Morning, everybody. We're gonna go ahead and get started. My name's Jim Salera. I run the packaged food and beverage practice here at Stephens. Today with us from Freshpet, we have Billy Cyr, Chief Executive Officer, and Todd Cunfer, Chief Financial Officer. Thank you, guys, for joining us today.
Glad to be here.
I think a good starting point, before we really dive into where you guys are going, is just maybe give a recap of the year. It's been a very exciting year for Freshpet.
Mm-hmm.
You guys have made a lot of headway, especially on the operations side. And so can you just give us highlights of some of the improvements you made this year and really the impact it's had on the business?
Yeah. I'll give you a top line, and, and Todd can add a couple pieces of commentary. But perhaps the most important thing that we've accomplished this year, this year, is we've transitioned back to the model of top-line growth is coming from, largely from volume and mix, less based on pricing. So we've survived 27% cumulative price increases over the last couple of years, and we're now back to a place where we'll, we'll burn off the last of the price increases on, you know, annualizing that, this coming February. But we're showing the top-line growth that's driven by volume that, frankly, we've historically shown and that we know that this business can thrive upon going forward.
That transition is probably one of the most important things that happened this year, is we got ourselves to the consumers, they digested the pricing, and we're growing volume. From an operations perspective, we told everybody this year that we would really focus on three key areas. One of them is input costs, second is logistics, and the third is our quality costs, and we've made meaningful progress in each of those areas. I will say that the place that we made the biggest progress most quickly was in logistics. It's been a huge step forward for us. About a third of that has come because the market's been favorable, lane rates and diesel costs. The other two-thirds, though, has been because of things that we've done, actions that we've taken.
But we've made progress in all three of those key strategic areas, and I think that we're really realizing the benefit from really focusing on them. And then the last comment I'd make is, our business, because of its high rate of growth, inherently requires that we become really good at adding capacity. Since the pandemic began, we've added Kitchens 2, we built Ennis, a facility in Texas that's gonna ultimately have almost 1 million sq ft to it. Built the facility, started up 2 lines, and are operating 2 lines, and the third line is being commissioned as we speak. So we continue to prove that we can bring on new capacity, whether it's a new facility or a new line or new staffing, and do that very reliably.
So we think from a top line, from the, you know, operating, elements, and then from the capacity addition, we're hitting on all those metrics. I don't know if I missed anything.
No, but, I mean, the profitability piece was obviously essential this year. We have not great performance from a margin perspective for in 2022. We laid out clearly in CAGNY at the end of February, what our long-term targets were, where we've, you know, very confident we can get to a 45% adjusted gross margin and an 18% EBITDA margin. And, we, you know, we jumped off of 2022, woefully short of those numbers, with 36% and 3% respectively, so a long way to go. Good news is, we've made a serious dent in those margin expectations. This year, we'll have... You know, we'll probably gain at least 350 basis points of gross margin expansion this year, which is terrific.
We'll go from a EBITDA margin of 3% to about 8%, based on the guidance we laid out last week. So, feel great about those numbers. Still got a lot of work to do, got a long way to go, but we have a very clear path of how to get to those, to that 18% EBITDA margin.
That's great. Billy, you touched on just, you know, the growth profile of the business.
Mm.
I think if we look at the pet food category as a whole, Freshpet continues to grow, you know, well ahead of peers. What does the competitive environment look like in pet food? Maybe, you know, broadly speaking, and then in your kind of more narrower product set. And then, how do you feel your products are positioned relative to competitors, both in terms of pricing and maybe.
Mm
Some in-store positioning?
Yeah. I mean, there's obviously a lot of attention has been brought to the pet food market of late. There's been, you know, Wall Street Journal story, USA TODAY story, and people are trying to take a look at, "Geez, there's this pandemic boom, and then there's this, you know, maybe there's a little bit of a bust on the backside," and looking for some proof points for that. Fundamentally, we believe that the category has got a lot of tailwinds, and it's going in the right direction. You know, people care more for their pets. They're replacing kids in many households. It's a fundamentally very, very good category. Within the category, what we're seeing is the growth has kind of become bifurcated. If you have a highly differentiated, really good proposition, consumers are buying good increasing rates.
The two fastest growing parts of the pet food market are our business and the DTC business, largely Farmer's Dog. And so you think about it, you know, people will talk about consumers trading down. The reality is, these are the two of the more expensive propositions in the category, and consumers are increasingly acquiring, you know, pet food at a higher and higher price point, and it points out the importance of the pet in their household. But the people who aren't doing that, you're finding relatively undifferentiated propositions in the kibble and canned business, and so they're starting to become a little bit more value-oriented in those segments. But we're not seeing any indication that that's having an impact on our business. We're not seeing trading down in our business.
