Lifecore Biomedical, Inc. (LFCR) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Landec Fourth Quarter and Fiscal Year End 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.

Good morning. Thank you for joining Landec's fourth quarter and fiscal year end 2015 earnings call. I have with me today Greg Skinner, Landec's Chief Financial Officer; and Molly Hemmeter, Landec's Chief Operating Officer and CEO Elect, as announced in yesterday's press release. Before we get into operating results, I want to congratulate Molly on her promotion to CEO when I retire at Landec's shareholders meeting in mid-October. Molly has clearly earned this promotion. She has all the credentials to succeed and continue our progress and I look forward to working with her in my role as a Director of Landec. 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 Exchange Commission, including the company's Form 10-K for fiscal 2014. Operationally we had a very good fourth quarter compared to last year’s fourth quarter, with consolidated revenues increasing 11%, gross profits increasing 16% and operating profits increasing 17%. For all of fiscal 2015 our consolidated revenues increased 13% year-over-year to a record $539 million driven by strong sales of our Eat Smart salad kit products. Apio’s overall revenues during the fiscal year grew 16%, while its operating income grew 25%. The sale of salad kit products containing a mixture of nutrient rich superfood vegetables increased 53% during the quarter and 88% for the year compared to the same periods last year. We are very positive about the continued growth in our Apio business particularly the expected continued growth in our salad kit line of products. Apio has recently reached an average weekly run rate of $2.9 million in revenues from its Eat Smart salad kit products. We believe our Apio products are on trend as Americans increase their focus on healthy nutritious eating as a direct way to stay healthy. We expect to launch on average one new salad kit product per quarter with a focus on nutrient rich blends of superfood vegetables. Most of our products utilize our BreatheWay packaging technology, which provides for 17 to 20 days of shelf life and we will continue to build our national brands Eat Smart and GreenLine. During fiscal 2016, we expect to continue a product mix shift to more unique blends of vegetables in the salad kit format and correspondingly continue to increase margins. As expected in fiscal year 2015 Lifecore revenues for the year decreased 12% while its operating income decreased 50% due to the previously disclosed reduction in purchases by key Lifecore customer due to a one time inventory adjustment. In our current fiscal year 2016, this customer is resuming its historical purchasing levels. We expect Lifecore to be a major driver of growth for this year and certainly a significant contributor to operating income and cash flow going forward. Specifically we expect Lifecore revenues to grow 20% to 25% and operating income to more than double in fiscal year 2016, as Lifecore continues to grow its HA and its partnering businesses. The key customer that cut its purchases in half in fiscal year 2015 in order to adjust its inventory levels has as I said return to historical purchasing levels. The plan in Lifecore is to continue to invest in its aseptic filling business to meet the increasing demand of existing and new customers. This filling business and the commercialization of product development programs are expected to begin generating meaningful revenues in late fiscal 2016 and help fuel Lifecore’s growth over the next five years. Lifecore has committed a considerable amount of resources developing and advancing its aseptic filling capabilities and after our Lifecore facility expansion this year we will be well positioned to meet anticipated increases in demand for the foreseeable future for both our core HA business as well as our new partnering collaborations with pharmaceutical companies, that are seeking our expertise in process development, formulations and filling of aseptic finished products. Across Apio and Lifecore we will spend up to $40 million to $45 million this year in new equipment and expanded facilities and we recently have added or will be adding organizational leadership capabilities in operations, marketing, sales and procurement. We are obviously investing for continued growth in people products and facilities. Our Windset investment continues to grow in fact our investment has grown every quarter since we first invested in Windset in February 2011. However the change in the fair market value of our Windset investment in each quarter or fiscal year can be higher or can be lower than the change in the fair market value recorded in the year ago period. For the fiscal year 2015 we originally expected the change to be lower than the $10 million we recognized in fiscal 2014 because we knew at that time that Windset has decided to take a pause on further expansion during the fiscal year 2015. Due to recent unexpected permitting issues in California Windset’s new expansion plans have now been delayed. The permitting delay involves a new government jurisdiction, which unexpectedly is requiring a new permitting process. As a result the increase in fair market value for the fourth quarter and the fiscal year 2015 was less than we had been projecting. The increase in fair market value of our Windset investment in the fourth quarter was $400,000 instead of approximately $2.5 million that had been expected in the fourth quarter. The difference negatively impacted net income in the fourth quarter by $0.05 a share. For all of fiscal year 2015 the increase in Windset investment was $0.07 per share lower than we had originally projected again, due to these permitting issues. The permitting delay is also going to affect the increase in the fair market value of Windset for fiscal year 2016, and that is why we expect the increase in fair market value of our Windset investment in fiscal year 2016 to be flat to slightly up compared to fiscal year of 2015. This new expectation is considerably lower than what we had originally been forecasting for fiscal year 2016, again all due to this permitting delay. This delay does not impact Windset’s long-term trajectory. Windset is committed to expansion plans at its Santa Maria, California location and plans to construct new hydroponic greenhouses with the new state-of-the-art design focused on new crop targets. Windset is one of the fastest growing food companies in North America, growing on average by 21% per year over the past five years. Windset’s 6 million square foot hydroponic greenhouse facility in Santa Maria, California is one of the highest if not the highest yielding tomato greenhouse in the world. They’re one of the market leaders in innovation and new technologies for hydroponic growing in a highly controlled environment with the ability to grow produce here around with exceptional yields and quality and use very little water in doing so. Let me turn it over to Greg to report more details on our financial results.

