Nov 11, 2015
Executives
Katie Turner - Investor Relations Richard Thompson - Chief Executive Officer Dick Kassar - Chief Financial Officer Scott Morris - Chief Operating Officer
Analysts
Jason English - Goldman Sachs Peter Benedict - Robert Baird Robert Moskow - Credit Suisse Bill Chappell - SunTrust Joe Edelstein - Stephens Inc. Phil Terpolilli - Wedbush Securities Jon Andersen - William Blair Mark Astrachan - Stifel Scott Van Winkle - Canaccord
Operator
Good day, ladies and gentlemen and welcome to the Freshpet Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode.
[Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Ms.
Katie Turner. Ma’am, please begin.
Katie Turner
Thank you and good afternoon and welcome to Freshpet’s third quarter 2015 earnings conference call and webcast. On today’s call are Richard Thompson, 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 meanings of the federal securities laws.
These statements are based on management’s current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements. Please refer to the company’s quarterly report on Form 10-Q expected to be filed with the SEC 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 that 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, 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. Now, I would like to turn the call over to Richard Thompson, Chief Executive Officer.
Richard Thompson
Thank you, Katie and good afternoon everyone. To begin, I will provide a brief overview of our third quarter financial highlights and recent business performance.
Then Dick will review our financial results for the quarter in more detail and our updated outlook for 2015. Finally, Dick, Scott and I will be available to answer your questions.
It was just over one year ago that Freshpet became a public company. This was a significant milestone for Freshpet, one that has helped better position us to achieve long-term growth as we build and scale our business.
We are pleased with the progress our team has made in the past year and at the same time, there are key areas of our business where we plan to execute better in the future. Our business is uniquely positioned with a product offering that is at the confluence of natural, fresh, healthy ingredients, combined with pet parents that are highly motivated in how they treat and feed their dogs and cats.
The Freshpet business has a highly loyal consumer base and has helped consistently build our business year after year since 2006. Freshpet has brought the most significant innovation to the pet food category in more than 70 years.
By bringing fresh food to pets, we are a first mover and have revolutionized the pet food aisle. We are changing the way pets eat.
The third quarter sales increased approximately 36% to $30.6 million, driven by increased velocity growth per fridge. Our sales growth continued to outpace the distribution growth of Freshpet Fridges, which increased 13% year-over-year to 14,670 locations.
As we have previously communicated, we expect that our 2015 Freshpet Fridge location growth to be closer to the low end of our full year guidance of 15,100 to 15,600. And as we have gained more visibility, we now anticipate to end the year with approximately 15,000 Freshpet Fridges.
We believe that the difference from our original guidance range to where we expect to end the year will be approximately $2.4 million in lost sales. The recent bankruptcy of two grocery retailers has also impacted our fridge count and sales by approximately 100 locations.
While we are, of course, disappointed that we must temper our expectations for fridge growth near-term, this does not deter our confidence in Freshpet long-term growth opportunities. Time and time again, we have seen the addition of a Freshpet Fridge grow the overall pet category, attract new consumers, increase shopping frequency and provide category leading retail margins.
This continues to be a strong value proposition for retailers and we still believe on averaging over the next several years the approximate 2,000 fridges on an annualized basis is achievable long-term. As those familiar with our company know, our Freshpet Fridge allows us to control critical real estate while truly differentiating our product at the point of purchase.
As we own and maintain them, our Freshpet Fridges are key barriers to entry. This provides us with a unique Freshpet brand ambassador in every location.
The introduction of innovative new products in a diverse portfolio, are important to driving sales growth and increase velocity. Our innovation team and our developments this year have been tremendous and we are very pleased with the consumer response to our new products.
However, production capabilities, including the production throughput of our new Freshpet Shredded product has been lower than originally projected and this limited our anticipated growth contribution and our gross profit margin was negatively impacted in the quarter by approximately 90 basis points. I am pleased to say that our throughput rates improved a bit in October and early November and we expect continued flow-through improvements once we began to see the efficiencies from our upcoming manufacturing plant expansion with a target completion date of second quarter 2016.
Earlier this year, we communicated our action to increase price on certain Freshpet beef products to help us better absorb the drastic increase in beef commodity cost. As a result, we have experienced some softening in demand of those products.
Those products represent approximately 20% of our business and we experienced a 15% reduction or about a $900,000 in sales for Q3 and a $1.5 million for the year-to-date periods. We have since seen this trend level off, with volume currently trending flat to up.
Our fresh baked product test continues to progress well with our key retail partners. And today, this product is in about 5,000 retail locations across America.
Please keep in mind that as we mentioned last quarter, our Freshpet baked product currently has a lower gross margin at approximately 30% and we expect the gross margin to gradually increase to 35% by the end of 2015. As we realize greater efficiency behind our full scale with this product, we believe the gross margin contribution will improve by the end of 2016.
Dick will discuss our gross margin performance in more detail in his remarks. In addition, to support our future growth and brand awareness around our Freshpet baked product, we invested approximately $3.5 million in incremental marketing spend plus all operating margin earned on bank revenues, with $2.2 million spent in Q3 and $1.4 million spent in Q4.
Increased brand awareness continues to be a key area of focus for our team. Consumer trial of Freshpet products, and repeat purchase rates have increased significantly as a result of our marketing investment over the last few years.
