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Q3 2016 Earnings Call Transcript

Published: 11 Nov 2016

[Operator:]

Good afternoon, ladies and gentlemen, and welcome to the Blue Buffalo 2016 Third Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to the CFO of Blue Buffalo, Mike Nathenson. Mr. Nathenson, you may begin.

[Mike Nathenson:]

Good afternoon, everyone, and welcome to Blue Buffalo's Q3 earnings call. Some reminders before we start. Today's conference call will include forward-looking statements. These statements are made on the basis of our views and assumptions as of this time and are not guarantees of future performance. Actual events or results may differ materially from these statements. For information about certain factors that could cause such differences, investors should refer to our Form S-3, which was filed with the SEC at September 2016 and available on our website, including the information set forth under the captions Risk Factors and Statement Regarding Forward-Looking Disclosures. Except as required by law, the Company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. In today's discussion, revenue and sales refer to net sales. In our discussion, we will also refer to non-GAAP financial measures, which differ from our results prepared in accordance with GAAP. We will refer to adjusted EBITDA, adjusted net income and adjusted EPS, which exclude the costs associated with litigation and our public equity offerings. Adjusted EPS will refer to the adjusted diluted EPS. A full reconciliation with the corresponding GAAP measures is included in the press release and is posted on our IR website at ir.bluebuffalo.com. On today's call, I am joined by our CEO, Kurt Schmidt; and our President and Chief Operating Officer, Billy Bishop. With that, let me turn it over to Kurt.

[Kurt Schmidt:]

Thanks Mike. First, I too would like to welcome everyone to our call. We are pleased to share our results with you today. As you saw in our press release, Blue Buffalo's strong performance continued in the third quarter. Most importantly, we continue to drive pet product demand for our products across channel and a dynamic retail environment. On the financial side, we feel great about the way we continue to expand our margins on a sustain basis and deliver high quality earnings growth. As a reminder, Blue Buffalo is the undisputed leader in the wholesome natural, the fastest growing segment of the $27 billion U.S. pet food market. And we are over four times the size of the next largest brand in this segment. As one of the largest brands in the overall pet food market in a sea of legacy brands loosing the relevant to consumers, Blue has become the new mainstream brand that’s delivering the products that pet parents are looking for and connecting with them in an authentic way. With that said we still have only a 6% share in the U.S. and feed less than 3% of pets. So Blue Buffalo is a tremendous opportunity to grow. We have a clearly articulated growth strategy that starts with the U.S. market where we will continue to gain share across both the more developed areas such as dry dog food and across our underdeveloped areas such as cat food and treats. We are whole brand and our brand building efforts are designed to drive pet parents demand across our channel. In our largest channel U.S. pets superstores, we are more than twice the size of the next largest brand, and we are continuing to grow another specialty channels, where our shares only a third of our share in superstore. So, we have a long runway to continue to grow to build our share. We're also investing in new legs of growth by entering the veterinary channel and new international markets. Putting this all together, our goal is to continue to grow our revenues 10% plus annually in the coming year. We're also focused on productivity and expanding our margins in a high-quality sustainable way. And our three-year $200 million capital investment program is an important lever in this direction. In summary, we believe we are a new breed of CPG Company that's built for the 21st century. The third quarter was a great example of our competitively advantaged business model and how we execute against our strategy. Let's look at the highlights. Our revenue grew 11% versus prior year. This growth was well above the market and as a result, we gained share. We continue to grow in the rapidly growing underdeveloped specialty channels like e-commerce and farm and feed, while we continue to build our business in pet superstores and in neighborhood pet stores. We expanded our margins due to supply chain, pricing and positive mix. On the top line growth combined with expanded gross margins has allowed us to invest for future growth and still deliver healthy net income and EPS growth. Given our strong performance we are raising our EPS guidance for the full year. Now let's turn to U.S. pet food dynamics, for Q3 the category growth rates flowed across all the tracked brick-and-mortar channel, while untracked channels particularly e-comp continue to grow rapidly. In addition, superstores experience pressure as they lapped the high level of discounting in the back half of last year. These trends resulted some slow down in the overall category growth rate. Given our strong growth rate which was well above the market Blue continue to gain share. While our pet parents demand for our product is robust, we are not immune to the changing the dynamics in a retail landscape especially in the short-term, and we have seen some variability among our distribution channels, consistent with what we discussed on our last call and the market trends that I just described. Our sale through the pet superstore channels have stopped, while we have seen continued strength outside of superstore. In U.S. pet superstores, we held share while our Q3 superstore sale through was down low single digit versus last year. Outside of pet superstores, we estimate our sale through growth rate be in the mid 30. As a remainder, we have three main groups of accounts outside of pet superstores; one, regional and neighborhood pet stores; two, farm and feed stores; and three, e-commerce retail. We continue to see growth across all three groups of accounts. On the brick-and-mortar side, our performance in these channels reflects the runway we have ahead of us as we continue to increase our velocity, broaden our assortment in underpenetrated product types, and enter new locations particularly on the farm and feed side. On the e-commerce side, we continue to ramp up our sales and gain share in this rapidly growing channel across our major retail partners. We enjoy significant competitive advantages in e-commerce channel over the large, widely distributed brands given our high value per pound and addition to our unique go-to-market model that creates consumer pull for the Blue brand. We're gaining share by leveraging these competitive advantages, which is helping close our convenience gap. I'd like to wrap up this section with this observation. One of our core strength is our ability to drive pet parent demand by investing behind our Blue Buffalo master brand across our three strategic plans. As you can see, this has enabled our ability to drive strong growth in this dynamic retail landscape. In a few minutes, Mike will get into more details of our strong financial performance in the quarter. But first, let me turn it over to Billy, who will provide some additional color on our commercial performance.

