# Freshpet, Inc. (FRPT) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Freshpet, Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1611647/000143774924005542/frpt20231231_10k.htm
Accession: 0001437749-24-005542
Filing date: 2024-02-26
Report date: 2023-12-31
Extracted from a substantive MD&A body after the formal Item 7 span was a TOC or reference stub.
Confidence: high

Company profile: /company/FRPT/
All MD&A years: /company/FRPT/mda/
Previous year: /company/FRPT/mda/fy2022/ (FY 2022)
Next year: /company/FRPT/mda/fy2024/ (FY 2024)

Overview

We started Freshpet with a single-minded mission to bring the power of real, fresh food to our dogs and cats. We were inspired by the rapidly growing view among pet owners that their dogs and cats are a part of their family, leading them to demand healthier pet food choices. Since Freshpet's inception in 2006, we have created a comprehensive business model to deliver wholesome pet food that pet parents can trust, and in the process, we believe we have become one of the fastest growing pet food companies in North America. Our business model is difficult for others to replicate, and we see significant opportunity for future growth by leveraging the unique elements of our business, including our brand, product know-how, Freshpet Kitchens, refrigerated distribution, Freshpet Fridge, and culture.

Components of our Results of Operations

Net Sales

Our net sales are derived from the sale of pet food products that are sold to retailers through broker and distributor arrangements. Our products are sold to consumers through a fast-growing network of company-owned branded refrigerators, known as Freshpet Fridges, located in our customers’ stores. We continue to roll out Freshpet Fridges at leading retailers across North America and parts of Europe and have installed Freshpet Fridges in approximately 26,777 retail stores as of December 31, 2023. Our products are sold under the Freshpet brand name with ingredients, packaging and labeling customized by class of retail. Sales are recorded net of discounts, returns and promotional allowances.

Our net sales growth is driven by the following key factors:

[[GREPCENT_TABLE]]
[["","\u25cf","Increasing sales velocity from the average Freshpet Fridge due to increasing awareness, trial and adoption of Freshpet products and innovation. Our investments in marketing and advertising help to drive awareness and trial at each point of sale."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","Increasing penetration of Freshpet Fridge locations in major classes of retail, including Grocery, Mass, Club, Pet Specialty, Natural, and Digital. The impact of new Freshpet Fridge installations on our net sales varies by retail class and depends on numerous factors including store traffic, refrigerator size, placement within the store, and proximity to other stores that carry our products."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","Consumer trends including growing pet ownership, pet humanization and a focus on health and wellness."],["","\u25cf","At times we increase our sales price to offset any adverse movement in input costs."]]
[[/GREPCENT_TABLE]]

We believe that as a result of the above key factors, we will continue to penetrate the pet food marketplace and increase our share of the pet food category.

27

Gross Profit

Our gross profit is net of costs of goods sold, which include the costs of product manufacturing, product ingredients, packaging materials and inbound freight, as well as depreciation and amortization and non-cash share-based compensation.

We expect to continue to mitigate any adverse movement in input costs through a combination of cost management and price increases. 

Selling, General and Administrative Expenses

Our selling, general and administrative expenses consist of the following:

Outbound freight. We use a third-party logistics provider for outbound freight that ships directly to retailers as well as third-party distributors.

Marketing & advertising. Our marketing and advertising expenses primarily consist of national television media, digital marketing, social media and grass roots marketing to drive brand awareness. These expenses may vary from quarter to quarter depending on the timing of our marketing and advertising campaigns. Our Feed the Growth initiative focuses on growing the business through increased marketing investments.

Freshpet Fridge operating costs. Freshpet Fridge operating costs consist of repair costs and depreciation. The purchase and installation costs for new Freshpet Fridges are capitalized and depreciated over the estimated useful life. All new refrigerators are covered by a manufacturer warranty for three years. We subsequently incur maintenance and freight costs for repairs and refurbishments handled by third-party service providers.

Research & development. Research and development costs consist of expenses to develop and test new products. The costs are expensed as incurred.

Brokerage. We use third-party brokers to assist with monitoring our products at the point-of-sale as well as representing us at headquarters for various customers. These brokers visit our retail customers’ store locations to ensure items are appropriately stocked and maintained.

Share-based compensation. We account for all share-based compensation payments issued to employees, directors and non-employees using a fair value method. Accordingly, share-based compensation expense is measured based on the estimated fair value of the awards on the grant date using the Black-Scholes Merton option-pricing model. We recognize compensation expense for the portion of the award that is ultimately expected to vest over the period during which the recipient renders the required services to us using the straight-line single option method.

Other general & administrative costs. Other general and administrative costs include non-plant personnel salaries and benefits, as well as corporate general & administrative costs.

