Freshpet, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited consolidated results; comparisons are with the corresponding 2015 periods. Freshpet manufactures and markets fresh pet food and treats, sold through a refrigerated retail network.
Key financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $34.5 million | $30.6 million | $99.0 million | $86.0 million |
| Gross profit / margin | $15.4 million / 44% | $14.0 million / 46% | $45.2 million / 46% | $41.0 million / 48% |
| Operating income (loss) | $0.8 million | $(2.0) million | $(3.8) million | $(6.5) million |
| Net income (loss) | $0.6 million | $(1.7) million | $(4.4) million | $(6.5) million |
| Net income (loss) per share, basic | $0.02 | $(0.05) | $(0.13) | $(0.19) |
Q3 SG&A was $14.5 million (42% of sales), down from $16.1 million (53%). Nine-month SG&A rose to $48.9 million from $47.5 million, but declined to 49% of sales from 55%. Management-reported adjusted gross margin was 49.6% in Q3 and 49.5% year to date; adjusted SG&A was 40.8% and 44.8% of sales, respectively. These are non-GAAP measures and exclude specified expenses.
Cash flow and liquidity: Nine-month operating cash flow was $7.3 million versus $5.0 million in 2015; investing cash outflow was $22.8 million and financing cash inflow was $11.0 million. Cash fell to $3.5 million from $8.0 million at year-end 2015. Current assets were $19.3 million and current liabilities $19.6 million, yielding working capital of approximately negative $0.3 million, versus positive $16.2 million at year-end. Property, plant and equipment, net, was $100.0 million.
Debt: $9.0 million was outstanding under secured credit facilities at September 30, 2016; the company reported covenant compliance. The filing states $30.0 million of borrowing capacity was available. Variable-rate debt exposure means a 100-basis-point rate change would affect annual interest expense by about $0.1 million.
Material changes and business developments
- Sales increased 13% in Q3 and 15% for the first nine months. Growth was led by Grocery, Mass and Club refrigerated products. Freshpet Fridge locations increased 10.8% year over year to 16,261.
- Q3 gross margin declined 150 basis points year over year; nine-month margin declined 203 basis points. The company cited expansion-related depreciation and plant start-up costs, as well as throughput constraints and sales mix for the nine-month period.
- Q3 operating results improved to income from a loss, helped by higher sales and lower SG&A, including lower advertising, share-based compensation and outbound freight costs. The nine-month net loss narrowed by about $2.1 million.
- Freshpet invested $17.4 million in its Freshpet Kitchens expansion during 2016. Some new equipment entered service in July; the remainder was expected to enter service in Q4. Management said the expansion is expected to increase plant capacity by at least 130% over time.
Outlook, risks and contingencies
- No specific revenue or earnings guidance was provided. Management expected cash, operating cash flow and planned borrowing capacity to fund foreseeable requirements, and expected to repay the remaining expansion-related borrowing by the end of the first half of 2017.
- The company began a UK test with two retailers, with products in 63 stores. Management identified growth execution, manufacturing capacity, cash generation and access to financing as important uncertainties.
- Other cited risks include ingredient and commodity costs, reliance on key customers and suppliers, product safety and regulatory issues, marketing effectiveness, and the ability to sustain brand growth. One distributor represented 25% of Q3 sales; one vendor supplied about 22% of raw materials, and three vendors supplied 89% of packaging materials.
- A securities lawsuit filed against the company and certain officers and directors remained at an early stage. Freshpet said it intended to defend the claims and could not estimate a reasonably possible loss. Other ordinary-course claims were not expected to have a material adverse effect. The filing reported no material changes to previously disclosed risk factors.
- Accrued leadership-transition costs were $0.6 million at quarter-end. The company reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether expanded manufacturing capacity comes online as planned and improves utilization and gross margins after start-up costs and depreciation.
- Whether operating cash flow can support ongoing capital needs and the stated repayment timeline, given low cash and negative working capital.
- Whether sales growth and store additions continue, particularly in Grocery, Mass and Club, and how the UK test develops.
- Exposure to concentrated distribution, ingredient and packaging suppliers, and the potential impact of input-cost increases or disruptions.
- Developments in the securities litigation and any resulting financial exposure; the filing provides no loss estimate.