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Q4 2016 Earnings Call Transcript

Published: 1 Mar 2017

[Operator:]

Good afternoon, ladies and gentlemen and welcome to the Blue Buffalo 2016 Fourth Quarter and Full Year Results Conference Call. [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 Q4 and full year 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 in 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 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, Billy Bishop. With that, let me turn it over to Billy.

[Billy Bishop:]

Thanks Mike. First, I would like to welcome everyone as well. I am pleased to share our results with you today. As you saw on our press release, Blue Buffalo’s strong performance continued in the fourth quarter. Most importantly, we continued to drive pet parent demand for our products across channels in a dynamic retail environment. On the financial side, we feel great about the way we delivered high-quality earnings growth. And as a reminder, at Blue Buffalo, we have dedicated ourselves to creating pet foods with ingredients that pet parents prefer to feed their furry family members. Along the way, we have invested over $600 million to build one of the strongest, most recognized brands in the overall pet food market. And as a result, Blue Buffalo has become the undisputed leader in wholesome natural pet food, the fastest growing segment of the $28 billion U.S. pet food market. And we are over 4x the size of the next largest brand in this segment. Today, in the sea of legacy brands, losing their relevance with consumers, Blue has become the new mainstream brand that’s delivering products that pet parents are looking for and connecting with them in a true, 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 has a tremendous opportunity to continue to grow in the U.S. as well as a fantastic opportunity internationally. One of the benefits of sustained investment in our Blue master brand is that we are a true pull brand, with pet parents seeking out our products in stores and online. Our brand building efforts are designed to drive pet parent demand across all channels. We are also investing in new legs of growth by entering the veterinary channel and new international markets. In addition, we are also focused on productivity and expanding our margins in a high-quality, sustainable way. And our 3-year $200 million capital investment program is an important lever in this direction. Putting this all together, our goal is to continue to grow our revenues 10% plus, with EPS growth of about 20% annually over the coming years. In summary, we believe we are a new breed of CPG company, that’s becoming a mainstream brand built for the 21st century. I am pleased to say that Q4 was a strong finish to a great year. As you look back at our full year 2016 results, our revenue grew double-digit versus prior year. This growth was primarily driven by volume, which was well above market growth and as a result, we gained share. We delivered high-quality financial performance from double-digit top line growth to margin expansion and strong cash flow generation. We thrived in a market that experienced dynamic shifts in channel shopping behavior by continuing to strengthen our master brand with unwavering support in media, face-to-face education through our pet detectives and innovation to keep meeting the needs of pet parents. We expanded our margins driven by supply chain, pricing and positive product mix. And our top line growth, combined with expanded gross margins, has allowed us to invest for the future and still deliver healthy net income and EPS growth. As you have seen in our press release, our full year sales growth of 11.9% generated $1.150 billion, which is consistent with the most recent outlook we shared with you in November. In a few minutes, Mike will provide more details of our strong financial performance. But first, let’s look at the market dynamics and our performance at retail. In 2016, the total U.S. pet food market continued to grow low single-digits. From a channel perspective, untracked channels, particularly e-commerce, continued to grow rapidly, while tracked brick-and-mortar channels slowed. Given our advantage, go-to-market model and Blue’s strong growth rate, we estimate that our full year share grew by approximately 40 basis points, which is consistent with our long-term algorithm. While pet parent demand for our products is robust, we are not immune to the changing dynamics in the retail landscape, especially in the short-term and we