Freshpet Inc
NASDAQ:FRPT
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Freshpet Inc
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Greetings, and welcome to the Freshpet Inc. Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Katie Turner, with ICR. Thank you, Ms. Turner. You may begin.
Thank you, and welcome to Freshpet's Third Quarter 2019 Earnings Conference Call and webcast. On today's call are Billy Cyr, Chief Executive Officer; and Dick Kassar, Chief Financial Officer. Scott Morris, Chief Operating Officer, will also be available for Q&A. Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the Federal Securities Laws. These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could our cause actual results to differ materially from those described in these forward-looking statements. Please refer to the company's annual report on Form 10-K filed with the Securities and Exchange Commission and the company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.
Please note that on today's call, management will refer to certain non-GAAP financial measures, such as EBITDA and adjusted EBITDA, among others. While the company believes these non-GAAP financial measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP.
Finally, the company has produced a presentation that contains many of the key metrics that will be discussed on this call. The presentation can be found in the company's investor website. Management's commentary will not specifically refer to the presentation, rather at a summary of the results they will discuss today.
Now I'd like to turn the call over to Billy Cyr, Chief Executive Officer.
Thank you, Katie, and good afternoon, everyone. To begin, I will provide an overview of our financial highlights and recent business performance, and then Dick will provide greater detail on our financial results. Finally, Dick, Scott and I will be available to answer your questions.
We are very pleased with our third quarter results. We continued the top line momentum we have been delivering since we began our Feed the Growth Plan almost three years ago, bounced back from the adjusted gross margin dip we experienced in Q2, and demonstrated the strong bottom line growth potential that comes with added scale. That is the essence of our strategy, and it is working. We have created a virtuous cycle, where increased advertising drives increased velocity, which drives increased distribution, and that provides the added scale to both reinvest in the business and to also strengthen our bottom line. Our strategy is also working for pets and the pet parents who care for them. We are now producing pet food for more than 3 million households, and that number keeps growing. Pet parents continue to write and call us to tell us about the amazing differences that Freshpet makes in their pet's lives. We firmly believe that we are just scratching the surface of the opportunity to change the pet food category, enabling pet parents to provide fresh, healthy, less-processed food designed for pets.
In the third quarter, we delivered a particularly strong top line growth of 28%, and this was on top of 27% growth in the year-ago quarter. This was our eighth consecutive quarter of growth in excess of 20%, and 7 of those quarters have had growth in excess of 25%. The growth was driven by continued strong consumption gains generated by the expanded household penetration we delivered in Q2 and again in Q3. Mega channel, Nielsen-measured consumption was up 25% behind 34% growth in grocery, 25% growth in mass and 11% growth in big box pet. Same-store sales velocity grew 14% and accounted for more than 60% of the year-over-year growth. Our core dog business, which is the sum of our dog rolls, roasted meals and fresh-from-the-kitchen main meal items and accounts for more than 90% of our business was up 31% in the quarter. Our small but rapidly growing e-commerce business, which includes curbside programs with our key customers, home delivery via services like Instacart and Shipt and fresh e-commerce like Amazon Prime Now and FreshDirect was up 93% versus a year ago and now accounts for 2.5% of our business. More than 85% of that business went through our in-store fridge network.
Adjusted EBITDA in the quarter was $12.0 million, up $5.3 million or 78% versus a year ago, as we demonstrated the significant leverage we get from scale, particularly in SG&A. This indicates that we have reached an inflection point, where we are able to generate adjusted EBITDA growth in excess of net sales growth. You will recall that we set 5 strategic objectives for 2019. We made good progress against each of our goals. Our specific progress against those goals includes: One, expand the Freshpet consumer franchise. Clearly, our new advertising message and product innovations are working as we delivered very strong household penetration gains in the quarter. Total household penetration was up 21% versus a year ago to 2.45%, and the buying rate increased 4%. Our core dog household penetration was up 31% versus a year ago to 1.89%.
As expected, the rapid influx of new buyers limited the core dog buying rate growth, which was flat versus a year ago. As those new users mature, we expect to see continued increases in the buying rate. This data shows the effectiveness of our advertising at building a bigger and more loyal consumer franchise even in the face of the price increases we took in February. And there are many more consumers who look very similar to the consumers whom we have already attracted so the future growth potential is very robust. We will provide more insight on the growth of the total addressable market early next year.
Second, strengthen Freshpet's retail presence. The strong first half momentum with retailers continued into the second half, with another strong quarter of new stores, upgrades and second fridges that drove our ACV distribution to a new high. We added 365 net new stores in Q3, bringing our year-to-date increase to 1,280 net new stores and our total store count to 20,779. We upgraded another 174 stores from small or medium fridges to large fridges in the quarter bringing our total upgrades year-to-date to 537 versus the 695 we needed to hit our target of 1,500 upgrades since we started the program last year. And we added a second fridge to another 31 stores, bringing our total number of stores with 2 or more fridges to 778 stores.
ACV distribution grew 9% or 4.3 points, our biggest increase since 2016, to 49.4%. And TDPs grew 9%. It is very clear that retailers are responding to our 2-plus years of strong growth and that Freshpet is now achieving a level of scale where it can have a meaningful impact on their total category growth. This is also evidence that our Feed the Growth productivity loop, where increased advertising investment drives increased velocity and that drives increased distribution, is working as intended. As a result, we are delivering our strongest distribution gains in several years.
