Freshpet, Inc. — Q3 2020 Form 10-Q
Business context and period: Freshpet manufactures and markets refrigerated fresh pet food in the U.S. and international markets. This unaudited filing covers the three and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods.
Financial performance
- Revenue: Q3 net sales were $84.2 million, up 29.0% from $65.3 million. Nine-month sales were $234.3 million, up 30.1% from $180.1 million. Grocery, online, mass and club channels accounted for 84% of Q3 sales. Freshpet Fridge locations increased 7.7% year over year to 22,371.
- Profit and margins: Q3 gross profit was $36.7 million, up 19.4%; gross margin was 43.5%, down 350 basis points. Q3 operating income was $3.8 million versus $3.5 million, and net income was $3.5 million versus $3.1 million. Nine-month gross profit was $102.4 million; gross margin was 43.7%, down 290 basis points. Operating income was $1.1 million versus an operating loss of $5.1 million, while net income was $0.1 million versus a $6.0 million net loss.
- Non-GAAP measures: Q3 Adjusted EBITDA was $17.0 million (20.2% of sales), versus $12.0 million (18.4%). Nine-month Adjusted EBITDA was $34.0 million (14.5%), versus $16.0 million (8.9%). Management’s adjusted measures exclude specified items and are not GAAP measures.
- Cash flow and investment: For the nine months, operating cash flow was $13.1 million, investing cash outflow was $137.5 million, and financing cash inflow was $199.2 million. Capital expenditures for property, equipment and related items were $99.9 million; investing also included $27.6 million for an equity-method investment. Cash and equivalents were $84.2 million at September 30, compared with $9.5 million at year-end 2019.
- Liquidity and debt: Working capital was $113.5 million, up from $12.3 million at December 31, 2019. The company had no credit-facility borrowings outstanding at quarter-end. It reported $35 million available under its revolver (with $2 million reserved for letters of credit) and a $130 million delayed-draw term facility, subject to agreement terms. The facility matures in April 2025.
Material changes and drivers
- Sales growth was driven primarily by the grocery, online, mass and club channel, which added $16.3 million in Q3 and $49.8 million year to date. Store count growth and strong demand also supported sales.
- Gross margin declined despite higher sales. The company cited manufacturing start-up costs, processing costs, higher beef costs, COVID-related expenses, and higher depreciation and share-based compensation; pricing, mix and plant efficiencies partly offset these pressures.
- SG&A rose 21.1% in Q3 and 13.7% year to date, including higher volume-related costs, operating costs, media expense, depreciation and a $1.3 million equipment-disposal loss in Q3. SG&A as a percentage of sales declined year over year in both periods.
- The company raised $252.1 million net from a primary equity offering. During the nine months it borrowed $20.9 million and repaid $76.0 million under its credit facilities, leaving no debt outstanding at quarter-end.
Outlook, risks and unusual items
- Management’s “Feed the Growth—5 by 2025” plan targets adding five million households by 2025. The company expects to invest more than $300 million in capital expenditures over the next three years.
- Kitchens South began production in February 2020. Kitchens 2.0, a 90,000-square-foot expansion, was expected to begin saleable production in Q4 2020; approximately $100.5 million of an expected $115 million project investment had been made by the filing date. Initial production at Kitchens 3.0 in Ennis, Texas, was expected by Q4 2022. These are stated plans, not assurances of completion or results.
- Management said COVID-related demand surges had at times exceeded production capacity, contributing to depleted trade inventory and elevated out-of-stocks. It expected added capacity and Kitchens 2.0’s start-up to help rebuild inventory and reduce out-of-stocks over the following months. The 2020 outlook assumed no material change in customer operations, consumer purchasing behavior or supply chain conditions; the filing provides no specific revenue or earnings guidance.
- COVID-related expenses were estimated at slightly under $4 million for 2020. Risks include further pandemic disruption, manufacturing capacity constraints, supply interruptions and ingredient price increases. The company reported higher beef prices, while chicken prices were contractually fixed subject to limited exceptions.
- A shareholder derivative lawsuit settlement was approved in August 2020; the company said the $0.2 million settlement was paid by insurers. Other ordinary-course claims were not expected to have a material adverse effect, though the filing notes uncertainty if claims or amounts increase.
Important facts for investors to verify
- Whether Kitchens 2.0 and Kitchens 3.0 meet their expected production timelines, costs and capacity targets, and how the planned capital spending is funded.
- Whether production catches up with demand and improves trade inventory and out-of-stock levels, particularly if COVID-related demand or supply conditions change.
- Whether gross-margin pressures—including start-up, processing, beef, COVID-related and depreciation costs—ease, and how much reported profitability depends on exclusions in non-GAAP measures.
- Whether operating cash generation can support the company’s substantial investment program, and the availability and terms of borrowing capacity under the credit facility.
- The continued impact of equity issuance and share-based compensation on per-share results and shareholder dilution.