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 July 25, 2017 for the quarter ended May 28, 2017) 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:
We expect gross profit to increase 6% to 10% in fiscal 2018 compared to fiscal 2017 with our gross margin expected to grow at least 100 basis points. This growth is being primarily driven by a more favorable product mix at Apio due to a higher percentage of revenues and gross profit being generated by higher margin salad sales. As a result, we are projecting Apio's gross margin to grow approximately 100 basis points. At O Olive, we plan to significantly grow revenues and generate gross margin expansion of over 500 basis points. At Lifecore, we continue to shift to a higher percentage of revenues and gross profit coming from our CDMO business. In fiscal 2018, we expect Lifecore's gross margin to remain in the mid-40% range.
We expect total operating expenses to increase 2% to 3% in fiscal 2018 compared to fiscal 2017. Excluding the $5.5 million of unplanned operating expenses (see Q&A #6 below) in fiscal 2017, operating expenses are projected to increase approximately 10% year over year, with R&D expenses increasing approximately 17% due to our commitment to emphasize innovation and product development at both Apio and Lifecore as demonstrated by the recent hiring of the VP of R&D and Innovation at Apio.
Lifecore continues to make progress on the implementation of a new filling line to further enhance its growth strategy as a CDMO. Several active development projects have met significant milestone thresholds, and generated the required return on investment targets at the onset of this new equipment line. As a result, Landec has approved the remaining $12 million in capital needed to complete the facility expansion and installation of the new filling line during fiscal 2018. Lifecore is in the process of constructing new clean rooms to house the new filling line and formulation equipment, which we estimate will be installed and operational by end of fiscal 2018. This new line is projected to expand our overall filling capacity by 45% as the line provides versatility that can be used to fill either vials or syringes. It is specifically designed to align Lifecore's capability with market expectations of its partners, from both a capability and capacity perspective. This investment gives Lifecore the incremental capability for filling commercial quantities of drug products in a vial, which expands the breadth of products and markets Lifecore will be able to serve.
As previously disclosed, the acquisition of O Olive is a first step in our stated strategy of moving into adjacent product segments outside of produce that offer consumers healthy, convenient and delicious products that deliver a higher gross margin and leverage Apio's robust supply chain, logistics and customer reach. The integration is going very well, and we are currently in the process of securing long-term sourcing of olives ahead of the anticipated growth in olive oil sales while also beginning to expand our customer base.
The O Olive products are a clear adjacency to our salad kit products, a significant growth platform for Apio. The strong product innovation capabilities of the O Olive team along with product and logistical synergies with the Apio business provide a roadmap for future, sustainable growth. We are very excited about the growth prospects of this business. We expect revenues to grow 50-100% in fiscal 2018 compared to the trailing 12-month period and we expect O Olive to be profitable in fiscal 2018.
Since the beginning of the third quarter of fiscal 2016, the revenues of our core packaged vegetables business have declined as a result of (1) our strategic decision to discontinue select lower margin business, (2) some customers deciding to shift from single-sourcing to a multi-source strategy, and (3) our decision to reduce our dependency on certain highly volatile produce items resulting in the reduction of certain core packaged vegetable SKUs. A large majority of the discontinued business was lower margin business that carried a very high cost to service.
In fiscal 2017, this loss of core business resulted in a sales volume decrease of approximately 4% in our packaged fresh vegetable business. Because a vast majority of Apio's overhead is fixed, this loss of volume resulted in overhead being a higher percentage of Apio's cost of sales in fiscal 2017 than in past years. As volumes increase, Apio's per unit overhead expense will decrease (since most all of the overhead is fixed), resulting in margins expanding at a more accelerated rate.
During fiscal 2018, we expect to forego another $10 to $12 million of lower margin core packaged vegetables business, continuing with our strategy to increase margins in the long term. However, we believe that by the end of fiscal 2018 we will have achieved the optimum balance for this business and thus do not expect our core vegetables business to decrease meaningfully after fiscal 2018. We also expect that increased volume sales in our salad business will more than offset the decrease in volume sales in our core business and therefore result in a favorable overhead absorption in fiscal 2018 compared to fiscal 2017.
Within our export business, we plan to forego approximately $10 to $13 million of low margin fruit export business in fiscal 2018 in an effort to increase export margins as we have done with the core packaged vegetables business over the last 18 months
Revenues in Apio's packaged fresh vegetables business were down due to Apio's core vegetables business being down $14.5 million compared to last year and the loss of some salad kit business at Costco U.S. These reductions in packaged fresh vegetables business were nearly offset by our salad kit revenues benefitting from the North American salad kit 18% revenue growth in the retail channel, with all of that growth from U.S. retail.
Importantly, even though revenues in our packaged fresh vegetables business declined 4% in fiscal 2017 compared to fiscal 2016, that business generated a 26% increase in gross profit resulting in a 290 basis point improvement in gross margin to 12.4% as we continue to shift the mix of our product line.