In the near term, that will dilute our velocity gains, but longer term, it produces strong sustained net sales growth, supports a broader consumer franchise and makes it easier for consumers to find Freshpet and the specific item they want in the store of their choice. We have a deep pipeline of new distribution opportunities and second fridges that are queued up for late this year and early next year. We expect to deliver our annual targets of 1,500 to 1,600 net new stores this year, a cumulative total of 1,500 upgrades since we started our upgrade program last year, and 800 stores with 2 or more fridges. This should result in ACV gains in excess of our long-term average ACV distribution growth rate of 7% and TDP growth in excess of 9% during 2019.
Third, strengthen adjusted gross margin and adjusted EBITDA margin. Adjusted gross margin in the quarter was 49.8%, up 10 basis points versus the year-ago period. As we indicated on the Q2 earnings call, we've successfully resolved the manufacturing issues by the time of the August call but the issues have bled into the first part of the third quarter. Our performance since then has been much stronger, enabling us to restore customer service and replenish our customers' depleted inventories. We remain on track to deliver continued improvement in our adjusted gross margins in Q4 as we have now fully implemented each of the elements of our gross margin improvement plan, including price increases, higher margin innovations and full utilization of the labor we hired earlier in the year. We will, however, add additional labor in Q4 for the start-up of our final line on a 24/7 schedule in January.
As we indicated at the end of Q2, we believe that our manufacturing expertise is a critical advantage we have, and we fully intend to continue to develop and expand that advantage. We strive to make it very difficult for a competitor to match our level of mastery of fresh pet food manufacturing. To that end, we announced the hiring of two new top technical talents in August. Lynn Bingham, our new VP of Process Development and Strategic Quality; and Willie Everett, the General Manager of our Midwestern capacity expansion. Both of them started in late August, and we are already seeing the benefits of their efforts.
We also delivered significant gains in SG&A absorption this quarter, increasing absorption by 320 basis points of adjusted SG&A, excluding media, in the quarter and a cumulative 590 basis points versus where we ended 2016. Year-to-date, we have gained 360 basis points versus a year ago on SG&A absorption, excluding media spending. We are confident that our plans are on track to deliver our projected goal for both this year and the cumulative total of 700 basis points by 2020. We also believe that there are additional scale benefits we can accrue beyond 2020.
Adjusted EBITDA margin was 18.4%, up 510 basis points versus year ago. Year-to-date, adjusted EBITDA margin is up 110 basis points to 8.9% despite a significantly higher advertising investment this year. We expect that margin to grow further in Q4. Fourth, continue measured development in Canada and the U.K. Our U.K. and Canadian businesses made steady progress. We front-loaded our advertising investment in each market and have seen consumption growth behind those investments that is consistent with the growth rates that we see behind media investments in the U.S., and the impact was sustained after the advertising went off the air. We are now in conversations with key retailers in each market about ways to expand distribution to capture the benefits of the increased awareness. That is the same virtuous cycle that has worked for Freshpet in the U.S. and it seems to be working elsewhere.
It will take several laps around that productivity loop to achieve the scale and presence that we have in the U.S., but when it is done, we will have created a strong foundation for a highly profitable business in each of those markets. And everything we've experienced thus far suggests that both of these markets have the potential to be major contributors to our success once we have both the production capacity and distribution to support the development of a large consumer franchise.
Fifth, build capability to support accelerated longer-term capacity expansion. As we have said many times, the single biggest limiter to our growth is our ability to add capacity fast enough to keep up with the consumer demand that we know exists for Freshpet. We also believe that our scale and expertise in making fresh pet food is a real competitive advantage, and we plan to invest to continually expand that advantage. That is why we are investing in both facilities and technical talent this year.
The Freshpet Kitchens 2.0 on our Bethlehem campus is under construction and on track to start-up in Q3 of 2020 as planned. Additionally, we are in negotiations to acquire land for our next incremental capacity at a new site that will create geographic diversity in our supply and distribution system. And as I indicated earlier, we have already hired a General Manager, Willie Everett, to lead the development and start-up of that site.
Willie is a highly experienced manufacturing leader who has started up facilities before. He also has the full support of the technical team we have developed over the past few years to assist him in getting that site off the ground, and planning is well underway. He is spending his first year in Bethlehem, learning the Freshpet systems and culture and will relocate to the site of our new kitchen once we break ground. At our current growth rates, that kitchen would need to be up and running sometime in 2022. We expect to announce the location of that kitchen in Q1 of 2020.
In summary, 2019 is going to be another strong year for Freshpet and will position us well to deliver our long-term goals and tremendous potential. Our growth opportunities are abundant, and our greatest challenge is to make the right priority choices, ensure that we fully realize our potential and fulfill our mission of providing more pets with fresh, all-natural foods that enrich their lives and the relationships with their pet parents and doing so in ways that are good for our pets, for people and for our planet.
Before I turn it over to Dick, I want to let you know that we will be hosting an Investor Day on the morning of February 25, 2020, in concert with our Q4 2019 earnings release. At that time, we will outline our 2020 plan and guidance, provide an update on our capacity expansion plans, provide you with an update on the total addressable market for Freshpet and lay out our post-2020 goals. So save the date, and invitations will be forthcoming.
Additionally, I want to be sure that all of you saw our announcement in late September that we have added Olu Beck to our Board. Olu brings a wealth of experience in consumer products in both the U.S. and Western Europe and has deep strategic thinking and financial skills. We are thrilled that she has agreed to join the Freshpet team.
I will now turn it over to Dick to discuss our Q3 financials in more detail in our outlook for 2019.
