Freshpet Inc (FRPT) 2016 Q3 法說會逐字稿

Good day ladies and gentlemen and thank you for your patience. You have joined Freshpet's third-quarter 2016 earnings conference call. (Operator Instructions). As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Miss Katie Turner. Ma'am, you may begin.

Thank you. Good afternoon and welcome to Freshpet's third-quarter 2016 earnings conference call and webcast. On today's call are Billy Cyr, Chief Executive Officer; Scott Morris, President and Chief Operating Officer; and Dick Kassar, Chief Financial Officer.

Before we begin please remember that during the course of this call management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements.

Please refer to the Company's quarterly report on Form 10-Q expected to be filed with the Securities and Exchange Commission and the Company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

Finally, please note on today's call management will refer to certain non-GAAP financial measures such as non-GAAP gross profit margin, non-GAAP SG&A, EBITDA and adjusted EBITDA. While the Company believes these non-GAAP financial measures provide useful information for investors, the presentation of this information is not intended to be considered (technical difficulty) as a substitute for the financial information presented in accordance with GAAP.

Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. Now I would like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Katie, and good afternoon, everyone. I am pleased to be hosting my first earnings call with Freshpet. I have been with the Company eight weeks and I'm happy to say that the Company has the potential that I anticipated based on the extensive diligence I performed prior to joining the business this past summer.

I joined Freshpet because I think it is one of the few CPG companies that has the potential to change the industry it is in. The product is unique, strongly preferred by its users and on trend. And the Company has built a very strong platform that can exploit and defend that strong position. And to be brutally honest about it, when I saw the reaction of my dog, Cocoa, to Freshpet I knew it was a winner. She now sits in front of the refrigerator and barks until I feed her.

I also thought that I could add value to the business. I have 31 years of experience working with many of the same customers, managing a refrigerated supply chain in North America and Europe, developing market-leading brands that are driven by strong marketing and developing an organization capable of successfully running a midsize CPG business.

I'm now about halfway through my review of the Company's strategic initiatives and operations. I have done extensive reviews of the Company's products, manufacturing operations, marketing programs, the fridge program, core financials, product development plans, organizational capability and the UK test.

I have also begun engaging with our key customers and sales partners to better understand how they see our business and its opportunities. I can tell you that the opportunity remains very compelling. Unlike many other CPG companies, our challenge is not where to find growth but which opportunities to pursue first.

We have a unique brand with great potential. Our team knows we have a lot of work to do but I'm confident that the future is very bright. I expect to be able to provide a more detailed report on the business and our plans going forward sometime in the first quarter.

Now I would like to turn your attention to a review of our third-quarter results. I will provide a brief overview of our financial highlights and recent business performance. Then Dick will review our third-quarter 2016 financial results in more detail. Finally, Dick, Scott and I will open the line for questions.

We are pleased with our progress in 2016 as we execute on our mission to bring the power of fresh, real food to dogs and cats. We strive every day to give pet parents products that their dogs and cats love and that have a positive impact on their pets' lives. We see the results of our work in the thousands of happy letters we receive from pet parents which you can view on Freshpet.com.

In the third quarter we continued to improve upon key metrics as compared to the prior year and quarter. For our third quarter 2016 net sales increased 13% to $34.5 million driven by increased velocity per fridge and increased store count. Excluding our baked dry sales Freshpet refrigerated net sales grew 17.1% during the period. Freshpet fridge store count increased to 16,261 as of September 30, 2016, up from 14,670 in the third quarter of the prior year.

We are very encouraged by the sales growth on our fresh business and IRI is further demonstrating the positive rebound with recent trends showing total growth in excess of 19%. The growth is driven by solid innovation in advertising that are generating increased velocity in addition to steady distribution gains. Despite this solid performance we anticipate that we will not realize the total planned growth this year due to softer baked sales and lower than expected sales in the pet specialty channel.

Now that the kitchens are complete, we have been able to expand distribution of our shredded product in addition to placing other innovations into market. The transition out of some heritage products into the newer innovations has not gone as quickly as anticipated, but the early response of these products has been positive.

As I said earlier, one of the many reasons I decided to join the Company was my personal experience with Freshpet. My experience is not unique. After using Freshpet the response from pet parents is overwhelmingly positive and our new TV advertising campaign launched during Q3 captures the feedback we receive describing the significant positive changes experienced in a pet's physical appearance and vitality. These messages are resonating based on the recent response we have seen through POS and IRI data. We plan on continuing this theme during 2017.

