frpt-10q_20180930.htm

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of November 5, 2018, the registrant had 35,536,573 shares of common stock, $0.001 par value per share, outstanding.

This report contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this report are forward-looking statements. Forward-looking statements discuss our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “aim,” “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “outlook,” “potential,” “project,” “projection,” “plan,” “intend,” “seek,” “may,” “could,” “would,” “will,” “should,” “can,” “can have,” “likely,” the negatives thereof and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. They appear in a number of places throughout this report and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the industry in which we operate. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including:

While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors and it is impossible for us to anticipate all factors that could affect our actual results. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. You should evaluate all forward-looking statements made in this report in the context of these risks and uncertainties.

	September 30, 2018			December 31, 2017

ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	2,850,063		$	2,184,259
Accounts receivable, net of allowance for doubtful accounts		13,130,215			12,721,521
Inventories, net		8,709,111			10,118,394
Prepaid expenses		772,014			1,200,834
Other non-trade receivable		1,291,369			337,340
Other current assets		351,612			395,620
Total Current Assets		27,104,384			26,957,968
Property, plant and equipment, net		103,085,709			100,598,639
Deposits on equipment		3,540,516			4,370,922
Other assets		2,067,086			1,972,805
Total Assets	$	135,797,695		$	133,900,334
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable		9,889,931			9,173,169
Accrued expenses		6,821,475			7,519,348
Borrowings under Credit Facilities		2,000,000			—
Total Current Liabilities	$	18,711,406		$	16,692,517
Other liabilities		281,596			304,839
Total Liabilities	$	18,993,002		$	16,997,356
STOCKHOLDERS' EQUITY:
Common stock — voting, $0.001 par value, 200,000,000 shares authorized, 35,524,330 issued and 35,510,161 outstanding on September 30, 2018, and 35,132,548 issued and outstanding on December 31, 2017		35,524			35,132
Additional paid-in capital		320,115,324			312,783,195
Accumulated deficit		(203,110,100	)		(195,991,478	)
Accumulated other comprehensive income		20,171			76,129
Treasury stock, at cost — 14,169 shares on September 30, 2018 and no shares on December 31, 2017		(256,226	)		—
Total Stockholders' Equity		116,804,693			116,902,978
Total Liabilities and Stockholders' Equity	$	135,797,695		$	133,900,334

	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2018			2017			2018			2017
NET SALES	$	50,799,601		$	40,125,006		$	141,594,158		$	112,530,942
COST OF GOODS SOLD		27,183,648			20,622,277			74,972,294			59,055,099
GROSS PROFIT		23,615,953			19,502,729			66,621,864			53,475,843
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES		23,572,314			19,303,705			73,397,781			57,844,411
INCOME (LOSS) FROM OPERATIONS		43,639			199,024			(6,775,917	)		(4,368,568	)
OTHER INCOME/(EXPENSES):
Other Income/(Expenses), net		(27,392	)		41,435			(24,302	)		(515,473	)
Interest Expense		(94,381	)		(465,253	)		(261,307	)		(830,932	)
		(121,773	)		(423,818	)		(285,609	)		(1,346,405	)
LOSS BEFORE INCOME TAXES		(78,134	)		(224,794	)		(7,061,526	)		(5,714,973	)
INCOME TAX EXPENSE		19,032			20,754			57,096			62,261
NET LOSS		(97,166	)		(245,548	)		(7,118,622	)		(5,777,234	)
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	(97,166	)	$	(245,548	)	$	(7,118,622	)	$	(5,777,234	)
OTHER COMPREHENSIVE LOSS:
Change in foreign currency translation	$	(54,325	)	$	—		$	(55,958	)	$	—
TOTAL OTHER COMPREHENSIVE LOSS		(54,325	)		—			(55,958	)		—
TOTAL COMPREHENSIVE LOSS	$	(151,491	)	$	(245,548	)	$	(7,174,580	)	$	(5,777,234	)
NET LOSS PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS
-BASIC	$	(0.00	)	$	(0.01	)	$	(0.20	)	$	(0.17	)
-DILUTED	$	(0.00	)	$	(0.01	)	$	(0.20	)	$	(0.17	)
WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING USED IN COMPUTING NET LOSS PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS
-BASIC		35,396,550			34,666,180			35,259,365			34,316,161
-DILUTED		35,396,550			34,666,180			35,259,365			34,316,161