What we're seeing is consumers are adopting us and at rates that are similar to what we've seen in the past, based on the spending that we've done. There's also been a lot of conversation about what happens now that all the pet food companies that, you know, are in the traditional kibble and canned businesses, have all spent a lot of money in adding capacity, and it's just as that capacity is coming online, they're starting to see a slowdown in their volume. Well, it remains to be seen, but from what we can see from the data that we've got, is there's not a lot of trading between our business and the other pet foods, in part because it's really hard to compare the forms. I mean, you know, how much Freshpet replaces how much kibble?
How do I figure out the price, price per day? It's a very complicated exercise. And also inherently, the pet food market is a very loyal business, meaning consumers acquire pet food a brand, they stick with that brand for as long as it works for them, and only when it stops working for them, do they start looking for another alternative. So our base of users is pretty well locked in. The incremental users, the new people we've got to get in, are either going to be new to the category or somebody who's had a problem with their existing pet food.
So, if there's a price issue, it's not on our existing business, it's on what does it take to get in a new user, to, in essence, get them to trade up in value to or up in price to a higher-cost product. But so far, we're not seeing any indications that that is slowing.
You touched on, you know, there's really not an apples to apples comparison between, you know, Freshpet and kind of traditional dry dog food or canned dog food. Do you feel that there's kind of a relative price gap that needs to exist between those formats in your product? Do you have a lot of flexibility in kind of what, you know, the price gap can be between those?
Yeah, what's the answer to the question is, we don't think there's necessarily a price gap. The only place that we've seen evidence that there's price gaps that mean anything are if you are one of our you know, lower volume users, you use this as a mixer or a topper, so it's not the main meal, where you may look at the price of a Freshpet item versus a canned dog food, which has a similar purpose for many consumers, and you'd recognize there's, okay, there's a price value there. But if it's looking at the main meal item, we don't see a whole lot of discussion about the price gap, 'cause frankly, it's almost impossible to calculate it. So, you know, you can't do it in your head. You need a spreadsheet, and people just aren't willing to do that.
We are much, much more responsive to absolute price points. We do not engage in downsizing of our packaging 'cause the consumer buys a bag or a roll expecting it to work this many days or feed their dog for this many days. We don't want to have them get home and find out, "Oh, I thought this was going to feed my dog for six days, it only feeds them for five days." Inherently, they now realize they got less, and they also get pissed off because they run out of dog food. And so in our world, absolute price point means everything, but when we take pricing, the consumer's going to see it's a bare naked price increase, and we have to have a good value that justifies that. So far, 27% price increases later, we feel like we're in a good place.
That's great. Kind of continuing on that train of thought, in your conversations with your retail partners, have they given you any thoughts on, you know, pricing, pushback on pricing, maybe, you know, indicate that they want more promotional spend, anything like that, kind of to support the category, especially given, you know, your volume trend versus kind of the-
Yeah
Broader category volume trend?
Yeah. So forever, retailers have asked us for promotional support. And we always tell them: "That's not our model. That's not in your best interest, it's not in our best interest." And while we are small, you can get away with that pretty easily. As we get bigger and become a more important part of the category, they have this bucket on the side, where they have to fill this bucket with trade, promotional dollars, 'cause that's how they make their money, and we keep trying to convince them that they'd be better off making money on, you know, full revenue products and purchases every single day at full margin. And so far, that's worked, and they've kind of gotten used to it, but I will say it will always be a challenge. We'll always face that challenge.
But to be clear, we are, you know, in brick-and-mortar, we're the fastest growing brand, and we have some of the highest margins for retailers. So it's working for us, it's working for them. I think we can continue with this model for a long, long time.
Yeah.
That's great. Why don't I pause there and see if there's any questions from the audience? Cool. We can go right on. As of your most recent update, your total store count was just north of 26,000 stores, I believe.
Mm-hmm.
But only around 20% of those have multiple fridges. Do you have a sense for how high that number could get, and maybe what's the value proposition look like when you're speaking to your retail partners about getting that second or third fridge added in?
Yeah. So how high could it get? You know, it can get much higher. And obviously, there has to be enough room in the store for it to make sense. There has to be enough foot traffic in the store for it to make sense. But what's the conversation with the retailer look like? It's really a strategic conversation. Is what role do we play in the category? What role do we play in the store? So I'll give you the, you know, a couple examples. So for a Kroger, who has got unbelievably good loyalty card data, they made a strategic choice a while ago to invest in three fridge islands in their stores and build their pet department around it.
