Freshpet, Inc.

Greetings. Welcome to Fresh Pet's first quarter 2023 earnings call and webcast. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. If anyone today should require operator assistance during the conference, please press star zero from your telephone keypad. Please note this conference is being recorded. At this time, we'll now turn the conference over to Jeff Sonick. Mr. Sonick, you may now begin.

Thank you. Good morning and welcome to Fresh Pet's first quarter 2023 earnings call and webcast. On today's call are Billy Cyr, Chief Executive Officer, and Todd Confer, 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 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 or 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 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. 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 that we'll 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. Billy?

Thank you, Jeff, and good morning, everyone. The message I would like you to take away from today's call is that we are making the steady progress on the key drivers of costs and margins that we committed to deliver this year in the Fresh Future Plan, while still delivering strong growth that is in line with our long-term growth plan. This is due to strong operating performance by our teams in Bethlehem and Ennis, and another indication that the investment that we made in the Fresh Pet Academy is paying dividends throughout the P&L. I will share a few highlights of our performance and a few thoughts on the outlook for the balance of the year, and then Todd will provide more detail on the quarter. The highlights are, first, strong net sales growth. We delivered 27% net sales growth in the first quarter. This was in line with the guidance we shared for the quarter and puts us on track to deliver our 2023 plan. Nielsen measured consumption was up 29% in the quarter, but the year-ago quarter included some trade inventory refill, so our net sales growth was less than the consumption growth. The consumption growth was comprised of 14% volume growth and 15% price mix growth. We will be lapping significant trade inventory refill in the year ago through much of this year. We won't get nearly as much benefit from pricing this year as we did last year, but our growth appears to be strong, particularly with our heaviest users. Second, adjusted EBITDA ahead of guidance. As we discussed in our last call, first quarter adjusted EBITDA is expected to be weighed down by the heavy startup costs in NS and the startup of our Dallas, D.C., I'm very happy to say that both of those initiatives were completed successfully and on budget. But perhaps more importantly, our performance on quality and logistics were much better than we had planned, as strong performance on quality yielded improved gross margin and enabled higher fill rates that reduced logistics costs. Quality costs came in at 5.3% in net sales, down from 6.1% in the year-ago quarter. And logistics costs came in at 9.3% of sales, down from 9.9% in the year ago, despite the startup costs associated with the Dallas DC. These are both key operational areas that our team has been focused on, and we are very encouraged by this progress, as well as the opportunities it provides for continued upside as we execute our margin improvement strategy. Third, more effective balance between commodities and pricing. Input cost as a percent in net sales came in at 34.1%, which only reflects a partial impact from the February price increase. Looking ahead to Q2, we expect to reduce our input costs as a percent in net sales further. For perspective, our Q1 performance is 180 basis points better than the 35.9% we experienced for the full year of 2022 and 200 basis points better than the 36.1% in the Q1 of 2022. Many retailers did not reflect the higher pricing on shelf until late in the quarter, but so far it appears that consumers are accepting the pricing well. Fourth, NS Startup. The NS kitchen is off to a good start due in large part to the training and preparation of the incredible team that is supporting its build out and commercialization. We are now shipping product off both the bag line and roll line and are capable of producing a wide range of SKUs on those lines. We are still ramping up production on the bag line, but Once that is completed, there will be yet another critical achievement that will unlock significant logistics savings. We will be able to ship the vast majority of our product assortment out of the Dallas, D.C. using locally produced product. Further, our assessment of the quality of the product produced in Ennis is that it is every bit as good as the product we produce in Bethlehem, and we are doing it with fewer people due to the significant automation that we have integrated into the facility's design.

Fifth,

strong customer support. Now that we have restored customer service to a high 90s fill rate, our customers have begun to invest heavily in incremental fridge placements. In Q1, we added 369 net new stores, upgraded 241 stores to larger fridges, and placed second or third chillers in 685 stores. And there are many more of those coming later this year. we are well on track towards our goal of having 1.7 million cubic feet of space at retail by the end of this year. And six, household penetration growth. Household penetration growth was 7% in the past 52 weeks and buying rate growth was 28% based on numerator data. What is most encouraging is that our number of heavy and super heavy users grew 18% over that time period, despite the 20 plus percent increase in pricing. We believe this reflects solid loyalty amongst our heaviest users, or HIPOs, the high-profit pet-owning households, and the impact of our Flip the Bowl effort that is designed to increase the number of people who use Fresh Pet as the main meal. We now have 3.3 million HIPOs in our franchise. Looking forward, I expect to see continued improvement in our operations as the year progresses. We have momentum, and while the intangible benefits of a more experienced and better-trained team are increasingly clear to us, We are excited to see them turn into tangible benefits and show up in our financial performance. We have sizable opportunities to recover the efficiencies we lost over the last three years, and our reinvigorated operations team is relentlessly focused on the biggest of those, quality, input costs, and logistics. Although each of these categories has its own timetable for realizing the benefits, we have the critical talent in place, and the progress is increasingly obvious to our team with every passing day. Additionally, the key elements of our marketing model are being fully deployed for the first time in several years. We have new advertising on the air at heavy media weight that resonates with consumers. Customers are placing new fridges at the strongest rate ever. And we have a large number of new products in distribution that are scheduled to ship in the coming months. We are also updating our packaging graphics for the first time in several years, and the premarket testing has shown they elicit an extremely favorable response. Now let me turn it over to Todd for the details on the Q1 results.

