Freshpet, Inc.

Greetings and welcome to the Fresh Pat fourth quarter 2022 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 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, Jeff Sonick with ICR. Thank you. You may begin.

Thank you. Good morning. and welcome to Fresh Pet's fourth quarter 2022 earnings call and webcast. On today's call are Billy Cyr, Chief Executive Officer, and Todd Confer, Chief Financial Officer. Scott Morris, the company's 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 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, 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 financial measures. a reconciliation of the non-GAAP financial measures to the most comparable prepared in accordance with GAAP and limitations associated with such non-GAAP measures. Finally, as previously disclosed during our second quarter, the company is no longer adding back plant startup and launch expenses in its definition of adjusted EBITDA. The company has provided those costs in a table at the end of the 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, but 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'd now like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Jeff, and good morning, everyone. The message I would like you to take away from today's call is that our house is getting back in order after the stumbles we had earlier in 2022. It is not perfect, and it will take some time for us to get all the systems and processes working the way we want them to. but the actions we have taken since our early September announcement of organizational changes and a renewed focus on our key costs are beginning to show their potential impact. A few of the highlights are, first, strong net sales growth. We delivered 43% growth in the fourth quarter. This is the strongest quarterly net sales growth since the company went public in 2014. We finished 2022 with 40% growth for the year, our sixth consecutive year of accelerating growth and also our strongest net sales growth since we went public eight years ago. Second, adjusted EBITDA ahead of guidance. We delivered 20.1 million for fiscal year 22, well ahead of our guidance of greater than 15 million. This was due to a wide range of operational improvements in Q4, including better production that enabled higher revenues, improved costs in manufacturing and logistics, and lower startup costs in NS. Third, Improved logistics performance. By the end of the quarter, we were consistently shipping customers with a fill rate in excess of 90%, and that benefit flowed through our P&L. The logistics cost dropping to 9.4% in net sales in Q4 from 12.2% in Q3. Our in-stock position is now at pre-pandemic levels for the first time and improving by the day. Our fill rates are the best we've had since 2019, and customers are noticing it and adding fridges at an aggressive pace. Fourth, improved quality. The levels of secondary processing and disposals dropped considerably as we progressed through the quarter due to strong operational improvements that we believe are the result of the investment we've made in training and retention of our workforce via the Fresh Pet Academy. It typically takes a quarter for quality improvements to flow through to the bottom line, so we were quite pleased to see the rapid sequential improvement in Q4 where we realized a 24% drop in the rate of quality costs as a percent of net sales versus Q3, and the momentum has continued into Q1 of 2023 as well. Fifth, more effective balance between commodities and pricing. Input costs as a percent of net sales improved versus Q3 2022 due to the September price increase, coming in at 33.6% versus 34.7% in Q3, an average of 35.9% for the first nine months. Sixth, we have rebalanced our capacity expansion plan to drive better capital spending discipline and match our anticipated growth. As we indicated at CAGNI last week, we adjusted our capacity plan to reduce capital spending between 2022 and 2023 by $50 million, and we'll still have adequate capacity to support our planned growth with some headroom. Seventh, the NS startup is going very well. Our startup expenses came in a bit lower than we had projected because the NS startup is doing very well and is ahead of schedule. We are now producing virtually the entire range of roles and at volumes that are in excess of our previous projections. This allowed us to switch shipments to the state of California to come from the Dallas, D.C. in mid-January ahead of our schedule. We are also ahead of schedule on the startup of the bag line in NS and expect to be shipping a wide variety of SKUs from that line in Q2. We attribute this performance to the investment and training we made prior to startup and also to the realignment of our engineering resources into a single group as part of the organization changes we made in September. We believe these improvements position us well for 2023. We are starting the year with well-stocked fridges, healthy inventories, and experienced and well-trained production staff, a robust lineup of new product innovations, strong customer commitments for incremental fridges, outstanding advertising on the air, and pricing in the market that more closely matches our input costs. It will take some time for all those improvements to align and drive the resultant margin enhancement that we expect, but the early indicators are encouraging. Our plan for 2023 is a logical extension of the updated Fresh Future five-year long-term guidance we outlined last week at Cagney. We continue to believe Fresh