Income Taxes 

We had federal net operating loss (“NOL”) carry forwards of approximately $420.3 million as of December 31, 2023, of which, approximately $175.4 million, generated in 2017 and prior, will expire between 2025 and 2037. The NOL generated from 2018 through 2023, of approximately $244.9 million, will have an indefinite carryforward period, but can generally only be used to offset 80% of taxable income in any particular year. We may be subject to certain limitations in our annual utilization of NOL carry forwards to off-set future taxable income pursuant to Section 382 of the Internal Revenue Code, which could result in NOLs expiring unused. At December 31, 2023, we had approximately $312.8 million of state NOLs, which expire between 2024 and 2043, and had $20.7 million of foreign NOLs in the United Kingdom which do not expire. At December 31, 2023, we had a full valuation allowance against our net deferred tax assets as the realization of such assets was not considered more likely than not.

28

Consolidated Statements of Operations and Comprehensive Loss

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended December 31,"],["","","2023","","","2022","","","2021"],["","","Amount","","","% of Net Sales","","","Amount","","","% of Net Sales","","","Amount","","","% of Net Sales"],["","","(Dollars in thousands)"],["Net sales","","$","766,895","","","","100","%","","$","595,344","","","","100","%","","$","425,489","","","","100","%"],["Cost of goods sold","","","516,023","","","","67","","","","409,311","","","","69","","","","263,343","","","","62"],["Gross profit","","","250,872","","","","33","","","","186,033","","","","31","","","","162,146","","","","38"],["Selling, general and administrative expenses","","","281,318","","","","37","","","","238,016","","","","40","","","","186,809","","","","44"],["Loss from operations","","","(30,446",")","","","(4",")","","","(51,983",")","","","(9",")","","","(24,663",")","","","(6",")"],["Interest and other income, net","","","13,029","","","","2","","","","1,710","","","","0","","","","13","","","","0"],["Interest expense","","","(14,097",")","","","(2",")","","","(5,208",")","","","(1",")","","","(2,882",")","","","(1",")"],["Loss before income taxes","","","(31,514",")","","","(4",")","","","(55,481",")","","","(10",")","","","(27,532",")","","","(6",")"],["Income tax expense","","","210","","","","0","","","","282","","","","0","","","","162","","","","0"],["Loss on equity method investment","","","1,890","","","","0","","","","3,731","","","","1","","","","2,005","","","","0"],["Net loss","","$","(33,614",")","","","(4",")%","","$","(59,494",")","","","(10",")%","","$","(29,699",")","","","(7",")%"]]
[[/GREPCENT_TABLE]]

Twelve Months Ended December 31, 2023 Compared To Twelve Months Ended December 31, 2022

Net Sales

The following table sets forth net sales by class of retail: 

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2023","","","2022"],["","","Amount","","","% of Net Sales","","","Store Count","","","Amount","","","% of Net Sales","","","Store Count"],["","","(Dollars in thousands)"],["Grocery, Mass and Club (1)","","$","685,307","","","","89","%","","","21,135","","","$","524,971","","","","88","%","","","19,670"],["Pet Specialty and Natural (2)","","","81,588","","","","11","%","","","5,642","","","","70,373","","","","12","%","","","5,611"],["Net Sales","","$","766,895","","","","100","%","","","26,777","","","$","595,344","","","","100","%","","","25,281"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","Stores at December 31, 2023 and December 31, 2022 consisted of 14,800 and 13,847 grocery and 6,335 and 5,823 mass and club, respectively."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(2)","Stores at December 31, 2023 and December 31, 2022 consisted of 5,164 and 5,135 pet specialty and 478 and 476 natural, respectively."]]
[[/GREPCENT_TABLE]]

Net sales increased $171.6 million, or 28.8%, to $766.9 million for the twelve months ended December 31, 2023 as compared to the prior year. The $171.6 million increase in net sales was driven by growth in the Grocery, Mass, and Club channel of $160.3 million, with the remaining growth in Pet Specialty and Natural. The net sales increase was primarily driven by volume gains of 20%.

29

Gross Profit

Gross profit was $250.9 million, or 32.7% as a percentage of net sales, for the twelve months ended December 31, 2023, compared to $186.0 million, or 31.2% as a percentage of net sales, in the prior year. The increase in gross profit as a percentage of net sales was primarily due to improved leverage on plant expenses, reduced quality costs, and decreased input cost as a percentage of sales mainly due to an increase in net sales pricing, partially offset by increased depreciation expense associated with the Company's capacity expansion and cost related to the disposal of equipment. For the twelve months ended December 31, 2023, Adjusted Gross Profit was $306.6 million, or 40.0% as a percentage of net sales, compared to $214.1 million, or 36.0% as a percentage of net sales, in the prior year.

See "—Non-GAAP Financial Measures" for how we define Adjusted Gross Profit, a reconciliation of Adjusted Gross Profit to gross profit, the closest comparable U.S. GAAP measure, certain limitations of Non-GAAP measures and why management has included such Non-GAAP measures. 

