Freshpet, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; filed March 14, 2017. Freshpet manufactures and sells fresh, refrigerated pet food and treats, primarily in the United States. The filing also presents fourth-quarter results.
Business context and operating performance
Freshpet sells through company-owned refrigerated displays in grocery, mass, club, pet specialty and natural retailers. At year-end, its products were in 16,609 stores, up 10.6% from 15,015 a year earlier. Management cited increased store coverage and sales velocity as drivers of growth. A manufacturing expansion and a new adjacent Innovation Center were completed or brought into service during 2016; the company estimated expanded production capacity would be at least 130% of prior capacity when fully utilized.
Key financial metrics
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net sales | $133.1 million | $116.2 million |
| Gross profit / gross margin | $60.4 million / 45.4% | $54.6 million / 47.0% |
| Operating loss | $2.2 million | $3.6 million |
| Net loss | $3.2 million | $3.7 million |
| Operating cash flow | $12.8 million | $6.7 million |
| Capital expenditures | $30.0 million | $27.0 million |
| Cash and cash equivalents at year-end | $3.9 million | $8.0 million |
| Working capital at year-end | $0.6 million | $16.2 million |
| Debt at year-end | $7.0 million | None |
Net cash used in investing activities was $26.7 million, while financing activities provided $9.8 million. The company reported $30.0 million available under its credit facilities and said it expected to repay the remaining expansion-related borrowing by the end of 2017. Debt bears variable interest rates and is secured by substantially all company assets.
Non-GAAP Adjusted EBITDA was $17.7 million versus $11.1 million in 2015. Adjusted Gross Profit was $66.0 million (49.6% of sales), compared with $57.2 million (49.2%). These measures exclude specified costs and should not be viewed as substitutes for GAAP results or cash available for discretionary spending.
Fourth quarter: Sales were $34.1 million versus $30.2 million in Q4 2015. Gross margin was 44.7% versus 45.3%; net income was $1.2 million versus $2.8 million.
Changes versus the prior year
- Annual sales rose 15%, primarily from growth in grocery, mass and club, supported by store additions and higher sales velocity.
- Gross margin fell 1.66 percentage points. The filing attributes pressure principally to added depreciation and non-capitalizable start-up costs from the Kitchens expansion, partly offset by operational efficiencies.
- SG&A increased 7% in dollars but declined as a share of sales, from 50% to 47%. The year included $1.3 million of leadership-transition costs; lower advertising, R&D and outbound freight costs partly offset higher operating expenses.
- Operating and net losses narrowed, while operating cash flow increased. Cash declined amid substantial capital spending; working capital fell sharply year over year.
Outlook, risks and unusual items
- The filing provides no numerical revenue, earnings or margin guidance. Management expects new products and broader distribution to support growth, and expects increased utilization of expanded plant capacity to help leverage fixed costs over time.
- Management stated that cash, expected operating cash flow and planned borrowing capacity should fund obligations for the foreseeable future, while cautioning that this depends on revenue, cash generation, cost and working-capital management.
- Key risks include limited reliance on one manufacturing facility; dependence on major retail customers and distributors; ingredient, packaging, freight and energy costs; food safety, recall and regulatory exposure; competition and marketing effectiveness; and the need to fund growth and capital expenditures. One distributor accounted for 23% of 2016 net sales; Target accounted for 9%. Treat products rely on co-packers.
- A securities lawsuit filed in 2016 names the company and certain executives and directors. Freshpet disputes the allegations; it said it could not estimate a reasonably possible loss range. Ordinary-course claims were also disclosed.
- The company reported a full valuation allowance against deferred tax assets and approximately $160.7 million of federal and $132.4 million of state NOL carryforwards; use may be limited, including under Section 382. The company also disclosed a possible vendor incentive of $0.3–$1.0 million if performance targets were deemed probable; it had not accrued the amount.
- Management reported effective disclosure controls and internal control over financial reporting. The independent auditor gave an unqualified opinion on the financial statements.
Important facts for investors to verify
- Whether expanded production capacity can be utilized without continued margin pressure, and whether gross margins recover as start-up costs abate.
- Cash generation, capital spending, the low year-end working-capital balance, available borrowing capacity, and the planned repayment of remaining debt.
- Sales growth and customer/distributor concentration, including the distributor representing 23% of sales and the company’s reliance on large retailers.
- Developments and any loss estimates in the securities lawsuit, and any material food-safety, recall or regulatory events.
- The assumptions behind non-GAAP Adjusted EBITDA and whether excluded costs recur; also the realizability and potential limitations of NOLs.