lndc20180225_10q.htm
 

 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Quarter Ended February 25, 2018, or

 

[  ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition period for _________ to _________.

Commission file number: 0-27446

 

LANDEC CORPORATION

(Exact name of registrant as specified in its charter)

 

 Delaware

 94-3025618

 (State or other jurisdiction of incorporation or organization)

 (IRS Employer Identification Number)

 

5201 Great America Parkway, Suite 232

Santa Clara, California 95054

(Address of principal executive offices)

 

Registrant's telephone number, including area code:

(650) 306-1650

 

Securities registered pursuant to Section 12(b) of the Act:

 Title of each class 

 Name of each exchange on which registered

Common Stock

 The NASDAQ Global Select Stock Market

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   X    No ___

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   X    No ___

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer        ___     Accelerated Filer                     X  

Non Accelerated Filer           ___     Smaller Reporting Company ___

Emerging Growth Company ___

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ___

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ___ No   X  

 

As of April 2, 2018, there were 27,564,428 shares of Common Stock outstanding.

 


 

 

 

 

 

LANDEC CORPORATION

 

FORM 10-Q

 

For the Fiscal Quarter Ended February 25, 2018

 

INDEX

 

  

  

Page

 

 

 

  

Facing sheet

 

 

 

 

 

Index

i

 

 

 

Part I.

Financial Information

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

a)

Consolidated Balance Sheets as of February 25, 2018 and May 28, 2017

1

 

 

 

 

b)

Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended February 25, 2018  and February 26, 2017

2

 

 

 

 

c)

Consolidated Statement of Changes in Stockholders’ Equity for the Nine Months Ended February 25, 2018

3

       

 

d)

Consolidated Statements of Cash Flows for the Nine Months Ended February 25, 2018 and February 26, 2017

4

 

 

 

 

e)

Notes to Consolidated Financial Statements 

5

 

 

 

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

27

 

 

 

Item 4

Controls and Procedures

27

 

 

 

Part II.

Other Information

28

 

 

 

Item 1.

Legal Proceedings

28

 

 

 

Item 1A.

Risk Factors

28

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

28

 

 

 

Item 3.

Defaults Upon Senior Securities

28

 

 

 

Item 4.

Mine Safety Disclosures

28

 

 

 

Item 5.

Other Information

28

 

 

 

Item 6.

Exhibits

29

 

 

 

 

Signatures

30

 

i

 

 

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

LANDEC CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands except par value)

 

   

February 25, 2018

   

May 28, 2017

 
   

(unaudited)

         

ASSETS

 

Current Assets:

               

Cash and cash equivalents

  $ 7,650     $ 5,409  

Accounts receivable, less allowance for doubtful accounts

    50,438       47,083  

Inventories

    28,749       25,290  

Prepaid expenses and other current assets

    7,614       3,498  

Total Current Assets

    94,451       81,280  
                 

Investment in non-public company, fair value

    65,800       63,600  

Property and equipment, net

    143,362       133,220  

Goodwill

    54,779       54,779  

Trademarks/tradenames, net

    16,028       16,028  

Customer relationships, net

    6,052       6,783  

Other assets

    5,364       2,918  

Total Assets

  $ 385,836     $ 358,608  
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

Current Liabilities:

               

Accounts payable

  $ 35,240     $ 25,868  

Accrued compensation

    6,732       8,211  

Other accrued liabilities

    10,369       9,125  

Deferred revenue

    1,906       310  

Line of credit

    12,000       3,000  

Current portion of long-term debt

    4,940       4,940  

Total Current Liabilities

    71,187       51,454  
                 

Long-term debt, net

    38,595       42,299  

Capital lease obligation, less current portion

    3,665       3,731  

Deferred taxes, net

    15,822       24,581  

Other non-current liabilities

    6,417       8,391  

Total Liabilities

    135,686       130,456  
                 

Stockholders’ Equity:

               

Common stock, $0.001 par value; 50,000 shares authorized; 27,555 and 27,499 shares issued and outstanding at February 25, 2018 and May 28, 2017, respectively

    28       27  

Additional paid-in capital

    144,498       141,680  

Retained earnings

    103,191       84,470  

Accumulated other comprehensive income

    915       432  

Total Stockholders’ Equity

    248,632       226,609  

Non-controlling interest

    1,518       1,543  

Total Equity

    250,150       228,152  

Total Liabilities and Stockholders’ Equity

  $ 385,836     $ 358,608  

 

 

See accompanying notes.

 

-1-

 

 

 

LANDEC CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except per share amounts)

 

   

Three Months Ended

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

   

February 25,

2018

   

February 26,

2017

 

Product sales

  $ 149,323     $ 136,568     $ 409,137     $ 404,827  
                                 

Cost of product sales

    129,195       113,136       353,971       341,298  
                                 

Gross profit

    20,128       23,432       55,166       63,529  
                                 

Operating expenses:

                               

Research and development

    3,113       2,014       9,204       5,917  

Selling, general and administrative

    13,807       15,009       40,786       41,969  

Legal settlement charge

          2,080             2,580  

Total operating costs and expenses

    16,920       19,103       49,990       50,466  
                                 

Operating income

    3,208       4,329       5,176       13,063  
                                 

Dividend income

    413       413       1,238       1,238  

Interest income

    87       8       161       15  

Interest expense

    (531

)

    (400

)

    (1,415

)

    (1,432

)

Loss on debt refinancing

                      (1,233

)

Other income

          700       2,200       700  

Net income before taxes

    3,177       5,050       7,360       12,351  

Income tax benefit (expense)

    12,909       (1,556

)

    11,451       (4,138

)

Consolidated net income

    16,086       3,494       18,811       8,213  

Non-controlling interest benefit (expense)

    2       6       (90

)

    (75

)

Net income applicable to common stockholders

  $ 16,088     $ 3,500     $ 18,721     $ 8,138  
                                 

Basic net income per share

  $ 0.58     $ 0.13     $ 0.68     $ 0.30  

Diluted net income per share

  $ 0.58     $ 0.13     $ 0.67     $ 0.29  
                                 

Shares used in per share computation

                               

Basic

    27,547       27,286       27,524       27,252  

Diluted

    27,918       27,682       27,884       27,608  
                                 

Other comprehensive income, net of tax:

                               

Change in net unrealized gains on interest rate swap (net of tax effect of $210, $59, $552, and $251)

  $ 347     $ 103     $ 483     $ 430  

Other comprehensive income, net of tax

    347       103       483       430  

Total comprehensive income

  $ 16,435     $ 3,603     $ 19,204     $ 8,568  

 

 

See accompanying notes.

 

-2-

 

 

 

LANDEC CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(in thousands, except per share amounts)

 

   

Common Stock

   

Additional Paid-in

   

Retained

   

Accumulated Other Comprehensive

   

Total Stockholders’

   

Non-controlling

 
   

Shares

   

Amount

    Capital     Earnings     Income     Equity     Interest  

Balance at May 28, 2017

    27,499     $ 27     $ 141,680     $ 84,470     $ 432     $ 226,609     $ 1,543  

Issuance of common stock at $5.63 to $6.66 per share, net of taxes paid by Landec on behalf of employees

    3                                      

Issuance of common stock for vested restricted stock units (“RSUs”)

    53       1                         1        

Taxes paid by Company for employee stock plans

                (394

)

                (394

)

     

Stock-based compensation

                3,212                   3,212        

Payments to non-controlling interest

                                        (115

)

Net income

                      18,721             18,721       90  

Other comprehensive income, net of tax

                            483       483        

Balance at February 25, 2018

    27,555     $ 28     $ 144,498     $ 103,191     $ 915     $ 248,632     $ 1,518  

 

 

See accompanying notes.

 

-3-

 

 

 

 

LANDEC CORPORATION

Consolidated StatementS of Cash Flows

(Unaudited)

(In thousands)

 

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

 

Cash flows from operating activities:

               

Consolidated net income

  $ 18,811     $ 8,213  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    9,076       7,827  

Stock-based compensation expense

    3,212       2,842  

Deferred taxes

    (9,055 )     3,437  

Loss on early debt extinguishment

          1,233  

Change in investment in non-public company, fair value

    (2,200

)

    (700

)

Net loss on disposal of property and equipment

    93       264  

Changes in current assets and current liabilities:

               

Accounts receivable, net

    (3,355

)

    488  

Inventories

    (3,459

)

    2,262  

Prepaid expenses and other current assets

    (3,876

)

    (137

)

Deposit for workers’ compensation collateral

          (100

)

Accounts payable

    9,373       (6,140

)

Accrued compensation

    (1,548

)

    676  

Other accrued liabilities

    (449

)

    3,419  

Deferred revenue

    1,475       (403

)

Net cash provided by operating activities

    18,098       23,181  
                 

Cash flows from investing activities:

               

Purchases of property and equipment

    (18,533

)

    (9,488

)

Issuance of note receivable

    (2,099

)

     

Proceeds from sales of fixed assets

    88       74  

Net cash used in investing activities

    (20,544

)

    (9,414

)

                 

Cash flows from financing activities:

               

Proceeds from sale of common stock

    1       233  

Taxes paid by Company for employee stock plans

    (394

)

    (385

)

Proceeds from long-term debt

          50,000  

Payments on long-term debt

    (3,805

)

    (55,966

)

Proceeds from lines of credit

    18,000       1,500  

Payments on lines of credit

    (9,000

)

    (5,000

)

Payments for debt issuance costs

          (902

)

Payments for early debt extinguishment penalties

          (233

)

Payments to non-controlling interest

    (115

)

    (166

)

Other, net

          (8

)

Net cash provided by (used in) financing activities

    4,687       (10,927

)

Net increase in cash and cash equivalents

    2,241       2,840  

Cash and cash equivalents at beginning of period

    5,409       9,894  

Cash and cash equivalents at end of period

  $ 7,650     $ 12,734  

 

 

See accompanying notes. 