Selling, General and Administrative Expenses

Selling, general and administrative expenses ("SG&A") were $281.3 million, for the twelve months ended December 31, 2023, compared to $238.0 million in the prior year. As a percentage of net sales, SG&A decreased to 36.7% for the twelve months ended December 31, 2023, compared to 40.0% in the prior year. The decrease of 330 basis points in SG&A as a percentage of net sales was mainly a result of reduced logistics cost as a percentage of net sales, decreased cost related to the ERP implementation, and increased leverage on depreciation and share-based compensation as the business scales, partially offset by activism engagement charges, increased media spend and increased variable compensation accrual. 

Adjusted SG&A for the twelve months ended December 31, 2023, was $240.1 million, or 31.3% as a percentage of net sales, compared to $195.7 million, or 32.9% as a percentage of net sales, in the prior year. 

See “—Non-GAAP Financial Measures” for how we define Adjusted SG&A, a reconciliation of Adjusted SG&A to SG&A, the closest comparable U.S. GAAP measure, certain limitations of Non-GAAP measures and why management has included such Non-GAAP measures.

Loss from Operations

As a result of the factors discussed above, loss from operations decreased by $21.5 million to a loss from operations of $30.4 million for the twelve months ended December 31, 2023 as compared to a loss from operations of $52.0 million in the prior year.

Interest and Other Income, net

The Company recorded interest and other income, net of $13.0 million for the twelve months ended December 31, 2023 as a result of interest income generated from cash and short-term investments.

Interest Expense

Interest expense increased $8.9 million to interest expense of $14.1 million for the twelve months ended December 31, 2023 as compared to interest expense of $5.2 million for the same period in the prior year. The increase was primarily driven by the termination of our Credit Agreement in the current period resulting in the write-off of unamortized fees of $2.5 million which were recorded to interest expense, $5.2 million increase as a result of interest incurred on our Convertible Notes (as defined below) compared to interest incurred on the Credit Agreement that existed in the prior period, as well as a $1.2 million increase related to the interest on our finance lease liability.

Loss on Equity Method Investment

Our loss on equity method investment for the twelve months ended December 31, 2023 was $1.9 million as compared to a loss on equity method investment of $3.7 million in the prior year from the Company's interest in a privately held company, as discussed in Note 1.

Net Loss

Net loss decreased $25.9 million to a net loss of $33.6 million for the twelve months ended December 31, 2023 as compared to a net loss of $59.5 million for the prior year due to contribution from higher sales, increased gross margin and reduced logistics costs as a percentage of net sales, partially offset by increased SG&A including increased media spend of $23.1 million.

30

Adjusted EBITDA

Adjusted EBITDA was $66.6 million, or 8.7% as a percentage of net sales (also called Adjusted EBITDA Margin), for the twelve months ended December 31, 2023, compared to $20.1 million, or 3.4% as a percentage of net sales, in the prior year. The increase in Adjusted EBITDA was a result of increased Adjusted Gross Profit partially offset by higher Adjusted SG&A expense.

See "—Non-GAAP Financial Measures" for how we define Adjusted EBITDA, a reconciliation of Adjusted EBITDA to EBITDA, the closest comparable U.S. GAAP measure, certain limitations of Non-GAAP measures and why management has included such Non-GAAP measures; see the section entitled "Forward-Looking Statements" in this report and the section entitled "Risk Factors" in this report for factors that could cause our results to differ, in some cases materially.

Non-GAAP Financial Measures

Freshpet uses the following non-GAAP financial measures in its financial communications. These non-GAAP financial measures should be considered as supplements to the U.S. GAAP reported measures, should not be considered replacements for, or superior to, the U.S. GAAP measures and may not be comparable to similarly named measures used by other companies.

[[GREPCENT_TABLE]]
[["","\u2022","Adjusted Gross Profit"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Adjusted Gross Profit as a percentage of net sales (Adjusted Gross Margin)"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Adjusted SG&A expenses"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Adjusted SG&A expenses as a percentage of net sales"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","EBITDA"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Adjusted EBITDA"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Adjusted EBITDA as a percentage of net sales (Adjusted EBITDA Margin)"]]
[[/GREPCENT_TABLE]]

Such financial measures are not financial measures prepared in accordance with U.S. GAAP. We define Adjusted Gross Profit as Gross Profit before depreciation expense, non-cash share-based compensation, and loss on disposal of manufacturing equipment. We define Adjusted SG&A as SG&A expenses before depreciation and amortization expense, non-cash share-based compensation, implementation and other costs associated with the implementation of an ERP system, fees related to the Capped Call Transactions, loss on disposal of equipment, and advisory fees related to activism engagement. EBITDA represents net income (loss) plus interest expense net of interest income, income tax expense and depreciation and amortization. Adjusted EBITDA represents EBITDA plus loss on equity method investment, non-cash share-based compensation, implementation and other costs associated with the implementation of an ERP system, loss on disposal of property, plant and equipment, fees related to the Capped Call Transactions, and advisory fees related to activism engagement. 