So they literally had fridges facing three different directions, so the consumer could be drawn in, and they would see three distinctly different propositions from us on each of them. But this was where they recognized that the Fresh pet proposition was bringing into the store, the entire store, not just to the pet department, to the entire store, the kind of shopper who was of most interest to them. High value, they shop the produce department, the meat department, and whatnot. And so we became not just a good, you know, first or second fridge because of what we did on pet food sales, we became a very valuable proposition to the entire store. If you look at Target, when Target went big on Fresh pet back in 2015, they put Fresh pet on the end caps.
The reason they did it is because people didn't think they sold pet food, and they wanted to make a very clear message that they were in the pet food business, and that they were in the higher quality premium pet food, which sent a message about the whole store. In other words, "If we're going to be in pet food, it has to look better than other guys did." So the answer to the question is, it's every retailer will have their own strategy and how we fit in with what that strategy looks like. But if they're interested in pet, which most of them are increasingly interested in, if they're interested in... Sorry.
If they're interested in pet, and if they're also interested in building out the higher value consumer base that they have in the store, then we become a very good strategic tool for them to use. And the only question is: Are they going to add more items, or are they going to try to get higher velocity on the core items? And that's a choice they make.
And you guys touched on recently, you know, a couple new product additions, Large Dog, and some entry price point offerings. Does that also build into the value proposition to get a second or third fridge, just, you know, allowing kind.
Yeah
A broader SKU offering?
Yeah, we talk about it as fridge bait. You know, to get these items, you need to put a second fridge in. But we don't do that unless we think that that would add real value to that retailer's outlet. So, you know, we have Homestyle Creations, which is, you know, a product that replaces home cooking. We have the Large Dog, which is, you know, for people who have a large dog, and each of those items is designed to enhance the value of the total portfolio that we've got and make them more efficient.
But some people will use the second fridge for a different reason. I mean, there are some retailers out there who view the second fridge as a way to increase the holding power, so that they can get the velocity that they need without having to restock constantly.
There are some people who will use it to carry unique SKUs, SKUs that their competitor doesn't offer, which is part of their value proposition to their shopper. So at the end of the day, it's a delicate balance, and we have to find a way to make the Freshpet portfolio marry up with what their proposition is to their shoppers.
As you expand the number of second and third fridges, does that really, you know, deepen your competitive moat? Because, you know, there's a finite amount of kind of visible real estate in the stores, and I imagine as your fridges occupy more of that, that means that there's therefore less for, you know, competitors. How do you guys think about that, and if you can maybe offer some commentary on stores where you have multiple fridges versus stores where you only have one fridge.
Yeah
And kind of how that helps.
You know, there's, well, there's plenty of space in the store for somebody to put another fridge in. That's if they want to put more fridges in, there's a lot of space in the pet food section to put in multiple fridges if other competitors want to go down that path. So that's not a limiter. What is the benefit for us is if we put in multiple fridges, it supports the entire infrastructure, everything from our marketing investment, to the manufacturing scale, to the distribution system and the logistics that we get, to the buying power that we get.
So the benefit of multiple fridges is sort of the front end or the visible part of a system that gets much, much bigger, you know, barriers to entry for a competitor or competitive advantages that we'll have versus somebody else who comes in. But the fridge space itself, the expertise in managing the fridge is a barrier to entry, but people with deep pockets can go out, buy fridges, and convince somebody to put them in a store. That's but that's just one piece of the puzzle.
Yep. You guys have also seen strength in the club channel. You talked, you know, on Kroger and Target, but in clubs, a little bit of a different shopper, a little bit of a different shop. Can you give us a sense for, you know, what you guys have seen there and maybe the opportunity, you know, to expand your presence in club?
Yeah. So we've been in BJ's for a long time, and if you think about BJ's, BJ's is a retailer who really is more of a grocery store on steroids. They're less of, you know, they're not like a Costco. And so we've done very well there. Very, very well. You know, if we're part of your fresh shopping purchase, if your fresh buying is at, at BJ's, you shop for our product there. Costco has been the big home run for the last, last year. We've been in Costco for quite a long time, but it's store by store, region by region. In the last year, we've had a bit of a breakthrough, so we're now in something like 390 of the, call it 550 Costcos they have in the U.S., but it's been growing very rapidly.
Our proposition there is like it is in, you know, many for many other people in Costco, which is a value proposition. You buy, you know, a package that has multiples of rolls or a large size of our bags, and Costco takes a low margin, relatively low margin, so it becomes a very good value opportunity to buy large scale, and the velocities are phenomenal. I mean, absolutely phenomenal in there. So that's a really good proposition. We're not in Sam's today. We talked on our earnings call about that's a possibility in the future, but we're not in Sam's today. At some point, we'll find the proposition that works for them and for their shopper and their strategy, and once we do, that's upside opportunity for us.
