up add-back that we're explicit about, once we start up the lines, then we no longer add back once we have salable product. And so what you have is a very underutilized facility and lines that were starting up. And so that's the impact, which the biggest impact will come in Q4.

Having all of that, as I mentioned, the fuel cost impact on -- while it's obviously the biggest impact is on outbound logistics, we also are watching it closely around the impact to both inbound freight as well as our energy costs to run the facility and of course, natural gas being the key driver as well. And so there is some near-term impact that we're watching closely. We -- as we've always said, consistently, we would look to price if we believe that things are going to have -- are going to stick, and we're looking at that closely right now. And so a bit more to comment on where that impact might lie and how long that might last. But that -- the cadence is roughly the same as we shared with that, just additional risk on fuel.

Our next question comes from the line of Anoori Naughton with JPMorgan.

First, I just had a clarification question. You talked about some occasional users may be slipping. I was curious what -- do you have a sense of what percent of the business is actually these [stopper] users? And of those lost users? Do you have any sense of maybe where they're going instead?

Scott, you can take that one?

Yes, sure. So when we get into the -- I can tell you at an overall level on the business, our heavy users represented about half of our total dollars today, okay? The occasional users are in the kind of 30% to 40% of our business, and then the last group are very, very occasional. So there is a group of the occasionals that have left. We don't have as much detail and statistics as we'd like, especially for short periods of time on this, but it's -- we can see some of that kind of in the data. So it's hard to answer the exact specifications and the exact detail around that, to be quite transparent.

Understood. But the insight is helpful. And then my question is, in your new CapEx plan, when do you target having the chicken processing facility operational? And then does this change the way you'll be procuring chicken on a go-forward basis? I guess more broadly, can you just provide more details on what you think the expected benefits and savings will be from having a chicken processing facility on site?

Yes, Anoori, the reason for the chicken processing on site is actually to deliver higher quality. While it's likely it will give us some lower expenses because you don't have to transport the product as much, the reality is we want to use the freshest chicken possible. And so by having a processing operation on-site at our largest site gives us the opportunity to bring in the chicken, process it and then feed it directly into our manufacturing operations immediately or as quickly as we possibly can, close coupling the production of the -- or the processing of the chicken and the production of the Freshpet. That's really the driver.

We don't have the ability or the room to do that in Bethlehem, although the facility that does process our chicken is only about 20 miles away. So it is very, very close. And we're getting locally sourced chicken there. But we like this as an operating model. We feel very good about that as an ongoing benefit. We would do it for the quality. The cost will be an added benefit.

Our last question comes from the line of John Lawrence with Benchmark.

Yes. Congratulations, guys, on the progress. But can you talk a little bit about the ERP system getting installed, getting it up and running? What have been the positives and the negatives of the system at this point? And then what do you expect over the next couple of quarters?

Heather, you going to take that?

Yes, sure. Thank you. So we're live successfully in our new systems. So we're really thrilled about that. It's a big milestone, in that we fully converted to a new ERP system end-to-end. So the scope of it was all processes. And our goal was to ensure that we could run our end-to-end business on the new system, and we successfully are.

I would say the positives coming out right now is really around production, and we shared that in the prepared remarks, but the production is going quite well. You had your expected -- call it, just getting folks trained, having the change management done. But the production floor is running really well. In fact, they're running more favorably now than they were prior to the conversion. It was just a learning curve.

We're running, like I said, the full end-to-end processes. We're still -- as you'll see, in some of our working capital figures. You'll see a quarter-end impact in our working capital with a receivables number that is higher than we would expect just based on growth, and that's a function of the ERP and having to get some of those sort of the process of invoicing and all the way through on a timely basis. But again, it's all growing pains. But we do feel confident and good about being converted to the new system, and we're coming along quite nicely.

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Billy Cyr for closing remarks.

Thank you and our apologies to those whose questions we were not able to get to today. We're obviously on a very tight schedule with the news that we put out earlier today. I'll leave you with one thought.

The author, John Grogan said, "Such short little lives our pets have to spend with us, and they spend most of it waiting for us to come home each day." And I would add to that, serve them Freshpet when you arrive and will have been worth the wait. Thank you very much. We appreciate your interest and attention.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.