[Billy Bishop:]

Thanks, Kurt. As Kurt mentioned, the Buff had a strong quarter thanks to our ability to drive pet parent demand and our ability to deliver them great products more and more efficiently. Our growth is fairly balanced from our product lines with our more premium lines of wilderness, basics and freedom leading the way. We’re also encouraged by the strong performance of the underdeveloped parts of our portfolio. In the quarter, our cat products grew faster than our more penetrated dog portfolio even as the sales of our dog product portfolio continued to grow driving share gain. As we mentioned on previous calls, WTO which is our shorthand for wet foods, treats, and other products is a key leg of our growth strategy and continues to be an area of focus for us. In Q3, our WTO growth rate was 8.6%; and as I mentioned on our call in August, we expected the growth of WTO products to moderate in H2 from our 2Q levels due to timing. With that said our Q3 WTO consumer takeaway continues to be strong growing faster than our sell in. Now I'd like to spend a moment on our brand building and advertising efforts. As we've mentioned before we treat Blue Buffalo as a master brand. Similar to the way other iconic brands are matched. In that sphere we continue to invest in our three strategic plans. Innovation, education and communication, which create consumable and drive pet parent demand and conversions from widely distributed engineered brands to our wholesale natural Blue Buffalo products. Over the course of the year we have been optimizing and rebalancing our price driven promotional spending and reinvesting into stronger brand loading vehicles. Although this is near term headwind to our sales, we feel good about this approach and that would positions us continue to grow this share gain. Now, I'd like to pass it onto Mike for a closer look at the financials.

[Mike Nathenson:]

