Freshpet, Inc. — Q2 2022 Form 10-Q
Business context and reporting period. Freshpet manufactures and markets refrigerated fresh food and treats for dogs and cats. This unaudited quarterly report covers the three and six months ended June 30, 2022; comparisons are with the same 2021 periods unless noted. Financial amounts below are in millions of dollars unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net sales | $146.0 | $108.6 | $278.2 | $202.0 |
| Gross profit / margin | $51.1 / 35.0% | $43.1 / 39.7% | $95.8 / 34.5% | $79.4 / 39.3% |
| Operating loss | $(18.1) | $(6.5) | $(34.0) | $(16.2) |
| Net loss | $(20.6) | $(7.5) | $(38.1) | $(18.4) |
| Basic and diluted loss per share | $(0.45) | $(0.17) | $(0.85) | $(0.43) |
| Adjusted EBITDA (non-GAAP) | $3.9 / 2.6% margin | $10.9 / 10.0% margin | $9.0 / 3.2% margin | $18.6 / 9.2% margin |
- Q2 sales rose 34.4%; first-half sales rose 37.7%. For Q2, management attributed the $37.4 million increase to $20.3 million from price and mix and $17.1 million from volume, including trade-inventory replenishment. First-half growth included $46.5 million from volume and $29.7 million from price and mix.
- Q2 gross margin fell 4.7 percentage points. Management cited ingredient and labor inflation and quality issues, partly offset by pricing. Adjusted gross margin, a non-GAAP measure, was 42.4% in Q2 versus 46.1% a year earlier.
- Q2 SG&A was $69.2 million, or 47.4% of sales, compared with $49.6 million, or 45.6%. Higher media spending contributed to the increase. Adjusted SG&A was 39.7% of sales versus 36.1%.
- At June 30, cash and cash equivalents were $307.3 million and short-term investments were $19.8 million. Working capital was $383.9 million, compared with $91.4 million at year-end 2021.
- Six-month cash flow: operating activities used $62.4 million (versus $2.9 million provided in 2021); investing activities used $118.0 million; financing activities provided $415.0 million. Financing included $337.8 million net proceeds from a share offering and $78.0 million of credit-facility borrowings. Capital expenditures and related equipment/deposit purchases were $94.9 million.
- Borrowings under the credit facility were $78.0 million; $271.8 million was available, reflecting $0.2 million reserved for letters of credit. The balance sheet reports $10.4 million current and $65.0 million long-term debt, net of financing costs.
Material changes and management commentary
- Sales growth was concentrated in Grocery, Mass and Club refrigerated channels. Q2 sales in those channels increased $38.0 million, while Pet Specialty and Natural sales declined $0.6 million. Freshpet Fridge locations increased 4.8% year over year to 24,277.
- The company implemented three price increases: one in Q4 2021, one in Q1 2022, and a third planned for Q3 2022. Management said earlier increases had temporarily slowed household-penetration growth, while more recent trends had accelerated toward historical levels. Further increases in late 2022 or 2023 could be considered depending on inflation and other macroeconomic conditions.
- Management expects approximately $320 million of FY 2022 capital expenditures for capacity and recurring needs, including Freshpet Kitchens Ennis Phase 1, Ennis Chicken Processing, and Freshpet Kitchens South. It expects cash, operating cash flow, borrowing capacity and potential capital-market access to fund operations and growth for at least the next 12 months, while noting that this depends on revenue, cash generation, costs and working-capital management.
- Management’s long-term capacity-plan target is approximately 25% Adjusted EBITDA margin by 2025, measured annually. This is a target, not a near-term earnings forecast. Beginning with the period ending September 30, 2022, the company anticipated removing launch and plant start-up expenses from its Adjusted EBITDA add-backs.
- The April 2022 credit-agreement amendment adjusted capital-expenditure provisions and replaced LIBOR with Term SOFR for U.S. dollar loans. Debt bears variable interest rates; the filing identifies exposure to interest-rate, commodity/inflation and foreign-exchange movements.
Risks, contingencies and unusual items
- Phillips Feed Service sued over termination of a distribution arrangement, seeking more than $8.3 million plus additional damages and asserting a right of setoff. Freshpet disputes the claims and counterclaimed for amounts owed. The company reclassified $9.0 million due from Phillips to other noncurrent assets. Management does not currently expect a material adverse outcome but acknowledges an unfavorable resolution could be materially adverse.
- Inventory obsolescence expense was $3.5 million for the first half of 2022, compared with $0.3 million in the prior-year period. Management cited quality issues among the factors affecting margins.
- Receivables increased partly because the new ERP transition added approximately 11 days to receivables aging; management reported that the transition had not materially affected internal controls and said controls were effective. Implementation and transition work continues.
- The filing corrects previously reported gross-margin percentages: Q2 2022 to 35.0% from 35.8%, and first-half 2022 to 34.5% from 34.9%.
- Management cites inflation and interest-rate increases, supply-chain and input-cost pressures, manufacturing-capacity expansion and execution, customer concentration, product quality and regulatory matters, and the ability to generate cash or raise capital among the risks to results. The filing reports no material change to previously disclosed risk factors and no material off-balance-sheet arrangements.
- Non-GAAP measures such as Adjusted EBITDA exclude certain expenses and have limitations; they should not be treated as substitutes for GAAP results or as discretionary cash available for investment.
Important facts for investors to verify
- Whether pricing and volume growth can offset ingredient, labor and other inflation without further weakening household penetration or margins.
- Progress, timing and total cost of the planned capacity projects relative to the approximately $320 million FY 2022 capital-expenditure expectation.
- Operating cash use, working-capital trends and the effect of the ERP transition on receivables and inventory.
- How the company funds expansion and services variable-rate debt if operating cash flow remains negative or additional financing is needed.
- Developments in the Phillips litigation and recoverability of the $9.0 million reclassified receivable.
- Reconciliation of non-GAAP measures to GAAP results and the effect of the announced Adjusted EBITDA methodology change.