SunOpta's (STKL) CEO Rik Jacobs on Q2 2016 Results - Earnings Call Transcript

| About: SunOpta, Inc. (STKL)

SunOpta, Inc. (NASDAQ:STKL)

Q2 2016 Earnings Conference Call

August 10, 2016, 09:00 AM ET

Executives

Rik Jacobs - CEO

Rob McKeracher - CFO

Analysts

Amit Sharma - BMO Capital Markets

Peter Prattas - AltaCorp Capital

Eric Gottlieb - D.A. Davidson

Jon Andersen - William Blair

Chris Krueger - Lake Street Capital

Operator

Good morning and welcome to SunOpta's Second Quarter 2016 Earnings Conference Call. By now, everyone should have access to the earnings press release that was issued this morning. The release as well as the accompanying slides are available on the Investor Relations page on SunOpta's website at www.sunopta.com. This call is being webcast and its transcription will also be available on the Company's website.

As a reminder, please note that the prepared remarks, which will follow contain forward-looking statements and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance and therefore undue reliance should not be placed upon them. We refer you to all risk factors contained in SunOpta's press release issued this morning, the Company's annual report filed on Form 10-K and other filings with the Securities and Exchange Commission for a more detailed discussion of the factors that could cause actual results to differ materially from those projections in any forward-looking statements. The Company undertakes no obligation to publicly correct or update the forward-looking statements made during the presentation to reflect future events or circumstances, except as may be required under applicable securities laws.

Finally, we would like to remind listeners that the company may refer to certain non-GAAP financial measures during the teleconference. A reconciliation of these non-GAAP financial measures was included with the Company's press release issued earlier today. Also please note that, unless otherwise stated, all figures discussed today are in U.S. dollars and are occasionally rounded to the nearest million.

And now, I would like to turn the conference call over to SunOpta's CEO, Rik Jacobs.

Rik Jacobs

Good morning and thank you for joining us today. With me on the call today as usual is Rob McKeracher, our CFO. Today, we will highlight our second quarter results and financial position, discuss our business progress and update you on our 2016 operational goals. I would like to remind those on the call that there is an accompanying presentation on the Investor Relations page of our website, which we will reference today in our prepared remarks.

So with that please turn to Slide 2. Slide 2 relates to forward-looking statements, which the operator covered. So you can kindly turn to Slide 3.

We are a pure-play organic and non-GMO company with the largest organic raw material supply chain in the world. We've built the scalable platform and made significant investments that allow us to grow in all of our key categories. We've ramped up our innovation efforts that have started to hit the market and as a result of that I'm increasingly confident that the mid-term goals we shared earlier this year can be achieved in the timeline we established.

Please turn to Slide 4. Now our Q2 revenue was essentially unchanged year-over-year on normalized basis which excludes the impact of acquisitions, commodities and currencies. The primary drivers of this deceleration in revenue growth are the largely expected decline in revenues in our domestic sourcing business and the unexpected short term decline in revenues in frozen food which I’ll explain in a few moments.

Revenue was $348 million or $352 million adjusting for the impact of the sunflower recall, which is about flat with Q1 of 2016. Given the transformation of our company in 2015 with the acquisition of three businesses, we will continue to discuss sequential comparisons for comparability as well.

Gross margins for the quarter came in at adjusted rate of 11.5% which is ahead of our prior year by 80 basis points and essentially flat to the prior quarter. Adjusted EBITDA was $23.5 million and adjusted earnings per share was $0.05 both somewhat ahead of our Q1 results but lower than our expectations.

Please turn to Slide 5. Now we continue to see strong growth in our international organic sourcing business where revenues were up 22% versus the prior year. And that comes on top of a very strong Q2 last year and is ahead of their first quarter revenues as well. Our growth rate there is clearly in excess of end markets and is a testament to the ability of our team to source scarce organic raw materials and ingredients. We're making further investments in our sources of supply and have also approved the installation of a second cocoa processing line in our Crown of Holland facility to keep up with the ever increasing demand.

Margin in the quarter was somewhat negatively impacted by product mix but still was in the range of our expectations. Domestic sourcing continues to face the expected pressures of the strong U.S. dollar and lower commodity prices. As a result we've been contracting less acres for 2016 crops and continue to make strategic decisions on our portfolio to optimize future returns.

As it relates to sunflower we’re back in production at our Crookston facility following the recent recall although we did report lower revenues in the quarter as a result of the temporary shutdown and lower post startup production. We continue to supply our customers on a positive release basis to build back confidence in our product quality.

At the same time we're also working with our customers and insurance carriers to handle their claims in accordance with our contractual obligations. We remain very comfortable with our insurance coverage and Rob will get into more details on how we're treating the recall for accounting purposes.

Adding both platforms together our revenue in global ingredients was flat and the margin rate was 12.5% which again is inside our mid-term target range.

Please turn to Slide 6. Now we've made good progress against many of our target initiatives in the CPG platforms. The lower revenue and contribution within frozen food limited growth and profit margins during the second quarter.

