Greetings and welcome to the Freshpet, Inc., Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Katie Turner for opening remarks.

Thank you. Good afternoon, and welcome to Freshpet's second quarter 2018 earnings conference call and webcast. On today's call are Billy Cyr, Chief Executive Officer; and Dick Kassar, Chief Financial Officer. Scott Morris, Chief Operating Officer, 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 Quarterly Report on Form 10-K filed with the Securities and Exchange Commission, and the Company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Finally, 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 a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. Now I would like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Katie, and good afternoon, everyone. To begin, I will provide an overview of our financial highlights and recent business performance. And then Dick will provide greater detail on our financial results and our updated guidance for 2018. Finally, Dick, Scott and I will be available to answer your questions. We're very pleased with our Q2 results. Recall, our Feed the Growth Plan is designed to accelerate Freshpet's rate of growth, enabling us to fulfill our mission of providing more pets with fresh all natural foods that enrich their lives and their relationships with their pet parents. And we're committed to doing so in ways that are good for our pets, for people and for our planet. In the pursuit of that mission, we expect to deliver significant value to shareholders. We will accomplish this by creating a virtuous cycle, where increased investment in advertising drives increasing scale that we can use to drive greater distribution, increased manufacturing utilization and efficiency, and better leverage our organizational capacity. This will produce increased financial returns that we can use to drive further growth and long-term profitability, enabling us to serve more pets. Our financial goal is to deliver $300 million in revenue as soon as 2020 with a 20%-plus adjusted EBITDA margin. One key to delivering those goals is to deliver an accelerating rate of growth in 2018. Our second quarter results confirm that we are on track to deliver this accelerated growth rate in 2018 and we are progressing towards our longer-term target. Our increased investment in advertising, in conjunction with consistent distribution improvements and focused product innovation, have enabled us to cycle last year's strong growth and deliver an acceleration in Freshpet's consumption growth rate. Fresh consumption in the quarter was up 27.8% an acceleration from Q1's 25% in…

Thank you, Billy, and good afternoon, everyone. As Billy indicated, net sales in the quarter were $47.6 million, up 23% versus year ago period. I would like to remind you that we adopted new revenue recognition standards this year so the net sales in the prior year quarter two were $38.7 million under the new standards, excluding the discontinued baked items, fresh net sales were up 24% in the quarter. As we told you at the beginning of the year, we believe that quarter two would be our toughest year-on-year comparison, because of the movement of the holidays and due to the significant ramp up in consumption the year-ago period. So we are encouraged by the strong net sales results in the quarter and even more encouraged by the accelerating consumption growth. As a result, we are raising our net sales guidance for the year to greater than $190 million or plus 25% versus year-ago and plus 26% on our core fresh business. We expect the consumption trends across all classes of trade to remain strong throughout the balance of the year and to benefit from the increased penetration that our advertising investment is delivering. We expect that the shipment trends will closely mirror the consumption trends over time, but the only meaningful variation, period-to-period coming from temporary or seasonal changes in trade, inventory and [indiscernible] patterns around holidays. Adjusted gross profit for the quarter was 51.2%, up 50 basis points from the year-ago period and up 110 basis points from quarter one. Despite absorbing approximate 80 basis points of labor costs versus year-ago behind our seven-day production transition. Without these costs, our adjusted gross margin would have been approximately 52%. Further, we absorbed 140 basis points of a higher commodity costs versus year-ago. Adjusted SG&A in the quarter was…

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Robert Moskow from Credit Suisse. Please proceed with your question.

Hi, thank you. I guess two questions. One is I guess it's kind of hard to reconcile that the 900 basis points of margin expansion with - what's going to be - there's going be a big capacity expansion plan coming at the same time. Can you remind me or are you going to have to hire a lot of people for that capacity expansion as well and why are - how can you do those two things at once through 2020?

So Rob, the way we're - we'll do all the planning for the capacity expansion is all those costs will be capitalized until we begin production from the new facility and have saleable products coming out of the facility. So the costs that you're - that you would see would almost entirely end up capitalized.

Okay. So that includes labor or is the labor separate?

No. The labor associated without personnel they wouldn't be hired to mid-to-late 2020 and all cost associated with that labor which is part of our capital project while they're training and getting and testing production will be part of our capital planning.

Rob also when we outlined the plan on Wednesday, you'll see how we plan to handle the operation of that facility which will make it a little bit easier and clearer to understand how the hiring will unfold. But suffice it to say that if there is any impact in 2020 from the expansion of the capacity, it will be relatively modest on the financials in 2020.

Okay. Well I need to keep harping on this, but like when you get to 2021, I guess that doesn't mean - it doesn't mean that there's a step backward, is there just for the labor expense…

We don't expect that. We don't expect so, and again, when you see the operating plan that we're going to lay out on Wednesday you'll understand why that is.

