Landec Corporation
Q3 2015 Earnings Call Transcript

Published: 1 Apr 2015

[Operator:]

Good day, ladies and gentlemen. And welcome to the Landec Third Quarter Fiscal 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Mr. Gary Steele, Chairman and CEO of Landec Corporation. Please go ahead.

[Gary Steele:]

Good morning, and thanks for joining Landec's third quarter fiscal 2015 earnings call. I have with me today Greg Skinner, Landec's Chief Financial Officer; and Molly Hemmeter, Landec's Chief Operating Officer. During today's call, we may make forward-looking statements that involve certain risks and uncertainties that could cause actual results to differ materially. These risks are outlined in our filings with the Securities and Exchange Commission, including the company's Form 10-K for fiscal 2014. We experienced continued growth in our third quarter with consolidated revenues increasing 10% year over year, driven by a 90% growth in sales of our Eat Smart superfood products at Apio, our food business. Overall revenues in Apio's value-added vegetable business increased 21% due to increased same-store sales as well as penetration into new retail grocery chains. The growth in our superfood product line resulted in a favorable product mix change that led to a 34% increase in gross profit in our value-added food business and a 44% increase in Apio's operating income during the third quarter versus last year. Overall operating income in the third quarter was consistent with guidance for the quarter and included expected lower sales of higher margin fermentation products at Lifecore Biomedical. As we have previously reported, we experienced a one-time inventory reduction by one of our Lifecore’s long-standing customers resulting in a greater than 50% reduction in shipments to that customer during the third quarter compared to the third quarter last year. We do expect orders from this key customer to return to historical levels during our new fiscal year 2016 which commences in June. Let me turn it over to Greg to report more details of our financial results.

[Greg Skinner:]

Thank you, Gary and Good morning everyone. We reported yesterday that revenues for the third quarter of fiscal 2015 increased 10% to $138.5 million from $126.4 million in the year ago quarter. The improvement was primarily due to a 21% or $20 million increase in revenues in Apio’s value added business which includes its Eat Smart fresh-cut specialty packaged vegetable business, Apio Cooling and Apio Packaging. This increase in revenue was partially offset by a 27% decrease in revenues at Lifecore due primarily to expected lower sales from a one-time inventory reduction by a key customer and by a 23% decrease in revenues in Apio’s export business, primarily due to the West Coast longshoreman labor dispute. Net income in the third quarter of fiscal 2015 was $3.8 million or $0.14 per share compared to $6.4 million or $0.24 per share in the year ago quarter. The decrease was primarily due to a $5.6 million decrease in operating income at Lifecore, primarily from lower shipments to a key customer from a one-time inventory adjustment by that customer, and from a $793,000 write-off of the company's equity ownership in Aesthetic Sciences. These decreases in net income in the third quarter were partially offset by a 44% or $1 million increase in operating income at Apio, due primarily to increased revenues and a favorable product mix shift to higher-margin superfood products and from a $1.7 million increase in the change in the fair market value of the company’s Windset investment. For the first nine months of fiscal 2015, revenues increased 14% to $404.8 million from $355.9 million in the same period last year. The increase was primarily due to a 21% or $54.6 million increase in revenues from Apio’s value-added businesses and a 3% or $1.8 million increase in revenues at Apio’s export business. These increases were partially offset by a 20% or $7.6 million expected decrease in Lifecore’s revenue. Net income in the first nine months of fiscal 2015 was $9.3 million or $0.34 per share compared to $14.6 million or $0.54 per share in the first nine months of last year. The decrease was primarily due to, first, a $7.6 million decrease in operating income at Lifecore; second, a $4.6 million decrease in the change in the fair market value of the company's Windset investment, and third, a $793,000 write-off of the company's investment in Aesthetic Sciences. These decreases in net income in the first nine months of fiscal 2015 were partially offset by a 46% or $4.9 million increase in operating income at Apio and a $2.6 million decrease in income tax expense. Landec ended the second quarter with $15.7 million of cash which was a $1.5 million increase from fiscal year 2014. During the first nine months of fiscal 2015, Landec generated $13.4 million in cash flow from operations and increased net borrowings by $15.4 million. These increases in cash were offset by the company increasing its investment in Windset by $18 million and spending $10.2 million in capital expenditures primarily for capacity expansion. As of March 1, 2015, the company had $26.1 million available under its lines of credit. Let me now turn the call over to Molly.