In healthy beverages we grew revenue by 17% year-over-year and 9% sequentially. We nearly doubled our East Coast aseptic revenue in Q2 versus Q1 but also saw growth at our other two aseptic facilities. While we still incurred about $300,000 of start-up costs in Allentown the facility is now fully up and running so we do not expect to take any other charges going forward. We're ahead of our plan in terms of filling out a new capacity out of last year and in Q3 we expect to begin production of a new almond beverage for a significant food service customer.

Based on the current shift patterns, our factories are filling up quickly so now we’re in the process of adding more shifts and increasing our line efficiencies further to drive utilization back to 80% plus on a 24/7 basis so that we can realize the full margin potential of this platform. Our success here elevates our investments to build a national production platform and reflects our strong innovation pipeline.

In juice, we’re very pleased with our innovative new lemonade launches and continue to see opportunities for boarder distribution of these products. We also just completed a test of a new packaging format with our largest refrigerated juice customer with very strong results. That means we will now turn that into a national program as quickly as possible with significant incremental volume potential.

This packaging chain also provides an opportunity to evaluate how to further optimize our supply chain going forward including how to best utilize our San Bernardino facility, where we still do have challenges in sourcing enough local fruit for extraction. Net-net our innovation around both products and packaging has created significant momentum and we see further opportunities going forward.

In healthy snacks we grew revenue 9% year-over-year and we’re about flat sequentially. The growth was driven primarily by pouches where we continue to see better utilization of the Allentown facility. As you may have seen through our recent 8-K filing, we also successfully settled a legal dispute with our largest customer.

In the face of rising legal costs, we elected to settle for a cash amount roughly equivalent to our expected legal cost had we continued to dispute. In return for some additional discounts, we were able to agree on a long term manufacturing agreement for both our pouch and aseptic products.

Fruit snacks posted about 10% sequential growth and we've won several new listings. A number of our product innovations have been accepted by customers and we expect to see solid volume growth during the second half of the year. Finally, we recently signed a significant new contract in bars that will fill up capacity in our bars facility and could add up to $20 million of revenue annually. We expect to begin shipping to this customer in September.

With that please turn to Slide 7. Now in healthy fruit, frozen fruit sales declined 20% compared to the first quarter and we experienced more margin pressure than we expected and signaled during our Q1 conference call. While we did anticipate some impact on the timing of the strawberry harvest, the overall effect of the delay was more costly than we expected. The late start resulted in significant inventory rework and factory inefficiencies during the quarter. As well the cost of strawberries increased 15% over last year more than we had anticipated and while we can pass this through with pricing the majority of that will not take effect until the fall.

These factors had about $4 million margin impact which was further compounded by a temporary revenue shortfall experienced in the quarter. First, our largest customer experienced lower sales of their private label frozen fruit due to decline in customer demand that we directly attribute to recalls of frozen products announced by competitors.

These recalls involve both organic and conventional SKUs and since Sunrise produces products under some of the same labels, we also experienced a decline in sales even though none of the products we produce were implicated. As organic forms a larger portion of our sales we were disproportionately impacted by these challenges.

At the same time, our second largest customer went through a major distribution center and store reset and our largest foodservice customer delayed shipment until the second half of this year. Altogether these revenue - these factors resulted in the revenue shortfall of roughly $18 million and a significant loss of contribution from these sales.

Now the good news is that synergies are on track; we maintained our customers and the outlook for frozen in the back half of 2016 is positive. But we won’t get back all the revenue and margin that we lost during the second quarter. Finally, despite the delay the strawberry harvest did occur and we have sufficient supplies in place to meet anticipated demand.

With that I will turn the call over to Rob to go through the numbers in more detail and I will come back with an update on our operational goals and some closing remarks.

Rob McKeracher

Thanks Rik. I will take you through revenue, margins and earnings as well as highlight our EBITDA and cash flow performance during the second quarter.

Please turn to Slide 8. Slide 8 shows our revenues broken down by segments. Revenues for the second quarter of 2016 were $348 million compared to $352 million during the first quarter of 2016 and $278 million a year ago. Taking into consideration the impact of the sunflower recall, revenue would have been about flat with the first quarter and up 27% year-over-year. Most of the year-over-year growth was driven by acquired businesses as well as internal growth in aseptic beverages, resealable pouch products and internationally sourced organic ingredients.

After adjusting for changes in revenue including the impact of acquired businesses commodity prices and foreign exchange rates on a normalized basis consolidated revenues increased 0.3% compared to the second quarter of 2015 despite the challenges in frozen fruit during the quarter and lower sales of domestic we source raw materials as we focused on enhancing returns in that business.

Global ingredients reported revenues of $158.5 million during the second quarter compared to $146 million in the first quarter of 2016 and $161.8 million a year ago. This represent a 9% increase sequentially driven by seasonal sales of agronomy and other crop inputs as well as higher sales of internationally sourced organic ingredients.

After adjusting for commodity prices and foreign exchange revenues in global ingredients increased 2.7% year-over-year as Rik mentioned the sales trends in this segment versus prior year remained quite consistent with strong growth of 22% international organic ingredients offsetting an 18% decline in domestic raw material sourcing and supply. Consumer products reported revenues of $189.6 million growth of 64% year-over-year due primarily to acquisitions while down 8% sequentially compared to the first quarter of 2016.

