Inventure Foods' (SNAK) CEO Terry McDaniel on Q2 2016 Results - Earnings Call Transcript

| About: Inventure Foods, (SNAK)

Inventure Foods Inc. (NASDAQ:SNAK)

Q2 2016 Earnings Conference Call

July 27, 2016 11:00 ET

Executives

Katie Turner - IR

Terry McDaniel - President & CEO

Steve Weinberger - CFO

Analysts

Jon Anderson - William Blair

Mitch Pinheiro - Wunderlich Securities

Phil Terpolilli - Wedbush

Operator

Good day ladies and gentlemen and welcome to the Q2 2016 Inventure Foods Inc. Earnings Release. At this time, all participants are in a listen-only mode. Later, we will host a question-and-answer session and instructions will follow at that time [Operator Instructions] As a reminder, this conference is being recorded.

Now, I will hand the call over to, Katie Turner, you may begin.

Katie Turner

Thanks, good morning. Welcome to Inventure Foods' second quarter 2016 earnings conference call. On the call with me today are Terry McDaniel, Chief Executive Officer, and Steve Weinberger, Chief Financial Officer.

By now everyone should have access to the earnings release for the period ending March 26, 2016 that went out this morning at approximately 7:00 AM Eastern Time. If you have not received a release, it's available on Inventure's web site at www.inventurefoods.com. The call is being webcast and a replay will be available on the Company's website.

During the course of this call, Inventure will make projections or other forward-looking statements regarding future events or the Company's beliefs about its sales and earnings. We caution you that such statements are predictions and involve risks and uncertainties. Actual results may differ materially, factors which may affect actual results are detailed in the Company's filings with the SEC. Also, please note that Company undertakes no obligation to update or revise these forward-looking statements.

The Company will reference EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings, which are non-GAAP financial measures. These non-GAAP financial measures should not be considered in isolation, and please reference the Company's press release issued today for a reconciliation of all these non-GAAP financial measures to the comparable GAAP financial measure.

And with that, I would like to turn the call over to Inventure Foods' CEO, Terry McDaniel.

Terry McDaniel

Thanks Katie and good morning everyone. I will begin today's discussion with an update of our second quarter operational performance. Next, I will turn the call over to our CFO, Steve Weinberger, to discuss our financial results in more detail. Finally, I will provide a brief closing comments and we will open up the call to take your questions.

We remain focused on the operational and financial improvement of our business. During the second quarter we continue to make progress on our key initiatives. With another quarter of sequential improvement and gross margin which contributed $1.1 million of sequential improvement in EBITDA. As we progress through the year we believe we will continue to show improvement in the back half of 2016.

For the second quarter we reported consolidated net revenues of $69.3 million. Our healthy natural product portfolio was up 9.3% which was partially offset by an 18% decrease in our indulgent and specialty products compared to the prior year period.

For the quarter, SNAK segment net revenues increased 12.8% to $27.5 million as compared to the prior year period, and compared to the first quarter of 2016 snack segment net revenues increased $2.6 million or 10.5%.

This topline performance is primarily result of reduced volumes and a decrease of 7.9% in Boulder Canyon net revenue due to capacity constraints, a shortage of organic potatoes caused by the weather and the impact [ph]. The total impact of these three items reduced Boulder net revenues by over $1 million for the quarter.

I now like to focus on Boulder Canyon in greater detail. As we discussed in our first quarter call, we continue to expect Boulder to generate growth in the second half of the year. The good news is we believe the brand is on track and is now well-positioned for growth.

First, all four kettles are up and running in Bluffton, Indiana which will relieve some capacity pressure our at Goodyear facility. Secondly, gross profit increased 250 basis points as we ended our use of co-packers late in Q2. Going forward, we expect to see improved margin in the third quarter as we reduced freight and provide additional overhead coverage at our Bluffton facility.

Although hampered by capacity constraint, Boulder was up 11.6% excluding in and out business which is primarily for the Club channels, and all other channels showed growth within the quarter. The strategic slotting investment in Q2 which came late in the quarter are expected to expand distribution new customers such as stop and shop and in the second half of 2016.

In fact during the quarter Boulder Canyon reached 42.5% ACV of 8.2 points versus a year ago, and according to the most recent 12-week IRI data from which measures the grocery channel, Boulder Canyon potato chips were up 13.6% compared to the potato chip category which was relatively flat.

We will be also be introducing one of our strongest new product line ups late in the third quarter for Boulder both in non-potato products and potato products which we think are very unique to today's market.