Okay. That's very helpful. Thanks. And maybe just on the topline which was very good and better than what we thought, can you give us a little more color us to maybe household penetration rates so more evidence that if you're seeing maybe new - is it new users coming to the franchise, is it existing users expanding their use of the franchise, do you have more color on what's driving that the velocity in particular?

Yes. We've got a lot of color on that and I hate to just keep saying it this way, but when we talk on Wednesday, we will also give you a lot more detail on it. But the headline on it is household penetration is up about 20% year-on-year and we're also seeing expansion in the buying rate at the same time and the people that we're bringing into the franchise from look a lot like the same people we brought into the franchise last year. So it tells us that there's a pool of high quality prospects for this business that we continue to recruit and there are more that look like those that can be part of our future. But at this point it's exactly what we've seen and we've been talking about expanding the penetration and at the same time we are expanding the buying rate.

Okay. Thank you, Billy. Take care.

Thanks Rob.

Our next question comes from the line of Bill Chappell from SunTrust. Please proceed with your question.

Thanks. Good afternoon.

Hey there.

Just one clarification Billy on the holiday shift, so did that actually occur or was that really not as big of an impact in the quarter?

There was no impact on the front end. We had worried that would be impacts on both the front end and the back end. We worried that Easter would have a problem. There was no problem related to Easter. But what we saw as of the July 4, we shipped all - the vast majority of our shipments are LTL, and the last year because the holiday fell on the Tuesday a lot of people opted to pull the orders into the previous week rather than having them shipped out on the Monday and sit around. And so this year because the holiday move back a day, we saw a reduction in those shipments in the last week of the quarter when compared to the year-ago. I think they fell the way they should fall this year and last year they just happen to be a little bit larger than they would have expected.

Got it. So there's no incremental benefit as we move into the third quarter?

It means that we - on a year-on-year comparison means we started off strongly in July, but its normal consumption just the normal pattern. We're seeing consumption and shipments match each other very nicely in the middle of the year.

Got it. And then as we look to the back half in terms of marketing spend, remind me or help me understand kind of how it works? Have you started the process of kind of steer stepping it down or are we still in the - you posted for July and then you're off now for two or three months and then post it again in October type thing. Just trying to understand, how that the expense is going to work out and also what's your expectations now are for the drop off of or deceleration of sales if any?

So we've actually been off for about six weeks now off the TV and we had low levels of digital. It was planned during this period. We've historically seen not as a great responses in the summer period, so we've kind of straddled those periods and gotten better returns towards the front of the year. We do have TV coming back in the end of August and into September and we'll have digital and some mix of TV on in October and November and some of that still like TVD, but we will have advertising at a much lower level. But the nice thing is since we've been off, we've actually seeing kind of a very steady pace, flattening of growth, but a steady versus prior periods and really nice growth rate versus prior year, and we also have even seen a handful of like weekly records even being out of the media period. So we're pretty happy about that.

So just a follow-up. So the raising of the guidance for the full-year on the revenue side is due to year-to-date or I believe today maybe we're not going to see the drop off that we thought in the back half?

The guidance reflects the - we're ahead of where we thought we would be and a little bit of more bullishness on the back half, but more of it is reflecting the fact that whereas far ahead as we are in the first half.

Got it. Thanks so much.

Our next question comes from the line of Brian Holland from Consumer Edge Research. Please proceed with your question.

Thanks and good afternoon. The first question, I guess, just to sort of confirm, it sounds like it's what I'm hearing from you, but just to be clear. The topline guidance raise, EBITDA guidance held, can you sort of distinguish within that EBITDA guidance that you're maintaining? How much of that is - just Q2 played out exactly in line with plan and you anticipate that continuing, you talked about freight et cetera, and how much of that is - any decision to reinvest potentially upside that you saw in the first half supported by the increased revenue guide and reinvesting that? If indeed you are reinvesting maybe just specifically areas of focus that we should be thinking about whether that's more behind media in the back half et cetera?

Yes. So we aren't going to go on a whole lot of detail on decomposing that, Brian. What I can tell you is what we told folks at the beginning of the years, our advertising split between the first half and the second half will be 70/30 and we expect to see that play out. We also have other elements in the marketing spend mix. We did have seen the commodities, higher cost of commodities. We've been talking about it on the year, the commodity cost increases about $3 million and so that's playing into our decision on the EBITDA guidance. I'd also tell you that there is a discussion about freight. What we're seeing on the freight side, it's on inbound freight for us because that's a largely stuff that comes in at full truckload or close to full truckload quantities. On the outbound, we're not seeing inflation, but we're losing a savings. We had been expecting that we would see freight go down because of our increasing scale. And what's happening is our increasing scale is offsetting higher freight rates. So when you kind of decompose it all, it's going to be skewed towards the commodity side, but there will be other factors involved as well.