Thank you, Billy, and good afternoon, everyone. As Billy indicated, quarter three net sales were $65.3 million, up 28% versus the year-ago period. This keeps us on track to deliver our greater than $244 million sales guidance for the year and puts us within striking distance of our $300 million goal in 2020 as our annualized run rate at the end of quarter three is now $261 million. If we deliver $244 million in net sales in 2019, we would have to deliver 23% growth in 2020 to achieve our $300 million goal. We believe that is very achievable. Our continued strong growth is the result of the increased investment we made in advertising earlier this year, strong improvements in our retail presence and the continued strength of our product innovations.
As you know, our advertising investment is the single biggest driver of our growth. It invites consumers to try Freshpet. And once they try it, the repurchase rate is incredibly high. While our advertising investment in quarter three was less than the investment we made in each of the first 2 quarters, we clearly benefited from the - both the expanded franchise we built earlier this year and from the investment we made in this quarter.
We invested $4.5 million in advertising in quarter three, most of which ran in the second half of the quarter. We typically don't advertise much in July and early August. As we have seen historically, once the advertising went back on the year, our consumption growth increased again and we experienced significant gains in household penetration, providing strong momentum as we head into quarter 4. And a portion of this advertising investment was behind the new Awakenings message we discussed last quarter. That message, in conjunction with our established Letters campaign, is particularly effective at expanding the appeal of Freshpet.
We are seeing a similar impact from advertising in our international markets. While our advertising was also front-loaded in those markets, the benefits have sustained since the advertising went off the air and the increase in the run rate is - in established stores is comparable with our U.S. results. This gives us strong confidence that our model is working and provides the foundation for accelerated growth in both distribution and net sales in those markets next year.
Our customer service levels returned to the high 90s by the end of the quarter, and that has enabled us to replenish customer-depleted inventories and reduced out of stocks. It is hard to say exactly how much that contributed to the quarter, but we believe it added between 1 and 3 points of growth, about the same amount we lost in quarter two. At the end of the quarter, trade inventories were at normal levels, and our year-to-date shipments growth now matches our year-to-date consumption growth.
Adjusted gross margin for the quarter was 49.8%, up 10 bps from a year ago and 130 bps better than quarter two. As we indicated in our quarter two call, some of the production issues we had in quarter two did impact the first part of quarter three, but we resolved those issues and are now operating well. We had a record throughput in the quarter, greatly reduced our scrap and produced consistently high-quality product. We still have opportunities for improvement, and we are working on them. But we feel good about the progress we have made.
Additionally, all three elements of our adjusted gross margin improvement plan contributed positively in the quarter, and we believe we are on track to deliver a 50% adjusted gross margin for the year. That requires that we deliver adjusted gross margins slightly above 51% in quarter 4, and we're on track to deliver that. Looking forward, we will be taking our fourth line to a full 24/7 operation in January and have already begun hiring the necessary employees to support that production. We have also hired a small portion of the employees we will need to start Kitchens 2.0 in quarter three of next year. We will provide investors with a clear picture of the timing of that startup and the onetime costs associated with it when we outline our 2020 plan at our Investor Day in late February.
Adjusted SG&A in the quarter was $20.5 million or 31.4% of net sales, an improvement of 510 basis points versus the year-ago period. Media spending was flat versus the year-ago period. When you exclude media spending, SG&A improved by 320 basis points versus a year ago. Year-to-date, we have delivered 200 basis points of SG&A improvement despite having invested 150 basis points more in media than in the year-ago to date. Given that our advertising spending this year will be comparable as a percentage of sales to last year, we believe we are on track to beat our SG&A absorption goal of 240 basis points this year, and that will position us well to deliver the final 200 basis points of improvement we will need next year to deliver a total of 700 basis points of SG&A improvement by 2020. This meaningful benefit from scale is an essential part of the virtuous cycle embedded in our Feed the Growth Plan.
Adjusted EBITDA in the quarter was $12 million, up $5.3 million or 78% from the year-ago period. This demonstrates the significant leverage we get from scale as virtually every part of our P&L showed some meaningful benefit from the scale we have added since last year. That is also a good indicator of our ability to grow adjusted EBITDA in excess of the net sales now that we have achieved a meaningful scale. From time to time, we'll choose to increase investments to capture incremental growth opportunities, but excluding those opportunities, we expect to continue to generate scale benefits in the P&L and expand adjusted EBITDA margins for the foreseeable future.
Given these strong results, we are reiterating the 2019 guidance we provided at the end of quarter two, including delivering net sales greater than $244 million and adjusted EBITDA greater than $29 million.
We drew $35 million net of repayments on our credit facility year-to-date to cover the normal seasonal variations in our cash flow, funding of working capital and investment in our Kitchens 2.0. We have invested $21 million of capital against Kitchens 2 0.0 project this year and other projects designed to increase our capacity, and our total spending on those projects year-to-date is $23 million.
Cash from operations was $13.3 million, up $5.3 million a year ago. We continue to expect to produce positive cash flow from operations each year.
In conclusion, 2019 is going to be another strong year for Freshpet. The sustained top line growth is delivering the anticipated financial benefits that will help us realize our financial goals, and we are doing this while continually investing to improve our operations and build the capability to expand to meet future growth. Those efforts will enable us to fulfill our mission of changing the way people feed their pets.
To grow a company and change an industry is a once-in-a-lifetime opportunity that our team relishes, and that opportunity also helps us attract the new employees we need to support our growth. With that opportunity comes responsibility. We are working to improve the lives of pets and their families forever. We need to do it right for pets, for people and for the planet.