Pet is going to change the way people nourish their pets forever. And that will lead to more rapid increases in household penetration this year than we had last year. Buying rate will continue to grow at a strong rate due in part to higher pricing and consumers continuing to increase the value and quantity of Fresh Pet items that they buy. That will support strong net sales growth, but at a more measured pace that will allow us to address the margin improvement initiatives that are underway. So with that context, we are initiating 2023 guidance that is in line with our updated long-term growth plan, which equates to revenue of approximately $750 million, which would result in growth of about 26%. In setting that target, we are mindful that we are only getting 8.5 points of pricing growth this year versus the 15 points we got last year. We also considered that there was no more trade inventory refill needed, and we were lapping a year that had significant trade inventory refill. While it is hard to put a precise number on the trade inventory refill that happened last year, it is likely that it was somewhere in the range of $15 to $20 million. Finally, we believe we are facing potential recessionary headwinds at a time when we have also taken another price increase. We expect that there will be some impact from that on our unit movement and growth rate. Counterbalancing those headwinds are the significant increases in new fridges, a strong investment in media, and some of the best new products we've launched in a long time. And we will do that in an environment where we are not capacity constrained. We have more than enough installed capacity such that we can add staffing on about 90 days notice if necessary to meet higher demand. From an operations perspective, we're expecting to see continued improvement in all areas of our operation, but some of them will take a bit of time and some of them will have transitions that add expense before we actually see the cost benefits. For example, We now have more demand than we could supply from the Bethlehem Kitchens and Kitchen South, but not enough to fill both of them and the new lines at Ennis. For perspective, the first two lines in Ennis, if fully staffed, would add almost $250 million in capacity, while our guidance implies net sales will grow by about $155 million this year. In other words, while we are adjusting staffing to match the demand, we will be carrying the incremental overhead costs of the new Ennis Kitchen while we grow into our new capacity and achieve higher levels of net sales. Further, we will be shipping bags of product from PA to the Dallas, D.C. during Q1 and Q2 of this year to support shipments in Texas and the West Coast until the bag line in Ennis is fully capable of producing the wide array of bags we sell. Those incremental shipping and handling costs are transitory, but will impact us until we have a balanced role in bag production in Ennis. You should also see steady progress on adjusted gross margin and adjusted EBITDA margin as we move through the year. And by the end of the year, you should expect to see the fruits of those efforts in the form of much improved capacity dualization and lower freight costs. Furthermore, when measured on an annual basis for the full year 2023, we expect our results will be significantly better than last year's on several KPIs, including adjusted gross margin, freight as a percent of sales, and adjusted EBITDA margin. Kyle will take you through the details. All these improvements are enabled by the increasing strength of our operations team and our renewed focus on improving margins. While we still expect to make one or two additions to our operations team, the team we have is operating at a much higher level, and our entire leadership team is relentlessly focused on the leading indicators of performance and have developed action plans to drive the improvements we've outlined in our 2027 goals. As previously indicated, we have implemented a 5% price increase, effective with the orders beginning on February 6, 2023, At this time, we believe that the pricing we've taken adequately covers the known input and energy cost inflation we've seen. We've locked pricing on inputs that account for greater than 75% of our costs so far and will continue to add to our supply agreements as the year goes along. Due to the timing of our price increase being implemented six weeks into the start of the first quarter, we anticipate that we will have a small price-cost mismatch. But on a relative basis to our experience last year, We see this as much, much more manageable. Our advertising plan for the year is, like in most previous years, front loaded. We have greater than 60% of the spending planned for the first half of the year and have been on air since the beginning of January. We expect this to reaccelerate our household penetration gains, taking them from the 16% we had in 2022 to the low to mid 20s by the end of 2023. We are expecting record support from our customers in 2023. At the end of 2022, we had about 1.5 million cubic feet of fridge space at retail. We expect that to grow to more than 1.7 million cubic feet by the end of 2023. That represents approximately 1,200 net new stores, the addition of 3,000 second and third fridges, and fridge upgrades in approximately 1,000 stores. This is a terrific endorsement of Fresh Pet's value to our retail partners. We believe this will amplify our advertising investment, providing added visibility that reinforces our brand's distinctive offering. In