Freshpet, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Financial statements are unaudited. Dollar amounts below are in millions unless noted.
Business context and results
Freshpet manufactures and sells refrigerated fresh meals and treats for dogs and cats. Products are distributed through grocery, mass and club, pet specialty, and natural retailers. The company reported 25,963 Freshpet Fridge locations at quarter-end.
| Metric | Q2 2023 | Q2 2022 | First half 2023 | First half 2022 |
|---|---|---|---|---|
| Net sales | $183.3 | $146.0 | $350.9 | $278.2 |
| Gross profit / margin | $59.2 / 32.3% | $51.1 / 35.0% | $110.0 / 31.4% | $95.8 / 34.5% |
| Operating loss | $(16.8) | $(18.1) | $(38.3) | $(34.0) |
| Net loss | $(17.0) | $(20.6) | $(41.7) | $(38.1) |
| Loss per diluted share | $(0.35) | $(0.45) | $(0.87) | $(0.85) |
| Adjusted EBITDA (non-GAAP) | $9.0 | $(1.9) | $12.0 | $(2.2) |
Cash flow, liquidity and debt
- First-half operating cash flow was $(0.2), compared with $(62.4) in the prior-year period. Investing cash flow was $(215.9), including $102.5 of capital expenditures and $113.4 of short-term investment purchases. Financing cash flow was $327.5, primarily from the convertible notes.
- At June 30, cash and cash equivalents were $244.0 and short-term investments were $114.4; working capital was $409.7, versus $172.4 at December 31, 2022.
- Freshpet issued $402.5 principal amount of 3.00% convertible senior notes due April 2028. Their reported carrying value was $391.9 and disclosed fair value was $476.3. The notes are unsecured; the initial conversion price is approximately $69.68 per share. The company used $66.2 of proceeds for capped-call transactions, with an initial cap price of approximately $120.23 per share.
- The former credit facility was terminated effective March 15, 2023, with no borrowings outstanding. Q2 interest expense was $3.3; first-half interest expense was $6.5, including a $2.5 write-off of unamortized credit-facility fees.
Material changes versus comparable periods
- Q2 sales rose 25.6%; first-half sales rose 26.1%, driven by velocity gains and higher pricing, principally in grocery, mass and club. Store count increased by 1,686 year over year.
- Reported gross margin declined in both periods, reflecting higher depreciation from capacity expansion, unabsorbed plant costs and share-based compensation; lower input and quality costs partly offset these pressures. Adjusted gross margin, a non-GAAP measure, improved to 39.8% in Q2 from 38.7%, and to 39.2% for the first half from 38.5%.
- SG&A increased in dollars but declined as a share of sales: 41.5% versus 47.4% in Q2 and 42.3% versus 46.7% for the first half. Management cited logistics-cost reductions, media-spend leverage and lower ERP-related costs.
- Q2 net loss narrowed year over year, but first-half net loss widened. Management attributed the first-half increase to higher SG&A, including $7.4 of additional media spend, higher depreciation and unabsorbed plant costs, partly offset by contribution from higher sales.
Outlook, commentary and risks
- No specific revenue, earnings or margin guidance is provided in the filing. Management expects to spend an additional approximately $140.0 on production projects, new and replacement fridges, maintenance and other capital expenditures in the remainder of 2023. First-half capital spending was approximately $100.0.
- Management stated that cash, short-term investments, expected operating cash flow and potential capital-market access should fund operations and planned needs 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.
- Key execution risks include timely completion and benefits of Freshpet Kitchens expansions, matching manufacturing capacity to demand, input-cost inflation, supply-chain management, ERP stabilization and the effectiveness of marketing. The company also cites interest-rate, foreign-exchange, competitive, regulatory and climate-related risks.
- The Phillips Feed Service litigation includes a claim for damages exceeding $8.3, additional claimed damages and Freshpet’s counterclaim. Freshpet reclassified $9.0 due from Phillips to other noncurrent assets. Management does not expect a material adverse outcome based on information available, but notes an unfavorable resolution could be material.
- Freshpet disclosed shareholder activism as a risk, including potential expense, disruption, litigation or proxy contests. It reported disclosure controls effective and no material change in internal controls during the quarter; ERP-related control review continues.
Important facts for investors to verify
- Whether capacity expansion proceeds on schedule and converts into sales growth without continued pressure from depreciation and unabsorbed plant costs.
- Whether adjusted EBITDA progress translates into durable GAAP profitability and operating cash generation; adjusted measures exclude items and are not substitutes for GAAP results or cash flow.
- Remaining 2023 capital spending, funding needs and liquidity after planned factory and fridge investments.
- Convertible-note terms and potential dilution or cash-settlement exposure, including the capped-call limits.
- Developments in the Phillips litigation and shareholder-activism matters, as well as the ongoing stabilization of the ERP system.