Freshpet, Inc. — Q3 2015 Form 10-Q
Business and period: Freshpet manufactures and markets refrigerated natural pet food in the U.S. and Canada. This unaudited report covers the three and nine months ended September 30, 2015, compared with the same 2014 periods. The company reported 14,670 Freshpet Fridge locations at quarter-end, up from 12,970 a year earlier.
Financial performance
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net sales | $30.6m | $22.5m | $86.0m | $62.3m |
| Gross profit / margin | $14.0m / 46% | $10.9m / 48% | $41.0m / 48% | $30.2m / 49% |
| SG&A | $15.6m | $12.2m | $47.1m | $37.2m |
| Operating loss | $(1.5)m | $(1.3)m | $(6.1)m | $(7.0)m |
| Net loss | $(1.7)m | $(9.5)m | $(6.5)m | $(20.9)m |
| Net loss per share | $(0.05) | $(1.19) | $(0.19) | $(2.94) |
Sales grew 36% in Q3 and 38% year to date. Excluding the Freshpet Baked product test, management reported growth of 28% and 32%, respectively. Grocery, Mass and Club accounted for 77% of Q3 sales; Pet Specialty, Natural and Other accounted for 23%. Q3 gross margin fell 234 basis points year over year; excluding Baked, it declined 132 basis points. Nine-month gross margin decreased 93 basis points, or 23 basis points excluding Baked. SG&A declined as a share of sales, to 51% from 54% in Q3 and to 55% from 60% year to date.
Q3 net loss improved substantially year over year, primarily reflecting the absence of 2014 debt-guarantee fees ($6.8m in Q3 2014) and lower interest expense. The same prior-year items contributed to the nine-month net-loss improvement. Operating loss, however, increased in Q3. Freshpet Baked contributed $1.9m of Q3 loss and $2.5m of nine-month loss. Adjusted EBITDA, a non-GAAP measure, was $2.3m for Q3 and $7.1m for nine months, versus $1.1m and $1.5m, respectively; the company cautions that it is not a substitute for GAAP results or cash flow.
Cash, liquidity and investment
For the first nine months, operating activities provided $5.0m, compared with $3.5m used in 2014. Investing activities used $26.3m, including capital expenditures, a $5.0m adjacent-property purchase, and net purchases of short-term investments. Financing activities provided $0.3m. Cash declined by $21.0m from year-end to $15.3m; short-term investments were $3.7m. Working capital was $23.9m, down from $41.2m at December 31, 2014.
Freshpet had no debt drawn under its credit facilities at September 30 and reported $40m of available capacity; it was in covenant compliance. Total liabilities were $9.2m and total assets were $112.0m. Capital expenditures included $10.2m for the plant expansion during the nine-month period.
Outlook, commentary and risks
- Management expected to invest approximately $30m–$32m in capital expenditures during 2015 and 2016 to expand plant capacity and distribution, and believed the expansion could increase Freshpet Kitchens capacity by at least 130%. Management said available liquidity, expected operating cash flow and borrowing capacity should fund planned needs, while warning that financing might be needed if cash generation or growth differs from expectations.
- Management expected gross margins to improve as new products and manufacturing processes scale, and SG&A as a percentage of sales to decline with growth. It cited throughput constraints and start-up costs as pressures on gross margin, and noted input-cost volatility and possible pricing or cost actions.
- Key exposure areas include manufacturing capacity and execution, customer concentration (one distributor represented 21% of sales), reliance on suppliers, commodity prices, product safety and regulatory scrutiny, marketing effectiveness, and access to capital. Three vendors supplied 86% of purchased treats finished goods in Q3.
- The filing disclosed ordinary-course claims, primarily employment-related, but no material pending legal proceeding or known claim expected to have a material adverse effect. It reported no material change in previously disclosed risk factors, no material change in contractual obligations, and no material subsequent events. Management concluded disclosure controls were effective.
Important facts for investors to verify
- Whether the plant expansion stays within the $30m–$32m estimate, achieves the projected capacity increase, and relieves production constraints.
- Whether core sales growth and gross-margin trends persist after separating Freshpet Baked sales, costs and losses.
- Whether operating cash generation can support expansion and working-capital needs as cash and working capital decline.
- How customer and supplier concentration, ingredient costs, and any need to draw or expand credit facilities affect resilience and financing risk.
- The sustainability of reported adjusted EBITDA, including the exclusions used, alongside GAAP operating losses and capital spending.