Freshpet, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Unaudited; dollar amounts below are in U.S. dollars, generally millions unless noted. Freshpet manufactures and markets refrigerated fresh meals and treats for dogs and cats.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net sales | $200.6 | $151.3 | $551.5 | $429.5 |
| Gross profit / margin | $66.3 / 33.0% | $44.5 / 29.4% | $176.3 / 32.0% | $140.3 / 32.7% |
| SG&A / % of sales | $73.4 / 36.6% | $60.4 / 39.9% | $221.6 / 40.2% | $190.2 / 44.3% |
| Operating loss | $(7.1) | $(15.9) | $(45.3) | $(49.9) |
| Net loss | $(7.2) | $(18.4) | $(48.9) | $(56.6) |
| Adjusted EBITDA (non-GAAP) | $23.2 | $3.5 | $35.2 | $1.3 |
Q3 sales increased 32.6%; nine-month sales rose 28.4%. Management attributed growth to volume gains and higher pricing, chiefly in Grocery, Mass and Club. The company had 26,385 Freshpet Fridge locations at quarter-end, up from 24,651 a year earlier.
Q3 gross margin improved on lower unabsorbed plant costs as production grew into the Ennis facility and lower quality and input costs as a share of sales. For the nine-month period, reported gross margin declined, primarily reflecting higher depreciation and share-based compensation tied to capacity expansion, partly offset by lower input and quality costs. Adjusted Gross Profit margin, a non-GAAP measure, was 40.2% for Q3 and 39.5% year to date, versus 34.5% and 37.1%, respectively, in 2022.
SG&A increased in dollars but declined as a share of sales, reflecting lower logistics and ERP costs and operating leverage, partly offset by activism-related advisory fees and higher variable compensation. Q3 net loss improvement also reflected higher sales contribution, partly offset by increased SG&A, including $5.1 million of additional media spending. Interest and other income was $4.1 million for Q3 and $9.2 million year to date, mainly from cash and investments; interest expense was $4.1 million and $10.6 million, respectively.
Cash flow, liquidity and debt
- Cash and cash equivalents were $338.1 million at September 30, 2023, versus $132.7 million at December 31, 2022. Working capital was $378.6 million, compared with $172.4 million at year-end 2022.
- Nine-month operating cash flow was positive $39.0 million, versus negative $53.7 million in 2022. Investing cash flow was negative $161.6 million, primarily reflecting capital expenditures; financing cash flow was positive $328.0 million.
- Capital expenditures were approximately $161.6 million in the first nine months. Management expected to spend an additional $78.0 million in the remainder of fiscal 2023 on production projects, refrigerators, maintenance and other items.
- In March 2023, Freshpet issued $402.5 million principal amount of 3.00% convertible senior notes due April 2028. Their September 30 carrying value was $392.6 million and disclosed fair value was $473.1 million. The company spent $66.2 million on capped-call transactions intended to reduce potential conversion dilution, subject to a cap, and terminated its prior credit facility. A new manufacturing-equipment finance lease had $28.6 million of liabilities at quarter-end.
Outlook, risks and unusual items
Management said available cash, investments and expected operating cash flow, together with potential capital-markets access, should fund operations, obligations and growth for at least the next 12 months. This depends on achieving expected revenue and cash flow and managing costs and working capital; additional financing may be needed and may not be available on favorable terms. Capacity expansion at Freshpet Kitchens, including Ennis and South, is a major future cash requirement. The filing does not provide a full-year revenue or earnings forecast.
Key risks include timely completion and benefits of facility expansions, matching capacity to demand, input-cost inflation and supply-chain disruption, consumer demand and competition, ERP stabilization, interest rates, and macroeconomic and geopolitical uncertainty. Freshpet also disclosed shareholder-activism risks; Q3 included $5.5 million of advisory costs related to activism, and the nine-month amount was $8.2 million. The company reported an ongoing dispute with former distributor Phillips, which seeks damages in excess of $8.3 million plus other alleged damages; management did not believe an adverse material effect was likely based on information available, while noting an unfavorable outcome could be materially adverse. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter; ERP-related control work continues.
Adjusted EBITDA and adjusted gross profit are non-GAAP measures, exclude specified costs and other items, and should not be treated as substitutes for GAAP results or as measures of cash available for investment or debt service. Nine-month interest expense included a $2.5 million write-off of deferred financing costs when the credit facility was terminated.
Important facts for investors to verify
- Whether Ennis and South expansion projects meet construction, timing, cost and production-capacity expectations, and how the planned remaining-2023 capital spending compares with actual spending.
- Whether sales growth and improved Q3 margins persist, particularly given the nine-month decline in reported gross margin and continuing GAAP net losses.
- How operating cash generation develops relative to capital needs, note interest and lease obligations, and whether additional financing becomes necessary.
- The potential dilution and cash-settlement consequences of the convertible notes, including the conversion terms and capped-call limits.
- Developments in the Phillips litigation and shareholder activism, including related costs and any effect on operations or strategy.