 

-4-

 

 

LANDEC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

(Unaudited)

 

 

1.

Organization , Basis of Presentation, and Summary of Significant Accounting Policies

 

Organization

 

Landec Corporation and its subsidiaries (“Landec” or the “Company”) design, develop, manufacture, and sell differentiated products for food and biomaterials markets, and license technology applications to partners. The Company has two proprietary polymer technology platforms: 1) Intelimer® polymers, and 2) hyaluronan (“HA”) biopolymers. The Company sells specialty packaged branded Eat Smart® and GreenLine® and private label fresh-cut vegetables and whole produce to retailers, club stores, and foodservice operators, primarily in the United States, Canada, and Asia through its Apio, Inc. (“Apio”) subsidiary, and sells HA-based and non-HA biomaterials through its Lifecore Biomedical, Inc. (“Lifecore”) subsidiary. The Company’s HA biopolymers and non-HA materials are proprietary in that they are specially formulated for specific customers to meet strict regulatory requirements. Through its O Olive Oil and Vinegar (“O Olive”) division, which the Company acquired on March 1, 2017, the Company sells premier California specialty olive oils and wine vinegars under the O brand to natural food, conventional grocery and mass retail stores, primarily in the United States and Canada.

 

The Company’s technologies, along with its customer relationships and tradenames, are the foundation and key differentiating advantages upon which Landec has built its business.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements of Landec have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring accruals) have been made which are necessary to present fairly the financial position of the Company at February 25, 2018 and the results of operations and cash flows for all periods presented. Although Landec believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information normally included in financial statements and related footnotes prepared in accordance with GAAP have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission. The accompanying financial data should be reviewed in conjunction with the audited financial statements and accompanying notes included in Landec's Annual Report on Form 10-K for the fiscal year ended May 28, 2017.

 

The results of operations for the nine months ended February 25, 2018 are not necessarily indicative of the results that may be expected for an entire fiscal year because there is some seasonality in Apio’s food business, particularly, Apio’s export business, and the order patterns of Lifecore’s customers which may lead to significant fluctuations in Landec’s quarterly results of operations.

 

Basis of Consolidation

 

The consolidated financial statements are presented on the accrual basis of accounting in accordance with GAAP and include the accounts of Landec Corporation and its subsidiaries, Apio and Lifecore. All intercompany transactions and balances have been eliminated.

 

Arrangements that are not controlled through voting or similar rights are reviewed under the guidance for variable interest entities (“VIEs”). A company is required to consolidate the assets, liabilities, and operations of a VIE if it is determined to be the primary beneficiary of the VIE.

 

An entity is a VIE and subject to consolidation, if by design: a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by any party, including equity holders, or b) as a group the holders of the equity investment at risk lack any one of the following three characteristics: (i) the power, through voting rights or similar rights to direct the activities of an entity that most significantly impact the entity’s economic performance, (ii) the obligation to absorb the expected losses of the entity, or (iii) the right to receive the expected residual returns of the entity. The Company reviewed the consolidation guidance and concluded that its partnership interest in Apio Cooling, LP and its equity investment in the non-public company are not VIEs.

 

-5-

 

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. The accounting estimates that require management’s most significant and subjective judgments include revenue recognition; loss contingencies; sales returns and allowances; inventories; self-insurance liabilities; recognition and measurement of current and deferred income tax assets and liabilities; the assessment of recoverability of long-lived assets including intangible assets; the valuation of investments; and the valuation and recognition of stock-based compensation and contingent liabilities.

 

These estimates involve the consideration of complex factors and require management to make judgments. The analysis of historical and future trends can require extended periods of time to resolve and are subject to change from period to period. The actual results may differ from management’s estimates.

 

Cash and Cash Equivalents

 

The Company records all highly liquid securities with three months or less from date of purchase to maturity as cash equivalents. Cash equivalents consist mainly of money market funds. The market value of cash equivalents approximates their historical cost given their short-term nature.

 

Inventories

 

Inventories are stated at the lower of cost (first-in, first -out method) or net realizable value and consist of the following (in thousands):

 

   

February 25, 2018

   

May 28, 2017

 

Raw materials

  $ 13,512     $ 10,158  

Work in progress

    3,756       3,447  

Finished goods

    11,481       11,685  

Total

  $ 28,749     $ 25,290  

 

If the cost of the inventories exceeds their net realizable value, provisions are recorded currently to reduce them to net realizable value. The Company also records a provision for slow moving and obsolete inventories based on the estimate of demand for its products.

 

Related Party Transactions

 

The Company sells products to and earns license fees from Windset Holdings 2010 Ltd. (“Windset”). During the three months ended February 25, 2018 and February 26, 2017, the Company recognized revenues of $104,000 and $72,000, respectively. During the nine months ended February 25, 2018 and February 26, 2017, the Company recognized revenues of $299,000 and $265,000, respectively. These amounts have been included in product sales in the accompanying Consolidated Statements of Comprehensive Income. The related receivable balances of $144,000 and $388,000 are included in accounts receivable in the accompanying Consolidated Balance Sheets as of February 25, 2018 and May 28, 2017, respectively.

 

All related party transactions are monitored quarterly by the Company and approved by the Audit Committee of the Board of Directors.

 

Debt Issuance Costs

 

The Company records its line of credit debt issuance costs as an asset, and as such, $120,000 and $308,000 were recorded as prepaid expenses and other current assets, and other assets, respectively, as of February 25, 2018, and $120,000 and $399,000, respectively, as of May 28, 2017. The Company records its term debt issuance costs as a contra-liability, and as such, $60,000 and $155,000 was recorded as current portion of long-term debt, and long-term debt, net, respectively, as of February 25, 2018 and $60,000 and $201,000, respectively, as of May 28, 2017. See Note 7 – Debt of the Notes to Consolidated Financial Statements for further information.

 

-6-

 

 

Financial Instruments

 

The Company’s financial instruments are primarily composed of commercial-term trade payables, grower advances, notes receivable, and debt instruments. For short-term instruments, the historical carrying amount approximates the fair value of the instrument. The fair value of long-term debt approximates its carrying value.

 

Cash Flow Hedges

 

The Company entered into an interest rate swap agreement to manage interest rate risk. This derivative instrument may offset a portion of the changes in interest expense. The Company designates this derivative instrument as a cash flow hedge. The Company accounts for its derivative instrument as either an asset or a liability and carries it at fair value in Other assets or Other non-current liabilities. The accounting for changes in the fair value of the derivative instrument depends on the intended use of the derivative instrument and the resulting designation.

 

For derivative instruments that hedge the exposure to variability in expected future cash flows that are designated as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of Accumulated Other Comprehensive Income in Stockholders’ Equity and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of the gain or loss on the derivative instrument, if any, is recognized in earnings in the current period. To receive hedge accounting treatment, cash flow hedges must be highly effective in offsetting changes to expected future cash flows on hedged transactions.

 

Other Comprehensive Income

 

Comprehensive income consists of two components, net income and Other Comprehensive Income (“OCI”). OCI refers to revenue, expenses, and gains and losses that under GAAP are recorded as a component of stockholders’ equity but are excluded from net income. The Company’s OCI consists of net deferred gains on its interest rate swap derivative instrument accounted for as a cash flow hedge. The components of OCI and the changes in accumulated OCI, net of tax, are as follows (in thousands):

 

   

Unrealized Gains on

Cash Flow Hedge

 

Accumulated OCI, net, as of May 28, 2017

  $ 432  

Other comprehensive income before reclassifications, net of tax effect

    483  

Amounts reclassified from OCI

     

Accumulated OCI, net, as of February 25, 2018

  $ 915  

 

The Company does not expect any transactions or other events to occur that would result in the reclassification of any significant gains or losses into earnings in the next 12 months.

 

Investment in Non-Public Company

 

On February 15, 2011, the Company made its initial investment in Windset which is reported as an investment in non-public company, fair value, in the accompanying Consolidated Balance Sheets as of February 25, 2018 and May 28, 2017. The Company has elected to account for its investment in Windset under the fair value option. See Note 3 – Investment in Non-public Company for further information.

 

Intangible Assets

 

The Company’s intangible assets are comprised of customer relationships with a finite estimated useful life of eleven to thirteen years, and trademarks, tradenames and goodwill with indefinite useful lives.

 

Finite-lived intangible assets are reviewed for possible impairment whenever events or changes in circumstances occur that indicate that the carrying amount of an asset (or asset group) may not be recoverable. Indefinite lived intangible assets are reviewed for impairment at least annually. For goodwill and other indefinite-lived intangible assets, the Company performs a qualitative impairment analysis in accordance with Accounting Standards Codification (“ASC”) 350-30-35.

 

-7-

 

 

Partial Self-Insurance on Employee Health and Workers Compensation Plans

 

The Company provides health insurance benefits to eligible employees under self-insured plans whereby the Company pays actual medical claims subject to certain stop loss limits and self-insures its workers compensation claims. The Company records self-insurance liabilities based on actual claims filed and an estimate of those claims incurred but not reported. Any projection of losses concerning the Company's liability is subject to a high degree of variability. Among the causes of this variability are unpredictable external factors such as inflation rates, changes in severity, benefit level changes, medical costs, and claims settlement patterns. This self-insurance liability is included in Other accrued liabilities in the accompanying Consolidated Balance Sheets and represents management's best estimate of the amounts that have not been paid as of February 25, 2018 and May 28, 2017. It is reasonably possible that the expense the Company ultimately incurs could differ and adjustments to future reserves may be necessary.

 

Fair Value Measurements

 

The Company uses fair value measurement accounting for financial assets and liabilities and for financial instruments and certain other items measured at fair value. The Company has elected the fair value option for its investment in a non-public company. See Note 3 – Investment in Non-public Company for further information. The Company also measures its contingent consideration at fair value. See Note 2 – Acquisition of O Olive for further information. The Company has not elected the fair value option for any of its other eligible financial assets or liabilities.