And there's, I mean, just with Costco, there's also upside, you know, internationally. They have a very large Canadian business, which we could fit into quite easily. They actually have a very nice U.K. business, and we're in the U.K., so there's some opportunity in the U.K. as well. So feel great about that, club opportunity over the next couple of years.
Yeah. Actually, Todd, just going off of your comments there, is there a different value proposition for an international consumer versus a U.S. consumer, or is it largely the same?
Largely the same.
Okay.
Yeah. Very, very similar proposition.
When we're looking at the household penetration growth that you guys have seen, it's surprisingly strong among younger consumers who, you know, have less spending power. This is obviously a premium product. Can you just give us an overview of kind of your customer composition in terms of age, and then how that gives you confidence about kind of the long-term?
Yeah
Success of the business moving forward, as, you know, your consumers age up?
Yeah, it's interesting. Our largest group of consumers is going to be in the Gen X and in the millennial group, 'cause that's where, you know, you tend to have the largest households, and they're most likely to have a dog in the household. You know, the waning end of it is the baby boomers, who, you know, still have dogs and still getting new dogs, and they're still very interested in the Freshpet proposition. But the real opportunity for us has been the, you know, the Gen Z crowd.
You know, if you are, if you're an 18-year-old male in the United States today, and you think about what's gonna happen to you in the next six years, you're gonna graduate from high school, you might go get some higher education, whether it's college or trade school or whatever it is. You're gonna get your first job, you're gonna get an apartment or your first house or whatever it is. There is a 50% chance that you're gonna get a dog, and there's only a 25% chance you're gonna get married, okay? So just think about the priorities that you've got. And that's the reality.
That's what's happening, and those consumers in that audience are twice as likely to choose Freshpet as the first pet food they feed their dog, as somebody who would've been in the Baby Boomer generation or in the Gen X generation. So we feel very good about the long-term viability, but it's an up-and-coming group. So in terms of the share of our business today, it's still on the small end, but it's also the fastest-growing part of our business. The other thing that's really interesting when you look at a lot of people are very fixated in this economy on, well, how are you gonna do amongst consumers who are economically stressed? And what's funny is we have this sort of odd curve, where we have-...
Low-income consumers who are growing at a high rate, high-income consumers are growing at a high rate, and the lowest rate of growth, still growing at a good rate, is the sort of middle-income group. And that's, that's kind of disguising what's really going on, because the group that's in that low-income group is either retirees who don't have many you know, fixed costs or discretionary costs that they're having to deabsorb, or young people who have no car, no house, no mortgage payment, none of that stuff. And so their income might be relatively low, but their discretionary spending or where they're going to spend it, is much more focused in on things like their dog. If you have three kids in your household, that's the, the household that's most economically stressed.
So their income might be higher than the Gen Zers, but they're spending it on three kids or two kids or whatever it is, and all the costs that go with that. So we have this odd distribution of growth by income. But that's- we view that as a good thing, because as each of those groups matures, they're bringing along the Freshpet habit.
And it sounds like, based on that, that these households that don't have kids or maybe only have one kid or, you know, married with no kids, it's really not a discretionary purchase for them.
It's not.
I mean, it's a core staple item in their basket.
It very much is. And, you know, we always say Freshpet is replacing, or dogs are replacing kids. And, you know, I used to tease my kids that, you know, Freshpet or our dog, Appa. Appa, you know, is not just one of our children, she's my favorite child. And I think a lot of people are feeding their pets with that same kind of mentality. It's, you know... and it's good. It's good for our business. It's good overall.
That's great.
The kids don't think so, but, you know.
Recently, you guys have had more kind of visible prime time ad campaigns tying into maybe some of the themes that you just touched on.
Mm-hmm.
Can you just speak to the, kind of the theme of the ads, early kind of signs of success that you've seen from that, and what we should expect from kind of the messaging there?
Yeah. I mean, we've been blessed. Our advertising team, the advertising agency that we've been doing business with for many, many, many years, have done a phenomenal job. We rigorously test every piece of advertising we put on the air. Long before it goes on air, we always are queued up with a campaign, the next campaign or the pull out of the existing campaign. The advertising that we had on the air last year was doing incredibly well, but we thought we could go better.
And the current campaign that we have on air, it's, it says, "It's not dog food, it's food food," has sought to basically create a distinction between the person who thinks of their pet as that member of their family, and should be fed like they're a member of their family, like one of their treasured children, and the people who don't think that way. And so, you know, you've seen our ads that show a mother-in-law showing up and questioning why her daughter-in-law, you know, has got pet food in the refrigerator, and she gets kind of bounced out. And the same thing with the buddy in the man cave garage watching the football game.
If you don't think that feeding your pet food that's good enough to be in your refrigerator, then you're probably not a friend of mine." And that's worked incredibly well for us. It's really tapped into the psyche of our users.