have seen some variability among our distribution channels. Consistent with our discussions on recent calls, the U.S. pet superstore channel has seen a slowdown due to reduced traffic and we have seen continued strength outside of superstores. Given this trend, our Q4 superstore sell-through was down mid single-digits versus last year. Outside of pet superstores, we estimate our sell-through growth rate in the quarter was in the mid-30s. On the e-commerce side, we continue to ramp up our sales and gain share in this rapidly growing channel, which represented a mid-teens share of our U.S. sales retail mix in Q4. We enjoy significant competitive advantages in the e-commerce channel over the large, widely distributed brands given our higher value per pound as well as our unique go-to-market model that creates consumer pull for the Blue brand. We are gaining share by leveraging these competitive advantages, which is helping close our convenience gap with FDM. As we look into 2017, we expect to see a continuation of these trends in the retail landscape and we will continue to focus on our core strength. By our core strength, I mean our ability to drive pet parent demand in all channels, where pet parents expect to find premium, wholesome natural pet food. We will continue to invest behind our Blue Buffalo master brand across our three strategic planks. And as you can see, they served us well in 2016 and we are confident in our ability to succeed in 2017. Now, I would like to provide some additional color on our commercial performance. Growth was fairly balanced in one of our major product lines, with our more premium lines of wilderness, basics and freedom leading the way. 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 Q4, our WTO growth rate was 13.2%. This growth rate compares favorably to the 10.8% growth for our dry products. And we continue to work on ways to accelerate our WTO business. In total, our international business represented 4% of our overall mix, which was essentially flat versus 2015. As you know, over the last year, we entered Japan and Mexico. And in Q4, we continued to increase our points of distribution significantly in both markets. We now have achieved full geographic coverage in Japan, including new distribution with the largest veterinarian distributor. In addition, given our marketing initiatives, our velocity is increasing along with Blue’s distribution. In Mexico, one of the adjustments we made since our initial launch was to move to new distributor partners who are a better fit for our business. In Q4, our distribution continued to build significantly as our new distributors gained traction in the market. This was nice to see as a validation of the adjustments that we have made as we gain experience in these new markets. We still have a way to go to achieve full geographic coverage in Mexico, but we believe we are on the right track. And while our Mexican and Japanese businesses have good momentum, our Canadian business has experienced some headwinds. One headwind that we are seeing is the strength of the U.S. dollar. In Canada, the price gap between our products and the locally produced competition has widened over the last couple of years, which has been a significant headwind to our top line momentum. So, while we have been encouraged by the progress in our new international markets, we know we have some work to do in Canada. As mentioned on previous calls, we have been ramping up our True Blue Veterinary program. In Q4, we began the rollout of our kidney support and kidney mobility products. And our existing HF, GI and WU products continue to grow quarter-over-quarter. Although our Rx sales in Q4 represented continued progress, the absolute numbers are still small and the overall adoption curve is steady but slow. We continue to be excited about the size of the price in this channel and we are committed to its success. As a reminder, we have two objectives in the vet channel. The first objective is to educate the veterinarian community about Blue Buffalo and to generate recommendations for our current portfolio of wholesome natural products. Specifically, we see a strong opportunity to continue to build our puppy and kitten share by educating the most important influencer of pet food selection. Our second objective is to build a robust Rx pet food business with a line of natural therapeutic products that pet parents and pets prefer. Overall, I am pleased with our commercial performance. Now I would like to pass it on to Mike for a closer look at the financials.