That concludes our overview. We will now be glad to take your questions. Operator?
[Operator Instructions]. Our first question comes from the line of Peter Benedict with Robert W. Baird.
Dick, I think you - or Billy, one of you guys addressed this a little bit, but I just want to expand on a little bit. Just the full year revenue guide at $244 million. I know you're saying at least that number, but if you did take that number and just back out what you've done, it would have Q4 revenue below the level you did in 3Q. Is the - is that something that you're expecting, at least given the sell-in, I guess, you had in 3Q in order to kind of fill up some of the under-inventory position in some of the retailers? Or should we be focused kind of on the greater than $244 million part of that guidance?
First, Peter, first of all, we - as we said, the Q3 is probably a little bit bigger than what it would have been just because we are doing the catch-up from Q2. And if you look at the relationship between Q4 and Q3 last year, there's a small increase in Q4 from Q3, but it's not a huge piece. And part of that's because retailers take their inventory down in refrigerated products in the fourth quarter. So you could expect them to be relatively close to each other. And I think any difference is splitting hairs at this point. And we also don't want to get in the business of updating our guidance more than we did this year with doing it once midyear.
Okay, that's helpful, Billy. And I guess, with the core dog household buying rate kind of stabilizing, I mean, you spoke to that. It reflects kind of the new households you've been adding here. Is that a dynamic that persists for the next, I don't know, year? Like how do we think about - when do you think that hook - starts to hook back up in terms of the buying rate for the core dog household?
I spent a lot of time on that recently, Peter. And when you push the growth rate in the penetration beyond the high 20s, you'll see the buying rate go flat just because you add so many people so fast. But when that slows down a little bit when the buying rate - or the penetration rate grows, then you see the buying rate go up because the people who have been in the franchise are moving up. They're buying higher-value product, they're using the product more frequently. So we are seeing that - if we had a metric of stores open more than a year, we would see that group continuing to increase their purchases.
Okay. All right. No, that's great. I guess, my last question is just the media spend plans, it's normally very light in Q4, so I assume that's - continue to be the plan this year. But as you think about next year, as you're bringing on the new capacity, I mean, are you willing to speak at least generally what you're thinking in terms of how the media spend in 2020 will compare to 2019, at least as you sit here today?
We're not ready to do that yet because we're still trying to figure out exactly when our capacity is going to come online. That's what we'll talk about at our Investor Day at the end of February because by then, we should be under roof on our new Kitchens 2.0, and we'll be able to have a much firmer idea of what - when the capacity will come online.
Our next question comes from the line of Robert Moskow with Crédit Suisse.
Maybe if you've brought it - you've made the number public in the past, Billy, but is there a penetration rate that you really are targeting in the medium or longer term? I mean, it sounds like it just kind of chucks forward every single year. 2% is obviously very low. How do you think about how big that should be?
Yes. If you've seen in the investor deck that we put out in each of the quarters, I think we have a chart in there that sort of shows how media spend over time and household penetration tend to track together. And we use it as the measure - I - the measure I use in that deck that we put out is the core dog penetration number. And we show that at a theoretical $500 million run rate, your core dog penetration is around 2.5%. But the total penetration would be a little higher, call that in the 3% range.
But frankly, that's the biggest opportunity for us. As you said, the number is so small, and our ability to add them - consumers at an incredibly rapid rate just points to the significant opportunity that we see. The correlation of advertising spend to household penetration gains continues to grow, and it actually is getting stronger. And so we see that opportunity just being - that is the single best indicator and the single biggest driver of our long-term growth potential.
When we have our Investor Day at the end of February, we will provide an update on the total addressable market, and that will be one of the key metrics we'll talk about is what is that potential.
And a follow-up to that. I've noticed a lot of advertising for home delivery, fresh dog food that looks a lot like yours. Maybe you've talked about this in the past, but do you have a sense of what kind of penetration rate those competing brands have? There's probably more than one. And you expect - do you think that, that is your competition as it continues to evolve? Or do you think it's more like brick-and-mortar is your primary competitor?
Rob, so the way we like to think about this is that the way people buy fresh groceries now and into the future is the way - will be the primary way they buy their fresh pet food. Today, if you kind of look at most companies that are doing fresh food, fresh or frozen, they're seeing somewhere between 2% and 3% of their total sales being done through online vehicles. We do know that click and picks and a handful of other new vehicles are making it a little bit easier for people to do more. We're obviously focusing and very interested in what people are doing from a direct-to-consumer standpoint and keeping a close eye on that. We've even done some of our own testing and evaluation if that's interesting. We'll continue to evaluate that and see - kind of see how it plays out over the next couple of years. Right now, it's very small, but it's growing quickly.
Okay. Yes, I mean, the food itself is very premium positioned. I mean, it looks even more premium positioned than yours, but it would seem to me that maybe you could even extend in that type of arena as well if you chose to. But for the Investor Day. All right.
Our next question comes from the line of Bill Chappell from SunTrust Robinson Humphrey.
Can you talk a little bit about pricing both this quarter and then especially as you look to next year? And just it seems like starting this time last year, the whole category took some sizable pricing that's really driven the sales growth of the category. And as we start to lap that, I mean, do you see price gaps changing with your products? Do you see you taking incremental pricing? Do you see you rolling back pricing? Just kind of the outlook of what you see both for you and the whole category.
Well, I'll talk mainly about what we're doing and we're thinking. Earlier this year, we took a small price increase. We were able to pass it through very effectively to consumers. Retailers and consumers kind of accepted the price increase, and we saw really no impact on our velocity. We were greatly encouraged by that. And we think it demonstrates the potential of the business over time to maybe move more pricing.