We are very efficient at connecting with consumers through a wide range and diverse mix of marketing strategies. Whether through national television advertisements, our easily recognizable brightly-lit Freshpet Fridges filled with differentiated package products or digital, social and viral media campaigns.
We are making progress in enhancing our manufacturing and infrastructure capabilities at our Freshpet Kitchens in Bethlehem, Pennsylvania. Additionally, we are in the process of expanding our Freshpet Kitchens.
Our new infrastructure will include two additional higher capacity state-of-the-art production lines. This expansion will increase capacity to greater than $400 million per year in revenues.
We have recently achieved a 98% SQF certification rating, along with passing FDA inspection at the Bethlehem facility. Our team has built a strong foundation and we are well positioned for future growth.
We are confident that our strategic plan and we are intently focused on execution of our operational and financial objectives. Going forward, we will further improve our process, drive greater leverage across our business model and in turn enhance long-term shareholder value.
With that overview, I will now turn the call over to Dick, our Chief Financial Officer, who will review our financial results in more detail. Dick?
Dick Kassar
Thank you, Richard and good afternoon everyone. I will review our third quarter and year-to-date financial results and will then review our full year outlook for 2015.
For the third quarter, consolidated net sales increased 35.8% to $30.6 million. Net sales for the third quarter of 2015 included $1.8 million in net sales associated with our Freshpet baked test product.
This growth resulted from both distribution and velocity gains across all retail sales channels, including a 13.1% year-over-year increase in Freshpet Fridges. Gross profit for the quarter was $14.1 million compared to $10.9 million during the same period last year.
Gross profit margin was 45.9% for the third quarter of 2015 compared to 48.5% in the third quarter last year. The following items impacted our gross margin performance in the quarter.
As Richard mentioned, our Freshpet baked product currently has a gross margin of approximately 30%. While we do expect this will improve to approximately 35% by the end of the year, this lowered our margin in quarter three by 103 basis points.
In addition, our Freshpet Shredded throughput out of our manufacturing facility has been lower than our outlook originally projected and this resulted in a 91 basis point drag to gross margin in the quarter. Finally, we also incurred a charge of $150,000 or 49 basis points from the implementation of new manufacturing processes in the quarter as we continuously look for efficiencies to improve our Freshpet roll production.
In sum, these three items negatively impacted our gross margin performance in the quarter by approximately 243 basis points. SG&A expenses decreased as a percentage of net sales to 51% from 54.2% in the same quarter last year.
After adjusting for fair valuations of warrants and stock-based compensation expense, SG&A expense decreased as a percentage of net sales to 46.8% from 53.2% in the same quarter last year. Looking ahead, we expect to further decrease SG&A as a percentage of net sales as we increasingly scale our operation, better utilize our existing infrastructure while growing net sales.
Adjusted EBITDA increased $1.2 million when compared to the same period in 2014 to $2.3 million. The Freshpet Baked test product contributed a loss of $1.8 million to adjusted EBITDA during the three months period ended September 30, 2015.
As a reminder, adjusted EBITDA is a non-GAAP financial measure. On year-to-date basis, net sales for the first nine months of 2015 increased 38.1% to $86 million compared to $62.3 million in the first nine months of last year.
Net sales in the first nine months of 2015 included $3.3 million in net sales associated with the company’s Freshpet Baked test product. Adjusted EBITDA improved $5.5 million to $7.1 million and adjusted EBITDA as a percentage of net sales for the first nine months of 2015 was 8.2%.
Freshpet Baked test product contributed a loss of $2.5 million to adjusted EBITDA during the first nine months ended September 30, 2015. Turning now to the balance sheet, at September 30, 2015, the company had cash and cash equivalents and short-term investments, fully FDIC insured certificates of deposit of $19 million.
The decrease in cash is primarily due to expenditures related to the expansion of our Freshpet Kitchens, capital investment to increase distribution through the purchase of additional Freshpet Fridges and the purchase of land of 6.5 acres and building directly adjacent to the Freshpet Kitchens. Each quarter in 2015, we have generated positive cash flow from operations.
For the full year 2015, we are updating our previous guidance. We now expect Freshpet Fridges in the range of 14,900 to 15,000, representing an increase of approximately 11.3% to 12% compared to the prior year.
As a result, net sales are to be in the range of $115.5 million to $117 million, representing an increase of 33% to 35% compared to 2014. Our net sales guidance includes approximately $5 million from the Freshpet Baked test product.
Adjusted EBITDA is expected to be in the range of $10 million to $11 million, an increase of $4.5 million to $5.5 million compared to 2015, including the negative contribution of $3.8 million from the Freshpet Baked product. As a reminder, our adjusted EBITDA represents EBITDA plus loss on disposal of equipment, new plant startup expenses, share-based compensation, launch expense and secondary cost and warrant expense.
As discussed last quarter, we are strategically expanding plant capacity to provide sales up to $400 million, which represents an increase of 130% from current plant levels. We plan to invest approximately $31 million in capital expenditures to achieve this, of which $10 million has been spent to-date.
The projected completion date for construction is in the second quarter of 2016. Construction is on track to finish on our planned date, with operations beginning in June 2016.
