Freshpet, Inc.

Greetings and welcome to the Fresh Pet, Inc. first quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce Katie Turner for opening remarks.

Thank you. Good afternoon and welcome to Fresh Pet's first quarter 2020 Earnings Conference Call and Webcast. On today's call are Billy Cyr, Chief Executive Officer, and Dick Kisar, Chief Financial Officer. Scott Morris, Chief Operating Officer, and Heather Pomeranian, EVP of Finance, will also be available for Q&A. Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and beliefs and involve risks and uncertainties Thank you for joining us today. While the company believes these non-GAAP financial measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. Finally, the company has produced a presentation that contains many of the key metrics that will be discussed on this call. That presentation can be found on the company's investor website. Management's commentary will not specifically refer to the presentation, rather it's a summary of the results they will discuss today. And now I'd like to turn the call over to Billy Feer, Chief Executive Officer.

Thank you, Katie, and good afternoon, everyone. I'm talking with you from Bethlehem, PA. Dick is at home in Manhattan, and Scott and Heather are at their homes in New Jersey. We'll do our best to not trip over each other on the call. And please excuse any barking in the background. Obviously, we are in the midst of highly unusual times, so our comments will be a bit different than we would typically provide so that we can give you a clearer understanding of this unique operating environment, how we are addressing it, the opportunities and risks it creates, and the assumptions underlying our guidance. We will also provide you with our quarterly metrics and analysis, including the presentation we typically provide, and will highlight where the coronavirus crisis might be creating distortion, both favorable and unfavorable. will also share some April results where we have the data and it is relevant in the interest of maximum transparency in this turbulent time. That will allow you to see the pantry de-stocking that occurred in April following the March surge and consider the two months together for a more complete picture. To be as transparent about what is happening in this rapidly changing environment, our prepared remarks will be longer than usual. First and foremost, We view the coronavirus threat as a significant public health challenge and take our role as an essential business seriously. Being an essential business gives us the privilege to stay open, but also comes with a responsibility to operate safely, limiting the spread of the coronavirus amongst our employees, their families, and our communities, and serving the 3 million pet parents who rely on us to feed their pets with high-quality food. I believe we are living up to these responsibilities. and in doing so we are protecting and hopefully enhancing the long-term value of Fresh Pet for our many stakeholders. As we detailed in our press release on April 9th, we've gone to great lengths to protect our employees and greatly reduce the risk of coronavirus in our facilities. We hired third-party nurses to take the temperature and administer a brief health check of employees and any of the limited visitors we allow when they enter our kitchens. On average, the nurses direct two people per day for further screening and have succeeded at identifying people who had the virus but had no fever or cough. Retained a third-party deep cleaning company to clean our offices, common spaces, and locker rooms on a weekly basis, in addition to our stepped-up cleaning and daily sanitation. Installed additional space to allow our employees to spread out at the breaks and in meetings. Provide face coverings for every employee and required their use. installed the highest quality air filtration to reduce the risk of airborne virus transmission. Staggered our shifts to avoid a concentration of employees in our locker rooms and common areas. Installed sanitizer dispensers inside virtually every door and sanitized any meeting rooms before and after each meeting. Suspended our absenteeism policy so that no employee would feel compelled to come to work if they were not feeling well. As a result, our absenteeism increased from two to three percent to approximately 11% since we implemented this policy. To compensate for this, we brought in incremental staffing and paid for overtime. Followed all CDC and FDA guidelines for quarantining employees who may have been exposed, including paid leave while awaiting test results if they test positive for the virus or have been exposed to someone who tested positive or is awaiting test results. Our purpose in all these activities has been to prevent the virus from entering our facilities Eliminating places for it to harbor within our facilities and limiting its ability to spread in our facilities. We cannot protect an employee from getting the virus in the broader community, but we can try very hard to prevent it from entering our facilities and spreading there. We aspire to make our Fresh Pet facilities the safest place our employees could spend their day. To show our appreciation to our employees who continue to work through this crisis and help us meet the demand, We paid a $500 after-tax bonus to all Kitchens employees in April and have given all Kitchens employees a $50 gift card to local restaurants every two weeks since mid-March to both give them a break from home cooking and also help local restaurants survive the mandatory closing of their dining rooms. The feedback from our employees has been very positive and they have rewarded us with outstanding efforts. Simply put, Taking care of our employees ensures that we can meet the needs of pet parents. That is what we are doing and, so far, our efforts are succeeding at preventing the virus from spreading within our facilities. But we remain vigilant, continually reassessing our needs, getting guidance from the CDC, FDA, trade associations and other food manufacturers, advice from our board, and input from our employees. All of these efforts come at a cost, a cost that we think are well worth the expense. Vic will provide more details on