Freshpet, Inc. - Quarter Report: 2020 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

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FORM 10-Q

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(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2020

 

OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 001-36729

 

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FRESHPET, INC.

(Exact Name of Registrant as Specified in its Charter)

 

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Delaware

20-1884894

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

400 Plaza Drive, 1st Floor, Secaucus, New Jersey	07094

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (201) 520-4000

 

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Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading Symbol	Name of each exchange on which registered
Common Stock	FRPT	NASDAQ Global Market

 

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 if any, every Interactive Data File required to be submitted and posted 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.

 

Large accelerated filer		☒		Accelerated filer		☐
Non-accelerated filer		☐		Smaller reporting company		☐
Emerging growth company		☐

 

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 October 30, 2020, the registrant had 40,640,010 shares of common stock, $0.001 par value per share, outstanding.

 

 

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Forward-Looking Statements

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.

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

FRESHPET, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying notes to the unaudited consolidated financial statements.

FRESHPET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

See accompanying notes to the unaudited consolidated financial statements.

FRESHPET, INC. AND SUBSIDIARIES

CHANGES TO STATEMENTS OF STOCKHOLDERS’ EQUITY 

(Unaudited)

See accompanying notes to the unaudited consolidated financial statements.

FRESHPET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to the unaudited consolidated financial statements.

FRESHPET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Nature of the Business – Freshpet, Inc. (hereafter referred to as “Freshpet”, the “Company”, “we” or “our”), 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 and other international markets, into major retail classes including Grocery (including online), Mass and Club, 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 (the “SEC”). 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, 2020, the results of its operations and changes to stockholders’ equity for the three and nine months ended September 30, 2020 and 2019, and its cash flows for the nine months ended September 30, 2020 and 2019. The results for the three and nine months ended September 30, 2020 are not necessarily indicative of results to be expected for the year ending December 31, 2020, or any other interim periods, or any future year or period. Certain amounts that appear in this report may not add up because of differences due to rounding.

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, 2019.

Equity method investment – The Company utilizes the equity method to account for investments when the Company possesses the ability to exercise significant influence, but not control, over the operating and financial policies of the investee. The ability to exercise significant influence is presumed when an investor possesses more than 20% of the voting interests of the investee. This presumption may be overcome based on specific facts and circumstances that demonstrate that the ability to exercise significant influence is restricted. The Company applies the equity method to investments in common stock and to other investments when such other investments possess substantially identical subordinated interests to common stock. The Company has elected to record its share of equity in income (losses) of equity method investment on a one-quarter lag based on the most recently available financial statements. 

In applying the equity method, the Company records the investment at cost and subsequently increases or decreases the carrying amount of the investment by our proportionate share of the net income or loss. 

Variable interest entities ("VIEs") – In accordance with the applicable accounting guidance for the consolidation of variable interest entities, the Company analyzes its variable interests to determine if an entity in which it has a variable interest is a variable interest entity. The Company's analysis includes both quantitative and qualitative reviews to determine if we must consolidate a variable interest entity as its primary beneficiary.

Estimates and Uncertainties – The preparation of our consolidated 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 consolidated 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.

Fair Value of Financial Instruments – Financial Accounting Standards Board (“FASB”) guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement).

The three levels of the fair value hierarchy are as follows:

The carrying amounts reported in the balance sheets for cash and cash equivalents, short-term investments, other receivables, accounts payable and accrued expenses approximate their fair value based on the short-term maturity of these instruments. Certain assets, including the equity method investment, right-of-use assets and property and equipment are also subject to measurement at fair value on a non-recurring basis if they are deemed to be impaired as a result of an impairment review.

As of September 30, 2020, the Company's Short-term investments are level 2 assets. All other assets and all liabilities are level 1 assets and liabilities.

Short-Term Investments – The Company holds interest-bearing certificates of deposits with financial institutions with maturities ranging from three months to one year. Certificates of deposit are classified as short-term investments and interest is recorded as other income.

Trade accounts receivable – The allowance for doubtful accounts is based on the Company's assessment of the collectability of customer accounts. The Company regularly reviews the allowance by considering factors such as historical experience, credit quality, the age of the accounts receivable balances and current economic conditions that may affect a customer's ability to pay. 

Restricted Stock Tax Withholdings – To meet payroll tax withholdings obligations arising from the vesting of restricted share units, the Company withheld 25,967 shares totaling $1.6 million for the nine months ended September 30, 2020, and withheld 31,734 shares totaling $1.3 million for the nine months ended September 30, 2019. No shares were withheld during the three months ended September 30, 2020 and 2019. Shares of common stock withheld for tax withholdings do not reduce the Company’s total share repurchase authority.

FRESHPET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Debt Issuance Cost – During the first quarter of 2020, the Company paid the outstanding balance of the Delayed Draw Term Loan associated with the Fourth Amended and Restated Loan and Security Agreement and wrote down $0.6 million of the related fees to interest expense. 