Okay, thanks. And then - so I think Rob asked this question earlier and it sounds like from your response that your data is coming in a little bit stronger than even what I'm seeing from my end. So maybe this answers the question, but I guess if I was going to picking it based on the data that I can see, the more household penetration growth the better because as you mentioned sales per household keep going up which implies you're getting folks to continue to show increasing loyalty to the brand increased engagement. I'm just curious to what extent household penetration growth thus far is in line with your expectations. Is it better? Is it in line? I'm just kind of curious if you could sort of frame how that's coming along as obviously that media spend is primarily trained on bringing new households in?

Yes. As we showed you before, there's a pretty strong match between our core dog household penetration growth and the media spend, and that has continued as we outlined it in June and it continues now. We will be able to update you on that when we share more detail on Wednesday. But I would say that we're getting a little bit of an added benefit because some of the new products that we launched this year are doing particularly well and that has helped the household penetration as well. So the media I think is performing exactly as we thought and we're getting an added bonus from better than expected performance on the new products that we launched this year.

Perfect, thanks a lot. See you Wednesday.

Yep.

[Operator Instructions] Our next question comes from the line of Mark Astrachan from Stifel. Please proceed with your question.

Yes, thanks and good afternoon, everyone. Hey, so I guess just starting on the 70/30 ad spend, so the timing and expectations are still the same. I guess maybe this question is for Scott. So it seems like the correlation between spend and sales is pretty amazingly consistent and visible. Why not then more given the response? I mean, obviously, I assume this is something that you're debating internally, so I'm curious, why not pedal to the metal kind of thing, is it - I guess I'll let answer the question?

So yes, it is - I think for people that have been around this business, I think we've come to really see how consistent the results have been. I think for people outside when they see them, I think they're typically pretty impressed with the correlation of the spend in response. I think that it's up to us to - we obviously want to grow quite quickly and we're seeing, we'd love the numbers that we're seeing. But we want to grow at a pace that the organization is comfortable with and if we can make sure we can keep quality in place. We can keep expansion in place. There's a lot of work that we're doing and we want to make sure that we don't get ahead of ourselves because the number one thing that to deliver a really strong consistent product day in and day out to consumers. So I think that's the focus. In addition, there's obviously financial metrics that we've committed to and we're focused on for this fiscal year and we want to make sure that we're continue to deliver on those and keep the ship steady as it goes.

Got it, okay. And then on the velocity comment were even increased usage I guess, sort of like a double question. So how do you think about your ultimate penetration or de-ultimate penetration for Freshpet food compared to other dog, cat food categories of dried products? And I guess in thinking about the first part on the velocity, who are the incremental consumers as you do your work? Is it that people were previously mixing dry food in here? And now they're switching to more of your product. Is that you're bringing more consumers in? And then you sort of related to that back to that other question, which is - what is the ultimate penetration of your specific category within the broader pet food market?

So today we're still below two from penetration standpoint. The way - it's interesting, you kind of look at the data you do the math in the metrics around it and we have an input like - just kind of doing the hard numbers from the traditional consumer metrics and it looks like you can get like - there's many times opportunity to increase it. But I think what we're doing and I think it's starting to play out really well for us is we're kind of changing the categories. We almost can't tell how high is high quite honestly. We believe that as you continue to develop that and really get more and more people to look at it, you start to really define what good is and what great and healthy in the best food in the industry is and we think that we're becoming more of that beacon. So I mean quantitatively, yes, there's multiple times in penetration, we feel really confident in that. But I think longer term, I think this is a defining moment in the category and I think there is - it's kind of almost a question Mark on like what does it look like five years from now, 10 years from now and could Freshpet food be a 20 share of a category and it seems logical that it could be.

Right, right. Okay, thanks.

I know that is a little ambiguous. We got at the best crystal ball we have, but we again we feel confident in it. But I don't think there's a really super clear answer. Everything we have - we share that in the past. The things that we've had the data that we've shared show demonstrates really strong potential, but I think it's potentially even beyond that.

Yes, and that's helpful. I mean it certainly does seem like there's more people coming into the category, but what do I know? Just lastly maybe Billy question for you, I'm curious though how have the discussions evolved with retailers since you started? Freshpet seems to be obviously it's still small from the penetration standpoint, but accounting for a bigger percentage of category growth particularly of sales trends accelerate. So I guess I'm just curious, one, sort of broader strokes and two, within the retailers that you're not fully penetrated which is a lot of them. How are those discussions evolving to more fully penetrate where you are?