Thanks Billy. Our overall net sales growth in the quarter was 11%. Looking at product types, we saw strong growth both with our dry foods and WTO products. Our dry foods grew 11.6% and WTO grew 8.6%. Breaking down our overall sales growth, we grew principally by 9.4% volume, and 2.1% pricing which was slightly offset by halfer point less favorable mix due to WTO growing at a lower rate than dry fruits in the quarter. Before I talk through the rest of the P&L, I'd like to touch on our sales growth by customer. Overall, our sell-in growth was a little more than a point better than sell-through. In superstores, pet parents sell through was low single digits below a year ago and our sell in was slightly better, but still 0.9% below last year. As I mentioned on our Q2 call, we continue to remain cautious about superstore traffic, given the overall retail environment. Outside of pet superstores, our sales to other customers represented 39% of our total sales in the quarter and grew by 36%. We estimate the pet parents in these channels grew at a similar rate. As we mentioned in previous calls, we are currently in the early stages of our entry into the veterinary channel and new international markets. As a result, these two areas did not materially contribute to the sales growth in the quarter. We expect to see more meaningful contributions in 2017. Now let's turn to the bottom line and our margins. As you saw on our earnings release, our profit metrics grew strongly in the quarter driven by strong top line growth and expanding gross margins. Q3 adjusted net income was $44.7 million, up 32.3% and adjusted diluted EPS was $0.22 per share, up 31.5%. Our adjusted EBITDA was $74 million, up 21.4% versus last year and gross margin in the quarter was 46.3%, 460 basis points higher than last year. The increase in gross margin was driven primarily by supply chain efficiencies, including lower input cost. Margins also benefited from pricing and positive mix which was primarily driven our more premium products growing faster than the overall portfolio. Now let's turn to SG&A, excluding the costs associated with our equity offerings, as well as our litigation related expenses, SG&A grew 23% in the quarter versus last year. The increase was primarily driven by investments in our revenue generating activities and investments in our strategic initiatives as we continue to build our veterinary and international businesses. I also wanted to provide a few words about our litigation settlement. As our November 3, press release, we announced that Blue Buffalo and Nestle Purina have agreed to settle all outstanding litigation between our two companies. In connection with the settlement agreement, we’ve included a $32 million pretax charge as a discrete line item in the financials. As mentioned on our press release, we are continuing to prosecute our claims against other parties to recover our damages. None of this potential recovery is reflect on our financials. As a reminder, a detailed reconciliation of our GAAP and adjusted financials can be found in the attachment to our 8-K and press release. Our tax rate in the quarter was 33.1%, which reflects the early adoption of the new accounting standard for the exercise of stock options. We have a favorable impact from this accounting standard change, which is partially offset by a slight increase in the number of diluted shares in our calculation of EPS. All this resulted in a net EPS benefit of one-third of a penny in Q3. We now expect our full year tax rate to be between 36.6% and 36.8% which is lower than our previous estimate of 37.3%. Looking ahead we expect our normalize tax rate to be between 37.5% and 37.9%. We will be able to give more precise estimates of our tax rate, when we give our 2017 guidance fairly next year. Given our strong top line and bottom line results as well as our capital efficient business model, we continue to produce strong cash flow. For the first nine months of the year, our operating cash flow defined as cash from operations less CapEx was $94 million. Our CapEx was $18 million and at the end of the quarter we had $316 million of cash on our balance sheet. Turning to our public float in September, we completed an additional secondary offering on behalf of our larger shareholders. As a result, our public float increased by over 80% since our IPL. Now let's turn to our updated outlook for the full year. As you saw in our press release, we have raised our EPS guidance, while maintaining our top line guidance. We expect our full year net sales to be between $1.14 billion and $1.15 billion with adjusted EPS of $0.78 to $0.79 per share. With another quarter under our belt, we now expect our gross margins for the full year to be a proximally 45%. Combining strong top line and expanding gross margins, with a favorable tax rate results in our full year EPS guidance of $0.78 to $0.79 per share. Finally, for capital expenditures, we expect to spend between $50 million and $60 million for the full year, our program is on track and we still plan to begin commissioning in 2018 and expect to see the P&L benefits in 2019. Now, I will turn it back over to Kurt.

[Kurt Schmidt:]

Thanks Mike. Before I open it up to questions, let me tell you the five points I'd like everyone to walk away with today. One, with the competitively advantaged leader in the best part of a great category, the wholesome natural segment in the $70 billion global pet food market; two, we continue to gain share in both the overall market and the faster growing emerging channels; three, our advantage demand generating, brand building approach has continued to drive strong pet parents demand even with some shifting and dynamics in the retail landscape; four, we are seeing the benefits of improved supply chain performance positive mix and pricing in our expanded gross margin, and we're confident about the expected benefits of our three-year capital investment program which will enable further productivity, flexibility, and innovation; and five, we delivered high quality results in Q3. We're confident in our full year outlook and we're confident about our opportunity for future growth. Finally on a personal note, it's been my pleasure and put privilege to be part of the heard and lead the Company from its last four years, including the transformation of Blue Buffalo into a successful public company. We have built a strong leadership bench for each of our key role including the CEO. Billy together with his family founded this company in the back of the barn and built it into the billion dollar company it is today. He has defined the Buff culture and he has walked the talk since the beginning. I think you will all agree with me that we have every reason to be excited about Blue Buffalo's future under Billy's leadership.

[Billy Bishop:]

Thanks, K. I would first like to thank you for your dedication and contribution to Blue Buffalo. It's amazing how far we have come under your leadership and as we say once a Buff, always a Buff. I am honored to be given this opportunity to lead the herd and I look forward to working with our entire Buff team on our next chapter. With that, let's open it up for questions.

