Freshpet, Inc.

Greetings and welcome to Fresh PEC, Inc. Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A 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. I would now like to turn the conference over to your host, Katie Turner.

Thank you. Good afternoon and welcome to Fresh Pets second quarter 2020 earnings conference call and webcast. On today's call are Billy Cyr, chief executive officer, and Dick Kassar, chief financial officer. Scott Morris, chief operating officer, and Heather Pomerantz, executive vice president 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 that could cause actual results to differ materially from those described in these forward-looking statements. Please refer to the company's annual report on Form 10-K filed with the Securities and Exchange Commission and the company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note on today's call, management will refer to certain non-GAAP financial measures. such as EBITDA and adjusted EBITDA, among others. 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 walk through the presentation on the call, rather it's a summary of the results they will discuss today. And now I'd like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Katie, and good afternoon, everyone. I'm speaking with you from Bethlehem, PA. Vic is in his home in Manhattan, and Scott and Heather are in our offices in Secaucus. We'll do our best to not trip over each other on the call. and as always, please excuse any barking in the background and any other technical issues we might encounter. Let me start by saying that while it seems that the world is still quite unsettled, Fresh Pet has returned to the predictable growth that has been the hallmark of our business for the last several years. We are largely caught up on supply. The stores are back in stock on the vast majority of our SKUs. Our advertising is on air and driving strong increases in household penetration and consumption. Our retail partners have returned to installing new and upgraded fridges and our Nielsen measured results show the impact of this with continually accelerating growth now running well in excess of where we were in the pre-COVID period and ahead of where we would have been if there had not been a COVID crisis. That is not to say that we are immune to any future changes in the external environment because we aren't. We still face the same uncertainty related to the public health crisis and changing consumer and retail conditions that everyone else faces. But we do believe that our recent results demonstrate our ability to adapt quickly to changing market conditions and continue to deliver strong results. As a result, we are quite optimistic about the balance of the year and our progress towards our long-term goals. The COVID crisis presented some unique challenges, including new safety risks for employees, Badly disrupted retail environment, a surge in e-commerce, and drastic reductions in consumer mobility. But it also presented some new opportunities, including lower media rates, higher media viewership and engagement, increased awareness of the role pets play in our lives, and the willingness to try new e-commerce options. We believe that Fresh Pet is ideally positioned to take advantage of those opportunities and break out of the post-COVID surge and trough stronger than we went in. We have a business model where growth is largely driven by advertising. We don't rely on retail promotions or price discounting to drive penetration gains. And we are an incredibly nimble company, capable of creating and implementing new ideas very quickly. So at the end of Q1, we announced our post-surge pivot, building on our foundation of keeping our employees safe to rebuild our supply, and that would enable us to improve retail availability and offer new e-commerce options. With all of those key elements in place, we were able to turn on our advertising to drive consumption and penetration gains. During the quarter, we strategically invested in each of these areas, including safety enhancements to protect our team, incremental capacity at Kitchen South, incremental retail coverage, new e-commerce options and strong media support. The results of these efforts speak for themselves. Fresh Pet is now growing faster than it was before the COVID crisis, with the most recent Nielsen megachannel data up in the high 30s, ahead of the 28.8% growth we averaged in January and February. Consumption has grown consistently virtually every week since April 18th and shows no signs of slowing. Household penetration gains are strong. The buying rate is also growing. All this progress would not have been possible without the dedicated efforts of so many of our team members from the folks who have kept our production lines running virtually nonstop since the COVID crisis began to our incredibly nimble marketing and sales teams who use their creativity to seize new growth opportunities in a rapidly changing environment and position Fresh Pet for accelerated growth to our dedicated customer and consumer service teams who are diligent and enabled customers to rebuild their inventories and restore their stores in the face of challenging conditions. but most of