We also made progress on our planned product distribution test in the UK. At the end of Q3 our Freshpet fridges were in approximately 63 stores across two retailers. Early results of these tests are encouraging and we believe that over time the UK and other parts of Europe could represent strong markets for incremental growth.

From a manufacturing perspective our Freshpet kitchens expansion was complete as of mid-October and on budget. We continue to train our plant personnel on the new lines. We now have significant capacity available to meet anticipated demand for the next several years and can turn our focus to filling that capacity. Going forward we expect that our annual capital needs will be reduced significantly over the next several years to primarily support fridge growth and maintenance CapEx.

We remain focused on the execution of our strategic initiatives which have enabled us to generate increased adjusted EBITDA and positive operating cash flow during the past eight quarters while growing net sales and store count at a double-digit rate.

We appreciate the hard work and dedication of our entire team. We expect our efforts to drive greater leverage across our business model, improve profitability and enhance long-term shareholder value as we finish the year and enter 2017. With that overview I would like now to turn the call over to our CFO, Dick Kassar, to review our financial results in more detail. Dick?

Thank you, Billy, and good afternoon everyone. I will now review our third-quarter 2016 financial results. For the third quarter overall net sales increased 13% to $34.5 million. During the period our fresh sales grew 17.1%. This growth results from both distribution and velocity gains including a 10.8% year-over-year increase in Freshpet fridges.

Gross profit for the quarter was $15.4 million compared to $14 million during the same period last year. Gross margin was 44.4% for the third quarter of 2016 compared to 45.9% in the third quarter last year. After adjusting for depreciation and one-time start-up plant costs, non-GAAP gross margin for the third quarter 2016 was 49.6% versus 48.1% in the prior year.

After adjusting for stock-based compensation, fair value of warrant expense and leadership transition expense non-GAAP SG&A decreased as a percentage of net sales to 40.8% from 46.8% in the same quarter last year. Looking ahead we expect to continue to decrease SG&A as a percentage of net sales as we increasingly scale our operations and better utilize our existing infrastructure while growing net sales.

Adjusted EBITDA was $5.3 million for the third quarter compared to $2.3 million in the third quarter 2015. On a year-to-date basis net sales for the nine months ended September 30, 2016 increased 15.1% to $99 million compared to $86 million for the same period in 2015. Adjusted EBITDA improved $4.2 million to $11.3 million. Adjusted EBITDA as a percentage of net sales for the first nine months was 11.4% as compared to 9.5% in the same period last year.

Turning now to the balance sheet, at September 30, 2016 the Company had cash and cash equivalents of $3.5 million. The decrease in cash from the prior year is primarily due to expenditures related to the expansion of our Freshpet kitchens. Each quarter for the fourth quarter of 2016 through this quarter we generated positive cash flow from operations.

As many of you know, in conjunction with our initial public offering we entered into a $40 million credit facility as we have communicated part of our 2016 plan was to borrow approximately $8 million to $10 million from our credit facility by the third quarter 2016. As of September 30, 2016 we borrowed $10 million and have repaid $1 million. We continue to expect to repay this indebtedness by June 30, 2017.

Finally, I would like to review our annual guidance. We expect Freshpet fridges of over 16,600, an increase of approximately 10%; net sales of $133 million, an increase of approximately 14% versus guidance of $137 million; adjusted EBITDA of over $17 million, an increase of approximately 58% versus initial guidance of $18.5 million.

Based on our year-to-date results and outlook for the remainder of the year, we are lowering net sales and adjusted EBITDA guidance due to lower baked sales than projected and lower than expected growth in pet specialty while maintaining our Freshpet guidance. This guidance includes our expectation for continued adjusted gross margin expansion and leverage of our SG&A expenses.

From a seasonality perspective our adjusted EBITDA will be increased more heavily in the fourth quarter as our expenditures lighten considerably due to the timing of our planned media program. As a reminder, our adjusted EBITDA represents EBITDA plus loss on disposable equipment, new plant start-up expense, share-based compensation, launch expense, leadership transition expenses and warrant expense.

We expect strong growth for our products across our distribution network. We will continue to maintain a strong balance sheet and liquidity to meet demand and further grow our distribution network. That concludes our financial review. Billy, Scott and I are now available to take your questions. Operator?

(Operator Instructions). Jon Andersen, William Blair.

Good afternoon, everybody. Could I ask first of all on the guidance update on the top line, if you can talk a little bit about what is happening with baked? I am assuming that you anticipated some decline in that business. I know you have been reorienting around the fresh refrigerated offering.

And then if you can add a little bit more color too about what you have just seen in the pet specialty channel, if that is a channel -- overall channel dynamic or if you are seeing something more specific with your business? Thanks.

