# Freshpet, Inc. (FRPT) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Freshpet, Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1611647/000143774922004871/frpt20211231_10k.htm
Accession: 0001437749-22-004871
Filing date: 2022-03-01
Report date: 2021-12-31
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/
Next year: /company/FRPT/mda/fy2022/ (FY 2022)

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, our product know-how, our Freshpet Kitchens, our refrigerated distribution, our Freshpet Fridge and our culture.

Recent Developments

During 2021, our household penetration growth was below our historical rate, but we believe we are still progressing towards our long-term household penetration goal. During late 2021, we announced two price increases designed to address the margin impact of inflation on our input costs, logistics and labor. We believe the household penetration impact as a reaction to our price increase to be a short-term setback when the higher pricing first appears on the shelf, but we expect it to turn positive through product distribution and media. We believe our buying rate will likely benefit from the higher pricing. We have excess buffer capacity in our plans to ensure continuity of operations and insulate from disruptions and prepare us for the increased demand we expect by the end of 2022.

Continued Observations on the Effects of COVID-19

Our priorities during the COVID-19 pandemic continue to be protecting the health and safety of our employees, maximizing the availability of our products, and executing our "Feed the Growth" strategy.

We are unsure how long the COVID-19 pandemic, including current and evolving health and safety guidance and local health and safety responses as well as emergence of new variants, will require us to absorb higher costs to protect and reward our employees while simultaneously ensuring we can support our pet parents with a continual supply of Freshpet products. We are also monitoring our supply chain generally, including our supply of raw materials, ingredients and packaging materials along with other impacts to our Freshpet Kitchens. 

We will continue to monitor the retail environment and pet parent demand, and intend to adapt to changing conditions to continue to drive growth and meet our goal of "changing the way people feed their pets forever" during the evolving COVID-19 pandemic. 

28

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 23,600 retail stores as of December 31, 2021. 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 (including online), Mass, Club, Pet Specialty and Natural. 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."]]
[[/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.

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, amortization and non-cash share-based compensation tied to production. We expect 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 will focus 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.

29

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 $291.8 million as of December 31, 2021, of which, approximately $175.4 million, generated in 2017 and prior, will expire between 2025 and 2037. The NOL generated from 2018 through 2021, of approximately $116.4 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, 2021, we had approximately $229.5 million of state NOLs, which expire between 2022 and 2041, and had $14.3 million of foreign NOLs which do not expire. At December 31, 2021, 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.

Consolidated Statements of Operations and Comprehensive Loss

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended December 31,"],["","","2021","","","2020","","","2019"],["","","Amount","","","% of Net Sales","","","Amount","","","% of Net Sales","","","Amount","","","% of Net Sales"],["","","(Dollars in thousands)"],["Net sales","","$","425,489","","","","100","%","","$","318,790","","","","100","%","","$","245,862","","","","100","%"],["Cost of goods sold","","","263,343","","","","62","","","","185,880","","","","58","","","","131,665","","","","54"],["Gross profit","","","162,146","","","","38","","","","132,910","","","","42","","","","114,197","","","","46"],["Selling, general and administrative expenses","","","186,809","","","","44","","","","134,908","","","","42","","","","114,450","","","","47"],["(Loss) from operations","","","(24,663",")","","","(6",")","","","(1,998",")","","","(1",")","","","(253",")","","","(0",")"],["Other income/(expenses), net","","","13","","","","0","","","","87","","","","0","","","","5","","","","0"],["Interest expense","","","(2,882",")","","","(1",")","","","(1,212",")","","","(0",")","","","(991",")","","","(0",")"],["(Loss) before income taxes","","","(27,532",")","","","(7",")","","","(3,123",")","","","(1",")","","","(1,239",")","","","(1",")"],["Income tax expense","","","162","","","","0","","","","65","","","","0","","","","144","","","","0"],["Loss on equity method investment","","","2,005","","","","0","","","","-","","","","0","","","","-","","","","0"],["Net (loss)","","$","(29,699",")","","","(7",")%","","$","(3,188",")","","","(1",")%","","$","(1,383",")","","","(1",")%"]]
[[/GREPCENT_TABLE]]