Todd? Thank you, Billy, and good morning, everyone. As Billy said, we are off to a really good start this year. Let me break it down a bit further. Net sales came in at $167.5 million, up 27% versus a year ago. Our net pricing was up 14% versus a year ago in the quarter. That will drop to 8% in Q2 as we left the large price increase we took in February of 2022. The growth was broad-based across channels, including our pet specialty business, which saw consumption growth rebound, increasing 19% in the quarter versus prior year. Adjusted gross margin was 38.5% in Q1, slightly above the year ago, and above our base expectations. This improved performance was due to a variety of factors, including increased pricing, improvements in the cost of quality, and a strong startup in Ennis, all aspects of our operational improvement plan that our team is focused on. We expect these elements will continue to improve as we move forward and drive continued margin improvements. Now that we are shipping product from the bag line in Ennis, we are no longer capitalizing any startup costs on that line, so they will flow through the P&L and Q2 as we ramp up production. But that is putting us on a path to sustained growth, increased resilience, and margin expansion. Total adjusted SG&A was 36.7% in net sales, down from 38.7% in the year-ago quarter. consistent with our long-term trend of gaining scale in G&A. Our SG&A costs excluding media and logistics were 11.9 percent of net sales versus 12.5 percent in the year-ago period. We also gained 60 basis points of efficiency improvement in logistics costs versus year-ago, largely due to very high fill rates and partially offset by the startup costs related to our Dallas, D.C. We spent a healthy 15.5% of net sales immediate in the quarter, and this was slightly below the 16.3% we spent in the year-ago quarter. Adjusted EBITDA was $3 million in Q1. That is considerably better than the cadence we had initially provided and was primarily due to the strong operating performance in COGS and logistics. Capital spending in the quarter came in slightly below the most recent expectations at $60 million, largely due to sequencing of some sizable expenses and pennies related to completion of the first production building, the chicken processing facility, and the early stages of construction of phase two. There is no change in our outlook for capital spending this year, which we continue to project at $240 million. Our cash position is very strong. We greatly appreciate the support of our shareholders and other investors who participated in the convertible debt offering we completed in March. After the cost of the capped call option is factored in, we realized net proceeds of $325 million from that offering. In conjunction with our existing cash reserves, at the end of the quarter, we had $387 million in cash and short-term investments. We have invested the funds in a series of conservative interest-bearing instruments that will yield interest rates well above the 3% coupon cost of debt we issued. These funds are invested across several institutions and in T-bills with a maturity of no greater than 120 days. For the remainder of the year, we expect interest income and interest expense to largely offset each other. We believe that we have adequate cash to fully fund our growth through 2024 and will be cash flow positive in 2026. We also believe that we will have access to traditional non-diluted forms of capital to bridge a gap in 2025 if it occurs. In terms of the cadence of our business for the balance of 2023, we expect to continue the strong growth we demonstrated in Q1. but the net sales growth will increasingly be driven by volume growth versus pricing growth. At the beginning of Q1, our Nielsen measured volume growth rate was around 12%. By the end of the quarter, it was up to around 16% and growing. We need that to continue to grow into the high teens and low 20s by the end of the year to continue to support our plans. We believe our marketing, distribution, and innovation programs will deliver that. Q2 and Q3 net sales should have mid-20s growth rates, while the Q4 growth rate will be relatively lower due to the sizable trade inventory refill in the year-ago period. We expect to see continuing improvement in our operating costs in Q2, particularly in logistics and quality, along with a full benefit of the February price increase. However, we will be absorbing the full operating cost of the NSBAG line in Q2 and to a lesser extent in the second half until that line achieves full production later this year. The net result is year-over-year gross margin headwind due to underutilized capacity, which we expect to cause our Q2 adjusted gross margin to come in slightly below that of Q1 2023's performance of 38.5%. With respect to adjusted EBITDA, our expectation is that Q2 should be similar to that of Q1 on an absolute dollar basis, with the difference in some additional SG&A investments in Q2 offset by the contribution of higher net sales. Looking at the combined quarters of the first half, we expect to be slightly ahead of where we initially projected we would be at the midpoint of the year and confident in our ability to deliver our commitments for the year based on our strong start and the sustained underlying performance we are seeing. So we are reaffirming our guidance for the year that calls for net sales of approximately $750 million and adjusted EBITDA of at least $50 million. In closing, we are very encouraged by the start of the year. The capability improvements that we announced back in September are driving solid and steady improvement in our operating performance. Further, we are seeing significant operational improvement the investment we made in the fresh pet academy and the time and money we invested to train the nfc during the year prior to the startup of that facility we are even more encouraged by the magnitude of the opportunities that remain ahead of us we believe that we are on track to deliver the margin improvements required to deliver the long-term margin targets we announce as part of the fresh future plans The NS kitchen is up and operating on both lines, and that provides us with the capacity needed to support our long-term growth, adds resilience to our business, and provides significant opportunities for margin expansion. Further, the improvements we designed into that facility provide the opportunity for efficiency upside versus our long-term projection. In total, that leaves us feeling very bullish about our future. That concludes our overview. We will now be glad to take your questions. And as a reminder, please focus your questions on the quarter and the company's operations. Operator?

Thank you. If you'd like to ask a question at this time, please press star 1 from your telephone keypad and a confirmation tone to indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. So that we may address questions for as many participants as possible, we ask that you please limit yourself to one question and one follow-up. One moment, please, while we poll for questions. Thank you. Thank you. Our first question comes from the line of Michael Lavery with Piper Sandler. Please proceed with your questions.

Thank you. Good morning. Good morning. I just was wondering if you could unpack the guidance a little bit. You've got a full-year top-line guide consistent with the first quarter, but you have a pricing benefit that will moderate over the course of the year. Can you just point to some of what you expect on the volume side in terms of driving that acceleration and what kind of visibility you might have there?

Yeah, I'll take a shot at it. and the scripted comments that we've seen the increasing shift towards volume growth and less on pricing. So we began the quarter at Q1 at 12% volume growth. We ended the quarter at 16%, and we've seen it continue to grow from there. So by the end of the year, we're expecting that volume growth is going to be the biggest driver of our net sales growth. because pricing by the end of the year will basically end up accounting for something like 5% in the last quarter. So you're going to see an increasing shift towards volume, and we've already seen it.