We believe that each of these non-GAAP financial measures provide additional metrics to evaluate our operations and, when considered with both our U.S. GAAP results and the reconciliation to the closest comparable U.S. GAAP measures, provides a more complete understanding of our business than could be obtained absent this disclosure. We use the non-GAAP financial measures, together with U.S. GAAP financial measures, such as net sales, gross profit margins and cash flow from operations, to assess our historical and prospective operating performance, to provide meaningful comparisons of operating performance across periods, to enhance our understanding of our operating performance and to compare our performance to that of our peers and competitors.

Adjusted EBITDA is also an important component of internal budgeting and setting management compensation.

The non-GAAP financial measures are presented here because we believe they are useful to investors in assessing the operating performance of our business without the effect of non-cash items, and other items as detailed below. The non-GAAP financial measures should not be considered in isolation or as alternatives to net income (loss), income (loss) from operations or any other measure of financial performance calculated and prescribed in accordance with U.S. GAAP. Neither EBITDA nor Adjusted EBITDA should be considered a measure of discretionary cash available to us to invest in the growth of our business. Our non-GAAP financial measures may not be comparable to similarly titled measures in other organizations because other organizations may not calculate non-GAAP financial measures in the same manner as we do.

31

Our presentation of the non-GAAP financial measures should not be construed as an inference that our future results will be unaffected by the expenses that are excluded from that term or by unusual or non-recurring items. We recognize that the non-GAAP financial measures have limitations as analytical financial measures. For example, the non-GAAP financial measures do not reflect:

[[GREPCENT_TABLE]]
[["","\u25cf","our capital expenditures or future requirements for capital expenditures;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","the interest expense, or the cash requirements necessary to service interest expense or principal payments, associated with indebtedness;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","depreciation and amortization, which are non-cash charges, although the assets being depreciated and amortized will likely have to be replaced in the future, nor any cash requirements for such replacements; and"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","changes in cash requirements for our working capital needs."]]
[[/GREPCENT_TABLE]]

Additionally, Adjusted EBITDA (i) excludes non-cash share-based compensation expense, which is and will remain a key element of our overall long-term incentive compensation package, and (ii) certain costs essential to our sales growth and strategy. Adjusted EBITDA also excludes certain cash charges resulting from matters we consider not to be indicative of our ongoing operations. Other companies in our industry may calculate the non-GAAP financial measures differently than we do, limiting their usefulness as comparative measures.

The following table provides a reconciliation of EBITDA and Adjusted EBITDA to net loss, the most directly comparable financial measure presented in accordance with U.S. GAAP:

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["","","2023","","","2022","","","2021"],["","","(Dollars in thousands)"],["Net loss","","$","(33,614",")","","$","(59,494",")","","$","(29,699",")"],["Depreciation and amortization","","","57,058","","","","34,555","","","","30,468"],["Interest expense, net of interest income","","","1,069","","","","5,208","","","","2,882"],["Income tax expense","","","210","","","","282","","","","162"],["EBITDA","","$","24,723","","","$","(19,449",")","","$","3,813"],["Loss on equity method investment","","$","1,890","","","$","3,731","","","$","2,005"],["Loss on disposal of property, plant and equipment","","","4,321","","","","396","","","","1,000"],["Non-cash share-based compensation (a)","","","24,936","","","","26,092","","","","24,998"],["Enterprise Resource Planning (b)","","","2,457","","","","8,558","","","","1,379"],["Capped Call Transaction fees (c)","","","113","","","","\u2014","","","","\u2014"],["COVID-19 expense (d)","","","\u2014","","","","\u2014","","","","1,758"],["Activism engagement (e)","","","8,177","","","","\u2014","","","","\u2014"],["Organization changes (f)","","","(67",")","","","734","","","","\u2014"],["Adjusted EBITDA","","$","66,550","","","$","20,062","","","$","34,953"],["Adjusted EBITDA as a % of Net Sales","","","8.7","%","","","3.4","%","","","8.2","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(a)","Includes the true-up of share-based compensation expense during the period ended December 31, 2023. We have certain outstanding multi-year share-based awards, granted in FY 2020, with performance-based vesting conditions that require the achievement of certain Adjusted EBITDA targets in FY 2024 as a condition to vesting. At each reporting period, we reassess the probability of achieving the performance criteria and the performance period required to meet those targets set in 2020. When such performance conditions are deemed to be improbable of achievement, the compensation cost previously recorded is reversed."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(b)","Represents implementation, amortization of deferred implementation costs and other costs associated with the implementation of an ERP system."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(c)","Represents fees associated with the Capped Call Transactions."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(d)","Represents COVID-19 expenses including (i) costs incurred to protect the health and safety of our employees during the COVID-19 pandemic, (ii) temporary increased compensation expense to ensure continued operations during the pandemic, and (iii) costs related to mitigating potential supply chain disruptions during the pandemic."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(e)","Represents advisory fees related to activism engagement."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(f)","Represents a true-up to transition costs related to the organization changes designed to support growth, including several changes in organizational structure designed to enhance capabilities and support long-term growth objectives."]]
[[/GREPCENT_TABLE]]