[Molly Hemmeter:]

Thank you, Greg. We continued to experience growth in Apio’s value-added packaged food business, as consumers seek out easy and delicious ways to eat healthy and add more vegetables to their diet. The growth in Apio’s value-added business is being fueled by Apio’s Eat Smart salad kit products which contain a variety of superfoods. These products are currently being sold to over 100 club, retail and food service customers throughout North America. For the first nine months of fiscal year 2015, this new product platform has reached an average weekly run rate of $2.2 million in revenues with gross margins more than double that of our historical core products. We continued to meet our commitment of launching an average of at least one new product each quarter. During the first nine months of fiscal 2015, we added three salad kits to our line up – the Wild Greens and Quinoa Salad, Roasted Yam Salad, and the Beets & Greens Salad. We plan to launch our fourth salad kit for this fiscal year this month, starting with Costco Canada. We estimate the North American salad kit category including both retail and club stores in the US and Canada to be approximately $1.1 billion measured in consumer retail dollars. Although the Canadian salad kit market is much smaller than of that US, Eat Smart salad kits have experienced incredible growth in this market and are driving growth of the overall salad kit category in Canada. Eat Smart has an estimated 12% share of the North American salad kit market, including both retail and club stores, up from zero just under three years ago. Consumer awareness of our superfood products continues to grow. During the first quarter of fiscal year 2015, we launched the new EatSmart.net consumer website that is compatible with mobile phones and tablets. In November, 2014, we started a three months online advertising and social media trial in 11 states throughout the Northeastern and mid-Atlantic regions of the US to raise awareness of Eat Smart among consumers and to incent consumers to purchase our products in-store. The final results of this trial were extremely positive. In retail stores throughout our advertising geography, Eat Smart products experienced a sales lift of 20% as a direct result of the Eat Smart online campaign. Even more encouraging, Eat Smart products had experienced a sustained lift of 17% in the four weeks following the trial completion in the same retail stores. Due to these positive results, we plan to expand Eat Smart online consumer campaign during fiscal year 2016. In parallel with the focus and growth of our salad kit products, we have started to phase out specific lower margin ore vegetable products and selectively seek price increases for other core vegetable products. We expect to begin seeing result of this effort in fiscal year 2016. Revenues in our core product lines may decline slightly as a result but Apio’s gross margin should be enhanced longer-term. Along with growing the sales of higher-margin salad kit products, we believe margin enhancement in our core Apio business is essential for the long-term growth and profitability of Landec. Apio is the innovation leader in the packaged fresh vegetable category. We invest in gaining a deep understanding of consumer trends and strive to offer consumers easy and delicious ways to make vegetables an important part of their diet. The results of these investments are showing. Through the first nine months of this fiscal year, approximately one-third of Apio’s value-added sales are being generated by new products that Apio has launched within the last three years. We are committed to continuing to invest in new product development so that we can offer fresh, easy and delicious ways for consumers to eat healthy everyday. Let me turn it back to Gary.

[Gary Steele:]

Thanks, Molly. Increasingly our focus going forward will be on margin improvement in our food business. You will know that through our first nine months the gross margin in Apio’s value-added vegetable business increased 100 basis points from the prior year. Margin improvement over the next 24 months will come from product mix changes focusing on higher-margin salad kit products from operational cost reductions driven from capital expenditures to improve plant productivity and from selective price increases where possible and where appropriate. We may sacrifice some revenues during this period of time in order to improve margins. As we enter the fourth fiscal quarter we expect a strong finish in Apio’s value-added business generating good momentum into fiscal year 2016 which starts in June. Looking to fiscal year 2016, we expect substantial growth at Lifecore, continued growth in Apio’s superfood products and continued increases in the value of our Windset investment. We will be able to give specific guidance for fiscal year 2016 during our year-end fiscal 2015 earnings report and conference call. Based on preliminary estimates for fiscal year 2016, altogether we believe consolidated revenues, excluding the $9 million of revenues from the extra week in fiscal year 2015, could grow up to 10% in fiscal year 2016 compared to this fiscal year with preliminary estimates of net income increasing approximately 60% to 75%. Keep in mind that we are just in the middle of our budgeting process and this process is not at all complete. Our capital allocation priorities over the next 24 months are

[Operator:]

[Operator Instructions] Our first question comes from the line of Tony Brenner from ROTH Capital Partners.