[Operator:]

Thank you very much Mr. Bishop. [Operator Instruction] And our first question comes from David Driscoll from Citi. Your line is open.

[Alexis Borden:]

Hi, this is Alexis Borden in for David this afternoon. So, Kurt, how long has CEO transition been in the work for, just kind of looking for some more color on that?

[Kurt Schmidt:]

Let me start with the transition, it's always been part of our game plan. When I came to Blue Buffalo, I really have four adjectives I really wanted to accomplish. The first, we've built a great organization and I believe we have the best organization in the pet food industry. Secondly, was to prepare that team and that execute our successful IPO and I think we can all say that from this as it's turned to be fantastic. I think it's one of the best CPG IPOs in recent memory. Third, I wanted to set this strategic direction to reaches this next billion that is $2 billion goal, and that's through our strategic initiatives including the vet initiative and international. And although they are not complete, I think they are well underway and we're advancing them. And finally, we development strong leadership bench and succession plans for every key role including the CEO slot. And Billy is now ready, and I think it's appropriate it's the right time for Billy to take that position January 1, and it couldn’t be a better time business is in great shape. We have a fantastic quarter behind us again I think somewhere five or six. We have maintain our top line guidance we've actually raised our EPS guidance and I think we've been planning this carefully like we do everything and it's just going to be a very-very smooth transition.

[Alexis Borden:]

Thanks for that. switching gears little bit to the top line, revenue came in a little bit below consensus was there already some type of shipment timing issue in the quarter that maybe we should be aware of and then does this worth on the sequential growth in 3Q concern U.S. other trying to connect that's it's early reason to kick off in 2017?

[Mike Nathenson:]

Let me cover all of those. So first off, I just want to remind everybody that we only provide full year guidance not quarterly guidance. Where very confident in our ability to hit our 11.40 to 11.50 guidance which as the same top line guidance provided on our Q2 call and the same guidance that we've reiterated after Labor Day. The 11% top line shows our ability to drive pet parent demand and newly reinforces the fact that we are co-brand and we are not reliant on any one channel or one customer to push our products, and then over though as Chris said over the last five quarters we've been demonstrated the ability to navigate and win in a market with some shifting dynamics.

[Operator:]

Thank you. Our next question comes from Andrew Lazar from Barclays. Your line is open.

[Andrew Lazar:]

I wanted to dig down a little bit into WTO, if I could. I know that you had discussed a pull forward of sales into Q2, based on some of the new product introductions and I guess you lapped a product launch a year ago. I guess I was still a little surprised by the relatively more modest level of growth in the quarter. I think that last quarter you may have mentioned that the underlying growth, meaning excluding the pull forward, might have been in the teens, and I guess this quarter it was up around 8.6%. So, I guess we have a similar comp in the fourth quarter than we had in 3Q. So, I guess, is there any reason to expect maybe a meaningfully different level of growth in WTO in the fourth quarter versus the third quarter?

[Mike Nathenson:]

Just to be clear here are 8.6% net revenue growth was our sell-in growth. Our sell through growth was much higher than that and higher than our drive sell through. So we feel quite good about our WTO performance in the market. As always pushes and falls whenever you launched new products, in this case we have our WTO launch in Q2 of this year, last year that same innovation launch was in Q3. And so really you're just talking about timing differences.

[Andrew Lazar:]

Okay, thanks for that. And then, thinking about your revised full-year gross margin guidance, I guess it implies a sequential step down, maybe to closer to maybe 45% or so in the fourth quarter. Is that maybe just the typical seasonality you see in the business, with fourth-quarter gross margins lower due to holiday promotion and such, or are there other factors at work there?

[Mike Nathenson:]

No, this is just business as usual, so it the normal, it’s a normal seasonality.

[Operator:]

Thank you. Our next question comes from Bill Schmitz from Deutsche Bank. Your line is open.

[Bill Schmitz:]

Hey can you break down the Petco and PetSmart percentage of sales for me, I’m trying to be consistent here?

[Kurt Schmidt:]

No, I love you're asking your question, I actually had it ready for you because I knew you’re going to ask it.

[Bill Schmitz:]

I am not very creative.

[Kurt Schmidt:]

No, no, you are very creative. Pet superstores was 61% of our mix, PetSmart was 38% and Petco was 33%.