Thank you, Gary and good morning, everyone. We reported yesterday that revenues for the fourth quarter of fiscal 2015 increased 11% to $134.4 million from $120.9 million in the year ago quarter. This increase was primarily due to a 15% or $15.1 million increase in Apio’s value added business and $2.3 million or 29% increase in revenues for Lifecore. These increases were partially offset by $3.8 million or 26% decrease in Apio’s export business. Operating income increased 17% to $6.2 million from $5.3 million in last year’s fourth quarter, primarily due to operating income at Lifecore increasing nearly fourfold partially offset by a 6% decrease in operating income at Apio, due to increased SG&A expenses to support our new line of salad kit products including additional headcount. Net income in the fourth quarter of fiscal 2015 was $4.2 million or $0.15 per share compared to $4.5 million or $0.17 per share in the year ago quarter. The $898,000 increase in operating income in the fourth quarter was more than offset by the $1.5 million lower increase in the fair market value of our Windset investments compared to the increase in the fair market value reported in last year’s fourth quarter. For fiscal 2015, revenues increased 13% or $62.4 million to $539.3 million from $476.8 million in fiscal 2014. The increase was due to a $69.7 million or 19% increase in revenues from Apio’s value added business, primarily as a result of an 88% increase in salad kits sales. The increase in Apio’s value added revenues was partially offset by the expected $5.3 million or 12% decrease in Lifecore revenues due to lower purchases related to one-time inventory adjustment by key Lifecore customer and from a $2 million or 3% decrease in revenues in Apio’s export business, primarily due to lower volume sales as a result of the West Coast longshoreman labor dispute during a portion of fiscal 2015. Net income in fiscal 2015 was $13.5 million or $0.50 per share, this compares to net income of $19.1 million or $0.71 per share for fiscal 2014. The decrease in net income in fiscal 2015 compared to last year was primarily a result of a $6.9 million decrease in other income in fiscal 2015 from first a $6.1 million lower increase in the fair market value of our Windset investment and second about a 793,000 non-cash expense due to the write-off of Landec’c equity ownership in Aesthetic Sciences. In addition to the $6.9 million decrease in other income there were numerous operational items that impacted net income during fiscal 2015 compared to last year. The primary areas of operation that increased net income were $9.7 million increase in gross profit and Apio’s value added vegetable business and a $2.8 million increase in the income tax expense. These increases in operating income were offset by first a $5.7 million or 50% decrease in operating profit at Lifecore. Second, a $4.5 million or 20% increase in SG&A at Apio; third $1.1 million decrease in gross profit in Apio’s export business and fourth, a $539,000 in operating expenses in corporate. Turning to our financial position, cash totaled $14.1 million at fiscal year-end 2015, increases in cash included $26.2 million in cash flow from operations and increased net borrowings by $8.1 million. Decreases in cash included increase in the company’s investment in Windset by $18 million during fiscal 2015 and spending $17.5 million for capital expenditures primarily for capacity expansion. As of May 31, 2015 the company has $39.7 million available under its lines of credits. Let me turn the call over to Molly.