those. In addition to the incremental efforts to protect our employees and continue production, there have been other impacts from the coronavirus crisis. In a minute, I will list some of the more notable ones, but as you consider them, I want you to know that any impact from these events is temporary and can be offset with other incremental activities in our toolkit and still deliver our net sales plan for the year. and they certainly will not have any significant impact on our long-term goals nor our confidence in our ability to get to them. They will, however, change the mix of tools we can use to drive growth this year and we want to lean in to continue driving that growth. We will replace the volume gains we had anticipated from fridge placements and new products with increased investments in advertising and e-commerce, take advantage of some significant opportunities in front of us. But as you all know, the situation is fluid. We will continue to monitor it and make any adjustments in both our plans and guidance as necessary. I also want you to remember that, aside from the challenges of keeping our employees safe, the biggest disruptions we are seeing impact the retail environment, and our business is better insulated from that type of disruption than many CPG companies. We do not depend on retailers' discounting or promotional activity to drive volume or trial. Advertising drives 80 plus percent of our growth. This crisis has not impacted our ability to advertise and media rates are coming down, potentially making it more efficient. We do get the last 20 percent of our annual growth from the combination of enhanced retail presence, new stores, and from the contribution of new items, but that can be offset with incremental advertising. And we got fridges into some big stores before the crisis hit. Finally, our consumer demand is very consistent and not very fickle. The households that serve fresh pet are very loyal and dogs eat the same amount every day. So we have strong and steady demand with the vast majority of our growth coming from advertising. That is a good place to be right now. And we fully intend to take advantage of that strong position once our supply catches up to demand in Q2. So with those reminders, here are a few of the most significant impacts we've experienced or are watching closely. First, due to our capacity limits in Q1 and the tremendous surge in buying, we could not ship to demand and drew down trade inventories, resulting in out of stocks. At times, we were only able to ship 75% of the orders on our books. Even without the surge in buying behind the coronavirus, we told you at our investor day in our April 9th release, that our demand would exceed consumption in Q1 and that we would catch up in Q2. The surge related to COVID-19 only exacerbated the situation and we ended the quarter with very low trade inventories, particularly on our bags, and a very large order backlog carried into Q2. This also resulted in a bit of mixed benefit in Q1 as we had ample capacity on higher margin rolls and continued to ship those orders while we cut bag orders. Before the surge in demand, we estimated that the gap between scanner sales and shipments for the quarter could be three to four points, and in actuality, it was about five and a half points, resulting in roughly $4 million of net sales that moved into the second quarter. But it is important to note, we believe a meaningful portion of the actual in-home consumption will happen in Q2, so our shipments might end up closely matching the actual consumption thanks to our capacity limitations in Q1. We've already begun to see that. We expect our April net sales to be up 30-plus percent versus a year ago, while Fresh Pet's Nielsen megachannel consumption for the four weeks through mid-April post-surge averaged high single-digit growth, and we still have not restored normal trade inventories, and we have a sizable backlog of orders to carry into May. At this pace, we expect to replenish trade inventories by the end of Q2 and have a more normal shipment-consumption balance heading into Q3. We are seeing a gradual improvement in weekly consumption trends as April progresses and consumers draw down the pantry inventory they built in early March and our in-stocks improve. But there is some year-on-year distortion provided by the movement to Easter. May will provide a much clearer picture of the underlying consumer behavior and buying trends and should reflect much better in-stock levels for Fresh Pet. June should be even better as it will also reflect the impact of our return to advertising in May. The rate of dog adoptions and fostering soared in the midst of the crisis. Shelters in major cities reported a significant uptick in pet adoptions in February and March. While it is hard to tell how this will directly impact our business, it speaks volumes about how people feel about their pets when times are uncertain. That is likely, in part, why the pet food category has performed so well in recessions. A retail partner stopped most planned new fridge installations and new product placements in early March. As a result, we placed virtually no fridges in the month of March and don't expect many placements in Q2. For perspective, we placed a total of 111 new fridges in the first 24 days of April, below the pace we would normally expect, but not a complete stop. We did, however, place a significant number of full-size fridges on end caps in Walmart before retailers suspended their activity, and those are particularly high value and will drive volume all year long. Some customers are beginning to communicate their revised plans, but most customers remain in flux. As a result, we do not expect to install as many fridges this year as we had previously outlined. At this point, we are expecting about 1,000 net new stores this year, down from 1,430 previously projected. and about 500 upgrades down from 559 previously. We are, however, expecting to exceed our second-slash-third fridge target of 500, likely exceeding 1,000, as I will outline later. It is too early to say what the net of all these changes in fridge placement means, but they will be offset by the lean-in investments we intend to make to drive growth. We expect