Freshpet, Inc.

Greetings and welcome to the Fresh Pet Inc. Third Quarter 2022 Earnings 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 you, your host, Jess Sonick from ICR. Please go ahead.

Thank you. Good afternoon, and welcome to Freshcut's third quarter 2022 earnings call and webcast. On today's call are Billy Sear, Chief Executive Officer, and Dick Kassar, Interim 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 securities laws. These statements are based on management's current expectations and beliefs and involves 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, followed 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 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 how management defines such non-GAAP measures, a reconciliation of non-GAAP financial measures to their most comparable measures prepared in accordance with GAAP, and limitations associated with such non-GAAP measures. Finally, as previously disclosed during the second quarter call, beginning with this third quarter of 2022, the company is no longer adding back plant startup and launch expenses in its definition of adjusted EBITDAO. The company has provided those costs in a table at the end of its press release to assist in your analysis of the results under both methodologies. Additionally, 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 and guidance they will discuss today. Additionally, we'd ask that your questions remain focused on the performance of the business and the results in the quarter. Management will not discuss or speculate on other topics beyond what is being reported here today. With that, I would like to turn the call over to Billy Cyr, Chief Executive Officer. Billy?

Thank you, Jeff, and good afternoon, everyone. The message I would like you to take away from today's call is that we had a solid, on-plan quarter and that we are taking concrete steps to deliver on the enormous potential of Fresh Pet by addressing the most critical issues we outlined in our September organization change announcements. Those actions include, one, continuing to drive the strong and consistent top-line growth that Fresh Pet has demonstrated for the past six years. We delivered 41% growth in the latest quarter and are on track for our sixth consecutive year of accelerating growth. We are also well ahead of the pace needed to achieve our 2025 net sales goal of $1.25 billion. Second, executing on our operational improvement plan to drive margin expansion. In particular, the quality, logistics, and commodity cost management issues. I will provide more detail on our actions and progress on those in a few minutes. Third, aligning long-term growth with prudent capital expenditures. Our goal is to build a very large and comfortable cash buffer in order to optimize our liquidity and financial flexibility. We've made good progress on this so far, and we are fully confident that we have adequate resources to meet our growth goals with the cash we have on hand, available credit, and the cash flow from operations. I will touch on that in more detail in a few minutes as well, but the headline is that we are now projecting that our CapEx spending over the two-year period of 2022-2023 will be reduced by $100 million versus our last projection with no change to our near-term growth or our 2025 net sales targets. Additionally, I want to highlight that we are rapidly building the organizational capability needed to deliver the results we need. Today, we announce two important additions to our team. First, Todd Comfort will be joining Fresh Pet on December 1st as our new CFO. Todd is a proven public company CFO with experience in a high-growth food business. He has been the CFO of Simply Good Foods for the past five years and delivered exceptional performance there. Prior to that, he worked in a wide variety of finance roles at Hershey for more than 20 years. We are thrilled to welcome him to our team. We are also welcoming Dirk Martin to our team as VP of Customer Service and Logistics. Dirk is coming to us from Lamb Westin, where he managed a large network of third-party distribution centers and a complex supply network both brokered and direct freight in the U.S. and abroad. In total, he has spent more than 20 years in supply chain, inventory management, and logistics roles in a variety of industries and brings much needed expertise to our team. Dirk will begin at Fresh Pet this coming Monday. Now let me turn to the results for the quarter. I will start with a few key highlights of our strong top line performance. As I said, our net sales growth was 41% in the quarter. This was driven by 37% growth in Nielsen measured consumption and approximately 4% growth from our efforts to replenish trade inventory. We built market share in all classes of trade and are now the number four brand of dog food in the Nielsen mega channel and closing in on number three and number two. We are also the number one brand of dog food and grocery, despite having only 70% ACV distribution in that channel. Fresh fed velocity, i.e. dollars per point of distribution, in grocery is now 50% greater than the second highest velocity dog food brand. That makes Fresh Pet an incredibly valuable brand to retailers. According to scanner data, unit growth in the quarter was approximately 18%, with the remaining 19 points of consumption growth coming from price increases. Price sensitivity has stabilized behind the large price increase we took in February at levels that are considered very attractive in the world of packaged goods. We've just begun to see the third, much smaller, 2.6% September price increase show