We continue to expect to borrow approximately $8 million to $10 million from our credit facility in the first half of 2016 and we expect to repay this indebtedness by the first quarter of fiscal 2017. As many of you know, in conjunction with our initial public offering, we entered into a $40 million credit facility, of which zero was outstanding as of September 30, 2015.
We see strong growth for our products across our distribution network and we will continue to maintain a strong balance sheet and liquidity to meet demand and further grow our distribution network. That concludes our financial overview.
Richard, Scott and I are now available to take your questions. Operator?
Operator
Thank you. [Operator Instructions] Our first question is from Jason English with Goldman Sachs.
Your line is open sir.
Jason English
Hi. Thank you for the question.
So I just want to probe in a little bit more on the top line, first in terms of cooler placements, how much of this lowering, do you think is just deferral and do you have line of sight for new coolers over the next few quarters and is the pass-back to sort of your initial aspirations and maybe 2,000 coolers a year, is that at all possible or should we really be tempering our expectations quite a bit, just given the guidance for next quarter and the last couple of quarter run rate?
Scott Morris
I think if you – Jason, it’s Scott, I think if you look historically, we have seen every one of the years for the past several years be between 1,500 and up to 2,500 and we have been a little bit higher than that in a couple of years. We continue to feel comfortable that 2,000 is a good guidepost where we may have years that are going to be slightly lower and some that are going to be higher.
And we anticipate there will be a year that we might break through that number two in the future. If we look at the opportunity in front of us across the many different formats, we still know there are many, many thousands and thousands of fridges in front of us.
And we think 2,000 is still a number that we are planning towards into the future and we are thinking about into the future. So we do believe that, that’s a very achievable number.
And the thing that we need to focus on is developing really comprehensive programs across each channel of trade in order to kind of tackle those and make sure that those stores are coming in on a more consistent basis. We had, as we have discussed I think earlier on the year, we have had a handful of kind of key anchor tenants fall off this year that we anticipated having come into the mix and that’s caused us to be on the lower end of the range.
And in the last couple of weeks, we actually – we had a more recent surprise of around 100 stores between Haagen’s and A&P. So I would say many things did not materialize or develop as positively as we would have hoped this year.
Jason English
And then on velocity, your guidance implies that velocity growth per cooler slows quite a bit in the fourth quarter and actually declines sequentially quarter-on-quarter, which it’s been a while since we have seen that, what’s contributing to the lower velocity expectation?
Scott Morris
Well, I think we have gotten a lot of guidance and thought a lot about this. And we wanted to make sure that the numbers that we are – we wanted to adjust numbers, we want to make sure that the numbers we are putting out are something that we feel comfortable in achieving.
We recognized that given where we are from a store count basis and a media spend and some things around innovation, we have recognized that there is a little bit of a slowing down. We had numbers into the high 30s and early 40s from a change versus a year ago earlier in the year, that’s exceptional.
We think we will be returning to those types of levels at some point. However, based on kind of where we are in the timing and the fridges coming in, we wanted to make sure that we are putting out numbers that we feel comfortable with.
Jason English
Okay, thanks. I will pass it on and let some other folks have a turn.
Richard Thompson
Thanks Jason.
Operator
Thank you. Our next question is from Peter Benedict of Robert Baird.
Your line is open.
Peter Benedict
Thanks.
Richard Thompson
Hi Peter.
Peter Benedict
Thank you, guys. Hi Rich, just dovetailing off the last question there just on the velocity deceleration.
Scott, is it kind of planned across all channels, is there anything that’s concentrated in any of those channels, I mean you said you expect at some point to get back up to those higher levels, is that related to getting some new units out there or is it something you are expecting once you get the capacity back up, are we kind of in a capacity constrained situation here for the next couple of quarters?
Scott Morris
There has been – well, I guess, there are several different factors going on. So one of them is clearly, the store piece is multiple million dollars, which is significant to us.
So that’s the first one. And that’s something that we have to focus on.
And we are developing programs that we will be sharing in the not terribly distant future around. The second one is innovation timing around, where – when we are coming out with innovation and how we are phasing it in and basically the timing that we had last year, and you can kind of see what it delivered earlier on in the year and now there is innovation that’s coming.
However, our innovation pace is slightly modified based on some capacity. We have had some on certain products we have had some trimming on launching innovation based on some capacity challenges that we have had.
That’s fine we will move through those and work through those and obviously once we have the new plant – the new phase of the plant opened up, we will be in a terrific position. I mean, the last one is from a media standpoint, as you know, the media has contributed a lot to the business.
We spent a fair amount on media in the beginning of the year. Towards the end of the year, we actually – the majority of the media that we spent was focused on the baked launch.
So, that’s a component. And then finally, the other thing that was mentioned in the release was we actually took very significant pricing action to offset the beef commodity increases.
And that has slowed growth and it really had slowed growth and that’s the story we are talking about here is it slowed the growth on a couple of those items. So, that’s something that we are thoroughly evaluating on how to deal with that in the future, how to think about that and what we need to do from a pricing standpoint.
So, those pricing increases were anywhere between 8.9% all the way to up to 20% on a couple of items that were basically 100% beef. So, that’s something – that’s just another factor that’s coming to play.