all, who have taken on the responsibility for keeping our team safe. Pivot was built on the idea that we could keep our team safe and they would then be able to catch up to and meet the rising demand. Thanks to the efforts of those teammates, our team members come to work each day confident that the Fresh Pet Kitchens are a very safe place to work despite the numerous challenges that the coronavirus presents. Our safety program has three layers of protection. designed to stop the virus from entering our facilities, prevent it from harboring in our facilities if it does get in, and preventing it from being spread from one team member to another. This program has resulted in us having no record of the virus being transmitted from one team member to another in our facilities despite the virus being present in our communities. That is not to say that none of our team members have been afflicted with the virus because they have. and it is an awful virus and has impacted our team members and their families. But it says that none of our teammates got the virus in our facilities or gave it to another person in our facilities to the best of our knowledge and after significant contact tracing. We consider ourselves fortunate to have had such good results but are also incredibly grateful to the team that has worked tirelessly to keep our team members safe. Without them, none of the outstanding results I'm about to share would have been possible. I would also add that we are very grateful to the teams at St. Luke's Hospital and Lehigh Valley Hospital Network who have provided us with nurses, testing, advice, and help for our teammates in need while they cared for so many other members of our community during very challenging times. We could not have achieved the results we did without their support. But we are not out of the woods yet. Until there is a vaccine or effective treatment where the virus is no longer present in our communities, We must continue to be vigilant. Thus, we will continue to incur some of the $4 million in 19 costs that we outlined last quarter, although the costs will likely be lower in Q3 than in Q2. Part of that reduction is because our absenteeism has dropped significantly since we reinstituted our absenteeism policy on July 1st, with exceptions for employees with underlying health conditions or who have someone at home at significant risk. Absenteeism is now running in the mid-single digits versus the mid-teens. Now, on to the results. We feel very good about what we accomplished in the quarter. We posted our strongest quarter of net sales growth since 2015 and were able to drive a significant portion of that stronger top line into our best bottom line performance ever. Net sales were up 33% versus a year ago. and adjusted EBITDA was $10 million higher than the result we posted one year ago. As a result of this strong performance and the continued strong trends we are seeing, we are raising our net sales guidance for the year from greater than $310 million to greater than $320 million, representing greater than 30% growth in a year filled with COVID and capacity challenges. We are also raising our adjusted EBITDA guidance by $2 million. Dick will provide more details on our guidance later. The strong top-line results are the product of 21% Nielsen megachannel consumption growth for the quarter, despite starting with less than 10% growth in April's post-surge trough, and the volume benefit from refilling the trade inventory hole we dug earlier in the year. The consumption growth accelerated throughout the quarter, ending with 30-plus percent growth in June and still accelerating into July, where our growth is now in the high 30s. This is due, in part, to some outstanding work by our marketing team to make a very timely pivot, re-planning and rescheduling our media investment, taking the spending out of the shelter-in-place trough in April and investing more heavily in May through October, taking advantage of the higher viewership and lower media rates we are now seeing. The result was that we saw returns on our media investments well in excess of what we have seen historically and that is driving the accelerated consumption growth we are seeing today. It is also driving very strong velocity growth measured as dollars per million ACV, hitting 19% growth versus a year ago in the most recent four weeks. The Q2 growth is also the result of the efforts of our manufacturing team to produce enough product to catch up to the demand. The Fresh Pet Kitchens never stopped operating in the quarter. Producing record quantities and, in conjunction with the additional capacity we put in place at Kitchen South, we were able to increase our fill rates from the mid-70s in early April to the 90s by the end of the quarter. We are still not at the 95 plus percent rate we expect due to tighter capacity on a few items and surging demand, but we are getting close. We will, however, have very tight capacity on our fresh from the kitchen items until Kitchens 2.0 begins producing saleable product in Q4. As a result of these efforts, we were able to largely refill the trade inventory hole we had at the beginning of the year in which we dug deeper in Q1 behind the COVID