 

The accounting guidance established a three-tier hierarchy for fair value measurements, which prioritizes the inputs used in measuring fair value as follows:

 

Level 1 – observable inputs such as quoted prices for identical instruments in active markets.

 

Level 2 – inputs other than quoted prices in active markets that are observable either directly or indirectly through corroboration with observable market data.

 

Level 3 – unobservable inputs in which there is little or no market data, which would require the Company to develop its own assumptions.

 

As of February 25, 2018 and May 28, 2017, the Company held certain assets that are required to be measured at fair value on a recurring basis, including its interest rate swap and its minority interest investment in Windset.

 

The fair value of the Company’s interest rate swap is determined based on model inputs that can be observed in a liquid market, including yield curves, and is categorized as a Level 2 measurement investment and is included in Other assets in the accompanying Consolidated Balance Sheets.

 

The fair value of the Company’s contingent consideration for the acquisition of O Olive utilizes significant unobservable inputs, including projected earnings before interest, taxes, depreciation and amortization (“EBITDA”) and discount rates. As a result, the Company’s contingent consideration associated with the O Olive acquisition is considered a Level 3 measurement liability. For the nine months ended February 25, 2018, the Company reduced its contingent consideration liability from $5.9 million at May 28, 2017 to $5.4 million at February 25, 2018 due to the change in projected EBITDA and discount rates during the three year earn out period ended May 31, 2020.

 

The Company has elected the fair value option of accounting for its investment in Windset. The calculation of fair value utilizes significant unobservable inputs, including projected cash flows, growth rates, and discount rates. As a result, the Company’s investment in Windset is considered to be a Level 3 measurement investment. The change in the fair value of the Company’s investment in Windset for the nine months ended February 25, 2018 was due to the Company’s 26.9% minority interest in the change in the fair market value of Windset during the period. In determining the fair value of the investment in Windset, the Company utilizes the following significant unobservable inputs in the discounted cash flow models:

 

   

At February 25, 2018

   

At May 28, 2017

 

Revenue growth rates

    6%         4%  

Expense growth rates

   5% to 6%       4%  

Income tax rates

    15%         15%  

Discount rates

    12%         12%  

 

-8-

 

 

The revenue growth, expense growth, and income tax rate assumptions are considered the Company's best estimate of the trends in those items over the discount period. The discount rate assumption takes into account the risk-free rate of return, the market equity risk premium, and the company’s specific risk premium and then applies an additional discount for lack of liquidity of the underlying securities. The discounted cash flow valuation model used by the Company has the following sensitivity to changes in inputs and assumptions (in thousands):

 

   

Impact on value of

investment in Windset

as of February 25, 2018

 

10% increase in revenue growth rates

  $ 9,400  

10% increase in expense growth rates

  $ (8,800

)

10% increase in income tax rates

  $ (500

)

10% increase in discount rates

  $ (4,200

)

 

Imprecision in estimating unobservable market inputs can affect the amount of gain or loss recorded for a particular position. The use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

 

The following table summarizes the fair value of the Company’s assets and liabilities that are measured at fair value on a recurring basis (in thousands):

 

   

Fair Value at February 25, 2018

   

Fair Value at May 28, 2017

 

Assets (liabilities):

 

Level 1

   

Level 2

   

Level 3

   

Level 1

   

Level 2

   

Level 3

 

Interest rate swap (1)

  $     $ 1,467     $     $     $ 688     $  

Investment in non-public company

                65,800                   63,600  
Contingent consideration liability (2)                 (5,400 )                 (5,900 )

Total

  $     $ 1,467     $ 60,400     $     $ 688     $ 57,700  

 

 

(1)

Included in Other assets in the accompanying consolidated balance sheets.

  (2) Included in Other non-current liabilities in the accompanying consolidated balance sheets.

 

Revenue Recognition

 

See Note 9 – Business Segment Reporting, for a discussion about the Company’s four business segments; namely, Packaged Fresh Vegetables, Food Export, Biomaterials, and Other.

 

Revenue from product sales is recognized when there is persuasive evidence that an arrangement exists, title has transferred, the price is fixed and determinable, and collectability is reasonably assured. Allowances are established for estimated uncollectible amounts, product returns, and discounts based on specific identification and historical losses.

 

Apio’s Packaged Fresh Vegetables revenues generally consist of revenues generated from the sale of specialty packaged fresh-cut and whole value-added vegetable products that are generally washed and packaged in Apio’s proprietary packaging and sold under Apio’s Eat Smart and GreenLine brands and various private labels. Revenue is generally recognized upon shipment of these products to customers. The Company takes title to all produce it trades and/or packages, and therefore, records revenues and cost of sales at gross amounts in the accompanying Consolidated Statements of Comprehensive Income.

 

In addition, Packaged Fresh Vegetables revenues include the revenues generated from Apio Cooling, LP, a vegetable cooling operation in which Apio is the general partner with a 60% ownership position, and from the sale of BreatheWay® packaging to license partners. Revenue is recognized on the vegetable cooling operations as cooling and storage services are provided to Apio’s customers. Sales of BreatheWay packaging are recognized when shipped to Apio’s customers.

 

Apio’s Food Export revenues consist of revenues generated from the purchase and sale of primarily whole commodity fruit and vegetable products to Asia through its subsidiary, Cal-Ex Trading Company (“Cal-Ex”). As most Cal-Ex customers are in countries outside of the U.S., title transfers and revenue is generally recognized upon arrival of the shipment in the foreign port. Apio records revenue equal to the sale price to third parties because it takes title to the product while in transit. On February 28, 2018, the Company announced its plans to discontinue Cal-Ex by May 27, 2018.

 

Lifecore’s Biomaterials business principally generates revenue through the sale of products containing HA. Lifecore primarily sells products to customers in three medical areas: (1) Ophthalmic, which represented approximately 65% of Lifecore’s revenues in fiscal year 2017, (2) Orthopedic, which represented approximately 15% of Lifecore’s revenues in fiscal year 2017, and (3) Other/Non-HA products, which represented approximately 20% of Lifecore’s revenues in fiscal year 2017. The vast majority of Lifecore’s revenues are recognized upon shipment.

 

-9-

 

 

Lifecore’s business development revenues, a portion of which are included in all three medical areas, are related to contract research and development (“R&D”) services and multiple element arrangement services with customers where the Company provides products and/or services in a bundled arrangement.

  

O Olive’s business, which the Company acquired on March 1, 2017, sells premier California specialty olive oils and wine vinegars under the O brand to natural food, conventional grocery and mass retail stores, primarily in the United States and Canada. The revenues of O Olive are included in the Other segment. O Olive’s revenue is generally recognized upon shipment of its products to customers. The Company takes title to all products it trades and/or packages, and therefore, records revenues and cost of sales at gross amounts in the accompanying Consolidated Statements of Comprehensive Income.

 

Contract R&D revenue is recorded as earned, based on the performance requirements of the contract. Non-refundable contract fees for which no further performance obligations exist, and there is no continuing involvement by the Company, are recognized on the earlier of when the payment is received or collectability is reasonably assured.

 

For sales arrangements that contain multiple elements, the Company splits the arrangement into separate units of accounting if the individually delivered elements have value to the customer on a standalone basis. The Company also evaluates whether multiple transactions with the same customer or related party should be considered part of a multiple element arrangement, whereby the Company assesses, among other factors, whether the contracts or agreements are negotiated or executed within a short time frame of each other or if there are indicators that the contracts are negotiated in contemplation of each other. The Company then allocates revenue to each element based on a selling price hierarchy. The relative selling price for a deliverable is based on its vendor-specific objective evidence (“VSOE”), if available, third-party evidence (“TPE”), if VSOE is not available, or estimated selling price, if neither VSOE nor TPE is available. The Company then recognizes revenue on each deliverable in accordance with its policies for product and service revenue recognition. The Company is not typically able to determine VSOE or TPE, and; therefore, uses the estimated selling price to allocate revenue between the elements of an arrangement.

 

The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services or future performance obligations or subject to customer-specific cancellation rights. The Company evaluates each deliverable in an arrangement to determine whether it represents a separate unit of accounting. A deliverable constitutes a separate unit of accounting when it has stand-alone value, and for an arrangement that includes a general right of return relative to the delivered products or services, delivery or performance of the undelivered product or service is considered probable and is substantially controlled by the Company. The Company considers a deliverable to have stand-alone value if the product or service is sold separately by the Company or another vendor or could be resold by the customer. Further, the revenue arrangements generally do not include a general right of return relative to delivered products. Where the aforementioned criteria for a separate unit of accounting are not met, the deliverable is combined with the undelivered element(s) and treated as a single unit of accounting for the purposes of allocation of the arrangement consideration and revenue recognition. The Company allocates the total arrangement consideration to each separable element of an arrangement based upon the relative selling price of each element. Allocation of the consideration is determined at arrangement inception on the basis of each unit’s relative selling price. In instances where the Company has not established fair value for any undelivered element, revenue for all elements is deferred until delivery of the final element is completed and all recognition criteria are met.

 

For licensing revenue, the initial license fees are deferred and amortized to revenue over the period of the agreement when a contract exists, the fee is fixed and determinable, and collectability is reasonably assured. Noncancellable, nonrefundable license fees are recognized over the period of the agreement, including those governing R&D activities and any related supply agreement entered into concurrently with the license when the risk associated with commercialization of a product is non-substantive at the outset of the arrangement.

 

From time to time, the Company offers customers sales incentives, which include volume rebates and discounts. These amounts are estimated on a quarterly basis and recorded as a reduction of revenue.