And that will moderate over time too and we are now at a point where we are seeing that level off. And we have moved through these price increases many, many times before and we level off and we move through them and just continue to go right through them.
In the future, it will either provide us with a significant opportunity to either a), adjust pricing or b), we will have a nice pickup into the future if the commodities do come down and I think that’s anticipated.
Peter Benedict
Alright, that was going to be one of my follow-ups is just when you have done these price increases in the past what have you seen, you do typically see a pullback. It sounds like this might have been more than you even anticipated.
But you see a leveling off and then you start to grow through it. I guess, on the gross margin would be my other question.
Trying to understand the duration of this kind of pocket we have had here on gross margin, the dry headwind, I think we can pretty easily see when you start to cycle that, but how about the other two factors? I mean, are they – are we in for another couple of quarters where the gross margin is impaired similar to way it was in the third quarter?
Is the back half of ‘16 kind of when we are back to, I don’t know, with those 50% levels or how should we think about that?
Dick Kassar
Yes, it’s Dick. Thanks Peter.
Right now, our shredded product is our fifth largest SKU, and we are certainly excited about that. In the third quarter, our production rates were significantly lower than we had ever projected.
We did mention this at least individually, if not on the call. And in the fourth quarter on October and November, we have seen about a 30% increase in productivity on the line.
So, that’s good news. As Scott indicated, we have held back on further distribution of this product, because of capacity issues.
But the interesting part is when we put up our second packaging line, we will have – we will be adding equipment that will increase the productivity of that product by another 30%. So, there is – there are – those issues on the shredded product, although improving in the fourth quarter and slightly – and continuing to improve, we will be at a margin that is kind of in our ballpark once our packaging line is up.
On the roll line, we spent about as we indicated about $150,000 in the third quarter and we will continue to spend that kind of number so in the fourth quarter. And what we are trying to do is kind of improve the efficiency of that product line and to enhance margins.
And our new Executive Vice President of Manufacturing is kind of putting his foot to the pedal to get that moving along and we expect to see significant improvement. So for the fourth quarter, we certainly, on the refrigerated side, we should be somewhere around north of where we came in this quarter.
And then we will see gradual improvement. And then come in – once we have the other lines, the two new lines up and running, we will be able to see a five in front of our gross margins in the back half of 2016.
Peter Benedict
Okay, that’s helpful. Thanks.
Thanks, Dick.
Operator
Thank you. Our next question is from Robert Moskow of Credit Suisse.
Your line is open.
Richard Thompson
Hey, Robert.
Robert Moskow
Hi, good afternoon or good evening. In order to get your gross margins up that high though, Dick, don’t you also need substantially more roll volume for that to happen as well?
And I guess my concern is when I look at the velocity is just kind of like slowing down on the core roll business using our Nielsen data. It seems like it’s kind of stagnating on a sequential basis.
And I guess I want to know from both a marketing angle and manufacturing angle, what’s the outlook for rolls if the freezers are kind of not – if the freezer growth is kind of slowing, do you need velocity growth on the rolls in those existing units in order to hit those gross margin kind of targets? One question.
Dick Kassar
Well, I will talk about the manufacturing side and let Scott talk about the marketing side. On the manufacturing side, our equipment is significantly – new equipment is significantly faster and we will be growing in stores.
And although we see a movement from rolls to bags in our data also, there will be growth in rolls, because we will be adding additional stores. So, that 30% speed on the line will help us manage our cost per pound and see nice improvements in our cost per pound from manufacturing.
And on – as far as, I mean, one point, you forecasted this, Scott, on a factory basis, when you look at our third quarter results, we are around $152 per store per week. We had projected to finish the year at $147 per store per week, but we expected it kind of another 500 or 600 stores.
So, we – internally, we are content with our factory velocity, which was really carried from the first quarter and some in the early part of the second quarter to now, but Scott on the rolls and packaging in the roasted meals line?
Scott Morris
Yes. So, we are seeing – we think we had the roasted meals product, the bag product the base bag product out there for several years now and we are still seeing 35% to 40% plus growth.
In addition, we came with the new bag, the fresh from the kitchen or the shredded product this year and that looks to be highly incremental. While that’s going on, we are seeing around a 20% growth on rolls and that’s well beyond our store growth obviously.
We have seen continued growth on rolls although we see a slight shift in mix over time. And we anticipate that there will be a continued mix kind of over the long-term towards bags, they are just more convenient, more appealing.
On a positive side, they are much higher from a price per pound standpoint. And from – on the majority of the products, they are basically margin neutral for us.
So, we see this as a positive thing that’s happening on our business. We think we are kind of meeting the consumer with their thinking and we are coming out with products that are more and more relevant to them and widen the appeal of the portfolio.
So, we continue to see – we anticipate to see over time more roll growth, however, a faster growth on the bag side of the business and there will also be several innovations that were coming with into the next year. That will be some differentiated products and forms too that will go into the fridge, but we have – these bag products were launched in 2011 and we continue to see roll growth all the way through – while we have seen bag growth, we have seen roll growth direct the year two that outpaced our store growth.
Robert Moskow
And are you seeing that now those, Scott, like if you look at your roll like on a month – on a monthly basis, are you seeing it continuing to improve sequentially, because the Nielsen data doesn’t quite indicate that?
