Freshpet, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited, with comparisons to Q1 2016. Freshpet manufactures and markets fresh pet meals and treats, distributed through retail channels and more than 17,000 branded refrigerators.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $34.5 million | $31.5 million | Up 10% |
| Gross profit | $15.8 million | $14.9 million | Up 6% |
| Gross margin | 45.8% | 47.3% | Down 154 basis points |
| SG&A | $18.5 million | $16.5 million | Up 12% |
| Operating loss | $2.7 million | $1.6 million | Loss widened |
| Net loss | $2.9 million | $1.8 million | Loss widened |
| Operating cash flow | $2.1 million | $2.0 million | Up slightly |
| Capital expenditures, net cash used in investing | $3.3 million | $9.8 million | Lower, mainly due to reduced facility expansion spending |
Financial position and liquidity
- At March 31, 2017, cash was $2.0 million, total assets $126.8 million, and current liabilities $20.4 million versus current assets of $19.1 million, yielding negative working capital of approximately $1.3 million.
- Credit-facility borrowings were $5.75 million, down from $7.0 million at year-end 2016. The company reported $30.0 million available under its facilities and compliance with all covenants.
- Cash declined $1.9 million during the quarter. Operating cash flow was more than offset by $3.3 million of investing outflows and net financing outflows of $0.7 million.
- Non-GAAP adjusted EBITDA was $1.9 million, compared with $2.5 million in Q1 2016. The filing cautions that this measure is not a substitute for GAAP results or discretionary cash flow.
Material changes and management commentary
- Sales growth was driven by Grocery, Mass and Club, up $4.4 million; Pet Specialty sales declined $0.7 million and Baked product sales declined $0.6 million. Freshpet Fridge locations rose 10.4% to 17,031.
- Gross margin contracted primarily because depreciation related to the Freshpet Kitchens expansion increased; management cited cost savings and scale as partial offsets. Adjusted gross margin was 49.9%, versus 50.2%.
- SG&A rose mainly from $1.4 million of additional advertising, along with higher depreciation and operating costs, including hiring, benefits and refrigerator repairs. Management’s “Feed the Growth” initiative, announced in March, calls for heavier marketing investment and a more strategic selling approach. Management expects returns from added media spending and improved margins from scale and cost savings, but gave no quantified guidance.
- Q1 2017 operating cash flow benefited from higher accounts payable and other liability timing; inventory increased $2.3 million in cash-flow terms. This makes working-capital movements important to assess alongside reported cash generation.
Risks, contingencies and unusual items
- A securities lawsuit against the company and certain officers and directors remains in early stages. Freshpet disputes the allegations; it cannot estimate a reasonably possible loss range.
- Sales and procurement are concentrated: one distributor represented 24% of sales; one vendor supplied 24% of raw materials. Three vendors supplied 89% of packaging materials, and four vendors supplied 93% of treats finished goods.
- Debt bears variable interest and is secured by substantially all company assets. The company estimated that a 100-basis-point rate change would alter annual interest expense by approximately $0.1 million. Ingredient commodity-price volatility and British-pound movements are also identified risks.
- Management stated cash, expected operating cash flow and planned borrowing capacity should cover foreseeable needs, while noting that weaker-than-expected revenue or cash generation, faster expansion, or additional investment needs could require financing that may not be available on favorable terms.
- The company reported effective disclosure controls and no material changes in internal control during the quarter. It reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether the Feed the Growth marketing investment produces sales growth sufficient to offset higher SG&A and improve profitability.
- Whether margin improvement and production scale can offset the higher depreciation burden from the Kitchens expansion and input-cost pressure.
- Cash conversion and working-capital trends, particularly inventory, payables and the company’s negative working capital position.
- Available borrowing capacity, covenant compliance, variable-rate exposure and future capital-spending needs.
- Developments in the securities litigation and any changes in customer or supplier concentration.