	For the Nine Months Ended
	September 30,
		2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(7,118,622	)	$	(5,777,234	)
Adjustments to reconcile net loss to net cash flows provided by operating activities:
Provision for loss/(gains) on accounts receivable		(15,300	)		30,953
Loss on disposal of equipment and deposits on equipment		104,769			97,692
Share-based compensation		4,170,409			3,292,362
Fair value adjustment for outstanding warrants		—			334,628
Change in reserve for inventory obsolescence		69,912			315,006
Depreciation and amortization		10,418,274			9,411,173
Amortization of deferred financing costs and loan discount		86,327			398,648
Changes in operating assets and liabilities
Accounts receivable		(393,394	)		(3,534,273	)
Inventories		1,339,371			(3,603,074	)
Prepaid expenses, other non-trade receivables and other current assets		(481,201	)		(347,876	)
Other assets		(118,675	)		(162,488	)
Accounts payable		1,190,993			2,307,943
Accrued expenses		(697,873	)		2,129,095
Other liabilities		(23,243	)		236,878
Net cash flows provided by operating activities		8,531,747			5,129,433
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property, plant and equipment, software and deposits on equipment		(12,681,600	)		(10,835,532	)
Net cash flows used in investing activities		(12,681,600	)		(10,835,532	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Debt issuance costs		—			(245,291	)
Exercise of options to purchase common stock		3,071,883			5,612,557
Purchase of stock for tax withholding		(256,226	)		—
Proceeds from borrowings under Credit Facilities		6,000,000			7,500,000
Repayment of borrowings under Credit Facilities		(4,000,000	)		(9,000,000	)
Net cash flows provided by financing activities		4,815,657			3,867,266
NET CHANGE IN CASH AND CASH EQUIVALENTS		665,804			(1,838,833	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		2,184,259			3,908,177
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	2,850,063		$	2,069,344
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	164,202		$	489,738
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Property, plant and equipment purchases in accounts payable	$	572,465		$	497,209
Conversion of warrants to common stock	$	-		$	588,019

Note 1 – Nature of the Business and Summary of Significant Accounting Policies:

Nature of the Business – Freshpet, Inc. (hereafter referred to as “Freshpet” or the “Company”), a Delaware corporation, manufactures and markets natural fresh meals and treats for dogs and cats. The Company’s products are distributed throughout the United States, Canada, and Europe into major retail classes including Grocery (including online), Mass and Club as well as Pet Specialty and Natural retail.

Basis of Presentation – The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”). The unaudited consolidated financial statements include the accounts of the Company as well as the Company’s wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The interim unaudited consolidated financial statements have been prepared on the same basis as the annual audited consolidated financial statements and in accordance with the rules and regulations of the United States Securities and Exchange Commission. In the opinion of management, the interim unaudited financial statements reflect all adjustments, which include only normal recurring adjustments, necessary for the fair statement of the Company’s financial position as of September 30, 2018, the results of its operations for the three and nine months ended September 30, 2018 and 2017, and its cash flows for the nine months ended September 30, 2018 and 2017. The results for three and nine months ended September 30, 2018 are not necessarily indicative of results to be expected for the year ending December 31, 2018, or any other interim periods, or any future year or period.

These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes in Item 8 of Part II, “Financial Statements and Supplementary Data,” of our Annual Report on Form 10-K for the year ended December 31, 2017.

Estimates and Uncertainties – The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results, as determined at a later date, could differ from those estimates.

Treasury Stock – The Company may purchase or withhold shares of stock to satisfy statutory employee tax obligations upon the issuance of restricted stock units to employees. Such repurchased or withheld shares are treated as treasury stock and carried at cost on the Consolidated Balance Sheet in Stockholders’ equity. During the nine months ended September 30, 2018, the Company accumulated $0.3 million of treasury stock related to employee tax withholdings.

