Freshpet Inc (FRPT) 2017 Q4 法說會逐字稿

Greetings, and welcome to the Freshpet, Inc.

Fourth Quarter 2017 Earnings Conference Call.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Katie Turner, for opening remarks.

Please go ahead.

Thank you.

Good afternoon, and welcome to Freshpet's Fourth Quarter 2017 Earnings Conference Call and Webcast.

On today's call are Billy Cyr, Chief Executive Officer; and Dick Kassar, Chief Financial Officer.

Scott Morris, Chief Operating Officer, will also be available for Q&A.

Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws.

These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could 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-K filed with the Securities and Exchange Commission, and the company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

Finally, please note, on today's call, management will refer to certain non-GAAP financial measures such as 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 in isolation or 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.

The company has also provided a presentation to accompany today's call.

It's available online in the investor's section at Freshpet's website at www.freshpet.com.

And now I would like to turn the call over to Billy Cyr, Chief Executive Officer.

Thank you, Katie, and good afternoon, everyone.

To begin, I will provide an overview of our financial highlights and recent business performance.

And then Dick will review the impact of tax reform, a policy change related to the new revenue recognition standards and our guidance for 2018.

Following that, I will provide greater detail on our plan for 2018.

Finally, Dick, Scott and I will be available to answer your questions.

Let me start with Slides 5 and 6 in the presentation we have provided, which highlight our results for 2017.

We are pleased with our financial results for the fourth quarter and the year.

We delivered on our most important goal to accelerate the growth of Freshpet and prove that the core fresh business could sustain 20-plus percent growth again.

We exceeded our annual guidance of $156 million in net sales, delivering $156.4 million.

This was driven by 22% growth on the fresh business in Q4 and 20% for the year, up from 15% last year.

Fresh consumption across measured channels, plus pet specialty, exceeded shipment growth in the quarter as it was up 23.4%.

We also exceeded the $16 million adjusted EBITDA goal we set for the year, delivering $17.6 million, off less than 1% versus year ago despite a 60% increase in advertising investment.

The improved performance versus our goal is largely the result of higher net sales for the year.

The advertising investment that we made early in the year added new pet parents to our franchise, and our fourth quarter results prove that the brand is as sticky as we anticipated based on the retention of those users even with only minimal planned advertising investment in Q4.

This represents the cornerstone of our Feed the Growth strategy and gives us confidence that the plan is working and can drive significant growth in the years to come.

Slide 7. The growth in Q4 was broad-based, with the fresh business growing 20-plus points faster than the category in both grocery/mass as measured by Nielsen xAOC and pet specialty.

Freshpet was up 24% in grocery/mass versus a category that was up only 2%, and Freshpet was up 14% in pet specialty versus a category decline of 7% in the channel.

The baked business was a little more than 1 point drag on the total business in the quarter and brought the total growth rate in Q4 to 19.5%, the total growth rate for the year, to 17.5%.

Slides 8 and 9. This growth also came behind a significant increase in the Freshpet consumer franchise.

Aided awareness grew from 35% to 40%, but it is still well below our competitive benchmarks, leaving a lot of room for future growth.

Household penetration grew from 1.4% to 1.8% due in large part to our advertising investment but is still only a fraction of the potential 10% of households who are behaviorally similar to the consumers who buy Freshpet today.

Even more impressively, the average buying rate for Freshpet also grew 13% during the year, but it is less than 1/6 of the rate we would expect if the average 30-pound dog ate Freshpet exclusively.

We are very encouraged by these results but even more encouraged by the upside potential that comes from the combination of an expanding franchise and increasing dollars per household per year.

Slide 10.

On the operational side, our adjusted gross margin for the year increased 40 basis points over the prior year and 20 basis points versus the prior year fourth quarter.

While we sustained the progress we made on yields in Q3, we did not make the progress we had hoped to make on adjusted gross margin as we experienced increased costs on our inbound freight and some upward pricing pressure on specific ingredients.

We expect some of those cost increases to continue into 2018.

We also allocated time in Q4 to a number of new product trial runs, had some seasonal labor expenses and experienced a shift towards our higher-priced and higher-penny profit but lower percentage margin Fresh From The Kitchen line.

Our proprietary production process for Fresh From The Kitchen is slower, so the adjusted gross margin percentage is lower.

We continue to evaluate ways to provide a longer-term systemic solution that will resolve that issue and improve our future manufacturing performance.

In total, these items reduced our adjusted gross margin to 50.1% in the quarter and to 50.0% for the year, below our target of 51%.

From a longer-term perspective, while we have succeeded in eliminating all the start-up costs that we added back in 2016 and offset the gross margin impact of the ongoing mix shift, we did not make the added adjusted gross margin progress we expected.

We believe we understand the issues and are confident that we can restore the progress we saw in Q3 as we progress towards 2020.

But as we have said, progress will not be linear.

There will be some steps backward as we add staffing or continue to test and evaluate cost-savings efforts.

Slide 11.

In Q4, we continued to add stores but also saw the continued increase in store closings.

As a result, we ended the year with 18,004 stores.

For the year, our net store count was up 1,395 stores from 2016, reflecting gross new store additions of 2,001 and the loss of 606 stores, a large portion of them due to store closings.

As we've indicated previously, we believe that the net effect of the store additions and closings is that we are moving towards a more productive blend of stores that are capable of servicing the expanded consumer franchise we are creating.

The best measure of this has been our success at increasing the velocity per store or per point of ACV.

In 2017, we increased the weighted average velocity by 16%, accounting for about 70% of our total sales growth in measured channels.

Said another way, if we had added no new stores in the year, we would have grown the business at least 16% in the measured channels.

And fridges that have been in place for many years demonstrated strong same-store sales growth, further demonstrating that Freshpet's growth is more directly related to the expansion of the consumer franchise, driven by advertising rather than by the placement of more fridges.

Yes, older fridges can grow like younger fridges.

This can be seen on Slide #12.

We continue to believe that we will be successful at adding new stores due to the increasing velocity, strong margins and frequent store visits that Freshpet provides to retailers, but we are also mindful that brick-and-mortar retail is under pressure, so we will not rely on distribution growth as the primary driver of growth for the business.