Thanks, Greg. We continue 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 more 10,000 club and retail food service and food service locations throughout North America. During the fourth quarter of fiscal 2015, this new product platform reached an average weekly run rate of 2.9 million.

Molly let’s pause just a minute we don’t think, Jonathan can you hear us can anyone hear us? Operator Yes we can hear you, just fine.

Okay thank you. All right we’re good okay we’ll keep going. Please we may have been lost here for a moment, but we’ll keep going.

We estimate the North American salad kit category including both retail and club stores in the U.S. and Canada to be approximately $1.2 billion measured in consumer retail dollars. Although the Canadian salad kit market is much smaller than of that of the U.S., 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 a little more than 36 months ago. When combined with our historical core vegetable products we now are in 70% of retail purchase store sites in the U.S. and 75% of store sites in Canada, giving us a strong platform for future product expansion. Consumer awareness of our salad kit products continues to grow. And our EatSmart.net consumer website that is compatible with mobile and phones and tablets has accelerated that awareness. In parallel with the focus and growth of our salad kit products, we have started to phase out specific lower margin core vegetable products and selectively seek price increases for other products. We expect to begin seeing results of these efforts in fiscal year 2016. Revenues in our core vegetable products may decline slightly as a result, but Apio’s gross margins should be enhanced. Along with growing the sales of our higher-margin salad kit, we believe margin enhancement in our core vegetable products at Apio is essential for the long-term growth and profitability of Landec. Apio is the innovation leader in the packaged fresh cut 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 daily diet. The results of these investments are showing. During fiscal year 2015, 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 every day. Let me turn it back to Gary.

Thanks, Molly. Increasingly our focus going forward will be on margin improvement in our Apio food business and returning Lifecore margins to their historic levels. You will note that during fiscal 2015 the gross margins in Apio’s value added vegetables business increased 60 basis points from the prior year. Margin improvement over the next 24 months will come from prior mixed changes in Apio focusing on higher margin salad kit products from operational cost reductions driven from capital expenditures to improve plant productivity and from selected price increases were possible and appropriate. In fiscal 2016, we expect gross margins to increase in our Apio value added business by approximately 150 to 200 basis points and then our Lifecore business by approximately 750 to 800 basis points. Looking to fiscal year 2016, we expect substantial growth at Lifecore and continued growth in Apio’s salad kit products combining for an excellent year-over-year growth for Landec on a consolidated basis. Specifically we expect consolidated revenues to increase 7% to 9%, compared to fiscal year 2015. Consolidated operating income to increase 60% to 70%. Consolidated net income to increase 60% to 65%, Apio revenues to grow 6% to 7% and operating income in Apio to grow 30% to 35%. Lifecore revenues to increase 20% to 25% and Lifecore operating income to more than double and new corporate partner funded R&D and licensing revenues from two new licensing arrangements outside our food and medical businesses to be approximately $2.7 million to $3 million. And Windset fair market value increase to be flat to slightly up. The increases in net income in fiscal 2016 compared to fiscal 2015 are expected to be due to first at Apio increased sales in higher margin salad kits. Second at Lifecore resumption of growth as its key customers restores its historical purchasing levels and from new business initiatives advancing towards sustainable commercial products. Third at Apio reducing unfavorable operating variances in the value added vegetable business, primarily by executing on improved strategies for produce sourcing and increased plant operational efficiencies. This all results in an expected earnings per share for fiscal year 2016 of $0.80 to 0.83% per diluted share. Our capital allocation priorities over the next 24 months are continuing new product development of our salad kit product line at Apio with the launch of one new product per quarter on average. Second, expansion of our Hanover, Pennsylvania food processing facility. Third, investment in facilities for productivity improvements at all three of our Apio processing facilities. And fourth, expansion of our Lifecore facility adding aseptic filling capability and equipment. As a result of these priorities as stated earlier we expect capital expenditures to be between $40 million and $45 million in this fiscal year 2016 more than double fiscal year 2015. In summary, the Board and I feel very positive about Landec’s future. Landec has a seasonal leadership team, market leadership in the markets we serve with innovative products and growing markets with good tailwinds. The election of Molly as CEO ensures uninterrupted knowledge of Landec’s businesses and uninterrupted progress towards the next level of growth and profitability. We’re now ready for your questions.

