Freshpet, Inc. (NASDAQ:FRPT) Q4 2023 Earnings Call Transcript
Freshpet, Inc. (NASDAQ:FRPT) Q4 2023 Earnings Call Transcript February 26, 2024
Freshpet, Inc. beats earnings expectations. Reported EPS is $0.31, expectations were $0.09. Freshpet, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings. Welcome to Freshpet's Fourth Quarter and Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. At this time, I'll now turn the conference over to Rachel Ulsh, Vice President of Investor Relations. Ms. Ulsh, you may now begin your presentation.
Rachel Ulsh: Thank you. Good morning, and welcome to Freshpet's fourth quarter and fiscal year 2023 earnings call and webcast. On today's call are Billy Cyr, Chief Executive Officer, and Todd Cunfer, 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 Private Securities Litigation Reform Act of 1995. These include statements related to our long-term strategy, focus, 2027 goals, pace in achieving these goals, prospects for growth, and new technologies and 2024 guidance. Words such as believe, could, estimate, expect, guidance, intend, may, project, will or similar conditional expressions are intended to identify forward-looking statements.
These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements, including those associated with such statements and accuracies in third-party data. Please refer to the company's annual report on Form 10-K 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. Please note 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 the information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for how management defines such non-GAAP measures, why management believes such non-GAAP measures are useful, a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP and limitations associated with such non-GAAP measures. Finally, the company has produced a presentation that contains many of the key metrics that will be discussed on this call. That presentation can be found on the company's investor website.
Management's commentary will not specifically walk through the presentation on the call, rather, it is a summary of the results and guidance they will discuss today. With that, I would like to turn the call over to Bill Cyr, Chief Executive Officer.
Billy Cyr: Thank you, Rachel, and good morning, everyone. The message I would like you to take away from today's call is that we believe Freshpet has reached an inflection point on its journey towards becoming not only a sizable, but profitable business in the emerging fresh/frozen segment of the pet food market. We delivered the strong growth you've come to expect from us, but also turned a corner on our profitability and are on our way towards delivering the kind of profitability and cash flow one would expect of a market leader. In 2023, we made significant progress on nearly all the metrics we set out to deliver. And if we continue to execute as we did in 2023, we will prove that with increased scale comes increased profitability and in turn, shareholder value.
Our Feed the Growth strategy, which we implemented in 2017, was driven by our dual beliefs that fresh pet food is a scale-driven business, and that it was also important to maximize our first-mover advantage before competitors entered the fresh pet food market. Our transition to a fresh future plan last year reflected our belief that we are at the point where we have achieved sufficient scale and first-mover advantage such that we can begin to pivot to delivering the profitability that should come with that scale. Our 2023 results show the initial indications of our ability to drive that profitability, and we believe there is a significant opportunity to drive further profit improvement going forward. Now, let me walk you through some highlights for the fourth quarter and full year.
First, we ended the year with very strong net sales growth and exceeded our expectations with fourth quarter net sales of $215.4 million, up 30% year-over-year, driven primarily by volume growth of 25% and 5% price mix. This strong growth is compared to a very strong quarter last year when we had significant trade inventory refill. The growth was supported by a strong advertising presence and household penetration gains that accelerated throughout the quarter. Second, we continue to see the strong operational improvements our fresh future plans were designed to drive, including sequential improvement in adjusted gross margin, logistics costs and adjusted EBITDA. Fourth quarter adjusted gross margin was 41.1% compared to 40.2% in the third quarter and 33% in the prior year period.
Logistics costs came in at 6.3% of net sales, down from 9.4% in the prior year period, and 6.8% in the third quarter. Fourth quarter adjusted EBITDA was $31.3 million compared to $23.2 million in the third quarter and up 67% year-over-year. Fiscal year 2023 was our sixth consecutive year with greater than 25% sales growth with net sales of $766.9 million, up 29% year-over-year, on the high end of our targeted range and above our expectations. Full year adjusted EBITDA was $66.6 million, more than three times what we delivered in the previous year. These financial results demonstrate real momentum, the potency of our plans and the capability of our team. I'm incredibly proud of what you've been able to accomplish. In addition to those financial highlights, we delivered the significant increase in retail presence our retail partners sought as they became increasingly confident in our ability to supply them.