[Bill Schmitz:]

Okay. Great, thanks. So the gross margin is at your 2018 target you guys introduced during the offering process. So do you still think that -- I know you don't want to get into 2017 guidance, but before it was 2017 was going to be a flat gross margin year because of the new factory coming on line, but do you still think, A, that's true? And then, B, do you still think the new factory is another 250 basis points of margin expansion, given that the base level is so much higher than you probably thought it was originally? And then, do you think you could actually bridge that gap to the 50-ish gross margin you see for something like the center stored engineered brands?

[Kurt Schmidt:]

We’re very confident in our gross margins and we feel like they are sustainable, and as we look to the future, we’re going to continue to need to obviously to increase our gross margins overtime. So, if you remember last were actually early in the year, when we changed our guidance structure, we enter a 10% plus top line and about 20% EPS growth. So the reason we took the gross margin reference out was knowing that we needed to actually accrete our gross margin beyond that target. So the good news is that our performance has continued, our supply chain performance we’ve had some positive mix, we’ve had positive productivity so from that standpoint we fell quite good about gross margins. So from that stand point we do think we will do better, obviously when the CapEx comes online and that will increase our gross margins based on the rate at that time. We’re not ready to give you the details yet, we will obviously will give you our thoughts on the 2017 gross margin, at the time we give our full year guidance early next year and then we will talk about our about the expectations for the new plans once we get closer to the startup.

[Bill Schmitz:]

And then if I can sneak in one last one -- and, by the way, congratulations to both Kurt and Billy. That's terrific news. Congratulations. Billy, I have actually a question for you. So there is some rumblings in the industry about some of the pet superstores getting punitive with guys who are selling into some of the faster-growing e-commerce channels, including one notable competitor. Are you guys seeing any friction or are you benefiting at all from some of the actions you have seen by these guys?

[Kurt Schmidt:]

This is Kurt. I think I’ve said this before is always friction, but channels that’s growing very rapidly, but our work in our very important brand for all the entire channel. So this is just normal state of business at time, but nothing that doesn’t prevent us on driving kind of growth that we are driving and again that’s because really our focus is on the consumer and driving that demand.

[Bill Schmitz:]

Okay that’s fairs. Thanks.

[Kurt Schmidt:]

And just an important point to remember, we are totally agnostic for the channel. I mean when we get our growth from a margin and size for us is easy.

[Operator:]

Thank you. Our next question comes from Dara Mohsenian from Morgan Stanley. Your line is open.

[Dara Mohsenian:]

Your e-commerce business is obviously a very strong growth over the last year, but going forward you have got difficult comparisons, and now one of your main competitors in the space has mentioned they're looking to move more aggressively into that channel. So, I was hoping you could give us an update as you look going forward if you can sustain the momentum there, if we see some natural slowdown over time, given the penetration of your business is already greater there. And then, the second question on the superstore front, obviously you have seen a slowdown in the channel in 2016. As you look going forward, do you think that's more of the same as you look out to 2017? Are there some signs that the channel could rebound? And is the channel mix shifting just online or do you think it is shifting into other retailers also? Thanks.

[Billy Bishop:]

Hi, Dara this Billy, I’ll tackle e-commerce one. No, we don’t think we are going to hit any wall as we look to the future. I mean as you can see from our results, our e-commerce growth is not about really lapping any one-time step up. We continue to gain share in this growing channel. Again, we believe that our unique go-to-market model really drives great traffic online, and we see this is a perfect step for Blue to really close that convenient gap as we have said in the past between food, drug and mass, we are still over 70% of the pet food pound or sold. So, we going to continue to execute our go-to-market model, and we think that we can continue to grow as e-commerce continues to develop.

[Kurt Schmidt:]

And this is Kurt. I’ll talk about the superstore question. First of all the category continues to be robust, and that’s really driven by the humanization, premiumization of the categories. That is unabated. Per ownership remains stable over 160 million plus, the category growth during Q3 was bit slower than recent periods, but still low single digits. What we saw as you've noticed, the slowdown across all the tracked brick-and-mortar channels that food, drug, and mass, superstores, and neighborhood store et cetera with e-commerce growing very rapidly. And the channel shift is pretty similar to other CPG category. We continue to win, gaining share in the overall category, and we are winning in e-comp, and we are very forward looking company. So, again go back to our three strategic plans when we talk about innovation, we got coming in 2017, we continue to develop the communication and education, we feel pretty confident. We will continue to drive consumers.