Jon, let me take a stab at that and I will pass it off to Scott. But as you commented, the refrigerated business has done very well; you saw that in the data that we posted, that the core refrigerated product business had a very good quarter showing up in the IRI data, the trends are very good and our advertising is driving it quite well.

The basis for us taking the guidance down was the softness that we saw in the baked business and what we are seeing in the pet specialty channel. And we feel pretty good about where we have got the guidance going forward, but it is less than what we had anticipated when we built the plan at the beginning of the year.

The business though as we are looking at it and the core of the business is really in the refrigerated products business. We have some work to do to figure out how the baked part is going to fit in. But I will pass it to Scott to give you a little bit more detail on that.

So as Billy was saying, obviously the core refrigerated business is doing quite well. We are really actually very enthusiastic about how it has responded to advertising innovation. Throughout the year the last two quarters have -- we have seen nice gains there and the two areas of softness are really around the pet specialty business, as you mentioned and baked.

In the pet specialty business there are -- it is slightly softening from what we have seen kind of as an industry, but the key pieces for us or the core components to that softening really center around some transition that we had where we are going out of some products and into a couple of others. The transition was not as smooth as we would like.

And then secondarily, in order to put that business in a better position long-term we have actually changed distributors. So there is a fair amount of disruption going on in pet specialty and we think that is the lion's share of the impact in that channel.

So those are the two major components that we are seeing to really impact the business. And we are looking from now until the end of the year and seeing how the business is going to be pacing, our advertising is off air at this point, our innovation for the year is somewhat in and that is why we wanted to update the numbers for the back.

Okay, thanks. That is really helpful. Just one other one for me. On the advertising, the new campaign, could you talk a little bit about, number one, how much you spent in the quarter or plan to spend for the year on advertising and how that may evolve in 2017? And then just some of the kind of initial results you are seeing from that program? Thank you.

So we did put the new campaign on-air and we are very excited about how the business responded to that, which is really what drove the numbers in that quarter. So a combination of innovation and the TV. The TV was just on for three weeks, so it is almost a sampling, not really a lot of advertising in that quarter at all.

So it gives us a little bit of a feel for the response rate and the impact it has on the business and it leaves us feeling very encouraged about when we go on-air next year the response this should have or the impact it should have on the business.

So, we like the new campaign, we like the impact of it. And we think it kind of positions us really well next year once we kind of establish exactly the rates that we will be investing in behind the advertising.

Let me add a little bit of commentary to that coming from, first, my P&G background, then the last 11 years at Sunny D. One of the things that impressed me when I got here was when you look at the advertising, how quickly can see a reaction from the advertising in the market.

I'm used to seeing advertising build over a long period of time, but the organization here has developed a really nice capability to first see the impact the advertising on our Internet interaction, the social media interaction, the connections we have with the consumer. And so, even though the advertising was only on the air for three weeks, we started seeing early diagnostics that it was having an impact fairly quickly.

The second piece of it is that the advertising having been on the air for only three weeks gives me a lot of confidence that it has a lot of life left in it. We think we can run this as a campaign and broaden it out to a campaign, but even the initial executions have a lot of life left in them because they've only been on the air for three weeks.

But the third part is the quick response we saw in the market, I mean most of you see the IRI data and the uptick that we saw in the measured channels is really a strong testament to how effective this campaign was at re-engaging the consumer against the benefit that Freshpet offers.

So it gives me an awful lot of confidence that we have a winning marketing model. We haven't figured out how much we want to run that in the next year. That is the work that I am doing as part of our strategy work and we will share it with our Board later this year. But it does give you a really strong foundation to start with as you look for building blocks to build a plan going forward.

If I could just squeeze one more in. Billy, you mentioned in your prepared comments that you have begun the work of engaging with a number of key customers. Is there anything that you can share there in terms of feedback from key customers in terms of their overall view of the business and your confidence in your ability to continue to kind of drive the store count higher and drive velocity? But some findings from those initial discussions if you are willing to share any of that it would be helpful.

We are only in the middle of that part now which is, in fact, we are heading off to see another one tomorrow. But what I would say that I have learned so far is, first, when you have a proposition that is growing as quickly as we are with Freshpet customers are inherently interested. There is not a lot of things that they are seeing in the store today that have the level of growth that we are talking about and it is growth that comes at basically full retail price. So this is very attractive for the retailers and that is seen.

But the second part of it that I would highlight is most of these customers look at this as a slightly more complicated execution to get into this, it is not just put it on the shelf and watch it fly.