total, we believe we have all the necessary building blocks in place to generate consistent, long-term growth that is appropriately geared so that we can also achieve our margin improvement goals. We will be able to fully support this growth from our existing kitchens in Bethlehem, three lines in Kitchen South, and the first two lines in Ennis, with room to spare. As you heard at Cagney, we have modified our capital spending plan to better match the rate of sales growth we are expecting and can reliably support. We will continue construction and installation of the next two lines in Ennis so that they are ready to go in 2024 and 2025 when they are likely needed to support the next leg of our growth. Each step of the way, we are carefully assessing the latest view of demand against our available capacity so that we keep these two important variables aligned. This will help us control expenses while maximizing our opportunity to drive profitable sales growth. I want to be clear, however, that our long-term economics and the plan for 2023 assume that we will always have some amount of capacity in excess of our planned net sales because capacity comes on in chunks. It's form-specific, i.e. rolls or bags, and startups can be challenging, so we want to be sure that we don't get caught without enough capacity as we did for the past three years. Before I turn it over to Todd, I would like to share one additional thought. I am a big fan of identifying key metrics in our business that are leading indicators of performance. That is how we arrived at the intense focus we have on household penetration as the prime indicator of our net sales potential instead of store count in 2017. That has proven to be a very reliable indicator of our growth and upside potential, and it has also driven the right kinds of investment choices that have resulted in six consecutive years of accelerating growth. When it came to improving our operations, we struggled to find that critical leading indicator. There are so many that seem to be good indicators of parts of our operations, but nothing that could be a harbinger of broad-based operations improvement. But as I've seen our performance improve over the last 90 to 120 days, there seemed to be one factor that underpinned our improving performance on a wide range of metrics. employee retention within our hourly workforce. There appears to be a strong correlation between the improving retention we've had amongst our hourly workforce and the improvements we are seeing in throughput, quality, fill rate, and many more. While that should not be surprising, what is surprising is how quickly that impact can show up. It takes time to build the skills of our team, but relatively little time for those improved skills to pay off once they are in place. As we saw team members climb the ladder of the Fresh Pet Academy, we've seen our operating performance improve in turn. In this way, we believe that the investment we made in our talent and the Fresh Pet Academy is working. We are attracting more skilled team members, providing them with significant training opportunities, and rewarding them with career and compensation gains. As a result, our retention has improved dramatically, and we've advanced a large number of our team members to higher levels within the Fresh Pet Academy. One year ago, after more than 15 years of operation, we did not have any team members with the skills to be at level 600, the highest level in our Fresh Pet Academy. One year later, we now have 14 team members at that level. Those highly skilled employees are capable of running virtually any piece of equipment in our operation and demonstrate a level of proficiency that has proven to result in higher quality, less waste, and greater throughput. In Ennis, we already have 14 members who have reached level 400 due to the head start we gave them with one year of training in Pennsylvania. That is clearly contributing to our fast startup in Ennis. We are going to continue to focus on enhancing the skills and retention of our hourly workforce and expect to build upon the early gains we have realized since launching the Fresh Pet Academy. Those gains are very reassuring and gratifying because we strongly believe that focusing on the people part of pet's people planet will pay dividends and, in this case, it appears it is happening. It is also creating sustainable value for employees, their families, and the communities in which they live. These employees now have greater skills that will provide value for their entire career and are earning much higher pay with the added benefits of equity ownership. Every day, I hear stories from our production team members about how our investment in their careers is enabling them to enhance the lives of their families through home ownership, paying for a kid's education, paying off debts, and more. We are very proud to have created an ecosystem where their efforts and our training enable so many enhancements to their lives while simultaneously creating a recipe for sustainable shareholder value creation. Now let me turn it over to Todd for a more detailed look at our results. Todd has been with us since December 1st, but he has been vigorously working to get up to speed and has taken him very little time to do that. He has been a great addition to our team, and it's evidence that the Fresh Pet opportunity can attract first-rate talent. And if you prefer this early morning earnings call over our late afternoon and evening marathons, you can thank Todd for that too. Todd?