Scott Morris
Well, I have IRI down to a roll level and I did get a snapshot at Nielsen down to the roll level. But I mean we obviously see plenty of POS and I mean I was just looking at it literally while Dick was talking and we are seeing – if you look at total rolls, we see really nice growth.
So, in the most recent period, it’s one of the things I just mentioned too, one of the things that slowed rolls down in the near-term was we had those pretty significant price increase that affected only our roll lines and our products on rolls, especially if you separate that out. We are seeing definitely some slowing and a change in our overall mix.
However, the roll business has been growing for many, many years and down to the most recent four-week period, so...
Robert Moskow
Okay, thank you.
Scott Morris
Thanks a lot, Rob.
Operator
Thank you. Our next question is from Bill Chappell of SunTrust.
Your line is open.
Richard Thompson
Hey, Bill. Hey, Bill.
Operator
Our next question is from Joe Edelstein of Stephens Inc. Your line is open.
Joe Edelstein
Hi, good afternoon everyone. I wanted to come back to an earlier question just on the fridge count growth, really how early can you get some visibility into a quarter even kind of the next six months, do you have visibility into 2016 yet, I am just trying to gauge some of the confidence that you might have around that 2,000 unit guidepost that you spoke to?
Scott Morris
Here is what I can – I mean obviously, for the next couple – the next month and a half, we have incredible visibility and then really into kind of Q1 and even to the three months or four months into next year, so almost six months out, we start to get basically good direction on what we are seeing from fridge growth, but not the whole picture. What – we are not at a point obviously right now where we can share that detail.
But we are hoping soon into the New Year, we don’t exactly know when yet, we haven’t established that that we do want to share guidance on not only fridge count, but what we have been working on over the past 90 days to 120 days where we have actually put really comprehensive programs together across each channel of trade and to kind of basically tackle down exactly the fridge opportunities in each one and develop strategies against those. And I really do look forward, I am not trying to kind of just push this off, but I can’t get into ‘16 numbers at this point.
But I am really looking forward to being able to share with people the specific actions that we are taking across every class of trade and how we are gaining incredible confidence that, that’s going to help us kind of reaccelerate fridge growth and not rely on a handful of opportunities to develop.
Joe Edelstein
Okay. Thanks, Scott.
And also baked food products kind of $5 million run rate, curious just how pleased you are with that, whether or not you thought it would be ramping up a bit faster. And secondly, if you could also just comment about how you are feeling about the cat food test and just potential for a broader rollout there?
Scott Morris
Yes. So on baked, it is so close to projections.
It’s actually – someone actually gets a gold star in the marketing group on that one, quite honestly. The only thing that we were a little bit lower on was store count.
We anticipated slightly higher store count on the baked product. The potential, I guess early on.
So we are kind of roll – we are going to roll up over a little over 5,000 stores or so, which is nice. When we are looking at it in comparison, we are seeing the core SKUs, the kind of the smaller sizes already be kind of into the middle of the category on a dollars per point of distribution or a handful of other measures of that we are looking at or when we are looking at ranking reports.
So we are really happy that you can be in a market for three, four, five – I mean in full market really we want to start going in like July and really into August was when we say kind of the fuller broader market. And we look across accounts we are seeing kind of our SKUs – our small base SKUs already kind of into the middle of the pack, which I think is an incredible sign.
We do want to see more and more people transition and we are working on that, but we have also I think over the past like 60 days to 90 days, we have really figured out exactly what makes this business tick and how to develop it further. And refining some of the SKUs and we are refining some of the support behind it.
And if we – if depending on how we decide to develop it and where we are going with it, I think we have kind of come up with a handful of different components that will allow this business to develop well over time. But again, I think we are – the verdict is still out.
We are very excited about the progress we have been able to make. But I think we have a really kind of important Board meeting in the beginning of December to discuss the different opportunities and where we want to weigh in as an organization and really – and focus.
So very happy with baked coming along, developing and with brand new things that are different at a very unique, very high price point in the grocery and mass channel of trade. Sometimes take a little while to develop, but happy with our progress so far.
On the cat piece, we are at 120 stores in the cat test. We have literally hot off the presses, we have another kind of three SKUs that we are just starting to put into the market in the next like couple of weeks and into early January, which we think are a key component of kind of filling out that cat portfolio those cat fridges.
So it’s really early to tell. We know there is something there, but this is one of the things where it’s going to be test and refine test and refine.
We are hoping by the end of Q – and this is I think on track with what we have always shared is by the end of Q1 next year, evaluate how the cat test is going and then have a broader rollout in kind of Q3, Q4 of next year. And again, I think we are budgeting, we will kind of get into that later on.
But we are kind of budgeting a very I would say very modest number of stores and that bucket goes into our innovation contribution to build our revenues for next year.
Joe Edelstein
I appreciate all the color. Thanks and good luck.
Scott Morris
Thank you.
Richard Thompson
Thanks, Joe.
Operator
Thank you. Our next question is from Phil Terpolilli of Wedbush Securities.
Your line is open.
Phil Terpolilli
Yes, thanks for taking the question. A lot of my questions have been answered, but just two quick ones.
On Costco, I think you mentioned last call that you just started testing products over the last several weeks, could you just give us an update there how that’s going?
