Freshpet experienced a strong start to 2024 with significant net sales growth and improvements in profitability metrics.
Net sales for Q1 2024 reached $223.8 million, marking a 34% increase year-over-year, primarily driven by a 31% volume growth and a 3% price/mix improvement.
Adjusted gross margin for the quarter improved significantly to 45.3%, up from 41.1% in the previous quarter and 38.5% year-over-year.
Adjusted EBITDA for Q1 2024 was $30.6 million, a substantial increase from the prior year.
Diluted earnings per share (EPS) stood at $0.37, with an adjusted EPS of $0.17 when excluding a markup in the value of an equity investment.
Operational and Market Performance
The company achieved a customer acquisition cost (CAC) comparable to levels before the recent price increases, indicating the effectiveness of its marketing strategies and the resilience of its growth model.
Operational improvements led to significant year-on-year advancements in quality, input, and logistics costs.
Freshpet added 617 fridges in Q1, reaching a total of 34,812 fridges in retail stores, enhancing its retail visibility and availability.
The company’s household penetration increased to 12.367 million households, a 24% increase year-over-year, with high-profit pet owning households (HPPOs) growing even faster at 34%.
Freshpet continues to dominate the Fresh Frozen subcategory within the pet food market, holding a 96% market share.
Financial Outlook and Strategy
Freshpet maintains its net sales guidance for 2024 at at least $950 million, cautiously managing growth to align with capacity expansion plans.
Adjusted EBITDA guidance for 2024 has been raised to at least $120 million, reflecting the strong performance in Q1.
The company plans to invest approximately $210 million in capital expenditures to support capacity expansion, aiming to meet demand in 2025.
Freshpet’s long-term targets include achieving a 45% adjusted gross margin and an 18% adjusted EBITDA margin.
Capacity and Technology Investment
The Ennis facility is producing about 25% of the company’s total production volume with three lines currently operational and a fourth line expected to start by the end of Q3 2024.
Freshpet is focusing on maximizing throughput and capacity at existing sites and developing new technologies to improve yield and quality.
Management Commentary
The company’s leadership expressed confidence in the business model’s strength and the operational discipline demonstrated, emphasizing the criticality of maintaining momentum for consistent performance over the remaining quarters of the year.
Freshpet’s investment in organizational capability and technology aims to make its manufacturing systems more reliable, consistent, and efficient.
Question and Answer
Outlook and Growth Strategy
Question
Is the company’s outlook overly conservative, and are there areas where prudence is being exercised in the top and bottom-line guidance?
Answer
The company is pleased with Q1 performance, demonstrating strong volume-based growth and household penetration.
Prudence is exercised in managing growth to align with capacity constraints and ensure high fill rates.
The company is confident in its growth drivers and market environment but cautious about capacity limitations.
EBITDA Margin and Gross Margin Outlook
Question
What factors could potentially impact the EBITDA margin and gross margin guidance of at least 43% for the rest of the year?
Answer
Factors include the one-time benefit of inventory build in Q1, which will unwind later in the year.
Quality costs, wage increases, and the Ennis plant startup will also put pressure on gross margins.
However, the company remains optimistic and open to potential outperformance if conditions align.
Q2 Modeling and Factors to Consider
Question
Are there specific factors to consider when modeling Q2, such as media spending, bridge placements, or the timing of inventory unwind?
Answer
Q2 is expected to see a sequential increase in revenue and a strong media spend.
The timing of inventory unwind is still variable but is expected to occur later in the year.
Logistics continue to be favorable for the company.
Category Acceptance and Retail Expansion
Question
How does the company view the increased category acceptance and consumer demand for Freshpet products in relation to discussions with retailers about expanding fridge placements and further penetrating the market?
Answer
The company is confident in its superior product offering and sees retailers becoming more comfortable with expanding fridge placements.
Second and third fridges are expected to be added over time, driving further category growth.
The company’s focus is on optimizing its portfolio to maximize consumer demand and profitability.
Capacity Expansion and Future Growth
Question
Can the company provide a framework for understanding the incremental capacity that will be added through efficiency programs, existing facilities, and new technology investments?
Answer
The company manages capacity additions to align with projected net sales growth, maintaining high fill rates as a key indicator of operational performance.
The focus is on building capacity to supply projected sales over an extended period, with the ability to adjust to variations in growth rate.
The company views manufacturing as a core competency and a significant competitive advantage, with a focus on delivering improved return on invested capital and product quality.
Organizational Capacity and Talent Acquisition
Question
How is the company approaching the expansion of its organizational capacity to support future growth, both in the short term and the long term?
Answer
The company has added key talent in critical roles and will continue to evaluate and add top roles as needed.
Planning for organizational capability is a priority, learning from past experiences during the pandemic.
The company is focused on building a high level of sophistication across various areas to support its growth trajectory.
Long-Term Margin Expansion Opportunities
Question
With the gross margin already exceeding the 45% target, what are the potential opportunities for further margin expansion and operating margin upside in the long term?
Answer
The company is confident in its ability to exceed the 45% gross margin target and sees logistics as another area for improvement.
The primary focus for margin expansion is gross margin, with potential for further improvement through logistics.
The company is actively identifying projects to create longer-term annuities and margin expansion.
Sustainability of Unmeasured Channel Growth
Question
How does the company view the sustainability of the greater than 100% consumption growth in unmeasured channels and the opportunities in the online channel?