Reclassifications – Certain prior period amounts were reclassified to conform to the current period’s presentation. Other non-trade receivables previously presented in other current assets in the consolidated balance sheet is now presented separately.

In May 2014, the Financial Accounting Standard Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers,” (Topic 606). Under the ASU and subsequently issued amendments, revenue is recognized at the time a good or service is transferred to a customer for the amount of consideration received.

Topic 606 permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or modified retrospectively with the cumulative effect of applying the guidance as of the date of initial application (the cumulative catch-up transition method).

The Company adopted Topic 606 in the first quarter of 2018 using the full retrospective method approach and recast prior year results as shown below. The adoption did not have any material impact on our financial statements and is limited to classification differences within the Consolidated Statements of Operations and Comprehensive Loss from cost of goods sold to a reduction to net sales. The new accounting standard did not impact Net Loss.

The Company recast certain prior period amounts to conform with the adoption of the revenue recognition standard, as shown in the table below:

	Three Months Ended							Nine Months Ended
	September 30, 2017							September 30, 2017
	As Previously Reported		Adjustments			Current Presentation		As Previously Reported		Adjustments			Current Presentation
Net Sales	$	41,199,780	$	(1,074,774	)	$	40,125,006	$	115,682,698	$	(3,151,757	)	$	112,530,942
Cost of Goods Sold		21,697,051		(1,074,774	)		20,622,277		62,206,855		(3,151,757	)		59,055,099
Gross Profit	$	19,502,729	$	—		$	19,502,729	$	53,475,843	$	—		$	53,475,843

Revenue from product sales is recognized when obligations under the terms of the contract with the customer are satisfied, which occurs once control is transferred upon shipment to the customer. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods.

The amount of consideration the Company receives and revenue the Company recognizes varies with changes in trade incentives the Company offers to its customers and their consumers. Trade incentives consists 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.

Sales taxes and other similar taxes are excluded from revenue. Costs associated with shipping and handling activities, such as merchandising, are included in SG&A expenses as revenue is recognized.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2018		2017		2018		2017
Grocery (including Online), Mass and Club	$	41,882,395	$	32,766,387	$	115,874,906	$	91,266,283
Pet Specialty and Natural		8,917,206		7,358,619		25,719,252		21,264,659
Net Sales	$	50,799,601	$	40,125,006	$	141,594,158	$	112,530,942

In February 2016, the FASB issued ASU No. 2016-02, "Leases” (Topic 842), which requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The new guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is assessing the impact of Topic 842 on its corporate office lease, and upon adoption of this guidance, expects to record the lease on its consolidated balance sheet in accordance with Topic 842.

	September 30,			December 31,
	2018			2017
Refrigeration Equipment	$	78,118,968		$	70,489,454
Machinery and Equipment		51,681,285			47,558,838
Building, Land, and Improvements		25,575,213			25,543,568
Furniture and Office Equipment		4,745,053			4,404,735
Leasehold Improvements		393,474			375,661
Automotive Equipment		319,496			319,496
Construction in Progress		4,076,615			3,763,894
		164,910,104			152,455,646
Less: Accumulated Depreciation and Amortization		(61,824,395	)		(51,857,007	)
	$	103,085,709		$	100,598,639

Depreciation expense related to property, plant and equipment totaled $3,549,460 and $10,208,173 for the three and nine months ended September 30, 2018, respectively, of which $1,579,278 and $4,568,607 was recorded to cost of goods sold for the three and nine months ended September 30, 2018, respectively, with the remainder of depreciation and amortization expense recorded to selling, general and administrative expense.

Depreciation expense related to property, plant and equipment totaled $3,154,623 and $9,235,932 for the three and nine months ended September 30, 2017, respectively, of which $1,447,992 and $4,329,624 was recorded to cost of goods sold for the three and nine months ended September 30, 2017, respectively, with the remainder of depreciation and amortization expense recorded to selling, general and administrative expense.