On a normalized basis taking into consideration the revenues of acquired businesses year-over-year revenue declined 1.7% by consumer products due primarily to pressures in the frozen fruit category for the reasons previously discussed by Rik.

In Healthy Snacks pouch volumes were again strong in the Allentown operation and snacks platform revenues remain consistent with the first quarter of 2016. As Rik mentioned we expect to start delivering at the major new bar contract in the second half of 2016 and are pleased with deriving capacity utilization inside snacks. In healthy beverages we posted 17% normalized year-over-year growth driven by 20% growth in aseptic.

We are able to continue to add new aseptic business to our national network and posted solid sequential and year-over-year growth. Non-aseptic sales including shelf-stable and refrigerated juices were up approximately 30% compared to the first quarter of 2016 driven by innovative new product introductions for private label and we remain encouraged by the pipeline for non-aseptic beverages.

Turning to Slide 9, you will see that during the second quarter we generated gross profit of $36 million or 10.3% of revenues as compared to $29.7 million or 10.7% of revenues in the second quarter of 2015. After removing the impact of a non-cash acquisition accounting adjustment related to the Sunrise inventory sold in the second quarter, startup costs related to the ramp-up of production volumes at our Allentown aseptic facility and the impact of the sunflower recall gross margin would have been 11.5%, an 80 basis points increase over the second quarter of 2015.

The increased margin rate was driven mainly by increased efficiency and lower costs inside our beverage operations partially offset by increased raw material costs for frozen strawberries that could not be passed on immediately to customers as well as production inefficiencies within our frozen fruit operations, caused by the late harvest that Rik previously discussed.

For the second quarter reported operating income of $8.8 million or 2.5% of revenues compared to operating income of $2.6 million in the first quarter of 2016 and $9 million a year ago. Adjusting for the same items I just mentioned as well as legal costs related to the now settled litigation operating income in the second quarter would have been $14 million or 4% of revenues.

On July 29, 2016 we entered into a mutual release and settlement agreement with the customer of ours to resolve the dispute related to the 2013 voluntary recall of certain pouch for the products. Pursuant to the terms of the settlement agreement we will payout $5 million in cash and provide up to $4 million in rebates against purchases resealable pouch and aseptic broad products over the next four years.

The future rebates are dependent on the customer placing minimum order quantities in each of the next 4 to 12 month periods. In connection with this settlement we recorded a charge of $9 million during the second quarter of 2016 as we believe there is reasonable assurance that the minimal -- minimum order quantities will be achieved.

Also during the second quarter we announced a voluntary recall of certain roasted sunflower kernel products produced at our Crookston Minnesota facility. For the first half of 2016 we recognized estimated losses of $16 million related this recall. This reflects the estimated cost of the affected sunflower kernel products we expect to replace and the estimated cost to reimburse customers or costs incurred by them subject to our contractual obligations.

Please note that our estimate of recall-related losses are provisional based on information we have to-date. We may need to revise our estimates in subsequent periods as we continue to work with our customers to substantiate their claims. The company carries general liability and product recall insurance and we expect to recover recall-related costs through our insurance policies less applicable deductibles.

As a result in the second quarter we recorded estimated insurance recoveries of $15.4 million for the losses recognized to-date. We expect additional visibility into the magnitude of cost and related insurance recoveries in the third quarter as we continue to work through the recall with our customers and insurance providers.

On a GAAP basis for the second quarter we reported a loss from continuing operations of $4.1 million or $0.05 per diluted common share compared to earnings from continuing operations of $4.8 million or $0.07 per diluted common share in the second quarter of 2015.

Second quarter results were impacted by a number of items that are not reflective of normal operations and have been excluded when calculated adjusted – calculating adjusted earnings. These items include $9.7 million of costs related to a legal settlement and associated legal fees, $7.9 million of costs associated with the purchase accounting, financing and integration of the Sunrise acquisition, $0.5 million of product withdrawal and recall costs, $0.3 million of costs as we ramp-up production at our Allentown aseptic facility, $1.7 million gain on the settlement of contingent consideration and 400,000 of other costs including fair value adjustments to contingent consideration of previous acquisitions.

Excluding all of these items on after-tax basis adjusted earnings in the second quarter were $4.1 million or $0.05 per diluted common share. We realized adjusted EBITDA of $23.5 million during the second quarter of 2016 compared to $22.1 million during the first quarter and $15 million in the second quarter of 2015.

I would like to remind listeners that adjusted EBITDA and adjusted earnings are non-GAAP measures. Reconciliation of these measures to GAAP can be found towards the back of the press release issued earlier this morning.

Turning to Slide 10, from a cash flow perspective during the second quarter of 2016 we used $34.4 million of cash in continuing operations reflecting seasonal raw material purchases especially fruit which although later than usual did come up in fields in the second quarter.

During the second quarter reinvested $4.8 million to purchase capital assets and we expect to incur capital expenditures of approximately $20 million for 2016. During the quarter we drew $39 million on our operating facilities primarily to fund working capital demands. The seasonal outflow of cash in our business is greatest in the first half of the fiscal year due to the timing of raw material purchases from growers.