32

The following table provides a reconciliation of Adjusted Gross Profit to Gross Profit, the most directly comparable financial measure presented in accordance with U.S. GAAP:

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["","","2023","","","2022","","","2021"],["","","(Dollars in thousands)"],["Gross profit","","$","250,872","","","$","186,033","","","$","162,146"],["Depreciation expense","","","41,209","","","","20,774","","","","16,545"],["Non-cash share-based compensation","","","10,995","","","","7,293","","","","4,152"],["COVID-19 expense (a)","","","\u2014","","","","\u2014","","","","1,753"],["Loss on disposal of manufacturing equipment","","","3,547","","","","\u2014","","","","\u2014"],["Adjusted Gross Profit","","$","306,623","","","$","214,100","","","$","184,596"],["Adjusted Gross Profit as a % of Net Sales","","","40.0","%","","","36.0","%","","","43.4","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(a)","Represents COVID-19 expenses including (i) costs incurred to protect the health and safety of our employees during the COVID-19 pandemic, (ii) temporary increased compensation expense to ensure continued operations during the pandemic, and (iii) costs related to mitigating potential supply chain disruptions during the pandemic included in cost of goods sold."]]
[[/GREPCENT_TABLE]]

The following table provides a reconciliation of Adjusted SG&A expenses to SG&A expenses, the most directly comparable financial measure presented in accordance with U.S. GAAP:

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["","","2023","","","2022","","","2021"],["","","(Dollars in thousands)"],["SG&A expenses","","$","281,318","","","$","238,016","","","$","186,809"],["Depreciation and amortization expense","","","15,849","","","","13,781","","","","13,923"],["Non-cash share-based compensation (a)","","","13,941","","","","18,799","","","","20,846"],["Loss on disposal of equipment","","","774","","","","396","","","","1,000"],["Enterprise Resource Planning (b)","","","2,457","","","","8,558","","","","1,379"],["Capped Call Transactions fees (c)","","","113","","","","\u2014","","","","\u2014"],["Activism engagement (d)","","","8,177","","","","\u2014","","","","\u2014"],["COVID-19 expense (e)","","","\u2014","","","","\u2014","","","","5"],["Organization changes (f)","","","(67",")","","","734","","","","\u2014"],["Adjusted SG&A Expenses","","$","240,074","","","$","195,748","","","$","149,656"],["Adjusted SG&A Expenses as a % of Net Sales","","","31.3","%","","","32.9","%","","","35.2","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(a)","Includes the true-up of share-based compensation expense during the period ended December 31, 2023. We have certain outstanding multi-year share-based awards, granted in FY 2020, with performance-based vesting conditions that require the achievement of certain Adjusted EBITDA targets in FY 2024 as a condition to vesting. At each reporting period, we reassess the probability of achieving the performance criteria and the performance period required to meet those targets set in 2020. When such performance conditions are deemed to be improbable of achievement, the compensation cost previously recorded is reversed."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(b)","Represents implementation, amortization of deferred implementation costs and other costs associated with the implementation of an ERP system."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(c)","Represents fees associated with the Capped Call Transactions."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(d)","Represents advisory fees related to activism engagement."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(e)","Represents COVID-19 expenses including (i) costs incurred to protect the health and safety of our employees during the COVID-19 pandemic, (ii) temporary increased compensation expense to ensure continued operations during the pandemic, and (iii) costs related to mitigating potential supply chain disruptions during the pandemic included in SG&A."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(f)","Represents a true-up to transition costs related to the organization changes designed to support growth, including several changes in organizational structure designed to enhance capabilities and support long-term growth objectives."]]
[[/GREPCENT_TABLE]]

33

Liquidity and Capital Resources

To meet our capital needs, we issued approximately $402.5 million in convertible notes in March 2023 (the "Convertible Notes"), used $66.2 million of the proceeds to enter into capped call transactions, and used $11.0 million of the proceeds on debt issuance related costs. Further, on March 13, 2023, in connection with the proposed offering of the Convertible Notes, the Company, notified City National Bank of Freshpet's intent to terminate the Credit Agreement, and such termination became effective as of March 15, 2023 (the "Termination Date"). The Company had no borrowings outstanding under the Credit Agreement as of the Termination Date.