During the second quarter of 2020, as part of the Fifth Amended and Restated Loan and Security Agreement (as amended, the "New Loan Agreement"), the Company incurred an additional $0.8 million of fees associated with the debt modification, of which $0.6 million of the fees were related to the Delayed Draw Term Loan with the remaining balance relating to the Revolving Loan Facility. The Company’s policy is to record the debt issuance cost related to the Delayed Draw Term Loan, net of debt, for the portion of the Delayed Draw Term Loan that is outstanding, with the remaining amount recorded within assets. As of September 30, 2020, there was $1.1 million of debt issuance cost that were recorded to other assets and less than $0.3 million was recorded to other current assets.  

The Company amortizes debt issuance costs categorized as assets on a straight-line basis over the term of the loan and amortizes the debt issuance costs that are categorized net of debt using the effective interest method, over the term of the loan.

Net Sales - Information about the Company’s net sales by class of retailer is as follows:

Recently Issued Accounting Standards

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard requires an entity to utilize a new impairment model known as the current expected credit loss (“CECL”) model to estimate its lifetime “expected credit loss” and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in more timely recognition of credit losses. The new guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The reported results for the three and nine months ended September 30, 2020 reflect the application of ASU 2016-13. The application of the update did not have a material impact to our allowance for doubtful accounts. Please see the description of the Company’s “Trade accounts receivable” accounting policy above.  

In January 2020, the FASB issued Accounting Standards Update No. 2020-01, Investments - Equity Services (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. The standard addresses accounting for the transition into and out of the equity method and measurement of certain purchased options and forward contracts to acquire investments. The standard is effective for annual and interim periods beginning after December 15, 2020, with early adoption permitted. Adoption of the standard requires changes to be made prospectively. The Company is in the process of evaluating the impact the adoption of this standard will have, however, the Company does not expect the adoption of this standard to have a material impact on their financial condition and results of operations. 

Note 2 – Inventories:

Note 3 – Property, Plant and Equipment:

Depreciation expense related to property, plant and equipment totaled $4,970,451 and $14,708,962 for the three and nine months ended September 30, 2020, respectively, of which $2,128,590 and $6,422,288 was recorded to cost of goods sold for the three and nine months ended September 30, 2020, 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 $3,975,822 and $11,462,514 for the three and nine months ended September 30, 2019, respectively, of which $1,598,843 and $4,753,623 was recorded to cost of goods sold for the three and nine months ended September 30, 2019, respectively, with the remainder of depreciation and amortization expense recorded to selling, general and administrative expense.

FRESHPET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 4 – Equity Method Investment:

On September 2, 2020, the Company acquired a 19% interest in a privately held company that operates in our industry for $27.7 million. The total $27.7 million is comprised of an initial investment of $26.6 million and $1.1 million of transaction costs. The Company concluded that they are not the primary beneficiary, which is primarily the result of the Company's conclusion that it does not have the power to direct the activities that most significantly impact the economic performance. However, the Company completed an analysis over the investment and determined that based on the circumstances within the agreement, the Company does have the ability to exercise significant influence even though the Company's percentage of ownership is below 20%. As a result, this investment is accounted for under the equity method of accounting.

There is no equity in income (loss) of equity method investment included in our Consolidated Statement of Operations and Comprehensive Loss (Unaudited) for the periods presented because the Company has elected to record their equity in income (loss) using a one-quarter lag based on the most recently available financial statements. In the fourth quarter of 2020, the Company will begin including their equity in income (loss) of equity method investment. 

Note 5 – Accrued Expenses:

Note 6 – Debt:

On April 17, 2020, the Company entered into the New Loan Agreement, which amended and restated in full the Company’s Fourth Amended and Restated Loan and Security Agreement, dated as of May 15, 2019. The New Loan Agreement provides for a $165.0 million senior secured credit facility (the "New Credit Facility"), encompassing a $130.0 million delayed draw term loan facility (the "Delayed Draw Facility") and a $35.0 million revolving loan facility (the "Revolving Loan Facility"), which replaces the Company's prior $55.0 million delayed draw term loan facility and $35.0 million revolving loan facility. 

The New Credit Facility matures on April 17, 2025 and borrowings thereunder bear interest at variable rates depending on the Company's election, either at a base rate or at LIBOR (or a comparable successor rate if LIBOR no longer exists), in each case, plus an applicable margin. Subject to the Company's leverage ratio, the applicable margin varies between 0.50% and 1.00% for base rate loans and 1.50% and 2.00% for LIBOR loans. The Company has the option to borrow term loans under the Delayed Draw Facility ("Delayed Draw Term Loans") until October 17, 2022, subject to certain conditions. Commencing on December 31, 2022, the amount of any outstanding Delayed Draw Term Loans shall be repayable in equal consecutive quarterly installments equal to 1/28th of the outstanding Delayed Draw Term Loans and the remainder shall be due and payable on April 17, 2025. 

