This FAQ represents a set of Questions and Answers that were included in the most recent Landec Quarter Earnings Release (Read Press Release issued on January 4, 2017 for the quarter ended November 27, 2016) and offers comments for understanding Landec's business. Following the Disclaimer below, there is a list of questions. Thank you for your interest in Landec.
Important Cautions Regarding Forward Looking Statements
Except for the historical information contained herein, the matters discussed in this news release are forward-looking statements that involve certain risks and uncertainties that could cause actual results to differ materially, including such factors among others, as the timing and expenses associated with operations, the ability to achieve acceptance of the Company's new products in the market place, weather conditions that can affect the supply and price of produce, the amount and timing of research and development funding and license fees from the Company's collaborative partners, the timing of regulatory approvals, the mix between domestic and international sales, and the risk factors listed in the Company's Form 10-K for the fiscal year ended May 29, 2016 (See item 1A: Risk Factors) which may be updated in Part II, Item 1A Risk Factors in the Company's Quarterly Reports on Form 10-Q. As a result of these and other factors, the Company expects to continue to experience significant fluctuations in quarterly operating results and there can be no assurance that the Company will remain consistently profitable. The Company undertakes no obligation to update or revise any forward-looking statements whether as a result of new developments or otherwise.
Questions and Answers:
Lifecore's growth during the first six months of this year compared to the same period last year was driven by a substantial increase in revenues in its higher margin fermentation business as a result of increased demand from existing customers and from a 15% increase in aseptic sales primarily due to recent development products becoming commercialized. These increases were partially offset by lower business development revenues as a result of a key customer obtaining FDA approval of its drug product, moving that program from development to commercial production.
As a reminder, we lost approximately $30 million of packaged bag business during the last six months of fiscal 2016 as a result of (1) our strategic decision to discontinue select low margin business, (2) some customers deciding to shift from single sourcing to a multi-source strategy, and (3) prorating some customer orders during the produce shortages last fiscal year. A large majority of the business we lost was low margin business that carried a very high cost to service. Because this business was included in the first half of last year, over 80% of the decrease in revenues in Apio's packaged fresh vegetables business during the first six months of this year is attributable to this lost business.
In addition, salad revenues were down 4% during the first six months of this year compared to the same period last year primarily due to the loss of some salad kit business at Costco due to a corporate-wide decision by Costco to move to a multi-supplier sourcing strategy following industry-wide produce shortages in 2016. This reduction in salad kit revenues at Costco was partially offset by significant growth in salad kit revenues in U.S. retail and some growth in Canadian retail. Other factors affecting salad revenues included the delay in customer commitments for new salad kit products following the extensive industry-wide produce shortage last year until sourcing returned to normal and the launch of a market test of plant-based protein salads throughout all Costco U.S. stores during the first half of last year that was discontinued later in fiscal 2016.
Importantly, while packaged fresh vegetables revenues declined 8% in the first six months, that business generated a 14% increase in gross profit and a 260 basis point improvement in gross margin to 13.6%.
As consistent supply has resumed, customers are now reviewing our new products and we expect to launch new Eat Smart salad products during the second half of fiscal 2017 and first half of fiscal 2018. Although the shift to multi-sourcing salad kits by several customers has negatively affected Apio in the near term, there may be opportunities in the future for additional business as a result of this strategy.
The severe drop in growth appears to be directly related to a major recall of salad products by a competitor last January that has affected the entire product category. The recall of salads that had been distributed in the Eastern provinces was broadly publicized in Canada.
According to Nielsen data, for the 10 months ended January 2016 prior to the salads recall, the retail salad kit market category in Canada had grown at 36%, in significant contrast to the growth of that category in the 10 months from February through November 2016 following the salads recall when the retail salad kit category grew at only 5%. Any product recall in the category can affect all players in the category. There have not been any reported incidents since the one last January and we expect that salad kit growth in Canada will start to increase again as consumers re-gain confidence in the category.
We now expect revenues from our salad products to be flat to slightly down this year compared to last year due to Costco's multi-sourcing strategy and Canadian growth decline. However, on a positive front, our U.S growth for salad kits, excluding Costco, during the first six months of fiscal 2017 was 42% compared to category growth of 17%. We continue to see salads as a major growth platform at Apio as we innovate new items, add new products to existing accounts and expand our distribution to key U.S. accounts. Sam's Club continues to expand our salad products within their stores. In May of 2016, we began shipping our Sweet Kale Salad to approximately 400 Walmart stores. Due to its high performance, Walmart quickly expanded our salad to approximately 1,400 stores in October. The next opportunity to expand further in Walmart will be in April 2017.
Selling Eat Smart products to the highly competitive U.S. retail market has required Apio to evolve its sales capabilities. In May of 2016, we hired a new Chief Customer and Sales Officer at Apio to lead a re-structuring of the sales organization and the implementation of new systems and controls. Our new data analytics platform is a key tool that will arm the sales organization with the data required to drive a compelling brand story that includes shopper insights, merchandising, promotional and pricing information to grow a profitable business for both Apio and our customers.
To further differentiate Apio, we have invested in upgrading our market data analytics platform and insight analysis. Since our previous earnings call, Apio has completed the transition from Nielsen Perishables Freshfacts data to the Nielsen Answers data and added Nielsen Homescan Panel, which provides consumer scan data and shopper insights for all stores, including Costco. The switch to the new database provides many advantages. First, we now receive data from nearly double the number of retail stores (over 35,000 versus 18,000). Second, we have store-specific product, pricing and promotional data that is available by geography and banner. Finally, Homescan data provides consumer insights and Costco-specific data that we did not have previously. This new platform will provide improved data and shopper insights that will drive more informed product development, pricing and promotional decisions.
