Freshpet, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. Freshpet manufactures and markets refrigerated and other natural pet food products in the U.S., Canada and Europe. This unaudited quarterly report covers the three and six months ended June 30, 2018, compared with the same 2017 periods. The company reported 18,662 Freshpet Fridge locations at quarter-end.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $47.6 million | $38.7 million | $90.8 million | $72.4 million |
| Gross profit | $22.9 million | $18.2 million | $43.0 million | $34.0 million |
| Gross margin | 48.0% | 46.9% | 47.4% | 46.9% |
| SG&A | $26.3 million | $20.0 million | $49.8 million | $38.5 million |
| Operating loss | $3.4 million | $1.8 million | $6.8 million | $4.6 million |
| Net loss | $3.5 million | $2.7 million | $7.0 million | $5.5 million |
| Net loss per share, diluted | $0.10 | $0.08 | $0.20 | $0.16 |
- Cash flow: First-half operating cash flow was $3.1 million, versus cash used of $0.1 million in 2017. Investing activities used $8.9 million, primarily for plant, refrigeration equipment and other capital spending; financing activities provided $4.7 million. Cash declined from $2.2 million at year-end 2017 to $1.1 million.
- Liquidity and debt: Working capital was $7.5 million, down from $8.1 million at December 31, 2017. The company had $4.0 million drawn on its revolving credit facilities and reported $26 million of available capacity. The $30 million revolver matures in September 2020 and may be increased by $10 million, subject to terms. Debt bears variable interest; management estimated a 100-basis-point rate change would affect annual interest expense by less than $0.1 million.
- Balance sheet: Total assets were $133.4 million and stockholders’ equity was $113.0 million at June 30, 2018. Capital expenditures were $8.9 million in the first half, compared with $7.2 million in 2017.
Material changes versus the prior comparable period
- Q2 sales increased 23%; first-half sales increased 25%. Refrigerated grocery, mass and club channels drove most of the growth. Freshpet Fridge locations increased 7.5% year over year. First-half sales excluding Baked products rose 28%, while Baked sales declined.
- Q2 gross margin improved 110 basis points, and first-half margin improved 50 basis points. Management cited scale and production efficiencies, partly offset by higher raw-material costs and labor costs ahead of a seven-day operation planned to begin in Q3.
- SG&A grew faster than sales: 31% in Q2 and 29% in the first half. Higher media spending was a major contributor. SG&A rose to 55.2% of Q2 sales from 51.6%, and to 54.9% of first-half sales from 53.2%.
- Operating and net losses widened in both comparison periods, notwithstanding higher sales and gross profit. First-half adjusted EBITDA, a non-GAAP measure, was $4.3 million versus $5.1 million; Q2 adjusted EBITDA was $2.5 million versus $3.2 million.
Outlook, commentary, risks and unusual items
- Management expects to invest approximately $100 million in capital expenditures to expand plant capacity and distribution. It said cash, expected operating cash flow and planned borrowing capacity should fund obligations for the foreseeable future, while cautioning that funding depends on sales, cash generation and cost management. No specific revenue or earnings guidance is provided in the filing.
- Management’s growth strategy emphasizes expanding Freshpet Fridge placements and investing in marketing. It said increased media investment may keep SG&A as a percentage of sales from declining significantly in the near term.
- Key disclosed risks include manufacturing capacity, ingredient and commodity costs, supply-chain execution, marketing effectiveness, customer concentration, product safety and regulatory scrutiny, and the ability to generate cash or obtain financing on acceptable terms.
- Two securities lawsuits are pending. The company disputes the allegations and intends to defend itself; it cannot estimate a reasonably possible loss. The newer Meldon action was stayed pending specified developments in the earlier Curran action. The filing reports $0.2 million of litigation expense in the first half.
- Freshpet adopted revenue-recognition Topic 606 retrospectively in Q1 2018. The change reclassified certain amounts between net sales and cost of goods sold, did not materially affect the financial statements, and did not affect net loss. The company expects to recognize its corporate office lease on the balance sheet upon adopting the new lease standard.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether sales growth and refrigerator expansion continue, and whether growth translates into improved operating profitability.
- Execution, timing and funding of the planned approximately $100 million capacity and distribution investment, including cash burn and borrowing needs.
- Whether media spending, input costs and the transition to seven-day operations improve or pressure margins and SG&A leverage.
- Developments in the securities litigation and any resulting financial exposure.
- That non-GAAP adjusted gross profit, adjusted SG&A and adjusted EBITDA exclude specified costs and should be considered alongside GAAP results.