Borrowings under the New Credit Facility are secured by substantially all of the Company's and certain of its subsidiaries' assets. The New Loan Agreement requires compliance with various covenants customary for agreements of this type, including financial covenants and negative covenants that limit, among other things, the Company's ability to incur additional debt, create or incur liens, engage in mergers or consolidations, sell, transfer or otherwise dispose of assets, make voluntary prepayments to subordinated debt, permit a change of control, pay dividends or distributions, make investments, and enter into certain transactions with affiliates. The New Loan Agreement also includes events of default customary for agreements of this type. 

During the nine months ended September 30, 2020, the Company borrowed an additional $20.9 million under the Credit Facility, which consisted of $13.9 million related to Delayed Draw Term Loans, net of unamortized debt issuance cost of less than $0.1 million, and $7.0 million related to the Revolving Loan Facility, bringing the total outstanding debt to $76.0 million. Subsequent to the additional borrowings, the Company paid down the total outstanding debt on its Credit Facility of $76.0 million. As a result, the Company had no debt outstanding under the Credit Facility as of September 30, 2020.

Net borrowings under the Credit Facilities totaled $54.5 million at December 31, 2019, of which $40.5 million net of unamortized debt issuance cost of $0.6 million, related to the Delayed Draw Term Loans and $14.0 million related to the Revolving Loan Facility.

In connection with entering into the New Credit Facility, the Company incurred $0.8 million of debt issuance cost which is capitalized on the balance sheet and amortized over the life of the New Credit Facility. 

As of September 30, 2020, there was $1.3 million of the remaining debt issuance cost from the New Credit Facility as well as fees incurred from the prior credit facilities.  

FRESHPET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 7– Leases:

We have various noncancelable lease agreements for office and warehouse space, as well as office equipment, with original remaining lease terms of two years to nine years, some of which include an option to extend the lease term for up to five years. Because the Company is not reasonably certain to exercise these renewal options, the options are not considered in determining the lease term and associated potential option payments are excluded from lease payments. The Company’s leases generally do not include termination options for either party to the lease or restrictive financial or other covenants.

Weighted-average remaining lease term (in years) and discount rate related to operating leases were as follows:

As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the commencement date to determine the present value of lease payments.

Maturities of lease liabilities under noncancelable operating leases as of September 30, 2020 were as follows:

A summary of rent expense for the three and nine months ended September 30, 2020 and 2019 was as follows:

Supplemental cash flow information and non-cash activity relating to operating leases are as follows:

FRESHPET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 8 – Equity Incentive Plans:

Total compensation cost for share-based payments recognized for the three months ended September 30, 2020 and 2019 is $3,409,728 and $3,129,648, respectively. Total compensation cost for share-based payments recognized for the nine months ended September 30, 2020 and 2019 is $7,984,490 and $5,870,657, respectively. 

2010 Stock Plan—The outstanding options are time-based (vest between two and four years). At September 30, 2020, there were zero shares available for grant as the 2010 Plan is frozen. The total number of unexercised options for the 2010 Plan is 53,028.

2014 Omnibus Incentive Plan—In November 2014, the Company approved the 2014 Omnibus Incentive Plan (the “2014 Plan”). In September 2020, the 2014 Plan was amended to allow for the granting of an additional 700,000 shares of common stock to be issued or used for reference purposes as awards granted, for an available total of 4,679,200 shares. 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, 2020, 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 or cliff vest, as defined in the restricted stock agreement, and non-employee director RSUs vest over one year). The total number of unexercised options and RSUs for the 2014 Plan is 2,548,891.

At September 30, 2020, there were 1,344,050 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 and the nine months ended September 30, 2020, share-based awards were granted to the Company’s Chief Executive Officer and the Executive Vice President of Finance, at the time, who is currently Chief Financial Officer, respectively, as an inducement under the NASDAQ Marketplace Rules, and therefore outside of any Plan. Under the terms of the applicable agreement, each grant is governed as if issued under the 2014 Omnibus Plan. The awards are time-based (cliff vest over four years and three years, respectively) and performance-based (vest when performance targets are met, as defined in the stock option grant agreement).

Service Period Stock Options

The following table includes activity related to outstanding service period stock options during the nine months ended September 30, 2020.

Performance-Vested Stock Options

The following table includes activity related to outstanding performance-vested stock options during the nine months ended September 30, 2020.

As of September 30, 2020, 1,285,774 performance-vested stock options at a weighted average exercise price of $18.66 have performance metrics that are probable of achievement. These shares are included in share-based compensation costs for the nine months ended September 30, 2020.

Restricted Stock Units

The following table includes activity related to outstanding restricted stock units during the nine months ended September 30, 2020.

FRESHPET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 9 – Earnings Per Share Attributable to Common Shareholder:

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

The following table includes adjustments between weighted average common shares outstanding, for basic earnings per share and weighted average common shares outstanding for diluted earnings per share. 

For the three and nine months ended September 30, 2020 and 2019, there were no adjustments between net loss and net loss attributable to common stockholders.

The potentially dilutive securities are as follows:

For the nine months ended September 30, 2019, 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 period.

Performance awards are excluded from the calculation of dilutive potential common shares until the threshold performance conditions have been satisfied.