Velocity will be our primary driver, and we will focus our teams on a wide variety of ways that both we and retailers could increase velocity per store, including size of fridge, placement in the store, assortment and in-stock conditions.

In summary, 2017 was a very good year for Freshpet and positions us well to deliver our long-term goals.

Our Feed the Growth strategy is working and has demonstrated an ability to deliver to the kinds of returns Freshpet is capable of producing.

Now I will turn it over to Dick.

Thank you, Billy, and good afternoon, everyone.

Slide 14.

Let me start with tax reform and its impact on our business.

Simply put, there's very little impact on Freshpet.

As you know, we have a significant cumulative net operating loss or NOL, which should keep the company from paying federal income taxes for many years.

As a result, the reduction in the tax rate will have no impact on our after-tax income.

Additionally, our NOL was not capitalized, so there'll be no impact for our balance sheet from the change in the tax rates.

Any other impacts for the new tax law should be minor.

Slide 15.

Secondly, I want to inform you about our accounting change we make in 2013.

As most of you are aware, the financial accounting standards for revenue recognition policy requires companies to review the way they record revenue.

In conjunction with our auditors, we have completed our review and will adopt those new standards in 2018.

The net result of that change is that it will change the geography of certain charges within the income statement from collective goods sold to a reduction of net sales.

The net effect for Freshpet is that net sales will be approximately 2.6% lower than under previous accounting policy, and there will be a corresponding increase of roughly 130 basis points in gross margin.

There is no change to gross profit, adjusted EBITDA or net income.

For example, 2017's net sales of $156.4 million will be reported as $152.4 million under the new policy and the adjusted gross margin of 50% would be reported as 51.3%.

There is no change to net income, EBITDA or adjusted EBITDA in the year.

We plan to adopt the new standard using the full retrospective approach that ensures that when 2018 results are presented within our regulatory filings, they can be compared to prior year results under the new standard.

Slide 16.

In light of this, we considered whether we should change our long-term net sales target of $300 million in net sales as of 2020 and have concluded that we will not.

The new accounting policy means it will have to deliver about 2.6% more growth by 2020 to hit our goal, but we are very confident in the strength of our plans and the numerous ways in which we can achieve the goals.

We will, however, restate our adjusted gross margin goal, increasing it by approximately 130 basis points to 53.9%, which is solely a reflection of the benefits we are getting from the accounting change.

This accounting change does not change our view on the number and size of the savings opportunities we have, so we are comfortable increasing the target to full pass-through of the adjustment.

Slide 17.

Now to focus on our guidance.

2018 starts with net sales of $185 million, an increase of more than 21% versus year ago and up 23% on the fresh business alone.

Recall that I'm using the new revenue recognition standard for both our 2018 net sales projection and for the comparison to 2017.

Before the accounting change, the 2018 net sales guidance would have been at least $190 million.

While net sales should steadily progress through the year, various factors in the year ago period only dilutes the year-on-year comparisons.

We expect the net sales growth to be particularly strong in quarter 1 because of the trade inventory reduction we executed in the year ago period.

Further, the Nielsen consumption data for the measured channel is up more than 27% year-to-date in 2018.

Quarter 2 will be our toughest year-on-year comparison because last year's quarter 2 benefited from an initial 60% increase in advertising and the later Easter timing, and thus produced the strong year-on-year growth.

Quarter 3 and quarter 4 should then begin our reacceleration of the growth.

Our plans for 2018 includes the media investment increase of 60% with the bulk of the increase in media spending in the second half when compared versus the prior year.

While Billy will provide more detail on our overall media plan, it's important to note that the media investment we will make in quarter 3 and quarter 4 will not pay for itself this year but will provide significant momentum as we head into 2019, further accelerating our growth rate and likely exceeding the 25% growth rate we will need to average in order to deliver our $300 million net sales goal.

Adjusted gross margin will be very lumpy this year and we'll be hiring, training and starting up weekend staffing on at least one of our lines beginning in quarter 2 and continuing through quarter 4. The adjusted gross margin hit from that expansion will peak about 40 basis points.

Additionally, we'll be absorbing some higher freight costs and commodity costs in 2018.

We are projecting at least $20 million of adjusted EBITDA for the year.

Again, this was skewed towards the back half of the year as we grow into the media investment, and our plans still calls for more spending on the first half than the second half.

For the year, we're projecting CapEx of $14.5 million, which includes about $4 million of maintenance CapEx.

Our CapEx plan assumes a normal operating year in the Freshpet Kitchens and only includes some modest costs for potential capacity expansion planning that Billy will expand upon shortly.

Further, as Billy will explain, we are placing greater focus on upgrading fridges in existing stores, which will add about $3 million to our annual fridge spending.

Additionally, we'll incur some IT CapEx associated with our upgrading of our ERP system.

We are very comfortable with our operating free cash flow in combination with short-term borrowings to support any future capital needs.

In 2018, we expect net sales of at least $185 million.

On an apples-to-apples basis, that was up more than 21% from adjusted net sales of $152.4 million in 2017 under the new accounting policy and adjusted EBITDA of at least $20 million.

Now I would like to turn it back to Billy to provide more detail on 2018.

Thanks, Dick.

Slide 19.

Freshpet was founded on a set of operating principles and a nutritional ideology that dictate how we do business and the kinds of products we sell.

Dogs and cats are extraordinary and enhance our lives in so many ways.

We fundamentally believe that fresh natural foods are not just the way we should feed the humans in our family, but it's also a way that we should feed our pets, too.

So every day, we strive to produce the highest quality food for dogs and cats that can make their lives better and the pet-parent relationship stronger.

We fundamentally believe that if we operate our business according to those principles and with that ideology that we will change the way people feed their pets.

To fulfill that mission, we will focus our efforts on introducing an increasing number of pet parents to Freshpet, and we will do everything we can to ensure that the highest quality Freshpet is more readily available in the stores where pet parents shop.

If we are successful with this mission, we will double the number of dogs and cats who have access to wholesome all-natural fresh foods every 3 to 5 years until fresh becomes an everyday standard for the way we feed our pets, and we will increase the percent of the diet for each of those dogs and cats that is fresh every year.