[Mike Nathenson:]

Thanks Billy. Our overall net sales growth in the quarter was 11.3% and 11.9% for the full year. Looking at product types, we saw a strong growth, both with our dry foods and WTO products. For Q4, dry foods grew 10.8% and WTO grew 13.2%. For the full year, dry grew 11.4% and WTO grew 14.2%. Breaking down our overall sales growth, in the most recent quarter, growth was driven principally by 7.6% volume, with 2.3% pricing and 1.4% of mix. For the full year, volume growth was 8.9%, pricing was 1.7% and mix was 1.3%. Before I talk through the rest of the P&L, I would like to touch on our sales growth by customer. Overall, our sell-in growth was a few points better than sell-through. This difference was primarily driven by timing. In superstores, pet parent sell-through was mid single-digits below a year ago and our sell-in was slightly better, but still 3% below last year. Outside of pet superstores, our sales to other customers represented 41% of our total sales in the quarter and grew by 41%. We estimate the sell-through to pet parents in these channels grew in the mid-30s. Sell-in was a bit ahead of our sell-out, particularly in e-com, where retailers were building inventories to support their rapidly growing sales. Now, let’s turn to the bottom line and our margins. As you saw on our release, our profit metrics grew in the quarter, driven by strong top line growth and expanding gross margins, but were partially offset by investments in SG&A and lapping a favorable tax rate in Q4 of last year. Q4 adjusted net income was $35.6 million, up 13.9% and adjusted diluted EPS was $0.18 per share, up 13.1%. Full year adjusted net income was $156.8 million and grew 28% and full year EPS was $0.79 and grew 27.2%. Our Q4 adjusted EBITDA was $65.3 million, up 17.1% versus last year and full year adjusted EBITDA of $276 million was up 24.3%. Our gross margin in the quarter was 44.7%, 280 basis points higher than last year and full year gross margin was 44.9%, up 410 basis points. The increase in gross margin was driven primarily by supply chain efficiencies, including lower input costs. In Q4, we maintained a positive momentum in our operations. And for the full year, we were able to deliver meaningful productivity from our Heartland plant. Margins also benefited from pricing and positive mix, which was primarily driven by our more premium products growing faster than the overall portfolio and WTO growing faster than dry products. 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 21.5% in the quarter versus last year. For the full year, SG&A growth was 22%. The increase was primarily driven by investments in revenue generating activities and investments in our strategic initiatives. Our tax rate in the quarter was 38.7% and 37% for the full year. 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. 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 year, our operating cash flow, defined as cash from operations less CapEx, was $71 million. Our CapEx was $56 million. And at the end of the quarter, we had $293 million of cash on our balance sheet. As a reminder, our operating cash flow reflected the $40 million after-tax legal settlement payments. Before I discuss our 2017 guidance, I wanted to mention that our long-term outlook remains unchanged. We are committed to delivering 10% plus revenue growth and about 20% EPS growth. Turning to our 2017 guidance, the top end of our range is consistent with our long-term algorithm and assumes a continuation of recent trends. The bottom end of our range has a more conservative outlook for the top line and assumes additional pressure across brick-and-mortar channels. As a result, for the full year 2017, we expect net sales between $1.24 billion and $1.27 billion and adjusted EPS of $0.91 to $0.94 per share. Our operating margin, which combines our gross margin and our SG&A spending, is expected to improve in 2017. This year, we expect our gross margins to improve versus 2016, reflecting improved net pricing, some positive mix and supply chain productivity. On the commodity side, input costs are expected to be relatively stable. However, there are several of our proteins and fuel costs that are expected to be inflationary in 2017. As a result, similar to 2016, we took a modest price increase in January of 2017 on certain SKUs. Now turning to SG&A, in 2017, we will drive overall SG&A leverage in the P&L as overall SG&A will grow slower than our top line sales. We will continue to drive pet parent demand by growing our consumer pull [ph] spending, advertising, marketing, R&D and pet detectives with our top line and we will continue to keep a tight lid on overhead spending. Additionally, the bulk of our SG&A investments in our strategic initiatives is behind us, which will help provide leverage in 2017. I wanted to provide some additional commentary on our guidance regarding the shape of the year. For sales, we expect our growth rate to be higher in H2, given our year-over-year overlaps. On the SG&A side, SG&A growth in H1 will be higher than H2. This is primarily attributable to the timing of our 2016 investments as we ramped up our spending through the year. The ramp of our SG&A investments in our strategic initiatives is behind us, so we don’t expect to see the same type of SG&A growth going forward. For taxes, we anticipate a full year tax rate of 36% to 37%. Given the reporting rules, we expect a lower tax rate in H1 and a higher rate in H2. When you put all that together, we expect our EPS growth rate to be higher in H2 compared to H1 and we will continue to update our guidance during our quarterly calls. On the capital side, we have made great progress on our $200 million capital investment program to expand our manufacturing footprint and strengthen our R&D capabilities. Our program is on track. And in 2017, we expect to spend between $150 million and $170 million of capital, which also includes our ongoing CapEx. This level of CapEx is higher than our year ago guidance as it includes a catch-up from 2016 under-spending as well as additional productivity CapEx we have identified. Now, I will turn it back over to Billy.

[Billy Bishop:]

Thanks Mike. Before I open it up to questions, let me tell you the key points I would like everyone to walk away with today. One, we are competitively advantaged leader in the best part of a great category, the wholesome natural segment of $70 billion global pet food market. Two, 2016 was a strong year as we continue to gain share in both the overall market and the faster growing, emerging channels. Three, our advantaged brand building approach has continued to drive pet parent demand well above the category even with the shifting dynamics in the retail landscape. This will continue to serve us well in 2017 and beyond. Four, pet parent demand for Blue continues to be robust and we are confident in our ability to deliver our commitments this year. Five, we are seeing the benefits of improved supply chain performance, positive mix and pricing in our expanded gross margins and we are confident about the expected benefits of our capital investment program, which will enable us further productivity, flexibility and innovation. Sixth, we expect to start delivering more SG&A leverage in 2017. And seventh, we are confident in our full year outlook and we are confident about our opportunity for future growth. With that, I will open it up to questions.

[Operator:]

Thank you very much, Mr. Bishop. [Operator Instructions] Our first question comes from the line of David Driscoll from Citi. Your question please.

[David Driscoll:]

Great, thank you and good evening.

[Billy Bishop:]

Hey, David.

[Mike Nathenson:]

Hey, David.