With the new data platform, Apio's North American market share statistics showed very little change from the old platform (less than 100 basis points). For 52 weeks ended October 29, 2016, the size of the North American market in which Apio participates (vegetable bags, vegetable trays and salad kits) is approximately $3.2 billion in consumer retail dollars including retail and club stores. Of this market, Apio's overall share is approximately 17% while Apio's Eat Smart salad kits have a market share of approximately 13%. In Canadian retail, Eat Smart salad kits enjoy a 44% share while in U.S. retail, Eat Smart salads have a share of approximately 3%, presenting a large growth opportunity for Eat Smart salad kits in the U.S. retail market.
Apio's North American ACV statistics differed to a slightly larger extent from the old platform (between 100 and 1000 basis points depending on the product segment or geography), primarily due to the large increase in the number of retail stores being included in the new database. ACV is also not tracked for some categories. For the 52 week ended October 29, 2016, in U.S. retail Eat Smart salad kit ACV was approximately 17% while total Eat Smart branded packaged fresh vegetables ACV was approximately 34%. In Canadian retail, ACV for Eat Smart salad kits was 84%.
Our goal is to continue to grow the Eat Smart market share and ACV of salad kits in the U.S., specifically with major U.S. customers. We intend to share our new analytics and insights with those strategic customers who choose Apio as their innovation partner to drive growth and profitability for both partners.
Produce sourcing for the first seven months of fiscal 2017 has been within expectations, with an adequate supply of virtually all of our high volume crops. During our third fiscal quarter we enter the winter season when we source most of our California crops from southern California and Mexico. This is also the time of year when we get virtually all of our green beans from Florida. The winter season has historically been the time of year when we have suffered our most significant produce shortages, which occurred last year. Overall, for the first seven months of fiscal 2017 our produce sourcing costs are on plan and so far winter sourcing is consistent with our expectations.
Windset is nearing completion of a new ten-acre facility on land Windset owns in the City of Santa Maria using a new type of greenhouse structure that Windset intends to use to grow strawberries on a small commercial scale. They have also started construction on a new 30-acre glass greenhouse, which is also on land they own in the City of Santa Maria, where they currently intend to grow peppers and/or cucumbers.
Windset expects that it will begin commercially harvesting strawberries this month and peppers this spring.
Windset is also looking at constructing an even larger strawberry structure on land it owns in the City of Santa Maria but it is in the early planning stages and any construction of this new facility will not begin until later this calendar year.
Windset is still working with the County of Santa Barbara on permitting for land it is leasing in the County for the construction of greenhouses using its new type of greenhouse structures but does not expect approval for at least 9-12 months.
The Company refinanced its debt to lower its interest expense and increase its financial flexibility in support of Landec's five-year growth plan. Landec plans to use these funds to capitalize on the significant tailwinds in the healthy living segments in which it participates by expanding its existing operations and fueling its internal innovation initiatives.
Our new syndicated credit facility of $150 million with JPMorgan Chase, BMO Harris Bank and City National Bank, a subsidiary of Royal Bank of Canada, consists of a $50 million term loan that refinanced existing debt and a $100 million revolving credit facility.
The $50 million term loan has a five-year term with a ten-year amortization and no prepayment penalties. Our interest expense, excluding the $1.2 million write-off of unamortized debt issuance costs from the refinancing, over the next 12 months is projected to decrease by approximately $400,000 compared to the interest expense the Company would have incurred on the previous loans that were refinanced. The interest rate is based on Landec's leverage ratio and can range from LIBOR plus 1.25% to 2.25%. On November 1, 2016, the Company fixed its LIBOR rate for the next five years at 1.22%. The current spread is 1.75% and therefore the current interest rate on our term loan is 2.97%.
Our continuing priorities are:
(a) Shifting our product mix to higher margin products at both Apio and Lifecore while advancing the CDMO strategy at Lifecore.
(b) Increasing demand for both our packaged vegetable products and our biomaterials products to fill the additional capacity added in fiscal 2016.
© Developing innovative new salad products to broaden and strengthen our offerings.
(d) Expanding our retail presence in the U.S. through gaining new customers and increasing distribution with existing customers.
(e) Increasing return on invested capital by maximizing returns on each capital allocation decision.
(f) Focusing on evaluating the natural food product segment to identify areas where Landec can enter through new product development and/or strategic acquisitions or investments.
(g) Executing on our Lifecore programs with existing customers and securing new partnerships utilizing our CDMO strategy.
(h) Supporting Windset in its expansion plans to build new hydroponic controlled atmosphere structures using new growing methods for new crops.
The results are as follows (unaudited and in thousands):
|Apio Packaged Fresh Vegetables (a)||$||97,978||$||107,164||$||193,923||$||210,870|
|Apio Packaged Fresh Vegetables||12,001||9,979||26,407||23,231|
|Total Gross Profit||18,953||17,265||40,097||35,242|
|Net Income (Loss):|
a) Apio's packaged fresh vegetables business includes revenues and gross profit from Apio Cooling LP. and Apio Packaging.
b) Included in Corporate are the non-Apio and non-Lifecore royalties and profit sharing.
c) Included in Other are other operating income/(expense), net interest income/(expense), dividend income, change in the FMV of Windset, non-operating income/(expense) and income tax expense.
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