That being said, the goal that we have as an organization is to continue to increase and grow penetration as fast as we possibly can. We want to make sure our products are as widely available and picked up and consumed by as many people as often as possible. So we want to keep our pricing as low as we possibly can. So unless we're seeing significant cost pressures, our goal is to keep our pricing really where it is.
We will take modest pricing over time, and we'll continue to kind of put that in a cadence. It will be very targeted and strategic when we do take that pricing on very specific items, and it will be typically very, very low increases. But we don't see - foresee any significant pricing in the near future from what we're seeing from input costs or ingredients.
Got it. And then just on mix, did you or could you kind of give us a better idea of how the specialty channel, ex online, did in terms of growth versus that? And also, any kind of understanding on the bags versus rolls. And it seems like the growth difference between those two is starting to narrow, so that's not having as big of an impact on margins. But maybe a little more color would be great.
So what we're - from a pet specialty basis, we're seeing about 11% increase. This is kind of Nielsen data, 11% increase for Freshpet. We're seeing them overall as a channel, down about minus 4%. And we've seen gap there. It's a little less than what we had even planned on going into this year. We believe that their traffic continues to be off us a little bit, and it touches on a little bit of the impact of the DCM and grain-free trend that's been going on. We believe that's a component of it.
Yes, it's definitely impacted us, but keep in mind that pet specialty is about 16% of our total sales. Obviously, we'd like it to grow faster than - we want all segments growing incredibly fast, but we've been able to have great growth rates in some of the other channels.
When you get into bags and rolls, it's interesting. We've kind of seen rolls - there was a period where rolls without growing bags at a point this year, and now bags are outgrowing rolls. Depending on the period, our bags have had a really strong run in the last quarter or so. From a margin standpoint, the bags are slightly margin-dilutive. But moving into our new facility, it will be basically margin-neutral over time on our bag business.
When we took pricing last year, and the pricing we may take in the future will be kind of focused on our bag business in order to make it kind of margin-neutral if we do see transition from consumers to bags and rolls.
Our next question comes from the line of Brian Holland with D.A. Davidson & Co.
First question on household penetration. Year-over-year growth accelerated by my math in Q3 versus Q2 about 2x faster than I was forecasting given the step-down in media spend in the second half. And so Billy, I'm curious if there's anything - I don't know if it's cadence with when the media spend fell in, in Q2, and so there was some carryover effect from that ramp up in spend in Q2. Or if there's anything else you're seeing as far as - I know we've spoken about the multiplying effect of word of mouth once you get to level of brand awareness. I'm just curious if there's anything you're seeing there, and if that household penetration number came in, even maybe a little bit higher than what you guys were forecasting internally.
Brian, there are several factors at play. Clearly, we're very happy with the household penetration gain that we had, and we're also very happy with the household penetration gain we had at the end of Q2 that helped us quite a bit. I would say that there are three factors involved. Factor number one is we ran media all the way up to the end of June this year. So there was a carryover effect that happened into Q3, and then had our normal cadence come on in Q3. So we had a little bit of a benefit from running the media longer in Q2 to help Q3.
The second thing that we had is the new message. So we had 2 messages on air, our Letters campaign as well as what we call Awakening, which created a little bit more of a seed of doubt for people about why they should consider Freshpet food. That helped quite a bit. That didn't start airing until halfway or 2/3 of the way through the second quarter, and we got the benefit at the end of that quarter and then again in this quarter.
And the third thing is our out-of-stock issue was most pronounced in Q2, particularly if you look at it on a weekly basis in the second or third week of June. That's where we had the biggest issue. So we weren't going to be gaining as much of the household penetration then as we could as we restored the availability in Q3.
So now fully in stock, we have a very compelling advertising message we ran for the quarter, and it's worked incredibly well for us. And that's what makes us incredibly bullish about the household penetration growth potential of this business is with the right message, with the right products available, with the right distribution, we think the upside in household penetration is very significant.
That's helpful color. Last one for me. The EBITDA number, you stuck with the guidance there. Dick reiterated the gross margin guidance for the year. It seems like you'd have a fair amount of cushion at this point, mindful of the magnitude of beat that came through in Q3. So I just want to double check and make sure. Is there anything on the - I know you've talked about adding staff in front of the January ramp of the last line, so I don't know if that's a factor in here. But anything we should be mindful of in Q4 that might step down on the EBITDA?
We accrue incentive comp based on where we are at the point in time in the year versus our internal budget. And as you can see, we're approximately $16 million against a $29 million adjusted EBITDA guidance. So we have a fair amount more in the fourth quarter to accrue on incentive comp that is yet to be recorded. And that's one of the elements of a reconciliation between where we are today and greater than $29 million.
Our next question comes from the line of Jason English with Goldman Sachs.
Congrats on a strong quarter, really, really encouraging to see that revenue growth remains robust. As I listened to your prepared comments and some of the Q&A, I hear you talking about the increasingly strong correlation between advertising and penetration. I hear you emphasizing penetration growth. I heard you sort of back off or not talk about your plans for media spend next year, even though there are some numbers you've already put out there. And I heard you talk a lot about your - or a bit about 2020 in terms of revenue. But unlike last call, you didn't really talk a lot about the margin leverage or the EBITDA target for 2020.
It gives me pause and has me sort of step back and question whether or not you're rethinking that 2020 EBITDA as you also rethink the amount of investment you want to continue to put into the business next year. Is there anything - is that a reasonable interpretation?