surge. Refilling those two holes combined to add eight points to our growth rate in the quarter versus the consumption growth rate we experienced. But I want to be clear that we ended the quarter with trade inventories still slightly below what we would consider normal largely focused on a few SKUs that we're still catching up on. We also got the benefit of a slightly depressed quarter in Q2 last year due to short shipments in that quarter, providing an additional three points of growth versus a year ago, and improved performance on spoils this year, adding another point. Recall, in the second quarter of last year, we had some manufacturing issues that resulted in short shipments and an impact on our gross margin in that quarter. The favorable comparison that created versus year ago will reverse itself in Q3 as we caught up on shipments in Q3 last year. A full reconciliation of the gap between consumption growth and net sales growth in the quarter is in the accompanying investor presentation. If you look at the year-to-date results, you can get a clearer view of how we are performing. Year-to-date, Nielsen Mega Channel consumption growth is up 27% versus year ago through the end of June and accelerating. Year-to-date shipments are slightly ahead of that, up 31% due to the trade inventory hole we had at the beginning of the year, the short shipments in Q2 of last year, and the improvement in spoils this year. That reconciliation is also in the accompanying investor presentation. Another driver of our improvement in Q2 was a significant improvement in retail conditions. Our sales teams, in partnership with our customers and our broker partner, were able to restore the retail conditions and we now have greater than 90% in stocks on most SKUs and most customers. Additionally, we are now benefiting from a significant number of end cap fridges and double fridges in high profile retail outlets. The consumption growth was broad based with each class of trade showing growth by the end of the quarter and only pet specialty not showing growth for the whole quarter. But even the big box pet specialty business showed strong growth by the end of the quarter hosting double-digit sales growth every week in June, in part due to the placement of second fridges in more than 744 stores and the foot traffic generated by the resumption of their services business. That growth has accelerated further in July. Our e-commerce business grew rapidly, as you would expect, up 201% versus a year ago. Curbside pickup and last-mile delivery services like Instacart grew the fastest, resulting in more than 90% of our e-commerce business going through our in-store fridge network. We are most encouraged by the strong engagement we got from the new advertising we ran that featured our e-commerce options. Increasing click-throughs on our website where we now prominently feature our various e-commerce options and make it very easy for the consumer to get fresh pet any way they want it. ETC business is serving its purpose to those afraid to go into stores and not comfortable with other e-commerce options. as well as teaching us a bit more, but it is very small and not material to our results. Household penetration growth is strong at 19%, despite canceling the April media due to the conditions of the stores and the shelter-in-place orders. The penetration of our core dog business, i.e., the main meal items, which accounted for 92% of our sales in the quarter, grew 21%. Since the beginning of the year, we've added 350,000 households towards our goal of 5 million new households by 2020, in line with our expectations. The buying rate resumed its growth, growing 6% on the total business and 5% on the core dog business. What to expect when the number of new users added in the quarter was not so big that it would overwhelm the gains made on the existing user base as it did earlier this year. Bridge placements slowed in the quarter, as we had indicated they would, but the incremental placements were not inconsequential. We added 253 net new stores in the quarter, bringing our total for the year to 550 and putting us on track for our 1,000 net new stores target. As a result, ACV was up 12% versus the year ago, but only 0.5 points ahead of where we ended Q1. More importantly, we added 764 second fridges in the quarter and now have added 779 for the year. We upgraded another 186 fridges in the quarter, taking our total upgrades year-to-date to 218. We remain confident that we will be able to deliver our revised targets of 500 upgrades and 1,000 second fridges this year. Total distribution points, TDPs, were up 20% versus a year ago, as a result of the large number of upgrades and second fridges we placed and against the out-of-stocks we incurred in the year-ago period. All of this combined to drive the strong top line we saw in the quarter and give us confidence that we will see continued strong performance in the back half of the year. We are particularly bullish on the back half of the year as we had advertising on the air for most of the summer for the first time ever with high viewership and low media rates, and that is continuing to drive strong consumption gains. Nielsen megachannel consumption has been up 