Freshpet, Inc.

Greetings and welcome to the Fresh Pet first quarter 2021 earnings 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, Mr. Jeff Sonick with ICR. Please proceed, sir.

Thank you. Good afternoon, and welcome to Fresh Pet's first quarter 2021 earnings call and webcast. On today's call are Billy Sear, Chief Executive Officer, and Heather Pomerantz, Chief Financial Officer. Scott Morris, Chief Operating Officer, 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 security 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 SEC 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 that 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, 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 how management defines such non-GAAP measures reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP and limitations associated with such non-GAAP measures. Finally, the company has produced a presentation that contains many of the key metrics that will be discussed on this call. The presentation can be found on the company's investor website. Management's commentary will not specifically walk through the presentation on the call. There's a summary of the results and guidance they will discuss today. Now, I'd like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Jeff, and good afternoon, everyone. I want to start by giving you the punchline up front. The Fresh Pet Kitchens are delivering the increases in output we had expected and are now producing at a rate that is almost 50% above a year ago. That is enabling us to refill the trade inventory that we had drawn down during the back half of 2020 and satisfy our customers and consumers with much better in-stock conditions. We are not done refilling the inventory on all the SKUs at all customers, but we are getting close. We are incredibly grateful to the customers and consumers who have stood by us during the supply challenges we had over the last six months. We know it is frustrating for our customers to not be able to provide their shoppers with the high-quality, in-stock conditions they pride themselves on, and for consumers to have to search high and low for the fresh pet products that their pets have become accustomed to. Our team has done everything they could to catch up to demand under very challenging circumstances. I can't say enough good things about the efforts of our production, sales, logistics, and consumer care teams and their tenacity through the challenges of the past year. The progress we've made has allowed us to get back to doing what we do best, change the way people nourish their pets forever. Our advertising is on the air, household penetration is growing, we are launching new items, and our customers are planning to install new fridges, upgraded fridges, and second fridges. As a result of this progress and the strong fundamental trends we are seeing, we remain very bullish on our prospects for both this year and for the next several years. We are off to a very good start in 2021, despite the numerous challenges we face. In Q1, we grew net sales 33%, our strongest quarter of growth since the third quarter of 2015. Basically, we sold everything we could make in Q1. We also grew adjusted EBITDA in Q1 at a rate slightly above net sales growth of 35% versus a year ago. Heather will provide you with more detail and color on those results. I want to focus my comments on a few of the highlights and choices we made in that drove the results in the quarter and update you on our expectations for the balance of the year and early next year. I want to begin by discussing the state of our manufacturing operations. Overall, we are doing very well, delivering the commitments we had made on both our near-term and long-term capacity projects. As we have previously outlined, we made several additions to our capacity last year, including a two-shift operation at Kitchen South last June and the startup of Kitchens 2.0 in October. Despite those additions, our total output did not go up, i.e., we lost just as much output in our existing kitchens due to COVID testing and quarantine as we gained from those incremental operations. You can see this on the chart on page 36 of the accompanying investor presentation. In December, we made several interventions designed to correct that, and the plan is working. We are now getting the benefits of the incremental production capacity we added last year and adding more. Other than the two significant snowstorms in February, we've consistently produced in excess of meals and measured consumption every week since January 1, have not lost any production shifts due to COVID, and our April production was about 45% ahead of a strong month a year ago, and more than 60% greater than was consumed a year ago. We've now demonstrated the ability to produce at a level that will support the significant growth we are guiding to this year. We've been able to do this because of work our HR team did to bolster our staffing. We raised the wages for our night shift and recruited a flex pool of talent to both insulate us from any further COVID-related absenteeism and to further expand our capacity. COVID still exists in the Lehigh Valley community where the kitchens are located, so we are still incurring some COVID-related costs. We expect that to wind down in Q3 as our entire team became eligible for vaccines on March 31st. and we have strongly encouraged them to get vaccinated if they can. We have provided incentives to our team members to share their vaccination history with us, offering two incremental