Answer
The company sees significant opportunities to expand accessibility and reach consumers through various unmeasured channels, including e-commerce, club, and mass.
There is a long runway for growth and the company remains optimistic about the next several years.
Unmeasured channels have been outpacing growth for some time, and the company sees several years of opportunity ahead.
Opportunities to Accelerate Investments
Question
Are there opportunities to pull forward investments into the current fiscal year to capitalize on potential EBITDA upside?
Answer
The company is actively assessing opportunities to accelerate investments, particularly in gross margin improvement projects.
These projects aim to create long-term annuities and margin expansion.
The company is also considering investments in organizational capability to accelerate margin improvement.
CapEx Implications of Throughput Initiatives
Question
Do the company’s throughput initiatives and increased flexibility in manufacturing have any implications for future CapEx requirements and the timing of free cash flow inflection?
Answer
Throughput initiatives are expected to pay dividends and help push out CapEx investments while maintaining capacity for 25% growth.
Achieving free cash flow positivity in 2025 would be challenging, but the company remains confident in reaching that milestone in 2026.
Operating cash flow has improved significantly, and the company’s liquidity position continues to strengthen.
Key Focus Areas and Potential Variability
Question
What are the key areas of focus and potential sources of variability that could impact the company’s model and outlook over the next 12 months and beyond?
Answer
The company is appropriately conservative due to the significant step-up in gross margin and EBITDA margin from previous quarters.
The focus is on demonstrating sustained performance and managing growth to maintain high fill rates and operational effectiveness.
The top line growth is driven by the company’s ability to reliably supply products, and maintaining a high fill rate is crucial.
Roll Capacity and Product Form Demand
Question
Can the company provide more details on the potential roll capacity issues later this year and the demand for roll versus bag products?
Answer
Roll capacity is dependent on the timing and ramp-up of the new roll line in Ennis, and the company wants to avoid getting ahead of itself.
The company has made significant operational improvements in Bethlehem, allowing it to build inventory and meet roll demand through Q2 and Q3.
There is no issue with roll capacity; the company is being cautious and ensuring it stays within a comfortable band.
SKU Strategy for Second Coolers
Question
As the company expands its presence in second coolers, does it need to introduce more SKUs or product forms to maintain velocity, or is the current portfolio sufficient?
Answer
The company is actually working to optimize its portfolio by reducing complexity and the number of SKUs.
The focus is on developing a product portfolio that is well-suited for future state manufacturing and maximizes consumer demand and profitability.
The company is seeing success in second coolers by spreading out core SKUs and offering multipacks to address potential out-of-stock issues and cater to consumer preferences.
Both core SKUs and more specialized products are experiencing growth, and the company will continue to optimize its portfolio.
Path to Free Cash Flow and Capital Allocation
Question
Can the company provide more details on the path to free cash flow, including the relative contributions of profit growth, working capital, and CapEx requirements?
Answer
The company expects the majority of the path to free cash flow to come from profit growth as the business scales and margins expand.
The company is actively managing CapEx to stay within the 200 to 225 million range while building capacity for future growth.
Working capital is not expected to be a significant factor, and the focus is on profitability and scale as the primary drivers of free cash flow.
Convertible Bond Mechanics and Dilution
Question
Can the company explain the mechanics of the convertible bond and potential dilution, given the current share price and the possibility of conversion?
Answer
The convertible bond is a 5-year instrument, and while bondholders could technically force conversion, the optionality value makes it highly unlikely.
There will be no dilution from a GAAP perspective until net income exceeds $100 million.
The company has a capped call in place to protect against economic dilution up to a share price of $120.
Cash Position and Liquidity
Question
Does the company feel comfortable with its current cash position given the rapid growth and capital requirements?
Answer
The company feels very good about its cash position, with sufficient funds for this year and a good chance of having enough for next year.
The company is confident in its ability to manage its liquidity and, if needed, borrow effectively to support its growth plans.
Mix Shift and Main Meal Penetration
Question
Does the progress in shifting the product mix towards main meals versus toppers, as evidenced by the 48% figure, demonstrate success and contribute to the achievement of the 2027 goals?
Answer
The company is seeing consistent penetration growth, particularly among super heavy and heavy buyers, which naturally pushes up buy rates.
The company’s focus is on penetration, with the expectation that buy rates will grow at a low to mid-single-digit rate to achieve the 2027 goals.
The company is also observing expansion in buy rates and the purchase of multipacks, indicating that consumers view Freshpet as a main meal option.
New Technology Investments and Cost Considerations
Question
Can the company provide more details on the new technology investments, including the potential retrofitting or replacement of equipment, cost considerations, and the timing of these investments?
Answer
The company’s primary focus is on optimizing its current manufacturing footprint and lines, with significant opportunities for improvement.
There are also plans for small retrofits to existing lines to increase productivity and throughput.
A next-generation technology is in development and is expected to be ready for production on the seventh line in Bethlehem in the first half of 2025.
The company has budgeted for these investments and will evaluate the potential for using the new technology on new lines and retrofitting existing lines based on its success and margin improvement.
Commodity Cost Dynamics and Chicken Processing
Question
What factors contributed to the nearly 400 basis point benefit from commodities, and how is the chicken processing plant in Ennis performing?
Answer
The benefit from commodities is primarily due to deflation and the favorable performance of the chicken processing plant in Ennis.
The economics of the chicken processing plant are improving significantly as volume grows, and this trend is expected to continue.
The company is also experiencing positive results from its yield and OEE projects.