That's great. Why don't I pause one more time and open up, see if there's any questions in the audience?
Yeah.
Hey, Billy, can you give a quick update on the competitive landscape in terms of fresh product? Maybe a quick thought on more of the CESAR product and see-
Yeah
Fraction going on?
Yeah. So the most direct competition that we've had has been Mars entering into Walmart stores almost two years ago at this point, with rolls. And then earlier this year, General Mills launched the Blue Buffalo fresh product in Walmart stores. They went into about 200 stores. The Mars item ultimately got up into as many as 1,600 stores. Both those items have been discontinued. They might still be in distribution in some of the stores, but they've been discontinued. They won't be on the planogram. They're not on the planogram going forward, and there's a very good reason for that. In those stores, they were selling $30-$40 per store per week for the CESAR item. Same thing with the Blue Buffalo item.
In those same stores, we were selling $1,250 per store per week, so it was- it wasn't even close. So those items have, are gone. So we don't have a really strong direct competitor in broad distribution as a, you know, fresh product today. There are some people who are launching frozen versions, so you're seeing freezers show up in some stores. And those products are, you know, they're getting closer in form, but they're still frozen, because doing fresh is really hard. Nobody's figured out how to do fresh like we do. The other part of the category is the DTC business, which, you know, there's obviously been a lot of action in that area in the last couple of years. The breakout winner in that category has been Farmer's Dog.
We think that, you know, based on everything we're hearing, they're a business that in a net sales perspective, is about the same size as ours. They're. We hear they're not profitable. We don't know that. As we look at that business and, you know, think about that segment, we believe fundamentally that there's a limit to, you know, how big that business will get, based on its frozen, based on its DTC model and whatnot. So we don't want to go chasing, you know, rainbows and whatnot, but from where we sit, we think there's a very, very long runway for fresh, and we're the best at it, and we're going to do the best we can with that and make it as big as we can.
That doesn't mean we're not paranoid, not watching all these other things, and may consider to do things that are competitive with those items, but you should expect that the vast majority of our focus is going to be winning with fresh.
Do you have a sense for Farmer's Dog, where they, what pounds, how much their cost is on a pound basis versus your Texas facility?
So they're co-packing. They're coming out of, you know, a human food manufacturing facility. So it's a hard thing. They're selling prices about twice the feeding cost of what ours is. I can't tell you what their actual operating costs are.
But you still think... I think when you were raising money from Texas, you were saying that Texas would be the lowest cost dog food production.
Well, fresh food.
Fresh food.
Yeah, and we're pretty convinced that's the case.
And then, and just another one on Costco. So I think you said about 65% of the households coming in are new?
They're new to our franchise, based on data we get from Numerator, yeah.
Okay. I mean, what, how are they different than what your existing customers?
The demographics are very similar to existing customers. Remember, we only have 50% awareness on Freshpet today, so it's not unheard of for us to find people whose primary shopping is somewhere else, who still haven't heard about Freshpet.
And then the other hundred or so that you don't have, do you have the rights to? I think it was regional at some time, where you had it one each region, kind of region.
In independent decisions, you know, the-
Still?
Yep. Yeah, they don't buy at a corporate level, so they just kind of roll it out when they want to roll it out. So we're confident we'll get most of them over time, and we're kind of picking off 15, 20, you know, every couple of weeks, but those are individual decisions.
Do you have an ability to move it from back of the warehouse where it sits now, and move it to the front of the fridge?
Those are their decisions. I mean, obviously, we try to influence it as much as we can, but, you know, at the end of the day, I have a bigger issue, which is they use a different header card on the fridge. It's our fridge, it... I don't like the header card. But, you know, right now, I'll live with it while we're selling $5,000 per store per week in, in those stores, but at some point, I'd love to get it to be the Freshpet header card.
Thank you.
What's been the issue with Sam's?
You know, my first sales call, when I joined Freshpet seven years and change ago, was to Sam's. And since then, I think there have been four different pet food buyers there. I don't think that they had other issues to solve first, and now I think it's gotten to the point where there's only so many of those things they can solve, where they now have to face the obvious of the biggest thing that's going on in retail of pet food is us, and they've got to have some point of view on how they can play and how they can win. And we need to decide, you know, what that's gonna look like. They, like many retailers, when they decide to get in, they wanna know what makes them distinctive.
And oftentimes, if you're the club channel, you want that to be about price, and we're not interested in creating that kind of a pricing dynamic in the market. So if you take that off the table, it's gonna have to be something else.