We have to put the chillers in. And so the level of sophistication in the sales presentation that we have to make to the customers is a little bit more difficult, a little bit more challenging than what you would normally expect to see for a new item. It builds a heck of a barrier to entry once you get it put in but it does mean it is a little bit more sophisticated sell and it takes a little bit longer and my challenge is to find ways to get that to go more quickly.

You would logically think that when customers have put the chillers in 40%, 45% of their stores it would be a layup to say they should have this in 75% or 80% of their stores and that hasn't happened yet. And so my focus is to figure out what it will take to unlock that.

And we have a couple of good ideas but we are not ready to share those at this point. I would just say that I feel pretty confident that the customers will want to realize the opportunity that we have, the growth rate that we have in more of their stores and our challenge is to find a way to make that happen faster.

Thanks. I will get back in the queue.

Bill Chappell, SunTrust.

This is actually Stephanie on for Bill. My question is kind of going off what was said before at SG&A. It looks like it came in well below our expectations. Is this more or less kind of the new base you expect going forward? Or do you plan more of a meaningful step up due to media and advertising spend? Kind of just some color on what you are expecting from SG&A going forward would be helpful.

Sure. In our SG&A we have both fixed and variable costs. Our variable costs are our marketing spend, but the marketing spend for the third quarter was basically similar to the first two quarters of the year. It will come down somewhat in the fourth quarter.

The other variable expenses -- major variable expense is logistics. And logistics is tied to our revenues, but we did have a new supplier coming in in June and we have realized a nice savings when you see the details when the 10-Q comes out you will be able to uncover that.

So we are looking at SG&A for the year around $62.5 million and we feel good about how it is currently being leveraged.

Great. That is very helpful. And then my second question is kind of just looking at the 17% growth in the fresh product was very strong, kind of above what we were expecting. Is there anything we need to consider from a year-over-year comparability standpoint that may drive that or is this kind of a good proxy for going forward and like what is to come?

So our comparables last year were a little softer in this period, but the other thing that we are seeing is we are seeing period-on-period growth too which is what we really like. So we have been able to see a nice -- we have had a flattening in the middle of the year. And then over the past two quarters we have started to see growth reaccelerate so we have been able to see that.

So year-over-year you will definitely see a nice increase but also period-over-period or quarter-over-quarter, even four week basis we have seen kind of nice numbers coming around. So it really will correlate back to what we are spending on the business next year from an advertising standpoint and where we go from and innovation standpoint and then how these stores layer in. And those are basically the three building blocks of the business obviously. So it will -- I think it is going to be very variable depending on how we invest and structure the business plan next year.

Got it. That is it for me. Thanks.

Rupesh Parikh, Oppenheimer.

Thanks for taking my question. I also wanted to go back to the guidance changes for the full-year. First on the pet specialty channel, how quickly do you think you can move past some of the issues you had on the product side?

We think this is primarily going to be something that we saw a little bit of an impact in late Q3 and then into Q4, we think this will be balanced out by the beginning of next year. But I think that we will have a really strong perspective and update for everyone early in Q1 on exactly what we are seeing and how things have kind of balanced out.

Okay, great. And then on the baked side I just wanted to get a sense of what is in the guidance for the full-year on baked. And as you guys look forward to next year where does bake fall in terms of your priorities?

Let me start with we haven't figure out what the priorities are for next year yet, that is one of the things that we are working on. The guidance that we gave does reflect a softening on the baked business. Scott will give you a little bit more detail on that. But we are clearly watching and learning on the baked business to figure out what role it will play in our portfolio.

One of the things I'll build on too from a baked standpoint is this is a really unique proposition that is quite timely with consumers and really the softness that we are seeing is -- and I think we had mentioned there is going to be puts and takes from a distribution standpoint.

Most of what we are seeing is some distribution that has gone away on the baked business but we do expect a little bit of a softening in velocity for the balance of the year. But there is a nice opportunity and it can kind of balance out in the portfolio. Right now it looks like it was about -- we originally budgeted around $6.2 million and baked and it looks like it is going to end up being closer to a little bit over $4 million for the year.

Okay, great. Thanks for all the color.

Peter Benedict, Robert Baird.

Just back to the marketing, just curious, the 2016 marketing spend that you guys are going to come in with, how does that set up versus your initial plan? I mean are you spending what you thought you would? Are you spending a little less? Just trying to understand that.

And the plans for the fourth-quarter marketing, I think Dick may have said it was going to be down versus the prior few quarters. Trying to understand why -- I know historically you guys pulled back in the fourth quarter, but with the capacity now in place why won't you guys push the marketing right now?