First of all, we're not deliberately trying to guide one way or the other related to 2020 or change anything that we've said in the past. But what we are - want everybody to be mindful of is that as we get to closer to 2020, and we start looking at what is the potential for this business beyond 2020, and we will lay that out at the end of February, layout what that guidance looks like, we're seeing nothing but the opportunity getting bigger. And the single biggest barrier for us in fulfilling that opportunity is having capacity.
2020 becomes a tricky year for us because as we continue to grow very quickly, we need to bring that capacity online. We've got to get it started up and be able to fulfill the demand. So as we're thinking about 2020, we're trying to - use the term, we're trying to glide into that capacity. And the glide is how much media, when do you put the media on air so that you build the business to be as big and successful as you can in that sort of tricky balancing year.
But there's no doubt that when you get to the end of that year, and we have the capacity online, we know we have the tools. We know the consumer is interested. We will invest very heavily beyond 2020 to continue to fulfill the potential of Freshpet. It's just that 2020 is going to be one of those tricky years where we're bringing on capacity and need to make sure we don't outstrip the capacity with the marketing investment that we're making.
Billy, I thought you had enough capacity to fulfill roughly $350 million of revenue, which would be substantially above your $300 million target. Am I off-base for that?
We have about - capacity for - it depends on mix, but it's about $300 million in capacity is what we've told folks that we have. The biggest issue for us is that we'll run out of bags capacity before we run out of rolls capacity. And as we talked in the previous question, the bag business has been growing quite nicely. So we need to make sure we get those bags, the bag line to come on. We'll run out of that capacity probably six months or so before we run out of the rolls capacity. So it's not a - what the total capacity of the facility is, what is the capacity on the bags lines. That's the important driver.
And that's helpful. That's great context. I appreciate that.
Our next question comes from the line of Rupesh Parikh with Oppenheimer & Co.
So as we look at, I guess, the fridges for 2020, I was curious if you have any early reads in terms of what it's looking like for next year? And then, obviously, you are at a capacity constraint in 2020. So I was curious if you're also going to use fridges as a lever and potentially managing through capacity for next year.
So we've had a really strong year this year, adding fridges and obviously growing our ACV. We are really encouraged by the kind of the start of the end of this year and probably the start of next year at this point. We'll definitely use our advertising as a lever to kind of move back and forth to make sure that we are selling every product that we can possibly produce. The goal is to make sure that we are driving revenue as much as we can and using our advertising as a lever to be able to kind of move back and forth to drive the revenue growth.
Yes, we aren't going to - we won't pull back on the fridges to manage capacity, we would use the advertising as a lever to do that.
Okay, great. And then on the innovation front, Billy, just curious how your 2019 innovations have played out so far versus your expectations.
They've actually done quite well this year. We were a little lighter in innovation. We had a total of 6 SKUs that we brought to market this year. We look at them kind of net of cannibalization, and they have contributed at the exact rate that we anticipated. They're - so we're really happy.
I mean, innovation has been like a really core component to our growth over time. This past year, in '19, we probably didn't have quite as much innovation as we've had in the past, but they delivered quite well. And then next year, we have a handful of new items that we're very enthusiastic about that will enable us to continue to use innovation as a tool to attract new consumers into the franchise.
It's just one of those kind of core tenets of the business. And one of those key pieces. We don't just bring innovation to bring innovation. We recognize that it's our fridge, that we're taking space away from ourselves, sells very often. One of the goals is as we do have second and even third fridges in some retailers that we want to make sure that we are coming with enough innovation to utilize that space as effectively as possible.
Our next question comes from the line of Mark Astrachan from Stifel.
I guess, first, could you talk a bit about the percentage of consumers, loyal, mixer, visitors as a percent of sales. And maybe talk a bit about the buying rate for each bucket in the context of the broader commentary that was mentioned before about the flat buying rate despite the penetration increase amongst the core dogs.
So what we typically see is as there's a great attendance on dog size and the buying rate. We see people with smaller dogs being much more loyal and larger dogs using us a little bit more as a mixer. One of the things that you'll see us coming from an innovation standpoint over the next couple of years is us working on innovation in order to kind of - to a little more targeted not only to small dogs but also even to large dogs. We think that's an opportunity for us.
I don't think we've actually talked about specific buying rates by dog size. However, I think it's something, as we talk about the future potential of the organization and the opportunity, we have from a penetration growth rate over the next several years, it's something that we will probably share in the February investor presentation. We've done a lot of work around that. And we know not only who the consumers are, but even better about who the dog graphics, the makeup of the dogs in the household and who they are, what they're motivated by and what their buying rates are. So we'll probably get into a lot more detail around that in that February time frame, Mark. So I'd ask you to be patient with me on that.
Okay. Maybe asking then a different question. So what percent of Freshpet buyers today are loyal, and what's the current repeat rate or at least at the end of 3Q?
We typically refer to the repeat rates. So we have - we - and this is very interesting. In most packaged goods, so we have a 70% repeat rate. In most packaged goods businesses, when you drive new consumers in, your repeat rate goes down. We have never actually seen that dynamic. It's been quite interesting.
So that means within a year, 70% of the people that buy Freshpet will repeat on us 2 or more times. And we do see typically strong loyalty. We have groups of consumers that we followed over time; they continue to buy the product year after year. When we do follow those people at the time, we actually see them buying more and more over time. They may be mixing more and they may be kind of moving all the way through to buying us exclusively as their only pet food.