Specifically, a record of 5,251 fridge placements in 2023, including new stores, upgrades and second or third fridges, bringing us to a total of 34,274 fridges at retail or more than 1.7 million cubic feet of retail space. As of December 31, 2023, Freshpet could be found in 26,777 stores, more than 22% of which now have multiple fridges in the US. These fridge placements and store growth were supported by continued strong fill rates that ended the quarter in the high 90s. In addition to our strong retail business, we have also built a very strong digital business. Digital orders, which I previously referred to as e-commerce, we define as any time you order on a phone or a desktop, so this includes anything from buy online, pick up in store, to Instacart, Chewy and Amazon.
In 2023, our digital sales increased 58% year-over-year, and at this point, we are projecting digital orders to be over $100 million of net sales in 2024. The vast majority of our digital orders today are pickup or click and collect, which leverages our existing fridge network in retail. According to NielsenIQ, pickup is also the fastest-growing segment of online e-commerce in dog and cat food. During our ICR Conference presentation in January, you may recall hearing us talk about the mainstream main meal, more profitable plans, which I'll simply refer to as main and more. We're making the Freshpet brand more mainstream and getting people to use it as a main meal component, and this creates intensity and concentration of the business that we believe will allow us to be more profitable.
Diving a little deeper into the idea of mainstream, according to Nielsen Omnichannel data, which includes e-commerce and direct-to-consumer, as of December 30, 2023, total pet food is a $52 billion category. Within that is the $36 billion dog food category, which the majority of our business is today, and we have only a 3% market share, which leaves a vast runway for growth. At the same time, we have created a new segment within pet food, fresh/frozen pet food, that has gained scale and is growing quickly. Within the fresh/frozen subcategory in measured channels, Freshpet has a 96% market share. Our goal is to make fresh even more mainstream since our products appeal to a wide range of income groups, we have products for each stage of a pet's life and are growing our portfolio to better meet the needs of larger dogs.
Our household penetration at year-end was 11.555 million households, up 19% year-over-year and accelerating towards our target of over 20% household penetration growth. Our high-profit pet-owning households or HIPPOHs for short, grew even faster, up 28% versus a year ago. Household penetration has grown fastest with younger Gen Z consumers, and we saw growth across all income groups. We are on pace to meet our target of 20 million households by 2027. Overall retail availability continued to grow, with ACV at year-end of 64%, and we see upside in continued distribution gains going forward. We will continue to focus on depth too, not just breadth, increasing the percentage of stores with second and third fridges, I spoke about earlier. Focusing on the concept of main meal, we know that 40% of Freshpet buyers use the product as the main component of their pet's meal, and there is a huge opportunity to significantly increase this percentage even with our HIPPOHs. 37% of Freshpet users are HIPPOHs and they represented 89% of our sales in 2023.
We are using advertising to drive pet parents to feed Freshpet as the main meal item by focusing on healthy food, offering products at a variety of price points and expanding specialized recipes. The concept of converting toppers into main meal users will increase buy rate, which was $95.86 at year-end. Broadening availability of a wider range of our items can help drive more consumers to convert to using Freshpet as a main meal item. Adding second and third fridges enables us to do that, and this is -- also drives increased visibility for the brand, amplifying the value of our advertising. Based on mega-channel data, we currently have an average of 18.2 SKUs per store, up from 15.8 SKUs one year ago. Turning to the more part of main and more, more profitable, we are enhancing margins through improved operating performance and leveraging scale and efficiency.
