Freshpet, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports fourth-quarter results; it is an annual report, not a standalone Q4 filing. Unless stated otherwise, financial amounts below are in U.S. dollars.
Business context
Freshpet makes and sells fresh, refrigerated dog and cat food and treats through company-owned Freshpet Fridges in grocery, mass, club, pet specialty and natural retailers. It reported 18,004 fridge locations at year-end, up from 16,609 in 2016. The company identifies product innovation, consumer adoption and expanding fridge distribution as growth drivers.
Financial results and liquidity
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Net sales | $156.4 million | $133.1 million | Up 18% |
| Gross profit | $72.4 million | $60.4 million | Up 20% |
| Gross margin | 46.3% | 45.4% | Up 0.9 percentage points |
| SG&A | $75.2 million | $62.6 million | Up 20% |
| Operating loss | $2.8 million | $2.2 million | Loss widened |
| Net loss | $4.3 million | $3.2 million | Loss widened |
| Operating cash flow | $10.3 million | $12.8 million | Down $2.5 million |
| Capital expenditures | $13.0 million | $30.0 million | Down $17.0 million |
- Fourth-quarter 2017 net sales were $40.7 million, gross profit was $18.9 million and gross margin was 46.5%. The quarter recorded net income of $1.5 million, compared with a $1.2 million profit in Q4 2016.
- FY2017 Adjusted EBITDA, a non-GAAP measure, was $17.6 million versus $17.7 million in 2016. Management cautions that it is not a substitute for GAAP results or a measure of discretionary cash.
- Cash and cash equivalents were $2.2 million at year-end, versus $3.9 million a year earlier. Working capital was $10.3 million, compared with $0.6 million. The company reported no outstanding debt at year-end and $30.0 million available under its revolving facility, which matures in September 2020.
- Net sales growth was led by grocery, online, mass and club, which generated $126.4 million, up from $104.7 million. Pet specialty and natural sales were $29.9 million, compared with $28.3 million.
Material changes and unusual items
- Sales growth reflected higher product velocity and an 8.4% increase in fridge locations. Gross margin improved with cost savings, scale and production efficiencies, partly offset by increased depreciation from the manufacturing expansion.
- SG&A rose to 48.1% of sales from 47.0%, reflecting $5.5 million of additional media spending, higher volume-related costs and increased operating expenses. Management said its “Feed the Growth” marketing investment increased spending and expected SG&A as a share of sales to decline as benefits emerge.
- Freshpet adopted the new revenue recognition standard in Q1 2018 using retrospective application. It estimated 2017 sales would be approximately 2.6% lower under the new presentation, with no impact on net income; the change is primarily a reclassification from cost of goods sold to a reduction in sales.
- The 2017 results include $0.3 million of accelerated amortization of debt issuance costs following a credit-facility amendment and $0.3 million of warrant revaluation expense. Warrants were converted to common stock in September 2017.
- The 2017 Tax Act reduced the federal corporate tax rate, but the company reported no material tax-expense effect because it maintained a full valuation allowance against deferred tax assets.
Outlook, risks and contingencies
- No quantified financial guidance was provided. Management expects continued growth from new products and wider distribution, and believes cash, operating cash flow and borrowing capacity can fund foreseeable needs. It also cautioned that future growth and capital requirements may require additional financing.
- Key risks include dependence on a single primary manufacturing facility, limited capacity, ingredient and commodity cost volatility, reliance on third-party freight and treat co-packers, and concentration among customers and suppliers. McLane, the largest distributor by net sales, accounted for 18% of 2017 sales; ten customers collectively represented more than 67%.
- A securities lawsuit, Curran v. Freshpet, remained pending. The company said it intends to defend the case and could not estimate a reasonably possible loss range. Ordinary-course claims were not expected to have a material adverse effect.
- The company reported effective disclosure controls and internal control over financial reporting based on management’s assessment. The auditor did not provide an internal-control attestation, as the company was not required to obtain one.
- The company reported federal NOL carryforwards of approximately $175.0 million and state NOLs of approximately $143.4 million; their use may be limited, including under tax ownership-change rules. No cash dividends were planned for the foreseeable future.
Important facts for investors to verify
- Whether fridge expansion and sales velocity can continue to drive growth while improving GAAP operating profitability and margins.
- How the revenue-recognition transition affects reported sales and comparability in subsequent filings.
- Cash conversion, working-capital needs and capital spending, given lower year-end cash and a cash-flow decline in 2017.
- Customer and supplier concentration, manufacturing capacity, and exposure to freight, co-packer and ingredient disruptions or cost increases.
- Developments and any eventual loss estimate in the securities lawsuit, as well as covenant headroom and borrowing availability under the revolving facility.