Scott Morris
Yes. So with Costco again still we are in the 10-store test.
And the only – the things I can share with you is things that are available, otherwise I can’t get down to specific Costco-level data. We think – we feel as though we are making really good progress, I think we are getting positive feedback.
And I think what I have guided people around is that Costco in club, in general, will be a component of some of our growth next year, but not a significant component. We think this is something that takes a little while to develop.
And it’s – and we have a lot of different divisions and but we – as everything we are seeing so far, we are – we are happy with the numbers and we are getting good feedback around how we are in 10 stores. And as soon as we are making, I would say have any of expansion you guys will be the first ones to know as soon as we possibly can share that information.
Phil Terpolilli
Got it, that’s helpful. And then I just wanted to make sure I understood something from earlier on the shredded products, I think you talked about it being kind of highly incremental but margin neutral for the mix, just wanted to make sure I had that right.
I am trying to think about right now, we are seeing drags from baked, drags from the facility ramps, but no kind of impact from mix moving into shredded, is that the right way to think about it?
Scott Morris
No, I apologize. So actually on the shredded, that has been one of our most significant challenges.
Like Phil here on the great side of it, we have surpassed what we anticipated from a kind of same-store sales basis on shredded and incrementality. So we have been thrilled with that from a consumer standpoint.
From a manufacturing and production standpoint, it’s been something that has ramped slowly, where we have had some capacity issues with, we have actually decided to delay several piece of plans or pieces of a plan to continue to roll that out. And part of it is not only production, but the part of it is because the production is slower on that, that it’s causing us to have margin issues.
What I was referring to and I apologize we have always fun names for these segments, but the base bag business, meaning our roasted meals that had been existing for – since 2011, those are generally margin neutral. It’s the fresh from the kitchen with the shredded product that is not even – it is margin accretive and I think Dick shared that, some of those specifics in his comments early in the release.
He actually said it was 90 basis points, impacting over 90 basis points.
Phil Terpolilli
Right, okay. I just wanted to make sure I understood that correct.
Okay, that’s very helpful. I appreciate it.
Thank you.
Scott Morris
Yes. Sure.
Richard Thompson
Thanks Phil.
Operator
Thank you. Our next question is from Jon Andersen of William Blair.
Your line is open.
Jon Andersen
Hi everybody. Thanks for the questions.
I wanted to come back to the door count or the fridge count for a minute. So sequentially, the number of fridges you have been adding kind of sequentially through the year has decelerated to I think the Q4 guidance would imply 230 to 330 incremental fridges.
And I know earlier, you talked about 2,000 is the right way to think about it over the long-term. But I mean is there any more kind of color you can give us, give us some confidence that there is visibility into returning to that kind of level in ‘16 or maybe the reverse because this is an opportunity to maybe reset that expectation in the near-term?
Thanks.
Scott Morris
Yes. So again, I am not – and we maybe covered some of this a little bit in more detail in the past in some different conversations, but we really had two significant surprises this year and now more recently a third, which is minor, but still 100 stores doesn’t help.
But we had basically what we call anchor tenants. We had two people that had may commit, one of them we had actually bought refrigerators for and based on some internal challenges at that retailer, they had actually decided to originally delay and then finally basically postponed until the future that the expansion of those fridges.
So, unfortunately, sometimes all the cards don’t necessarily fall your way. So in the past, we have been lucky we have had other people kind of waiting in the wings and it’s kind of filled the bucket a different way.
And – but I think the piece that we are doing and again I think we will get into it and sharing it. And I don’t want to – I am not trying to just delay, I just feel like we – I feel that 2,000 is the right number.
It’s a number that we have generally talked about and then there is some years that are going to fall short, but I think there is definitely years that are going to exceed and that’s what we have seen historically and we feel good about going forward. But I really – we are going to get into a whole lot of detail and this is not something that we have prepared last week for this call.
This is something we have been working on for about 90 days, really kind of comprehensive plans by channel in order to kind of tackle the fridge count piece and close the gaps. And I feel as though we want to share that kind of early into the new year and get into a lot of detail with you guys around it, because they are not things that we are just, hey, there are some fridges over here, there are some fridges over here.
There is actually specific strategy and actions that we have put in place across each to help those fridges materialize into the future.
Richard Thompson
And Jon, this is Richard. I want just to assure you that, that’s a top priority for the company to put those strategies together and we have been working as Scott said for some time to improve the way that we go about doing that.
So, we are closer to the numbers we are looking at. So, it is a top priority for the company.
Jon Andersen
Okay. I guess one of the other kind of concerns I have is looking at expectations for 2016, I know you are not prepared necessarily to explicitly comment on that.
But given the guidance today for $10 million to $11 million of EBITDA, the Street’s sitting out there at, I think, $28 million for ‘16 which requires both strong top line growth, but significant margin expansion in the context of what you have talked about here, with some of the near-term margin challenges. I mean, how – is there anything you – we should be thinking about or collectively in terms of the outlook for ‘16, because that has been a challenge and I think the challenge for the stock and I would like to see that behind us sooner rather than later?
Dick Kassar
Sure. With store growth and with continued velocity growth, we will be pushing more pounds to our manufacturing facility.