Our plan for 2018 is designed to enable Freshpet to fulfill that potential.

Slide 20.

We also remain committed to operating our company in a sustainable way consistent with our pets, people, planet mantra.

We are keenly aware of and very deliberate about how we make our products and how we conduct our business every day.

We support -- we source the vast majority of our ingredients domestically, and many of them locally.

We use wind-energy credits to power our kitchens, we are 0 waste to landfill, and we actively support a wide range of pet shelters and assistance animal training facilities.

And importantly, we work with our employees and external partners with integrity and as a team to enable our vision to change the way people feed their pets.

Slide 21.

Our first financial milestone in the pursuit of our mission is our 2020 goals, including $300 million in net sales as soon as 2020 while continually investing 9% in net sales and media to expand the franchise and delivering healthy returns to the shareholders who enable us to provide fresh foods to our pets.

We are targeting those returns to be an adjusted EBITDA margin of 20-plus percent and free cash flow of 15% of sales before any new capacity expansion costs.

Slide 22.

Year 2 of our Feed the Growth Plan builds on the success we had in 2017 and reflects our confidence that media investments deliver exceptional returns and help us fulfill our mission.

Slide 23.

You will recall our operating model called for significant increase in advertising spend to drive velocity increases that would fuel distribution gains and create scale that we could leverage to increase profitability and lower costs.

Slide 24.

In 2017, our media investments delivered the strong results we expected, driving expansion of the franchise in the year, and this phenomenon is accelerating.

Our $13.5 million of advertising delivered an increased year-end run rate almost $27 million higher than where we ended 2016.

With a brand as sticky as Freshpet, pet incremental revenue produces an annuity of almost $11 million in incremental brand contribution that we can use to further expand the franchise or deliver to the bottom line.

At this stage of Freshpet's growth, we believe it is best to invest the gains back into driving the brand's growth.

Slide 25.

We also fundamentally believe that scale is our friend, enabling us to more fully utilize our manufacturing and SG&A infrastructure, delivering 9 points of fixed cost pickup by 2020.

Slide 26.

Further increasing scale strengthens our barriers to entry, including lowering our cost to manufacturing and distribution, strengthening our brand equity and building a more powerful retail presence and relationship with our customers.

Slide 27.

As a result, we are going to lean in again in 2018 to further drive the growth of our business and expand the number of pet parents we can reach.

We plan to increase our total advertising investment by more than 60% year-over-year.

In essence, we are choosing to reinvest the 200 basis points of fixed cost pickup from the added scale we will deliver in 2018 and a small portion of our other manufacturing savings back into incremental media investments beyond our long-term media spending rate to drive accelerated growth in 2018.

While this is in excess of our long-term investment rate of 9%, we believe that the compelling returns we get from our advertising investment justify the more rapid expansion of Freshpet now.

Slide 28.

This investment will allow us to accelerate our growth rate from 2017's 17.5% to more than 21% overall and provide significant momentum that will continue to increase the growth rate in 2019 and put us on track to deliver our 2020 net sales goal of $300 million, as seen on Slide 29.

If you exclude our now discontinued bake business in the base year, the growth rate is even stronger, at 23%.

Slide 30.

This plan should also drive further velocity gains.

We would expect velocity gains in measured channels to be in the high teens and to continue to account for more than 70% of our growth next year.

That will increase the value of our franchise to our customers and increase our effectiveness in each store.

Slide 31.

A meaningful driver of this growth will be an increased focus this year on upgrading existing fridges in the stores we are in, moving from smaller fridges to bigger fridges and improving placement.

We believe that drives increased awareness, a higher quality presentation, fewer out of stocks, less spoils and lower operating costs.

For perspective, we have plans to upgrade about 400 fridges in Q1 to larger, more impactful fridges and a total of more than 1,000 by early next year.

Additionally, while we expect to add a significant number of new stores this year, we have decided to not set a net stores target.

Our focus on increasing the size and presence of our fridges in the stores we already have and the rise of e-commerce stores as well as the store closures makes the stores goal less and less meaningful to our overall growth rate over time.

Further, our demonstrated ability to consistently drive brand availability growth in measured channels no matter how volatile the retail environment has been, as seen on Slide 32, should provide investors with comfort that we can deliver the distribution needed to drive our success.

We will continue to report our store count each quarter, but we will not set any stores goal for the year.

Slide 33.

We will also continue to develop our e-commerce business in conjunction with our customers.

We firmly believe that the winning model for fresh e-commerce will likely include highly efficient delivery to our customer supply chains to distribution points close to our consumer and then a variety of routes to the consumers home based on each consumer's preference.

Our e-commerce business includes curbside delivery offered by our key customers, home delivery through systems like Instacart and Shipt in partnership with our key brick-and-mortar retailers, and fresh home delivery via storeless services like AmazonFresh, Jet.com, FreshDirect and Peapod.

E-commerce is a very small but fast-growing business for us, and we will continue to support our customers as they strengthen and perfect these new operating models in support of outstanding and efficient consumer service.

From an operations perspective, the rapid growth of Freshpet will enable us to more fully utilize our existing capacity but will also push us into a 7-day operation on at least 1 of our 4 lines during 2018.

That step change in staffing will result in a short-term setback on our adjusted gross margin progress, peaking in Q2 and gradually declining until year-end.

Slide 34.

Further, in 2018, we will begin planning for potential capacity expansion that we will need by mid-2020 if we stay on track to deliver our 2020 sales goals.

It takes about 2 years to add new capacity, 1 year for planning and permitting, and 1 year for construction and startup.

So if we believe our run rate, particularly on our bagged products, will outgrow our capacity by the end of 2020, we will need to have a plan in place by the end of 2018 and make financial commitments in late 2018 and throughout 2019 and 2020.

We will update you on that plan later this year as the business continues to demonstrate the growth we are expecting and our plans for the size and scope of any potential expansion are clearer.

Slide 35.

I do, however, want to be transparent about how we are thinking about any potential capacity expansion decision we would make.

First, we fundamentally believe that Freshpet has tremendous growth potential, and we are just scratching the surface.

Our consumer data tells us that there are many more consumers who look like the ones who have already chosen Freshpet, but who are not aware of the brand yet or have not been presented with the opportunity to consider Freshpet.