[Tony Brenner:]

Two topics. First of all, Molly, your website indicates that there are a total of 11 superfood kits in the marketplace. You talked about – or the release in the kits are really seven. There were six salad kits on the website, not five, and three slaw kits, whatever those are. What’s the difference?

[Molly Hemmeter:]

That’s because you are including the slaw kits, so we have different product lines. We look at our salad kits that are slaw kits, that’s a separate product line than are vegetable salad kits that are based on superfoods.

[Tony Brenner:]

But the website includes six salad kits, and you talk about there only being five.

[Molly Hemmeter:]

Sometimes we have different varieties of the same one. I have look at what’s on the website right now. We’ve got two SKUs of Wild Greens and Quinoa, for example. With Wild Greens and Quinoa, we have an avocado dressing version and we also have a strawberry version, that is in Costco, so that can make the difference. We also have the other difference is Ginger Bok Choy, our Asian salad. And Sesame Bok Choy is just a variation on Ginger Bok Choy that we sell only to public because they had a specific request not to have peanuts. So we have some of those where we do special SKU, that is a variation on an existing SKU and when I am talking on these ,meetings I am only including the core SKUs, not all the variation.

[Tony Brenner:]

And what are the slaw salad kits?

[Molly Hemmeter:]

We had this for many, many years at Apio and they have been very successful over the years. We have three of them, a broccoli slaw kit, salad kit, what we have an Asian salad kit and we have a [indiscernible] salad kit. They have probably been out for 15 years, or so.

[Tony Brenner:]

But that’s not considered a superfood.

[Molly Hemmeter:]

They’re very separate from the superfood and have a different positioning and the superfoods are more taking the concept of these slaw salads but these are more on trend with current vegetables and current kind of health concerns that consumers have.

[Tony Brenner:]

The other question concerns Windset farms. Your guidance previously was for a total contribution of 8.5 million to 9.5 million, including dividends, it looks like you are going to between $1 million and $2 million short of that for this fiscal year. There is no incremental capacity that comes into play this year so presumably the differences that Windset has fallen short on its expectations for revenue and the earnings growth I wonder if you can elaborate a little bit on that?

[Greg Skinner:]

Sure. This is Greg. It’s not - so much of that Tony is the fact that we just received for the first time in 15 months updated projections from them in February. And yes, we have given everyone a heads up for some time now that we were expecting new projections, based on those new projections it could change our projections and they have – but the primary reason is that we had certain expectations in our guesstimates on when new expansions one of which is in Nevada, we’ve mentioned that, a greenhouse that they’ve purchased in Nevada could come online. That’s been delayed about six months due to permitting and other issues. And then a new technology, new technique for growing new crops at a much lower costs than glass greenhouses in California. That is going to start later than we had originally expected and it’s going to start small which makes sense because you’ve got to approve the concept and then grow from there. So the combination, those are the primary changes to the projections were used in the fourth to the new ones, and as a result, we do expect the fair market value change is going to increase next year, we expect that increase to be higher than the increased this year, it’s just going to be lower than what we had been anticipating three to six months ago.

[Tony Brenner:]

So the delay in the Nevada greenhouse permitting, is affecting this year or next year, or both?

[Greg Skinner:]

Primarily, this year because we thought this would start up in June originally, it’s now looking more like January of next year. That one can affect this fourth quarter and then the –

[Tony Brenner:]

How does it affect the fourth quarter if you thought it would come out in June?

[Greg Skinner:]

You’ve got to understand how -- and I don’t think this is the forum they go through this level of detail but the fair market value is based on a cash flow concept.

[Tony Brenner:]

Okay, I got it, I understand. Don’t go through it.

[Gary Steele:]

Windset’s core business is doing well, Tony. It’s a timing of these projects.

[Operator:]

Thank you. Our next question comes from the line of Morris Ajzenman from Griffin Securities.