Yeah, I mean, Sam's versus Walmart, if you have a good proposition, Walmart will probably take you in. They have hundreds of SKUs in the pet category, okay? Club probably only has 20. So whatever that buyer is or whatever the strategy is at the time, you know, they're gonna have a point of view on what limited number of SKUs they're gonna put in. So it's just, it's a different buying phenomenon. Look, we're having conversations. I'm very confident at some point in time we will get into Sam's, 'cause we have a terrific proposition. I'm sure they're seeing what's going on at Costco. Obviously, we're doing incredibly well at their sister company, Walmart stores. So we'll get in there at some point in time.
How do you differentiate their messaging in terms of... You said they would have to have some sort of messaging that's-
Well, it's not just messaging, it's the product offering. So, for example, in Costco, the brand name on the product is Deli Fresh. It's Freshpet's Deli Fresh product, so it has a ... It's, it's just like we do in the pet specialty channel, we sell Freshpet Vital. In the natural channel, we sell Freshpet Nature's Fresh. In Costco, we do Freshpet Deli Fresh, so it's got slightly different characteristics to it. We do it in a box that is a, you know, multi-pack box of rolls. It's moving from a 4-pack to a 6-pack in order for us to get more efficiencies in doing that. Those kinds of degrees of flexibility exist when you're dealing with customers as big as Costco or a Sam's.
Look, they're a great operator. We'd love to get in there. I'm sure, you know, confident at some point in time we'll get in there. They sell a lot of pet food, so, we're optimistic.
Great. I think one of the more impressive feats that you guys have delivered is, you know, your resilient volume trends, even in the face of higher pricing. How should we think about the composition of your sales growth moving forward? Kind of what's the contributions that you expect from price mix versus volume?
Yeah.
Um.
If you're shooting for a 25% annual net sales growth, we would expect that you would see from a pounds perspective, call it in the low to mid-20s. We reported in Q3, it was up 23% on volume. In the most recent weekly Nielsen, so remember, the Nielsens do not include the Costco business, but in the most recent weekly Nielsens, we're up 22 on volume. You'd add the Costco gains to that. We think that kind of, you know, in the low to mid-20s on volume, and then the rest of it coming from consumers migrating up the franchise into higher value per pound items, is a pretty sustainable model over the long haul.
There will be years where it's skewed a little bit more towards volume and a little bit more or more towards mix, depending on what innovations we've launched, which customers have invested in double fridges, that kind of thing, but that's sort of the sustainable model for us.
Okay. Recently, you guys have talked about, you know, managing your growth to make sure that you don't overextend the network. Obviously, a very high-quality problem to have. Can you walk us through kind of some of the levers that you have to manage growth, to make sure that you don't have, you know, excess demand, kind of beyond what you wanna put in the network?
Yeah, I mean, it starts with advertising. I mean, our business is so closely correlated to our advertising spend, that if we set the advertising spend number, you can get yourself to what the net sales number is gonna be, pretty darn close, and dial it up, dial it down, based on that. There is the amplification value of incremental fridges and the visibility that that provides, and there is also the variable of, you know, who or what new items do you launch that year, and what impact do those items have? 'Cause some items are bigger than other items. But over the long haul, as we think about what tools do we have to control the growth rate, it's literally control the advertising spending. That's. We spend 99% of our time thinking about it that way.
Okay. If you do have excess demand and, and you pull back on the ad spending, but, you know, given, like you said, you have kind of this greater in-store visibility, do you feel like that gives you a little bit more leeway to maybe be more aggressive on pricing if you have, you know, the volume trends, you haven't really seen them rein in?
Pricing is a very difficult or sensitive topic for us because, you know, the pricing decision is not just ours, it's also the retailer. You know, you have to, you know, they're not pushovers on just take more price. And the other part of it is that we still think that this category is in its infancy, and we do not want this to become a niche category because the products got so expensive. We really want this to become, ultimately, the mainstream of the pet food market. Now, we think the market's mainstream is going to move up to meet us, but we can't have it be so high up that the consumer ultimately always pigeonholes us in, "You're that thing over there that's only for certain kinds of people." We want to be in the mainstream.
We are very respectful to the margins that we have to get, and we have to recover the commodity costs and input costs that we had. We have to justify the capital we're spending, so we're very, very mindful of that, but we don't want to be the brand that pushes the price so high that we limit the kinds of consumers we can bring into the franchise.
That's helpful. Talked a lot about the top line, so maybe we switch gears a little bit and drill down on some of the operational improvements-
Mm-hmm.
That you guys have made this year, which, you know, as we mentioned before, are significant. How does Ennis Kitchen help support the improvements that we've seen this year? And maybe what should we think about as kind of the next shoe to drop at Ennis?