Finally, as many of you know we will expand the boulder brand through the introduction of our Frozen Boulder Rice Vegetable Product which begins shipping this month to a large natural customer as well as several supermarket retail customers. Initial feedback from our customers have been very positive.

In summary, we are excited to be back on track for our most important brand and look forward to a much improved second half. All other SNAK segment net revenues were down due to the loss of the major co-pack customers as we discuss last quarter and decreased sales of license products.

Turning now to the Frozen segment. Net revenues in the quarter increased 19.7%, excluding fresh frozen, Frozen segment net revenues increased 4.4% as compared to prior year primary as a result of the demand of our branded Frozen fruit.

Sales of our Radar Farms' branded product increased a 158.8% for the quarter. We continue to ramp up distribution across sales channels including Club, Mass and several key supermarket retailers for Radar Farms' fresh start.

Our team remains focused on ways to grow our branded Frozen Berry business to support our long-term strategy to convert our Frozen Berry business into a more profitable branded business. Frozen fruits sales were up 7.4% in the second quarter. Adjusting from the net effect of the 2015 harvest pricing, frozen berry sales would have been up 14.3% for the quarter.

Although it is still early in the berry season, based on the information to-date we expect to have a much better crop this year. The Frozen Fruit category continues to be a strong growth category with sales up 12.9% and our branded sales up 25.9% according to the latest 12-week IRI data.

Turning to Fresh Frozen. Our priority continue to be returning Fresh Frozen brands back to profitability. As we mentioned in the last few quarters, we just started to proactively adjust the brands retail packet size to better match competitor retail sizes as we work to improve the margin profile in 2016. We also started to realize greater plan efficiency as a result of operational improvements.

Importantly, gross margin of our frozen vegetables improved 860 basis points from the first quarter of 2016. We believe there are opportunities for further margin expansion as we progress to the balance of 2016.

In addition, we continue to pursue the growth opportunities across our key brands in our Jefferson, Georgia manufacturing facility. For example, we are also manufacturing Boulder, Canyon's new frozen product in Jefferson. As I mentioned, early acceptance of the product looks promising with first shipments starting this quarter. Fresh frozen and as manufacturing facility have always offered an avenue for product innovation in key product category and additional manufacturing capacity. Both of which are finally beginning to see initial benefits in 2016. And we look forward to further benefits over the next several years.

We are selectively taking up new doors of existing customers such as ATV and a few other regional supermarket chains, and we plan to target additional new distribution beginning in 2017. The planned manufacturing expansion of our existing company-owned IQF berry processing and packaging facility in Bellingham, Washington is complete, and operation started at the beginning of May. We are beginning to realize initial cost efficiencies from this expansion, and over the next few quarter multiple opportunities including lowering freight costs and enhancing our capacity productivity to our IQF operations.

Our team is intently focused on continuing to add to our strong portfolio of healthy natural brands by increasing distribution and launching new innovative products under our Boulder Canyon brand as well as our strong rollout of the Radar Farms fresh start and other frozen fruit products. We also continue to focus on improving our bottom lines through cost savings in capital projects such as our further consolidation of our Frozen Berry business and initiatives which will enhance our IQF capacity as well as making our overall berry operations more efficient.

We believe these key strategic initiatives will help to improve our performance throughout the year and better position us for increased growth over the next several years.

With that overview, I'd now like to turn the call over to Steve. Steve?

Steve Weinberger

Thank you, Terry, and good morning everyone.

I will now review our second quarter financial results in more detail. Reported EBITDA which does not include any adjustment was $3.6 million, a $1.6 million improvement compared to the adjusted EBITDA of $2 million in the second quarter of 2015. And as Terry said a $1.1 million sequential improvement in the first quarter of this year.

We reported a net loss of $300,000 or $0.01 per share for the second quarter of 2016. Again, this result is a sequential improvement from the reported net loss of $1 million or $0.05 loss per share in the first quarter of this year.

I will now focus on the other components of the PNL with all comparisons to the second quarter of 2015 adjusted to exclude the cost of the product [ph]. Gross profit was $10.3 million in the second quarter of 2016, an increase of $1.1 million, compared to the $9.2 million in the second quarter of last year. As a percentage of net revenue, gross profit expanded 100 basis points, to 14.8 %, compared to 13.8% last year.