And is that helped by the step up in advertising or the distribution gains or just all the above? What's the real key factor there in terms of what accelerates the volume side?

Yeah, let me just give you my comments. Sky will probably add some color to it. But as we said, the reality is we're now back in business, doing business the way we want to. So we've got full fridges, high fill rates. We've got a broad assortment of products, advertising on the air at heavy weights, new advertising, better packaging, a lot more stores, a lot more upgraded stores. So the growth is coming from and will continue to come from our business model, our marketing model, working the way we want it to work.

I think Billy hit on most of the points, but I would say the overall model is intact. It's continuing to perform, and we've got penetration growth. The most interesting aspect, we talked about it at ICR. We introduced this idea of like these super heavy heavies or hippos that Billy mentioned in the script. We see really strong growth from that group. We really, really like that. Those are our core, core consumers. Their buy rate is up substantially. The number of fridges that will place this year will be extraordinary. It will be an all-time record for the company, the number of fridges in total that we placed this year, which gives us the platform to continue to expand our portfolio and appeal to a larger group of consumers. So it just feels like every single thing is hitting on all cylinders. And then you couple all of that platform with great, great advertising that continues to drive record traffic to our website, which we know converts to the store locator, which we know converts to eventual people coming into the brand. And it really is all working together, and I think we're in a really fortunate position.

Okay, that's great. And just a quick follow-up on the ad spend. And sorry if I missed this. I don't know if you said it, but is the second quarter spending level similar to the first? How does that play out as far as the trajectory over the course of the year?

Yeah, Q2 will be a similar level to Q1 and will be fairly heavily weighted to the front half of the year. I don't know if we've actually split it out that way, but a little bit over 60% of the advertising will be in the first half of the year, 65 or so.

Yeah, heavy spend in the first two quarters. Actually, Q2 is projected to be up slightly over Q1, and then it tails down in the second half of the year. But unlike last year where we spent very little in Q4, our expectation is we will spend a reasonable amount in Q4 as well. Okay, great. Thank you so much. Thank you.

Our next question is from the line of Brian Spillane with Bank of America. Please proceed with your questions.

Thanks, Operator. Good morning, guys. Just two quick ones for me. One, just a clarification on the guidance slide. Adjust EBITDA to Q. We're talking that you're expecting to be similar to 1Q in absolute dollars, not year-on-year growth Correct. Okay. And then, Billy, maybe, and Scott, maybe if you guys can just maybe zoom out a little bit. I know there's been some concern just about, you know, the household spending, consumer spending being under pressure. And again, you're now kind of getting back up to the curb. So if you can talk a little bit about just, you know, as you're back in the market and your fill rates are better, just your observations about the consumer. Is it more heavy users? using the product more? Is there any barrier to attracting new households? Just kind of how the whole macro environment is playing into your growth expectation as you now are beginning to add more product in the market.

Hey, Brian. You know, I think that we talk about this a lot and we literally look at it like every couple of weeks very, very closely. And we have pretty expensive data that goes fairly deep down into understanding exactly what the dynamics are. And yes, I mean, there's been that there's a lot of discussion in the market around kind of what's going on from a consumer standpoint where There have been people that have, you know, they're concerned about the economy, they're concerned about inflation, et cetera. I mean, I think that we have really been an exception to that case. We have definitely seen some of our kind of weaker, non-frequent consumers kind of move out, but we have focused on, and we started focusing literally in the beginning of the year to make sure that those heavy and those hippo consumers are the ones that are really kind of coming into the brand and continuing to buy us, et cetera. So I think that there has been a lot of discussion around the category level, around what's going on. I think that we have been fortunate that we have not really had much impact from that. And we feel like we're on a really terrific course for this year and getting the right types of consumers in. We continue to see interest in the brand and the proposition that we're bringing to market. And also, we're always really cognizant of trying to make sure that the entire portfolio has as affordable and accessible to as many consumers as possible. And we always are keeping an eye on that, and we continue to do work in that area. Thank you.

Thank you. The next question is coming from the line of Rupesh Parikh with Oppenheimer. Pleased to see you with your question.

Good morning, and thanks for taking my question. So I was just curious, as we look at your gross margins, I think last quarter you guys indicated that you expect gross margins to be up more than 200 basis points. Curious if you saw the same expectations for the year.

We do at this point. Look, really pleased about Q1. Obviously came in a bit higher than our original projection. A little bit of that was timing. We built a little more inventory in Q1 that got capitalized. for the quarter, you know, that probably will come back in the second quarter. Look, it's really early. We're off to a great start. And so it's just too hard to call the remainder of the year. So really no change in the expectations at this point. But, you know, we're really pleased. Look, Ennis is still ramping up. We haven't started chicken processing there at that facility yet. So we still got a little bit of wild card going on. But feeling really good about the start of the year, Rupesh.

Great. And then maybe just one follow-up question. I know you've launched a fresh pet food subscription with Petco. Just curious how that launch is going at this juncture. I know it's early. Just curious if it's already in stores and how that's progressing.

Yeah, it's in literally around 300 stores at this point, so it's super early. We've gotten, I think, a really, really high visibility and a really good response from it at this point. It is super early. I think we remain super enthusiastic about the potential of it, and we will start to support it literally in the next couple of weeks once we kind of have everything kind of flattened out and kind of calmed down from a supply chain standpoint with that specific product. So we'll start to support it then. I think at that point we'll start to get a real feel for consumer interest, broad consumer interest, and just kind of what type of size of business that will be over time. Great, thank you.

Our next question is from the line of Bill Chappelle with Truist Securities. Pleasure to see your questions.