	September 30,		December 31,
	2018		2017
Accrued Compensation and Employee Related Costs	$	3,305,920	$	3,902,688
Accrued Chiller Cost		1,464,609		1,371,940
Accrued Freight		515,396		354,959
Accrued Marketing		478,683		835,997
Accrued Customer Consideration		409,371		263,235
Accrued Utility		118,158		198,000
Accrued VAT		14,499		172,711
Other Accrued Expenses		514,839		419,818
	$	6,821,475	$	7,519,348

During the third quarter of 2017, we amended our Credit Facilities to replace our Term Facility and Capex Commitments of $30.0 million and $10.0 million Revolving Facility with a straight $30.0 million revolver (the “New Revolving Facility”) and the ability to increase the New Revolving Facility by an additional $10.0 million. The New Revolving Facility will mature in September 2020 and borrowings thereunder will bear interest at variable rates depending on the Company’s election, either at a base rate or at the London Interbank Offered Rate (“LIBOR”), in each case, plus an applicable margin. Subject to the Company’s leverage ratio, the applicable margin will vary between 0.75% and 1.25% for base rate loans and 1.75% and 2.25% for LIBOR loans. The amendment resulted in a reduction in the unused rate of between 25 and 75 basis points and a reduction in the total rate of between 200 and 250 basis points.

Borrowings under our Revolving Credit Facilities totaled $6.0 million, offset by repayments of $4.0 million, for the nine months ended September 30, 2018. There was $2.0 million of debt outstanding under the Credit Facilities as of September 30, 2018.

Interest expense and fees totaled $0.1 million and $0.3 million for the three and nine months ended September 30, 2018, respectively, and $0.5 million and $0.8 million for the three and nine months ended September 30, 2017, respectively. There was less than $0.1 million of accrued interest on the Credit Facilities as of September 30, 2018 and December 31, 2017.

Total compensation cost for share-based payments recognized for the three months ended September 30, 2018 and 2017 is $1,866,604 and $1,132,852, respectively. Total compensation cost for share-based payments recognized for the nine months ended September 30, 2018 and 2017 is $4,260,638 and $3,292,362, respectively.

2006 Stock Plan—The options in this plan are time-based (vest over five years). Certain option awards provide for accelerated vesting if there is a change in control (as defined in the 2006 Plan). At September 30, 2018, there were zero shares available for grant as the 2006 Plan is frozen. The total number of unexercised options for the 2006 Plan is 6,266.

2010 Stock Plan—The outstanding options are time-based (vest between two and four years). At September 30, 2018, there were zero shares available for grant as the 2010 Plan is frozen no further grants may be issued under the 2010 Plan. The total number of unexercised options for the 2010 Plan is 610,658.

2014 Omnibus Incentive Plan—In November 2014, the Company approved the 2014 Omnibus Incentive Plan (the “2014 Plan”). Under the 2014 Plan 3,979,200 shares of common stock may be issued or used for reference purposes as awards granted. These awards may be in the form of stock options, stock appreciation rights, restricted stock, as well as other

stock-based and cash-based awards. At September 30, 2018, the awards granted were either time-based, performance-based (vest when performance targets are met, as defined in the stock option grant agreement), or restricted stock units (employee RSUs vest over three years and non-employee director RSUs vest over one year).The total number of unexercised options and RSUs for the 2014 Plan is 1,575,814.

At September 30, 2018, there were 1,937,945 shares of common stock available to be issued or used for reference purposes under the 2014 Plan.

NASDAQ Marketplace Rules Inducement Award—During fiscal year 2016, share-based awards were granted to the Company’s Chief Executive Officer as an inducement under the NASDAQ Marketplace Rules, and therefore outside of any Plan. Under the terms of the agreement, the grant is governed as if issued under the 2014 Omnibus Plan. As of September 30, 2018, the awards granted were time-based (cliff vest in equal increments over four years) and performance-based (vest when performance targets are met, as defined in the stock option grant agreement).

The following table includes activity related to outstanding service period stock options during the nine months ended September 30, 2018.

The following table includes activity related to outstanding performance-vested stock options during the nine months ended September 30, 2018.