Thus, any capacity expansion decision should enable the company to logically and rationally expand capacity significantly either in a single step or multiple coordinated steps to meet the anticipated long-term demand but do it with a most efficient use of both capital and our technical talent.

I also want to be clear that we will continually assess all the data we can gather on the long-term volume potential of Freshpet and balance that potential demand against the need to be prudent with our capital in the near term.

Secondly, we believe it is of paramount importance for us to continue to advance our manufacturing expertise advantage in this fast-growing and game-changing product form, not just perpetuate the existing operating system.

We want any future capacity to embrace our best ideas for improving product quality and employee well-being and lower our ongoing operating costs.

We believe there are numerous opportunities to use more automation than we currently use to deliver on each of those goals.

Third, we do not want any capacity expansion efforts to reduce our focus on adjusted gross margin progress in our existing facility.

As a result, we will not expect our Freshpet Kitchens operating team to also plan and construct the new capacity.

We do not want to dilute their focus on sustainable cost improvements.

So we will add incremental engineering staff to plan and execute any capacity expansion.

Those costs will be capitalized.

Finally, the potential location of any capacity expansion has not been determined.

We have conducted an extensive national search for potential sites, including in Bethlehem, PA, where our current operations are located.

There are many factors to consider, including access to raw materials and skilled labor, sustainability impacts, freight costs, weather risks, utility costs, local incentives, technology transfer risk and many others.

We are very comfortable that we have several very strong options, and our challenge will be to determine which factors are most important at this phase of our brand's growth.

As I indicated earlier, we will share more details on our plans as they become more definite and as the business situation confirms the need.

In the interim, we will focus on margin enhancement across the entire supply chain, continuing to drive yield improvement and executing our expansion to a 7-day operation flawlessly.

Slide 36.

While our adjusted gross margin gains from increased volume will be nonlinear, our plan for 2018 shows the expected scale benefits in SG&A, excluding media and brokerage.

In 2017, we gained 50 basis points of fixed cost leverage in manufacturing, and we are projecting that we will gain another 150 basis points in 2018.

Our total gains and fixed cost leverage, including SG&A, will exceed 200 basis points in 2018.

These gains will keep us on track with our internal plan to generate a total of 900 basis points in infrastructure burden improvement by 2020.

Slide 37.

Finally, we expect to increase our adjusted EBITDA from this year's $17.6 million to at least $20 million for fiscal year '18, an increase of 14%.

We are prioritizing revenue growth over EBITDA growth, and that is constraining the magnitude of our adjusted EBITDA growth in 2018.

Much of the increase in media spending versus 2017 will be happening in the second half of 2018, and that will not turn into significant adjusted EBITDA gains until 2019, but we think it is the right thing to do for the business now.

We have advertising that's been proven effective and which pays for itself in less than 13 months.

Slide 38.

An increased scale is valuable to us both strategically and financially, so now is the time to put our foot on the gas and accelerate.

In conclusion, we are very confident in the future of Freshpet.

The past year has demonstrated our ability to tighten our focus and drive growth on our unique and distinctive fresh product offerings.

We have momentum and the organizational talent, the proven marketing tools, strong customer support, outstanding manufacturing capability and exceptional products that can change the way pet parents feed their pets.

We are united in that mission and committed to delivering it in a way that we can all be proud of.

That concludes our overview.

We will now be glad to take questions.

Operator?

(Operator Instructions) Our first question comes from the line of Brian Holland with Consumer Edge Research.

So if I just tried to make through these 42 slides here, you cover a lot of the questions that I wanted to hit.

But maybe if I could just ask, our data showing the household penetration on a trailing 13-week basis reaccelerated sharply in January, dollars per household on a trailing 52-week basis continue to move up sequentially.

So obviously, that's all very encouraging.

Can you give me a sense with the marketing spend?

I understand where it's more weighted towards and maybe were a little darker in the back half of the year last year and you turn it on this year.

But I mean, like, for instance, January, February, the first quarter, however you want to think about it, is that still up year-on-year, the ad spend?

Is that the likely driver?

And then maybe just as a second follow-up on that, and forgive me if you covered this, but when we think about the top line increase, obviously, that's being driven by how much you intend to spend on media.

So is there a -- is that more household penetration continuing to accelerate?

Or is it dollars per household on existing -- what's the mix?

And maybe not even to quantify it, but just qualitatively how you think that builds over the next 12 months with that media spend.

Sure.

Brian, it's Scott.

So we -- one of the things that we really wanted to do is some experimentation around how much pressure we could put into the media, so we actually ran a little bit more aggressively in January than we have historically, and we saw a really, really nice response to that, which is probably what you're seeing in your early data that you're starting to take a look at.

If you look at the year, we are going to -- as we typically do, we're going to spend more in the front half than we are in the back half.

You're probably going to see more of a 60% to 65% of the total spend for the year in the front half versus the back half of the year overall for the overall media investment we're making.

When we think about penetration and buying rate, we've been seeing really nice consistent increases in buying rate over time.

We anticipate that those are going to continue to increase, but the major, I guess, investment that we're making is a bet that it's going to increase in the penetration piece, which we've also been seeing really good returns on.

So the major focus is increasing the penetration.

We expect that we'll see the nice increase in penetration as you are already seeing, really helps deliver incremental consumers into the brand.

And then the buying rate, we anticipate continue to see it tick up slowly, maybe not quite as fast as we have seen in the past because the focus is the penetration piece and pressing more people into the -- into our business.

Brian, I would just add to that, Scott mentioned that we did some experimentation in January.

Scott and his marketing team have done that pretty continually last year, the year before and that's one of our core capabilities is we have a very highly capable both creative but also analytically very strong marketing organization that gives me confidence that whatever it is we're implementing this year, we will learn and do better next year.

And that's a big driver of our ability to hit our 2020 goals is that we continually adapt to the external marketplace, finding new ways to use the tools we've got or creating new tools to drive the kinds of top line growth that we're getting.

So it's not just the static plan.

It's also the intellectual capability that we have in our organization to continually adapt and grow.

Okay.

Just following on the media spend.