Thanks, good morning. Morning. Hey, just on a pricing standpoint, I understand that you're successfully pushing through this pricing, but maybe you can talk about where you stand in terms of price gaps with the competition, what you expect, you know, the category to do in pricing as costs do come back or pull back in the back half of the year and we get maybe a little more promotional environment. Understand that you have a differentiated product than the kibble, but still, you know, there's some pricing dynamics between the two. Yep.

Bill, we've been watching this closely, and I, you know, you could definitely imagine where in certain environments there would be increased spending and promotional support activity. We really haven't seen any of that pick up yet. It's definitely possible. And I would say it's actually at this point even been slightly below some traditional levels, historical levels. So I think some of it will come back in the past that hasn't had a tremendous impact on our business as you brought up. I think that it's a pretty rational category, and I think you have pretty rational players in place. I think people recognize that they appreciate the profitability of the category. And I think it's going to be rational behavior from pretty much everybody, including the retailers, which will really be the ones who either drive it or suppress it. So at this point, I mean, it's hard to exactly speculate what could happen later in the year. But I don't see it getting, you know, it gets irrational in some categories. I have not seen that in pet over time.

But the price gaps with competition are where you want them to be right now.

Yeah. Yes. We like where we are, and we're watching that. And I think the biggest thing that we're seeing, you know, was called out. No matter which way you look at it, our volumes continue to grow. Whether you look at prior periods, literally from the beginning of the year till now, it's been really, really nice, consistent volume growth. So I'm looking at pounds. And in this case, when there's so much going on with dollars, I'm looking at pounds. If you're increasing pounds and units, you're doing great work in this type of environment. And that's what we're doing. We've seen the, you know, we go back on air. We are completely very, very, very low levels of any type of advertising in Q4. We go back on air and we consistently see our pounds continue to progress through the first quarter, which I don't think anyone could have asked for anything better. So I think what the market's telling us is the price gaps are acceptable where they are, and consumers continue to come into the brand and spend a lot of money with us.

Got it. And then, Billy, I know household penetration and market share are not interchangeable, but several years ago, the thought was you had kind of low single-digit market share nationwide, but you had close to 10% in some of the West Coast Albertsons. Now you're talking about household penetration being close to 7%. And I guess just trying to understand, as capacity comes online, where do you think household penetration and market share, for that matter, can go this year and next? Are we talking double digits? Are there any barriers? Are there keys to unlocking that, such as like more fridges per door or stuff like that? Any color would be great. Thanks.

Yeah. Yeah, it's one of the issues that we watch very closely. Obviously, with all the rapid price increases that have gone into the market, what you've seen is the occasional user or the person who views this as more of an indulgence or an extra, as opposed to the person who uses this as the main meal, has been a little bit less willing to bring on a new habit or continue a habit that might have viewed as discretionary. The flip side of that is the 87% of our business that is the hippos or the people who view us as a regular main meal have been growing at a very, very healthy rate. I actually did a little exercise to look at if for the, if while consumers are digesting basically for price increases in 18 months, if you have to lean hard on the heaviest users, the people who recognize the benefits whose dogs don't want to change, Can you get from here to where you want to get to on the backs of those consumers? And the answer is yes, you can get there. But over the longer haul, we do want to get back to where we're bringing in the new users at a much more aggressive rate than the 7% we reported in the first quarter. We just think it takes longer for them to adapt to the new pricing that's in the market. They just don't go through as many purchase cycles when you're not a heavy user. And it takes a couple purchase cycles for them to adapt. So by the end of this year, I'd like to see that number in the double digits. And frankly, by sometime next year, I'd like to see the number being in the 20% range.

Thank you. The next question is from the line of Peter Benedict with Baird. Please proceed with your question. Mr. Benedict, please go ahead with your question.

Sorry about that. Hey, guys. Good morning. So first question, on that specialty channel, the acceleration you saw there, was that just kind of better in stocks, you think, drove that? Was there anything that any of the players in that channel were doing to help get the better velocity there?

Yeah, our in stocks were particularly bad even through the very end of Q4 and pet specialty. So just the return of full fridges, I think is a really, really big piece of it. Secondarily, we are seeing nice expansion in fridges at pet specialty through the course of this year. That will be a help. It's not really kind of shown in the numbers at this point, but that'll be a continued help over the course of the year. Yeah, I think those are the two aspects, Peter, and making sure that the products and the portfolio is well represented, not only being in stock, but also really being as sharp as we can on pricing.

Got it. Understood. And then maybe just two quick ones for Todd. Just curious on commodity input costs, can you get us up to speed on that? Chicken, beef, just kind of where you stand, what you've got locked in, remind us on that. Just the DNA line, taking a look at that, kind of annualize the first quarter that gets you in the high 50s for the year. Is that what we should be expecting from DNA this year? Thank you.

Yeah, so steady as it goes on commodities. So, you know, we're locked in around 80%, no big swing. So we're still kind of seeing... mid-upper single-digit inflation, so much better than we've seen in the last couple of years. So that's positive. That will allow us, with the pricing we have in place, to get some margin expansion there. So no big swings of commodities, and I think we're in pretty good shape. From a DNA perspective, yes. In total, around 60%, both up in gross margin and down below, and that should be close to the run rate for the year.

Great. Thanks very much.

Thank you. Our next question is from the line of Jason English with Goldman Sachs. Please proceed with your questions.

Hey. Good morning, folks. Thanks for stopping me in. Good morning. A couple questions. First, I guess, Billy, coming back to your new user comments, the penetration data you shared, 26% last year and rolling 52 through April 3rd, having now dropped to seven, suggest really sharp deceleration, perhaps even outright declines, and the math actually would suggest outright declines year to date over the last three months. What's driven such a sharp decel there? Why the setback? And how do we foot it with the volume, which actually looks fine?