We believe increased business intensity and concentration will drive increased efficiency, and we are seeing that play out in our margins already. Fourth quarter adjusted gross margin was up 810 basis points year-over-year to 41.1%, and adjusted EBITDA as a percent of net sales was 14.5% compared to 11.3% in the prior year period. Three key areas we have been most focused on have been input costs, logistics and quality. And we've improved all three this past year, with logistics now only 6.3% of net sales in the fourth quarter, down from 9.4% in the prior year period. In total, we improved those three areas by 390 basis points in Q4 and 560 basis points for the full year. Focusing on capacity. We feel good about where we are today. December was an all-time production record across the system despite the loss of time for holidays, driving very strong fill rates in the high 90s today.
And January production topped the December record. All three lines in the first phase of Ennis are operating today, and that site now accounts for 25% of our total system production, and as Phase 2 construction is on track for the start-up of the first roll line by the end of the third quarter of 2024. We've continued to evolve our capacity expansion plans to drive greater capital efficiency. We are very focused on, first, maximizing the output of our existing lines by investing in an operational excellence program designed to increase throughput. We are making good progress on that program in Bethlehem, and just started the plan in Ennis. Second, maximizing the capacity of our three existing sites so that we can avoid the high cost of incremental infrastructure and overhead.
This means finding ways to get more lines into each of the three sites. We've already announced plans to add a seventh line in Bethlehem. We believe we found a way to get an additional line or two in Kitchen South, and are also looking for ways to get more lines in Ennis. Third, developing new technologies that generate more throughput per line and per square foot of space. We've been working on this for some time and are making good progress, but are not ready to share any details at this time. Overall, 2023 put us ahead of the pace needed to deliver our 2027 goals and gave us increased confidence in our ability to either meet or exceed those goals. The strong 29% net sales growth in the year was ahead of what we had projected. As we head into 2024, we intend to manage the growth very closely, so that we do not get ahead of capacity or organization capability.
Our model works very well at 25% net sales growth over time, generating the right balance of cash generation and capital spending to deliver our financial targets. We do not want to get too far ahead of ourselves and upset that balance. We recovered 400 basis points of adjusted gross margin during the year, ahead of both our target and the pace needed to hit our 2027 target of a 45% adjusted gross margin, and we ended the fourth quarter with an even higher adjusted gross margin at 41.1%, giving us even more encouragement about our ability to deliver our long-term goal. We are well ahead of our long-term logistics target of 7.5% of net sales, delivering the target three years early and ending the year at a rate well below the target. It is clear that we have an opportunity to further improve in logistics and will likely set a new lower target in the future.
Operating cash flow of $76 million was also ahead of our plan and increases our confidence in our ability to fund our growth with no need for additional equity and potentially not even needing any new debt. In summary, we had a very good year, and we believe we are on the cusp of profitability with greater scale and efficiency due to increased business intensity and concentration and disciplined capital management. Now, let me turn it over to Todd to walk through the details of the Q4 results and our guidance for 2024. Todd?
Todd Cunfer: Thank you, Billy, and good morning, everyone. As Billy mentioned, we had an excellent fourth quarter and a very strong year. Now, I'll give you some more color on our financials and guidance for the year. Fourth quarter net sales were $215.4 million, up 30% year-over-year. Nielsen measured dollar growth was 28% versus prior year period with broad-based consumption growth across channels. We saw a 15% growth in pet specialty, 30% in xAOC, and over 100% growth in the unmeasured channels. Fiscal 2023 net sales were $766.9 million, up 29% year-over-year. Nielsen measured dollar growth was 27% versus prior year, again, with broad-based consumption growth across all channels, with 18% growth in Pet Specialty, 29% in xAOC, and approximately 85% growth in the unmeasured channels.