The build-up in working capital then reduced over the back half of the year resulting in a positive cash flow expectation from now until the end of 2016. We expect cash flows from continuing operations for the full year of 2016 to be sufficient to cover capital expenditures, interest payments and lead to lower total debt over the course of the year.

If you please to turn Slide 11, you’ll see our key balance sheet metrics. At July 2, 2016 SunOpta's balance sheet reflected total assets of $1.2 billion, total debt of $557.8 million and total-debt-to-equity ratio of 1.38:1.

At July 2, 2016 our leverage is approximately six times pro forma adjusted EBITDA after factoring in the run rate EBITDA of acquired businesses and cost synergies expected to be realized in 2016. The increase in leverage reflects the seasonal increase in debt that I previously explained, as well as the temporary impact of the slowdown in the frozen fruit business had on EBITDA. We continue to expect to de-lever in 2016 but given the slower EBITDA growth in the second quarter, the timetable for de-levering by 1 to 1.5 times in the first 12 to 18 months following the Sunrise acquisition has been modestly extended.

From a liquidity perceptive we ended the quarter with approximately $75 million of available capacity on our asset backed credit facility and this is at our peak usage. So we expect availability to increase over the back half of the year.

In addition I would like to remind listens that due to the excess availability we have under our credit facility we’re not currently required to maintain compliance of any specified financial ratios under that credit facility. We remain focused on debt leverage, reduction and expect noticeable improvements in these metrics by the end of the year.

With that I’ll turn it back over Rik who will conclude our prepared remarks.

Rik Jacobs

Thanks Rob and please turn to Slide 12. Now every quarter I update you on our progress against our 2016 operational goals which are first laid out after taking over as CEO in the fourth quarter of 2015. So first in healthy beverage we said we will increase gross margin in juice by at least $6 million, thereby achieving break even or better in that business while also concluding our pipeline in aseptic beverage to achieve double-digit top line growth.

As you’ve already heard we’re more than achieving this goal in aseptic haven driven double-digit growth during the first half with the addition of new products and customers as well as expansions with existing customers.

Within juice we’re one-third of the way toward our goal having added $2 million to juice gross profit during the first half but as I indicated earlier we’re very bullish on the back half of the year as a result of our product and package innovations.

In healthy fruit we said that we were committing to successfully integrate Sunrise growers and maintaining its strong growth rate while capturing the $5 million to $7 million of cost synergies we identified. Through the first half of the year we’re on track to meet our cost synergy target with the closing of Buena Park and have successfully integrated the business.

However, the challenging environment on sourcing and the revenue that impacted Q2 offset the Q1 strength in the business and while we expect a very good back half of the year it will not offset the Q2 shortfall.

In healthy snacks we identified fruit snacks as a key growth area as we look to drive growth of at least 10%. For bars and pouches we plan to fill the available capacity with higher profitability private label products especially in bars. Thus far we’re tracking towards this goal. We’ve seen strong pouch growth during the first half and re-consigning of a major contract to produce bars to fill the majority of the capacity beginning in the second half of the year.

We also said that all three CPG categories must be heavily supported by increased innovation and we plan for on at least $10 million of new product innovation hitting the market in 2016. This goal has already been achieved with innovation adding significantly to our aseptic business at both retail and in food service. Several roasted snack innovations launched, as well as our lemonade success and new packaging instruction.

Now even though we did not stage this as an explicit goal we are obviously not pleased with the operational challenges we’ve experienced and this will continue to be key area of focus for our company as we work to improve the consistency of our execution.

Finally we committed to controlling our cost and targeted to keep SG&A below 8% sales. We well achieved this goal during the first half and are in a good position to deliver again in the second half of 2016.

I would like to take this opportunity to comment on the strategic review process. As you know on the 27 of June we announced that we retained Rothschild as the financial advisor and we continue to evaluate a complete range of strategic and financial access that SunOpta could undertake to maximize shareholder value.

The Board will provide further details as and when appropriate. We’re not in a position to provide details while the process is underway. Hence we will not be fielding questions on today’s call in relation to that strategic review process.

So please turn to Slide 13. Now in conclusion we’re on track with most of our operational goals thus far in 2016. We continue to capture market share in organic ingredients, our aseptic business is delivering strong growth and improved margins and momentum is building in snacks supported by strong innovation.

We’re executing against the Sunrise synergy plan and winning new business across the three CPG platforms where we’ve not achieve our goals at the cost of non-performance basically not executing excellently all of the time. We recently reorganized our internal quality control organization and are holding everyone accountable for execution. We're correcting each challenge and are becoming stronger as a result.

While we did not deliver the top or bottom line growth we expected during Q2 due largely to the unexpected and temporary shortfall in frozen fruit. We expect notable improvement in back half of 2016 as a result of our increased pipeline. In July we're seeing a good uptick in revenue in all CPG platforms and continued growth in our organic ingredient sourcing business.