So I mean, we're very early stages in Ennis. We have two lines running currently. The third line's gonna come up here right at the end of the year, beginning of January of 2024. And even the two existing lines are not running, the throughputs are not still at full capacity. They're still, they're still ramping up. You know, we have conservatively said that the Ennis production will be at a similar cost of Bethlehem. We actually obviously feel we can do better than that over time. We have chicken processing on site, which ultimately will give us better cost structure. Labor rates in Texas are a bit lower than they are in Pennsylvania, so there is. And the lines are a little bit more advanced, bigger. There should be ultimately more throughput there.
You know, we're very pleased with, you know, trying to start up a greenfield. It's very, very challenging, especially in this environment, so it's going, it's going very well. But we have a ton of upside at Ennis. Obviously, it's gonna bring on a lot of capacity over the next couple of years for us. The one I just mentioned, coming on at the end of the year, we have a rolls line coming on probably at the end of the third quarter. But we're just at the beginning of starting to really leverage that facility, both from a direct cost perspective, but just from a fixed cost overhead leverage perspective. There's, there's a lot of upside in that, in that plant. So, we feel great about the footprint we have between Bethlehem, Ennis, our Kitchen South facility.
We're good for the next several years. There's enough capacity in the footprint that we have to get us through, you know, at least 2028. We will need to start working on what's next in the next couple of years, because lead times are long, but we're in pretty good shape right now.
That's great. Can you maybe just remind us where you guys think you'll be at for capacity at the end of this year?
Yeah.
And then kind of, you know, year by year up to that?
With the third line coming on here, we'll be a little over $1 billion of capacity, and the good part about that is it allows us to have a little bit of flexibility of how much, how many of those lines we are actually staffing, so we can turn on the staffing a little bit on and off. That's, we had some of that this year as well, and that gives us some extra flexibility. But, you know, we'll get to over $2 billion. By 2027, we'll be at over $2 billion worth of capacity, the way we've laid out our plan. Again, with the existing footprint we have, we have another line in Bethlehem that we're actually gonna put in. We're gonna use a dry storage facility there.
We got, you know, 8 more lines coming on at Ennis. We probably have 3 more lines we can put in, in the Kitchens South facility. So a lot of upside in the capacity. Plus, some new technologies that we're working on, and we haven't, you know, we're not far enough along to count on them yet, but they potentially could add some more efficiencies and capacity with the same footprint.
Jim, I just, I would add to that, the one thing we're spending a lot of time on right now is also capacity at the macro level is nice, but at the end of the day, we have to have rolls capacity and bag capacity, and so keeping them both in balance, because you bring on a bag line, you know, in Ennis, we now have 2 bag lines and 1 roll line, you know, it gets you a little out of balance, and that's not just from a demand perspective, but it's also from a logistics perspective. You know, we wanna have balanced production of rolls and bags in Ennis and in Pennsylvania, so that they go to their DCs and get distributed to the customers to meet the demand. Right now, we feel really, really good about the bag capacity.
We have a roll line that comes up next in Ennis, sometime at the end of the third quarter of next year, and that's critical for us. So even though we tell you we got $1 billion of capacity at the end of this year, we really need that roll line to come on next year in order to meet the demand.
And the other thing I'm, you know, this really is such a scale business. The one thing about Ennis right now, where we're unfortunately penalizing them right now with 1 bag and 1 roll facility is, and we have a distribution center right near that facility, and we want to utilize that distribution facility for the West, you know, western states, is we're forcing that facility to produce a lot of SKUs.
Mm.
The changeovers are very high right now on those two lines. Once we get the second of each line up, it gives a lot more flexibility to have the one bag line cranking out one or two of the power SKUs, and the other one kind of feeds in the smaller runs. So that will create a lot of efficiency once we have two and two up, and you can only imagine when you have five and five, ultimately, you're literally gonna have a line where it's just producing one power SKU all day long, and the efficiencies and throughput efficiencies that we can get from that will be tremendous. The 8 billion, is that the eight lines, the five Kitchens two, is that inclusive of those ones you're bringing, or what's that?
I'm sorry, what do you- The, excuse me, the $2 billion. Yeah. Yeah, it is. It is.
Yes.
I mean, that would be nice. Yeah, well, yeah. Yeah, it's correct, it is. Got it.
Todd, you mentioned your, your DC, and that's near the Ennis facility. I think logistics is an area that you guys have made really a ton of headway on this year and really-
Yeah
Kind of outperformed, you know, our expectations certainly, but even I think your own expectations.
Correct.
Could you just give us some color there and what you think, you know, the logistics costs look like moving forward?