We are basically going to spend from a marketing standpoint almost exactly how we had planned for the year. And when we planned out the initial part of the year we had planned to kind of pull back in the Q4 period.

We do have tremendous capacity at the kitchens now and that is something that we would want to pull together in an overall strategic plan for next year, establish what the level of spending and a level of investment in the business and the response we anticipate getting.

So, I think we have got a really good feel for the new campaign, as I mentioned earlier. And it puts us where we are in a position to be very well educated around how we invest in the business and really what the results should be for next year.

And so just historically I guess what has been the timing of the demand response? You turn on some advertising, how long does it take to show up in the sales numbers? And is the recent three-week test; did that show any changes in terms of that, assuming that the demand response could be that quick? Maybe it takes longer than that. So just curious how that works.

We saw almost -- within kind of two weeks we saw an acceleration in the business behind the advertising and that coupled with the innovation that we layered in gave us that nice kind of pop that we have been able to see in IRI and also in POS.

And it was planned -- like I said, it was planned on how we budget the year and that we were coming off in Q4. Typically we will come off in Q4. This year is a fairly complicated Q4 whether it is elections and holidays, etc. But that was really planned out in the beginning of the year.

Peter, I would emphasize the comment I made earlier which is that we get pretty good indications very quickly about whether the advertising is having an impact based on the commentary we get in social media. And then from there you started seeing it in the IRI data. And so it gives me a lot of confidence that we have the right advertising and the right message.

There is the fact of life that when you put advertising on air, while you can get an immediate impact it is not necessarily going to be an immediate payout, payout takes a longer period of time. And so running the media, skewing it more towards the front end of the year has obviously been a smart choice for this business as it would build demand throughout the year and we would expect to see that going forward.

The absolute level of the media spend is the thing that we have got to really work on. Right now the spending is as it was planned for this year and the spending that we had this year was relatively consistent with prior years. The question is is that the right level for this business?

That makes sense, Billy. And just as you think about that for next year with the prospects for that spending to probably go up it sounds like, are there areas of the business where you see some ways to kind of fund that increased investment whether it be in efficiencies in certain areas, cost outs in other areas? Or is that just the kind of thing you just have to take some P&L pain in order to get the longer term gain?

You sound like you are asking the same questions I am asking as I'm doing my strategic review. But clearly you have to think about this business as a business that is growing very quickly, it is relatively young in a lot of ways. Even though the Company is 10 years old, a lot of the capabilities that the Company has built have been built relatively recently.

And so the challenge for us is to figure out which of them we need to focus on and emphasize, which of the opportunities we want to pursue because there are more opportunities here than most companies see across a much larger portfolio.

And then also where are the opportunities to do things more efficiently? Because as you basically build an organization to meet demand you don't spend a lot of time focusing on doing things efficiently early on, you just want to get them done.

Now we have the time and the resources to focus on doing things more efficiently. And I will tell you just like there are a lot of opportunities for growth, there are also a lot of opportunities for growth, there are also a lot of opportunities for efficiency. The challenge is to figure out which ones we want to resource and prioritize first.

Okay, thanks. Just a last question around CapEx, can you give us a sense of what the CapEx was in the third quarter and kind of the plan for the year. Where do you think that comes in? And then just remind us the maintenance CapEx needs maybe on a per fridge basis, how we should think about that as we model going forward, thank you.

CapEx year to date was $26 million and we will be somewhere in the $28 million by year end. We have about $1 million left for completion of our manufacturing facility; it was a hold back from the construction management team.

CapEx on maintenance, looking at for the year about $1.5 million. We probably have about $200,000 or $300,000 left going forward as we might have mentioned in the past. CapEx going forward is just basically chillers. We have capacity, as we've told you before, in the $350 million to $400 million range in our existing facility in addition.

So there is really no capital from a plant other than maintenance CapEx which we are estimating at about $2.5 million. CapEx for fridges will be about $3,500 a store for 2017 and we will be letting you know what we perceive our store count gain to be in the early part of 2017.

Okay, that is helpful. Thanks, guys.

Jason English, Goldman Sachs.

Good morning, folks or good afternoon I guess it is now. My time is all screwed up. Real quick on dry -- if refrigerated was up 17% it looks like dry was down around 50% this quarter. Does that math sound about right to you guys?

Yes, last quarter it was about -- last year it was about $1.8 million, this quarter is around $900,000.

There was pipeline in the year ago and pipeline for some significant new customers in the year ago period.

Okay. Is there any return sort of dampening the number this year or is this sort of a real baseline to operate off of right now, the $900,000?