the volume from new items to be less than what we had previously planned and several customers did not put the new items on the shelf before they stopped the planogram changes. Some of our larger customers had already stocked the new items and others have communicated that they will in Q3. New items only accounted for a small portion of our growth plan this year, so this impact is not significant. Any impact on this can also be offset by our lean-in investments. We pushed our April advertising spending back into May and August due to the lack of supply we had after the surge in March and when so many retailers were struggling to stock their stores. This could impact both our rate of household penetration and consumption growth in Q2 and also the timing of our ad spending, pushing a portion of it out of Q2 and into Q3. However, the media rates we are now getting for May and beyond are significantly more attractive than what we previously anticipated. The same retail chaos that occurred in the U.S. also occurred in Canada and the U.K., muting the impact of the advertising investments we were making there as consumers flooded stores and loaded up on their existing brands. We will reassess our advertising timetable once those markets settle down a bit. We lost some production efficiency in the quarter. We put a higher priority on getting maximum hours from our production lines than on labor efficiency, so we deliberately overscheduled labor to offset absenteeism. Despite that, though, we still had sporadic days where we did not have enough labor to run all four lines in our kitchens. We believe that absenteeism is costing us about 5% to 10% of our output, even with the incremental staffing we brought in. Based on what we know, that issue will continue into Q2 and likely into Q3. The construction of Kitchens 2.0 now appears to be delayed by about one month. We were able to continue construction after a two-week delay while our contractor qualified the project as an essential business. It's been hard to get all the subcontractors fully staffed every day, so we estimate that our Kitchens 2.0 will start up at the end of September or early October instead of our previous plan of starting up in early September, with production at a significant rate in November. The delay in the startup of Kitchens 2.0 could impact our supply of fresh from the kitchen in Q3. We are bringing on a second shift at Kitchen South in Q2, so our overall bag capacity will meet our needs, but we could develop an issue with Fresh from the Kitchen. We don't think that will have a material impact on the year, but it will impact the quarterly cadence, i.e., some net sales might move into Q4 from Q3 and could move some volume from Fresh from the Kitchen to our other bag product, Roasted Meals. We are closely watching our supply of various proteins. As all of you have read, the meatpacking industry has been hit hard by the coronavirus. While we have not experienced any extended interruptions to date and our chicken prices for the year are fixed, we have had to go to previously qualified second source suppliers from time to time. So we are watching this closely to head off any potential future supply interruptions and have taken some steps to better protect our supply. I will also point out some really good work by our procurement team. They spotted the potential for significant supply disruptions in late January and began to build inventory of ingredients and packaging materials then. So we arrived at the crisis with significantly larger supplies of many key ingredients and packaging. They also finalized some long-standing initiatives designed to put in place backup suppliers on key materials we source and on our fresh ingredients where we cannot build inventory. That does not mean that we have not had challenges. Our challenges have been made significantly smaller and less disruptive thanks to their good work. The question all of you are probably asking yourself is, where does this leave Fresh Pet overall? I would answer that in the following way. We feel very fortunate to have such a robust business, strong balance sheet, and to have a plan that is working to protect our employees. And there is nothing in the current situation that tells us that our long-term strategy, plans, and goals need to be altered. In fact, We remain very confident that, despite the short-term chaos we see today, the long-term opportunity for Fresh Pet remains significant, our strategies remain sound, and our team has proven its capability. We have strong demand, a proven growth model, a diverse customer base, are well capitalized, and have a strong organization. We have also learned quite a bit during this crisis that will strengthen us going forward. We are very well positioned for both short-term and long-term success. As a result of these changes, we've decided to make some incremental investments to offset any impact from the retail issues I described, capitalizing on a changing environment and leveraging our competitive strengths. We will invest in incremental second half advertising. The combination of low media costs, a highly relevant message, increased pet adoptions, and incremental capacity is the ideal time to lean in on our advertising in the second half. Enhanced e-commerce. We've developed several initiatives designed to make it easier to acquire Fresh Pet via e-commerce through all channels that offer Fresh Pet and are developing some new channels. This will include incremental second fridges to support curbside pickup and pet specialty, tagged advertising supporting online ordering, and an SOS program that allows consumers who are desperate for Fresh Pet to order our most premium homestyle creations line and have it delivered to their home. Strengthen retail coverage. Given the challenges of stocking the stores, we are investing in incremental third-party retail coverage to quickly recover our in-stock conditions at a time when retailers can't keep up. The total amount of the incremental investment we are making is $4 million this year. Some of the volume we expect to get from that investment will offset the impact of the delays on fridges and new product placements, ensuring that we deliver our guidance, and some of