30

Twelve Months Ended December 31, 2021 Compared To Twelve Months Ended December 31, 2020

Net Sales

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

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020"],["","","Amount","","","% of Net Sales","","","Store Count","","","Amount","","","% of Net Sales","","","Store Count"],["","","(Dollars in thousands)"],["Grocery (including Online), Mass and Club (1)","","$","356,965","","","","84","%","","","18,139","","","$","272,008","","","","85","%","","","17,770"],["Pet Specialty and Natural (2)","","","68,524","","","","16","%","","","5,492","","","","46,782","","","","15","%","","","4,946"],["Net Sales (3)","","$","425,489","","","","100","%","","","23,631","","","$","318,790","","","","100","%","","","22,716"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","Stores at December 31, 2021 and December 31, 2020 consisted of 12,723 and 12,560 grocery (including online) and 5,416 and 5,210 mass and club, respectively."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(2)","Stores at December 31, 2021 and December 31, 2020 consisted of 5,017 and 4,470 pet specialty and 475 and 476 natural, respectively."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(3)","Online sales associated with each class of retailer are included within their respective total."]]
[[/GREPCENT_TABLE]]

Net sales increased $106.7 million, or 33.5%, to $425.5 million for the twelve months ended December 31, 2021 as compared to the same period in the prior year. The $106.7 million increase in net sales was driven by growth in the Grocery (including Online), Mass, and Club refrigerated channel of $85.0 million, and Pet Specialty and Natural of $21.7 million. The net sales increase was driven by overall velocity gains and an increase of Freshpet Fridges store locations and fridges, which grew by 4.0% from 22,716 as of December 31, 2020 to 23,631 as of December 31, 2021.

Gross Profit

Gross profit increased $29.2 million, or 22.0%, to $162.1 million for the twelve months ended December 31, 2021 as compared to the same period in the prior year. The increase in gross profit was primarily driven by higher net sales offset by decreased gross margin.

Our gross profit margin of 38.1% for the twelve months ended December 31, 2021, was a decrease of 360 basis points compared to the same period in the prior year, due to increased costs at our Freshpet Kitchen of 290 basis points as a result of the wage increase and investments as we grow into capacity, inflation of ingredient cost of 90 basis points, increased depreciation and stock compensation cost of 120 basis points, slightly offset by lower plant start-up cost of 70 basis points, and lower COVID-19 related cost of 70 basis points. 

Adjusted Gross Profit was $189.5 million and $154.1 million in the years ended December 31, 2021 and 2020, respectively. Adjusted Gross Profit Margin as a percentage of net sales was 44.5% and 48.3% in the years ended December 31, 2021 and 2020, respectively. Adjusted Gross Profit excludes $16.5 million of depreciation and amortization expense, $4.9 million of plant start-up expense, $4.2 million of non-cash share-based compensation and $1.8 million of COVID-19 expense in 2021 and excludes $9.6 million of depreciation and amortization expense, $6.0 million of plant start-up expense, $2.1 million of non-cash share-based compensation and $3.5 million of COVID-19 expense in 2020. See “—Non-GAAP Financial Measures” for how we define Adjusted Gross Profit and 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.

31

Selling, General and Administrative Expenses

SG&A expenses increased $51.9 million, or 38.5%, to $186.8 million for the twelve months ended December 31, 2021 as compared to the same period in the prior year. Key components of the increase include higher variable costs of $21.7 million due to increased volume and increased freight cost, increased non-cash share-based compensation of $12.1 million, increased media expense of $13.1 million, increased depreciation expense of $2.4 million, higher incremental operating costs of $0.6 million and selling expense of $2.1 million. The increased operating expenses were primarily due to new hires, and increased employee incentive and benefit costs. As a percentage of net sales, selling, general and administrative expenses increased to 43.9% for the twelve months ended December 31, 2021 from 42.3% for the twelve months ended December 31, 2020.