Well, we are projecting, as Scott said earlier, about $4.3 million for 2016 versus what we planned was $6.2 million.

Okay, so it looks like -- I think that implies even sequential deceleration in sales in the fourth quarter, is that right?

And Jason, I think I just touched on it, but a lot of it was around -- and we knew there were going to be some puts and takes from a distribution standpoint, so we have actually -- there has been some distribution that has gone out and there is actually some distribution that we anticipate coming in over the next few months too.

So it is too early to zero this out as we think into next year then, if you are picking up new distribution, is that fair?

Yes, that is right.

And then can you help me on the math on how we leak out $4 million of sales, $2 million is pretty much on the dry which doesn't make any money. So you are kind of losing $2 million on refrigerated and it drops all the way through to a $1 million reduction at EBITDA. And it sounds like expense wise there is no surprises there. So is it just a variable contribution on the sales as they leak out, it is leaking out at a 50% rate -- for refrigerated?

Yes, we have a gross margin of approximately for the quarter, when you take refrigerated out of the picture, somewhere around 45%. We certainly have depreciation in there. We will be experiencing some additional depreciation in the fourth quarter as we deploy our chub line. The chub line is ready but we just didn't need it, but we'll start to need it in November.

So it's about -- we kind of generate to the bottom line about 40% of -- 40% goes to adjusted EBITDA for every dollar of sales. So if we are going to be down $2 million in sales -- and I agree with you -- there is not much of a contribution coming on the baked side, that is why we kind of took down our EBITDA from $18.5 million to $17.5 million.

Got it. Thanks a lot, guys. That is helpful.

Eric Gottlieb, D.A. Davidson.

Touching on the change in distributors, one, what prompted the change; and two, how much savings -- you have explain this quarter there is some leakage, but going forward how much savings do you anticipate?

From a specifics around savings that is something that I think we need to kind of get into when we discuss our full business plan for next year. We do anticipate some savings but a lot of it will center around service levels also and alignment with a handful of other things around the business. So that is something we will probably need to touch on in more detail in the future.

Okay, so it was a servicing decision and not a financial decision for the most part?

There are some savings, but it is also service related and aligning with a couple of other things that we are trying to do on those businesses also.

Could we talk about some of the other channels? I mean we talked about pet specialty a lot, but how is grocery, mass at natural stores? How did they perform?

For Freshpet or for the category?

Both actually.

So for the category I think that what you will hear across the industry is there has been a slight slowing overall in pet, but the people that have a lot of typical traffic in their stores, grocery and mass, and most of the mass accounts where they have a lot of people coming in on a more frequent basis, they have been able to weather the storm quite well. And most of them are putting out modest growth not quite as high as 2%, 3%, 4% like you have seen in the past, but they are definitely showing and posting growth.

From a Freshpet standpoint our kind of growth has really mirrored that where in grocery and mass those have been the channels that have really accelerated, and also natural. The place that we have seen some softness is on the pet specialty piece. But as I have mentioned, there's a couple of other factors that are contributing on the pet specialty component.

When you step back and you think about the way the shopper or the way the consumer buys this product, you have to recognize that because we have relatively short shelf life product the consumer puts us in the refrigerator where they don't have a lot of space. We get people who shop more frequently for this, so that obviously skews the business to the channels that they visit more frequently.

We sit and listen to consumers in research tell us how it is so much more convenient to buy this product because they don't have to go to -- necessarily to a pet specialty store, they can buy it in a lot of different outlets including the grocery stores as part of their regular shopping trip. And so there is a lot of value for it in the breadth of the distribution that we offer.

And it also is good for the retailers and the retailers like it because we end up bringing consumers into the aisle shopping more frequently. But going back to the advertising piece too. It also means you can see a more rapid impact back to the advertising because consumers are purchasing this brand more quickly.

When you put advertising on the air you can see a reaction much more quickly. Rather than waiting for a 30- or 60-day purchase cycle we can be 7- or 10- or 14-day purchase cycle. So there is some real benefits there and we start seeing that in the channels of like mass and in grocery. It is a really started asset of the business.

Got it. Thank you for the color. One last one on the store count guidance being unchanged. I am curious if this quarter met your internal projections? Meaning did you have some cushion built in there on the full-year 2016, [600]? Or are we right where we thought we would be?

No, we have been tracking really tight on store count and store growth for the year. And I think what we have tried to do based on past years is make sure that we are budgeting as appropriately as possible for store count.

Very good. With that I will pass it on. Thank you.

Rob Moscow, Credit Suisse.