days of vacation and a $25 cash incentive if they share their vaccination record with us within the first two months after they became eligible, and one day of vacation if they share it within the following two months. Further, while the state of Pennsylvania has not allowed companies to do on-site vaccinations, we hired nursing staff to sit in our break rooms for eight hours per day, work with our team members to navigate the challenges of finding vaccination appointments. They have successfully found vaccine appointments for numerous team members at times and locations that worked for them. We are thrilled with the success of this program, and our team members are very appreciative that we made it so much easier for them. While not everyone will choose to get vaccinated, we believe enough will choose to be vaccinated to reduce our dependence on most of our COVID-related interventions by the end of Q3. Due to our success in navigating these unusual and dynamic variables, we do not expect further supply interruptions this year due to COVID, and as a result, we anticipate winding down our COVID add back to adjusted EBITDA by the end of Q3. We are mindful, however, that the future of COVID is uncertain, and there is the possibility of new variants that evade our vaccines, further government mandated lockdowns, and new unforeseen supply chain interruptions. We will remain nimble. always keeping the safety of our team as our top priority, and we'll communicate any changes to our expectations in a timely manner. Looking forward, we remain on track to add a new production line at Kitchen South later this year and another one early next year. And construction of our largest kitchen in Ennis, Texas, is making good progress. We remain comfortable with the timetables we've communicated previously in terms of facility startup timing and the total production capacity each of those facilities will provide. Further, when NS opens next year, it will be another example of our ability to continually improve the manufacturing technology for Fresh Pet, creating higher quality products at an attractive cost and in a very positive work environment. Kitchens 2.0 was a major step forward for us against those metrics. NS will be another step beyond that. I also want to point out that we are constructing the NS facility with environmental sustainability in mind. For example, We've already poured 3,700 cubic yards of low carbon concrete. That is concrete that uses fly ash to lower the carbon footprint. That has saved approximately 100 metric tons of CO2 emissions so far in the construction at facility versus ordinary concrete. We can't replace all of our concrete with low carbon concrete, but where we can, we are doing it. We are also installing a variety of measures designed to both limit our water and energy usage. but also generate clean water and energy on site. We will provide a much more in-depth review of our entire environmental sustainability and broader ESG effort this summer when we release our first ESG report. The second topic I would like to address is the composition of our growth in the quarter. As we said when we provided our guidance in late February, the year and year comparisons are not particularly meaningful due to the COVID surge and trough in the base year. In the accompanying presentation, we attempt to provide a bit more clarity so that you can understand the various moving parts, including not only the year-ago COVID impacts, but also the impact of our out-of-stocks this year. The key points I would highlight are, first, the out-of-stock impact was most significant in mid-February when winter storms Orlina and Uri interrupted both production and distribution. You can see this in the drop in total distribution points, TDPs, monthly net sales versus year-ago in February, and our two-year stacked Nielsen consumption growth rate. Prior to those February storms, our improving production resulted in strong January shipment and healthy consumption growth. Since the end of the second storm in mid-February, we've seen similarly strong bounce back in shipments, consumption, retail availability, and our production levels. Those trends continued into April with a strong upward trend in the weekly Nielsen consumption through the most recently reported week. we are now running at the consumption growth rate we need to deliver our guidance for the year. Second, we successfully refilled a portion of the trade inventory in Q1 and expect shipments to exceed consumption in each quarter this year. We believe that we refilled about $3 million of trade inventory in Q1, and that contributed about four points to our growth rate. We would have filled considerably more, but we lost $3.5 million of production to winter storms So virtually all the trade inventory refill happened in March, and it is accelerating. While estimating trade inventory levels is always very difficult and imprecise, we believe that leaves another $12 million of trade inventory to fill in Q2, and we have seen a significant portion of that happen in April as we've had very strong production performance. As we indicate in the presentation, our net sales in April are anticipated to be up about 42%. While consumption in April is expected to be up by a similarly strong growth rate, please remember that we were also refilling trade inventory in the year ago. Last year, we reported our total Q2 net sales growth rate included 11 points of trade inventory adjustments. We expect that this year's Q2 trade inventory refill may contribute to