Freshpet, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. Freshpet manufactures and markets fresh pet food and treats in the United States and Canada.
Financial results
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $31.5 million | $27.1 million | Up 16% |
| Gross profit | $14.9 million | $13.3 million | Up 12% |
| Gross margin | 47% | 49% | Down 170 basis points |
| SG&A | $16.5 million | $15.7 million | Up 5% |
| Operating loss | $1.6 million | $2.4 million | Loss narrowed 34% |
| Net loss | $1.8 million | $2.6 million | Loss narrowed 32% |
| Net loss per share | $0.05 | $0.08 | — |
| Operating cash flow | $2.0 million | $1.1 million | — |
| Capital expenditures and equipment deposits | $13.0 million | $5.0 million | — |
| Cash at quarter end | $0.3 million | $24.9 million | — |
Gross margin was pressured by newer products, manufacturing throughput constraints and $0.2 million of non-capitalizable start-up costs. Excluding those start-up costs, Q1 2016 gross margin was 48%, still down 100 basis points year over year. SG&A fell to 52% of sales from 58%.
Adjusted EBITDA, a non-GAAP measure, was $2.5 million versus $2.0 million. It includes adjustments for stock compensation, launch and plant start-up costs, equipment disposal and warrant valuation; the company cautions that it is not a substitute for GAAP results or a measure of discretionary cash.
Business performance and material changes
- Sales growth reflected higher sales velocity across retail channels and an increase in Freshpet Fridge locations from 14,019 to 15,429, up 10.1%.
- Grocery, mass and club generated $24.2 million, or 77% of sales; pet specialty, natural and other generated $7.3 million, or 23%.
- Freshpet Baked sales were $1.6 million, or 5.2% of sales, compared with $0.6 million, or 2.0%, a year earlier.
- Inventory increased to $8.2 million from $6.9 million at December 31, 2015. Working capital fell to $5.7 million from $16.2 million, primarily reflecting capital spending, higher inventory and lower cash.
Liquidity, debt and outlook
- At March 31, Freshpet had no borrowings outstanding under its $40 million secured credit facilities and was in covenant compliance. The facilities carry variable interest rates and are secured by substantially all assets.
- In April 2016, the company drew $5 million. Management said it planned to borrow approximately $8 million to $10 million to fund the expansion and expected to repay that borrowing by Q1 2017.
- The Freshpet Kitchens expansion is intended to increase production capacity by at least 130%. The company spent $10.7 million on the project in Q1 and expected to spend up to a further $7 million to complete it by the end of Q3 2016.
- Management expects scale, higher utilization and expanded capacity to support improved gross margins, and expects SG&A to decline as a percentage of sales. These are expectations, not quantified financial guidance.
- Management believed cash, operating cash flow and borrowing capacity would fund obligations and planned spending for the foreseeable future, while warning that additional financing might be needed if operating results or cash generation fall short.
Risks, contingencies and other items
- A securities lawsuit filed in April 2016 named the company and certain executives and directors. Freshpet said it intended to defend the claims; it had not been served and could not estimate a reasonably possible loss.
- Sales concentration included one distributor, which sells to three customers, accounting for 21% of Q1 sales. Supplier concentration included one raw-material vendor at 22%; four vendors supplied about 90% of treats, and three supplied 72% of packaging materials.
- Other disclosed risks include manufacturing capacity and execution of growth plans, ingredient and commodity cost volatility, dependence on marketing effectiveness and key customers, and product safety, regulatory and reputational matters.
- There were no material changes to the risk factors in the 2015 Form 10-K. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the Kitchens expansion was completed on schedule and within the remaining budget, and whether added capacity improved throughput and gross margin.
- Actual borrowing under the credit facilities, repayment timing, interest costs and continued covenant compliance.
- Whether operating cash flow and liquidity adequately support capital spending and working-capital needs given the low quarter-end cash balance.
- Whether sales growth and refrigerator placement translate into sustained sales velocity, profitability and reduced customer or supplier concentration.
- Developments in the securities lawsuit and whether any loss estimate or disclosure becomes possible.