We experienced several unplanned, non-recurring expenses in fiscal 2017 that negatively impacted our results by a cumulative amount of $6.7 million or $0.15 per share after taxes, specifically:
a. A loss on the refinancing of our debt of $1.2 million
b. A legal settlement expense of $2.6 million for labor-related litigation
c. Legal expenses of $2.1 million associated with the labor-related litigation; and
d. Severance expenses of $800,000 primarily from restructuring our Apio sales team
At Apio, the unexpected loss of two Costco distribution centers for our Sweet Kale Salad in fiscal 2017 and the cumulative net loss of approximately $40 million of core vegetable business since late fiscal 2016 has created a much smaller, although more profitable, product and volume base for our projected fiscal 2018 growth and beyond. In addition, for overall Landec, we expect operating expenses, excluding the $5.5 million of unplanned operating expenses in fiscal 2017, to increase approximately 10% primarily due to an increase in new product development expenses and employee incentive compensation programs aligned with revenue, net income and ROIC goals. Lastly, we expect our income tax expense to approximately double next year as it returns to approximately a 36% annual tax rate.
For the 52 weeks ended May 27, 2017, the size of the North American market in which Apio participated (vegetable bags, vegetable trays and salad kits) was approximately $3.3 billion in consumer retail dollars, including retail and club stores. Of this market, Apio's overall market share is approximately 16% while Apio's Eat Smart salad kits have a market share of approximately 12%. In the retail market, excluding Costco, Eat Smart salad kits enjoy a 41% market share in Canada and a 4.5% market share in the U.S. Due to recent distribution gains in the U.S., the U.S. market share number is up 100 basis points from a year ago.
Our goal is to continue to aggressively grow the Eat Smart market share and ACV for all our multi-serve salad kit products as well as our newly launched single-serve salad kit products.
The tax rate for the fourth quarter of fiscal 2017 was considerably lower than our estimated 36% rate mainly due to a higher than expected number of stock option exercises that occurred during the quarter, largely due to a block of stock option grants that were about to expire if not exercised by the holder. Due to new stock-based compensation accounting rules, which the Company adopted in fiscal 2017, the Company's tax deduction, for the excess tax benefits related to the stock-based compensation charged to the holder, is now recorded as an income tax benefit in the income statement. In the past, these excess tax benefits were recorded to equity as additional paid-in capital. Also, the Company recognized a larger than expected tax benefit related to R&D tax credits in the quarter primarily related to resolution of prior period R&D tax positions and increased R&D expenses in the current year.
It should be noted that due to the new stock-based compensation accounting rules, the Company's tax rate will likely be more volatile in the future, on a quarter to quarter and annual basis, and will fluctuate from the expected 36%, especially when large amounts of stock options are exercised at substantial gains to the holder. The Company expects its tax rate for all of fiscal 2018 to be approximately 36%, however, this rate is subject to change if projected stock exercises are significantly different than those projections and /or R&D activities are different than projected.
With the addition of O Olive in fiscal 2017, Landec now has six operating facilities and two distribution centers located throughout the U.S. Our annual "base" capital expenditures, which include annual productivity initiatives, are now approximately $12 to $15 million for these eight locations. The remaining capital expenditures we plan to spend in fiscal 2018 are for growth initiatives, approximately half at Lifecore for its new syringe/vial filling line and approximately half in our food businesses.
Our continuing priorities are:
(a) Shifting our product mix to higher margin products at both Apio and Lifecore while advancing the CDMO strategy at Lifecore.
(b) Increasing demand for both our packaged vegetable products and our biomaterials products to fill the additional capacity added in fiscal 2016.
© Developing innovative new salad products to broaden and strengthen our offerings.
(d) Expanding our retail presence of Eat Smart products in the U.S. by gaining new customers and increasing distribution with existing customers.
(e) Increasing return on invested capital by maximizing returns on each capital allocation decision.
(f) Working with the O Olive team to significantly increase the sales of its line of olive oil and vinegar products while leveraging operating synergies to achieve an even higher rate of profitability.
(g) Focusing on evaluating the natural food product segment to identify areas where Landec can enter through new product development and/or strategic acquisitions or investments.
(h) Executing on our Lifecore programs with existing customers and securing new partnerships utilizing our CDMO strategy.
(i) Supporting Windset in its expansion plans to build new hydroponic controlled atmosphere structures using new growing methods for new crops.
The results are as follows (unaudited and in thousands and for comparability excludes the impact from the GreenLine trademark impairment charge in fiscal 2016):
|Apio Packaged Fresh Vegetables (a)||$||108,651||$||105,641||$||408,021||$||423,859|
|Apio Packaged Fresh Vegetables||14,626||12,913||51,148||40,479|
|Total Gross Profit||19,657||22,784||83,186||70,957|
|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 Other are Corporate licensing and R&D revenues and Corporate expenses, the non-Apio and non-Lifecore royalties and profit sharing and the O Olive operations.
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.
Please submit your question using the form below.