Yeah, it's a good question. First of all, you have to remember the number on the household penetration is a net number. So if you end up with some number of consumers who are your sort of discretionary purchasers not purchasing or purchasing less frequently, you can see that number go down regardless of whether you've added new users. And so I think what my comments were intended to say is that bringing in new users, we're still bringing in new users, but there are some number of people out there for whom this was not a critical purchase. It was more of a discretionary purchase. Those are the folks who are not continuing or not continuing at the same rate that we had seen before. The flip side is the people who have been buying us as the main meal became even more committed than before. The most encouraging part to me was not only did they absorb the price increases, they increased the buying rate beyond what the pricing would be. So in our data, we're showing 41% increase in the dollars that we're getting from the super heavy users. And so that's encouraging. It says the people who've decided that we're the main meal are continued to bias and bias at a heavier rate. I think over the long haul, though, we do need to get it to the point where we're bringing people in the front end of the funnel at a more rapid rate. I think Four price increases in 18 months shook out some of the people who were more discretionary buyers, and now we're focusing on bringing in the new people who are going to move along that purchase curve and become super-heavy users in the future.

So, Billy, is it right that year-to-date, last few months, you're losing as many consumers as you're bringing in?

I don't think that's right, but I'll have to look at the data on that. I don't think that's right. There's been some moderate growth.

Yeah. Okay. Okay, that's helpful. And then everything you're talking about in terms of more retail presence, more advertising, better on-shelf availability, better packaging, all that sounds great. And clearly you've been leaning in. Why aren't we seeing more acceleration in 2Q? Your guidance would suggest, like, despite we're no longer lapping that ship in headwind, it's not really going to look a lot better.

You mean why the growth rate in Q2 is not a stronger growth rate than Q1?

Yes, yes, that's right, exactly. It's given the investment, given the acceleration and volume, given that we no longer have a two-point drag on cycling the prior year shipments.

Yeah, I mean, we haven't given you a specific number. We said sort of in the mid-20s, we'll see where it ends up shaking out when it's all said and done. We like the trends we're seeing. We feel good about the trends that we're seeing, but, you know, we want to see it all play through.

And there is, obviously, there is some pricing that kind of wanes off in Q2. And as Billy said earlier, the volumes are coming in really, really nicely. So in total, we feel good about the way it's rolling up, but obviously we've all gotten a bit of a benefit from pricing. The good news is our volumes are still really, really strong.

I mean, Jed, the other thing to consider with fridges is when a fridge goes in, it takes literally six months for it to have significant impact. So even the fridges that we're putting in now, you can kind of start banking on those for the back half a year. where they really start contributing and adding significant incremental dollars to the business.

Makes sense.

All right. Thank you.

Thanks. Our next question is from the line of Mark Asherchen with CIFL. Please proceed with your question.

Hey. Good morning, everyone. Good morning. I guess just to follow up a little bit on the last line of questioning there, advertising spend increasing, expectations will continue to increase, especially through 4Q. I guess I'm curious how you're thinking about how the return is today versus historical levels. You know, the correlation has always been very strong. Is it as strong as it's been in terms of the advertising spend to sales growth? I mean, you could elaborate there. It would be helpful.

Yeah, so I think – I think Billy touched on this concept too. And really what we're seeing is just like when you go through like a change in the economy, there are certain businesses that basically don't come through, right? They just, they wash out basically. And I think there are a group of consumers that are in the category that were also, some of them were in fresh bed that are kind of moving out. So what it does is that that's, that's shown in the total number and you're, so you're losing some of these people that were occasional consumers, low-level buyers. And as you move through those, you start to get to your real core group of consumers, and you kind of start to return to the model that we've had for 10 years, where we spend dollars and we see that productivity in the advertising and in the CAC, like the way we think about it. So I think we're going through a transition period where we're flushing out some of those weaker, less committed consumers that were buying us occasionally that may have gotten some type of economic stimulus, that may have had enhanced savings for a period of time, et cetera. So I think that's what we're seeing and we're going through. So when you ask about the return, we believe we're getting – here's what we know. We know we're getting the best response ever to the TV advertising. We know we're getting tons of people going to the store locator. And historically, again, for 10 years, we've been able to see people go through that and come into the brand. What's being kind of masked by some of those less dedicated consumers leaving, so it's hard to calculate exactly the return. but we believe that nothing has changed that we've seen for a really, really long historical periods. And that as we kind of move through this in the near term, we'll get right back to similar types of returns on when we spend, what we spend in advertising will drive, you know, incremental new consumers. Got it.

And from a consumer standpoint and those that have left, can you get them back or is it about going after new kind of

non fresh pet household today um and i suppose if you're not going then after the lost um households that have come in and out does that then reduce the longer term opportunity yeah i think that that uh i think globally we as we like two things we presented at icr that i think uh are important to that one of them is we can seem to see and this has like been a five- or six-year trend that we demonstrated where the total addressable market for fresh pet food has really continued to expand. And I don't think there's anything that's changed the direction of that. I think there's some short-term disruption in that, which is the commentary I was just referring to. So I don't think there's really been any change in that, and it will continue to grow over time. So I think that's where I am, Mark.

Mark, I would just add to that is I think that what we're seeing is as people are increasingly recognizing Fresh Pet as a main meal item, we are seeing the buying rate become an increasing driver of the growth. It's not what we modeled. It's not what we built out. But at some point, that will be a critical driver of growth of the business as people recognize it. We're just happening to see it in an environment where those who are committed to the brand are very, very committed, and those people for whom it was a more discretionary purchase, they're less committed.

Yeah, and the other thing, I'm sorry, I meant to, we touched on at ICR where we mentioned this idea of these hippos. We talked about it a couple times on the call about targeting that group. That's really where we're seeing the increase in not only households, but also the buy rate. So it's really, the strategy that we put in place in the beginning of the year seems to be playing through well. Got it. Thank you.