Hi there, Billy. Just a couple questions. So the first is we had a chance to meet with you recently and I think your commentary was you have done a preliminary overview of the business, no big surprises. And I just want to make sure that the guidance reduction here wasn't like an end of quarter kind of surprise or if it was just kind of like -- well, it makes sense based on where the business was headed. And then I will just have a follow-up.

So when I told you no surprises my focus was very much at a sort of broad strategic level, are there any big bogeymen in the closet somewhere that tells me that this business isn't going to have the long-term potential that I anticipated it would have? And as I said when I met with you, the long-term potential of this business is very clear. And in fact, if I was going to say there was a surprise and there really haven't been any significant surprises.

But the surprises could be the number of opportunities are probably a little bit greater than what I'd expected and that is going to put the burden on us to be a little bit more choice will about which opportunities we pursue.

The magnitude of the reduction that we gave you in the guidance is a relatively small reduction. And so when I met with folks, and if you look at across the quarter and you kind of trend it across the balance of the year, it is not a huge change. And so really it's not one thing happened at the end of the quarter that is going to have an impact.

It's just sort of a glide path reflected in the bake business, reflected in the pet specialty business that cumulatively adds up to over the second half of the year the numbers that we have given you for the guidance. If it was a huge change I'd think you would be fair in poking at really where is the surprise. But it is not a huge change; it is just reflecting the reality that we are seeing on sort of the glide path in those two parts of the business.

I just wanted to make sure from your perspective.

No, that is a good question.

And secondly, just on the logistics thing, I guess I am still a little confused. What kind of services was that distributor providing? Were they in the stores resetting shelves? Was it vans going to pet specialty? And how is the new provider different? Is it the same type of service that they are providing?

So these are folks that deliver to pet specialty. You look for a handful of options -- everything from the overall agreement on kind of what the charges are for delivery, but you'll look at frequency, you'll look at fill rate and service levels, you're going to look at minimum drop levels which can start obviously affecting your frequency.

So every one of those have the ability to impact the business in a positive way, both on being an in-stock rate but also from a cost standpoint. So after kind of looking at this for a pretty extensive period of time we evaluated it, thought about it, did some testing around it and thought it was a really smart move for kind of the long-term piece of business. We hope it positions pet specialty in a -- put us in a better position in pet specialty over the next several years.

So, Scott, I just want to make sure like when you say that the transition to heritage products in the stores hadn't gone as quickly as you had hoped, is that a function of that distributor not executing well or is it just the retailer just not willing to make that transition?

No, the retailers were willing to make it, it is just a combination of we had just because of timing that the retailers have to actually change out products. So there's specific timing as you are well aware, there are certain times of the year. So we had certain products kind of going in and out at the same time we had a distributor transition.

So you kind of add those things together and we knew that there were potential downsides to it, but typically we have been able to manage them pretty well. In this case things did not go quite as smoothly, as you can imagine, transitioning a piece of business like that.

And making sure one distributor is kind of moving out, another distributor is coming in and maintaining the service levels, even the prior service levels that we had in the store can be fairly tricky. And that is where we got caught up. And couple that with some product transitions and those two pieces together created some softness in the business.

Okay, thanks. And last question, Dick, you might have said it, but did you give a new gross margin, adjusted gross margin target for the year? Is it something around the lines of like 45% or something?

As you know we came in in the quarter we have first time -- we got hit with a new depreciation for the expansion; this quarter had $500,000 additional in the quarter. And in the fourth quarter when we bring up the chub line we are expecting another $250,000. So the depreciation for all of the new equipment, for the upgrade of the facility will be at about $3 million incremental to where it was. Previously we were in the $2.2 million range. So we are looking at now $5.2 million.

And so during that quarter we also had about $500,000 of plant startup expense. For the year with what we are trying to do now, what we did on the press release we wanted to show you what is happening without this depreciation and without these startup expenses and we displayed for the quarter 49.6% versus 48.1% in the prior year.

And it gives the reader a sense that when you look at the margin going down it is a result of non-cash items you kind of think we are being inefficient. But what is really occurring is we are starting to leverage some of that.

And obviously as time goes by, as we increase our productivity on our lines that we have just purchased we advised earlier that those lines could produce potentially 30% more currently over time but it is going to take time.

For the year we are on a -- on an adjusted basis I don't have a problem with 49% when you add back the depreciation and the startup expenses. But if I'm going to take a $250,000 hit in the fourth quarter above and beyond the current depreciation our numbers will be in the 44% range after depreciation for the fourth quarter.

Okay, so, Dick, before you said it was 46% last quarter. So -- and that was all in with all the depreciation charges, right? So I'm just basing it off of that. So are you down versus that?