our growth rate at a level equal to or slightly above last year's adjustment. Looking to the second half of 2021, I'd remind you that in late Q3 and all of Q4, 2020, we could not keep up with demand, so shipments did not grow as fast as consumption, and we drew down trade inventory. We believe we will have adequate capacity this year to meet the increasing demand, and our shipment growth rate should exceed the consumption growth rate for the second half of the year. Third point, despite our out of stocks in the first quarter this year, we continue to successfully build both household penetration and line rate in the quarter. As you know, maximizing our first mover advantage in the fresh pet food space is a critical strategic priority for us. So our bias is always to lean in to maximize the number of households who become part of the fresh pet franchise. In early November, we delayed the start of our advertising in Q1 2021 to mid-February in an effort to better match our projected timing for improved retail conditions with a healthy media schedule to follow for the balance of the quarter. If we'd known in early November about the production challenges we would face in late November and December due to COVID, not to mention a series of major winter storms that would curtail our production and accelerate out of stocks, we would have made a different choice. Needless to say, that was not ideal. Despite that, we were still able to bring in new households at a very strong rate. Consumers saw the advertising and were motivated by it, driving household penetration up 25%, and exceeding 4 million households for the first time. The efficiency of the spend was likely reduced from our 2020 levels, but our early read suggests that it was in line with our 2019 levels of efficiency, which was still quite positive. We also built the buying rate by 3% despite consumers' inability to find our items for a good portion of the last six months. Once it became apparent that the retail conditions would not be restored until the end of April, We delayed the start of Q2 advertising until April 19th. While that will delay our ramp-up in household penetration gains in Q2, we believe we got the timing right as retail conditions had improved dramatically by the time the advertising went on the air. We will now be on the air almost continuously for the balance of the year, and that will provide significant momentum, particularly in the back half of the year. The third topic I would like to cover is how our retail partners are thinking about Fresh Pet today in light of our recent out of stocks and the implications for fridge placements later this year and next year. If there's anything that this experience has taught our retail partners and us, it is that Fresh Pet has become a very important destination for pet parents. When a store is out of stock on Fresh Pet, consumers are willing to go to a second or third store to find the product, and they will call us asking where they can find it. Fresh Pet really is that important to our pet parents and their pets, and our retail partners have noticed. Fresh Pet is now larger than all dry dog food brands in the grocery channel, which is where some of our biggest distribution opportunities lie. And our total dollar sales growth is now larger than the growth of every other wet and dry dog food brand in the Nielsen mega channel. While the out-of-stocks didn't always make for the most comfortable conversations with our customers, one clear theme emerged from them. They now realize that winning with Fresh Pet is very important to their overall success in pet food, and many of our leading customers are now planning to lean in on fresh. In fact, eight of our top 10 customers now have significant tests or expansions of dual fridge placement, and many are planning more. But before we place new fridges, we need to be able to supply them. It makes no sense to put lots of new fridges in stores if we can't supply the fridges that we already have. As a result of the out of stocks we incurred in Q1, in cooperation with our customers, We delayed many of the new store fridge placements until later this year, early next year, when our capacity could support them. Thus, our net new stores were only up 174 to 22,890 in Q1. However, we had a strong quarter on upgrades, placing 293 of them, and a decent quarter on second fridges, placing 121 of them. This pace is consistent with the guidance we provided in February, and we are on track to deliver our full year 2021 goals. We expect to see a steady stream of new placements throughout this year, with the most significant placements occurring in Q4 and the first half of 2022. We continue to expect to have the capacity to support a $590 million revenue run rate business by the end of this year and about $1 billion revenue run rate by the end of 2022. That will give us plenty of capacity to support the aggressive expansions our customers are contemplating, and we have shared that information with them, so we remain coordinated. Before I turn it over to Heather, I want to personally thank all the investors who supported our recent equity offering. That offering is allowing us to accelerate our pace of capacity expansion, enabling us to build the capacity to support a $2 billion revenue business, and helping us achieve our goal of changing the way people nourish their pets forever. While we have lots of work to do, we are well on our way to deliver those projects. Now I will turn it over to Heather to provide the details on our financial results.