The next question is in the line of Cody Ross with UBS. Please proceed with your questions.

Good morning. Thank you for taking our questions. I just want to dig in a little bit on the EBITDA because it came in about 5 to 6 million better than your guidance here. I think you mentioned that gross margin is supposed to sequentially decel a little bit here. Can you just unpack that for us and just, you know, explain to us what those drivers are?

then how you expect the cadence through the back half to trend and then i have a follow-up thank you yeah so i mean let me break down q1 first so you know in just like kind of direct input cost pricing versus commodities actually improved by about 200 basis points so we you know we've talked about how we've fallen behind the last couple years with inflation we're starting to get a nice chunk of that back So that's great news. Quality costs were favorable about 80 basis points. We're seeing continued progress there. And then as we gave everybody a heads up on, hey, look, we are bringing on some new lines in Ennis. There is going to be an absorption issue through the first half of the year particularly. And we saw that by about 250 or 260 basis points in Q1. That'll actually get a little bit higher in Q2 as we bring all the full costs of that second Ennis line in place. Everything else we feel good about is really that incremental absorption that's going to kind of hurt us in Q2. As we build into, as we grow into the volumes of Ennis in the second half of the year, as we've been saying, you know, our volume has been trending up nicely. As we build into that volume in the second half of the year, we'll start to leverage that facility a little bit more and we'll be lapping all those costs of last year. So again, a slight headwind in versus Q1 for Q2, and then we expect it to be much stronger in the second half.

That's helpful. Thanks. And then I just have a follow-up here. You've had some new entrants in the category and you've took two rounds of price over the last year. Can you just discuss the trial trends and if you're seeing any change in repeat purchase behavior? Thank you.

Yeah, there have been a tremendous amount of people that have entered, and we track that very, very closely. And maybe I'll touch on that first. So a year and a few months ago, we talked about us having 96.4% of what was out there in fresh and frozen pet foods. and today we're at 96%. So basically, if you think about it, over the course of a year and a few months, we lost four-tenths. So I think that that's probably the most illustrative way to think about there have been a ton of entrants. They haven't really grown in size, and we have maintained basically our share of the offering. And I think the performance of almost all of them has been really, I would say, I mean, it's early, early, but I think they're very kind of subpar what would make retailers very excited about it, at least from what I can tell. So I think that's probably the most important aspect of it. So when we look at trial and we look at repeat, and I think it's illustrative in some of the stuff that we we just were talking about with the hippos where we're getting, you know, I mean, our buy rate is the thing that's like been extraordinary and really driving the business. Um, it's driving it more than almost ever before. And I think that that naturally, uh, demonstrates the dedication that consumers have, uh, to the, to the products once they try it. And we have not made it particularly easy for people over the past, you know, more recently it's been much better, but up until literally the past like 60, 90 days, We have not made it particularly easy for people to get the products they want and the sizes they want all the time. We still have plenty of work to do in that area. There are still some pockets across the U.S. where we definitely have opportunities to make sure our fridges are fuller and better represent our full offering.

Thank you. Our next question is from the line of John Anderson with William Blair. Please proceed with your questions.

Hey, good morning. Two quick ones. I was wondering if you could talk about the cadence of the new fridge placements that you expect during the year. I think your number of net new stores is up 7% in the first quarter. But again, help on the cadence there. And then also on media for the year, what are your expectations for media spend as a percent of sales on a full year basis? Thank you.

I'll touch on the fridges real quick, and then Todd can hit on the media percent of sales. So really the way the year is laying out is Q2 and Q3 will be our biggest ads for fridges. And it's not just new placements. We'll actually end up with almost double the number of second and third fridges this year than we actually have in new placements. And I think the important thing to note is, A second and third fridge, a second or a third fridge in a high-velocity outlet is worth the same as a new fridge for the most part. So I think that hopefully dimensionalizes the impact that new fridges can have. And again, second and third fridges are a critical component to us continuing to build out what we're building out for fresh pet foods.

And from an immediate perspective, we'll spend close to 11% of net sales this year. And first half, second half, you know, first half, you know, somewhere in the 60 to 65% of that spend will occur. And as I mentioned earlier on the call, the big change in the back half is we will spend a lot more in Q4 than we did this past year.

Thank you.

Our next question is from the line of Ken Goldman with JP Morgan. Please proceed with your questions.

Hey, good morning. Morning. You know, obviously, the, and we talked, you guys talked about this a little bit. There's some great numbers in terms of buy rates and overall shipment trends. I did want to come back a little bit to the questions on household penetration, though, especially for the non-HIPPO users. only because I just wasn't quite sure what the plan of attack was from your perspective. And again, you're focused on the hippos this year. I get it. You can't be everywhere all at once. But is the plan just to sort of, for now, kind of advertise and hope that the shock, I guess, of higher pricing fades? Are there other things you can do? Can you introduce smaller packages? Can you do more targeted ads, I guess? I'm just trying to get an idea of sort of, what the strategy is and kind of what the path ahead is for what we should expect for household numbers over the rest of the year.