During the three months ended September 30, 2018 an additional 219,185 performance shares were deemed to have performance metrics that are probable of achievement. Due to the change in assessment an additional expense of $544,530 was incurred. As of September 30, 2018, 707,537 performance-vested stock options at a weighted average exercise price of $9.97 have performance metrics that are probable of achievement. These shares are included in share-based compensation costs for the three and nine months ended September 30, 2018.

The following table includes activity related to outstanding restricted stock units during the nine months ended September 30, 2018.

Basic net loss per share of common stock is calculated by dividing net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Diluted net loss per share of common stock is computed by giving effect to all potentially dilutive securities.

For the three and nine months ended September 30, 2018 and 2017, there were no adjustments between net loss and net loss attributable to common stockholders.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2018		2017		2018		2017
Service Period Stock Options		1,932,268		2,471,469		2,009,372		2,691,504
Restricted Stock Units		208,402		152,598		197,492		142,180
Performance Stock Options		13,283		—		13,283		—
Total		2,153,953		2,624,067		2,220,147		2,833,684

For the three and nine months ended September 30, 2018 and 2017, diluted net loss per share of common stock is the same as basic net loss per share of common stock, due to the fact that potentially dilutive securities would have an antidilutive effect as the Company incurred a net loss during such periods.

Concentration of Credit Risk—The Company maintains its cash balances in financial institutions which are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000 each. At times, such balances may be in excess of the FDIC insurance limit.

The Company evaluates events that have occurred after the balance sheet date but before the consolidated financial statements are issued. Based upon the evaluation, the Company did not identify any recognized or unrecognized subsequent events that have required adjustment or disclosure in the financial statements.

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

The following discussion summarizes the significant factors affecting our consolidated operating results, financial condition, liquidity and cash flows as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the accompanying unaudited consolidated financial statements and related notes in Item 1 and with the audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K.

In addition to historical information, this discussion and analysis contains forward-looking statements based on current expectations that involve risks, uncertainties and assumptions, such as our plans, objectives, expectations, and intentions set forth under the sections entitled "Forward-Looking Statements" in this report and "Risk Factors" in our Annual Report on Form 10-K. Our actual results and the timing of events may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in the section entitled "Risk Factors" in our Annual Report on Form 10-K.

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 inception of the company 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.

Due to the continued growth of the Company’s fresh pet food sales, the Company has plans to expand its manufacturing capacity. The expansion includes the renovation of an existing 50,000 square foot building and a 90,000 square-foot addition. The $100 million strategic capital investment is expected to support Freshpet’s growth in the United States, Canada and Europe by creating total capacity that exceeds $500 million in net sales from the facility. The facility “Freshpet Kitchens 2.0” will make greater use of automation to improve quality, safety and reduce costs. Production start-up is slated for the second half of 2020.

Our net sales are derived from the sale of pet food to our customers, who purchase either directly from us or through third-party distributors. 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 across leading retailers and have installed Freshpet Fridges in over 19,100 retail stores as of September 30, 2018. All of our products are sold under the Freshpet brand name. Sales are recorded net of discounts, slotting, returns and promotional allowances.

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.

Our gross profit is net of costs of goods sold, which include the costs of product manufacturing, product ingredients, packaging materials and inbound freight.

Our gross profit margins are also impacted by the cost of ingredients, product mix and packaging materials. We expect to mitigate any adverse movement in input costs and product mix through a combination of price increases and cost management.

Selling, general & administrative (“SG&A”) costs as a percentage of net sales have historically been decreasing. SG&A as a percentage of net sales decreased from 81.3% in the year ended 2012 to 48.0% in the year ended 2017. Due to our Feed the Growth initiative, which increases our investment in media, we expect our SG&A as a percentage of net sales to be roughly stable in the near-term. We believe that as we begin to realize the benefits of our Feed the Growth initiative, SG&A expenses will once again significantly decrease as a percentage of net sales. SG&A as a percentage of net sales was 51.4% in the nine months ended September 30, 2017 and 51.8% in the nine months ended September 30, 2018.

Outbound freight. We utilize 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.

Brokerage. We utilize 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. 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.