[David Driscoll:]

I wanted to ask a little bit about the revenue guidance in 2017. You did a little bit in your prepared comments, but could you just develop for us a bit what gets you to the bottom end and what gets you to the top end of the sales growth guidance? And then related to that, could you also discuss what is the importance of the vets and international components of your business in the ‘17 revenue growth guidance?

[Billy Bishop:]

Sure, David. I will kick it off and then I will turn it over to Mike to get into the ranges. But guys, first and foremost, we are focused on being a pull brand and driving pet parent demand for Blue, wherever Blue products are sold. And I think you have seen how we performed in 2016 despite these shifting channel dynamics. One of the key things that will continue to grow Blue Buffalo is our core U.S. business continues to be strong and we are focused on our key U.S. based initiatives, which include growing with puppies and kittens, growing with younger pet parents, continuing to build and grow our Wet, Treat and Other initiatives, our product lines as they continue to develop for the more premium product lines that we have with wilderness, freedom and basics, plus our product innovation. On top of that, as you alluded to, David, we are developing our long-term strategic initiatives, which we believe in the size of the prize for both of those guys and that will serve us well for future growth. We expect some choppiness within the quarters, as we talked about on our prepared remarks, and we feel H1 is going to be slower than H2, but we are focused on the full year and delivering our full year growth numbers. Again, I want to remind everybody that Blue Buffalo is a pull brand and we drive pet parent demand across all channels, where Blue Buffalo products are sold.

[Mike Nathenson:]

Hey, David, this is Mike. So, the way to think about our guidance is that the top end of the range is really reflects the current trends coming out of Q4. It reflects the momentum that we are seeing out of there, which is some pressure in superstores and again, good performance in sales outside the superstores, particularly e-commerce. The top end of our guidance does not assume any improved trends. So from that standpoint, that’s what gets us comfortable with that top end. At the bottom end, it’s really just assumes some more pressure across brick-and-mortar.

[David Driscoll:]

If I could just do one follow-up, you gave us I think you said that the total pet category had low single-digit growth. Can you tell us what did the premium natural sub-segment of pet, what was the category growth rate in 2016? And then is it – again, I know there is a little bit of a range here, but is it expected to continue at roughly that rate into ‘17?

[Mike Nathenson:]

Yes, this is Mike. We estimate that the wholesome natural, the premium segment of the business grew between high single-digits to low double-digits. Right now, we don’t see that changing in the near term. Obviously, we see us being a big part of that growth.

[Billy Bishop:]

Yes. And again, David, the trends haven’t been changing the premiumization. The humanization trends are still there within the pet category.

[David Driscoll:]

Terrific. Thank you. I will pass it along.

[Billy Bishop:]

Thanks.

[Operator:]

Thank you. Our next question comes from the line of Andrew Lazar from Barclays. Your question please.

[Andrew Lazar:]

Good evening, everybody.

[Billy Bishop:]

Good evening, Andrew.

[Andrew Lazar:]

I just want to dig in a little bit deeper to the mid single-digit decline that you have talked about, some of the data shown in the superstore side. More specifically, on I guess, how much do we know about where that shopper is going? So in other words, do you think the bulk of that is just literally Blue customers shifting to where they are buying their products, such that you are just getting them at a different segment such as e-commerce or so or is there a section of that, that’s going to the mass premium side or just too frankly different brands other than Blue? I am trying to get a sense of how deeply you can get into what’s driving that mid single-digit decline specifically for Blue?

[Billy Bishop:]

Sure, Andrew. This is Billy. Again, we see some turnover that happens within pet food year-over-year. We do see pet parents preferring to shop online. I mean, clearly, that’s a secular trend that we think is here to stay and is going to continue to build. What’s important for us, again, as Blue is to make sure that we are continuing to be a pull brand and driving pet parent demand wherever they prefer to shop for Blue products.

[Andrew Lazar:]

And then I think you talked about obviously growth outside superstores in terms of sell-through and ship-in. Is there – do you have a number that you can share of what your growth was either sell-in or sell-out or both for e-commerce specifically in the quarter?

[Billy Bishop:]

Yes, hey Andrew, we don’t share that level of detail. We don’t give the specific information by sub-channel.

[Andrew Lazar:]

Okay, thanks very much.

[Billy Bishop:]

Thanks, Andrew.

[Operator:]

Thank you. Our next question comes from the line of Bill Schmitz from Deutsche Bank. Your question please.