While it’s not our intention to provide quarterly guidance on an ongoing basis given this unexpected volatility we experience into Q2 we wanted to provide some additional visibility into our Q3 expectations. For the third quarter we expect revenue to be $10 million $15 million higher than what we reported in Q2 and we expect adjusted EBITDA to grow $2.5 million to $3.5 million over the second quarter as well.

For an explanation of how we calculate adjusted EBITDA please refer to the reconciliation of non-GAAP financial measures that was included with the company’s press release issued earlier today.

So with that, I'd ask the operator to please open up the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Amit Sharma with BMO Capital Markets. Your line is open.

Amit Sharma

Hi good morning everyone. Rik, can you provide a little bit more color on what exactly happened with the frozen fruit business in the quarter and how much of that is avoidable or could have been mitigated with further insight?

Rik Jacobs

I really would classify it as a one-time event. I mean the strawberry harvest that we experienced is happening once every 10 to 15 years, maybe that it is this late, if it is this late what that really means Amit is that A, you have a lot of inefficiencies in your factories because you are hiring all these crews to basically sort the strawberries in your factories but as you can imagine if the strawberries are not coming in you are still having to pay these workers.

And secondly you have to go into your inventories rather than going straight into a retailer or a food service package and that also adds a lot of cost because now we’re utilizing [indiscernible]. That was the biggest impact when it came from a margin perspective. When it comes from a revenue perspective, I think everybody is aware of two very significant recalls in the frozen food category in the quarter that impacted especially the club channel and the club channel is our largest customer and we pack under the same label as a result of that our products were also very negatively impacted.

Secondly, our second largest customer that is a very large national retailer, they decided to reset their shelves, the great news on that is that we increased our share, we’ve seen revenue growth in July but they did reduce their promotional activity significantly in the second quarter to facilitate this reset that has impacted us as well.

And then finally as we mentioned, our largest food service customer while we have committed minimum volumes that they should take, decided to take that in the third quarter rather than the second quarter. So that should come back to us.

Amit Sharma

And I don't know if I heard it right, there seemed like you are a little bit more concerned about price elasticity of having to pass higher prices

Rik Jacobs

No, we’re not concerned about that. We are - in most of our contracts we are allowed to pass the prices through. The only thing that Rob or I mentioned is that there will be a bit of a gap between us basically taking in the inventory at a higher price and taking the price increase through. That price increase basically happens in the fall. So for a couple of months you are stuck with somewhat higher cost that you cannot offset with higher pricing.

Amit Sharma

And, then, the next one, you talked about improving the consistency of performance, and clearly that is on top of the minds for most investors. Now, when you really think about this issue and we have had a number of issues in the last several quarters, all different issues, do you see this as a management bandwidth issue that would potentially be fixed by bringing in maybe more reinforcement, or is it simply the cost of operating in a segment where there are a lot of unknowns and something could potentially go wrong at any time?

Rik Jacobs

Look, I think everybody that is in the food business will experience something every once in a while. I mean if I just go look at the second quarter and I look at what we achieved in our healthy beverages, what we achieved in our healthy snack, if I look at the pipeline going forward over there, what we achieved in our organic ingredients, international ingredients, I am very, very pleased with that and I would definitely say that in my opinion we have turned a corner and I look forward to improve performance. Now what happens inside our frozen fruit, I would argue was largely outside of our internal control and has nothing to do with bandwidth, in fact we have been strengthening the management team at Sunrise Growers and all the management team that was there before the acquisition is still in place.

So, overall I am pleased with the progress that we are making, I look forward to notable improvement in the second half. Unfortunately all of the gains that we have made in the second quarter were basically offset by A, delayed strawberry harvest and B, a temporary slowdown in retail.

Amit Sharma

And last one for me, thanks Rik, thanks a lot for that update - last one for me, you talked about sequential improvement in the aseptic business and on track to get 80%-plus utilization. Are you able to say where are we at this point?

Rik Jacobs

Yes, I would say that on a 24/7 basis, we are probably close to 70% utilization right now, but remember that last year when we experienced a slowdown, we actually took some shifts out of our factories in order to obviously not have to pay people while we didn’t have the production.

So right now we are aggressively hiring new shifts and trying to get all of our factories back to 24/7 as quickly as possible because, and quite honestly Amit, even though we didn’t of course come as nicely and smoothly as anybody would have expected, we feel somewhat vindicated with our decision to invest in a national platform because we are really starting to reap the benefits of that right now.

Amit Sharma

Got it. Thank you very much.

Operator

Our next question comes from the line of Peter Prattas with AltaCorp Capital. Your line is open.

Peter Prattas

Good morning guys. I wanted to spend just a minute on aseptic first since that seems to be your biggest opportunity to improve going forward. Can you say, just given the growth you saw in the second quarter, where your utilization rates have left it to, I think you are at around 60% in healthy beverages or at aseptic during the investor day. So where are you now? And just given the wins that you have already in place, assuming no further wins, where do you get to in utilization rates exiting the year? Thanks.

Rik Jacobs

Yes, we are, as I just mentioned to Amit, and you may not have got that, we are close to 70% utilization on 24/7 basis, and exiting the year I would expect that percentage to continue to grow given continued strong demands. We continue to see sequential improvement, as well obviously significant year-over-year but also sequential improvement.