For the Frozen segment, gross profit was $4.8 million, or 11.6% as a percentage of revenues, compared to 9.6% in the first quarter of this year and 10.7% in the prior year period. The year-over-year sequential margin improvement was primarily driven by steps taken to improve our Fresh Frozen margin profile, including our adjustments to the brand's retail packaging side. Our Frozen Vegetable gross margin, as Terry said again, increased 360 basis points versus the first quarter of this year.

The Snack segment gross profit was $5.4 million, flat with the prior year. But as the percentage of net revenues, this gross profit was 19.7%, compared to 18.1% in the first quarter of this year, and 17.2% in the second quarter of last year.

SG&A expenses were $8.5 million for the second quarter of 2016, compared to $8.0 million in the prior year period. SG&A expenses increased $0.5 million and as a percentage of net revenues, SG&A expenses were 12.3%, a 120-basis-point decrease, compared to the 13.5% in the second quarter of last year.

While we are pleased with our progress to date, we believe it will take time to sufficiently improve our margins and earnings over the next several quarters. For the second half of 2016, we expect results to continue to sequentially improve from the second to the third and fourth quarters. We believe it is important to take the necessary steps to help us strengthen our operating platform and best position us for long-term sustainable growth.

We continue to take steps to improve our balance sheet. During the first half of this year, we reduced inventories by $10.6 million and paid down our line of credit by $3.3 million, even while investing $7.6 million net of equipment financing in Capital Expenditures. At the end of the quarter, our line of credit balance was $22.7 million and we had $22.5 million available. We remain in compliance with all of our loan covenants and continue to have a very strong relationship with our lenders.

That concludes our financial review. Terry?

Terry McDaniel

Thanks, Dave. Our management team and Board of Directors are committed to increasing shareholder value. This morning, we also issued a separate press release announcing that the Company and its Board of Directors will commence a strategic and financial review of the business. Rothschild has been retained as our financial advisor and DLA Piper as our legal advisor to assist in this process. The objective of this review is to identify the best way to deliver maximum value to all shareholders.

At the same time, we are moving forward with our strategic initiatives to strengthen our foundation, increase productivity across both Frozen and Snack segments and sustain operating momentum. We will provide additional information when appropriate. As such, we ask that you please limit your questions during Q&A to operating results and initiatives.

In summary, as we discussed, we continue to make progress in key metrics of our business. We have a history of improved earnings and revenue and an excellent team of associates, strong brands with real growth opportunities, industry-leading innovation, and great facilities. We look forward to working with our Board and Rothschild on how we can ensure that we are in a position to take advantage of our opportunities and to maximize the value to our shareholders.

I'd like to thank our investors, analysts and our employees, who continue to support our effort. This concludes our prepared remarks. Steven and I are now ready to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Jon Anderson of William Blair. Your line is now open.

Jon Anderson

Good morning, Terry and Steve. I wanted to start with Boulder Canyon. Could you talk a little bit about the end demand trends? I don't know, you've cited in the past some IRI consumption growth but also the data for the natural challenges. Give us a bit more perspective on how that brand is performing at retail, because I know there are some internal things that you're working through that are affecting shipment.

Terry McDaniel

Yes, that's a good question. I'd start with when you look at the brand by channels, and you look at supermarkets, and you look at C stores -- I mean, every channel we're in, we're showing very good growth. Obviously, we have been shorting some customers. In fact, you mentioned -- and I guess we should have put that up -- according to the latest 12-week data, Boulder was up 10.6% on -- and we'll revise the PC category, as that's 90% of our business -- excuse me, spends. And then when the PC category was up 7.7%, we were up 10.6%. So good performance in the natural. But we have cut customers and it's been a problem. You know, I mentioned in the call…organic…we had booked a couple million pounds of organic potatoes. But because of a shortage and weather here in Maricopa County, we came up about a half a million short, which would have all gone to Boulder.

So that has hampered our ability to grow. However, most of that growth that we have not -- or the volume that we have lost has been mainly not permanent, it's been in and out, business that we couldn't necessarily supply. So velocity in our key channels -- for the most part, all of our major key channels are up, most of them double digit. So we're making progress, but you don't see it in the total numbers because of some of the in-and-out business, mainly tied to the club accounts.

Now, going forward, in the second half, I -- I mean I wish everyone could -- because I mean -- it's a shame, we need a Facebook page to put it up. To show what's going on in our Bluffton facility. I was out there two weeks ago. All four kettles now are up and running. A good year in its capacity issues. We had a little problem getting some of the packaging machines up and going. Some of the new equipment, that has been fixed. So we're in prime position to now get back to where we need to, to invest, and then, last but not least, part of the growth of Boulder Canyon for the last three or four years, to be quite frank, part of the -- one of the biggest strengths of our company has been innovation. And we've got some great potato products, but what I'm real excited about is some of the non-potato products that's going to be coming out of Bluffton that's kind of unique and different and right on trend with the health trends in the industry.