And in addition to that, we will be producing at about a 30% faster rate than we currently produce. So, with those opportunities and simultaneously from a logistics perspective, we will be putting and this is going to be in the SG&A piece, we will be putting more poundage upon our trucks.
We expect our margins to go to where I indicated previously and simultaneously for that to get – the shortage of that we have in margin in the first 6 or 7 months during the fiscal year, that shortage should be made up on the logistics side. And in addition to that, we have not had anything in any of our projections on baked.
So, to the extent that bake develops as we hope it will, there would be also not necessarily margin accretion, but there would be operating profit accretion.
Jon Andersen
Okay. And last one for me just on marketing, the incremental spending that you did in the third quarter and plan to the fourth, how is that being directed?
Is it largely towards baked? Is it towards branding or building awareness for the fresh brand in aggregate?
And are you happy with kind of the returns, initial returns you are seeing on that spend? Thanks, guys.
Richard Thompson
So, the significant amount of the spending that we are doing in Q3 and Q4, especially around television was – did have kind of a baked focus on it and we had departed from some fresh specific advertising that we are doing. We also did a fair amount of sampling demos and a handful of other key tactics across.
The thing that we are recognizing is there are certain pieces of that mix that I won’t share, because I am sure my good friends at other companies are listening. But there are certain things within the mix on the baked support and that’s what I was kind of mentioning earlier that have really had great returns.
There are other parts that I think that we anticipated better returns and we do not see them. But I think we have kind of gotten that piece really kind of figured out.
And we have really kind of learned it what seems to work well for that piece of business. And that’s how we will be – I think we will be much smarter about it and much more productive with that spend next year from a baked standpoint.
And then we will also return to a real focus in television around our fresh refrigerated product. And those are the types of numbers and when we were – when we had – we have spent a lot of our TV kind of early on in the year.
It’s a place where we get the best return for it, because we spend it early in the year and it actually helps you carry through the year. And that’s with that and some of the innovation we have brought, that’s where we are seeing these incredible growth rates.
And that’s what we return to from a model standpoint and early next year and then we are going to separate out some of the baked spending and do it – do some of the tactics that we found that worked best for that.
Jon Andersen
Great, thanks for the color, guys. Appreciate it.
Operator
Thank you. Our next question is from Mark Astrachan of Stifel.
Your line is open.
Mark Astrachan
Yes, thanks and afternoon everybody. I guess I am curious could you give us a bit of an update on what’s going on at the non-tracked retailers?
I mean, if you look at the scanner data, sure it’s slowing, but it looks like the growth in the other channels, Petco, PetSmarts seems worse. And then the implication for 4Q guidance, if you extrapolate current, scanner trends would also indicate that, that business materially worsens.
So, if you could just sort of give some update there that would be helpful?
Richard Thompson
So, we have seen – I think everyone has expressed this in the pet community, there has been a little bit of a softening in some of the pet retailers this year in kind of the pet specialty space. And I think part of it is there are other retailers that are sharpening their pens a little bit and they have gotten smarter and better at what they are doing.
And I think there is – there are a lot of new players in that mix that are kind of in this kind of smaller to mid-tier that are getting better at what they are – getting better at operating kind of these smaller pet stores, but I think we have seen a little bit of a slowing at a national level for them. And I think that some of our trends have followed that, but the pricing action that we put in place, there are a handful of SKUs that were significantly impacted there.
And that’s something again that we are taking a hard look at reviewing and kind of figuring out and reviewing the entire kind of model and the products and the mix of products that we are going to be really focusing on in the pet specialty class of trade. So, I think when we see – what you are looking at in total is, again, if you go back to the numbers that we had put out for this next period, those numbers we are anticipating trying to put in place numbers that we feel really comfortable with.
And there is no specific class of trade implications there. It’s really kind of across the board where we are trying to look at numbers that we feel really confident about.
Mark Astrachan
Okay. And then going back to advertising just a follow-up to the last question, so historically, you have talked about the correlation of ad spend with sales growth, how do you feel about that today?
Scott Morris
We feel – this is not something that was new for us. We had been doing this really since – we have done some local testing in 2010 and really from ‘11 – 2011 all the way through today, we have seen a really, really tight correlation around TV and growth of the business.
We really kind of changed our advertising strategy with the introduction of baked, as I had mentioned, in this kind of Q3 period. And I think we found really what does work and that’s where I was talking about in Q1 we will return to kind of a fresh focused communication with some – basically a fresh focused communication on TV and then use some other tactics around the baked advertising.
So, this continues to feel really good about it kind of know what works. Obviously, TV is a changing world, but change happens slowly.
And it’s not just from a TV standpoint. Even what we are doing from a digital standpoint, we are really expanding what we are doing digitally.
I think you will see some exciting stuff from us in the next kind of 4 to 6 weeks from a digital standpoint also. And Richard was recently featured as a star on the profit too, which is always great news.
Mark Astrachan
Got it. Okay, thank you.
Operator
Thank you. Our next question is from Robert Moskow of Credit Suisse.
Your line is open.
Robert Moskow
Hey, Richard, the stock is down a lot. It probably is going to go down a little bit more.
You have obviously – you have great confidence in the long-term value of the business. Would you consider increasing your stake in the business and buying back shares for yourself?