[Bill Schmitz:]

Hey, guys. Can you just answer my question I asked on the conference call on percentage of sales to Petco and PetSmart, I know you said 41% was outside of those two. But can you give us the granular breakdown again?

[Mike Nathenson:]

Absolutely, Bill. I have a specific chart ready for you every time you call. So, I have it ready to go. So, for the 59% that represented our superstore mix, 38% was PetSmart and 21% was Petco.

[Bill Schmitz:]

Okay, great. Thanks so much. And then just in terms of the receivables, it seems like the days keep going up. And my suspicion is that just different trade terms in the e-commerce channel, but if you look year-over-year and even sequentially, there is a big increase both in dollars and in the ratio of days receivable. So I am just curious like, what’s the dynamic there?

[Mike Nathenson:]

Yes, sure. Happy to help. Currently, all of our customers are paying on time and our receivables are higher based on customer mix and timing. There is a portion of our customers that choose not to take advantage of our early pay discount. As a result, the days receivable has grown. That said our credit team really monitors it every single day.

[Bill Schmitz:]

Okay, great. And then just one last quick one, just sequentially it seems like the gross margin came down quite a bit. And I don’t think there is a lot of seasonality in the business in terms of margin. So, is that just the commodity inflation we saw in the fourth quarter?

[Mike Nathenson:]

No, not at all. So, as we talked about in our last call, we gave some indication that we expected the margin in Q4 to be lower than Q3 and it’s really due to seasonality. The margin for the full year was right in line with what we had guided to, but typically, you get a little bit more spending on holiday sales, merchandising, so you see that little bit more and you also see some additional costs for additional shipping. Typically, there is a press for trucks during the holiday season. And also during the November and December timing, our plant doesn’t operate through all of those holiday periods. So that’s what drives the difference.

[Billy Bishop:]

It’s really just seasonality.

[Bill Schmitz:]

Okay, that’s very helpful. Thanks, guys.

[Billy Bishop:]

Thanks, Bill.

[Operator:]

Thank you. Our next question comes from the line of Ken Goldman from JPMorgan. Your question please.

[Ken Goldman:]

Hi, thank you. This is about as back of the envelope as it gets, but we are modeling – or not modeling, we are interpreting the overshipment maybe 3% to 4% of your total sales growth last quarter. First, I am curious is that a reasonable number in your mind for how much you overshipped? And second, does all of that, I assume then get eaten away from the first quarter next year? I am just trying to get a better sense of how light the first quarter sales growth maybe – might be given some of the timing of shipments.

[Mike Nathenson:]

Yes, it’s a full point. And remember, we provide a lot of transparency to the investors to make sure that they understand that. As part of our guidance, our guidance takes into account the exit momentum out of Q4 as well as what we are seeing in the early part of Q1. So from that standpoint, when you combine the additional pressure that we are seeing in brick-and-mortar, along with our laps and combine that with the momentum we have coming out of Q4, that’s what’s driving our guidance. And I was going to say, as a reminder, that’s why we said that we expected H2 to grow a little bit faster than H1.

[Ken Goldman:]

No, it totally makes sense. I heard you say full point. So just to make sure, it sounds like my math was a little aggressive there. So it sounds like maybe 1% in 4Q gets shaved from 1Q. Is that a fair way to look at it?

[Mike Nathenson:]

No, no. What I said was a few points. So I didn’t say...

[Ken Goldman:]

A few points, okay. I am glad I asked.

[Mike Nathenson:]

I didn’t articulate that.

[Ken Goldman:]

I didn’t hear it right. So I think I am glad I asked again. And very quickly as a follow-up. You guys – your guidance for cash allocation, over time, in my view, it’s – you have been a little, I think purposely and understandably vague about where you want some of that cash to go, but the cash on the balance sheet continues to build up, is there any helpful color you can give or unhelpful color you can give about sort of what you are thinking in terms of how did this cash build, where your emphasis will be from here, I am just trying to get a better sense for modeling purposes down the road?

[Mike Nathenson:]

Yes. I think we have talked about this in prior calls. But we are comfortable with our capital structure as it exists right now. As you can see from the prepared remarks, I said that we were stepping up significantly our capital spending next year, which was $150 million to $170 million, which is a step-up. From that standpoint, we know we have got some high ROIC projects ahead of us. And again, this is probably the best example. But all that said we are not blind to the strengthening of our balance sheet. And it’s something that we are discussing and when we are ready to share an update, we will do that. I think the best thing to remember is that we are all investors and we understand the need to provide some additional information once the time is right.