So we're looking, as we said last quarter, we didn't expect much this quarter. We expected our growth to look good the second half, and that's what we're looking forward to, going forward.

Jon Anderson

That's helpful. Just to stick with that for a minute. So would it be fair then, as we think about the back half of the year and the three items you called out, capacity, constraints…can we kind of put that one aside at this point, given that the four new kettles at Bluffton are up and running. Is that one we can kind of put in the rearview mirror? And then, if that's the case, can you just comment on the potato supply? Is that a constraint that's now in the rearview mirror as well, or is that something that will persist?

Terry McDaniel

We only do organics on an in-and-out basis so that volume is missed until next year. That's growing more and more and we want to increase that next year, but…So the potato issue is not a problem. We should have plenty of regular potatoes and, as I mentioned, organics is just a seasonal item that we do. You know, capacity, that is -- we had a backlog of volume, now we're up and going. Other than the first few weeks of this quarter, that should not be an issue going forward.

Jon Anderson

Okay. And then I know that you talked in the past about the capacity challenge impacting your ability to promote, get into the regular promotional cadence, that you've had historically with retailers. What's your outlook for getting back onto a more normal promotional kind of rhythm?

Terry McDaniel

I think, Jon, it will improve this current quarter and improve even further in the fourth quarter. It will take a little bit of time to get everybody back, and then feeling confident that we'll ship what we say. But I think you'll see some improvement third quarter and I think you'll see even more improvement fourth quarter.

Like I said in the call, I feel like -- I mean, it's probably not the right word to say, but the monkey's off our back, and we've been operating kind of one hand behind our back. Now we can really start moving forward. And also, that new distribution I talked about, most of that came very late in the quarter. That's going to help us as well. And one of the other things -- I mean, Boulder's the national brand. We've been running a national brand and shipping 100% of it out of Goodyear, Arizona. Now, anybody in the snack business knows shipping air across the country and shipping something all the way to Boston from Goodyear is not a really efficient way to do business or effective way. We're now in position to fully support our business both East Coast and West Coast. So all of these things provide us a lot of optimism and, I'll be honest, our boulder team and our entire company, there's a lot of things that's going on the last. This is one that I think we can finally say, okay put this behind and let's move forward.

Jon Anderson

You teased us with this new product, a non-potato product. Is there anything else you can kind of say about that [ph] what just might be closing, kind of category innovation and when to expect it and just something you expect to be material out of the gate?

Terry McDaniel

No, I mean anytime we introduce the product, John, I mean you're not going to see a tremendous amount of impact, none third quarter. You'll see it a little bit fourth quarter. A lot of these things happen after the natural expo in March. We'll get some early takers, so it will be a bill process. But I'll just say that if you think as a healthy trend of looking at things such as ancient grains and vegetables, and those high products, it will be in the line in those type categories. We were looking at where the trends are, where the consumers, we've had great success with using unique roles, and some of our competitors have tried to copy our success. So we're going to look at unique roles as well in some of these products, and hopefully I think at the next call we'll be able to mention at least a couple of these products that will be introduced. But we've had a very strong potato business and a small but decent non-potato. More of these will be geared toward the non-potato side.

Jon Anderson

Okay, that's helpful. Shipping gears on fresh frozen. The business obviously popped a lot year-over-year given the nature of the recall last year. It was down just a little bit sequentially, but to your point earlier it sounds like you've seen profit improvement there. So can you talk a little bit more about how the, I guess the big initiative there right now is -- what's the status of that in terms of that kind of getting out onto the shelf, what kind of volume impact you're seeing [ph] having a profit impact you expected? Just a little bit more color around that right now and your expectations going forward.