Note 10 – Concentrations:

Concentration of Credit Risk—The Company maintains its cash balances in financial institutions that 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.

Note 11 – Commitments and Contingencies:

A shareholder derivative lawsuit, Meldon v. Freshpet, Inc. et al, Docket No. 2:18-cv-10166, was instituted June 5, 2018 in the United States District Court for the District of New Jersey against us and certain of our current and former executive officers and directors on behalf of certain holders of our common stock. We were served with a copy of the complaint in June 2018. The plaintiffs seek to recover damages for investors based on state law claims (alleged breaches of fiduciary duty, waste, and unjust enrichment) in connection with the alleged violations of federal securities laws alleged in the Curran action. On April 3, 2019, the Court granted a stay of the Meldon case pending resolution of certain matters in a related case, Curran v. Freshpet, Inc., which has been settled. The parties to the Meldon action then entered into settlement discussions, after which the parties reached an agreement in principle to settle the case based on the Company’s commitment to continue certain governance practices. The parties also reached agreement on attorneys’ fees. The settlement was approved and certified on August 4, 2020. As of September 30, 2020, the settlement funds due were paid by the Company's insurers, totaling $0.2 million. 

In addition, we are currently involved in various claims and legal actions that arise in the ordinary course of our business, including claims resulting from employment related matters. None of these claims or proceedings, most of which are covered by insurance, are expected to have a material adverse effect on our business, financial condition, results of operations or cash flows. However, a significant increase in the number of these claims or an increase in amounts owing under successful claims could materially and adversely affect our business, financial condition, results of operations or cash flows. 

Note 12 – Subsequent Events:

The Company evaluates events that have occurred after the balance sheet date but before the financial statements are issued for recognitions or disclosures.

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.

For information regarding our consolidated operating results, financial condition, liquidity and cash flows for the nine months ended September 30, 2019 as compared to the same period in 2018, refer to "Part I—Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2019, filed with the SEC on August 6, 2019, which information is incorporated herein by reference.

Overview

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

Recent Developments

Observations on the Effects of COVID-19

In December 2019, a novel coronavirus disease (“COVID-19”) was reported and in January 2020, the World Health Organization (“WHO”) declared it a Public Health Emergency of International Concern. In late February 2020, the WHO raised its assessment of the COVID-19 threat from high to very high at a global level due to the continued increase in the number of cases and affected countries, and in March 2020, the WHO characterized COVID-19 as a pandemic.

Due to COVID-19, our retail customers, experienced a surge in consumption as consumers stocked up on food and necessities towards the second half of Q1 2020. The unexpected surge in consumption caused a spike in orders which at times were greater than our production capacity. 

At the end of Q1, we announced our post-surge pivot. That strategic pivot was built on a foundation that said, if we could keep our employees safe, then we could rebuild our supply and that would enable us to replenish our product supply in retail stores, which would allow us to turn on our advertising to drive consumption and household penetration gains. As a result, we invested in each of those areas, including safety enhancements to protect our team, incremental capacity at Kitchens South, incremental retail coverage, new e-commerce purchase and delivery options and additional media advertising. 

The Company made and continues to make investments designed to protect its team members. These efforts include taking the temperature of every team member and administering a brief health screening before entering our Freshpet Kitchens, installing increased space for social distancing, instituting staggered shifts, enhancing daily sanitation efforts and weekly deep cleaning of all common areas, requiring use of face coverings by all employees, and limiting visitors, who must also submit to a health check before entering the facilities.  

Despite the COVID-19 related disruptions, our ability to bring the power of fresh to pet parents has continued, in part due to our post-surge pivot. Consumers' increased interest in their pets, the strong appeal of the Freshpet idea and products, our ability to continuously run our manufacturing facilities and successfully add capacity, the increased impact of our advertising, and our customers' realization of the value that Freshpet brings to their pet food category offerings and stores has resulted in some of our strongest growth. As noted above the unexpected surge in consumption towards the second half of Q1 2020, as well as the subsequent strong growth has caused us to draw down on trade inventory and have higher out of stocks than usual. With the additional capacity brought on during Q2 and Q3, as well as Kitchens 2.0 startup, we believe we will be able to rebuild our trade inventory and decrease our out of stocks within the next few months. 

We are unsure how long the COVID-19 pandemic will require us to absorb higher costs to protect and reward our employees while simultaneously ensuring we can support our pet parents with a continual supply of Freshpet products. We are also monitoring our supply of raw materials, ingredients and packaging materials. Although we have not experienced any extended supply interruptions to date and our chicken prices for the year are fixed contractually, subject to limited exceptions, we have used our secondary suppliers from time-to-time, and have also experienced higher beef prices as a result of reduced supplies. We have estimated that we will be slightly under $4 million this year on COVID-19 related expenses.   

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

Our outlook for the balance of 2020 assumes there is not a material change to customer operations, consumer purchasing behavior, or unexpected changes to our supply chain for the remainder of the year. See the important information in Item 1A. “Risk Factors” below, under the caption “The COVID-19 outbreak has had a material impact on the U.S. and global economies and could have a material adverse impact on our employees, suppliers, customers and end consumers, which could adversely and materially impact our business, financial condition and results of operations.”