[Operator:]

Thank you. Our next question comes from John Baumgartner from Wells Fargo. Your line is open.

[John Baumgartner:]

Thanks for the question. I would like to ask about the pricing environment in the supers channel. That channel has benefited quite a bit from price and mix for a number of years, but given the traffic slowdown you are seeing, the deflationary inputs that are still out there, and the new products being on the market, what are you seeing in terms of price compression or the risk of price compression or promotion in that space?

[Mike Nathenson:]

Hi, John, it's Mike. There has been some dynamic changes in the pets superstore channel. One of the things that we know from a year ago is that were lapping a pretty intense price competition period last year. So from that standpoint that's probably one of the key factors that was a headwind in the superstore channel this year and then also obviously there was some traffic fresher as well compounding that. So those are that the two factors that we saw. On top of that when you look at 2016 this year, you are seeing the dollar per pound actually come up a bit in superstores and I think that's just a lapping of that higher promotion environment from a year ago.

[John Baumgartner:]

Okay, and then just a follow-up. In terms of the SG&A line, your spending there is up about over 20% year-to-date. How should we think about the moderation in the growth there going forward? When can we get more leverage on that line? Is it a 2017 opportunity? Is it more of a 2018 opportunity, given the increase in the veterinary expenses?

[Mike Nathenson:]

As we have said as we talked about our business, you should probably look for leverage beginning in 2018 as when to think about it. As we think about it, both Billy, Kurt and I, we manage SG&A ruthlessly; so, we look at the overhead cost were always making sure that our target is for overhead cost to really growth with inflation; and now that we are lapping the full year of being a public company, we feel very comfortable in our goals here in this area. Obviously, when you look at the SG&A that really counts which is revenue driving, we want that to at least go with our top line, and so from that standpoint, that is advertising, marketing, tech detectives R&. Those are the things that actually matter and move the needle from a revenue standpoint. And then we are going to continue to invest in the strategic initiatives for the next chapter of our growth. And in this case, it's the veterinary and international businesses.

[Operator:]

Thank you. Our next question comes from Rupesh Parikh from Oppenheimer. Your line is open.

[Rupesh Parikh:]

Thanks for taking my question. I first wanted to ask a question just on your full-year sales guidance. So based on my math, it implies Q4 sales growth could be anywhere between 7.5% to 11%. I was just curious what is driving that wider range for the quarter.

[Kurt Schmidt:]

So, really as we look at this were very comfortable in our guidance for the full year. So as we look at our guidance and as we look at the range of possibilities actually that range and gives us a wide variety of possibilities. Obviously as we look at this when we gave our guidance to reiterate, we were very comfortable in it and we continue to do so. So when you look at the Q4 what we're saying is that the on the top line is really status quo. Looking at the range in the guidance, we are not assuming any difference in the change in superstores. But we're also assuming, there are our sales outside the superstores continue to be very-very robust. And as I said, there is more a range of possibilities obviously you can model whatever you think is the likely outcome as for superstores and for sales outside the superstores. For us, as we look at this, we are not assuming a change. The top end of our guidance assumes kind of status flow in superstores in Q4 versus Q3 and then you can obviously kind of model how you think the rest of the business will do with that. But as we look at the business, were comfortable in that range.

[Rupesh Parikh:]

Okay, great. And then, just going back to your gross margins, again another strong gross margin quarter performance, I was just curious. One of the factors you called out was lower input cost. So as we look at the gross margin performance, is there anything that concerns you about the sustainability of the improvement that we saw during the quarter?

[Kurt Schmidt:]

Nothing at all, we’re very comfortable. Obviously, our supply chain just from an underlying operating efficiency continues to do well. So we fully expect productivity to continue and start contributing to that. No positive mix will continue. We believe that is a key factor. So from that stand point, we feel pretty good. In terms of input, again they continue -- you guys are looking at the same thing, that we’re looking its fairly benign. But obviously as we get back if that should ever change and the commodities should shift one way or the other, we’re very comfortable in our ability to take pricing. So from that standpoint, we feel very comfortable.

[Operator:]

[Operator Instructions] And our next question comes from Pablo Zuanic from SIG. Your line is open.