Terry McDaniel

Yes, I mean sequentially it would go down because first quarter, fourth and first are the two strongest quarters in the frozen vegetables. The summer is generally, going into spring, summer is a weaker consumption period for the category. Yes, I mean from the projections that we made and improving our overall operating [00:03:26.15] over 800 basis points improvement. So we are seeing what we expected. Some of our inventories that we've built during the recall on finished goods, those are coming down which is helping. We have further moves that we're making in the next month that's going to improve margins and profitability further leveraging [00:03:49.13] if the veggie rice takes off, there will be move overhead coverage. So we expect those margins to improve. To be quite honest we picked up, I mentioned one major customer. We picked up another division of that major customer. We picked up some regional change. But we haven't been investing a lot to go after new business and the ways of slotting and the reason for that is number one priority was to get the business back up to a margin level so that we could support that investment. We believe that in 2017, the brand had held strong. I can tell you our largest customer we did this wait out earlier, and our volume on their internal numbers is basically we saw no impact, a negative impact of the wait out in that particular customer. Now it's going to vary by customer to customer, so I think the consumer, it's 100% out there. We have no of the non-wait out products left. And so what our goal is as we go into 2017 is to get back investing and putting this into more places because we know the brand is strong. We know that consumers like this brand, they like the positioning, our customers like the clear bag, and the differentiation of it in other competitors. And so while we were not seeing tremendous growth this year in the brand, we haven't invested for the growth but hopefully next year we'd be in a position to do so.

Jon Anderson

Last one for me. So the SNAK business, the gross margins of the SNAK business segment have recovered quite nicely and are actually trending back towards kind of a prior peak in the high teens, 20% range. The frozen product, I guess haven't come to par yet [ph]. But if you think kind of longer term about the frozen part of your business, what are you aspiring to or what do you think is the right way to think about the next kind of gross margin profile of the part of your business over kind of you look ahead into 2017?

Steve Weinberger

Hey, John, it's Steve. It's a great question. A couple of things. First of all, this year's harvest as Terry said is looking really really good. So that in it of itself is going to improve our fruit margin, number one. Number two, we've said for the last little while, and excuse the pun, we were trying to take our fruit business up the food chain. So sort of to decommoditize if you will fruit and veg. Fresh start was one way of doing that. Building our other Radar branded products is another way of doing that. So that continues to be the plan to get those margins up and get away, as I said from the sort of the commodity nature of this business, sort of new and different fruit blend, not just berries in the bag. So I think the combination of, and yes we've had a good harvest this year, but we have restructured the way we operate our frozen berry business. We're doing a little bit more as our, some plant consolidation to provide more efficiencies next year in terms of allowing us to freeze more fruits. So combination of doing a better job, getting more efficient in our internal processing. We got lucky this year with the weather, but just as importantly through innovation, moving up sort of the branded food chain on our product portfolio. And I think we've not only got from the weather standpoint but operating our frozen berry as one and having one objective helped us. I think when we look at moving that bagging operation on the middle of our IQF operation. That puts us in a position to bring more outside growers in on the raspberry [ph]. There's a lot of things that improved, and of course the other thing that we would expect to see next year if we're talking overall frozen is fresh frozen. If margins, we should have a full year better margins if all goes well compared to what we started with at the first of this year.

Jon Anderson

Thanks, guys, good luck.

Terry McDaniel

Okay, John, thank you.

Steve Weinberger

Thank you.

Operator

Thank you, and our next question comes from the line of Mitch Pinheiro of Wunderlich Securities. Your line is now open.

Steve Weinberger

Hey, Mitch.

Terry McDaniel

Good morning, Mitch. Hello? Mitch?

Operator

If your phone is on mute, please unmute it.

Terry McDaniel

Hello? Next question. Operator?

Operator

And our next question comes from the line of Phil Terpolilli of Wedbush. Your line is now open.

Phil Terpolilli

Yes, thank you, good afternoon.

Terry McDaniel

Good morning.

Phil Terpolilli

Whatever time. I guess a couple of things. First on frozen, going back to some of the things you mentioned before. I'm sort of curious with the 2Q performance, particularly around headlines. Just looking online it looked like there was a number of different frozen vegetable recalls away from you guys, of course. But did that worked to your benefit at all with any of your customers, maybe in terms of shelf space or new customers that you might be looking to win distribution with in the future?

Terry McDaniel

I mean obviously there has been a lot on frozen Fruit and Vegetables, and a bunch of different products, as of late. And we're very -- we did a lot of changes and that's helped us, but, you know, that's always a possibility. But one of the things that has helped us, I think, with our customers, and as we talk to our customers, and as a major customer puts us in another division, is the stand that we took as far as some of the things that we're doing in the Frozen Vegetable industry, which was first. Things like seven-day test and hold, testing all inbound ingredients, and I think that as more and more of this occurs in the industry, a lot of customers are starting to ask: What are your procedures? And I think that's going to help us because it's going to force many of our competitors to start spending at a higher level than they are today, which, to be quite honest, we've been at a little bit of a competitive disadvantage. In fact, I heard the other day one of our largest competitors is going to spend $10 million on food safety going forward.