We expect to make future capital expenditures in connection with the completion of our planned development of Freshpet Kitchens Ennis phase 2 and 3. During fiscal year 2023, we spent approximately $239.1 million of capital to meet our capacity needs as well as recurring capital expenditures. In fiscal year 2024, we expect to spend approximately $210.0 million. 

We expect to rely on our current and future cash flow from operations, may issue additional debt, and/or raise capital through our access to capital markets, if appropriate. Our ability to obtain additional funding will be subject to various factors, including general economic and market conditions, our operating performance, the market's perception of our growth potential, lender sentiment and our ability to incur additional debt in compliance with other contractual restrictions.

Our ability to make future minimum interest payments on the Convertible Notes, to refinance any indebtedness and to fund any necessary expenditures for our growth will depend on our ability to generate cash in the future. If our business does not achieve the levels of profitability or generate the amount of cash that we anticipate or if we expand faster than anticipated, we may need to seek additional debt or equity financing to operate and expand our business. Future third-party financing may not be available on favorable terms or at all. 

Our primary cash needs, in addition to our plant expansions, are for purchasing ingredients, operating expenses, marketing expenses and capital expenditures to procure Freshpet Fridges. We believe that cash and cash equivalents, short-term investments, expected cash flow from operations, amounts previously raised through the issuance of the Convertible Notes and our ability to access the capital markets, if appropriate, are adequate to fund our debt requirements, operating and finance lease obligations, capital expenditures and working capital obligations for the foreseeable future. We believe our sources of liquidity and capital will be sufficient to finance our continued operations, growth strategy and additional expenses we expect to incur for at least the next twelve months. However, our ability to continue to meet these requirements and obligations will depend on, among other things, our ability to achieve anticipated levels of revenue and cash flow from operations and our ability to manage costs and working capital successfully. Additionally, our cash flow generation ability is subject to general economic factors, including but not limited to increasing interest rates and inflation, financial, competitive, legislative and regulatory factors and other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations in an amount sufficient to enable us to fund our liquidity needs. Expanding certain of our Freshpet Kitchens primarily comprises our material future cash requirement. However, our capital requirements, including our cash requirements, may vary materially from those currently planned if, for example, our revenues do not reach expected levels, or we have to incur unforeseen capital expenditures and make investments to maintain our competitive position. If this is the case, we may seek alternative financing, such as selling additional debt or equity securities, and we cannot assure you that we will be able to do so on favorable terms, if at all. Moreover, if we issue new debt securities, the debt holders would have rights senior to common stockholders to make claims on our assets, and the terms of any debt could restrict our operations, including our ability to pay dividends on our common stock. If we issue additional equity or if the Convertible Notes are converted to common shares, existing stockholders may experience dilution, and such new securities could have rights senior to those of our common stock. These factors may make the timing, amount, terms and conditions of additional financing unattractive. Our inability to raise capital could impede our growth or otherwise require us to forego growth opportunities and could materially adversely affect our business, financial condition and results of operations. 

34

The following table sets forth, for the periods indicated, our working capital:

[[GREPCENT_TABLE]]
[["","","December 31,","","","December 31,"],["","","2023","","","2022"],["","","(Dollars in thousands)"],["Cash and cash equivalents","","$","296,871","","","$","132,735"],["Accounts receivable, net of allowance for doubtful accounts","","","56,754","","","","57,572"],["Inventories, net","","","63,238","","","","58,290"],["Prepaid expenses","","","7,615","","","","9,778"],["Other current assets","","","2,841","","","","3,590"],["Accounts payable","","","(36,096",")","","","(55,088",")"],["Accrued expenses","","","(49,816",")","","","(33,016",")"],["Current operating lease liabilities","","","(1,312",")","","","(1,510",")"],["Current finance lease liabilities","","","(1,998",")","","","-"],["Total Working Capital","","$","338,097","","","$","172,351"]]
[[/GREPCENT_TABLE]]

Working capital consists of current assets net of current liabilities. Working capital increased $165.7 million to $338.1 million at December 31, 2023 compared with working capital of $172.4 million at December 31, 2022. The increase was primarily a result of an increase of $164.1 million in cash and cash equivalents primarily resulting from the sale of the Convertible Notes as we fund our capital expansion plan, an increase in inventory of $4.9 million, a decrease in accounts payable of $19.0 million as a result of timing and capital expenditures of approximately $15.5 million related to our capital expansion plan and a decrease in current operating lease liabilities of $0.2 million. The increase was partially offset by a decrease in accounts receivable of $0.8 million, a decrease in prepaid expenses of $2.2 million, a decrease in other current assets of $0.7 million, an increase in accrued expenses of $16.8 million due to timing and capital expenditures of approximately $3.8 million related to our capital expansion plan, and an increase in current finance lease liabilities of $2.0 million.