Adjusted SG&A was $146.5 million and $107.2 million in the years ended December 31, 2021 and 2020, respectively. Adjusted SG&A increased as a percentage of net sales to 34.4% in the year ended December 31, 2021 as compared to 33.6% of net sales in the year ended December 31, 2020. The increase of 80 basis points in Adjusted SG&A is a result of increasing variable cost of 259 basis points due to freight costs, and media as a percentage of net sales increasing by 51 basis points, offset by leverage of 230 basis points. 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

Loss from operations increased $22.7 million from a loss of $2.0 million for the twelve months ended December 31, 2020 to a loss of $24.7 million for the twelve months ended December 31, 2021 as a result of the factors discussed above.

Interest Expense

Interest expense was $2.9 million and $1.2 million for the twelve months ended December 31, 2021 and 2020, respectively, relating primarily to our credit facilities. See “—Liquidity and Capital Resources.”

Other Income/(Expenses), net

Other income/(expenses), net decreased $0.1 million from an income of $0.1 million for the twelve months ended December 31, 2020 to income of less than $0.1 million for the twelve months ended December 31, 2021.

Loss on equity method investment

Our loss on equity method investment for the twelve months ended December 31, 2021 was $2.0 million from the Company's 19% interest in a privately held company.

Net Loss

Net loss increased $26.5 million, or 831.6%, to net loss of $29.7 million for the twelve months ended December 31, 2021 as compared to net loss of $3.2 million for the same period in the prior year. Net loss was 7.0% of net sales for the twelve months ended December 31, 2021 as compared to a net loss of 1.0% of net sales for the same period in the prior year.

32

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 GAAP reported measures, should not be considered replacements for, or superior to, the 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"]]
[[/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"]]
[[/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, plant start-up expense, non-cash share-based compensation and COVID-19 expenses. We define Adjusted SG&A as SG&A expenses before depreciation and amortization expense, non-cash share-based compensation, launch expense, fees related to equity offerings of our common stock, implementation and other costs associated with the implementation of an ERP system, loss on disposal of equipment and COVID-19 expenses. As of the fourth quarter of 2021, all remaining COVID-19 related expenses are part of our operating performance. EBITDA represents net income (loss) plus interest expense, income tax expense and depreciation and amortization. Adjusted EBITDA represents EBITDA plus loss on equity method investment, non-cash share-based compensation, launch expenses, plant start-up expense, fees related to equity offerings of our common stock, implementation and other costs associated with the implementation of an ERP system, loss on disposal of equipment and COVID-19 expenses.  

We believe that each of these non-GAAP financial measures provides 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.

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]]

33

Additionally, Adjusted EBITDA excludes (i) non-cash share-based compensation expense, which is and will remain a key element of our overall long-term incentive compensation package, (ii) certain costs essential to our sales growth and strategy, including an allowance for marketing expenses for each new store added to our network and non-capitalizable freight costs associated with Freshpet Fridge replacements, and (iii) plant start-up expense incurred to add manufacturing lines and additional Freshpet Kitchens. 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,"],["","","2021","","","2020","","","2019"],["","","(Dollars in thousands)"],["Net (loss)","","$","(29,699",")","","$","(3,188",")","","$","(1,383",")"],["Depreciation and amortization","","","30,468","","","","21,125","","","","15,921"],["Interest expense","","","2,882","","","","1,211","","","","991"],["Income tax expense","","","162","","","","65","","","","144"],["EBITDA","","$","3,813","","","$","19,213","","","$","15,673"],["Loss on equity method investment","","$","2,005","","","$","-","","","$","-"],["Loss on disposal of equipment","","","1,000","","","","1,805","","","","787"],["Non-cash share-based compensation","","","24,998","","","","10,925","","","","7,834"],["Launch expense (a)","","","3,130","","","","3,421","","","","4,563"],["Plant start-up expenses (b)","","","4,868","","","","5,962","","","","\u2014"],["Equity offering expenses (c)","","","\u2014","","","","58","","","","302"],["Enterprise Resource Planning (d)","","","1,379","","","","1,682","","","","\u2014"],["COVID-19 expense (e)","","","1,758","","","","3,854","","","","\u2014"],["Adjusted EBITDA","","$","42,951","","","$","46,920","","","$","29,159"],["Adjusted EBITDA as a % of Net Sales","","","10.1","%","","","14.7","%","","","11.9","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(a)","Represents new store marketing allowance of $1,000 for each store added to our distribution network, as well as the non-capitalized freight costs associated with Freshpet Fridge replacements. The expense enhances the overall marketing spend to support our growing distribution network."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(b)","Represents additional operating costs incurred in connection with the start-up of our new manufacturing lines as part of the Freshpet Kitchens expansion projects."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(c)","Represents fees associated with public offerings of our common stock."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(d)","Represents implementation and other costs associated with the implementation of an ERP system."]]
[[/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 to mitigate potential supply chain disruptions during the pandemic."]]
[[/GREPCENT_TABLE]]