So it does help us. Can we materialize that into additional volume at this point? Probably not a major uptick, but these are things that are cumulative, these are things that, when we get back out and we start saying, hey, we're going to go after some new distribution with slotting, we're going to be in a better position to do so.

A lot of what happened in the recalls…it was a lot of West Coast business. And there were two major West Coast packers that were impacted, one that's still not in business today. So we're -- we've been more of an East Coast business, so we didn't see as much from the consumption standpoint as we would have liked to have seen. Not that we like to see any of this, because it's not good for anybody, we know. We went through it. But I think, over the long term, Phil, and as we go into next year and we look at starting to go back after some of this business, I think it will help us.

Phil Terpolilli

Got it. That's helpful. And then one more on Frozen. You mentioned earlier in the prepared remarks sort of an opportunity for further cost-out in the second half of the year and it sort of piggy backs on Jon's question, but any sense of -- or more color around what that exactly is? The timing of that, if it's sort of blanket across 3Q and 4Q? Does it build near the end of the year? How do we think about that line in your mentioning?

Terry McDaniel

I think -- I mean, a lot of what we've done, guys -- and you can see, we went from $300,000 -- $200,000 EBITDA fourth quarter, to 2.5, to 3.6…we're taking baby steps. And we're getting better each quarter. So we expect each quarter on Frozen Vegetables to get -- not to go like it did this quarter. That was a pretty big jump: 850 basis points. But it should improve because some of the things that we're doing -- obviously as inventories come down, we're using less outside cold storage. As we put more volume in that facility, we have more overhead coverage. And we're doing some things strategically on some sizes other than our two-pounds, which will start showing up third and fourth quarter, which should improve our overall margin.

I mean, one thing that we did recently: We converted that whole operation to Oracle, which made it more efficient, from processing bills and payables and receivables. So we're taking baby steps. The goal is to sequentially improve each quarter. Now I can't say what that's going to be, but we expect to do that in the third and fourth quarter as well.

Phil Terpolilli

Okay, great. And then just real quickly on the Snack side. Sort of going back through and I hear everything you were mentioning earlier and of course I'm not going to hold you to these numbers by any means, but sort of with all the puts and takes that we saw in this quarter, you mentioned sort of, you've been restricted in in-and-outs, there seems to be more reason to [indiscernible] that could come on line, capacity's getting better, etc. What sort of reasonable growth number do you think that we should think about in our models for Boulder Canyon, when you get into the back half of the year and going into early next year?

Terry McDaniel

Well, we don't -- I mean, again, as you know, we don't forecast volume. I mean, we believe the back half will show positive growth. At what level? I mean, we just -- Phil, I just don't want to give those numbers, when we've never given those numbers, but --

Steve Weinberger

We don't give that kind of guidance, Phil, but as Terry said, it should be a whole lot better in the back half than it was in the first half.

Phil Terpolilli

Right. Okay. And I'm kind of trying to put it in the context of, I'm looking at the growth rate that you had in 2015 and it doesn't sound like you're maybe necessarily getting back to that rate right away. But what does the ramp look like when you look at 3Q, 4Q, 1Q…if there are certain impediments that we're still getting through over the next two quarters.

Terry McDaniel

No, like I mentioned to Jon earlier, I think the third quarter will be better, the fourth quarter will be better hopefully than the third quarter. So I think it will get better as we go along. Will it get back to that total number that we did? Probably that would be a big stretch that we did in the prior year, which was extremely strong growth. But I would hope, by the time we get into 2017, we'll be in a position to do the things that we have done historically on the growth that we have done on this brand that we did for six or seven years in a row.

We still have a lot of ACV growth. The brand -- even in the midst, it's hard to look at it because you guys just see total numbers. But if you look at even our largest customer, which we've been in for years and years, it's having a great year with us. So the brand is very healthy. We've got to get the impediments out of the way. Unfortunately, in the Snack business, a lot of volume is in-and-out. There's a lot of club sometimes, and you've got to -- you know, you've got to prepare for that, you've got to be able to ship and all these things.

And so there's no doubt that the brand has not been hurt from the consumer standpoint. Now we're not operating with one hand behind our back and we look forward to getting back to where we used to be. Will that be second half totally? It will be better than the first half, but by 2017, look out.