up at retail, but have not seen any indications of significant price sensitivity behind that increase and don't expect to see much. As anticipated, household penetration continued to grow now that we are back in stock and media is on the air. In the most recent 52-week period of Nielsen household panel data, fresh pet household penetration was up 14% and buying rate was up 19%. It will take some time for the rolling 52-week measure to reflect our improved growth rates, but we are well on our way. It is also interesting to note that the rate of growth amongst heavy and super heavy users is even stronger, suggesting that we are succeeding at converting more households to using Fresh Pet as the main meal item. Going forward, we will be transitioning our reporting to data provided by Numerator as it provides a larger panel with more in-depth demographic information and provides better coverage of all channels. we will reconcile the old reporting and the new reporting when we make that transition. Now I'd like to turn to the operational plan to drive margin expansion that we've outlined previously, with particular focus on logistics, commodity cost management, and quality. Let me start with our commodity cost management. As a reminder, this issue has been the result of a mismatch between the timing of when we incur increased input costs as compared to when we can pass on those higher costs to our customers. In 2022, we estimate that lag cost us approximately $19 million. Given the magnitude of this headwind, our entire organization is focused on this, and it is an area that we have already taken some action on. In the near term, we've gotten closer to our suppliers so that we can better understand the variables driving their costs so that we can better anticipate cost increases. Additionally, we've put in place a more rigorous system of tracking underlying cost drivers adjusting the frequency and duration of our supply commitments, and are working with our suppliers to find ways to create greater cost certainty that works for them and for us. We are already in discussion with some potential partners about hedging a wider range of our commodity costs and have locked 75% of our natural gas exposure for next year and are looking at other items such as diesel. In total, we have contracted for inputs totaling 25% of our costs already and expect to have significantly more committed prior to the beginning of the year. The point is that we are seeing headwinds sooner and using that information to take more timely price increases. As a result, we've now taken a hard look at our anticipated costs for 2023, roughly two months sooner than we have in previous years, and have concluded that the basket of input costs will go up in the near term. And in response to that work, we've already announced a 5% price increase to go into effect in early February. That increase is designed to protect our margins and to greatly reduce the impact of any timing mismatch. On logistics, as I mentioned previously, we've just announced the hiring of a new VP of logistics who has extensive experience with the cold supply chain in the U.S. and abroad during his time with Lamb Weston. His focus will be to help us more efficiently grow into our expanded distribution network and drive out the elevated costs we have absorbed over the past year. Additionally, we are making good progress with the startup of our second DC, but do not expect to see the benefits of that until sometime in late Q1 of 2023 or early Q2. In the area of quality, I don't want to go into too much detail because we view the improvements we make in this area to be highly proprietary and a source of long-term competitive advantage. But I can say we are already rolling out one new technology we developed over the past three years, that we believe can make a sizable impact and have two more under development. Improvements in this area will take time, but will also provide a meaningful extension of our formidable long-term competitive moat. In addition, we have very strong candidates under consideration for the new leadership roles in this area. In Q3, our quality costs, i.e., disposals and secondary processing costs, both declined versus Q2, with disposals cut in half. We're off to a good start in Q4. We see this as a big opportunity for both cost improvement and proprietary advantage and are resourcing it as such. The accompanying presentation contains details on these efforts and a few additional efforts we are undertaking to enhance margins. In summary, we have a deep appreciation for the importance of rebuilding credibility with you and our team's ability to execute on our operational plan to drive margin expansion will be a primary proof point. I want to impress upon you the focus and determination we have. We've made good progress on each of these efforts since we identified them early in Q3, but we have lots of work left to do. The path is clear and we are doing that work. Now we'd like to discuss how we are aligning our net sales growth goals with prudent capital spending to grow capacity. Let me start by providing some context. Our primary motivation over the past several years was to build as large of a consumer franchise as possible before competition arrived. We described this as a land grab, and we were determined to get as big as we could as fast as we could. And while this is no easy task in a normal operating environment, it was made doubly difficult by the pandemic and the related supply chain and labor issues of the past three years. Over the past year, however, that situation has begun to change. While we've continued