 

A summary of revenues by type of arrangement as described above is as follows (in thousands):

  

   

Three Months Ended

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

   

February 25,

2018

   

February 26,

2017

 

Recorded upon shipment

  $ 141,575     $ 125,765     $ 373,486     $ 339,917  

Recorded upon acceptance in foreign port

    4,414       7,276       25,982       56,316  

Revenue from multiple element arrangements

    1,528       2,624       5,230       5,892  

Revenue from license fees, R&D contracts and royalties/profit sharing

    1,806       903       4,439       2,702  

Total

  $ 149,323     $ 136,568     $ 409,137     $ 404,827  

 

-10-

 

 

Legal Contingencies

 

In the ordinary course of business, the Company is involved in various legal proceedings and claims.

 

The Company makes a provision for a liability relating to legal matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least each fiscal quarter and adjusted to reflect the impacts of negotiations, estimate settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. Legal fees are expensed in the period in which they are incurred.

 

Apio has been the target of a union organizing campaign which has included two unsuccessful attempts to unionize Apio's Guadalupe, California processing plant. The campaign involved a union and over 100 former and current employees of Pacific Harvest, Inc. and Rancho Harvest, Inc. (collectively "Pacific Harvest"), Apio's labor contractors at its Guadalupe, California processing facility, bringing legal actions before various state and federal agencies, the California Superior Court, and initiating over 100 individual arbitrations against Apio and Pacific Harvest.

 

The legal actions consisted of three main types of claims: (1) Unfair Labor Practice claims ("ULPs") before the National Labor Relations Board (“NLRB”), (2) discrimination/wrongful termination claims before state and federal agencies and in individual arbitrations, and (3) wage and hour claims as part of two Private Attorney General Act (“PAGA”) cases in state court and in over 100 individual arbitrations.

 

A settlement of the ULPs among the union, Apio, and Pacific Harvest that were pending before the NLRB was approved on December 27, 2016 for $310,000. Apio was responsible for half of this settlement, or $155,000. On May 5, 2017, the parties to the remaining actions executed a settlement agreement concerning the discrimination/wrongful termination claims and the wage and hour claims which covers all non-exempt employees of Pacific Harvest working at Apio's Guadalupe, California processing facility from September 2011 through the settlement date. Under the settlement agreement, the plaintiffs are to be paid $6.0 million in three installments: $2.4 million, which was paid on July 3, 2017, $1.8 million which was paid on November 22, 2017 and $1.8 million which is due in July 2018. The Company and Pacific Harvest have each agreed to pay one half of the settlement payments. The Company paid the entire first two installments of $4.2 million and will be reimbursed by Pacific Harvest for its $2.1 million portion which is included in Other assets in the accompanying Consolidated Balance Sheets. This receivable will be repaid through monthly payments until fully paid, which the Company expects to occur by December 2020. The Company and Pacific Harvest are each required to make one half of the third installment in July 2018. The Company’s recourse against non-payment by Pacific Harvest is its security interest in assets owned by Pacific Harvest.

 

As of February 25, 2018 and May 28, 2017, the Company had accrued $1.0 million and $3.2 million, respectively, related to these actions, which is included in Other accrued liabilities in the accompanying Consolidated Balance Sheets.

 

-11-

 

 

Recent Accounting Guidance Not Yet Adopted

 

Revenue Recognition

 

In May 2014, the FASB issued ASU 2014-09, which creates FASB ASC Topic 606, Revenue from Contracts with Customers and supersedes ASC Topic 605, Revenue Recognition (“ASU 2014-09”). The guidance replaces industry-specific guidance and establishes a single five-step model to identify and recognize revenue. The core principle of the guidance is that an entity should recognize revenue upon transfer of control of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. Additionally, the guidance requires the entity to disclose further quantitative and qualitative information regarding the nature and amount of revenues arising from contracts with customers, as well as other information about the significant judgments and estimates used in recognizing revenues from contracts with customers. Since its original issuance, the FASB has issued several additional related ASUs to address implementation concerns and to further clarify certain guidance within ASU 2014-09. The Company will adopt these updates beginning with the first quarter of its fiscal year 2019 and anticipates doing so using the modified retrospective method, which will be applied retrospectively only to the most current reporting period presented.

 

Currently, the Company is in the process of evaluating the impact of the adoption of ASU 2014-09. As a result, the Company has initially identified the following core revenue streams from its contracts with customers:

 

 

Finished goods product sales (Packaged Fresh Vegetables and O Olive);

 

Shipping and handling (Packaged Fresh Vegetables and O Olive);

 

Product development and contract manufacturing arrangements (Biomaterials).

 

The Company’s assessment efforts to date have included reviewing current accounting policies, processes, and systems requirements, as well assigning internal resources and third-party consultants to assist in the process. Additionally, the Company has reviewed historical contracts and other arrangements to identify potential differences that could arise from the adoption of ASU 2014-09. Most notably, the Company is evaluating its current conclusions with respect to contract manufacturing arrangements for its Biomaterials business, as well as the timing of revenue recognition for its product development contract manufacturing arrangements in its Biomaterials business, to determine whether the application of ASU 2014-09 necessitates changes to such reporting. Beyond its core revenue streams, and the items listed above, the Company is also evaluating the impact of ASU 2014-09 on certain ancillary transactions and other arrangements.

 

Currently, the Company cannot reasonably estimate the impact the application of ASU 2014-09 will have upon its consolidated financial statements. The Company continues to assess the impact of ASU 2014-09, along with industry trends and additional interpretive guidance, on its core revenue streams, and as a result of the continued assessment, the Company may modify its plan of adoption accordingly.

 

Leases

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which requires companies to generally recognize on the balance sheet operating and financing lease liabilities and corresponding right-of-use-assets. ASU 2016-02 also requires improved disclosures to help users of financial statements better understand the amount, timing and uncertainty of cash flows arising from leases. The Company will adopt ASU 2016-02 beginning in the first quarter of fiscal year 2020 on a modified retrospective basis.

 

The Company is currently in the process of evaluating the impact that ASU 2016-02 will have upon its consolidated financial statements and related disclosures. The Company’s assessment efforts to date have included:

 

 

Reviewing the provisions of ASU 2016-02;

 

Gathering information to evaluate its lease population and portfolio;

 

Evaluating the nature of its real and personal property and other arrangements that may meet the definition of a lease; and

 

Evaluating systems’ readiness.

 

As a result of these efforts, the Company currently anticipates that the adoption of ASU 2016-02 will have a significant impact to its long-term assets and liabilities, as, at a minimum, virtually all of its leases designated as operating leases are expected to be reported on the consolidated balance sheets. The pattern of recognition for operating leases within the consolidated statements of comprehensive income is not anticipated to significantly change.

 

Income Taxes

 

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income that permits a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act enacted in December 2017. The standard is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.

 

-12-

 

 

 

2.

Acquisition of O Olive

 

On March 1, 2017, the Company purchased substantially all of the assets of O Olive for $2.5 million in cash plus contingent consideration of up to $7.5 million over the next three years based upon O Olive achieving certain EBITDA targets. All accounting for this acquisition is final.

 

The potential earn out payment up to $7.5 million is based on O Olive’s cumulative EBITDA over the Company’s fiscal years 2018 through 2020. At the end of each fiscal year, beginning in fiscal year 2018, the former owners of O Olive will earn the equivalent of the EBITDA achieved by O Olive for that fiscal year in an amount not to exceed $4.6 million over the three year period. The former owners can also earn an additional $2.9 million on a dollar for dollar basis for exceeding $6.0 million of cumulative EBITDA over the three year period. Each quarter the Company performs, with the assistance of a third party appraiser, an analysis of O Olive’s projected EBITDA over the earnout period. Based on this analysis the Company records a contingent consideration liability, included in Other non-current liabilities. As of February 25, 2018 and May 28, 2017 the contingent consideration liability was $5.4 million and $5.9 million, respectively, representing the present value of the expected earn out payments. The $500,000 reduction in the contingent consideration liability was recorded during the first nine months of fiscal year 2018 as a reduction to Selling, General and Administrative expenses in the accompanying Consolidated Statements of Comprehensive Income. For this analysis, the Company assumed that the maximum earn out of $7.5 million would be paid over the three year period with over half being earned in fiscal year 2020.

 

The operating results of O Olive are included in the Company’s financial statements beginning March 1, 2017, in the Other segment.

 

Intangible Assets

 

The Company identified two intangible assets in connection with the O Olive acquisition: trade names and trademarks valued at $1.6 million, which are considered to be indefinite lived intangible assets and therefore, will not be amortized; and customer relationships valued at $700,000 with an eleven year useful life. The Company recorded $17,000 and $67,000 of amortization expense from the amortization of the customer relationships intangible during the three and nine months ended February 25, 2018, respectively. The trade name/trademark intangible asset was valued using the relief from royalty valuation method and the customer relationship intangible asset was valued using the excess earnings method.

 

 

3.

Investment in Non-public Company

 

On February 15, 2011, Apio entered into a share purchase agreement (the “Windset Purchase Agreement”) with Windset. Pursuant to the Windset Purchase Agreement, Apio purchased from Windset 150,000 Senior A preferred shares for $15 million and 201 common shares for $201. On July 15, 2014, Apio increased its investment in Windset by purchasing from the Newell Capital Corporation an additional 68 common shares and 51,211 junior preferred shares of Windset for $11 million. After this purchase, the Company’s common shares represent a 26.9% ownership interest in Windset. The Senior A preferred shares yield a cash dividend of 7.5% annually. The dividend is payable within 90 days of each anniversary of the execution of the Windset Purchase Agreement. The non-voting junior preferred stock does not yield a dividend unless declared by the Board of Directors of Windset and no such dividend has been declared.

 

The Shareholders’ Agreement between Apio and Windset, as amended, includes a put and call option (the “Put and Call Option”), which can be exercised on or after March 31, 2022, whereby Apio can exercise the put to sell its common, Senior A preferred shares, and junior preferred shares to Windset, or Windset can exercise the call to purchase those shares from Apio, in either case, at a price equal to 26.9% of the fair market value of Windset’s common shares, plus the liquidation value of the preferred shares of $20.1 million ($15 million for the Senior A preferred shares and $5.1 million for the junior preferred shares). Under the terms of the arrangement with Windset, the Company is entitled to designate one of five members on the Board of Directors of Windset.