So I would say 75% by the end of the year and ramping up to north of 80 and once we are north of 80 that's when we start realizing the full margin potential of this platform.

Q – Peter Prattas

Excellent. And then, just on the impact of your frozen fruit supply here, I think you said $4 million was the impact for the quarter. I am just wondering how much of an impact will it be in Q3, and then are you completely normalized by the fourth quarter?

Rik Jacobs

Yes, we mentioned that the factory inefficiencies and the late harvest had an impact of about $4 million, obviously on top of that there has also been an impact on the loss of contribution margins in that platform from the lower revenues. We believe that we are going to be basically back on track inside of the third quarter already, right. And so far our July numbers are proving that out.

Peter Prattas

Great. And then my last question is regarding your balance sheet. Just looking at your credit facilities, where you have room there, I am just wondering how prepared are you to use those facilities to reduce your long-term debt?

Rob McKeracher

Yes, we definitely, it’s Rob, Peter, we definitely have the ability, we negotiated that as part of both facilities that we can draw on our operating ABL to repay some of the long term, that’s not something we are evaluating. We will be evaluating over the course of the year, obviously we are at peak utilization right now.

On the ABL side, I think quite honestly, the consideration that we give for that would come later in the year than right now given that we’re at peak, but definitely have the ability to do that and take advantage of that availability at a lower rate to reduce some of the higher rate interest of that.

Peter Prattas

Okay. That’s it for me. Thanks very much.

Operator

Our next question comes from the line of Eric Gottlieb with D.A. Davidson. Your line is open.

Eric Gottlieb

Yes, good morning. You talked about getting back to 80% in utilization. What kind of a gross margin impact would you expect something from where we are now to that level?

Rik Jacobs

I’d say that’s going to be a minimum of three points of margin improvement.

Eric Gottlieb

Okay. Got it. And then, talking about the $20 million order that was potential, right? What exactly is near-term expectations for that contract?

Rik Jacobs

I basically mentioned that on an annual basis that would be $20 million, and we will begin shipping in September. So I think one-third of the $20 million is our expectations. Potentially, a little bit higher because it needs to be a pipeline fill as well.

Eric Gottlieb

Got it. Okay.

Rob McKeracher

Between 7 and 10 million this year.

Eric Gottlieb

$7 million and $10 million this year. Okay. And then, I am going to jump around a little bit. How modestly extended is the 1% to 1.5% deleveraging?

Rob McKeracher

As we mentioned, post Sunrise, we were roughly 5.3 times adjusted pro forma level at that point in time, and of course, we thought we’d bring it down to 1 to 1.5 times, the first 12 to 18 months. I’d suggest that we are anywhere from 3 to 6 months extended into 2017 from that timeframe established at that time.

And the important point to take away from this is that we do continue to expect to see that reduction and leverage reduction both over the course of this year and for the fiscal year itself.

So it's truly just a bit of a slowdown in pace due entirely to the results of the second quarter, and through which while we can’t make that up, we do, as Rik mentioned, see that coming right back on to where it should be in the back half. So to answer your question, it's about a three to six month delay.

Eric Gottlieb

Got it. Okay. I think that’s it from -- one other question…

Rik Jacobs

I think it’s important to know that we still fully anticipate to be well below five times leverage by the end of the year now. But the target was 4.3. I think we’ll be modestly higher than that by the end of the year. And we wanted to be upfront about that.

Eric Gottlieb

Okay. Any insights into replacing that 9.5 debt? Have you been able to shop that around at all?

Rik Jacobs

We announced obviously earlier on the quarter that we expected in the near future to come out. Clearly, that hasn't taken place. What I'd suggest is that just given the mix of markets, as well as the goings on in the company, that has not yet taken place but it’s still certainly a possibility prior to October 9.

Eric Gottlieb

Got it. And then, on your expectations for the next quarter, that $26 million, $27 million in EBITDA, what is your contribution expectations for each business, roughly?

Rik Jacobs

The way I characterize that is actually to try and give you a sense of what gives rise to that improved EBITDA. I guess I talked to the two segments focusing on margin because quite frankly we don’t see a big change in terms of our SG&A load or some of the other items that factor into EBITDA.

But in the first half of the year, in our global ingredients segment, it’s quite normal to see a bit of a pick in terms of our input sales - agronomy and other inputs. So that’s when the crops were being planted. So directionally, you could see perhaps a $4 million decrease in terms of EBITDA dollars that are generated through the global ingredient segment offset by an increasing consumer products. I think which would be around a $7 million increase, if you did the math. I think that’s kind of how I would frame that up Eric.

Eric Gottlieb

Okay. Very good. Thanks for the additional color, and will that, I'll pass it on.

Operator

Our next question comes from the line of Jon Anderson with William Blair. Your line is open.

Jon Anderson

Hi, good morning guys. I wanted to ask, first, on the fruit sales, the impact in the quarter, it sounds like the issue with the reset at your second largest customer and then the food service customer, which I guess would be the USDA, those would be transitory issues. Can you comment on the consumer demand impact? You saw a club in the quarter that was driven by some of the recalls, and are you seeing that demand kind of return to normal at this point?