Fourth quarter adjusted gross margin was 41.1%, up 810 basis points year-over-year. This was driven by leverage on plant costs as well as improvements across our key focus areas, including quality costs. Fiscal 2023 adjusted gross margin was up 400 basis points year-over-year to 40.0% driven by progress on our operational improvement plan. Fourth quarter adjusted SG&A was 26.6% of net sales compared to 22.4% in the prior year period. We spent 6.3% of net sales on media in the quarter, up approximately $10 million from Q4 last year to help us get off to a fast start in 2024. We saw continued improvement in logistics costs, down to 6.3% of net sales, a decrease of 310 basis points compared to the prior year period. Fiscal 2023 adjusted SG&A was 31.3% of net sales, down from 32.9% in the prior year period.
Media spend for the year was 11.1% of net sales, up slightly from 10.5% from the prior year. Logistics costs were down to 7.5% of net sales, a 320 basis point improvement over the prior year. Fourth quarter adjusted EBITDA was $31.3 million or 14.5% of net sales compared to $18.7 million or 11.3% of net sales in the prior year period. This improvement exceeded our expectations and guidance and was driven by better-than-expected net sales and strong operating performance and cost of goods sold and logistics. Fiscal 2023 adjusted EBITDA more than tripled year-over-year to $66.6 million or 8.7% of net sales. Capital spending for fiscal 2023 was $239.1 million, in line with our expectations. Operating cash flow was $76 million, and we had cash on hand of $297 million at the end of the year.
We continue to believe that we have adequate cash to fully fund our growth through 2024, and we will be free cash flow positive in 2026. We also believe that we will have access to traditional non-dilutive forms of capital to bridge a gap in 2025 if it occurs. Now, turning to guidance for 2024. We expect net sales of at least $950 million driven by volume, and adjusted EBITDA to be in the range of $100 million to $110 million. We expect capital expenditures of approximately $210 million to support the installation of capacity to meet demand in 2025, further fridge placements and ordinary maintenance. It is important to understand that our growth rate directly impacts the capital we need to spend to build capacity. We are closely managing our cash balance, being very disciplined in our media spend and carefully managing sales growth while expanding capacity and increasing profitability.
We exceeded our expectations for 2023, which is why the net sales growth rate of at least 24% is slightly below our long-term target of 25%. We do not want to get ahead of the capacity build that we are putting in place. In terms of cadence, we expect a fast start to the year based on strong momentum from 2023, with Q1 being the highest percentage net sales growth rate year-over-year. We expect to see sequentially lower net sales growth rates as we progress throughout the year as we manage our growth to deliver the right balance between growth and capital investment as we talked about earlier. This should not be construed to imply that the business is slowing, quite the opposite. We are rigorously managing the timing and pace of our advertising investments to regulate the growth so that we can live within our capacity plans and carefully manage the cash required to build capacity.
We want to deliver as close to our long-term target of 25% net sales growth over time so that we don't get too far ahead of our capacity expansion. We expect an adjusted gross margin expansion of at least 100 basis points, and the absolute gross margin percentage to be slightly higher in the second half of the year versus first half. We will have some start-up costs on the third line in Ennis in Q1, and additional start-up costs on the fourth line in Ennis in Q4. At this point, we have about 70% of our commodity costs locked in for the year and currently expect modest deflation in 2024. We anticipate media to grow in line with sales, and we will pull back as necessary to control sales growth. Lastly, we expect sequential quarterly improvement in adjusted EBITDA.
Overall, we are proud of our 2023 results and believe we are in a strong position to deliver on our guidance with our momentum so far in 2024. With the actions we've taken and continued strong demand for our products, we remain confident in our ability to deliver on our fresh future plan and 2027 goals. We believe that when we look back a year or two from now, it will be apparent that 2023 was truly an inflection point for Freshpet in the fresh frozen category, and that Freshpet will be on its way to having a leading share in that segment and delivering the kinds of profits one would expect from the market leader in an emerging high-growth market. That concludes our overview. We will now be glad to answer your questions. As a reminder, we ask that you please focus your questions on the quarter, the guidance and the company's operations.
Operator?
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