Supporting Freshpet’s Growth –

At the Company’s February 2020 Investor Day. Freshpet’s updated strategic plan was presented – “Feed the Growth – 5 by 2025”. The strategic plan looks to add 5 million more households by 2025. To support the strategic plan Freshpet is committed to invest in production capacity as well as upgrades to our systems and processes. During 2020 the investments related to capacity upgrades include:

Additionally, the Company is upgrading its enterprise resource planning (“ERP”) system. The project commenced in Q1 2020 and expected to run through Q4 of 2021

In order to fund the strategic capital investments as well as provide the Company with capital flexibility, in March 2020, the Company completed a primary equity offering which provided proceeds of $252.1 million.  

In addition, on April 17, 2020, the Company entered into a Fifth Amended and Restated Loan and Security Agreement with City National Bank, as the arranger and administrative agent, and the other lenders party thereto (the “New Loan Agreement”). The New Loan Agreement provides for a $165.0 million senior secured credit facility (the “New Credit Facility”), encompassing a $130.0 million delayed draw term loan facility (the “New Delayed Draw Facility”) and a $35.0 million revolving loan facility (the “New Revolving Loan Facility”), which replaced the Company’s prior $55.0 million delayed draw term loan facility and $35.0 million revolving loan facility.

The Company intends to use the net proceeds from the primary equity offering, borrowings from the New Credit Facility and cash from operations to continue to fund the Freshpet Kitchens expansion projects.

Components of our Operating Results

Net Sales

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 at leading retailers across North America and parts of Europe and have installed Freshpet Fridges in approximately 22,371 retail stores as of September 30, 2020. Our products are sold under the Freshpet brand name with ingredients, packaging and labeling customized by class of retail. Sales are recorded net of discounts, returns and promotional allowances.

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

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

Gross Profit

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

Our gross profit margins are also impacted by the cost of ingredients, packaging materials, and labor and overhead and share-based compensation related to direct labor and overhead. We expect to mitigate any adverse movement in input costs through a combination of cost management and price increases.

Selling, General and Administrative Expenses

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

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

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

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

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

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

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

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

Income Taxes

We had federal net operating loss (“NOL”) carry forwards of approximately $198.1 million as of December 31, 2019, of which approximately $175.0 million, generated in 2017 and prior, will expire between 2025 and 2037. The Company may be subject to the net operating loss utilization provisions of Section 382 of the Internal Revenue Code (the “Code”). The effect of an ownership change would be the imposition of an annual limitation on the use of NOL carry forwards attributable to periods before the change. The amount of the annual limitation depends upon the value of the Company immediately before the change, changes to the Company’s capital during a specified period prior to the change, and the federal published interest rate. At December 31, 2019, we had approximately $160.0 million of state NOLs, which expire between 2020 and 2039. At December 31, 2019, we had a full valuation allowance against our net deferred tax assets as the realization of such assets was not considered more likely than not.

Consolidated Statements of Operations and Comprehensive Loss

Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019

Net Sales

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

Net sales increased $18.9 million, or 29%, to $84.2 million for the three months ended September 30, 2020 as compared to $65.3 million in the same period in the prior year. The $18.9 million increase in net sales was driven by an increase of $16.3 million in our Grocery (including Online), Mass, and Club refrigerated channel and $2.6 million in our Pet Specialty and Natural refrigerated channel. Our Freshpet Fridge store locations grew by 7.7% to 22,371 as of September 30, 2020 compared to 20,779 as of September 30, 2019.

Gross Profit

Gross profit increased $5.9 million, or 19.4%, to $36.7 million for the three months ended September 30, 2020 as compared to $30.7 million in the same period in the prior year. The increase in gross profit was primarily driven by higher net sales, offset by increased cost.

Gross profit margin of 43.5% for the three months ended September 30, 2020 decreased 350 basis points compared to the same period in the prior year, due to plant start-up cost of 220 basis points, increased processing cost of 100 basis points, increased beef input cost of 70 basis points, COVID-19 related cost of 50 basis points, increased depreciation and stock compensation cost of 50 basis points, partially offset by increase in sales price and shifting selling mix of 70 basis points and plant cost efficiency of 70 basis points.

Adjusted Gross Profit was $41.5 million and $32.5 million in the three months ended September 30, 2020 and 2019, respectively. Adjusted Gross Profit Margin was 49.3% and 49.8% in the three months ended September 30, 2020 and 2019, respectively. Adjusted Gross Profit excludes $2.1 million of depreciation expense, $1.8 million of plant start-up expense $0.5 million of share-based compensation expense, and $0.4 million in COVID-19 expenses in the three months ended September 30, 2020 and excludes $1.6 million of depreciation expense and $0.2 million of share-based compensation expense in the three months ended September 30, 2019. 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

Selling, general and administrative expenses increased $5.7 million, or 21.1%, to $32.9 million for the three months ended September 30, 2020 as compared to the same period in the prior year. Key components of the dollar increase include higher variable costs due to volume of $1.7 million, higher incremental operating costs of $1.0 million, increased media expense of $1.3 million, increased loss on disposal of equipment of $1.3 million, and increased in depreciation and options expense of $0.4 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 39.1% for the three months ended September 30, 2020 from 41.6% for the three months ended September 30, 2019.

