Freshpet, Inc. — Q2 2016 Form 10-Q
Business and period: Freshpet manufactures and markets fresh pet food and treats. This unaudited filing covers the quarter and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $33.0 million | $28.4 million | $64.5 million | $55.4 million |
| Gross profit | $14.9 million | $13.7 million | $29.8 million | $26.9 million |
| Gross margin | 45% | 48% | 46% | 49% |
| SG&A | $17.9 million | $15.7 million | $34.4 million | $31.4 million |
| Operating loss | $3.0 million | $2.1 million | $4.6 million | $4.5 million |
| Net loss | $3.2 million | $2.2 million | $5.0 million | $4.8 million |
| Net loss per share | $0.10 | $0.07 | $0.15 | $0.14 |
- Sales increased 16% in both periods, with management attributing growth to higher sales velocity and a 10% increase in Freshpet Fridge locations, to 15,795. Grocery, mass and club accounted for 78% of sales.
- Gross margin declined 298 basis points in Q2 and 233 basis points for the half. Management cited new-product and sales mix, manufacturing throughput constraints, and expansion start-up costs of $0.4 million in Q2 and $0.7 million for the half.
- SG&A rose in dollars, but fell as a share of sales: 54% versus 55% in Q2 and 53% versus 57% for the half. Q2 included $1.6 million of leadership-transition costs; management also reported higher advertising, depreciation, and operating expenses.
- Six-month operating cash flow was $3.4 million, versus $2.1 million in 2015. Investing cash outflow was $18.0 million, principally reflecting capital investment; financing cash inflow was $8.2 million, including $8.0 million of credit-facility borrowings.
Financial position and liquidity
- At June 30, cash was $1.7 million, down from $8.0 million at December 31, 2015. Current assets were $18.6 million and current liabilities $20.6 million, producing negative working capital of approximately $2.0 million.
- Debt outstanding was $8.0 million under the credit facilities; the company reported $32.0 million of facility availability and compliance with covenants. In July, it drew an additional $2.0 million. Management expected to repay the borrowings by the first half of fiscal 2017.
- Six-month capital expenditures and equipment deposits were $21.2 million in cash-flow reporting. The Freshpet Kitchens expansion accounted for $15.3 million of investment during the half; approximately $2.5 million more was expected to complete the project by the end of Q3. Management expects the expansion to increase production capacity by at least 130%.
- Management said available cash, operating cash flow and borrowing capacity should fund foreseeable needs, while cautioning that growth, cash generation, financing availability and working-capital needs could affect liquidity.
Outlook, risks and unusual items
- Management expects gross margins to improve over time as production scales, new products mature and expanded capacity yields efficiencies. It also expects SG&A to decline as a percentage of sales and anticipated logistics efficiencies from a new provider.
- These are expectations, not quantified earnings guidance. The filing does not provide a clear numerical revenue or earnings forecast.
- Adjusted EBITDA was $3.5 million for Q2 and $5.9 million for the first half, versus $2.8 million and $4.8 million, respectively. This is a company-defined non-GAAP measure; the filing cautions it is not a substitute for GAAP results or discretionary cash flow.
- A securities lawsuit filed in April 2016 names the company and certain officers and directors. Freshpet disputes the allegations but could not estimate a possible loss. Other ordinary-course claims were not expected to have a material adverse effect.
- Key risks include manufacturing capacity and execution of the expansion, ingredient and commodity costs, customer or supplier concentration, product safety and regulation, and the ability to generate cash or obtain financing. One distributor represented 21% of first-half sales; one vendor supplied approximately 22% of raw materials, while three vendors supplied 87% of packaging materials.
- Disclosure controls were reported effective, with no material change in internal control identified during the quarter.
Investor verification priorities
- Track whether the capacity expansion finishes on schedule and budget, and whether the anticipated capacity and margin benefits materialize.
- Assess cash burn, working capital, available borrowing capacity, covenant compliance, and repayment timing after the additional July borrowing.
- Reconcile sales growth and store expansion with falling gross margins, operating losses, and the company’s non-GAAP adjustments.
- Monitor distributor and supplier concentration, commodity exposure, and the status and potential financial impact of the securities lawsuit.
- Review the assumptions behind management’s margin and cost-efficiency outlook; the filing gives no quantified earnings guidance.