[Ken Goldman:]

Perfect. Thanks so much.

[Operator:]

Thank you. Our next question comes from the line of Dara Mohsenian from Morgan Stanley, your question please.

[Dara Mohsenian:]

Hey, good evening guys.

[Billy Bishop:]

Hi Dara.

[Dara Mohsenian:]

So Billy, I was hoping for some more detail on the superstore front, clearly the channel slowdown accelerated throughout 2016, so can you take a step back and just talk about what you think is driving that and I guess as you look going forward, is it more of the same in 2017, parsing through some of the Mike’s comments, I guess it sounds like you are probably looking at a lot of mid single-digit decline in superstores in 2017, is that in the right kind of range?

[Billy Bishop:]

Sure, Dara. Near-term, we see continued pressure on the superstores. And again, we know traffic is the primary issue there. Longer term, we know that the superstores are committed to growth. We know they want to open up new stores. We know that they want to enhance their e-commerce initiatives. And again, I think they want to be able to continue to communicate that pet specialty has a differentiated in-store experience from a lot of other CPG, brick-and-mortar retailers, be it the products, be it the services, if you will the total pet solutions that they can offer and they can leverage. So we are continuing to work with all of our brick-and-mortar partners to try to help change that trend, drive more traffic and obviously, grow our businesses. So I think the first half of the year is going to be challenging. We are going to still see a headwind. But we are confident and optimistic that the back half of the year, we are going to see some things turn around.

[Dara Mohsenian:]

Okay, that’s helpful. And then can you give us an update on where you think your market share stands now in e-commerce?

[Billy Bishop:]

I am sorry, I will lose shares is just the market share question, I am sorry [Technical Difficulty].

[Operator:]

John Baumgartner, your line is open.

[John Baumgartner:]

Hi, good evening. Thanks for the question. I wonder if we could just start off thinking about the vet therapeutic in light of what we understand is a major competitor exiting that channel, how does that impact your expectations for how quickly the business can ramp and become profitable and how much of a volume or mix benefit can we expect from vet therapy in 2017?

[Billy Bishop:]

I apologize. I know Dara was only trying to finish his question and that’s just distracted, would you mind just repeating the question one more time?

[John Baumgartner:]

Sure. In terms of vet therapy, we have heard that one of the major competitors there has exited the channel, so maybe just given that, how does it impact your expectations, quickly you can ramp in that channel become profitable and how do you think about the contribution from vet therapy either in terms of volume or mix for 2017?

[Billy Bishop:]

If you are talking about a major competitor, I think you are referring to maybe Hain’s [ph] and we know they are exiting out. They actually had a small share in the therapeutic space. So net-net, our experience so far in talking to veterinarians, really, we have two objectives I want to remind everybody about. The first is introducing Blue Buffalo to this community, so we can gain their recommendations for our current line of I guess what I will call right now, OTC products, so our core line of Blue products. And obviously, the second one is to grow our therapeutic business, with a line of wholesome natural therapeutic diets. This is the business that you have to put in the time. It’s a clinic by clinic business and it’s something that you have to be committed to for the long-term, which Blue Buffalo is. So again, we are seeing nice growth quarter-over-quarter. We are adding clinics, we are building sales. But it’s something that again, Blue Buffalo is in for the long haul. So we think it’s going to be a slow and steady build, but we are confident in the size of the price.

[John Baumgartner:]

Thanks Billy. And just a follow-up, in terms of e-com, I think part of the dynamic there has been spending to capture banner placements and some high visibility areas on these websites, but as e-com increases and importance to the trade, can you speak to maybe what you are seeing in terms of rate inflation or competition for those areas of prime visibility and how we should think about the environment there moving forward?

[Billy Bishop:]

Yes. Sure, John. I mean again, I know everybody is focused obviously on how they can continue to increase their business in this fast-growing channel. We believe it’s really a combination of a bunch of things that really, again sort of feeds off of the Blue Buffalo go-to-market model. So this is something that again, we have been investing in for years and years and years. Its part of that $600 million master brand investment that we have been doing. So for us, it’s continuing to execute our game plan. We have to continue and we are today the number one searched brand online, which still search – organic search results and branded Blue search terms drive the most traffic to our online e-customer partners. So we want to continue to do what we do to ensure that we are the number one searched brand. I don’t know if you guys happen to see, but there was a recent published article by one of the third-party data sources that has Blue Buffalo as the number one online sales CPG brand out of all CPG companies, so against some of the larger iconic brands such as Pampers and Gillette. So again, I think it talks to our Blue brand building, demand generating model. And for us I think we can’t take our eye off the ball on continuing to invest behind our master brand.