At December 31, 2017, we had federal NOL carryforwards of approximately $175.0 million, which expire at various dates between 2025 and 2037. We may be subject to the NOL utilization provisions of Section 382 of the Code. The effect of an ownership change would be the imposition of an annual limitation on the use of NOL carryforwards attributable to periods before the change. The amount of the annual limitation depends upon our value immediately before the ownership change, the federal published interest rate and changes to our capital during a specified period. If we were to undergo an ownership change, it is likely that the utilization of the NOLs will be substantially limited. A valuation allowance is appropriate when management believes it is more likely than not that the deferred tax asset will not be realized. At December 31, 2017 and 2016, we determined that a valuation allowance of 100% was appropriate.

	Three Months Ended September 30,												Nine Months Ended September 30,
	2018						2017						2018						2017
	Amount			% of Net Sales			Amount			% of Net Sales			Amount			% of Net Sales			Amount			% of Net Sales
	(Dollars in thousands)												(Dollars in thousands)
Net sales	$	50,799			100	%	$	40,125			100	%	$	141,594			100	%	$	112,531			100	%
Cost of goods sold		27,184			54			20,622			51			74,972			53			59,055			52
Gross profit		23,615			46			19,503			49			66,622			47			53,476			48
Selling, general and administrative expenses		23,572			46			19,304			48			73,398			52			57,844			51
Loss from operations		43			0			199			0			(6,776	)		(5	)		(4,368	)		(4	)
Other income/(expenses), net		(27	)		(0	)		41			0			(24	)		(0	)		(516	)		(0	)
Interest expense		(94	)		(0	)		(465	)		(1	)		(261	)		(0	)		(831	)		0
Loss before income taxes		(78	)		(0	)		(225	)		(1	)		(7,061	)		(5	)		(5,715	)		(5	)
Income tax expense		19			0			21			0			57			0			62			0
Net Loss	$	(97	)		(0	)%	$	(246	)		(1	)%	$	(7,118	)		(5	)%	$	(5,777	)		(5	)%

Three Months Ended September 30, 2018 Compared to Three Months Ended September 30, 2017

	Three Months Ended September 30,
	2018							2017
	Amount		% of Net Sales			Store Count		Amount		% of Net Sales			Store Count
	(Dollars in thousands)
Grocery (including Online), Mass and Club* (1)	$	41,882		82	%		14,030	$	32,766		82	%		12,777
Pet Specialty and Natural (2)		8,917		18			5,077		7,359		18			4,873
Net Sales		50,799		100	%		19,107	$	40,125		100	%		17,650

(1)Stores at September 30, 2018 and September 30, 2017 consisted of 9,880 and 8,872 Grocery (including online) and 4,150 and 3,905 Mass and Club, respectively.

(2)Stores at September 30, 2018 and September 30, 2017 consisted of 4,664 and 4,539 Pet Specialty and 413 and 334 Natural, respectively.

* Includes sales from Freshpet Baked product of $0.4 million, or 1.0% of total net sales, for the three months ended September 30, 2017.

Net sales increased $10.7 million, or 26.6%, to $50.8 million for the three months ended September 30, 2018 as compared to the same period in the prior year. The $10.7 million increase in net sales was driven by growth of $9.5 million in our Grocery (including Online), Mass, and Club refrigerated channel and $1.6 million in our Pet Specialty and Natural refrigerated channel, partially offset by declines in Freshpet Baked product of $0.4 million. Net sales excluding Freshpet Baked product increased $11.1 million, or 27.6%, for the three months ended September 30, 2018 as compared to the

same period in the prior year. Our Freshpet Fridge store locations grew by 8.3% to 19,107 as of September 30, 2018 compared to 17,650 as of September 30, 2017.

Gross profit increased $4.1 million, or 21.0%, to $23.6 million for the three months ended September 30, 2018 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 46.5% for the three months ended September 30, 2018 decreased 210 basis points compared to the same period in the prior year, due to increases in raw material cost of 200 basis points, unabsorbed labor cost in advance of a new seven day operation of 90 basis points, partially offset by leverage on depreciation expense of 50 basis points, and increased efficiencies through scale and production improvements of 30 basis points.