If I recall, around midyear last year, talking to you all, the impression I got was that, hey, if we knew this was the kind of response we were going to get on this uptick in media spend, we might have leaned even a little bit harder.

And if I look at the guidance this year, it goes from plus 60% in '17 to 60-plus percent in '18.

You talked about the experimentation in January.

At least my data is showing the implied results of that, which are very encouraging.

How much wiggle room do you have there?

And how do you think about that?

I mean, is that 60-plus percent -- I'm just making up and that could be 70%, 80%?

And is that going to be driven by, hey, if we're really seeing the return here on household penetration, we're going to lean a little bit faster for the reasons you mentioned that obviously makes sense to convert people now as you're the sort of first mover?

Brian, we've laid in and what we shared today is the plan we have as of today.

Obviously, we continually sense the market and understand what's going on in the market and if opportunities exist that we think we can get a good return for, we would obviously take a good long hard look at them and see how they might impact the overall picture for the business.

But we feel very comfortable with the plan we've got today getting us on path to the goals that we've outlined.

And we want to be very smart about it.

We want to invest in things that are -- deliver the proven returns.

We want to do it in a way in which we know we can source and supply.

We want to do it in a way in which the shareholders can see progress made both on the top line but also see that we can convert some of that into improved structural economics on the business, expansion of the gross margin, fixed cost pickup, that kind of stuff.

So we'll constantly monitor it, but right now, this is the plan that we've got.

Then I'll get out of here with this one.

Retailer bankruptcies, you've talked about those being a bit of a headwind at least on your store count number, but maybe not necessarily having much of an impact on adoption or just ongoing traction.

Bankruptcy apparently coming here in Florida, which is where you have as I recall about 11% of your fridges, which could be a negative, could be a positive insofar not a positive, but indifferent insofar as maybe that's a good place for that to happen because you have more fridges to service folks.

They don't have to look far to find you.

Can you give us any sense what impact that might have if we see something happen in the Southeast and Florida in particular?

And then just kind of remind us how you think about the consumer behaving and if they can't find you one place, they're picking you up somewhere else.

Yes.

So there's 3 dimensions to that.

The first dimension is there isn't any sort of receivables credit risk that you might have.

Obviously, we're very mindful of that and are taking the appropriate steps to be prudent on that side.

So I think we -- our plan reflects an understanding of what are some of the likely outcomes.

The second question will be typically with one of the -- with the -- if there is a retailer that goes through bankruptcy, there's closing of stores, sale of some stores and whatnot.

And so that could have some impact on the fridge count that we have if there are closed doors or there are sold stores, it depends on what the -- what our position is with the acquirer of the stores.

But overall, we suspect that those total changes will not be significant or material to the franchise that we have in terms of fridges.

On the third part, which is what the consumer do, if a store closes, the sales go somewhere else and we have broad enough representation across a wide range of retailers that I'm pretty comfortable that the consumer would find us in one of the other stores where they might shop.

So while it is a headwind, it is something that we need to have to watch out for.

We are mindful of it and we think we've planned for it.

And we think the consumer who likes our product and has adopted it will be smart enough and tenacious enough to find it in some other outlets.

Our next question comes from the line of Jason English with Goldman Sachs.

Congratulations on the impressive sales results this year.

Geez, lots of questions still on the table.

I'm not going to run through them all for the sake of time and out of respect for others in the queue, but let's pick up where the last one left off, store bankruptcies, store closures, digitization.

It seems like your addressable universe of potential stores to place your coolers is shrinking or going to shrink and already is shrinking or probably shrink more.

On top of that as Blue transitions to General Mills, assuming that deal closes, it looks like retailers are likely going to have to find a lot more space to be able to cut that in.

Why are you sticking to your 23,000 store count figure to 2020?

Is that realistic in context of the environment?

So first of all, on the starting point on a comment about the universe shrinking, we're showing the sort of long-term available retail outlets at 30,000 not in the near-term 2020 goals, but at 30,000 to reflect a little bit of that retail consolidation reality that's happening.

But we're not concerned that in the near term with our ability to pick up significant number of stores.

You have to pick about 1,600 stores a year between now and the end of 2020 to get there.

And while last year was below that, a little bit below that at about 1,400 stores, we did have a very large number of relatively small stores closed last year.

And as we look at the universe that becomes a better and better concentration of larger retailers are more sustainable stores.

So we're still -- we still remain comfortable with that guidance.

But I would also tell you that one of the reasons that we're not providing a stores goal for the year is because it is a very volatile environment, and our focus is so directly on building out velocity.

And wherever the consumer chooses to buy it, we will try to make it available in the best possible presentation that we can.

So I think that in the grand scheme of things, I think that the environment will change.

Our focus will be on the consumer.

Retail availability will be important, but not the driver of our growth.

Does that address the question?

Yes.

Sure.

I mean, I think it's -- we'll have to wait and see what happens on the retail front.

The landscape looks like it's pretty rapidly evolving.

If I step back and just look at the algorithm, clearly, next year is another year of reinvestment, but -- so the breaking point of profit flow-through looks like it's going to be deferred out into '19, at least relative to where we are expecting.

Frankly, I think what you suggested last March.

So we're going to layer in more investment this year and more CapEx.

Historically, there's diminishing returns to investment and also large bases, harder to sustain the same growth rate on.

As I look at your forecast out beyond the next year, you seem to be suggesting acceleration even beyond this year despite what should be the national forces of diminishing returns and the effect of a large base.

So help us get comfortable with that, because the optics looked a bit aggressive and a bit optimistic.

Yes, so let me take you through a progression.

If you take out the noise that comes from any changes in trade inventory, both our deliberate action a year ago as well as any other wobbles that you might see along the way and you really just look at consumption and you take out the mix, the baked product, which as I said in my comments, we discontinued as of February 1. So you take the noise that comes out of that.

In 2015 -- in 2016, the fresh business grew 15%.

In 2017, the fresh business grew 20%.

And if you look at the consumption in the fourth quarter, it was up over 23% in the fourth quarter.

So not only did they accelerate for the year, it was accelerating at the end of the year.

And then if you look at the consumption in the first quarter this year, in Dick's comments, he highlighted what the Nielsen xAOC number is for year-to-date at 27%.