 

On October 29, 2014, Apio further increased its investment in Windset by purchasing 70,000 shares of Senior B preferred shares for $7 million. The Senior B preferred shares pay an annual dividend of 7.5% on the amount outstanding at each anniversary date of the Windset Purchase Agreement. The Senior B preferred shares purchased by Apio have a put feature whereby Apio can sell back to Windset $1.5 million of such shares on the first anniversary, an additional $2.75 million of such shares on the second anniversary, and the remaining $2.75 million on the third anniversary. After the third anniversary, Apio may at any time put any or all of the shares not previously sold back to Windset. At any time on or after February 15, 2017, Windset has the right to call any or all of the outstanding common shares, but at such time must also call the same proportion of Senior A preferred shares, Senior B preferred shares, and junior preferred shares owned by Apio. Windset’s partial call provision is restricted such that a partial call cannot result in Apio holding less than 10% of Windset’s common shares outstanding.

 

-13-

 

 

The investment in Windset does not qualify for equity method accounting as the investment does not meet the criteria of in-substance common stock due to returns through the annual dividend on the non-voting senior preferred shares that are not available to the common stock holders. As the put and call options require all of the various shares to be put or called in equal proportions, the Company has deemed that the investment, in substance, should be treated as a single security for purposes of accounting.

 

The fair value of the Company’s investment in Windset was determined utilizing the Windset Purchase Agreement’s put/call calculation for value and a discounted cash flow model based on projections developed by Windset, and considers the put and call conversion options. These features impact the duration of the cash flows utilized to derive the estimated fair values of the investment. These two discounted cash flow models’ estimate for fair value are then weighted. Assumptions included in these discounted cash flow models will be evaluated quarterly based on Windset’s actual and projected operating results to determine the change in fair value.

 

During each of the three month periods ended February 25, 2018 and February 26, 2017, the Company recorded $412,500 in dividend income. During each of the nine month periods ended February 25, 2018 and February 26, 2017, the Company recorded $1.2 million in dividend income. The increase in the fair market value of the Company’s investment in Windset for the nine month periods ended February 25, 2018 and February 26, 2017 was $2.2 million and $700,000, respectively, and is included in Other income in the accompanying Consolidated Statements of Comprehensive Income.

 

 

4.

Stock-Based Compensation

 

The Company’s stock-based awards include stock option grants and RSUs. The Company records compensation expense for stock-based awards issued to employees and directors in exchange for services provided based on the estimated fair value of the awards on their grant dates and is recognized over the required service periods, generally the vesting period.

 

The following table summarizes the stock-based compensation for options and RSUs (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

   

February 25,

2018

   

February 26,

2017

 

Options

  $ 380     $ 308     $ 1,057     $ 907  

RSUs

    762       761       2,155       1,935  

Total stock-based compensation

  $ 1,147     $ 1,069     $ 3,212     $ 2,842  

 

The following table summarizes the stock-based compensation by income statement line item (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

   

February 25,

2018

   

February 26,

2017

 

Cost of sales

  $ 137     $ 124     $ 398     $ 361  

Research and development

    41       23       82       69  

Selling, general and administrative

    969       922       2,732       2,412  

Total stock-based compensation

  $ 1,147     $ 1,069     $ 3,212     $ 2,842  

 

The estimated fair value for stock options, which determines the Company’s calculation of stock-based compensation expense, is based on the Black-Scholes option pricing model. RSUs are valued at the closing market price of the Company’s common stock on the date of grant. The Company uses the straight-line method to recognize the fair value of stock-based compensation arrangements.

 

As of February 25, 2018, there was $5.0 million of total unrecognized compensation expense related to unvested equity compensation awards granted under the Landec incentive stock plans. Total expense is expected to be recognized over the weighted-average period of 2.0 years for stock options and 1.9 years for restricted stock unit awards.

 

-14-

 

 

 

5.

Diluted Net Income Per Share

 

The following table sets forth the computation of diluted net income per share (in thousands, except per share amounts):

 

   

Three Months Ended

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

   

February 25,

2018

   

February 26,

2017

 

Numerator:

                               

Net income applicable to Common Stockholders

  $ 16,088     $ 3,500     $ 18,721     $ 8,138  
                                 

Denominator:

                               

Weighted average shares for basic net income per share

    27,547       27,286       27,524       27,252  
                                 

Effect of dilutive securities:

                               

Stock options and restricted stock units

    371       396       360       356  

Weighted average shares for diluted net income per share

    27,918       27,682       27,884       27,608  
                                 

Diluted net income per share

  $ 0.58     $ 0.13     $ 0.67     $ 0.29  

 

For the three and nine months ended February 25, 2018, the computation of the diluted net income per share excludes the impact of options to purchase 1.7 million and 1.5 million shares, respectively of Common Stock as such impacts would be antidilutive for this period.

 

 

6.

Income Taxes

 

The company’s effective tax rate for the nine months ended February 25, 2018 and February 26, 2017 was a benefit of 154% and expense of 36%, respectively. The income tax benefit was $11.5 million for the nine months ended February 25, 2018, and income tax expense was $4.1 million for the nine months ended February 26, 2017. The income tax benefit and discrete benefit for the nine months ended February 25, 2018 is primarily due to a $13.9 million discrete benefit that mainly reflects the impact of the re-measurement of net deferred tax liabilities resulting from the permanent reduction in the U.S. statutory corporate tax rate from 35% to 21%. The income tax provision for the nine months ended February 26, 2017 was primarily due to state income taxes and incentive stock option expense; partially offset by the domestic manufacturing deduction and research and development credits.

 

On December 22, 2017, the U.S. Government enacted the reconciled tax reform bill, commonly known as the Tax Cuts and Jobs Act of 2017 (the “TCJA”), which became effective on January 1, 2018. Among other tax related changes, the Company’s federal statutory tax rate has been reduced from 35 %, to an average rate of 29% for the fiscal year ended May 27, 2018, and then 21% for fiscal years thereafter. The TCJA also enhances and extends through 2026 the option to claim accelerated depreciation deductions on qualified property; however, the domestic manufacturing deduction, from which the Company has historically benefitted, has been eliminated. Under GAAP, the Company is required to recognize the effects of changes in tax laws and tax rates on deferred tax assets and liabilities in the period in which the new legislation is enacted. At February 25, 2018, the Company had not completed its accounting for the tax effects of enactment of the TCJA; however, the Company made a reasonable estimate of the effects on its existing deferred tax balances and the one-time transition tax.

 

The changes included in the TCJA are broad and complex and the Company does not have all the necessary information to analyze all income tax effects of the TCJA. The above income tax benefit amount is a provisional amount based on a reasonable estimate of the impact of the reduction in the corporate tax rate on our current and deferred tax liabilities. Changes in the estimate of the Company’s deferred tax asset and liability activity during fiscal year 2018 could impact the Company’s remeasurement of net deferred tax liabilities. The Company will continue to evaluate the TCJA and adjust the provisional amounts as additional information becomes available. The ultimate impact of the TCJA may differ from the provisional amounts due to changes in the Company’s interpretations and assumptions, as well as additional guidance on the interpretation of the TCJA. The Company will continue to assess its provision for income taxes as future guidance is issued. Although not anticipated, revisions to the Company’s provision for income taxes will be treated in accordance with the measurement period guidance outlined in Staff Accounting Bulletin No. 118.

 

As of February 25, 2018 and May 28, 2017, the Company had unrecognized tax benefits of approximately $472,000 and $537,000, respectively. Included in the balance of unrecognized tax benefits as of February 25, 2018 and May 28, 2017 is approximately $366,000 and $419,000, respectively, of tax benefits that, if recognized, would result in an adjustment to the Company’s effective tax rate. The Company does not expect its unrecognized tax benefits to change significantly within the next twelve months.

 

The Company has elected to classify interest and penalties related to uncertain tax positions as a component of its provision for income taxes. The Company has accrued an insignificant amount of interest and penalties relating to the income tax on the unrecognized tax benefits as of February 25, 2018 and May 28, 2017.

 

Due to tax attribute carryforwards, the Company is subject to examination for tax years 2015 forward for U.S. tax purposes. The Company is also subject to examination in various state jurisdictions for tax years 2012 forward, none of which were individually material.

 

Our estimated annual effective tax rate may be subject to further uncertainty due to the recent changes in U.S. tax rates and tax laws.

 

-15-

 
 

7.

Debt

 

Long-term debt, net consists of the following (in thousands):

 

   

February 25, 2018

   

May 28, 2017

 

Term loan with JPMorgan Chase Bank (“JPMorgan”), BMO Harris Bank N ,A . (“BMO”), and City National Bank; due in quarterly principal and interest payments of $1,250 beginning December 1, 2016 through September 23, 2021 with the remainder due on maturity, with interest based on the Company’s leverage ratio at a per annum rate of the Eurodollar rate plus a spread of between 1.25% and 2.25%

  $ 43,750     $ 47,500  

Total principal amount of long-term debt

    43,750       47,500  

Less: unamortized debt issuance costs

    (215

)

    (261

)

Total long-term debt, net of unamortized debt issuance costs

    43,535       47,239  

Less: current portion of long-term debt, net

    (4,940

)

    (4,940

)

Long-term debt, net

  $ 38,595     $ 42,299  

 

On September 23, 2016, the Company entered into a Credit Agreement with JPMorgan, BMO, and City National Bank, as lenders (collectively, the “Lenders”), and JPMorgan as administrative agent, pursuant to which the Lenders provided the Company with a $100 million revolving line of credit (the “Revolver”) and a $50 million term loan facility (the “Term Loan”), guaranteed by each of the Company’s direct and indirect subsidiaries and secured by substantially all of the Company’s assets, with the exception of the Company’s investment in Windset.