Adjusted SG&A Expenses was $24.5 million and $20.5 million in the three months ended September 30, 2020 and 2019, respectively. Adjusted SG&A Expenses decreased as a percentage of net sales to 29.1% in the three months ended September 30, 2020 as compared to 31.4% of net sales in the three months ended September 30, 2019. The decrease of 230 basis points in Adjusted SG&A is a result of 240 basis point gain in SG&A leverage, slightly offset by 10 basis points increase in media as a percentage of Net Sales. Adjusted SG&A excludes $2.9 million of depreciation expense, $2.9 million of non-cash share-based compensation expense, $1.3 million of loss on disposal of equipment, $0.8 million of launch expense, $0.4 million in enterprise resource planning expense, and $0.2 million COVID-19 expenses in the three months ended September 30, 2020 while excluding $2.5 million of depreciation and amortization expense, $2.9 million for share-based compensation expense, $1.3 million of launch expense and $0.1 million of secondary offering expense in the three months ended September 30, 2019. 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 (Loss) from Operations

Income (Loss) from Operations increased $0.2 million to income from operations of $3.8 million for the three months ended September 30, 2020 as compared to the same period in the prior year as a result of the factors discussed above.

Interest Expense

Interest expense relating to our credit facilities decreased $0.1 million, or 30.5%, to $0.2 million for the three months ended September 30, 2020 as compared to the same period in the prior year as a result of the factors discussed above.

Other Income/(Expenses), net

Other income (expenses), net increased $0.2 million, or 117.9%, to other income of $0.0 million for the three months ended September 30, 2020 as compared to the same period in the prior year as a result of the factors discussed above.

Net Income (Loss)

Net Income (loss) increased $0.5 million, or 15.6%, to net income of $3.5 million for the three months ended September 30, 2020 as compared to net income of $3.0 million for the same period in the prior year as a result of the factors discussed above.

Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019

Net Sales

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

Net sales increased $54.2 million, or 30.1%, to $234.3 million for the nine months ended September 30, 2020 as compared to $180.1 million during the same period in the prior year. The $54.2 million increase in net sales was driven by an increase of $49.8 million in our Grocery (including Online), Mass, and Club refrigerated channel and $4.4 million in our Pet Specialty and Natural refrigerated channel. Our Freshpet Fridge store locations grew by 7.7% to 22,371 as of September 30, 2020 compared to 20,779 as of September 30, 2019.

Gross Profit

Gross profit increased $18.4 million, or 22%, to $102.4 million for the nine months ended September 30, 2020 as compared to $83.9 million during the same period in the prior year. The increase in gross profit was primarily driven by higher net sales, offset by increased cost.

Gross profit margin of 43.7% for the nine months ended September 30, 2020 decreased 290 basis points compared to the same period in the prior year, due to plant start-up cost of 130 basis points, COVID-19 related cost of 90 basis points, increased processing cost of 90 basis points, increased depreciation and stock compensation cost of 30 basis points, increased beef input cost of 30 basis points, partially offset by increase in sales price and shifting selling mix of 80 basis points. 

Adjusted Gross Profit was $115.4 million and $89.2 million in the nine months ended September 30, 2020 and 2019, respectively. Adjusted Gross Profit Margin was 49.3% and 49.5% in the nine months ended September 30, 2020 and 2019, respectively. Adjusted Gross Profit excludes $6.4 million of depreciation expense, $1.4 million of share-based compensation expense, $2.2 million in COVID-19 expenses, and $3.0 million of plant start-up expense in the nine months ended September 30, 2020 and excludes $4.8 million of depreciation expense and $0.5 million of share-based compensation expense in the nine months ended September 30, 2019. 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

Selling, general and administrative expenses increased $12.2 million, or 13.7%, to $101.3 million for the nine months ended September 30, 2020 as compared to the same period in the prior year. Key components of the dollar increase include higher variable cost due to volume of $4.3 million, incremental operating costs of $3.4 million, increase in depreciation and options expense of $2.8 million, increase on loss on disposal of equipment of $1.3 million, and increased media spend of $0.4 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 43.2% for the nine months ended September 30, 2020 from 49.5% for the nine months ended September 30, 2019.