Rob McKeracher

Yes, I think it's important to point out that the – obviously that was not our recall, right. It was competitor recall there were two and there was one in Canada and there was one in the United States and both of them were very, very significant. Both of them were in the organic space and that is where we over index, right. Given our legacy business and now also with the addition of Sunrise and that by the way also where this club customer over index.

So that's why we were impacted because we got a lot of call from consumers more than 30 a day I would say for significantly at a time. Is this also your guy that’s probably been impacted; now it is not. But you know that if you are getting 20 calls obviously that represents a lot more consumers out there that are confused by which product is impacted and which one is. Now all that product has obviously now been removed from the shelf it’s all been replaced. It’s gone away.

We have just gotten the second quarter IRI data and the good news is that if you look at an overall retail basis which measures everything except for the club that is the category continues to grow at about 8% rate despite this temporary slowdown in organic. So I see that, I see that organic sales coming back but definitely the category as a whole is intact and that’s important.

Jon Anderson

On the guidance, the sales guidance for the third quarter, is the $10 million to $15 million increase, is that over $348 million the recorded number or the adjusted revenue number of $352 million for Q2?

Rob McKeracher

All that sequential guidance we gave is over the reported numbers, Jon.

Jon Anderson

Okay. So the $348 million in Q2?

Rob McKeracher

Right.

Jon Anderson

Okay. And, again, just for clarification, the new business that you quoted, I think, at about $20 million on an annualized basis, that was bar business, right? That wasn't beverage business. Is that accurate?

Rob McKeracher

Correct.

Jon Anderson

Okay.

Rob McKeracher

I mean, in bar – in the beverage obviously that number is larger than that.

Jon Anderson

Yes. That was kind of my follow-up, Rik. You talked about a major new customer on the almond milk side. Can you talk about maybe the impact of that addition, either in the second half of the year or on an annualized basis?

A – Rik Jacobs

Yes, I would say that just that one alone is probably between 4 and 5 million and obviously there is a significant pipeline filled that needs to rampant by the beginning of September. And we – this is one of the customers that we have a strategic relationship with a long-term relationship we are able to supply them with all of their non-dairy needs and it’s not all there’s almond mill that is going with the roof. There’s other non-dairy beverages that are increasing rapidly as well.

Jon Anderson

Excellent. You mentioned the juice business and the San Bernardino plant and maybe some lingering inefficiencies on the extraction side. Can you talk a little bit more about that? What some of the -- what is driving some of those inefficiencies and what the outlook is there? It sounded like you may be even taking a bigger picture view of how to maybe rationalize some of that.

Rob McKeracher

Yes, exactly right. You know look, if we look at that the plants in San Bernardino which sort of basically made up of two parts of that plant. The one part of the plant is the extraction where you could take oranges and lemons and you basically make them into juice.

And the second part of the plant is the following plant where you basically take juice and put it into bottle. Now starting with the bottling plant, we've got very good utilization of their 75% plus. The plant is running well but with this very new innovative packaging that we’re coming out was for our largest customer that represents more than 60% of the volume.

That is not a packaging format that we currently have. The dozen -- but we have the ability and also I think the obligation to present our customers with the best innovation out there. And so just we’re clear for these largest customers we already are confect manufacturing some of that volume on east coast. We’re doing currently that volume in San Bernardino on the west coast.

So it will require incremental investment in our bottling facility and that is what we need to evaluate whether or not that gives us higher return. Then you know and a higher focus on that manufacturing. The second part is on the extraction site and on the extraction site I'm assuming that most of you guys are aware of this screening disease that is really been hitting the Orchards in Florida now starting to hit the orchards in California as well.

That means that there is a significant decrease in the crop of local oranges and lemons that are available. And as a result of that there is a continued under-utilization of that asset. And that is what we need to address is that does it make sense to continue to run something even if your longer-term future suggest that you may not be able to get to full utilization.

Jon Anderson

Okay. Thanks. The last one for me is just on the domestic sourcing -- ingredient sourcing business and kind of your current thoughts there on the outlook for that business and maybe your view on the strategic importance of the business in the context of other things that you are focused on. Thanks.

Rik Jacobs

Yes, so I mean look on the domestic sourcing we've made a very, very positive decision that we are not going to sit there and chase any market share gains or revenue gains. We've made constant decision and have done so for the last 18 months to really focus on those items that where we can make a descent margin. And we’re also you know there is a good strategic fit. So as I think we have been mentioning we’ve reduced the sunflower acres that we’re planting, we have reduced the number of variety of soy corn that we’re utilizing.

So really what it is all about for us is in that domestic sourcing business to make sure that we get a decent gross margin and a decent return. Of course while that is going on that has a negative impact if you like, if you look at on an overall basis on the growth rate of our business. But quite frankly what we're doing internally we're kind of not even looking at that 18% decline where we’re looking at is what dollar margin and percentage margin are we able to eat out of whatever revenue we generate.

Jon Anderson

That makes sense. Thanks for the color. I appreciate it guys.