37% versus a year ago during the first three weeks of July. We entered the third quarter with strong and accelerating consumption growth trends, strong household penetration, and real momentum on fridge placements. All of that should support strong growth and make 2020 our strongest growth year since 2015 when FreshPak grew 34%. To support that growth, we are making very good progress on our capacity expansion initiatives. So far this year, we've taken our second roll line to a 24-7 operation in January, started up Kitchen South in mid-February, and added a second shift there by the beginning of June. At this point, we have run rate capacity of $350 million, or about $87.5 million per quarter, assuming average absenteeism and holidays, and full utilization of the product mix our lines produce. Kitchen's 2.0 is on track to start up within the next eight weeks, Shipping saleable product in October and meaningful quantities in November. Once that facility is fully operational by Q1 of 2021, we'll have almost 600 million in total capacity, making 2021 the first year in quite some time where we have the ability to grow without worrying about capacity. We intend to take advantage of that capacity. Also, we are breaking ground next week on Kitchens 3.0 in Ennis, Texas. This facility will be built in two phases and is targeted to be operational by the third quarter of 2022. Once fully operational, it will take our total capacity to about $1.3 billion. Adjusted EBITDA in the quarter was $11.2 million, up $10 million or more than nine times the year ago, as we demonstrated the significant leverage we get from scale, particularly in adjusted SG&A, excluding media, and the contribution from incremental volumes. Before I turn it over to Dick, I want to inform you that next week we will be releasing the proxy for our annual shareholder meeting in September. In that proxy, we will outline a significant series of steps that we are planning to take to transition from the governance practices we have had since Fresh Pet went public in 2014 as a fast-growing, small-cap, private equity-backed company into the governance practices of a fully mature, and many more. This plan was developed by our board after consultation with some of our most significant long-term shareholders with advice from governance experts and by studying the academic literature on the best ways to optimize success for high-growth companies like ours. We believe this plan delivers the right balance between the guidance needed by early-stage companies and the governance required for larger, more complex companies from our board over the next phase of our growth. We also believe that laying out and committing to a long-term plan of governance enhancements now provides the greatest clarity for our investors about how we will continue to grow and develop Fresh Pet and is in keeping with what they have come to expect from us, i.e., a highly disciplined, transparent, and proactive approach to the long-term development of the company they have invested in. We will be speaking with members of our shareholder base about this once the proxy is issued later this month. I will now turn it over to Dick to discuss our Q2 financials in more detail and our outlook for 2020. As a reminder, this will be the final quarter that Dick will be presenting our financials as the CFO. On October 1, 2020, Dick will become Vice Chairman and Heather Pomerantz, who joined us in January, will become the CFO. Dick has taken this business from a startup through the angel investor and private equity phases through a public offering and two subsequent equity offerings to a company that now has a market cap in excess of $3 billion and is showing no signs of slowing down. And that is just the last 14 years of his almost 50 years as a financial professional. He had enough achievements before Fresh Pet to satisfy and impress almost anyone, including a very successful run with private equity-backed companies. But in an age when most people think about retiring, Dick started on the Fresh Pet journey. We're awfully glad that he did. We would not be where we are today if it had not been for Dick's intelligence, tenacity, creativity, and good humor. It has been a privilege for all of us to have him as our CFO. The last seven months have provided Heather a tremendous opportunity to learn every aspect of our business, tap Dick's vast knowledge, and begin to forge relationships with our team and board the analysts who cover us and our shareholders. She has been part of the launch of our new five-year strategic plan, a successful equity offering, the renegotiation of our credit facility, and all the challenges presented by the COVID-19 crisis. Her presence gave us added horsepower to manage all that work simultaneously bringing her up to speed on our business. Through it all, Dick has been a tremendous mentor to Heather and he will continue to be available to all of us in his new role. that has made this one of the most successful transitions we could have hoped for. And I hope it is an indicator to all of you that we continue to put in place well-thought-out plans to manage the many challenges of a rapidly growing business. And now let me turn it over to Dick.