34

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,"],["","","2021","","","2020","","","2019"],["","","(Dollars in thousands)"],["Gross Profit","","$","162,146","","","$","132,910","","","$","114,197"],["Depreciation expense","","","16,545","","","","9,576","","","","6,370"],["Plant start-up expense (a)","","","4,868","","","","5,962","","","","\u2014"],["Non-cash share-based compensation","","","4,152","","","","2,132","","","","922"],["COVID-19 expense (b)","","","1,753","","","","3,497","","","","\u2014"],["Adjusted Gross Profit","","$","189,464","","","$","154,077","","","$","121,489"],["Adjusted Gross Profit as a % of Net Sales","","","44.5","%","","","48.3","%","","","49.4","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(a)","Represents additional operating costs incurred in connection with the start-up of our new manufacturing lines as part of the Freshpet Kitchens expansion projects."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(b)","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 to mitigate 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,"],["","","2021","","","2020","","","2019"],["","","(Dollars in thousands)"],["SG&A expenses","","$","186,809","","","$","134,908","","","$","114,450"],["Depreciation and amortization expense","","","13,923","","","","11,549","","","","9,551"],["Non-cash share-based compensation","","","20,846","","","","8,793","","","","6,912"],["Launch expense (a)","","","3,130","","","","3,421","","","","4,563"],["Loss on disposal of equipment","","","1,000","","","","1,805","","","","649"],["Equity offering expenses (b)","","","\u2014","","","","58","","","","302"],["Enterprise Resource Planning (c)","","","1,379","","","","1,682","","","","\u2014"],["COVID-19 expense (d)","","","5","","","","357","","","","\u2014"],["Adjusted SG&A Expenses","","$","146,526","","","$","107,243","","","$","92,473"],["Adjusted SG&A Expenses as a % of Net Sales","","","34.4","%","","","33.6","%","","","37.6","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(a)","Represents new store marketing allowance of $1,000 for each store added to our distribution network, as well as, the non-capitalized freight costs associated with Freshpet Fridge replacements. The expense enhances the overall marketing spend to support our growing distribution network."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(b)","Represents fees associated with public offerings of our common stock."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(c)","Represents implementation and other costs associated with the implementation of an ERP system."]]
[[/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 to mitigate potential supply chain disruptions during the pandemic included in SG&A."]]
[[/GREPCENT_TABLE]]

35

Liquidity and Capital Resources

Developing our business will require significant capital in the future. We expect to make future capital expenditures of approximately $219.0 million in connection with the completion of our planned development and of Freshpet Kitchens Ennis Phase 1, Ennis Chicken Processing and Freshpet Kitchens South. We have invested approximately $243.6 million in the Ennis Phase 1 project to date of a budget of $335 million. To meet our capital needs, we expect to rely on our current and future cash flow from operations, our available borrowing capacity, and access to the capital markets, if appropriate. Our ability to obtain additional funding will be subject to various factors, including general 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, such as financial covenants under our debt agreements.

Additionally, our ability to make payments on, and to refinance, any indebtedness under our credit facilities 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, expected cash flow from operations, planned borrowing capacity and our ability to access the capital markets, if appropriate, are adequate to fund our debt service requirements, operating 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, 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 convertible debt securities, 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 financings 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.