[John Baumgartner:]

Great. Thanks Billy.

[Billy Bishop:]

You bet.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Rupesh Parikh from Oppenheimer, your question please.

[Rupesh Parikh:]

Thanks for taking my question. So I also had a question on the superstore channel, I was just curious, as you look at the brick-and-mortar part of the PetSmart and Petco business, are you seeing any changes in the competitive or promotional environment within that channel given all the struggles. And I also wanted to get a sense of whether you have been able to maintain your market share?

[Billy Bishop:]

We haven’t seen any heightened competitive activity. I mean it always is competitive within that space. And if you look over the course of 2016, Blue Buffalo has been able to basically hold its share within those superstore channels. So again, we want to gain share, we are going to continue to execute our marketing model and drive pet parent demand. But we feel again, as these channels continue to grow and develop, we think we are in a great spot to be able to grow with them.

[Rupesh Parikh:]

Great. And then my follow-up question, so you are going to reaffirm your longer term targets, say for the 10% top line growth and 20% bottom line growth, I was just curious, as you look at the continued challenges of brick-and-mortar, just want to get a sense of what gives you confidence to be able to get back up to that 10% plus growth level in I guess, FY ‘18 and beyond?

[Billy Bishop:]

Sure. Again, just as a reminder, guys we feed less than 3% of pets. We have a 6% share in the U.S. We continue to compete with all channels. We like our model and we think there is a lot of growth to be had in the channels that we are in. So for Blue Buffalo, again, it’s focusing on the things that we do best and continue to make that right connection with pet parents and make sure that we provide them with the products that they want to feed their furry family members.

[Rupesh Parikh:]

Great, thank you.

[Billy Bishop:]

Thanks.

[Operator:]

Thank you. And we have the line of Dara Mohsenian from Morgan Stanley back in the queue. Your line is now open.

[Dara Mohsenian:]

Hi guys.

[Billy Bishop:]

Hi Dara.

[Dara Mohsenian:]

So the question was just market share now for BUFF in e-commerce, where does that stand and also, what percent of your e-commerce business do you think is now subscription based?

[Billy Bishop:]

Sure, Dara. You may have, I don’t know if you heard, but there was again a third-party data company that just published some results showing that Blue Buffalo is the number one CPG brand online, which again was pretty exciting given the fact that we are higher in sales than such iconic brands such as Pampers and/or Gillette. But we think our share is in the mid-teens and growing rapidly. And we know subscription is a big part of online sales. We would estimate that it would be right around 50% where subscription is available. So, I think we have to continue to execute the Blue model and I think we are poised to grow as that channel continues to accelerate.

[Dara Mohsenian:]

Great. Thanks.

[Billy Bishop:]

Sure.

[Operator:]

Great, thank you. [Operator Instructions] Our next question comes from the line of Pablo Zuanic from SIG. Your question please.

[Pablo Zuanic:]

Yes, thanks. Look, I have two questions. One if I may just go back to the number guidance that you gave, Michael. I am sorry to be so nitty-gritty. Did the quarter improve as we went to November and December? Because you said that based on your sell-through, you were supporting the high-end of guidance of 10%. But if I do the math right, mid-30s on the base and then minus 5% or mid single-digits on the superstores, that was also about a sell-through for the quarter of about 7.8%, 8%. So, did I misunderstand that? I mean, did you say that based on your sell-through, you are supporting the 10% guidance for next year? Just that you exited the quarter in such a strong way – you exited the quarter better than what the quarter average was. So that supported 10%. Sorry, just want to clarify that? Thanks.

[Mike Nathenson:]

Yes, no worries. We don’t usually give inter-quarter color. What I would say is that your math is fairly good. Obviously, when we said our sell-through was a few points lower than our sell-in that would suggest that the sell-through was high single-digits in the quarter. Obviously, there is puts and takes throughout the year. We are very comfortable in our full year guidance. There is a number of things that gives us confidence in the full year. Obviously, we have opportunities in Wet Foods and Treats. We indexed higher with puppies and kittens and younger pet parents. And as we look at the shape of our year, our faster growing channels are becoming a larger and larger part of our mix. So, that’s a key piece of it, pieces that we have got innovation that we are launching this year and we expect to gain space along the way. So in terms of the guidance that I set, the top end of our guidance takes into account the momentum that we had seen coming out of the quarter from Q4 going into Q1 and that assumes that there isn’t any degradation in the trends. We are not assuming that it improves to hit the high end of our guidance range for the full year, but it’s going to be choppy throughout the year.