Richard Thompson
Absolutely. I think not only myself but both Dick, Scott and I when the appropriate window opens next week for us, you will see us buying shares.
Absolutely.
Robert Moskow
Good to know. Thank you.
Richard Thompson
You are welcome.
Operator
Thank you. Our next question is from Scott Van Winkle of Canaccord.
Your line is open.
Scott Van Winkle
Good evening, guys. Just a follow-up here.
Most of my questions have been answered. Scott, when you are talking about – you sound like you got kind of excited about the new programs you have for door growth next year.
Have you changed the sales process? I mean, is there something different that you are going into ‘16 kind of articulating to the consumer or to the retailer from a standpoint of adding fridges than you did maybe 12 months ago?
Scott Morris
Yes, there really are, Scott. And I – when I do get into the detail, I really want to do it face-to-face and explain it in detail.
And it’s not – honestly, it’s not a lot of us just waving our arms, it’s really some kind of fundamental platform that we have really changed in the way we are approaching some of the conversations, working with our partners, the data and even strategically from a product standpoint some of the things that we are doing that we have actually done some testing around and it’s really opening up additional opportunities for us. So, I hate to sound so incredibly vague quite honestly, but I think we will take you through them.
We really are making pretty significant changes in how we are approaching it. And I think it’s – it could have incredible dividends for us and we are excited about what we are already seeing, so…
Richard Thompson
And Scott, I always have a saying, I always reserve the right to be smarter tomorrow.
Scott Van Winkle
Thanks. A couple of other follow-ups.
Just quickly there, the cat test, the 120 store, what class of trade is that or is that split up against different types of retailers?
Scott Morris
There is pets been out there for a little while that’s actually expanded. There is some grocery and then there is some mass coming too.
So, there is – we are basically across all three channels of trade. So, it’s – and again that’s something that we are in the early stages on.
We are developing it and – but it will – it’s going to play a key component for us in kind of our – kind of 3-year growth over time and it will start contributing next year, but really on kind of over like the next three years, it will become a major contributor to our growth.
Scott Van Winkle
Great. And then the last one is on baked, you talked about some of the primary SKUs or you have kind of been in the middle of the category and that’s certainly a level of success.
Where is the bogey to where, from a standpoint of margin, right-sized spend, whether it’s number of doors from the 5,000 that you targeted to just dollar sales, what’s the bogey for baked to where we are not breaking it out in the P&L?
Dick Kassar
Well, the reason we were breaking it out in the P&L from earlier on, because it was never discussed during the IPO and it was something that was in the background. We were looking at it, but we weren’t sure whether or not we were going to commit to it or launch it.
And after discussions with Richard and the board, they said, let’s go ahead. And then what we wanted to do is kind of reduce confusion by segregating it in our reporting on the press release.
And last quarter, we actually segregated it and now we have kind of showed last quarter versus this quarter’s guidance. And going forward, we will certainly have it broken out in the Q on a sales basis.
I am not so sure that we will go on a net income base or an operating income basis, but you will be able to see it, so you can determine what our growth is on refrigerator and what our growth is on baked.
Scott Van Winkle
Yes. So I think I asked the question really poorly, I meant more to where you kind of have to break it out to the standpoint where it’s not losing 2X its sales or something of that nature.
I am wondering when the threshold of – did it breakeven or whatever metric we want to kind of decide as this is – it’s not a big drag, it’s not an over-spend, etcetera, etcetera. Is there some dollar amount, door amount, what’s the point – what’s the point in the maturation scale where it’s a profitable business or it’s just another piece of the innovation?
Dick Kassar
Yes. The middle of next year, we will know how many more doors we are in.
We will see more data associated with not only our small bag but our large bag to see consumer commitment. And as we go from – we had indicated we would be at 35% by year end.
And moving from there, as we get more comfortable with larger production runs, then we would be then committed to the product. And it would be – we would certainly be part of our – a contributor to earnings, I mean a lot CPG companies launched products, spend a fortune behind it.
What we are doing is and what we said we would spend on our margin about $3.5 million in 2015, see where it goes and see if it becomes a nice piece of our earnings base going forward.
Scott Van Winkle
Great, thank you.
Richard Thompson
Thank you, Scott. Anybody else?
Operator
No other questions in queue, I would like to turn it back to management for any closing comments.
Richard Thompson
Yes. A couple of things, first of all, I just want – keep in mind that I am very proud of where we are and what we have accomplished is that this company is not only innovative and disrupting a $25 billion category, but we have got a great management team, experienced management team that’s done this before.
We are in a great category, pet. We have great assets, our manufacturing is state-of-the-art.
We are doubling up on where we are. We are debt-free.
We have no debt on the business at this time. And I think that we are in a really good place growing 30-plus percent a year.
So when you add all those things up, yes there are things we need to do better. I will raise my hand and say that.
And I reserve the right to be smarter tomorrow and tomorrow we are going to do better. And I am a big fan of where we are and my management team.
So I am excited about moving forward to this last quarter and especially into 2016 with all the elements that we put into place. And then lastly, I would like to say a big salute to all the veterans, I don’t know if there is any veterans on this call but if so, big salute.
And if not, then out to be broader course of America. So God bless America and that’s all we have tonight.
Thank you.
Operator
Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your program.
You may now disconnect. Everyone have a great day.