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

[[GREPCENT_TABLE]]
[["","","December 31,","","","December 31,"],["","","2021","","","2020"],["","","(Dollars in thousands)"],["Cash and cash equivalents","","$","72,788","","","$","67,247"],["Accounts receivable, net of allowance for doubtful accounts","","","34,780","","","","18,438"],["Inventories, net","","","35,574","","","","19,119"],["Prepaid expenses","","","5,834","","","","3,378"],["Other current assets","","","1,349","","","","914"],["Accounts payable","","","(42,612",")","","","(16,452",")"],["Accrued expenses","","","(14,950",")","","","(15,371",")"],["Current operating lease liabilities","","","(1,384",")","","","(1,298",")"],["Total Working Capital","","$","91,379","","","$","75,975"]]
[[/GREPCENT_TABLE]]

Working capital consists of current assets net of current liabilities. Working capital increased $15.4 million to $91.4 million at December 31, 2021 compared with $76.0 million at December 31, 2020. The increase was primarily a result of an increase of $16.5 million in inventory and $16.3 million in accounts receivable, offset by an increase of $26.2 million in accounts payable primarily related to an increase of capital expense not paid as of December 31, 2021 compared to prior year. 

36

We normally carry three to four weeks of finished goods inventory. The average duration of our accounts receivable is approximately 16 days.

For the year ended December 31, 2021 our capital resources consisted of primarily $72.8 million cash on hand, $348.0 million available under our $350.0 million credit facilities, which reflects $2.0 million reserved for two letters of credit. For the year ended December 31, 2020, our capital resources consisted primarily of $67.2 million cash on hand and $163.0 million available under our credit facilities. The credit facilities will mature in February 2026. 

As of December 31, 2021 and December 31, 2020, we had no debt outstanding under our credit facilities. 

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,"],["","","2021","","","2020"],["","","(Dollars in thousands)"],["Cash at the beginning of period","","$","67,247","","","$","9,472"],["Net cash generated in operating activities","","","647","","","","21,193"],["Net cash used in investing activities","","","(322,099",")","","","(162,462",")"],["Net cash provided by financing activities","","","326,993","","","","199,044"],["Cash at the end of period","","$","72,788","","","$","67,247"]]
[[/GREPCENT_TABLE]]

Net Cash Provided by Operating Activities

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

2021

Net cash provided by operating activities of $0.6 million in 2021 was primarily attributable to:

[[GREPCENT_TABLE]]
[["","\u25cf","$31.2 million of net income adjusted for reconciling non-cash items, which excludes $60.9 million of non-cash items primarily related to $30.5 million in depreciation and amortization, $25.0 million in share-based compensation, $2.0 million of investments in equity method investment, $1.3 million of change in operating lease right of use asset, $1.2 million of amortization of deferred financing costs, $0.5 million in loss on disposal of equipment, and $0.3 million in inventory obsolescence."]]
[[/GREPCENT_TABLE]]

This was offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$30.6 million decrease due to changes in operating assets and liabilities. The decrease is primarily due to the change in accounts receivable, inventory, other assets, prepaid expenses, other lease liabilities and accrued expenses, offset by change in accounts payable."]]
[[/GREPCENT_TABLE]]

2020

Net cash provided by operating activities of $21.2 million in 2020 was primarily attributable to:

[[GREPCENT_TABLE]]
[["","\u25cf","$33.0 million of net income adjusted for reconciling non-cash items, which excludes $36.2 million of non-cash items primarily related to $21.1 million in depreciation and amortization $10.9 million in share-based compensation, $1.8 million in loss on disposal of equipment, $1.3 million of change in operating lease right of use asset, and $0.8 million of amortization of deferred financing costs."]]
[[/GREPCENT_TABLE]]

This was offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$11.8 million decrease due to changes in operating assets and liabilities. The decrease is mainly due to the change in accrued expenses, inventory, accounts payable, other assets, and other lease liabilities, offset by change in prepaid expenses and accounts receivable."]]
[[/GREPCENT_TABLE]]

37

Net Cash Used in Investing Activities

2021

Net cash used in investing activities of $322.1 million in 2021 relates primarily to:

[[GREPCENT_TABLE]]
[["","\u25cf","$3.0 million capital expenditures related to Freshpet Kitchens Bethlehem expansion."],["","\u25cf","$73.8 million capital expenditures related to Freshpet Kitchens South expansion."],["","\u25cf","$208.2 million capital expenditures related to Freshpet Kitchens Ennis."],["","\u25cf","$16.8 million in plant recurring capital expenditures."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$20.3 million capital expenditures relating to investment in fridges and other capital spend."]]
[[/GREPCENT_TABLE]]

2020

Net cash used in investing activities of $162.5 million in 2020 relates primarily to:

[[GREPCENT_TABLE]]
[["","\u25cf","$67.4 million capital expenditures related to Freshpet Kitchens Bethlehem expansion."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$6.1 million capital expenditures related to Freshpet Kitchens South expansion."],["","\u25cf","$30.6 million capital expenditures related to Freshpet Kitchens Ennis expansion."],["","\u25cf","$7.5 million in plant recurring capital expenditures."],["","\u25cf","$23.0 million capital expenditures relating to investment in fridges and other capital spend."],["","\u25cf","$27.9 million in connection with an equity method investment pursuant to which the Company received a 19% interest in a privately held company."],["","\u25cf","$20.0 million purchase of short-term investments."]]
[[/GREPCENT_TABLE]]

This was partially offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$20.0 million proceeds from maturities of short-term investments."]]
[[/GREPCENT_TABLE]]

Net Cash Provided by Financing Activities

2021

Net cash provided by financing activities was $327.0 million in 2021 mainly attributable to:

[[GREPCENT_TABLE]]
[["","\u25cf","$332.2 million of proceeds from common shares issued in a primary offering, net of issuance cost."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$2.3 million of proceeds from the exercise of stock options."]]
[[/GREPCENT_TABLE]]

This was partially offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$4.2 million for tax withholdings related to net share settlements of restricted stock units."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$3.3 million for debt issuance cost related to the new credit facilities."]]
[[/GREPCENT_TABLE]]

2020

Net cash provided by financing activities was $199.0 million in 2020 mainly attributable to:

[[GREPCENT_TABLE]]
[["","\u25cf","$252.1 million of proceeds from common shares issued in a primary offering, net of issuance cost."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$20.9 million of proceeds from borrowing under our credit facilities."],["","\u25cf","$5.4 million of proceeds from the exercise of stock options."]]
[[/GREPCENT_TABLE]]

This was partially offset by:

[[GREPCENT_TABLE]]
[["","\u25cf","$76.0 million repayment of borrowing under our credit facilities."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","$2.6 million for tax withholdings related to net share settlements of restricted stock units."],["","\u25cf","$0.8 million for debt issuance cost related to the new credit facilities."]]
[[/GREPCENT_TABLE]]

38

Indebtedness

See Note 6 to our Consolidated Financial Statements for a discussion of our debt obligations.

Contractual Obligations and Commitments 

The following table sets forth our expected contractual obligations as of December 31, 2021: 

[[GREPCENT_TABLE]]
[["","","Payments Due by Period"],["","","Total","","","Less than 1 Year","","","Between 1-3 Years","","","Between 3-5 Years"],["Operating lease obligations","","$","7,863","","","$","1,764","","","$","4,523","","","$","1,576"],["Manufacturing processing obligations","","","8,961","","","","2,663","","","","6,298","","","","\u2014"],["Utility servicing obligations","","","2,853","","","","443","","","","2,410","","","","\u2014"],["Warehouse obligations","","","280","","","","205","","","","75","","","","\u2014"],["Equipment and building obligations","","","4,055","","","","4,055","","","","\u2014","","","","\u2014"],["Total","","$","24,012","","","$","9,130","","","$","13,306","","","$","1,576"]]
[[/GREPCENT_TABLE]]

Critical Accounting Policies and Estimates

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

The preparation of financial statements in conformity with 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 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.

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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 2021 through FY 2024. 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 (Recently Adopted Standards) 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.

40