I am going to give you a topline overview and Scott might be able to provide a little bit more color on it. But as you can imagine most retailers are struggling for growth right now and so when you walk in and you can show a retailer that you are in their same-store sales metrics delivering numbers that are north of 20% growth on average and some are better than that obviously. You obviously get people's attention and versus where we work two years ago we now not only have a strong growth rate, but we also are able to do that with more significant scale. And when you think about strategically as these retailers try to figure out, how they're going to compete long-term particularly with e-commerce, fresh is an area that many of them are focused. So our conversations have gotten to the point where they're much more engaged and interested. They still face many of the same obstacles that prevent them from putting us in every one of their stores. But I think what you can see - what we're seeing and what you can see is those who have figured it out and are on sort of the leading edge and understand what the potential is or jumping in with both feet. So that means they're upgrading their fridges. So this year we've already upgraded about 700 fridges from smaller to larger ones. There are some retailers out there with conversations going on about adding a second fridge. And there are many retailers where we're completing the distribution. So we're in 50%, 60%, 70% of stores are going to 80% or 90% of their stores. So I think those conversations are getting much more positive, but you have to remember the backdrop that most retailers are operating in it's a very challenging backdrop and particularly for them to continue make investments in the stores. And so we do operate in that environment, but I think what you can see is our growth in distribution is incredibly consistent and incredibly steady. When measured the stores it looks like kind of lumpy, but when you measure that ACV, we've been growing ACV at 7% a year pretty consistently now for four or five years. And I expect to see that continue over the long haul and I'd also expect to see some retailers get in such a big way that we see them leading in transforming the category. I know Scott might have some more color on that.

Billy did a great job, answering that. But to build go a little bit more on it to over answer the question maybe a little bit is like - as Billy mentioned we've got growth. We've got really strong category of leading margins. We've got incredible traffic that we bring in and frequency that we bring in. We're kind of the milkening to the pet aisle. We consistently bring in new consumers who have been able to demonstrate that from retailers. We're starting to demonstrate real scale in the category. There are retailers that we have a 10, 11%, 12%, 13, 14% share of dry and wet dog food in the stores we're in. So that's really playing out. And then finally, we're able to bring the best of the perimeter into the center of the store and I think when retailers look at that and recognize what we bring, I think that Freshpet really is becoming more of a solution to help them continue to grow their category into the future. So I think they do look at it. I feel like the conversations have continued to change as now we've been able to kind of surpass the growth rates we've had historically, but also that we've been able to do it at a level where we're starting to be like real in size for many of the retailers in the stores that we currently participate in. So I think it's going to play out really well for us over time. I think we're being looked at as a favor partner.

Great, thanks guys.

Our next question comes from the line of Jon Andersen from William Blair. Please proceed with your question.

Hey, good afternoon everybody.

Hey, Jon.

Hey, there.

Most of my questions have been answered, but just a couple and I leave you to answer. One, could you talk a little bit more about the buy rate among existing Freshpet households, how much running room you have there to increase the buy rate? Kind of the trends you've seen historically and what your expectations are going forward? And then second if you could comment broadly on and I know there's been a lot of focus internally on improving the retail conditions. In the fridges and your level of progress there and kind of comfort level with the where things are today and how much more opportunity is there maybe? Thanks.

So from a buy rate perspective, we actually just recently redid a study that we've done a couple of years ago and we have consistently seen people in their second and third year in the franchise actually continue to spend more and more over time. Typically what we see is they come in and as they kind of very light level mixing behavior then it becomes a more of a visual mixing behavior then it becomes even more of the bowl and then a lot of people do transition over time to being 100% user in - for Freshpet. So we're - we love that data. There's nothing that tells you kind of a help of a franchise and a product line more than that component and then secondarily on the retail conditions, we have done a lot of different work around improving retail conditions. We had probably another five to seven tests out there this year. We've definitely made some progress in a few areas. I would say they're definitely not at the standard that we would like and kind of hold our brand, our product and our company too. So we're continuing to work on that and we're in active discussions again looking at next year on what we can do. One of the things that does help retail conditions is the overall improvement in the fridge network and the fleet that we're putting out there. We're putting best-in-class fridges out there in situations where fridges that are not up to our standards. Those are some of the renovation work that we've shared of the upgrade work that we've shared in the past and we're putting better and better fridges in. That are easier to merchandise, have greater visibility, easier to clean, better take care off, easier to stock et cetera. So that those two things coupled together will continue to kind of improve our overall retail presence over time.

Great, thanks for the color, and we look forward to the Investor Day. Thanks.

Great, thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

Great, thank you very much for your questions and interest. We obviously feel very good about what we delivered this quarter and we're looking forward to the balance of the year. Obviously, we referenced in the call that we'll have more to say later this week about the Freshpet kitchens 2.0 and provide a little bit more color in detail on the business performance to date and where we think the potential this business is. So we look forward to sharing that information with folks on Wednesday. Thank you for your time.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.