Yeah. So first of all, you know, we did not have good logistics expenses in 2022 for lots of reasons. Some of those were market-based. Diesel costs, lane rates were very high. Because of our capacity constraints, we, you know, trucks weren't full. So we had, we had a lot of issues with logistics last year. We brought in a new team who are just doing a tremendous job, and we, we kinda laid out at our CAGNY presentation that, you know, by 2027, we'd get to 7.5%. Well, we're, we're below 7% now in year one, so we really screwed up that projection big time. And I think we still have some more room to grow. But about a third, about a third of the big decrease this year is market-based.
I mean, to be fair, one, and everyone's, everyone's enjoying it. Diesel rates are down, lane rates are down, so we're benefiting from that. But the other two-thirds are things that we've done internally. So now we've got capacity, we've got full trucks, we've put bracket pricing in to encourage customers to order very, very efficiently. We're negotiating, you know, much better lane rates besides just market-based advantages. Just, we have, you know, multiple people bidding against each other right now. So the team's just done a tremendous job. And so look, we're and, and with the second facility in Dallas now, the number of miles that on average that we're traveling to get to a customer is way down as well, and that will continue to build over the next couple of years.
So, made a lot of progress, still got a lot more room to grow, and obviously, we feel like we can get well below 7.5.
My, my favorite stat that we quoted on the earnings call about the logistics in the third quarter was: we had 23% more pounds that we shipped, but we had 28% less freight miles. Think about that. That's pretty remarkable, and it just is all the reasons that Todd described. It was a lot of things that we did, you know, second DC, higher fill rates, bracket pricing, all those things that drove that.
That's great. Maybe one more question on the margin side. Just give us some color around the commodity basket. What does that look like, and any sense you have for cost moving into 2024?
Yeah, look, I think we feel pretty good. I definitely don't see any inflation in 2024. I've been saying, you know, kind of flattish. If we get lucky here, we're gonna lock in a good portion of it in the next 30 days, just the way chicken prices are purchased. If we get lucky, we may have a little bit of deflation, but we're gonna... We'll see, we'll see how that plays out, but feeling fairly confident at this point.
Okay, great. Maybe open it up one more time for questions, and then I have one final question. Great. So I think as final question, as we wrap things up, just given the progress that you've made in 2023, what do you guys view as kind of the next set of opportunities as we move into 2024 and, and beyond?
You want to take that?
Sure. Look, I, you know, we feel great about the 25% CAGR that we've kind of laid out. Look, it's not, that's not simple, it's not easy, but we've proven we can grow this business, and the media works, and there's so much upside, and the consumers really recognize the value proposition of fresh pet food. So, you know, we feel great about that 25% will continue. Still, you know, like, like I said earlier, we've made some really nice progress on margins, but we got a long, long way to go. We got 10 more margin points on EBITDA that we got to get over the next few years. Half of it, very controllable below the gross margin line. We'll slow down media in the out years.
We'll be able to grow G&A at half the cost of net sales and get a tremendous amount of leverage, and then obviously, the logistics that we talked about. The harder part is the gross margin. We still got about five or six points of gross margin that we need to get over the next few years. But we have very clear building blocks of how to get there, just leveraging the footprint that we have, reducing the quality costs, which we made some nice impacts this year. So it's there. We have, again, very clear building blocks. We just got to go execute. It's as simple as that.
You know, I tell people all the time that we have a 2027 target of 45%, and I'm very comfortable with that target, and we're not going to take that target up. But if I'm sitting here in 2027, we're only at 45%, I'll actually be very disappointed because I think there's, I think there's upside to that number. But got a long way to go, but we feel great about the head start we got in 2023.
And Jim, I would just add one thing to it, and it's part of the organization maturing. I mean, we during the pandemic, we got behind on our organizational capability, and we've had to do a lot to fill it out. The thing that we're really focusing in on right now is, while we're doing all this capacity addition, and we have to do it well, and while we're focusing on each of those three focus areas, we also know that we need to get operations that are more mature to operate as if they're more mature. And so we've invested a lot of time and energy in the last year into building operating effectiveness into our Bethlehem Kitchens.
And so while Ennis is focusing on doing all this work to ramp up capacity and start up operations and learn how the thing works, Bethlehem needs to recognize that, you know, there's six lines there. They're operating at full capacity. They need to be more efficient, and that's what good manufacturing operations do, and we've hired the people to do it. They're making good progress. It's a long runway of opportunity ahead of them, and I feel really good about it, but that's part of the maturing of the company. We're really good on the top line. We've always been good on the top line. We've gotten good at adding capacity at the right time, at the right pace.
We now need to demonstrate that we can do the things that mature companies do and execute really well on the operating cost side in the existing facilities, where they're not dealing with those new challenges of capacity additions.
Great. Well, thank you, everyone, for your time today.
Yep.
Billy, Todd.
Thank you.
Thank you for joining us, and, I think we'll leave it there.
Great. Thanks, Jim.