Adjusted SG&A Expenses was $81.5 million and $73.2 million in the nine months ended September 30, 2020 and 2019, respectively. Adjusted SG&A Expenses decreased as a percentage of net sales to 34.8% in the nine months ended September 30, 2020 as compared to 40.7% of net sales in the nine months ended September 30, 2019. The decrease of 590 basis points in Adjusted SG&A is a result of 250 basis point gain in SG&A leverage, and 340 basis points leverage gain in media. Adjusted SG&A excludes $8.5 million of depreciation expense, $6.4 million of non-cash share-based compensation expense, $2.4 million of launch expense, $1.3 million of loss on disposal of equipment, $0.8 million in enterprise resource planning expense, $0.1 million in equity offering expense, and $0.3 million in COVID-19 expenses in the nine months ended September 30, 2020,while excluding $7.0 million of depreciation and amortization expense, $5.2 million for share-based compensation expense, $3.3 million of launch expense and $0.3 million of secondary offering expense in the nine months ended September 30, 2019. 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 (Loss) from Operations

Income (loss) from Operations increased $6.2 million to income from operations of $1.1 million for the nine months ended September 30, 2020 as compared to the same period in the prior year as a result of the factors discussed above.

Interest Expense

Interest expense relating to our credit facilities increased $0.3 million, or 45.1%, to $1.0 million for the nine months ended September 30, 2020, of which $0.6 million related to the recognition of debt issuance fees with the repayment of the Draw Term Loan, while interest expense was $0.7 million in the nine months ended September 30, 2019.

Other Income/(Expenses), net

Other income (expenses), net increased $0.2 million, or 149.5%, to other income of $0.1 million for the nine months ended September 30, 2020 compared to the same period in the prior year.

Net Income (Loss)

Net income (loss) increased $6.1 million, or 101.8%, to net income of $0.1 million for the nine months ended September 30, 2020 as compared to a net loss of $6.0 million for the same period in the prior year as a result of the factors discussed above.

Non-GAAP Financial Measures

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

Such financial measures are not financial measures prepared in accordance with U.S. GAAP. We define Adjusted Gross Profit as Gross Profit before non-cash depreciation expense, plant start-up expense, COVID-19 expenses and non-cash share-based compensation. We define Adjusted SG&A as SG&A expenses before depreciation and amortization expense, non-cash share-based compensation, launch expense, loss on disposal of equipment, fees related to equity offerings of our common stock, implementation and other costs associated with the implementation of an ERP system and COVID-19 expenses. EBITDA represents net income (loss) plus interest expense, income tax expense, and depreciation and amortization. Adjusted EBITDA represents EBITDA plus loss on disposal of equipment, non-cash share-based compensation, launch expenses, plant start-up expenses, fees related to equity offerings of our common stock, COVID-19 expenses and implementation and other costs associated with the implementation of an ERP system. We have changed our method for calculating Adjusted Gross Profit, Adjusted SG&A and Adjusted EBITDA in light of certain non-recurring expenses related to the COVID-19 pandemic and in light of the implementation of a new ERP system.

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

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

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

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

Additionally, Adjusted EBITDA excludes (i) non-cash share-based compensation expense, which is and will remain a key element of our overall long-term incentive compensation package, and (ii) certain costs essential to our sales growth and strategy, including an allowance for marketing expenses for each new store added to our network and non-capitalizable freight costs associated with Freshpet Fridge replacements. Adjusted EBITDA also excludes certain cash charges resulting from matters we consider not to be indicative of our ongoing operations. Other companies in our industry may calculate the non-GAAP financial measures differently than we do, limiting their usefulness as comparative measures.

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

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

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

Liquidity and Capital Resources

Developing our business will require significant capital in the future. To meet our capital needs, we expect to rely on our current and future cash flow from operations and our current and future available borrowing capacity. Our ability to obtain additional funding will be subject to various factors, including general market conditions, our operating performance, the market’s perception of our growth potential, lender sentiment and our ability to incur additional debt in compliance with other contractual restrictions, such as financial covenants under our debt agreements.

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

Our primary cash needs are for ingredients, packaging and operating expenses, marketing expenses and capital expenditures to procure Freshpet Fridges and expand and improve our manufacturing plants to support our net sales growth.

Over the next three years we also expect to invest over $300 million in capital expenditures to expand our plant capacity and increase distribution. We believe that our cash and cash equivalents, short-term investments, expected cash flow from operations and planned borrowing capacity are adequate to fund debt service requirements, operating lease obligations, capital expenditures and working capital obligations for the foreseeable future. From time to time, we may access the debt and/or equity markets in order to increase our capital for funding capital expenditures or otherwise. However, our ability to continue to meet our capital resource requirements and obligations will depend on, among other things, our ability to achieve anticipated levels of revenue and cash flow from operations, our ability to manage costs and working capital successfully and our ability to access the debt and equity markets. Additionally, our cash flow generation ability is subject to general economic, financial, competitive, legislative and regulatory factors and other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations in an amount sufficient to enable us to fund our liquidity needs. Further, our capital requirements may vary materially from those currently planned if, for example, our revenues do not reach expected levels, or we have to incur unforeseen capital expenditures and make investments to maintain our competitive position. Moreover, if we issue new debt securities, the debt holders would have rights senior to common stockholders to make claims on our assets, and the terms of any debt could restrict our operations, including our ability to pay dividends on our common stock. If we issue additional equity or convertible debt securities, existing stockholders may experience dilution, and such new securities could have rights senior to those of our common stock. These factors may make the timing, amount, terms and conditions of additional financings unattractive. Our inability to raise capital could impede our growth or otherwise require us to forego growth opportunities and could materially adversely affect our business, financial condition and results of operations.