Steve Weinberger

I think just another comment, Phil, is that as Terry mentioned, we have an 8-point increase in the ACV, the benefits of which will accrue from the third quarter on. So we've got more doors, we've increased distribution quite a bit. It'll start to ramp up, so none of that is really -- has shown up yet in our results today. So that's a big jump --

Terry McDaniel

And we invested in this a lot, which hurt our net revenue.

Steve Weinberger

Which hurt our net revenue for the quarter, because it was late in the quarter. So we've done some selective slotting investments, we've improved the ACV by 8 points. The benefits of all of that will start accruing to us, starting in Q3.

Terry McDaniel

Yes, our gross revenue is in a much better position than our net. But even though customers like the ones I mentioned will not -- these are top customers in the country -- they don't put a brand in unless they see something in it. And obviously they see the momentum of the people that they've competed with and, you know, there's more opportunity to do that.

Phil Terpolilli

That's great. And actually -- just one last thing. It's more of a housekeeping item. It ties into what you were just saying. That $1 million you referenced. Can you sort of break out how much was capacity versus the produce shortage versus the slotting? And then any more of those pressures to be expected 3Q and 4Q, whether it's slotting or something else?

Steve Weinberger

Just on the top of my head, I think half of that was the potato shortage, about $0.5 million of the $1 million shortfall was the shortage in organic potato.

Terry McDaniel

Which, by the way, was sold business.

Steve Weinberger

Yes. I mean, that was a done deal, though we just couldn't get enough potatoes. And the good chunk of the rest was capacity.

Phil Terpolilli

Got it. Okay, great. Thanks. I appreciate it, guys.

Steve Weinberger

Thank you, Phil.

Operator

Thank you, and our next question comes from the line of Eric Gotleed [ph]. Your line is now open.

Unidentified Analyst

Thanks for taking my questions. First, on the potato shortage. Where do you source from? And is it possible to expand that?

Steve Weinberger

In this particular case, they were -- I believe most of them were Miracopa County, which is right here in Arizona.

Terry McDaniel

Steve, let's be clear: they were just organic potatoes.

Steve Weinberger

There's no potato shortage. Just the organics.

Terry McDaniel

Just the organics.

Steve Weinberger

It's just the organics and where we grow them. We had an extremely hot June, early in June. I'll go even further. Normally we'll run this time of year organic one week, go back to conventional. It even hurt our capacity issues because, basically, we had to take them or we were going to lose them all. And so it even further hampered our capacity issue in the month of May. So that is for next year. We're not only looking how do we expand it, but we're looking can we go to a year-round supply. So we're looking at that as a possibility. Year-round supply would be we would grow an x amount and we would have to store. Now that would drive our cost up in the offseason but we've gotten a lot of play on our organic business.

Unidentified Analyst

Is there an opportunity to source out of Arizona?

Steve Weinberger

Yes, but I mean, remember the farther you go depending on where they're at. These are potatoes that they're not like organic fruit so much. I mean you have to contract ahead. The farmer has to plan them. You have to be ready to buy them. And yes there is opportunities to do that, but you can't get too far away from the source. Because shipping potatoes, every pound of potatoes, the way to look at it it's worth about, once you bring in a pound of potatoes you get about $0.25, every dollar of potato $0.25 or 25% becomes the potato, the rest is waste. So the more you ship, the more it costs. It's mostly water.

Terry McDaniel

It's mostly water. And the potatoes [ph]. Yes, the problem is the organic potato is more expensive to begin with and when you add on freight. The further you get from here, the mass becomes harder to work.

Steve Weinberger

We get a lot of our own regular potatoes here in at least for a couple of months. Then we do a lot in New Mexico, a little bit in California and some in Idaho during the winter. But we're looking every day how do we get, convince our growers here how can we grow more closer to the facility.

Unidentified Analyst

And if you grow, if you source regular potatoes from Arizona, why was the problem only restricted to the organic?

Steve Weinberger

Well because organic, they grow potatoes here for a mini potato chip manufacturers. Organic was specifically for, we put in the order of x pound and we were half a million of those pound.

Unidentified Analyst

Okay, I got it. In the past, you said that 20% gross margin of SNAK was reasonable. We're already at 19.6%. Any, would you care to raise that comment or touch on that a little bit?

Steve Weinberger

Well we're pleased with the progress. We're hoping it will continue to show that progress and some of that will be helped by shipping boulder for East Coast business out of Bluffton, making it there and shipping it out of there. Hopefully that will help. So we're pretty much where we had targeted for the year. Yes, and you got to get to 20% before you start getting north. So we're getting closer.