 

Both the Revolver and the Term Loan mature in five years (on September 23, 2021), with the Term Loan providing for quarterly principal payments of $1.25 million commencing December 1, 2016, with the remainder due at maturity.

 

Interest on both the Revolver and the Term Loan is based on either the prime rate or Eurodollar rate, at the Company’s discretion, plus a spread based on the Company’s leverage ratio (generally defined as the ratio of the Company’s total indebtedness on such date to the Company’s consolidated EBITDA for the period of four consecutive fiscal quarters ended on or most recently prior to such date). The spread is at a per annum rate of (i) between 0.25% and 1.25% if the prime rate is elected or (ii) between 1.25% and 2.25% if the Eurodollar rate is elected.

 

The Credit Agreement provides the Company the right to increase the Revolver commitments and/or the Term Loan commitments by obtaining additional commitments either from one or more of the Lenders or another lending institution at an amount of up to $75 million.

 

The Credit Agreement contains customary financial covenants and events of default under which the obligation could be accelerated and/or the interest rate increased. The Company was in compliance with all financial covenants as of February 25, 2018.

 

On November 1, 2016, the Company entered into an interest rate swap agreement (“Swap”) with BMO at a notional amount of $50 million. The Swap has the effect of changing the Company’s Term Loan obligation from a variable interest rate to a fixed 30-day LIBOR rate of 1.22%. As of February 25, 2018, the interest rate on the Term Loan was 3.57%. For further discussion regarding the Company’s use of derivative instruments, see the Financial Instruments section of Note 1 – Organization, Basis of Presentation, and Summary of Significant Accounting Policies.

 

In connection with the Credit Agreement, the Company incurred lender and third-party debt issuance costs of $897,000, of which $598,000 and $299,000 was allocated to the Revolver and Term Loan, respectively.

 

As of February 25, 2018, $12 million was outstanding on the Revolver at an interest rate of 3.57% under the Libor option.

 

-16-

 
 

8.

Stockholders’ Equity

 

During the three months ended February 25, 2018, the Company did not grant any equity awards. During the nine months ended February 25, 2018, the Company granted options to purchase 498,000 shares of common stock and awarded 200,000 RSUs.

 

As of February 25, 2018, the Company has reserved 3.1 million shares of Common Stock for future issuance under its current and former equity plans.

 

On July 14, 2010, the Company announced that the Board of Directors of the Company had approved the establishment of a stock repurchase plan authorizing the repurchase of up to $10 million of the Company’s common stock. The Company may repurchase its common stock from time to time in open market purchases or in privately negotiated transactions. The timing and actual number of shares repurchased is at the discretion of management of the Company and will depend on a variety of factors, including stock price, corporate and regulatory requirements, market conditions, the relative attractiveness of other capital deployment opportunities and other corporate priorities. The stock repurchase program does not obligate Landec to acquire any amount of its common stock and the program may be modified, suspended or terminated at any time at the Company's discretion without prior notice. During the fiscal year ended May 28, 2017 and the nine months ended February 25, 2018, the Company did not purchase any shares on the open market.

 

 

9.

Business Segment Reporting

 

The Company manages its business operations through three strategic business units and an Other segment. Based upon the information reported to the chief operating decision maker, who is the Chief Executive Officer, the Company has the following reportable segments: the Packaged Fresh Vegetables segment, the Food Export segment and the Biomaterials segment.

 

The Packaged Fresh Vegetables segment markets and packs specialty packaged whole and fresh-cut fruit and vegetables, the majority of which incorporate the BreatheWay specialty packaging for the retail grocery, club store and food services industry. In addition, the Packaged Fresh Vegetables segment sells BreatheWay packaging to partners for fruit and vegetable products. The Food Export segment consists of revenues generated from the purchase and sale of primarily whole commodity fruit and vegetable products predominantly to Asia. The Biomaterials segment sells products utilizing hyaluronan, a naturally occurring polysaccharide that is widely distributed in the extracellular matrix of connective tissues in both animals and humans, and non-HA products for medical use primarily in the Ophthalmic, Orthopedic and other markets. Other includes licensing and R&D activities from Landec’s Intelimer polymers for agricultural products, personal care products and other industrial products and from the operations of the O Olive business which was acquired on March 1, 2017. The Other segment also includes corporate general and administrative expenses, non-Packaged Fresh Vegetables and non-Biomaterials interest income and income tax expenses. All of the assets of the Company are located within the United States of America.

  

The Company’s international sales by geography are based on the billing address of the customer and were as follows (in millions):

 

   

Three Months Ended

   

Nine Months Ended

 
   

February 25, 2018

   

February 26, 2017

   

February 25, 2018

   

February 26, 2017

 

Canada

  $ 20.3     $ 16.6     $ 56.0     $ 50.6  

Taiwan

  $ 1.4     $ 3.0     $ 12.7     $ 27.9  

Belgium

  $ 11.5     $ 12.9     $ 14.3     $ 19.8  

Japan

  $ 1.6     $ 1.3     $ 4.8     $ 11.8  

Indonesia

  $ 0.2     $ 1.5     $ 4.0     $ 6.6  

Philippines

  $ 0.5     $ 0.6     $ 1.5     $ 6.2  

China

  $ 0.3     $ 0.4     $ 1.6     $ 1.9  

All Other Countries

  $ 2.1     $ 2.8     $ 6.7     $ 8.5  

 

-17-

 

 

Operations by business segment consisted of the following (in thousands):

 

Three Months Ended February 25, 2018

 

Packaged Fresh

Vegetables

   

Food

Export

   

Biomaterials

   

Other

   

Total

 

Net sales

  $ 120,942     $ 4,414     $ 22,959     $ 1,008     $ 149,323  

International sales

  $ 20,285     $ 4,414     $ 13,156     $ 51     $ 37,906  

Gross profit

  $ 7,944     $ 318     $ 11,609     $ 257     $ 20,128  

Net (loss) income

  $ (2,545 )   $ (216 )   $ 6,175     $ 12,674     $ 16,088  

Depreciation and amortization

  $ 2,120     $     $ 940     $ 82     $ 3,142  

Dividend income

  $ 413     $     $     $     $ 413  

Interest income

  $ 32     $     $     $ 55     $ 87  

Interest expense, net

  $     $     $     $ 531     $ 531  

Income tax (benefit) expense

  $ (630

)

  $ (61 )   $ 1,763     $ (13,981

)

  $ (12,909 )
                                         

Three Months Ended February 26, 2017

                                       

Net sales

  $ 105,447     $ 7,276     $ 23,532     $ 313     $ 136,568  

International sales

  $ 16,802     $ 7,276     $ 15,024     $     $ 39,102  

Gross profit

  $ 10,114     $ 558     $ 12,581     $ 179     $ 23,432  

Net (loss) income

  $ (2,492

)

  $ (116

)

  $ 7,135     $ (1,027

)

  $ 3,500  

Depreciation and amortization

  $ 1,862     $     $ 794     $ 61     $ 2,717  

Dividend income

  $ 413     $     $     $     $ 413  

Interest income

  $ 8     $     $     $     $ 8  

Interest (benefit) expense, net

  $ (77 )   $     $     $ 477     $ 400  

Income tax (benefit) expense

  $ (594

)

  $ (33

)

  $ 2,031     $ 152     $ 1,556  
                                         

Nine Months Ended February 25, 2018

                                       

Net sales

  $ 330,662     $ 25,982     $ 49,236     $ 3,257     $ 409,137  

International sales

  $ 56,135     $ 25,982     $ 19,330     $ 124     $ 101,571  

Gross profit

  $ 32,404     $ 1,628     $ 20,348     $ 786     $ 55,166  

Net income (loss)

  $ 968     $ (264

)

  $ 7,280     $ 10,737     $ 18,721  

Depreciation and amortization

  $ 6,050     $     $ 2,715     $ 311     $ 9,076  

Dividend income

  $ 1,238     $     $     $ 1,238     $ 1,238  

Interest income

  $ 61     $     $     $ 100     $ 161  

Interest expense, net

  $     $     $     $ 1,415     $ 1,415  

Income tax expense (benefit)

  $ 372     $ (75

)

  $ 2,110     $ (13,858 )   $ (11,451 )
                                         

Nine Months Ended February 26, 2017

                                       

Net sales

  $ 299,370     $ 56,316     $ 47,795     $ 1,346     $ 404,827  

International sales

  $ 51,073     $ 56,316     $ 25,896     $     $ 133,285  

Gross profit

  $ 36,522     $ 3,436     $ 22,640     $ 931     $ 63,529  

Net (loss) income

  $ (419

)

  $ 812     $ 9,690     $ (1,945

)

  $ 8,138  

Depreciation and amortization

  $ 5,474     $ 3     $ 2,225     $ 125     $ 7,827  

Dividend income

  $ 1,238     $     $     $     $ 1,238  

Interest income

  $ 15     $     $     $     $ 15  

Interest expense, net

  $ 594     $     $ 13     $ 825     $ 1,432  

Income tax (benefit) expense

  $ (81

)

  $ 229     $ 2,769     $ 1,221     $ 4,138  

 

During the nine months ended February 25, 2018 and February 26, 2017, sales to the Company’s top five customers accounted for 46% and 43%, respectively, of sales. The Company’s top two customers, Costco Wholesale Corporation and Wal-Mart Stores, Inc., from the Packaged Fresh Vegetables segment, accounted for 18% and 17% of revenues, respectively, for the nine months ended February 25, 2018, and 17% and 14% respectively, for the nine months ended February 26, 2017. The Company expects that, for the foreseeable future, a limited number of customers may continue to account for a significant portion of its revenues.

 

 

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the unaudited consolidated financial statements and accompanying notes included in Part I, Item 1, of this Form 10-Q and the audited consolidated financial statements and accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Landec’s Annual Report on Form 10-K for the fiscal year ended May 28, 2017.