We normally carry three to four weeks of finished goods inventory and less than 30 days of accounts receivable.

For the year ended December 31, 2023 our capital resources consisted primarily of $296.9 million of cash and cash equivalents on hand.

For the year ended December 31, 2022, our capital resources consisted primarily of $132.7 million of cash and cash equivalents on hand, $270.0 million available under our $350.0 million credit facilities, subject to debt covenants. Our credit facilities reflected $2.0 million reserved for two letters of credit and the remaining availability after the 2022 borrowing activity of $78.0 million under the Delayed Draw Facility.

We expect to fund our ongoing operations and obligations with cash and cash equivalents, and cash flow from operations. 

35

The following table sets forth, for the periods indicated, our beginning balance of cash, net cash flows provided by operating, investing and financing activities and our ending balance of cash.

[[GREPCENT_TABLE]]
[["","","Year Ended"],["","","December 31,"],["","","2023","","","2022"],["","","(Dollars in thousands)"],["Cash at the beginning of period","","$","132,735","","","$","72,788"],["Net cash provided by (used in) operating activities","","","75,940","","","","(43,227",")"],["Net cash used in investing activities","","","(239,093",")","","","(233,364",")"],["Net cash provided by financing activities","","","327,289","","","","336,538"],["Cash at the end of period","","$","296,871","","","$","132,735"]]
[[/GREPCENT_TABLE]]

Net Cash Provided by (Used In) Operating Activities

Cash provided by (used in) operating activities consists primarily of net loss adjusted for certain non-cash items (i.e., provision for (gains) loss on receivable, loss on disposal of property, plant and equipment, share-based compensation, change in reserve for inventory obsolescence, depreciation and amortization, write-off and amortization of deferred financing costs and loan discount, change in operating lease right of use asset and loss on equity method investment).

2023

Net cash provided by operating activities of $75.9 million in 2023 was primarily attributed to:

[[GREPCENT_TABLE]]
[["","\u25cf","$61.7 million of net income adjusted for reconciling non-cash items, which excludes $95.3 million of non-cash items primarily related to $4.3 million of loss on disposal of property, plant and equipment, $24.9 million of share-based compensation including amortization of warrants, $58.5 million of depreciation and amortization, $4.1 million of write-off and amortization of deferred financing costs and loan discount, $1.5 million of change in operating lease right of use asset and $1.9 million of loss on equity method investment."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$14.3 million increase due to changes in operating assets and liabilities. The increase was primarily due to the change in accounts receivable, accounts payable and accrued expenses, primarily offset by the change in inventories, prepaid expenses and other current assets, other assets and operating lease liability."]]
[[/GREPCENT_TABLE]]

2022

Net cash used in operating activities of $43.2 million in 2022 was primarily attributed to:

[[GREPCENT_TABLE]]
[["","\u25cf","$10.9 million of net income adjusted for reconciling non-cash items, which excludes $70.4 million of non-cash items primarily related to $34.6 million in depreciation and amortization, $26.1 million in share-based compensation, $3.7 million of investments in equity method investment, $3.5 million in inventory obsolescence, $1.4 million of change in operating lease right of use asset, $0.8 million of amortization of deferred financing costs and $0.4 million in loss on disposal of property, plant and equipment."]]
[[/GREPCENT_TABLE]]

This was offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$54.1 million decrease due to changes in operating assets and liabilities. The decrease was primarily due to the change in accounts receivable, inventory, accounts payable, other assets, other lease liabilities and prepaid expenses, offset by change in accrued expenses."]]
[[/GREPCENT_TABLE]]

36

Net Cash Used in Investing Activities

2023

Net cash used in investing activities of $239.1 million in 2023 was primarily attributed to:

[[GREPCENT_TABLE]]
[["","\u25cf","$5.3 million in capital expenditures related to Freshpet Kitchens South expansion."],["","\u25cf","$183.5 million in capital expenditures related to Freshpet Kitchens Ennis expansion."],["","\u25cf","$39.3 million in capital expenditures related to investment in fridges and other capital spend."],["","\u25cf","$11.0 million in plant recurring capital expenditures."],["","\u25cf","$113.4 million purchase of short-term investments."]]
[[/GREPCENT_TABLE]]

This was partially offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$113.4 million of proceeds from maturities of short-term investments."]]
[[/GREPCENT_TABLE]]

2022

Net cash used in investing activities of $233.4 million in 2022 was primarily attributed to:

[[GREPCENT_TABLE]]
[["","\u25cf","$28.4 million in capital expenditures related to Freshpet Kitchens South expansion."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$165.1 million in capital expenditures related to Freshpet Kitchens Ennis expansion."],["","\u25cf","$27.4 million in capital expenditures related to investment in fridges and other capital spend."],["","\u25cf","$9.2 million in plant recurring capital expenditures."],["","\u25cf","$19.8 million purchase of short-term investments."],["","\u25cf","$3.3 million investment in equity method investment."]]
[[/GREPCENT_TABLE]]