I think some numbers we have shared in the past is about half of our acquirers are - yes, about half of our buyers are - I'm sorry, 31% of our buyers represent 53% of our total dollars. It's probably a number that we've shared in the past, and they spent an average of $167. That data is older, I will tell you. And as we grow every year and we increase our buying rate, that number is behind some of the data that we see currently.
Yes, we'll share the more updated versions. Because, Mark, to your question, we don't update that data on a quarterly basis. We look at it sort of the total on a quarterly basis because it's just too fine a cut. But we will update it when we have the Investor Day in February, and you'll have a more detailed look at each of the segments then.
Got it. Okay. And then on the outlook for next year, without getting into specific numbers, it would seem like based on your commentary, you're looking at a much stronger first half than second half, unless capacity comes online sooner. So I guess the question is, A, flexibility doesn't sound like it on capacity, but maybe is there a plan B, just in case you can't get it online as you anticipate? And then secondly, if that rough split is right, first half versus second half sales and you're spending less to "glide" into sales, how do you think about the ability to turn back on the spend to reaccelerate the business? What gives you comfort you can do that?
So Mark, I don't definitely want to leave anyone with the impression that we're going to back off our spend significantly really during any period next year. We are very fortunate that we do have the advertising, and there's a component - a component or components of the advertising that has high flexibility. So we are really confident in the numbers that we've shared. There are very - there's obviously many alternative plans that we can basically implement through the year depending on what our longer-term objectives may be. And we do have kind of a plan B, and we even have kind of a plan C from a volume standpoint or from a capacity standpoint.
So when you end up seeing our media spend next year, you're going to look at it and think - unless we're so far ahead of the game, you're going to see very consistent spends that you've seen kind of throughout the year and maybe even in this year, as maybe a good example. You see fairly consistent spends that we've - as we've done in the past. And if we're way ahead of the game, we may back off some of those spends slightly and use that advertising is a little bit of a throttle.
And I want to reinforce 2 points. One is the connection between advertising spend and volume is incredibly tight for us. So once we have a really concrete idea when that plant is going to come up and running, that gives us the ability to lay in the spending. And we have a base plan that we know what it looks like, we know how it matches up with the capacity, and we feel very good about that plan. But we have a lot of steel going up, and we want to make sure we're under roof before we make that determination.
And that's the second point, which is we are making very good progress. Anybody who drives by can see a lot of steel going up on our facility in Bethlehem, and we feel confident that we'll be able to get that up and running. We just need to know that we've taken the weather risk out of the process. And in the next 2 months, we'll be able to do that.
Got it. And just one follow-up then, Scott. So your plan B, C comment, does that mean then there isn't necessarily a capacity constraint next year? I'm a little bit confused.
Obviously, there's some high-end capacity constraint. We put a plan in place that will allow us to have a little bit more flexibility than we would if we had not done that. And so - and it all comes down to the mix issue that I think Billy mentioned earlier. It really comes down to bag availability at this point. And what we've done is we've been working on for over 6 months, maybe up to 8 months where we kind of have put a plan B in, which will give us a little bit more flexibility to have a little bit more bag capacity.
And we've been very kind of thoughtful and cautious around that. But that's - it's put us in a much more flexible position. What we didn't want to do is have the facility come up later in the year, not have capacity earlier on and then be rushing to make the number for the year. This affords us the ability to kind of have - Bill used the term glide. I think it's a really good term for next year. We're going to be able to glide and have a much more even cadence to the growth throughout the year than we would have been able to if we didn't have kind of what I'll call plan B.
Our next question comes from the line of Jon Andersen with William Blair.
Most of my questions have been asked and answered. Maybe a couple of quick ones. On the advertising campaigns, you mentioned the Awakenings. It's a relatively new campaign relative to Letter. Could you just talk about the difference between those 2 campaigns, the messaging? And is the intent different? One to drive household penetration and other to drive buy rate? Just trying to understand that a little bit more.
Yes. So the focus of our advertising is all of our advertising is very, very focused on driving awareness and then eventually penetration. We really don't - we use our product to help encourage buy rate or repeat purchasing. And we want to make sure that someone's having an incredible consumer experience day in and day out on the product.
So back to the advertising piece, the spend is really driven to focus on the penetration. We're delivering a slightly different message than we have in the past. The goal is to obviously educate people on Freshpet food, the benefits of Freshpet food, the benefit the Freshpet as a company and the work we've done.
The Letters campaign is really kind of a modern-day testimonial on letters that we have received from consumers. The thing that's been pretty amazing about this business is we thought we had done a really nice job from a formulation standpoint and a product concept that we were bringing to market, which is use fresher, less-processed ingredients, process them as little as possible, pasteurize them and keep them refrigerated with no preservatives. And as we brought that to market, people have seen incredible results.
So we actually have over 5,000 testimonials on our website today, and they come in unsolicited. It's pretty amazing. And the results we hear about are terrific. And that's really inspired the first campaign.
We felt we were also now at an opportunity where we could round out our messaging and our communication. And what we tried to do is get people to be thoughtful about the food they eat and how they eat a fresher, healthier and less-processed diet. And why wouldn't we do something similar for our pets. Obviously, you need to feed pets pet food or food formulated for them, but the ideology around fresher, less0-processed and more natural food.
So we actually had worked on it many times where we're trying to get people to reassess the concept of current pet food and maybe their - pique their interest in Freshpet food. And we finally were able to break that code in the second spot we call Awakening. And really what it does is it just gets people to be thoughtful around what is Freshpet food and why it might be better for their pet.