Rik Jacobs

All right.

Operator

Our next question comes from the line of Chris Krueger with Lake Street Capital. Your line is open.

Chris Krueger

Good morning. Just a couple quick ones. Back on your Investor Day a few months ago, you guys spent some time highlighting the opportunity of aseptic soup broth as a big market opportunity. Just wondering what kind of progress have you made there and what can you update us on that topic?

Rik Jacobs

Yes, well first of all, as part of the settlement that we reached in the dispute you will have noticed that we will be contract manufacturing some of the aseptic gross products there already. Secondly we have been actively pitching this to our retail customers and already you have gained some listings the most significant one was a West Coast retailer that has more than 2,000 stores. So we’re making progress and we're very excited about that.

Having said that Chris it doesn't mean that we are not continuing to focus on our non-dairy as well and non-dairy continues even though in the retail market as observed you don't see a lot of growth in non-dairy. That is absolutely not the case for us. We're seeing growth in non-dairy because of our innovation and also because of our channel approach where by a large part of our volume is hold in food service where non-dairy aseptic continues to share from dairy quite frankly.

Chris Krueger

Okay. And then, just my other question, now that we are into the month of August, how is the growing season going for your contracted growers?

Rik Jacobs

Yes, I think so far the growing season is going well. We did plant less acres and that is totally by design as follow-up to the answer today that I just gave. We just want to plant what we know we can sell with a decent margin as opposed to ending up in long positions that we didn't have to get rid off at zero margins as we had to do last year quite frankly.

So we have reduced our acreage quite significantly but the acres that we have on the contract are so far looking to have good yields this year. And I think that’s the same across the Midwest by the way not just in the acres that we’ve planted.

Chris Krueger

Okay, thank you, that’s all.

Operator

[Operator Instructions] And we have a follow-up from the line of Amit Sharma with BMO Capital Markets. Your line is open.

Amit Sharma

Hi, thanks for taking my follow-up. Rob, a quick one for you. The interest expense, how should we model for the back half? Similar to what we saw in the first half, or is there some miscalculation there?

Rob McKeracher

From a cash perspective, I guess two things, you’ll notice that at the start of the year there was roughly $8 million to $9 million of the fees that it's yet to establish the second lien loan that amortized over the course, just the one thing I cautioned everyone that there is a non-cash component to our interest that you need to really reduce from modeling perspective. You can still see the note to our 10-Q how much of that left I think it's around $2 million or so.

But there forward Amit most of it is, to say easy to calculate, you'll be able to do it at an assumed rate of as much as 9.5% on the second lien loan and then you can use our effective rate as we disclosed on our operating line. So, interest expense on the face of the statement will look lower in the second half than the first half because we had more of the amortization come off in the first half.

Amit Sharma

Got it. Thank you for that. And then, Rik, turning back to the consistency question and management, can you maybe tell us what are some of the things that you are putting in place internally so that you are more confident that performance and the consistency of performance could get better execution, could get better from where it has been previously?

Rik Jacobs

Yes, look I mean, if you start with our visit, the revenue generation which is really obviously the sale side. We have been actively hiring people that have retail sales experience because we firmly believe from a strategic point of you that that is where the future of this category is, that is where consumers are doing their value based organic shopping if you like. So we've been hiring people that have experience in retail sales.

Along with that we believe comes our obligation to make sure that we take an overall category approach. So, we've also been hiring category management resources. So, that’s kind from the revenue generation side.

And I think and the last one there, I think you are while I don’t think I know you're seeing a significant impact of the whole, innovation center that we put in place last June. We were cautiously optimistic with our $10 million this year, quite frankly we're blowing to get out of the water, on all kinds of different things. So, that from a consistency perspective, I think it is well on the way and I think it's evidenced by what we are able to produce right now.

The second part I think that, that we have - need to have an increase focus on, is obviously in our operations because we had for the last year and also for the first half of this year too high level of cost of nonperformance. We think that is unacceptable and therefore we are continuing to focus there to add more resources, to make sure that we have a structure that is appropriate i.e. fitting out quality from operations. So that I would say is a significant - continues to be a significant focus going forward for all us.

And then I would say finally, when it comes into the area of - the support areas I think we are well staffed over there, we have experienced some turnover, hence I am confident that we have the right teams in place over there. So freely around revenue generation and cost maintenance.

Amit Sharma

Got it. Thank you very much.

Rik Jacobs

Okay, so thank you operator. I would like to leave you if I can with fie key take-away from my perspective. We have a well defined strategy focus on efficient two type supply chains to ultimately build private-label brands in our three defined categories, healthy beverages, healthy food, and healthy snacks.

And we're tracking well against most of our operational goals as well in 2016. We see a tremendous opportunity in private label and food service categories we serve, and the customers continuous to seek value oriented healthy food. We continue to capture market share on organic ingredient sourcing and our innovation pipeline is building momentum for our consumer business.

Our debt capital structure is secured till 2021 and it offers us ample flexibility to grow our business and deliver our midterm targets. We remain focus on execution filling our production capacity and achieving operational excellence.

So thanks for participating in the conference call. And have a great day.

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