This was partially offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$19.8 million of proceeds from maturities of short-term investments."]]
[[/GREPCENT_TABLE]]

Net Cash Provided by Financing Activities

2023

Net cash provided by financing activities of $327.3 million in 2023 was primarily attributed to:

[[GREPCENT_TABLE]]
[["","\u25cf","$393.5 million net proceeds from Convertible Notes."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$4.5 million cash proceeds from the exercise of stock options."]]
[[/GREPCENT_TABLE]]

This was partially offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$66.2 million for the purchase of capped call options."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$2.0 million for debt issuance costs."],["","\u25cf","$1.4 million for tax withholdings related to net share settlements of restricted stock units."],["","\u25cf","$1.1 million for principal payments under finance lease obligations."]]
[[/GREPCENT_TABLE]]

2022

Net cash provided by financing activities of $336.5 million in 2022 was primarily attributed to:

[[GREPCENT_TABLE]]
[["","\u25cf","$337.5 million of proceeds from common shares issued in a primary offering, net of issuance cost."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$78.0 million of proceeds from borrowings under Credit Facility."],["","\u25cf","$0.5 million of proceeds from the exercise of stock options."]]
[[/GREPCENT_TABLE]]

This was partially offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$78.0 million for repayment of borrowings under Credit Facility."],["","\u25cf","$1.4 million for tax withholdings related to net share settlements of restricted stock units."]]
[[/GREPCENT_TABLE]]

37

Indebtedness

For a discussion of our material indebtedness, see Note 6 and 7 to our Consolidated Financial Statements included in this report.

Critical Accounting Estimates and Policies

Our management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the revenue and expenses incurred during the reported periods. On an ongoing basis, we evaluate our estimates and judgments, including those related to accrued expenses and share-based compensation. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Changes in estimates and policies are reflected in reported results for the period in which they become known. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting estimates and policies are described in the notes to our financial statements appearing in this report, we believe that the following critical accounting estimates and policies are most important to understanding and evaluating our reported financial results.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of net sales and expenses during the reporting period.

We believe that the accounting estimates policies discussed below are critical to understanding our historical and future performance, as these policies related to the more significant areas involving management’s judgments and estimates. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. Actual results, as determined at a later date, could differ from those estimates. To the extent that there are differences between our estimate and the actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

38

The following critical accounting policies reflect significant judgments and estimates used in preparation of our consolidated financial statements:

Revenue Recognition and Incentives—Revenue is reported net of applicable trade incentives and allowances.  Amounts billed and due from our customers are classified as receivables and require payment on a short-term basis. The Company applies judgment in the determination of the amount of consideration the Company receives from its customers. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods. Revenue the Company recognizes varies with changes in trade incentives the Company offers to its customers and their consumers. Trade incentives consist primarily of customer pricing allowances and merchandising funds, and consumer coupons are offered through various programs to customers and consumers. Estimates of trade promotion expense and coupon redemption costs are based upon programs offered, timing of those offers, estimated redemption/usage rates from historical performance, management’s experience and current economic trends. 

Share-based Compensation—We account for all share-based compensation payments issued to employees, directors and nonemployees using a fair value method. Accordingly, share-based compensation expense is measured based on the estimated fair value of the awards on the date of grant. We recognize compensation expense for the portion of the award that is ultimately expected to vest over the period during which the recipient renders the required services to us using the straight-line single option method.

We have outstanding share-based awards that have performance-based vesting conditions in addition to time-based vesting. Awards with performance-based vesting conditions require the achievement of certain financial criteria as a condition to the vesting. For certain performance-based awards, the quantity of awards received can range based on the level of performance achieved. The performance-based awards with financial criteria either have a Net Sales and/or Adjusted EBITDA target from FY 2023 through FY 2026. We recognize the estimated fair value of performance-based awards as share-based compensation expense over the performance period based upon our determination of whether it is probable that the performance targets will be achieved. At each reporting period, we reassess the probability of achieving the performance criteria and the performance period required to meet those targets. Determining whether the performance criteria will be achieved involves judgment, and the share-based compensation expense may be revised periodically based on changes in the probability of achieving the performance criteria. Revisions are reflected in the period in which the probability assessment is changed. If performance goals are not met, no share-based compensation expense is recognized for the cancelled shares, and, to the extent share-based compensation expense was previously recognized for those cancelled shares, such share-based compensation expense is reversed.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements, see Note 1 (Summary of Significant Accounting Policies) to our audited consolidated financial statements included in this report.

Segment

We have determined we operate in one segment: the manufacturing, marketing and distribution of pet food and pet treats for dogs and cats.

39