Freshpet, Inc. — Q1 2020 Form 10-Q
Business context and period. Freshpet manufactures and sells refrigerated fresh pet food and treats. This unaudited report covers the three months ended March 31, 2020, compared with Q1 2019; balance-sheet comparisons are with December 31, 2019.
Financial results and liquidity
| Metric | Q1 2020 | Q1 2019 / comparison |
|---|---|---|
| Net sales | $70.1 million | $54.8 million; up 27.9% |
| Gross profit / margin | $31.8 million / 45.4% | $25.9 million / approximately 47.3% |
| SG&A | $34.7 million; 49.5% of sales | $29.2 million; 53.4% of sales |
| Operating loss | $2.9 million | $3.3 million |
| Net loss / diluted loss per share | $3.6 million / $0.10 | $3.4 million / $0.10 |
| Adjusted EBITDA (non-GAAP) | $5.7 million; 8.2% of sales | $2.8 million; 5.1% of sales |
| Cash from operations | $(2.5) million | $(4.5) million |
| Investing cash flow | $(54.2) million | $(10.5) million |
| Financing cash flow | $196.8 million | $11.1 million |
At March 31, cash and cash equivalents were $149.5 million and short-term investments were $20.0 million, versus $9.5 million of cash and no short-term investments at year-end. Working capital was $177.4 million, up from $12.3 million. The company reported no debt outstanding at quarter-end. It had $35.0 million available under its credit facilities, with $2.0 million reserved for letters of credit.
Q1 financing included $252.1 million net proceeds from a 4.0 million-share equity offering, $20.9 million of credit-facility borrowings and $76.0 million of debt repayments. Investing outflows included $34.2 million for property, equipment, software and equipment deposits, plus $20.0 million for short-term investments. The filing describes approximately $28.1 million of Kitchens capital expenditures and $6.1 million for fridges and other capital spending.
Material changes and operating drivers
- Sales rose $15.3 million, primarily from Grocery (including online), Mass and Club, which contributed $60.8 million; Pet Specialty and Natural sales were $9.3 million. Freshpet Fridge locations increased 9% year over year to 21,867.
- Gross margin declined about 190 basis points. Management cited higher processing costs, labor and overhead from seven-day production, plant start-up costs and COVID-19 costs, partly offset by pricing and mix.
- SG&A increased 18.6% in dollars, including higher media spending, operating costs, volume-related costs, depreciation and options expense. As a share of sales, SG&A declined. Adjusted gross profit, Adjusted SG&A and Adjusted EBITDA are non-GAAP measures; the company cautions they are not substitutes for GAAP results and may not be comparable across companies.
- Net loss increased slightly despite improved operating loss, partly reflecting $0.7 million of interest expense, including a $0.6 million write-off of debt issuance fees on repayment of the term loan.
Outlook, risks and unusual items
- COVID-19: Stockpiling drove a surge in customer orders late in Q1, at times exceeding production capacity; Freshpet said it could not ship all orders. The surge continued into early April. Management expected to catch up with demand and rebuild trade inventories in Q2, based on assumptions that customer operations, purchasing behavior and supply chains would not materially worsen. This was preliminary commentary, not quantified financial guidance.
- The company added employee safety measures and staffing, and reported higher pandemic-related costs. It cited uncertainty around future fridge placements, product listings, costs, supply availability and the pandemic’s duration and effects.
- Capacity investment: Kitchens South began production in February after approximately $15 million of investment. Kitchens 2.0, a 90,000-square-foot expansion, was expected to begin production in the second half of 2020; approximately $57.5 million of an estimated $110 million cost had been invested by the filing date. Initial production at Kitchens 3.0 was expected by Q4 2022. The company expected to invest over $300 million in capital expenditures over the next three years.
- The February 2020 “Feed the Growth — 5 by 2025” plan targets adding five million households by 2025. Freshpet also began ERP-system selection work, with the project expected to run through Q4 2021.
- On April 17, 2020, after quarter-end, Freshpet amended its facility to $165 million, comprising a $130 million delayed-draw term loan and a $35 million revolver, maturing in 2025. The company planned to use equity proceeds, facility borrowings and operating cash to fund expansion.
- Litigation: The company accrued $10.1 million for a securities settlement and recorded a matching probable insurance recovery. The court approved the settlement on March 11; no appeal was taken within the 30-day period and the judgment became effective April 10. A related derivative case had an agreement in principle, subject to court approval; $0.2 million was accrued with a matching probable insurance recovery.
- Other identified risks include manufacturing capacity and execution, supply-chain and commodity costs, customer concentration, competition, product safety and regulation, and ability to fund growth. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether production capacity and trade inventories recovered as expected after the Q1 demand surge, and whether customer demand and shipments remained aligned.
- Actual costs, timing and production ramp-up of Kitchens 2.0, Kitchens 3.0 and other planned capital projects, alongside the stated multiyear capital-spending plan.
- Cash burn, working-capital needs and funding availability, including terms and conditions of the post-quarter $165 million credit facility.
- Drivers of gross-margin pressure and whether the non-GAAP adjustments provide a useful view alongside GAAP margins and losses.
- Completion and insurance recovery of the securities settlement, and court approval and resolution of the derivative lawsuit.