If you look at it in an all-in basis across all the channels, it's up over 24%.

So you can see that, that progression of going from 15% growth to 20% to 23% to now 24%.

And so despite the base getting bigger, we are still able to see the growth accelerate.

And that's a really a function of as you increase the advertising spend, we're not finding a diminishing return.

In fact, we're finding we're getting better returns across a larger base, and we expect that to continue because we're far from having saturated the media plan that we could have at the levels in which we're spending today.

So we're pretty comfortable that we're going to continue to see this acceleration.

And one of the reasons we're very comfortable about the '19 acceleration is because of the significant investment we're making in the back half of '18 will, in essence, provide a higher run rate at the end of the year and starting point for the next year.

In essence, more pet parents are buying the product that gives us a roll into next year.

So we would expect to see the growth rate in 2019 benefiting from that and representing another acceleration from where we are in '18.

Last question.

Dick, can you give us any sort of free cash flow guidance?

And even if you don't want to get specific, whether or not you expect to be positive for the full year?

And then I'll pass it on.

Yes.

We'll have operating free cash flow for the year like we have had in the last several years, and that's based -- and then besides that, we'll have -- this excludes any increase in our plant capacity that Billy alluded to in his report.

Those expenditures we'll be talking about in the end of the second quarter, and some of those dollars may fall into this year but more likely in '19 and '20.

And Jason, as you think about it, part of the way we built this year's plan is we knew that building scale faster was in the best interest of this business.

And so we chose to reinvest back the fixed cost pickup and some portion of the savings.

We also are mindful where that took us from a cash position, and we believe that, that gets us -- the combination of the total investment we're making kind of pushes us to a very high level of growth while not putting us in a position that we wouldn't feel comfortable with from a cash flow perspective or an EBITDA perspective.

Yes.

In 2017, we paid off our debt.

We finished the year with no debt and a few million dollars from cash.

We still have a $30 million line.

Our next question comes from the line of Rupesh Parikh with Oppenheimer & Co.

So maybe first on the online front.

As you look at your efforts with Amazon and some of your brick-and-mortar partners, I was curious where you're currently seeing the best traction, whether it's the pure click-and-collect model or maybe with some of e-commerce players.

So Rupesh, we've talked a little bit about this in the past, where the -- our major focus is to see -- basically to play as many seats as possible, understand what we're doing in the e-commerce area and where we're seeing the most progress quickly is the people that are using basically brick-and-mortar down to the last mile.

And the 2 models that pivot off that our where there's a delivery model like a Shipt or an Instacart and also the click and collect.

I think the click and collect is something that I think we see great, great promise longer term, but I don't know if enough consumers have adopted that yet.

We're doing a lot of testing in that area.

We have incredibly aggressive goals behind making sure that our products are widely available through e-commerce this year.

We made great progress last year.

We have a lot of testing in place.

We have made really good progress in those areas.

But right now, I wouldn't say there's any necessarily winning model.

The ones that seem to be taking a hold the fastest are the ones were brick-and-mortar is the major component and then there's some delivery or pickup component for the last mile, I would say.

So I don't think there's a winning model at this point.

And then as you look at your, I guess, your 2020 targets, what do you assume in terms of how this part of the business could potentially ramp?

Right now, this year, we're anticipating it growing well above our normal growth rates this year.

And I think from now, it's still 1 percentage of the business.

I think in the future, it will be probably several percent.

At this point, we don't ever want to peg a number on it.

I think that the way we're continuing to think about this is there's an incredible opportunity from a penetration standpoint for our organization and to let more consumers know about Freshpet food, to pick it up in a medium that is most accessible and convenient for them, and it's going to work across retail.

It's going to work across pickup, and it's going to work through a delivery service.

So I think if we can get that piece, and that's our focal point then I think the rest of it and making sure were available across those different ways that people want to receive our product, I think that's going to put us in a really strong position.

I don't think we have specific channels that we're going to focus on and peg growth numbers around.

For you think that -- I don't know if anyone has a real strong understanding of exactly how this is all going to play out.

Our next question comes from the line of Robert Moskow with Credit Suisse.

A couple of questions.

The first one was kind of going back to Slide 9. What I noticed was when I took the ratio of your penetration versus awareness compared to your peer group, it was a lower ratio.

It was almost like -- and this may not be a fair comparison, but to convert someone from being aware to actually buying the product seemed a little lower compared to the other brands on that chart.

Do you look at that ratio as anything meaningful?

And does it mean anything to you?

It does, and I think it's a good pickup, Rob.

The way we think about this and what we've seen is because anything that's different is a little uncomfortable and unusual, and sometimes slower adoption to consumers.

So when you're looking at the peer group in here, it's either a normal wet or dry type item that they can make a transition to.

There's a little bit of mystery around Freshpet, and our goal is to kind of unwrap that mystery, let consumers kind of know what the product is about, what the -- educate them on it and get them comfortable with purchasing it.

So I think we're going to have to work a little harder than someone who has kind of a more consistent and mainstream proposition.

And so we definitely recognize that.

I do think it's good pickup.

But what we have seen is really consistent productivity in whatever media that we've been using in order to drive new consumers into the brand, as we have talked about historically, and we continue to see that.

So I think that's a great observation.

However, I think the model going forward, we definitely see significant continued opportunity.

It's not just about awareness.

It's a level of awareness and education the consumer has to go through to make that purchase and come in and count as penetration for us.

Okay.

Another question.

How many of these fridge improvements have you made so far in Q1, upgrading them?

The picture looks great.

Have you seen productivity improvements from those fridges when you take those actions?

So we've done some work behind this really over the past 2 or 3 years, and we have enough instances where we had done this where we've done some fridge upgrades and seen the productivity and the sales increases, where we felt comfortable that it was a good capital investment for us.

In the slide, there was an approximate 3-year payback that was on there.

As you know, we use lots of different fridges, and we have lots of different dollars per store per week at our different retail partners.

So there's a pretty significant difference but -- in the different retail partners.

But that 3-year return is really where we're pegging it at, and we are seeing a fair pickup in sales.

But I think there's a holding power aspect, there's a general marketing and merchandising aspect to it.