 

Except for the historical information contained herein, the matters discussed in this report are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Potential risks and uncertainties include, without limitation, those mentioned in this Form 10-Q and those mentioned in Landec’s Annual Report on Form 10-K for the fiscal year ended May 28, 2017. Landec undertakes no obligation to update or revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report.

 

-18-

 

 

Critical Accounting Policies and Use of Estimates

 

There have been no material changes to the Company's critical accounting policies which are included and described in the Form 10-K for the fiscal year ended May 28, 2017 filed with the Securities and Exchange Commission on August 10, 2017.

 

See Note 1 – Organization, Basis of Presentation, and Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements for a discussion of recent accounting guidance not yet adopted.

 

The Company

 

Landec Corporation and its subsidiaries (“Landec” or the “Company”) design, develop, manufacture and sell differentiated health and wellness products for food and biomaterials markets. There continues to be a dramatic shift in consumer behavior to healthier eating habits and preventive wellness to improve quality of life. In our Apio, Inc. (“Apio”) Packaged Fresh Vegetables business, we are committed to offering healthy, fresh produce products conveniently packaged to consumers. Apio also exports whole fruit and vegetables, predominantly to Asia through its subsidiary, Cal-Ex Trading Company (“Cal-Ex”). In our Lifecore Biomedical, Inc. (“Lifecore”) biomaterials business, we commercialize products that enable people to stay more active as they grow older. In our O Olive Oil and Vinegar (“O Olive”) business acquired on March 1, 2017, we sell premium California sourced specialty olive oils and wine vinegar products.

 

Landec’s Packaged Fresh Vegetables and Biomaterials businesses utilize polymer chemistry technology, a key differentiating factor. Both businesses focus on business-to-business selling such as selling directly to retail grocery store chains and club stores for Apio and directly to partners in the medical device and pharmaceutical markets, with a concentration in ophthalmology for Lifecore.

 

Landec has three operating segments – Packaged Fresh Vegetables, Food Export and Biomaterials, each of which is described below and an Other segment. The results of the O Olive business are included in the Other segment in fiscal year 2018 because they are not significant to Landec’s overall results for fiscal year 2018. Financial information concerning each of these segments is summarized in Note 9 – Business Segment Reporting.

 

Apio operates the Packaged Fresh Vegetables business, which combines our proprietary BreatheWay® food packaging technology with the capabilities of a large national food supplier and value-added produce processor which sells products under the Eat Smart® brand to consumers and the GreenLine® brand to foodservice operators, as well as under private labels. In Apio’s Packaged Fresh Vegetables operations, produce is processed by trimming, washing, sorting, blending, and packaging into bags and trays that in most cases incorporate Landec’s BreatheWay membrane technology. The BreatheWay membrane increases shelf-life and reduces shrink (waste) for retailers and helps to ensure that consumers receive fresh produce by the time the product makes its way through the distribution chain. Apio also generates revenue from the sale and/or use of its BreatheWay technology by partners such as Chiquita Brands International, Inc. (“Chiquita”) for packaging and distribution of bananas and berries and Windset Holding 2010 Ltd., a Canadian corporation (“Windset”), for packaging of greenhouse grown cucumbers and peppers.

 

Apio also operates the Food Export business. The Food Export business purchases and sells whole fruit and vegetable commodities predominantly to Asian markets.

 

Lifecore operates our Biomaterials business and is involved in the development and manufacture of pharmaceutical-grade sodium hyaluronate (“HA”) products and providing contract development and aseptic manufacturing services. Sodium hyaluronate is a naturally occurring polysaccharide that is widely distributed in the extracellular matrix in animals and humans. Based upon Lifecore’s expertise working with highly viscous HA, the Company specializes in fermentation and aseptic formulation, filling, and packaging services, as a contract development and manufacturing organization (“CDMO”), for difficult to handle (viscous) medicines filled in finished dose vials and syringes.

 

O Olive was acquired on March 1, 2017. O Olive, founded in 1995, is based in Petaluma, California, and is a premier producer of California specialty olive oils and wine vinegars. Its products are sold in over 4,600 natural food, conventional grocery and mass retail stores, primarily in the United States and Canada.

 

Landec was incorporated in California on October 31, 1986 and reincorporated as a Delaware corporation on November 6, 2008. Our common stock is listed on The NASDAQ Global Select Market under the symbol “LNDC”. The Company’s principal executive offices are located at 5201 Great America Parkway, Suite 232, Santa Clara, California 95054, and the telephone number is (650) 306-1650.

 

-19-

 

 

Description of Core Business

 

Landec operates its business in three core business segments: Packaged Fresh Vegetables, Food Export and Biomaterials, and it has an Other segment.  

 

Packaged Fresh Vegetables Business

 

Based in Guadalupe, California, Apio’s primary business is fresh-cut and whole vegetable products primarily packaged in proprietary BreatheWay packaging. The Packaged Fresh Vegetables business markets a variety of fresh-cut and whole vegetables to the top retail grocery chains, club stores, and food service operators. During the fiscal year ended May 28, 2017, Apio shipped approximately 26 million cartons of produce to its customers throughout North America, primarily in the United States.

 

There are four major distinguishing characteristics of Apio that provide competitive advantages in the Packaged Fresh Vegetables market:

 

 

(1)

Packaged Vegetables Supplier: Apio has structured its business as a marketer and seller of branded and private label blended, fresh-cut and whole vegetable products. It is focused on selling products primarily under its Eat Smart brand, with some sales under its GreenLine brand and private label brands. As retail grocery chains, club stores and food service operators consolidate, Apio is well positioned as a single source of a broad range of products.

 

 

(2)

Nationwide Processing and Distribution: Apio has strategically invested in its Packaged Fresh Vegetables business. Apio’s largest processing plant is in Guadalupe, CA, and is automated with state-of-the-art vegetable processing equipment in one of the lowest cost, growing regions in California, the Santa Maria Valley. With the acquisition of GreenLine in 2012, Apio added three East Coast processing facilities and five East Coast distribution centers for nationwide delivery of all of its packaged vegetable products in order to meet the next-day delivery needs of customers.

 

 

(3)

Expanded Product Line Using Technology and Unique Blends: Apio, through the use of its BreatheWay packaging technology, is introducing new packaged vegetable products each year. These new product offerings range from various sizes of fresh-cut bagged products, to vegetable trays, to whole produce, to vegetable salads and to snack packs.

 

 

(4)

Products Currently in Approximately 70% of North American Retail Grocery Stores: Apio has products in approximately 70% of all North American retail grocery stores. This gives Apio the opportunity to sell new products to existing customers and to increase distribution of its approximately 120 unique products within those customers. 

 

Most vegetable products packaged in Apio’s BreatheWay packaging have an approximate 17 day shelf-life. In addition to packaging innovation, Apio has developed innovative blends and combinations of vegetables that are sold in flexible film bags or rigid trays. More recently, Apio has launched a family of salad kits that are comprised of “superfood” mixtures of vegetables with healthy toppings and dressings. The first salad kit to launch under the Eat Smart® brand was Sweet Kale Salad, which now has significant distribution throughout club and retail stores in North America. Additionally, we have launched under the Eat Smart brand several other superfood salad kits including Wild Greens and Quinoa, Beets and Greens, Southwest Salad, and Asian Sesame and more recently a new line of single-serve salads under our new Salad Shake-Ups!™ brand. The Company’s expertise includes accessing leading culinary experts and nutritionists nationally to help in the new product development process. We believe that the Company’s new products are “on trend” and strong market acceptance supports this belief. Recent statistics show that more than two-thirds of adults are considered to be overweight or obese and more than one-third of adults are considered to be obese. More and more consumers are beginning to make better food choices in their schools, homes, and in restaurants and that is where the superfood products can fit into consumers’ daily healthy food choices.

 

-20-

 

 

In addition to proprietary packaging technology and a strong new product development pipeline, the Company has strong channels of distribution throughout North America with retail grocery store chains and club stores. Landec has one or more of its products in approximately 70% of all retail and club store sites in the U.S. giving it a strong platform for introducing new products.

 

The Company sells its products under its nationally-known brand Eat Smart to retail and club stores and its GreenLine brand to foodservice operators. The Company also periodically licenses its BreatheWay packaging technology to partners such as Chiquita for packaging bananas and berries, and Windset for packaging peppers and cucumbers that are grown hydroponically in greenhouses. These packaging license relationships generate revenues either from product sales or royalties once commercialized. The Company is engaged in the testing and development of other BreatheWay products. Landec manufactures its BreatheWay packaging through selected qualified contract manufacturers.

 

Windset

 

The Company believes that hydroponically-grown produce using Windset’s know-how and growing practices will result in higher yields with competitive growing costs that will provide dependable year-round supply to Windset’s customers. In addition, the produce grown in Windset’s greenhouses uses significantly less water than field grown crops and has a very high safety profile as no soil is used in the growing process. Windset owns and operates greenhouses in British Columbia, Canada and in Nevada and California. In addition to growing produce in its own greenhouses, Windset has numerous marketing arrangements with other greenhouse growers and utilizes buy/sell arrangements to meet fluctuation in demand from their customers.

 

On March 15, 2017, the Company and Windset agreed to extend their relationship through March 31, 2022.

 

See Note 3 – Investment in Non-public Company of the Notes to Consolidated Financial Statements for a discussion about the Company’s 26.9% minority ownership interest in Windset.

 

Food Export Business

 

Food Export revenues consist of revenues generated from the purchase and sale of primarily whole commodity fruit and vegetable products primarily to Asia through Apio’s export company, Cal-Ex. The Food Export business is a buy/sell business that realizes an average gross margin between 5 and 10%.

 

Biomaterials Business

 

Lifecore uses its fermentation process and aseptic formulation and filling expertise to be a leader in the development of HA-based products for multiple applications and to take advantage of non-HA device and drug opportunities which leverage its expertise in manufacturing and aseptic syringe filling capabilities. Elements of Lifecore’s strategy include the following:

 

 

(1)

Establish strategic relationships with market leaders: Lifecore will continue to develop applications for products with partners who have strong marketing, sales, and distribution capabilities to end-user markets. Through its strong reputation and history of providing pharmaceutical grade HA and products, Lifecore has been able to establish long-term relationships with the market leading ophthalmic surgical companies, and leverages those partnerships to attract new relationships in other medical markets.