[Pablo Zuanic:]

Just two questions, as a result of this settlement with Nestle, do you have any restrictions in terms of the claims you can make or do you have to make any changes to your labels, on, again, ingredients of claims?

[Kurt Schmidt:]

This is Kurt. No.

[Pablo Zuanic:]

Okay, that's a short answer. And then the other one, in terms of what are you seeing in terms of the natural or wholesome natural segment in mainstream. I know you have your definition, but I am seeing Purina Beyond there that they call natural. I am seeing Rachael Ray's product they call mass premium. Are you seeing more natural products in mainstream, and is that one of the reasons why superstores would be slowing?

[Billy Bishop:]

H, Pablo. It's Billy. We’ve been watching the market. We always keep an eye on the market. This is not the new phenomenon. Folks have been reformulating change in the names of their products. I would say, to close for a decade now. We’re watching the Rachael Ray brand in fresh and that is gaining momentum in grocery stores, but we really feel that competes more so with the likes of Beneful as it is one of their lower price point product lines. So again I think there is any new game changer here that has taken place.

[Pablo Zuanic:]

Okay, just a quick follow-up --

[Billy Bishop:]

Pablo just to add to that, that's reflected at FDM growth has not changed at all, right, so it’s relatively flat to declining term. So, it has changed the prospects of the FDM side.

[Kurt Schmidt:]

I think it’s more, it’s more in relation to the untracked channel is where the shifting channel dynamics are. And that’s one of the reason why we think we’re winning, we’re winning in those untracked channels given the way we continue to generate that kind of demand.

[Pablo Zuanic:]

Okay, and just a quick follow-up. Obviously, I am new to the name, but the way I understand it, natural penetration and it is very small at the moment. Superstores, if I go to a PetSmart or a Petco, I find what you call engineered products there. If I go to neighborhood specialty stores, local stores, they are normally all natural. So the question is you have, outside of superstores, your share is one-third, you said, in specialty. But in theory, your share outside of superstores and specialty should be even higher because in total natural in those channels is much higher than in superstores. Am I missing something there or is that the correct assumption?

[Billy Bishop:]

As we talked Pablo, as we get outside of superstores, we are underpenetrated first and foremost, so we have all of our complete products with most part in PetSmart. Have about 80%, 90% if you will in Petco since that’s where we got out start with superstores. And as you read out into the other specialty channels, farm and feed, obviously neighborhood pet, regional pet, we are product portfolios are underpenetrated. So again that’s an opportunity for us to continue to drive growth, and not what are you seeing, I think as Mike talking about why we are gaining so much share in untracked channels.

[Pablo Zuanic:]

I understand, but what I am -- thanks for that. But what I'm asking, if I go to a PetSmart or a Petco, I find their engineered products, right, so what I'm trying to say, in terms of the total sales in those stores, natural as a percentage of your total store should be higher in the other parts of specialty compared to superstores. So as a result, in the future -- I know you are underpenetrated there in the future your market share in those specialty channels should be higher than in superstores.

[Kurt Schmidt:]

It's two things. This is Kurt. One, I think e-commerce that’s not the case because you got the full portfolio for all those products there, that’s one of the fastest growing. Farm and feed natural was really a later entry into the farm and feed. That was established on engineered products. And again, so that is the upside opportunity for us as we are building our business there. Farm and feed are great example, that’s a geographic play. Because we started in superstore, which is tends to be pretty softer. Now, we are getting in geographic locations. Farm and feeds also growing their own natural category where are the number one natural brand. So we benefit from space gains in that channel as well. And as we talked about e-commerce, it's explosive and we have a competitively advantage economic model in that because of our price point. So we agree with you that we should keep growing in farm and e-commerce. Our goal is to meet or surpassed the share we have in superstores. That’s all ahead of us.

[Operator:]

Thank you. And I am showing no more questions at this time Mr. Schmidt. I would now like to turn the conference back to you.

[Kurt Schmidt:]

Okay, thank you very much. Thanks again everyone, it's been a pleasure sharing our strong results with you during earnings call. And now, I want to pass the baton to Billy to finish up this call.

[Billy Bishop:]

We look forward to talking with you again when we report our Q4 results in early 2017. I would again like to thank Kurt for his leadership and also thank our herd members around the world for making it happen. May the Buff be with you, guys.

[Kurt Schmidt:]

Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a wonderful day.