Freshpet, Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Unaudited consolidated results; amounts below are in U.S. dollars, generally millions unless noted.
Business context
Freshpet manufactures and markets refrigerated natural pet food and treats, sold through retail partners and company-branded refrigerators. It reported 23,381 Freshpet Fridge locations in its retailer-channel table at September 30, 2021, up 4.6% year over year. The company is investing heavily in manufacturing capacity and systems to support its growth strategy.
Financial performance and liquidity
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net sales | $107.6 | $84.2 | $309.6 | $234.3 |
| Gross profit | $41.5 | $36.7 | $120.9 | $102.4 |
| Gross margin | 38.6% | 43.5% | 39.1% | 43.7% |
| SG&A | $42.4 | $32.9 | $138.0 | $101.3 |
| Operating income (loss) | $(0.8) | $3.8 | $(17.0) | $1.1 |
| Net income (loss) | $(2.1) | $3.5 | $(20.4) | $0.1 |
| Diluted EPS | $(0.05) | $0.09 | $(0.48) | $0.00 |
| Adjusted EBITDA | $14.6 | $17.0 | $33.2 | $34.0 |
| Adjusted EBITDA margin | 13.6% | 20.2% | 10.7% | 14.5% |
Q3 sales grew 27.8% year over year; nine-month sales grew 32.2%. Grocery, Mass and Club generated $91.1 million of Q3 sales, while Pet Specialty and Natural generated $16.4 million. For the nine months, the respective channel sales were $259.2 million and $50.4 million.
Cash used in operations was $3.3 million for the first nine months, versus $13.1 million provided in the prior-year period. Investing activities used $220.8 million, primarily for manufacturing expansion and other capital spending; financing activities provided $327.8 million, principally from a February 2021 stock offering. Cash increased to $170.8 million from $67.2 million at year-end 2020. Working capital was $209.0 million, compared with $76.0 million at December 31, 2020.
At September 30, 2021, the company had no borrowings under its $350 million senior secured credit facility and reported $348 million available, net of $2 million reserved for letters of credit. Total liabilities were $34.8 million, including operating lease liabilities; no funded debt was outstanding. Property, plant and equipment, net, was $472.0 million, including $226.6 million of construction in progress.
Material changes versus prior comparable period
- Despite strong sales growth, Q3 gross margin fell 490 basis points to 38.6%; nine-month gross margin fell 460 basis points to 39.1%. Management attributed the pressure to kitchen labor and capacity costs, ingredient inflation, partner production costs, and higher depreciation and share-based compensation. Lower start-up and COVID-related costs partly offset Q3 pressures.
- SG&A rose 28.8% in Q3 and 36.2% for the nine-month period, reflecting higher volume-related and freight costs, share-based compensation, marketing, staffing and depreciation.
- The company moved from Q3 2020 net income of $3.5 million to a Q3 2021 net loss of $2.1 million, and from nine-month 2020 net income of $0.1 million to a nine-month 2021 net loss of $20.4 million.
- Share-based compensation expense rose to $18.6 million for the first nine months from $7.8 million. The company also recorded a $1.1 million nine-month loss on its equity-method investment.
- The February 2021 public offering generated $332.2 million net proceeds and increased shares outstanding. Capital expenditures were $220.8 million for the first nine months, compared with $99.9 million for the comparable 2020 period.
Outlook, management commentary and risks
- No specific near-term revenue, profit or cash-flow guidance is provided. Freshpet raised its 2025 household penetration target from 8 million to 11 million households.
- Management expects to invest approximately $565 million in future capital expenditures for the Bethlehem, South and Ennis kitchen projects, with the planned capacity intended to support approximately $2.0 billion of annual net sales. Management stated it believed cash, expected operating cash flow, borrowing capacity and potential capital-market access would fund needs for the foreseeable future, while cautioning that funding depends on performance and market access.
- Management expected the first phase of Freshpet Kitchens South to be completed by year-end 2021, its second phase by the start of 2023, and initial production at Freshpet Kitchens Ennis by Q2 2022. The ERP upgrade was expected to run through Q1 2022. Construction delays or failure to match capacity with demand could affect the growth plan.
- Risks highlighted include COVID-19-related costs and disruption, ingredient and packaging inflation or shortages, supply-chain constraints, freight and labor costs, execution of kitchen expansions, demand and customer concentration, competition, product safety and regulatory issues, and the need for cash generation or additional financing. The credit facility is variable-rate, but there were no borrowings at quarter-end.
- Ordinary-course claims and employment-related matters were disclosed; management did not expect them to have a material adverse effect, while noting a significant increase could be harmful. No material risk-factor changes or material changes in contractual obligations were reported. No material subsequent events were identified.
Important facts for investors to verify
- Reconcile strong sales growth with declining gross margins, operating losses and lower Adjusted EBITDA; assess how much cost pressure management expects to persist.
- Track actual spending, completion dates, production ramp and returns for the Bethlehem, South and Ennis capacity projects against the stated investment and capacity plans.
- Monitor operating cash flow and working-capital needs as capital spending continues, and verify the availability and covenant conditions of the credit facility.
- Review the effect of ongoing share-based compensation and the 2021 equity issuance on per-share results and dilution.
- The filing’s overview gives 23,394 fridge locations, while the detailed retailer-channel tables report 23,381; verify the correct store-count measure. Also note that the nine-month channel table totals $309.621 million, while the financial statements report $309.620 million, consistent with rounding.
- Evaluate Freshpet’s non-GAAP measures alongside GAAP results: Adjusted EBITDA excludes several costs, including share compensation, launch and plant start-up expenses, and the company cautions that the measure is not discretionary cash available for investment.