[Morris Ajzenman:]

As a follow up to Tony’s question there I want to comment that we had two facilities up and running for Windset, in the past year we took a pause to get things operationally up to optimal speed so to speak. Are you prepared to comment on this next fiscal year as far as new expansion at this point for Windset?

[Gary Steele:]

I guess I am a little confused on your question, Morris, exactly what are you asking? The expansion that we foresee for them in the next year is what Greg just talked about, Nevada and this new approach with a lower capital, it’s going to be a totally new project, new expansion in California, new targets, a different greenhouse approach, still using their know how and your proprietary hydroponic approach. So those are the two expansion areas in this next fiscal year.

[Morris Ajzenman:]

So what I was referring to the Santa Maria, there’s nothing on calendar for fiscal, this coming fiscal year, Santa Maria, that’s what I was referring to.

[Gary Steele:]

The new technology approach, the new target project, that’s in California, that’s contiguous with their Santa Maria huge operation. So it’s right next door. But there are no plans for large glass greenhouses in their current projection for this next year.

[Morris Ajzenman:]

I guess a question for Molly. I look over the last couple of quarters and your first fiscal quarter when you talked about Eat Smart, the superfoods, you talked about a 1.5 million per week run rate, or if you annualize that’s 78 million. The last quarter, second quarter was up 2 million, 104 million run rate, now it’s 2.2 million, 115 million run rate. What sort of rate can that increase to over the next handful of quarters, do you have anything you want to share with us, what sort of growth you see that continuing at?

[Molly Hemmeter:]

Hi Morris, first just the cracker map [ph], with the 2.2 million run rate, if you multiply that by 53 week, I think you should get about 117 million for this year. So we should be at about that run – that for this year annually. As far as future growth, we’re going to keep launching products. We have a great new product coming out this quarter that we’re very excited about, we’re going to test it with Costco Canada and see what the consumer response is and we have plans to continue to launch at least one new product per quarter. So I think we have done our research. I think we’ve already been pre-selling these products to key accounts. So I think we will get the distribution and the growth is going to depend on the consumer, and how well received they are and if they turn. So we’re going to be doing our marketing campaigns that I talked about online, to get the word out to consumers and raise awareness and let them know about these new products, and the amount of growth will turn on the velocity we see in the store.

[Morris Ajzenman:]

Let me ask a little differently then. The capacity you brought on stream and something to tweak, what’s the availability capacity for this particular category Eat Smart the superfood product line?

[Molly Hemmeter:]

Let me tell you we have at least enough capacity to get us to $200 million in revenue for the superfoods. And we are building more and that should make us through for the next year, as we’re building more capacity. I think we talked last quarter about the capacity we are expanding on Hanover.

[Morris Ajzenman:]

So from this 12 months, is it fair for us to look out 12 months out and that capacity would be fully utilized or is that a conjecture on my part?

[Molly Hemmeter:]

I think that’s a conjecture on your part.

[Morris Ajzenman:]

Are you – with that conjecture?

[Molly Hemmeter:]

Yes. We want to build to the upside, and in case somebody’s products really kick off with the consumer like our free kale salad did, we want to build for that. But we want to make sure we have the capacity we need but I would not plan on that, all that capacity for next year. I think the guidance is more along with what Gary talked about for next year.

[Morris Ajzenman:]

One last question and I will get back in queue. Going back to Lifecore Biomedical, I guess inventory reduction by one large customer. Clearly you stated in the press release and on the call that you expect that to resume to normalcy as of June 1, I presume that’s with close conversation with customer, are there any other nuances we should be aware of, positive or negative as you look out to fiscal ’16 for Lifecore?

[Gary Steele:]

The positives are that we are darn confident that that customer comes back in normal ordering patterns. And the other is that we have been working with a partner company to help them formulate and manufacture their products for a therapeutic application, pharmaceutical therapeutic application that, they are in clinical studies, so far it’s going well, they tell us that their plans to submit to the FDA are on track and hopefully this will have a positive impact on Lifecore in the second half fiscal year FY’16. It’s a substantial program and they are a good partner, and they have been doing a very large clinical study and they are about to wrap up and conclude that study and then look at the data and then based on that submit to the FDA. So we’re hopeful that that program continues on track and has an effect on us in the second half of fiscal year ’16, and then in FY’17 really be substantial, that would be quite material in ’17 and ’18.