Uh, yeah. Um, so Ken, as I mean, I'll touch on a couple of things that we probably hit on, but I will, I will expand a few, few different comments. So, um, look, we, we, I, I, at ICR, we did mention this idea of like, we wanted to focus on hippos. And one of the things that we've done in that area, is when we think about the advertising that we're putting on air, we're now at a point where we're comfortable and we're willing to basically be more aggressive and I think more direct in what we're trying to communicate. And that has been demonstrated to attract and bring in the hippos into the brand. So we kind of set that out at ICR. We knew that the advertising was going to change. And you're seeing our advertising kind of, you know, take a course, whether, you know, you've seen some of the things we had on earlier in the year, you know, the disguise where we're talking about dry pet food, you're seeing what we're doing now. We're picking consumers that are really, really dedicated to their pet. And we think that's really a core piece of not only this year, but long-term strategy to focus on these hippos. I do think that when the category gets When all this pricing, and it's not even pet food pricing, it's pricing of my grocery bill. When people finally get more comfortable and digest the overall pricing with their grocery bill, and they will. I mean, it's been shown over the past 50 years that when these things go through, eventually people get more comfortable where the pricing is and they return to more normalized behavior. I think we're going to get a lot more of those consumers that are a little concerned about where the economy is, I think we'll start to see some of them float back into the brand. Now, again, they're not as valuable. They're just not as valuable. But what we're doing in the meantime, and I do think this could be 12 to 18 months before we get to this normalization, is we're getting as sharp as we possibly can on every aspect of the base model, which is the advertising, the products that we offer, the price points that we have on especially key entry sizes, and we're also launching a couple of products that are kind of a little bit more value-oriented and a little bit we're calling them limited ingredient products, we are starting to offer those products up and including one of the things that we'll start offering up in the next kind of six to 12 months is basically bulk packs. And in those bulk packs, we think it will dramatically change buying behavior. If you look at the top 13 items in wet pet food, they are not single items. They are bulk packs. And we think it's time for Fresh Pet to start introducing a product portfolio, expanding out, where we give someone the ability to buy not one or two at a time, but now buying four, six, or eight at a time. We've been able to test this. We've been able to demonstrate that there's been success in doing that. And we'll start offering those on a broader basis across the country over the next year. So that's definitely a piece of what we're doing over time. But look, the other thing is just get back to the fundamentals on what we're doing, which is the advertising works, the portfolio works, the new products that we've always brought, the innovation we brought works. And if we're doing that well with these other pieces, we feel really great about the business plan.

Great. That's helpful. And then a quick follow-up, if I can. You mentioned that, again, the first quarter was ahead of your expectations. I think most of it was quote-unquote organic, but You mentioned there was a little bit of a benefit from timing some inventory capitalization. Is there any way to quantify that and think about how much of that reverses into Q?

Yeah, we had about a million-dollar benefit approximately from that. We also had about a million-dollar benefit from some miscellaneous sales and marketing spending, non-media expenses that we believe will happen in Q2. So those are the biggest pieces.

Thanks so much. Thanks.

Our next question is from the line of Corey Grady with Jefferies. Please proceed with your questions.

Hey, good morning, and thanks for taking my question. So I wanted to follow up on your comments on fridge placements for the year. Can you just remind us of your decision process to add a second or third fridge, and what the volume step-up benefit you see from the new fridge? And if you can, what portion of your stores are current second or third fridge candidates? Thanks.

Okay, so there's probably a multi-part question and answer. I'm going to try and address it at a fairly high level, and then we can definitely talk in more detail when we get to the one-on-one calls. So when we look at a retailer, there is definitely a threshold for different stores that we would put a second or third fridge in. And typically what we do is we'll start off with a top 20% of, and every retailer, there are different retailers that have different volumes, but what we'll take is the highest volume retailers with the highest percent of velocity, so we'll take the top 20% of stores, and those are typically the first candidates for a second fridge. And then what we've seen over time is as those progress, retailers are interested in taking the next 20 or 30% of their fridges and putting second and sometimes even a third in the first 20. So we're starting to continue to see that progression. And really what is probably the most important aspect to it is if we look at dollars per store per week and we consistently see increases in dollars per store per week over time, that is the core aspect. So if we're seeing those consistent dollars per store, that's going to open up the entire network to more and more second and third bridges. So hopefully that's giving you a little bit of a feel for it. And I would say today we have the opportunity for about half of our network to have either a second or a third bridge that's applicable. And then what we tend to end up having to wait on is when there's these reset cycles where retailers are willing to touch the aisle in a pretty big way because to take out four feet of something and put in a second or third fridge can be pretty significant. So I think that's probably a very broad way to think about it. And year after year, we can continue to see same-store sales increases, and that's the dollars per store per week. And that really continues to open up more and more of the network. So the more we can do from an advertising standpoint, grow penetration, buy rate, et cetera, I think the more opportunity we'll have over time for second and third fridges.

That's really helpful. Thank you. And then I know this has been asked a few different ways, but just to follow up on household penetration, just from the 7% growth you saw this quarter, I mean, is that in line with your expectations to get up to 20% plus by year end? And then, I mean, do you expect household penetration to be more back half-weighted? And should we think about that as kind of making up for pricing benefits rolling off? Thanks.

Yeah, I think the way we had planned it was we thought we would see a little bit higher overall penetration. Like, again, when we talked at ICR in January, we started focusing. We wanted to focus on these hippos, these higher-value consumers. And we started to deliver on that. Um, I think that we, we anticipated slightly higher overall penetration and I think what's over delivered is the hippos and also the buy rate has really honestly over delivered from what we kind of had really budgeted and plan. But I think what's happened is we've seen and it's amazing and we're. If you look at where the category is, it's amazing what the category is doing and what we're doing. The category looks like some brands, I think, would be very upset with where they are. And I think what's happened is you have people that deload pantries a little bit, and that stretches a little bit. You have some consumers that aren't getting some economic stimulus, and that changes the dynamics of when they're buying a number of consumers. So I think once we kind of go through this cycle, we're going to return to kind of a much more normalized growth and penetration. I would think it would be towards the back of the year that we'd see kind of more normalized overall penetration. And if we can hang on and make progress on the HIPAAs like we're doing, it could be something that expands our overall revenues.

Thank you.

Our next question comes from the line of Jim Solera with Stevens. Let's proceed with your questions.