We'll probably come in the year around 45%.

45%.

The depreciation charges were higher than I anticipated.

Okay, thank you.

Mark Astrachan, Stifel.

Thanks and good afternoon, everyone. On the third quarter, the 17% growth in the core product, how much of that came from innovation, how much of that came from the UK launch?

The UK launch is really small, we are a little over 60 stores there, so it is almost a rounding error. Now since you brought up the UK launch, I mean what we see and Billy mentioned there are several opportunities on the business. We like what we are seeing in the UK, we are moving forward, we are now in two of the majors, the velocity trends look strong upfront, so we are encouraged by that.

But that is another thing where we are going to have to be really thoughtful about the resources that we put against that. But overall the UK launch -- very, very small contribution for this quarter.

What about for the year?

Even for the year. I mean you are dealing with 60 stores out of over 16,000. So it is a really, really small piece of business. It is incredibly small. I mean we are talking in the hundreds of thousands kind of number. But on a per store basis that is what we are looking at.

From an innovation standpoint, I mean really if you look at the back of the year here, we look at same-store sales you are seeing a low-double-digit number in the quarter and of that it is broken out almost 50-50 between innovation and TV.

I think it is also important to know when you think about the Company's track record with innovation, success the Company has had, it is important to take a step back and realize where we are on the product which is way ahead of competitors.

The product differentiation and the superiority of the product versus all the alternatives is quite impressive. And so while we have a history here of driving innovation as a key driver of velocity, at some point you have to look at it and say how much more can we get out of the innovation that we have already done. That is one of the questions that we are looking at.

I don't have a conclusion to that, but as you look at the success that we have had of late and where some of our greatest performance has been, it is on some of the products that have been launched recently, but they have all lot of life left in them. They have a lot of room to grow household penetration, distribution, there is a long runway for the products that we already have.

Got it. And then for the fourth quarter what is guidance implying about pet specialty sales given the deceleration it seems at least in our numbers for the two-year sales CAGR based on what you have given? And obviously we can see what the scanner data is doing in the food, drug and mass channel, so it sort of gets you the same thing.

So I guess the question is what is the number that you are expecting? Or sort of broader strokes how are you expecting pet specialty to perform in your guidance in the quarter? And is there also inventory out there in wherever it is, channels whether food, drug, mass or pet specialty that needs to be drawn down?

So from a pet specialty standpoint, so the rest of the business we continue to see some growth around it, but in pet specialty specifically we see it being very flat through this next quarter. So basically pet specialty and baked are going to be basically almost directly flat and potentially down a little further than what we saw in Q3. And from a -- I'm sorry, what was the second (multiple speakers)?

Oh, from an inventory standpoint -- there is always kind of some ebb and flow in that. We don't anticipate anything significant from an inventory standpoint, inventory adjustment standpoint.

Got it, okay. And then just lastly, back to Rob's question. So Billy, I understand it has been eight weeks since you have been there. If you want to sort of read probably too much into what you have said in terms of taking a good look at the business. Am I wrong in thinking that there is a probability of a larger reset coming in 2017 given all that you have outlined?

You've talked about the comment that Scott just made about resources in the UK, the comments about advertising spend in terms of what it is that you wanted to support. So as you are sort of looking at revenues from a trajectory standpoint, call it mid-teens this year, are we talking about numbers that on a revenue basis are going to be worse than they are this year as you are sort of selectively looking at businesses that you want to be in?

And then, is the cost to grow those businesses decently greater than sort of the run rate that we are at today. And I get that you are not going to know the answer, but for those out there that are trying to think about whether there is more to come here what can you do to either allay those fears or say look, it may be that case?

Well, first of all you are right, I'm not going to be in a position that I am ready to talk about it. We haven't shared it with our Board and we haven't aligned to what the plan will be yet. But I would tell you that the overarching comment is that there are more growth opportunities here than I probably expected. And the question is how are we going to pick between them?

So I am not expecting us to come back with any plan that would talk about decelerating growth. I think the focus and the mandate that I have got is to find a way to accelerate the growth. How we do that and what resources we have available to do that, that is the question that we are wrestling with. But this is a growth oriented Company, we are striving for faster revenue growth and that is what we are going to be driving for.

Great, thank you.

At this time I would like to turn the call back over to management for any closing remarks.

Thanks, everybody. We appreciate you joining us for the call and look forward to finishing up the year and letting you know how that turns out. So thank you very much, everybody.

Thank you, sir, and thank you, ladies and gentlemen. That does conclude your program. You may disconnect your lines at this time. Have a wonderful day.