Freshpet, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Freshpet manufactures and markets refrigerated fresh pet food in the U.S. and international markets. Financial statements are unaudited.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $65.3M | $50.8M | $180.1M | $141.6M |
| Gross profit | $30.7M | $23.6M | $83.9M | $66.6M |
| Gross margin | 47.0% | 46.5% | 46.6% | 47.1% |
| Operating income (loss) | $3.5M | $0.04M | ($5.1M) | ($6.8M) |
| Net income (loss) | $3.1M | ($0.1M) | ($6.0M) | ($7.1M) |
| Operating cash flow | — | $3.5M | $8.5M | |
| Capital expenditures and equipment deposits | — | $40.7M | $12.7M |
Q3 diluted EPS was $0.08, compared with a loss per share reported as $0.00 in Q3 2018; nine-month loss per share was $0.17 versus $0.20. Q3 sales grew 28.5% year over year, led by grocery, mass and club. Nine-month sales grew 27.2%. Freshpet Fridge locations reached 20,779, up 8.8% year over year.
At September 30, cash was $7.2M; total current assets were $52.4M and current liabilities $38.4M. Working capital was $14.0M. Long-term debt was $35.4M net of debt issuance costs; the MD&A reports $35.6M outstanding before that net presentation. The company reported $54.4M of available credit, including $2.0M reserved for letters of credit. Total assets were $206.3M and stockholders’ equity $123.8M.
Material changes and drivers
- Q3 gross margin improved 50 basis points, reflecting pricing and mix and depreciation leverage, partly offset by commodity inflation and inbound freight. Nine-month gross margin declined 50 basis points, with scrapping, processing costs, commodity inflation, freight and labor costs partly offset by price/mix and operating efficiencies.
- SG&A increased 15.3% in Q3 and 21.4% year to date, but declined as a share of sales. Management cited higher marketing, volume-related costs, hiring, employee costs, depreciation and stock compensation; operating leverage improved.
- Operating cash flow fell to $3.5M from $8.5M for the nine months, with working-capital use—especially receivables and inventory—contributing. Investing outflows rose substantially as expansion spending increased; financing cash flow included net credit-facility borrowings.
- Freshpet adopted lease accounting Topic 842 in 2019, recognizing $9.5M of operating lease right-of-use assets and $9.8M of lease liabilities at quarter-end. Prior-year comparisons were not restated.
Outlook, risks and unusual items
- Management planned approximately $100M of capital expenditures over the next two years to expand capacity and distribution. Freshpet Kitchens 2.0 is a 90,000-square-foot addition; production start-up was slated for the second half of 2020, with facility capacity intended to support approximately $540M in net sales. The company had invested $21.0M in the project and other expansions during the first nine months of 2019.
- Three of four manufacturing lines had converted to seven-day production; the fourth conversion was planned by Q1 2020. Capacity, construction timing, execution, and funding needs are important uncertainties. Management said cash, expected operating cash flow and planned borrowing capacity should fund foreseeable needs, but cautioned that additional financing might be needed and may not be available on favorable terms.
- A securities class action settlement was proposed for preliminary court approval on October 3, 2019. At quarter-end, Freshpet accrued $10.3M for the estimated probable loss and recorded a matching $10.3M insurance recovery as probable. A separate derivative suit remained stayed; the company could not estimate a possible loss range.
- After quarter-end, borrowings increased a further $5.9M in October. An October 30 credit-agreement amendment increased the 2019 capital-expenditure covenant limit and addressed certain qualified financial contracts.
- Key disclosed risks include manufacturing-capacity constraints, growth-project execution, dependence on customers and effective marketing, ingredient and commodity costs, supply-chain management, product safety and regulation, competition, and ability to generate cash or obtain capital. Variable-rate debt exposure: a 100-basis-point rate change was estimated to affect annual interest expense by about $0.3M.
Important facts for investors to verify
- Progress, cost, timing and expected capacity benefits of Freshpet Kitchens 2.0 and the broader capital program.
- Whether operating cash flow and available credit can support planned capital spending, working capital and debt service; monitor borrowing levels and covenant headroom.
- Final court approval and payment terms for the proposed securities settlement, and collection and timing of the related insurance recovery.
- Whether sales growth, gross margins and cash conversion persist as the company scales, including effects of input costs, freight, labor and retail-channel mix.
- Share-based compensation and other adjustments underlying non-GAAP measures; the filing cautions these measures are not substitutes for GAAP results or cash flow.