So I think it helps us on multiple fronts.

But a nice pickup in sales.

I don't think it's a number that at this point we have enough experience with on a wide basis that we're going to kind of put that out there.

But keep in mind, we are trying to make sure that the capital investment has a strong payback.

And from a reporting standpoint, will be you be reporting this as a launch expense and then stripping it out to get to adjusted EBITDA?

Or is this going to be absorbed?

No, it's absorbed.

Absorbed, okay.

I think that's the right way to do it.

And the last question, you mentioned incremental freight costs and input costs, maybe that's on protein.

How much higher have those costs risen versus your original expectations, Dick?

And can you give us a number for what it means for 2018?

You're still guiding to a pretty healthy degree of EBITDA growth even with those higher costs.

So what are you doing to absorb them?

Yes.

We're getting scale on our SG&A, that's one thing we talked about gaining approximately 200 basis points in 2018.

We have increased costs associated with logistics, basically in the SG&A area, plus inbound freight.

And that increases approximately 5% of our freight costs, and we've budgeted for that, and that's what we're seeing right now.

We expect potentially some softness in the back half of the year, but we'll wait and see.

On chicken prices, we -- those prices have gone up.

We've budgeted them for the year.

We locked in those prices for the entire year, and that's a big piece of our commodities.

Our beef prices have gone up.

We expect some softness at the back half of the year, but we also budgeted that.

And we're getting basically our payback is on incremental revenues and leverage on SG&A other than the incremental media spend.

Okay.

So you can offset all that even though you're not getting any price increases?

Right.

Our next question comes from the line of Peter Benedict with Robert W. Baird.

Most of mine have been asked but -- or answered, I should say.

A couple -- how visible are the fridge upgrades you're expecting over the next 12 months?

It sounds like you've got a handful coming very soon.

Are they in any specific channel or any partners specifically that are doing this?

And how many of those include kind of a new location in the aisle, maybe moving to a better spot in the aisle?

We do have, I think, a pretty good idea of what our goal is for the year.

We -- I think what Billy had mentioned in the script was about 400 are being done in Q1.

This is something that we've worked on at the end of last year.

It's across a couple of different retail partners.

Typically, they're significant size increases.

The size increase that we went through, it's not quite all out in the retail, so I really don't want to get into the exact specifics on the retail partner.

But on the -- the size increase is about a double from a size increase standpoint, and that allows us to put increased holding power and also new SKUs in, in several of those fridges.

It's also very similar to what we've done historically where we've seen really nice sales increases from that.

Okay.

That's helpful, Scott.

Any update on kind of the trends you guys are seeing in those channels of those stores that are getting the new natural brand entrants on the dry side, Blue Buffalo but also more recently Nutro.

Anything to call out there?

Yes, we've obviously kept a really close track on that.

And as we kind of experienced for the first few retailers that's taken in several of the new brands, our sales trends look really consistent in those retailers as they are on a national basis.

So we feel like -- we feel really good about -- because we know there's a lot of change in the category and to be able to have that much change and have our sales trends really continue to grow and stay at the same rate they are on a national basis gives us great confidence in the proposition and our overall approach and the opportunity in the business.

So I -- does that help, Peter?

Yes.

No, that's fine.

And then my last question, just on -- I don't think you guys talked about the -- what's going on in the U.K. I know you've been doing test over there.

Any update there?

Or any milestones we should be thinking about either in 2018 or 2019 in terms of the U.K.?

We're continuing to work to perfect the model.

To get the Freshpet model to work, you have to not only have a product the consumer likes, you have to have a proposition that works for the retailer.

You have to figure about the fridge model.

You have to figure out how to supply it.

You have to figure out what the consumer marketing model would be.

And I say we've ironed out many of those things already.

We have not ironed out all of them yet.

There's a few more things we want to work on.

So we started with just a handful of stores, and we're up to a much more significant number of stores as we kind of built out and vetted each of the pieces and got more confidence and retailers have gotten more confident in where the proposition is going.

But we're not ready yet to put our foot on the gas and say, "Yes, this is the model's right and ready for acceleration." We want to be patient, take the right amount of time to get it right before we choose to invest the money.

Our next question comes from the line of Bill Chappell with SunTrust Robinson Humphrey.

Quickly going back to the kind of revenue growth.

If I look at just your math of $185 million [at least] this year and going to $300 million, that's just simple math implies 27% growth in '19 and 27% in '20.

So I guess the question is, is that the right way to look at it?

Should we see an acceleration into that number this year?

Or is it really going to be a stair-step change as we move into 2019?

So if you think about the guidance that Dick gave about how this year was going to unfold, as we told you, we'll have a very -- we feel very good about having a strong first quarter, partly because of the inventory adjustment we did a year ago.

If you look at second quarter, that will be the toughest comparison, but then we expect to see an acceleration in the third and fourth quarter because that's where we're going to get the benefit of the added media spending, and that will then flow into 2019.

So we'd expect to see that acceleration into 2019.

So if you go back to the cadence I laid out for you before, last year's total growth rate on the fresh business was 20%, but the fourth quarter was 23%, and that's on a consumption basis.

And now in the first quarter this year, we're running north of 24% all in, and we expect to see that continue to accelerate a little bit up and down depending on how much media we have on any particular point in time.

But think of it as accelerating from there towards the end of the year and heading into next year with the acceleration continuing into next year.

Because if you think about it, we run advertising, a significant number of people choose to try the product, a very high percentage of them repurchase, our 71% repurchase rate, and that just builds our franchise larger and they continue to repurchase.

And at the same time, the buying rate gets bigger.

So you start seeing -- in 2019, if we do -- let's say we do the 23% on fresh that we're talking about, this year, 21% overall, but 23% on fresh, but it accelerates towards the back half of the year, you could leave the back half of this year with a rate north of that and it be that momentum you're carrying into next year.

Okay.

And maybe I'm missing something, but on the 23% versus 21%, if you discontinued dry in February, I'm trying to understand how big -- how dry is that big of a delta.

Yes, so there's a little bit of rounding in there.

It's a little more than a 1-point drag on the growth rate, but the 21% is like, probably a little more than 21% and the 23% is around 23%.