to increase our scale, the latest competitive entry from a leading competitor and with the support of a very large retailer has made a little progress. We're outselling that competitor seven or eight to one in the stores where both our brand and theirs is distributed. This provides another proof point for how significant our competitive advantage is and how much of a head start we have. Executing a fresh pet food program is extremely difficult. We've learned that the hard way at times, but our potential competitors also have to contend with a complex moat that we have created over the past 16 years which covers the formidable combination of manufacturing know-how, fridge placement and management, fresh food distribution, and more. In that context, and with the successful completion of the NS Facility, we are well positioned to balance growth and margins with our increased scale and do so within a prudent financial and investment framework. As a result, we are revising our expansion plans and can smooth our CapEx spend to enhance liquidity and financial flexibility while still achieving our robust growth expectations. We have already shifted a few projects that we believe we won't need until further down the road. We aren't ready to provide the full impact of those decisions yet, but we can say that our expected CapEx spending this year and in 2023 will be approximately $100 million less than we previously anticipated, with a $30 million CapEx reduction in 2022 and $70 million next year. As noted, importantly, we remain confident in our 2025 net sales target. We have the resources and capacity to achieve that target, and we believe we are well on track to deliver it. For perspective, with Ennis up and running, we will have enough installed capacity to support more than $1 billion in net sales before any of the technology improvements previously mentioned or added investments in capacity. Finally, before I turn it over to Dick to provide more detail on the quarter, I want to comment on the startup of our NS Texas kitchen. We are already producing very high quality rolls on our first line. We will be able to ship those rolls once we've completed our final validation on the building security and process controls. Our priority there is to produce the widest range of SKUs rather than the maximum volume because that enables us to make full utilization of our Dallas DC. Today, we have qualified 12 SKUs and we will continue our projected ramp up, which is on track. having already shifted to 24-7 production on the roll line. For context, that is about six months faster than we were able to hit that milestone in Kitchens 2. The number of SKUs we have qualified is similarly ahead of the pace we have delivered on previous startups. That is largely due to the extensive planning and training we did in advance of this startup, including the significant investment we made to train our production team in PA for up to a full year. The second line in NNS, a bag line, will begin test runs in January, about one to two months later than previously indicated, and we expect it to begin shipping product about one to two months after that. This added time is designed to ensure that we have completed the optimization of the Rolls-Royce startup, where we have a greater need for the capacity. We have adequate bag capacity in our system to meet the current level of demand, so this delay will not impact our growth. However, it will delay the full utilization of the Dallas DC until later in Q1 or early Q2. Once those two lines are operating, we believe that we will have enough capacity to fully support our growth for 2023, enabling us to provide exceptional service to our customers and consumers and support the aggressive growth plans we are aiming for in 2023. We also believe that at scale, Ennis will be our most efficient plant. The Ennis facility has the capability to have higher throughputs with less labor and longer run times as a result of greater automation, some technology improvements, and through enhanced sanitary design. Additionally, the onsite chicken processing will offer improvements in quality and cost versus what we experienced in Bethlehem. In summary, we are seeing evidence that the foundation we have laid over the past year is paying dividends and will continue to do so in the coming months and years. We have our largest and most efficient capacity project completed, and it will begin shipping product in a week or two. That gives us a long runway for growth and margin expansion. We started up our second DC, which will ultimately shorten the distance our product travels to customers and reduce our freight costs. We've restored retail conditions and the household penetration growth is on track to support our long-term net sales goals. We have proven that Fresh Pet has the pricing power needed to offset rising costs and still deliver strong growth and will ultimately produce attractive margins. We are executing on a multifaceted operational improvement plan to drive margin expansion over time. We are also taking a more prudent approach to CapEx and have reduced expected CapEx spending substantially. We are attracting the caliber of talent we need to address our challenges and support our growth. And we have strong support from our customers and consumers. We are improving the quality of our execution and look forward to demonstrating the cash generation that this business is capable of delivering. That is what we are focused on. Now let me turn it over to Dick for a more detailed review of our financials, including a discussion of the change in the reporting method. Dick?