Hey, guys. Good morning. Thanks for squeezing me in. Just wanted to ask, as you're looking at the retailers that are adding these second and third fridges, is that incremental buyer just a high-frequency user that now that there's more availability, they're increasing their buy rate? Or does the second or third fridge bring in a new incremental buyer that maybe, you know, the fridge is busy and they usually don't go there, so now there's more opportunity, you see incremental buyers?

Yeah, so there's probably two major aspects to the second fridges. In some retailers, it literally gives us enough holding power where we can actually get through a weekend. So literally on some of our highest volume items, like our six-pound roll, for example, which some of our most loyal users buy, they'll come in on Saturday afternoon and it's sold out. And unfortunately, fridges don't get stocked as well as we would like. So it gives them some additional holding power in some cases. So you get a buy rate pickup from that aspect. The second thing that we've been able to do and really demonstrate over time is as we add a second fridge, it allows us to add certain items in. And we think about items very differently than I think certain CPG companies. It's our fridge. We want to make sure the space is as productive as possible. We're not trying to just kind of get a few inches from somebody else. So what we've been able to do is as we expand the portfolio of products and offerings, We find products that appeal to a slightly different consumer group or broader consumer group, so it does help to expand penetration within that individual store. And I think all of those details, which many retailers have extraordinary shopper card data on, and when they see some of those aspects, that's what's encouraging them. In addition to the overall kind of high-level holistic data, when they look at some of those details around the individual impact in the aisle, the buy rate driving new consumers in, the frequency that it drives for the category, et cetera, that is some of the final deciding factor for them to put in the second and third fridges.

I would just add to that, in addition to the holding power benefit and the extended assortment that the second and third fridges provide, there's an amplification value of our advertising Think of it as virtually every CPG manufacturer would kill to have a very large off-shelf display or whatnot. We have lighted four-foot-wide, seven-foot-tall fridges sitting in aisles. And when they put a second one in or a third one forming an island or on end caps, it has an amplification value of the advertising that is very sizable. And if a reasonably good-sized retailer does it in a meaningful number of stores, we can actually see it in the Nielsen data. And so there is that benefit, and we frankly think that is a significant added value to the advertising.

Okay, great. And if I can maybe sneak in one last follow-up on that. As you add in a retailer that has a second or third fridge, does that provide kind of the shield around the pet aisle that makes it harder for a competitor to get products in there? You know, we talk about the competitive landscape. I mean, if you have a third fridge, Does that mean that there's no availability for them or significantly less availability? Or does the pet aisle as a whole just expand?

Look, I think that it helps expand the competitive advantage, but by no means does it limit anyone else from coming in and putting either their own fridge or the retailer put a fridge in. You know, it's... Billy mentioned it periodically, but five years ago we came up with a strategy and part of that core strategy was we want to change the way consumers think about pet food. We want them to think about fresh first or flipping the bowl, sometimes it's referred to, and we want retailers to think as fresh first as they're building out their aisle. And I think what's starting to happen is they recognize that fresh food has all the benefits that they see in other areas of the store in pet food now. And it's a really meaningful piece of their category, and I think they're building out. And there have been a few retailers that have added some of their own fridges out there. So I think it's great for us, and I think it's encouraged some retailers to, you know, see what else they want to do to build up the segment.

Great.

I'll pass it on. Thanks, guys. Thank you. Our next question is from the line of John Lawrence with the Benchmark Company.

Good morning, guys. Thanks for squeezing me in. Billy, you've mentioned for a long time that as you got better fill rates up that these retailers would come back. I know you've talked a lot about these retail partners, but when you look at other new people that are coming to discuss this category with you that you've been after for a period of time, they went through the you know, lower fill rates and now they're coming back and you've mentioned some of those decision matrix and what they're looking at. Can you expand on that just a little bit and what's happened since you've really restored these fill rates and what are these retailers, what are those discussions like, maybe for the first time and then the second and third fridge?

Yeah, let Scott take that one. He's closer to that. Yeah, it's actually been, I think, pretty exciting to see that once we were able to make sure that we had enough supply, that current retailers were willing to expand and have discussions around second and third, and to be really excited about it. I mean, there were times where they were almost coming to us, and they were expanding the store list even more sometimes than what we had maybe brought or mentioned to them. But I think the other dynamic is, There are some retailers, there are a few retailers, not many, that have said no for a very, very long period of time. And I think in the last, literally in the last 90 to 120 days, we've had a few of those actually be receptive to having conversations. And I think it's going to open up a few additional retailers for us, which we'd like to see. We believe that we should be able to be in 90% of all the stores, you know, kind of typical grocery mass, club, stores out there, we should be in almost all of them with some type of offering. It may not be eight feet of fridges in all those stores, but there's some type of offering in the majority of stores out there. And we started to see that open up. And boy, when we didn't have supply, not only were we not encouraging it, but they weren't interested either. Why would you want to add anything in where you can't have product to offer a consumer and you're taking up space for something that you can sell. So I think we're starting to see past that. So anyway, we're kind of excited to kind of see that develop.

Great.

Thanks.

Good luck. Great. Thank you. Thank you. At the time of each end of our question and answer session, I'll turn the floor back to Mr. Serra for closing remarks. Great. Thank you very much, everyone.

I always like to end with a quote. The source of this quote is unknown, but it is very apt. The quote is, it's no coincidence that man's best friend cannot talk. To which I reply, reward them for their silence and feed them fresh pet.

And I'll actually build on that. There's four pets in the dogs in the fresh pet family that I wanted to recognize. Rocky, which was one of the dogs in our advertising. Angus, Macy Gray, and Pinocchio, who was one of the dogs that... of our head of R&D, and has helped us develop many products along the way.

Great. Thank you very much, everyone.

Thank you. This does conclude today's conference. Let me disconnect your lines at this time. Thank you for your participation.