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

Working capital consists of current assets net of current liabilities. Working capital increased $101.2 million to $113.5 million at September 30, 2020 compared with working capital of $12.3 million at December 31, 2019. The increase was mainly a result of an increase in cash and cash equivalents and short-term investments from the equity raise presented within cash and cash equivalents and short-term investments, and an increase in accounts receivable and inventories, as well as a decrease in accounts payable and accrued expenses. The increase in cash and cash equivalents and short-term investments is mainly from our $252.1 million equity raise and $13.1 million of cash from operations, offset by investments in the increase in accounts receivable and inventories is mainly due to the growing business. The decrease in accounts payable was mainly due to the timing of capital expenditure spend. The decrease in accrued expenses, net of the legal contingency, is mainly a result of the timing of our variable compensation. Further, the Company acquired a 19% interest in a privately held company for $27.7 million on September 2, 2020. 

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

As of September 30, 2020, our capital resources consisted primarily of $84.2 million of cash on hand, $10.0 million in short-term investments, $35.0 million available under our credit facilities, of which $2.0 million is reserved for two Letters of Credit, and $130.0 million delayed draw term loan facility.

We expect to fund our ongoing operations and obligations with cash and cash equivalents, cash flow from operations and available funds under our credit facilities.

The following table sets forth, for the periods indicated, our beginning balance of cash, net cash flows provided by (or used in) operating, investing and financing activities and our ending balance of cash:

Net Cash from Operating Activities

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

For the nine months ended September 30, 2020, net cash generated in operating activities of $13.1 million was primarily attributed to:

This was partially offset by:

For the nine months ended September 30, 2019, net cash generated in operating activities of $3.5 million was primarily attributed to:

This was partially offset by:

Net Cash Used in Investing Activities

Net cash used in investing activities of $137.5 million for the nine months ended September 30, 2020, was primarily related to:

This was partially offset by:

Net cash used in investing activities of $40.7 million for the nine months ended September 30, 2019, was primarily related to:

Net Cash Provided by Financing Activities

Net cash provided by financing activities was $199.2 million for the nine months ended September 30, 2020, attributable to:

This was partially offset by:

Net cash provided by financing activities was $36.9 million for the nine months ended September 30, 2019, attributable to:

This was partially offset by:

Indebtedness

For a discussion of our material indebtedness, see Note 6 to our consolidated financial statements included in this report.

Contractual Obligations

There were no material changes to our commitments under contractual obligations, as disclosed in our latest Annual Report Form 10-K.

Off Balance Sheet Arrangements

We have no off balance sheet arrangements.

Critical Accounting Policies and Significant Estimates

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

There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our latest Annual Report Form 10-K.

Recent Accounting Pronouncements

Recently Adopted Standards:

See Note 1 of our consolidated financial statements for additional information.

Standards Effective in Future Years:

We consider the applicability and impact of all Accounting Standards Updates (ASUs) issued by the Financial Accounting Standards Board (FASB). ASUs not listed herein were assessed and determined to be either not applicable or are expected to have minimal impact to our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

Interest Rate Risk

We are sometimes exposed to market risks from changes in interest rates on debt and changes in commodity prices. Our exposure to interest rate fluctuations is limited to our outstanding indebtedness under our credit facilities, which bears interest at variable rates. As of September 30, 2020, we did not have any outstanding borrowings under our credit facilities.

Commodity Price Risk

We purchase certain products that are affected by commodity prices and are, therefore, subject to price volatility caused by weather, market conditions and other factors which are not considered predictable or within our control. In many cases, we believe we will be able to address material commodity cost increases by either increasing prices or reducing operating expenses. However, increases in commodity prices, without adjustments to pricing or reduction to operating expenses, could increase our operating costs as a percentage of our net sales.

Foreign Exchange Rates

Fluctuations in the currencies of countries where the Company operates outside the U.S. may have a significant impact on financial results. The Company is exposed to movements in the British pound sterling and Euro. The Statements of Financial Position of non-U.S. business units are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. The percentage of consolidated revenue for both the three and nine months ended September 30, 2020 recognized in Europe was approximately 1%.

The Company may, from time to time, enter into forward exchange contracts to reduce the Company’s exposure to foreign currency fluctuations of certain assets and liabilities denominated in foreign currencies. Historically, the foreign currency forward contracts have not been designated as hedges and, accordingly, any changes in their fair value are recognized on the Consolidated Statements of Operations and Comprehensive Income (Loss) in Other expenses, net, and carried at their fair value in the Consolidated Balance Sheet with gains reported in prepaid expenses and other current assets and losses reported in accrued expenses. As of September 30, 2020, there were no forward contracts outstanding.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of such date our disclosure controls and procedures were effective.

Changes in Internal Control

There were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, believes that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at the reasonable assurance level. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.