[Operator:]

Our next question comes from the line of Mitch Pinheiro from Imperial.

[Mitch Pinheiro:]

So what was the rate of growth in the last quarter of the non-Eat Smart value added Apio sales?

[Gary Steele:]

The non-Eat Smart – oh, you mean like private label?

[Mitch Pinheiro:]

Well, yes, so everything value added category other than Eat Smart?

[Gary Steele:]

Wow, you got me.

[Mitch Pinheiro:]

I guess what I am asking is you are also talking earlier about you’re going to sacrifice some revenue to improve margins, you also talked about phasing out some lower margin veggie. So if you are going to grow next year, like the value add side, 10% on average, is that 10% minus 3%, or is that 12%, 13% minus 3% to get to 10%? And what was and how is it performing now?

[Gary Steele:]

Let me try – Molly, you want to try? Because I am understanding that we have this high growth superfood category, as you know we have numbers in the release and in our comments about the enormous growth of that program. But it wouldn’t be unrealistic as we go – we are in this budgeting progress, it wouldn’t be unrealistic that we have this core veg line that has nothing to do with superfoods. It wouldn’t be unrealistic given what I said about looking for some pruning, looking for some price increases, so it wouldn’t be unrealistic to see that core business flat. And then 10% would be driven by the growth in superfoods which would be 25%, in that ballpark.

[Mitch Pinheiro:]

And the superfood, the 2.2 million a week, at a run rate now of about 115 million, is that correct?

[Molly Hemmeter:]

That’s right.

[Mitch Pinheiro:]

And is it just going to be sort of normal ordinary business quarter by quarter, we will see some pruning if there is any or does it come in chunks?

[Molly Hemmeter:]

I think it should be pretty normal business unless we have a single customer that we had that the large customer that comes in chunks, I cannot say I know that right now. But I don’t think – I think it should be pretty much quarter on quarter like this year.

[Mitch Pinheiro:]

These are the same accounts. These are the same accounts you have been talking about for a while that – okay.

[Gary Steele:]

Mitch, just to expand on a little bit. In our core business, that’s a superfood business we’ve talked for several years now about margin compression, cost going up, difficulty in raising prices. Then so we have been focused on product mix changes but it’s time to really pass on some of these costs and so we have this cost reduction effort, productivity improvements but we’re going to have some price increases and it’s possible that there could be a chunk, meaning there could be a sizable customer that is just real unhappy and it involves only your core lower margin business and they could walk, you’ve got to be prepared for that.

[Mitch Pinheiro:]

And like how low of a margin, when you say your lower margin stuff, does that – your average, half year average?

[Gary Steele:]

It would be half year average.

[Mitch Pinheiro:]

The second thing – question for Molly is – so you’ve been doing a great job with one new product a quarter. Is that cadence really necessary? Is it – I mean eventually obviously one new product core you hope continues to – you keep on adding your shelf space, so I get that. But does it complicate maybe the supply chain so to speak and are you getting – we have to remove – is it just matter of culling the bottom in, is that what you are doing with this one new product? And does it cost a lot of money to introduce these new products? So is there a risk – not a risk, but some earnings lost or hit by a bad new product?

[Molly Hemmeter:]

I think to answer your last question first, there is definitely an investment in the product development, in this product. However the ROI on the sales has been extremely high. So we believe that investment is worth it. As far as the cadence coming out with one product per quarter, we believe that’s the right cadence for now. But to your point, it doesn’t mean that it will be forever. We see opportunity, we are coming out with one per quarter and it makes sense now. There is going to be continued challenge to increase phasings at retail. There is going to be increased challenge to buy more flats at club, but at the same time when you launch a new product line, you have to create an entire line of products. And that line needs to have enough SKUs to justify the entire line. We also need to make sure – we also know that all these products are getting hit and be winners. And so we always need to keep innovation going so that one isn’t turning, we don’t lose that phasing to a competitor and we have the next one to fill that slot. At the same time, remember we are pruning SKUs. So even in our core business we are pruning SKUs, opening up phasings, to put in new products and we want to replace those SKUs that we pruned with new products of higher margins.