So it gets -- it looks like 2 points -- but it's a little more than 1 point of drag from bake.

Okay.

And then other question just to understand on the gross margin.

I mean, I understand you're saying it was choppy, it doesn't directly go one direction, but if I look at it this year, you should have some pretty easy comparison with some manufacturing in the peak and season, what have you, especially second and third quarter.

Does that progress through the year?

Or is it going to be choppy as well?

And I understand you have some mix in there.

Yes, so mix is going to be one impact.

And the second is, as Dick said, we're adding 7-day production capability starting in the second quarter.

So there'll be a hit from the hiring, training of the personnel to do that, and it'll be basically underutilized as we move into that incremental shift, in essence.

So you'll see a little bit of a decay in the second quarter, then we'll start to build a backup as we increase capacity utilization against that incremental staffing.

Got it.

And lastly, just a random question, but sounds like the 500 stores that closed in pet specialty, what happens to those stores?

Because don't you own them.

Don't they go somewhere else?

We bring them back and we refurb them, and we reissue them.

It's kind of like a starter cooler.

I believe you'd take possession of them.

And then I did have one other question.

On one of your slides, you talked about pet specialty, the dog food and pet specialty in general was down 5.5% -- sorry, down 7%, but you were up in the pet specialty, natural and other channel, 7%.

So what are your like-for-like trends in pet specialty excluding, I assume, other is Costco, Whole Foods, online and that type of things?

It's a [recorder of] thing.

It's -- the pet specialty -- as the trend accelerated throughout the year and we're currently running -- and what's measured as pet specialty in the range of 14%.

Our next question comes from the line of Mark Astrachan with Stifel.

I wanted to ask maybe Scott.

How do you think about the stickiness of the new consumers here?

Obviously, given the increased spend.

So is the retention to where you want it?

What's the learning curve?

Or what's the retention curve in terms of trying to get that consumer back as a repeat purchaser?

And then how do you think about that as far as an evolution if there is one from including it in dry food to sort of exclusive use of the products?

So everything that we've seen so far is the folks that continue to come into the business, really over the past couple of years and even in the more recent window, seem to look almost exactly like the people that have historically come in.

They just that were not at the time where they were either receptive to the concept, hadn't heard about it, awareness is really low.

So those people who are coming in, we're seeing very similar repeat rates.

We're seeing them kind of branch out and get more involved in the overall portfolio and product line and become repeat purchasers and really consistent repeat purchasers into the brand.

So I'd say it's really consistent from what we've seen historically.

As Billy mentioned, we've looked at it many, many different ways.

And we see for the people that are out there that haven't tried Freshpet, there's a much larger universe of people that look exactly like the consumers buying today out there as an opportunity for the business or for the brand.

So do that -- is that kind of answering what you're looking for?

Yes, it broadly is.

I mean, I guess it's a question of you spending a lot more to bring more in, so you want to obviously continue to see more.

So I guess, yes, that's sort of what you're getting at.

Well, we are seeing -- again, assume overall similar return and very similar consumers -- types of consumers coming into the business.

Yes, okay.

And then where are you regarding penetration as a percentage of available stores with the national accounts like the Walmarts and Targets, Costco -- I mean, Costco, I guess, is still a test, Whole Foods still limited.

Sort of where are you and where could you go there?

We're about at a 50% ACV, and so we really -- no, I don't know if we'll ever get to 100%, and that's really not -- sorry, near-term plan, the 3 -- 2- to 3-year plan.

It's not really to get to 100% ACV by any means.

But we see a pretty long runway.

And you may have heard me say this before and -- but I think it's going to be true again this year.

For every year for probably the past 5 years, we've seen every one of our top 10 customers continue to increase and give us more and more stores and get deeper and deeper into their overall ACV across the different types of stores, their formats.

We've seen more preferential treatment from positioning.

Peter mentioned a question on that earlier, I didn't answer that specific point, but we're seeing kind of more where the aisle is starting with either Freshpet or some other super premium type brands.

So we're well positioned, and there's a tremendous amount of ACV there.

And I think one of the things that the retailers really do appreciate about our businesses is it's not a business that lends itself to duplication online where someone can potentially come in and offer a lower price point online delivered to someone's house.

And I think that they are getting more and more concerned about the online business going away from any of the brands that they're selling today.

Got it.

And following up on that, I guess, I'm curious, one, why is it not something that you focus on?

And I guess, two, sort of related to that, how do the discussions go given I would think accelerating velocity, accelerating overall sales, obviously, bigger overall base increased awareness, you would think that those discussions would get easier and that the retailers would want to embrace a product that's helping grow the category.

So I guess why not to the first part there.

So maybe I misspoke or I didn't explain something correctly on it, but from the -- we're getting, I think, increased receptivity from retailers.

And again, I think they are adding those stores in.

I don't think it's an accelerating rate, but I think it's at a very consistent rate to what we've seen historically.

The nice thing that we're starting to see at this point is we actually have -- we're starting to get reasonable size shares, so a little bit of scale, and we also now have really strong growth rates.

And I think that really sets us apart.

When they look at the rest of the category and they realize it can be delivered to the consumer's doorstep -- not fresh, but other dry products can be delivered to the consumer's doorstep as easily as it is but at a lower price.

We've heard a lot of retailers talking about that, and really, a high degree of concern around that, that there's basically showrooming going on in pet food, that concept.

From Freshpet, that's not going to be something that consumers going to be able to do.

They're going to go through a click-and-pick model or a delivery from store type of model that we had mentioned a little bit earlier like Instacart, et cetera.

So I think that's giving them increased confidence to continue to expand our business across their stores.

Ladies and gentlemen, we have reached the end of the question-and-answer session.

And I would like to turn the call back to management for closing remarks.

Thank you.

We appreciate your time and interest.

As we said, we are very confident in the growth prospects for the Freshpet business.

We feel very good about the Feed the Growth Plan that we launched last year and its opportunity to continue to drive accelerated growth into 2018.

And we are very committed to delivering our 2020 goals.

So we appreciate your interest and your support, and thank you very much.

This concludes today's conference.

You may disconnect your lines at this time.

Thank you for your participation.