Unidentified Analyst

Good point. So I was wondering about one thing. Has the smaller package size in the fresh frozen actually gained new distribution? I'm thinking there might have been customers that you have observed or used to carrying that similar, that size of product because that's what their customers used to. And I'm wondering if maybe that might have gotten you in the door there, like that played out at all?

Steve Weinberger

No, it hasn't at this point. You're talking about our one pound package of frozen vegetable, the two pound being taken down and such, which one are you mentioning? Two pound?

Unidentified Analyst

Yes, the smaller package sizes.

Steve Weinberger

No, it really hasn't played into it. What will help I believe, the number one size out there is, we call it one pound, it's really 12 ounce. That's the biggest consumer size in frozen vegetables. And we're making some changes in our packaging there. That is going to put us in a much better position to go after that size of the business which may open some new doors for us. This was always a two-pronged project. One was downsizing the -- and there was to change the one pound which is in Q3. And we're not like changing it, we're improving the factors tremendously. And it will be the only one pound bag like this, we won't call it one pound. The only small bag like this in the supermarket industry. So that's something, and I mean again, we're going slow on this. Number one goal is we have to get our margin back to where we have the money out of that business to reinvest. That's what number one is. I think we're moving in that direction. Number two will be, now let's go and run with this thing again.

Unidentified Analyst

Is it possible to pull out the margin impact of going down in size this quarter?

Steve Weinberger

What do you mean?

Unidentified Analyst

How much margin did the change in packaging specifically add?

Steve Weinberger

We said we improved our margin 860 basis points from Q2 versus Q1. The line share of that -- not 100% but the line share, most of it.

Unidentified Analyst

Okay, I think that's it for me. I'll ask the other questions -- fresh frozen, you're 85% last quarter, are we still there?

Steve Weinberger

We're up a point or so from that.

Unidentified Analyst

Got it. Okay, with that I'll pass it on.

Steve Weinberger

Okay, thank you.

Operator

Thank you. [Operator Instructions] And our next question is a follow up question from Jon Andersen of William Blair. Your line is now open.

Jon Andersen

Thanks for the follow up. I'll give this a shot. I just wanted to ask about the other press release this morning, the strategic and financial review. Can you talk it all about the comment in the press release on this is the right time, why this is the right time? Can you talk about, how should we think about the duration of this process and when would be getting any kind of update? How should we be thinking about update if this process plays out? Thanks.

Steve Weinberger

I mean, first of all, we're always looking at when, strategically, what's the best option for our shareholders. I mean, we look at it at the end of first quarter. We look at it before we ever had the issue with the recall. At this point it's been decided by management and the board this is a good time to look at all of our different options, and those options I think stated, they were stated in the press release. Basically looking at a current capital structure, looking at an equity rate, selling pieces or assets up to selling an entire business. So we were always looking at that, and so we decided to hire a banker. Obviously, this is a big decision, and we want to make sure we go down the best path that benefits our shareholders. From a timing standpoint, we don't know how long this is going to take. I don't want to put a time on it because I want to do the right thing, and depending on which path we go will determine the timing required to conclude it. As far as update, obviously we're in a period where we can't say much, and will be in that period for quite some time. Unless something happened, unless we go down a certain path and we're going to conclude that path and we come out with an announcement. So there won't be a lot of things that Steve and I or our Company can say because it's obviously confidential, it obviously impacts, could potentially impact our shareholders and impacts our company employees. And our goal right now, Steve and my goal, is to focus on making sure we continue to see the sequential improvements on our business. John, as we review our business, we have some really really good brand, if you guys know. And we have still a lot of life space in all of these brands which presents huge opportunities going forward. As we assess our business, we really need to ramp up investment of these brands, right. If we're going to accelerate and get back to sort of high double-digit growth of the company we need to ramp up investment again in this business. And as you well know, our capital structure as it sits today sort of precludes us from really ramping up the investments that this great brand need. This company has great bones and we need to ramp up. And so again we're looking at all of the options. Terry said, how can we figure this thing out to give the brand the kind of investment they really need to grow like crazy.

Jon Andersen

Thanks for the comment. I appreciate it and good luck Terry and Steve.

Operator

[Operator Instructions] And at this time, I'm showing no further questions in the queue.

Terry McDaniel

With that I'd like to thank everyone for attending today's call. I look forward to next quarter and talking to you again about our progress. And if any of you have any questions, please reach out to us and we'll be glad to discuss today's results further. Thanks.

Operator

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

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