[Pablo Zuanic:]

Understood. And then just a couple more. So regarding the superstores and I realized that they are obviously a very important customer for you, but there are these factors that are affecting that channel, but they have new owners, they are probably improving trends. So what do you see there on the positive side in terms of what the superstores are doing that will make us think that things will improve there? And related to that, are the superstores becoming more aggressive in terms of their own e-commerce platforms or there is still some catching up to do? Thanks.

[Billy Bishop:]

Hey, Pablo, it’s Billy. Yes, definitely, our superstore partners are aggressively looking at ways to continue to drive traffic to provide a differentiated experience in-store, again, with all their products, their services that they can offer as well as they are focused on improving their e-commerce business as well. So. I think near term, again, it maybe a little bit bumpy, but we are optimistic of the longer term that they are going to figure it out and we are going to continue to grow as they grow.

[Pablo Zuanic:]

And one last one, so you said 41% is the other channels outside superstore, e-commerce 15%. So, can we talk about that other 36%, which would be farm and feed and I guess, regional, local neighborhood stores? Anecdotally, when we talk to some of those chains, I visited some where actually a salesperson, the owner or the guy – the person in charge there says, okay, Blue Buffalo is on the shelves. And it’s a new brand that we are talking. And on the other hand, there are other smaller chains that are maybe opposed to Blue Buffalo in a way, because maybe it’s too mainstream for them as a natural brand in that segment. Can you talk about that in terms of any pushback that you find as you try to enter these other specialty regional, local neighborhood stores? Thanks.

[Billy Bishop:]

Sure. Again, gosh, just as a reminder, we got our start in superstores. We launched the brand in superstores. So, the superstores have the majority of our product portfolio. We are the most developed within the superstores. As you look outside that superstore channel, at neighborhood and regional pet, it’s farm and feed, again, we are underdeveloped and underpenetrated. So, that’s something that we are continuously working on as trying to get the best of Blue products in all of those other outlets, if you will. So farm stores, as an example, have limited space. So, they want to sell the products that sell. You may have some outlying in individual mom and pops that want to try to differentiate themselves, so they maybe looking for more smaller products that are more niche and more unique that again can’t advertise or drive pet parent demand. But overall, we see that the Blue Buffalo business is continuing to build and grow in channels outside of the superstores, where again we are under-penetrated and underdeveloped.

[Pablo Zuanic:]

Thank you. That’s very helpful. Look if I may just – I want to squeeze one more. Would you say that the mass-market channel, Walmart, Target, the supermarkets, are they doing a better job in terms of the natural segment? And if that were to happen and they begin to develop the natural segment like it’s happened in human food, what do you do? I mean, do you – how do you compete in that segment or do you think that the growth for wholesome natural is so strong in specialty and e-commerce that there is no need to worry about the mass-market? Thanks.

[Billy Bishop:]

Sure. I mean, again, I think everybody is aware that the fastest growing pet food segment within pet food is wholesome natural products. Again, I look back to Blue’s portfolio. We have the widest and broadest selection of wholesome natural products. Obviously, we advertise and we market our products to pet parents and we want to find that right product that meets that pet’s specific need, whether it’s a large breed dog with food sensitivities, whether it’s a small breed dog that loves high-protein and in such real feeding. So again, I think you are going to see more and more pseudo naturals, value naturals pop up. I think what’s important for Blue Buffalo is to continue to be a pull brand and execute our marketing models, so pet parents can know the unique products that Blue offers and where they can find them.

[Mike Nathenson:]

Yes. One thing, Pablo, this is Mike that I would add is that even with some of the value naturals growing rapidly in that channel, our look at the data suggests that the FDM growth rate has still stayed around 1%. So, there really hasn’t been resurgence in FDM pet food growth. We have seen it being fairly cannibalistic with existing widely distributed brands that are sold in that particular channel. That said, we monitor everything very, very closely.

[Pablo Zuanic:]

Right, thank you. That’s very helpful.

[Operator:]

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

[Billy Bishop:]

I want to thank all of our members around the world guys for a great 2016. Way to go, BUFF. Also, it was a pleasure sharing our strong Q4 results and we look forward to talking with everybody again when we report our Q1 results. May the BUFF be with you, guys.

[Operator:]

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.