[Mitch Pinheiro:]

And then just last question, when I look at – when I go into the grocery channel, that you are seeing a lot more copycats. People are putting salad kits out. I mean obviously yours is certainly favored by consumers but there’s going to be a lot of trial by consumers, saying, hey, let me try this, and at what point, when does the salad kit category get commoditized or more commoditized, are we in the early innings of this, mid-innings, where do you think we are there?

[Molly Hemmeter:]

Well, obviously there will be a maturity to it. Right now the market is still growing at – over 30%. So that’s a pretty high growth rate and that’s why a lot of people are jumping into it to see if they can capture a part of that market. I think we’ve said in the press release if you look at North America including club and retail US and Canada, we’ve gone from zero to 12% market share in just three years. We are hoping that growth continues and we are hoping to take more than our share of the pie because of our innovative salads that we believe offer more value.

[Gary Steele:]

Mitch, let me mention one other distinguishing thing. You will see in Array, from the Doles, and Fresh Expresses, salad kits and chop sales, they are lettuce based. There are all kinds of different forms of lettuce that are chopped in, throwing some radicchio, that kind of thing. Our wrangle is to take very healthy high nutrition vegetables and make those into salads and salad kits. So it’s an unique approach and you’re buying a lot of nutrition and good health when you eat those products. So we are distinguished from the lettuce based salads.

[Operator:]

Your next question comes from the line of Rick Fetterman from Fetterman Investments.

[Rick Fetterman:]

I just had – wanted to get one thing cleared up. One of the early caller – earlier callers mentioned – I am asking a question that – the Lifecore customer who has deferred purchases this year, this fiscal year, was going to start again, you’d said in fiscal ’16, the caller said beginning again June 1, may not be June 1, but have you had an indication from that customer as to when they may begin purchasing again on a regular basis?

[Greg Skinner:]

They are going to go back to historical order patterns and quantities and I could tell you and you see the results in this third quarter, this customer takes the lion share if not a 100% of the product that they reduced this year by more than half in the third quarter. So that will be the core, you will see the impact from them going back to historical levels.

[Gary Steele:]

The reference to June 1, Rick, was that, that’s when our new fiscal year begins.

[Rick Fetterman:]

No, I realize that. I just didn’t know if there was going – if we should expect any revenue and resulting profit starting again in early in the year or if it will be as primarily in the back half?

[Gary Steele:]

Yes, third quarter.

[Operator:]

And our next question comes from the line of Will Lauber from Sterling Capital Management.

[Will Lauber:]

What products are you guys making and I guess the food service business, have you had any progress on that?

[Molly Hemmeter:]

We’ve done mostly our green bean products which are in several different varieties of green beans from your traditional green beans to yellow beans to whack beans. We’ve also sold a lot of its kale salad blend that we don’t have the master packs in there but the food service operators are beginning to order more and more of the kale salad for the base vegetable and then they customize in their restaurant. And we do have very small amount of cut veg business from our Eat Smart products but it’s a very small amount. We haven’t made a lot of progress in selling the Eat Smart products except for the kale salad –

[Greg Skinner:]

The margins there are more challenging. You’ve got a third party typically a Cisco or US food service will and it hasn’t been a strength of ours, it’s not a focus of ours but it is over $30 million in annual sales.

[Molly Hemmeter:]

If we increase that, it will be a much lower margin than we are typically seeing in retail or club.

[Will Lauber:]

And would there be any potential with the restaurants or I guess quick service, I mean there is talk of McDonald’s putting kale in the menu now, and I saw you guys someone from Apio was quoted in one of the stories in the pack around that, I mean would that be a possibility at all?

[Molly Hemmeter:]

Yes, again we sell the kale kit and those are being used in many many restaurants right now. As far as McDonald’s, I don’t think that’s an immediate one on our list but we’re out there bidding for the business. End of Q&A

[Operator:]

[Operator Instructions] And this does conclude the question and answer session of today’s program. I’d like to hand the program back for any further remarks.

[Gary Steele:]

We want to thank you all for being with us on the call today and we look forward to keeping you apprised of our progress and our plans. Many thanks.

[Operator:]

Thank you ladies and gentlemen for your participation in today’s conference. This does conclude the program. You may now disconnect.