So it's a slightly different message. It seems to be very well received. We check our advertising incredibly closely, and we're seeing really good results on it. Our payback is now less than a year in our advertising investment, so we're really proud of that. We think it provides - continues to provide incredible opportunities for the business to grow over time and take advantage of the - or optimize, I think, the level of interest out there in Freshpet food.
That's really helpful. I appreciate it. Last one for me, international, can you talk about - I mean, how important is international to you in achieving your longer-term goals for the business? And is it principally - is it predicated on you growing in Canada and the U.K. Are there other large markets that you may be considering such as Continental Europe? And should we be aware of any kind of investments that you may make in maybe local capacity over time to serve those markets?
Yes. First of all, all the guidance that we provided when we gave our original 2020 guidance, and as we think about our prospects beyond 2020, are fundamentally going to be built off of U.S.-based dog food business as our core, where we have the greatest strength and the best metrics. And so that's where we lead and that's the bulk of our guidance. But I would also say that we believe that we have a once-in-a-lifetime opportunity to take advantage of our first-mover position and do, in essence, a land grab. But we want to do it in a very responsible way. We think we have done that in Canada and the U.K. We have been, and we've said this in previous quarters, been prospecting on the continent to figure out what market would come next.
But we're going to be very disciplined about it. We're going to build the model where we validate that each component of the model works, and then put it all together and validate that it all works together and then begin the investment cycle as we have done in Canada and the U.K., and we will continually ramp that up.
As we told folks this year, we did make an investment this year in those markets, and we're very pleased with the results we've got. We now have to contemplate how we will expand upon those results next year and the years beyond. But at this point, we feel very fortunate to have a situation where the model is working. It's working as intended, and we have every intention of taking advantage of the first mover that we've got.
In terms of local capacity, our focus right now is getting Kitchens 2.0 up and running. And then the next incremental capacity that I mentioned in the prepared remarks today is squarely on our radar screen. And the expectation, as we've said before, that next facility would be a fairly sizable facility which would be able to support our growth out through a significant number of years beyond where we are.
So the need for capacity in Europe isn't anything on our near-term horizon. Eventually, long term, if you build a big enough business there, you'd like to source in local currency and in the local ingredients, but that's not our focus. Our focus is to source that - those markets out of the U.S. for the foreseeable future.
And our next question comes from the line of Ryan Bell with Consumer Edge Research.
So I was wondering, capacity aside, is there an updated heuristic to think about the ability to grow second fridges within the U.S.? We continue to see strong growth in the first bridge number. How do we think about the opportunity to expand the presence of second fridges? It seems like there's a good deal of room for growth. Is there a point where, say, the velocities or the turns of a second fridge just don't support that decision?
So I'm going to take a tiny trip down to memory lane here for a second. If - when we first started many years ago, people would say there wasn't room for a small first fridge. I think we're really over that hurdle. And really, the thing that's gotten us over that hurdle over time where people are now - I think 90-something percent of the fridges going out the door now, well over into the high-90s are large, like full-sized fridges. There's very, very few small fridges going out.
So I think if we're able to continue to increase our velocity, and this is in same-store sales, our velocity, year after year as we have, where we're seeing double-digit velocity growth every single year, over time, not only will everyone have one large fridge but they'll have a second fridge. And then we're actually seeing kind of leaders - thought leaders put in even third fridges in some locations.
So we really feel more and more confident. I think every day that the potential of this business is enormous, and that we'll see - we're going to need to build that second fridge number. And even in the right situations, a third fridge number.
And I'd say when we come - when we do our Investor Day, and we update folks on the total addressable market and remind folks, the last time we updated that was in 2016, and a lot has happened since then. We provide a new view of what the addressable market is. We feel confident that you'll feel like not just having one large fridge is an appropriate thing, but over a reasonable period of time having multiple fridges in a store is a very good investment for both us and the retailer.
That makes sense. And if I could ask one more. With the competition heating up in the premium side of the pet food category, what are your thoughts about the ability to maintain your competitive moat? And have you noticed really any difference in the overall category dynamics that might impact you?
So we're - like we're incredibly proud of our progress. We're proud of our growth rate. But the reality is we're, call it a $250 million run rate in a $30 billion category. So we're - and we have - we recognize more and more today that we have so much potential to go forward. This has been a very, very kind of long-term business to develop. It's very challenging to get into. I think that there's opportunity for someone to potentially enter at some point, but I think it's a fairly heroic and enormous effort. Whether it's capital expenditure, development of manufacturing, supply chain, fridges, you name it. We talked about them in some of our presentations over time. We think it's challenging. And I think it's hard for many people to see the investment they make and the near-term returns that they would see.
So at some point, we think someone else may show up. We don't know what it will look like, and we challenge ourselves every day to make sure that we are thinking about the business that we're developing as a business where we may be competing with someone that's very similar. Today, the nice thing is that as there has been more premiumization and many products have become more and more mainstream, we're really an and purchase and not an or purchase. So that's actually been a help to us over time. And I think retailers are getting more comfortable with the role that we play in the category.
So we think there's tremendous long-term potential in front of us, and hopefully, it's a land where there's a lot more Freshpet fridges out there. But we obviously work very hard to make sure that what we're developing is good for the retailers, in addition to us, and it's a great partnership.
There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.
Thank you very much for your interest and attention. I will leave you with one thought. Will Rogers once said, "If you think dogs can't count, try putting three dog biscuits in your pocket and give then give him only two of them," to which I'd add, "And if you think they can't tell time, try skipping a Freshpet mealtime." Thank you very much.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.