 

 

(2)

Expand medical applications for HA: Due to the growing knowledge of the unique characteristics of HA, and the role it plays in normal physiology, Lifecore continues to identify opportunities for the use of HA in other medical applications, such as wound care, aesthetic surgery, drug delivery, device coatings, and through pharmaceutical sales to academic and corporate research customers.

 

 

(3)

Utilize manufacturing infrastructure to pursue contract aseptic filling and fermentation opportunities: Lifecore has made strategic capital investments in its contract manufacturing and development business focusing on extending its aseptic filling capacity and capabilities. It is investing in this segment to meet increasing partner demand and attract new contract filling opportunities. Lifecore is using its manufacturing capabilities to provide contract manufacturing and development services to its partners in the area of sterile pre-filled syringes and fermentation and purification requirements.

 

 

(4)

Maintain flexibility in product development and supply relationships: Lifecore’s vertically integrated development and manufacturing capabilities allow it to establish a variety of contractual relationships with global corporate partners. Lifecore’s role in these relationships extends from supplying HA raw materials to providing tech transfer and development services to manufacturing aseptically-packaged, finished sterile products, and to assuming full supply chain responsibilities.

 

Other

 

Included in the Other segment is Corporate and O Olive.

 

-21-

 

 

Results of Operations

 

Revenues (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

   

Change

   

February 25,

2018

   

February 26,

2017

   

Change

 

Packaged Fresh Vegetables

  $ 120,942     $ 105,447       15

%

  $ 330,662     $ 299,370       10

%

Food Export

    4,414       7,276       (39

%)

    25,982       56,316       (54

%)

Total Apio

    125,356       112,723       11

%

    356,644       355,686       0

%

Biomaterials

    22,959       23,532       (2

%)

    49,236       47,795       3

%

Other

    1,008       313       222

%

    3,257       1,346       142

%

Total Revenues

  $ 149,323     $ 136,568       9

%

  $ 409,137     $ 404,827       1

%

 

Packaged Fresh Vegetables (Apio)

 

Apio’s Packaged Fresh Vegetables revenues consist of revenues generated from the sale of specialty packaged fresh-cut and whole processed vegetable products that are washed and packaged in Apio’s proprietary packaging and sold under the Eat Smart and GreenLine brands and various private labels. In addition, the Packaged Fresh Vegetables revenues include the revenues generated from Apio Cooling, LP, and a vegetable cooling operation in which Apio is the general partner with a 60% ownership position and from the sale of BreatheWay packaging to license partners.

 

The increase in Apio’s Packaged Fresh Vegetables revenues for the three and nine months ended February 25, 2018 compared to the same periods last year was primarily due to a 11% and 7%, respectively, increase in unit volume sales with a majority of the increase in revenues coming from increased sales of our salad products which are higher priced products compared to the Company’s lower priced core products whose sales were essentially flat for the three and nine months ended February 25, 2018 compared to the same periods last year.

 

Food Export (Apio)

 

Apio’s Food Export revenues consist of revenues generated from the purchase and sale of primarily whole commodity fruit and vegetable products to Asia by Cal-Ex. Apio records revenue equal to the sale price to third parties because it takes title to the product while in transit.

 

The decrease in Apio’s Food Export revenues for the three and nine months ended February 25, 2018 compared to the same periods last year was due to a 49% and 57%, respectively, decrease in unit volume sales due to the Company’s strategic decision during fiscal year 2018 to discontinue its lower-margin export fruit business. The Company recently announced that it plans to exit the entire Food Export business before the end of fiscal year 2018. As a result, the Food Export's business operations will be reclassified as discontinued operations in the Company's fiscal year end 2018 financial results on a retrospective basis for all periods presented therein.

 

Biomaterials (Lifecore)

 

Lifecore principally generates revenue through the sale of products containing HA. Lifecore primarily sells products to customers in three medical areas: (1) Ophthalmic, which represented approximately 65% of Lifecore’s revenues in fiscal year 2017, (2) Orthopedic, which represented approximately 15% of Lifecore’s revenues in fiscal year 2017, and (3) Other/Non-HA products, which represented approximately 20% of Lifecore’s revenues in fiscal year 2017.

 

The decrease in Lifecore’s revenues for the three months ended February 25, 2018 compared to the same period last year was due to a $1.2 million decrease in fermentation sales from existing customers partially offset by a $670,000 increase in aseptic filling revenues from existing customers.

 

The increase in Lifecore’s revenues for the nine months ended February 25, 2018 compared to the same period last year was due to a $2.1 million increase in business development revenues primarily from new customers and a $3.9 million increase in aseptic filling revenues from existing customers, partially offset by a $4.6 million decrease in fermentation sales from existing customers, a portion of which is due to the timing of shipments within the fiscal year.

 

Other

 

Other revenues for the three and nine months ended February 25, 2018 are from the sale of olive oils and vinegars by O Olive and for the three and nine months ended February 26, 2017 are primarily from two licensing agreements with corporate partners.

 

The increase in Other revenues for the three and nine months ended February 25, 2018 compared to the same periods last year was due to $1.0 million and $3.3 million, respectively, of revenues from the O Olive business that was acquired on March 1, 2017 compared to $313,000 and 1.3 million, respectively, in revenues for the three and nine months ended February 26, 2017 primarily from two license agreements that were completed in August 2016 and December 2016.

 

-22-

 

 

Gross Profit (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

   

Change

   

February 25,

2018

   

February 26,

2017

   

Change

 

Packaged Fresh Vegetables

  $ 7,944     $ 10,114       (21

%)

  $ 32,404     $ 36,522       (11

%)

Food Export

    318       558       (43

%)

    1,628       3,436       (53

%)

Total Apio

    8,262       10,672       (23

%)

    34,032       39,958       (15

%)

Biomaterials

    11,609       12,581       (8

%)

    20,348       22,640       (10

%)

Other

    257       179       44

%

    786       931       (15

%)

Total Gross Profit

  $ 20,128     $ 23,432       (14

%)

  $ 55,166     $ 63,529       (13

%)

 

General

 

There are numerous factors that can influence gross profit including product mix, customer mix, manufacturing costs, volume, sales discounts and charges for excess or obsolete inventory, to name a few. Many of these factors influence or are interrelated with other factors. The Company includes in cost of sales all of the costs related to the sale of products in accordance with GAAP. These costs include the following: raw materials (including produce, seeds, packaging, syringes and fermentation and purification supplies), direct labor, overhead (including indirect labor, depreciation, and facility-related costs) and shipping and shipping-related costs. The following are the primary reasons for the changes in gross profit for the three and nine months ended February 25, 2018 compared to the same period last year as outlined in the table above.

 

Packaged Fresh Vegetables (Apio)

 

The decrease in gross profit for Apio’s Packaged Fresh Vegetables business for the three and nine months ended February 25, 2018 compared to the same periods last year was primarily due to $3.6 million and $7.7 million of incremental produce sourcing costs during the three and nine months ended February 25, 2018, respectively, resulting from hurricanes and tropical storms and from unseasonably hot weather in California which negatively impacted produce yields and quality. These incremental produce sourcing costs were partially offset by gross profit resulting from increased salad sales.

 

Food Export (Apio)

 

Apio’s Food Export business is a buy/sell business that realizes an average gross margin from 5-10%. The decrease in gross profit for Apio’s Food Export business during the three and nine months ended February 25, 2018 compared to the same periods last year was primarily due to a 39% and 54%, respectively, decrease in revenues due to transitioning away from this low-margin export fruit business.

 

Biomaterials (Lifecore)

 

The decrease in Lifecore’s gross profit for the three months ended February 25, 2018 compared to the same period last year was higher than the 2% decrease in revenues as a result of an unfavorable product mix change to a higher percentage of revenues coming from lower margin aseptically filled product sales than from higher margin fermentation sales during the same period last year.

 

The decrease in Lifecore’s gross profit for the nine months ended February 25, 2018 compared to the same period last year was a result of an unfavorable product mix change to a higher percentage of revenues coming from lower margin aseptically filled product sales than from higher margin fermentation sales during the same period last year. Gross profit also decreased because of the timing of production and thus overhead absorption within the fiscal year.

Other

 

The increase in Other gross profit for the three months ended February 25, 2018 compared to the same period last year was due to the $257,000 of gross profit for the three months ended February 25, 2018 from O Olive (which was acquired on March 1, 2017) being more than the gross profit primarily from two license agreements for the same period last year because one of the licensing agreements was completed in the first quarter (August) of last year and therefore generated no gross profit during the third quarter of last year and the other was completed early in the third quarter (December) of last year.

 

The decrease in Other gross profit for the nine months ended February 25, 2018 compared to the same period last year was due to the $786,000 of gross profit for the nine months ended February 25, 2018 from O Olive (which was acquired on March 1, 2017) being less than the gross profit primarily from two license agreements for the same period last year which were completed in August 2016 and December 2016.

 

-23-

 

 

Operating Expenses (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

February 25,

2018

   

February 26,

2017

   

Change

   

February 25,

2018

   

February 26,

2017

   

Change

 

Research and Development:

                                               

Apio

  $ 1,339     $ 339       295

%

  $ 3,805     $ 862       341

%

Lifecore

    1,406       1,362       3

%

    4,108       4,027       2

%

Other

    368       313       18

%

    1,291       1,028       26

%

Total R&D

    3,113       2,014       55

%

    9,204       5,917       56

%

                                                 

Selling, General and Administrative:

                                         

Apio

    8,586       10,447       (18

%)

    25,926       29,296       (12

%)

Lifecore

    1,444       1,362       6

%

    4,387       4,072       8

%

Other

    3,777