that will come next year. In either case, we view it as a good investment to continue our momentum. Now let me turn your attention to our first quarter results. I'll preface this by saying that we are very encouraged by our start to the year and think that, with only a few minor exceptions, they are reflective of the underlying strength of the business and they are better than our going-in plan. Due to our capacity constraints, we realized very little of the benefit of the surge in demand that you see in the scanner data. We'll get that shipment volume in Q2. So this is probably one of the more normal quarters that a CPG company could report in this environment. For the quarter, we continued the strong, top-line momentum we have been delivering since we began our Feed the Growth plan three years ago. We continued to demonstrate the profit gains from leveraging our increasing scale. This is the essence of our strategy, and it is working. We've created a virtuous cycle where increased advertising drives increased velocity, which drives increased distribution, and that provides the added scale to both reinvest in the business and to also strengthen our bottom line. Our strategy is also working for pets and the pet parents who care for them. We are now producing pet food for more than 3 million households and that number keeps growing. Pet parents continue to write and call us to tell us about the amazing difference that Fresh Pet makes in their pets' lives. We firmly believe that we are just scratching the surface of the opportunity to change the pet food category, enabling pet parents to provide fresh, healthy Less Processed Food Designed for Pets. In the first quarter, we delivered top-line growth of 28%, and this was on top of 27% growth in the year-ago quarter. In fact, eight of our last nine quarters have had growth in excess of 25%. The growth was driven by continued strong consumption gains generated by the expanded household penetration we delivered in 2019. Nielsen megachannel consumption was up 33%, behind 40% growth in grocery. 39% growth in mass and 10% growth in bigpox pet. Prior to the surge in early March, our Nielsen megachannel business was up 29% in line with our long-term trends. So the last four plus points of growth are likely related to the surge in buying and not representative of the underlying consumption. Velocity grew 17% and accounted for more than 60% of the year-over-year growth. Our core dog business, which is the sum of our dog rolls, roasted meals, and fresh from the kitchen main meal items, and accounts for more than 90% of our business, was up 37.5% in the quarter. Our small but rapidly growing e-commerce business, which includes curbside programs with our key customers, home delivery via services like Instacart and Shipt, and fresh e-commerce like Amazon Prime Now and Fresh Direct, was up 98% versus a year ago, and now accounts for 3.3% of our business. More than 80% of that business went through our in-store fridge network. Curbside pickup now accounts for more than 50% of our e-commerce volume and was up 102% in the quarter. There is no doubt that a major shift to online consumption during the shelter-in-place weeks contributed to our growth, but we were seeing very strong growth before that as well. Adjusted EBITDA in the quarter was $5.7 million, up $2.9 million, or 100% versus a year ago. as we demonstrated the significant leverage we get from scale, particularly in adjusted SG&A excluding media. Progress against our key business drivers was as follows. Expanding the consumer franchise, total household penetration grew 28% versus a year ago to 2.58% in the quarter, and core dog penetration grew 33% to 2.0%. Plying rate was basically flat, which is what we would expect with such robust household penetration gains. We've included a chart in our investor presentation that documents how the household penetration growth has impacted buying rate growth over time so that you can see this phenomenon. But the long-term trend towards growth on both measures is very clear. We looked at the penetration data by week in March to see what impact the surge in demand had, and it was negligible, which makes sense. Consumers were not trying new items then. They were stocking up on items they already buy. We also looked at the buying rate data by week, where we would expect to see some impact, but we saw very little. This is likely because it happened so late in the measured one-year period, and because our data suggests that consumers only bought about one extra week of Fresh Pet versus dry dog food, where they bought almost one month's extra supply. Further, our out-of-stocks and, we believe, consumers' tight fridge space limited their ability to buy forward. Second, strengthen Fresh Pet's retail presence. We only added 297 net new stores in the quarter, which was below our expectations. As I mentioned, new installations virtually stopped at the beginning of March. The same phenomenon occurred on upgrades and second fridges as we added 32 upgraded fridges and 15 second fridges, also fewer than anticipated. However, we will be picking up a large number of second fridges in Q2 as the Australian competitor that has been attempting to enter the U.S. market for several years is now exiting and we expect to pick up a significant amount of their space and acquire those fridges, totaling more than 500 that are largely in the pet specialty channel. While we are thrilled to get the space, the validation of the strength of our business that this decision provides is even more meaningful. In total, we expect to add more than 1,000 second fridges over the balance of the year. Third, increased capacity. In addition to our Kitchens 2.0 project, we started up the small size line at Kitchen South in February. Production is going very well and running ahead of our plan. We are planning on adding a second shift there in Q2. That will provide added buffer against any supply interruptions. Additionally, we've begun hiring in Ennis, Texas. We now have five employees hired to support the planning, design, and construction of that facility already, and more are on the way. I will now turn it over to Dick to discuss our Q1 financials in more detail and our outlook for 2020.