Freshpet, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Freshpet manufactures and markets fresh pet food distributed through retail channels. Figures are unaudited.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $80.0 million | $60.1 million | $150.1 million | $114.8 million |
| Gross profit / margin | $33.9 million / 42.4% | $27.3 million / 45.5% | $65.7 million / 43.8% | $53.2 million / 46.4% |
| Operating income (loss) | $0.2 million | $(5.3) million | $(2.7) million | $(8.7) million |
| Net income (loss) | $0.15 million | $(5.66) million | $(3.44) million | $(9.08) million |
| Cash flow from operations | Not separately presented for Q2 | $(5.1) million | $(9.8) million |
- Q2 sales increased 33.2% year over year; first-half sales increased 30.7%. Grocery, online, mass and club channels drove most of the increase. Freshpet Fridge locations rose 8.4% to 22,120.
- Q2 GAAP gross margin declined 310 basis points year over year; first-half margin declined 260 basis points. Management cited COVID-related costs, plant start-up and processing costs, ramp-up of seven-day production, depreciation and share-based compensation; pricing and mix partly offset these items.
- Q2 GAAP SG&A was $33.7 million, up 3.2%, while SG&A as a share of sales fell to 42.1% from 54.4%. Q2 adjusted EBITDA, a non-GAAP measure, was $11.2 million (14.0% of sales), versus $1.2 million (2.0%).
- Six-month investing cash outflow was $93.3 million, including $73.3 million for property, equipment, software and equipment deposits, and $20.0 million of short-term investment purchases. Financing cash inflow was $196.6 million.
- At June 30, cash and cash equivalents were $107.7 million, short-term investments $20.0 million, working capital $153.2 million and total assets $411.9 million. Cash plus short-term investments totaled $127.7 million.
- No credit-facility borrowings were outstanding at June 30, compared with $54.5 million net debt at December 31, 2019. The new senior secured facility provides up to $165 million: a $130 million delayed-draw term facility and a $35 million revolver, subject to conditions and covenants. Lease liabilities totaled $9.2 million.
Material changes and business developments
- Freshpet raised $252.1 million net through a primary equity offering, issuing 4.0 million shares; shares issued rose from 36.2 million at year-end 2019 to 40.5 million at June 30, 2020.
- Capital spending expanded substantially: property, plant and equipment net increased to $220.1 million from $165.3 million at year-end, with construction in progress of $96.2 million.
- Kitchens South began production in February 2020; a second shift was advanced during Q2. Kitchens 2.0, a planned 90,000-square-foot expansion, was expected to begin production in Q4 2020. The company reported approximately $70.6 million invested in that project to date. Kitchens 3.0 planning began, with initial production expected by Q4 2022.
Outlook, commentary and risks
- COVID-19 initially drove a demand surge that exceeded production capacity and caused incomplete order fulfillment. Management said Q2 record production helped raise fill rates from the mid-70% range in early April to the 90% range by quarter-end; it expected further improvement toward 95% or more as capacity expanded.
- Management estimated approximately $4 million of COVID-related expenses for 2020, with Q2 the peak quarter, and expected beef costs to rise nearly $2 million in the second half. Chicken prices were contractually fixed, subject to limited exceptions. The company had used secondary suppliers at times but reported no extended supply interruptions to date.
- The 2020 outlook assumed no material change in customer operations, consumer purchasing behavior or supply chain conditions. The company expected to invest over $300 million in capital expenditures over the next three years and said available liquidity, anticipated operating cash flow and borrowing capacity should fund foreseeable needs.
- Key uncertainties include further pandemic waves, employee and supplier disruption, demand and retail traffic changes, capacity-project execution, ingredient cost inflation, and the ability to generate cash or obtain financing. COVID-related demand could again exceed capacity.
- The Curran securities lawsuit settlement was fully paid by insurers and became final in April 2020. A separate derivative suit remained subject to court approval of a proposed settlement; Freshpet accrued $0.2 million and recorded a probable insurance recovery of the same amount. Other ordinary-course claims were not expected to have a material adverse effect, though the filing notes claims could increase.
Investor verification points
- Track whether Kitchens 2.0 and Kitchens 3.0 meet planned timelines, budgets and production targets, and whether added capacity supports sustained fill rates.
- Compare reported GAAP margins and cash generation with non-GAAP adjusted results, reviewing the exclusions for COVID costs, start-up expenses, depreciation and share-based compensation.
- Assess whether demand growth persists after pandemic-related stock-up activity and whether retailer and consumer behavior normalizes.
- Monitor second-half beef costs, COVID-related expenses, working-capital needs and operating cash flow against management’s estimates.
- Verify availability and conditions of the delayed-draw and revolving facilities, covenant compliance, and whether future capital spending requires additional financing or shareholder dilution.
- Follow court approval and final resolution of the derivative lawsuit settlement.