Adjusted Gross Profit was $25.2 million and $21.0 million in the three months ended September 30, 2018 and 2017, respectively. Adjusted Gross Profit Margin was 49.6% and 52.2% in the three months ended September 30, 2018 and 2017, respectively. Adjusted Gross Profit excludes $1.6 million and $1.4 million of depreciation expense in the three months ended September 30, 2018 and September 30, 2017, respectively. 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.

Selling, general and administrative expenses increased $4.3 million, or 22.1%, to $23.6 million for the three months ended September 30, 2018 as compared to the same period in the prior year. Key components of the dollar increase include higher media spend of $0.5 million, higher selling expense of $0.6 million, higher variable cost due to volume of $0.9 million, higher depreciation and option expense of $0.9 million and incremental operating expenses of $1.4 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 decreased to 46.4% for the three months ended September 30, 2018 from 48.1% for the three months ended September 30, 2017.

Adjusted SG&A decreased as a percentage of net sales to 42.5% in the three months ended September 30, 2018 as compared to 45.2% of net sales in the three months ended September 30, 2017. Adjusted SG&A excludes $1.7 million of share-based compensation, $0.1 million of litigation expense, and $0.1 million of fees related to a shelf registry statement for the three months ended September 30, 2018 and $1.1 million for share-based compensation expense and $0.1 million of leadership transition expense for the three months ended September 30, 2017. See “—Non-GAAP Financial Measures” for how we define Adjusted SG&A and a reconciliation of Adjusted SG&A to SG&A, the closest comparable U.S. GAAP measure.

Income from Operations decreased $0.2 million to less than $0.1 million for the three months ended September 30, 2018 as compared to the same period in the prior year as a result of the factors discussed above.

Interest expense relating primarily to our Credit Facilities was $0.1 million and $0.5 million in the three months ended September 30, 2018 and 2017, respectively. Interest expense in the three months ended September 30, 2017 included $0.3 million of accelerated amortization of debt issuance costs related to the amendment of our Credit Facilities.

Other income (expenses), net decreased to less than ($0.1 million) for the three months ended September 30, 2018 as compared to the same period in the prior year.

Net loss decreased $0.1 million to $0.1 million for the three months ended September 30, 2018 as compared to the same period in the prior year.

Nine Months Ended September 30, 2018 Compared to Nine Months Ended September 30, 2017

Delaware	20-1884894
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
400 Plaza Drive, 1^st Floor, Secaucus, New Jersey	07094
(Address of principal executive offices)	(Zip Code)

		Page No.
Part I. Financial Information
Item 1.	Unaudited Consolidated Financial Statements	4
	Consolidated Balance Sheets	4
	Consolidated Statements of Operations and Comprehensive Loss	5
	Consolidated Statements of Cash Flows	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Conditions and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures About Market Risks	25
Item 4.	Controls and Procedures	26
Part II. Other Information		27
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 6.	Exhibits	28

	September 30,			December 31,
	2018			2017
Raw Materials and Work in Process	$	2,667,133		$	2,471,498
Packaging Components Material		1,108,469			804,616
Finished Goods		4,952,142			7,105,425
		8,727,744			10,381,539
Reserve for Obsolete Inventory		(18,633	)		(263,145	)
	$	8,709,111		$	10,118,394

Service Period Stock Options	Shares			Weighted Average Exercise Price
Outstanding at December 31, 2017		2,030,266		$	9.47
Granted		95,366			16.45
Exercised		(291,229	)		9.74
Outstanding at September 30, 2018		1,834,403		$	9.79

Performance Based Options	Shares			Weighted Average Exercise Price
Outstanding at December 31, 2017		1,154,393		$	10.50
Granted		21,456			16.45
Exercised		(25,970	)	9.05
Outstanding at September 30, 2018		1,149,879		$	10.64

Restricted Stock Units	Shares			Weighted-Average Grant-Date Fair Value Per Unit
Outstanding at December 31, 2017		165,240		$	10.99
Granted		118,764			16.70
Issued upon vesting		(74,583	)		10.53
Forfeited		(188	)		16.45
Outstanding at September 30, 2018		209,233		$	14.39