Freshpet, Inc. — Q3 2018 Form 10-Q
Business context and period: Freshpet manufactures and markets fresh pet food in the U.S., Canada and Europe. This unaudited quarterly report covers the three and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Freshpet reported 19,107 Freshpet Fridge locations at quarter-end, up 8.3% year over year.
Financial results and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $50.8 million | $40.1 million | $141.6 million | $112.5 million |
| Gross profit / margin | $23.6 million / 46.5% | $19.5 million / 48.6% | $66.6 million / 47.1% | $53.5 million / 47.5% |
| Operating income (loss) | $0.04 million | $0.20 million | $(6.8) million | $(4.4) million |
| Net loss | $(0.10) million | $(0.25) million | $(7.1) million | $(5.8) million |
| Operating cash flow | Not reported quarterly | Not reported quarterly | $8.5 million | $5.1 million |
- Q3 sales rose 26.6%; nine-month sales rose 25.8%. Grocery, online, mass and club generated 82% of sales in both periods. Pet specialty and natural sales also increased.
- GAAP gross margin fell 2.1 percentage points in Q3 and 0.5 points for the nine months. Management cited higher raw-material costs and labor costs ahead of seven-day operations, partly offset by scale, production efficiencies and depreciation leverage.
- SG&A was $23.6 million in Q3 and $73.4 million for the nine months. Nine-month SG&A rose 26.9%, faster than sales, reflecting higher media spend, volume-related costs, depreciation and option expense, and increased staffing and employee costs.
- For the nine months, investing cash outflow was $12.7 million, principally capital expenditures; financing cash inflow was $4.8 million. Cash increased $0.7 million to $2.9 million. Capital spending exceeded operating cash flow by approximately $4.1 million.
- At September 30, cash was $2.9 million, current assets $27.1 million and current liabilities $18.7 million. The company reported $2.0 million of credit-facility borrowings and $28.0 million of available capacity under the facility. Working capital was approximately $7.5 million.
- Total assets were $135.8 million and total liabilities $19.0 million. Interest expense was $0.1 million for Q3 and $0.3 million for the nine months. The $30 million revolving facility matures in September 2020; rates are variable.
Changes, outlook and notable items
- Freshpet plans a roughly $100 million manufacturing expansion, including renovation of an existing 50,000-square-foot building and a 90,000-square-foot addition. The company expects the facility to support capacity exceeding $500 million in net sales; production start-up is planned for the second half of 2020. These are plans, not guaranteed outcomes.
- Management said cash on hand, expected operating cash flow and borrowing capacity should fund operations and planned investment for the foreseeable future, while cautioning that funding needs depend on revenue, cash generation and cost management. The filing provides no specific sales or earnings guidance.
- Freshpet adopted revenue-recognition Topic 606 retrospectively in 2018. Prior-period net sales and cost of goods sold were reclassified, with no material effect on net loss or gross profit.
- Q3 Adjusted EBITDA was $6.7 million versus $5.6 million a year earlier; nine-month Adjusted EBITDA was $11.1 million versus $10.7 million. These are non-GAAP measures and include specified adjustments; they should not be treated as substitutes for GAAP results or cash flow.
- Share-based compensation expense increased; a revised assessment of performance-option targets deemed an additional 219,185 shares probable of achievement and resulted in $0.5 million of additional Q3 expense.
- The company faces commodity-price, manufacturing-capacity, supply-chain, competition, marketing-effectiveness and financing risks. It reported two securities lawsuits; Freshpet disputes the allegations and said it could not estimate a reasonable possible loss. The second case was stayed pending specified milestones in the earlier case.
- 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 the manufacturing expansion remains on schedule and within the planned investment, and when additional capacity can be utilized.
- Whether sales growth can continue while raw-material and labor costs are contained and gross margins stabilize.
- Cash conversion and capital needs: nine-month operating cash flow was $8.5 million against $12.7 million of investing outflows; confirm the future funding plan for the expansion.
- Availability and terms of revolving-credit borrowing, including variable-rate exposure and the September 2020 maturity.
- Developments and potential exposure in the securities litigation, which the company said it could not quantify.
- Comparability of reported growth: 2017 sales were recast under Topic 606, and non-GAAP Adjusted EBITDA and margin measures exclude selected costs.