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

Good morning Tony.

Thank you. Good morning congratulations Molly.

Thank you, Tony.

You are welcome. Couple of questions regarding Apio, could you tell us what the salad kit revenues were in fiscal 2015?

They were approximately between $120 million and $130 million.

Okay. And then in the fourth quarter Apio’s operating income declined as a result you say of higher SG&A payment headcount, yet you project - I mean that appears to be now a one quarter phenomenon and even though those cost will remain in place, why just a one quarter impact from that?

Well, we had a lot of hirings that occurred late in the fiscal year, lot on the beginning of the fourth quarter plus there was a big push in the fourth quarter on the marketing side. Now look before we expect sales and marketing at Apio to continue to grow year-over-over probably about at the same rate as they grew last year for similar reason.

Does that answer your question Tony?

Well, sort of, but will there not be a big push in marketing going forward, I mean is this again you hired a lot of people, but they’re still going to be on board, I mean, I am still puzzled as to why this just had an impact in the fourth quarter and not going forward?

Yeah. So, the other things that are going on next year Tony is that we will continue to increase the sales of our salad kits, which will contribute more profitability and we are focused on the lot of cost reduction initiatives as well. So, those are going to counter act some of those increases next year.

This year, the year we are in.

Right, the year we are in.

The year in that we just started.

Okay.

Does that make sense?

Right. And last question, the lease you refer to quote unquote improved strategies for Apio sourcing, are there other things that you’ve not talked about previously that are now in place?

The thing that we’ve talked about previously are in place, but nothing new that we haven’t already talked about it.

Okay, thank you.

Alright. Thanks, Tony.

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

Hey Mitch.

Hey, good morning. Congratulations, Molly.

Thank you.

So, couple of questions. First, when you’re looking at sort of the produced category and the produced industry, generally a lower margin business and I get it that you’re moving out of some of the lower margin more commodity type items, but I am curious how Molly or everybody would view the ability to sustain your gross margins in salad kits, which are double, triple what your normal margins are with the influx of competitors of the very strong category, I mean how long do you have these advantageous margins and I know you continue to move with new products that will keep the margins up, but wouldn’t we expect these margins overtime to get little down a little bit?

Mitch this is Molly. I think the challenge will be there, that there will continue to be pricing pressures, but right now the category still shows extremely strong growth. The category is growing over 30% and retailers and consumers are looking for new products. So I think that the focus is on continuing to launch new and innovative things out in the market to keep those margins as high as possible and that’s what we need to do.

Mitch that’s a fair question it has been true for the industry that you’ve got some lifecycle issues. Molly and her team have just launched this protein salad business, which adds a new dimension a new platform of adding protein, non-meat protein to the products and that’s more value. So you can start to think about good margins in that product line as well. So I guess our view is that as long as we continue to innovate and launch new products that will help maintain margins. And secondly we are seeing knock on wood, we’re seeing first to market advantages this retail salad being first in really has made a difference for us and we’re seeing good traction with the Wild Greens and Quinoa salad, we’re seeing good traction with the Beet salads. So being first seems to really give us at least a several year advantage. So we’ll hope to maintain that as we launch new products.

Okay, that’s helpful. And then speaking of new products where are you in terms of distribution of the new the salad protein kits.

We are in Costco we’ve been on a rotation program in both Costco U.S. and Costco Canada. So I believe right now we have a product that’s the protein barbecued ranch in Costco U.S. and Canada, but that will be rotated out soon for other products. But I believe right now, you should be able to find it in almost any Costco store. We have just launched three single served versions. The protein salads in a few retailers and we will be scaling that up more in the fall.

Okay. So right now small distribution where do you think you would be by year-end in the perfect world? ACV vice or…

I think we’ll be in five, how about this will be in 5 to 10 retailers by the end of this calendar year is my expectation.

Okay, that’s helpful. Thank you. And then the capacity you are adding on East Coast. When do you think that’s complete and does that have any margin drag while sort of ramping up the capacity there?

The completion of schedule for early next calendar year to begin using that new capacity. We don’t expect any margin drag just because of the margins of the products we’re putting through there.

Okay. That means you already have it sort of pre-sold some of the capacity?

Yeah. So we are adding approximately 44,000 square feet in our Hanover facility. We’re building the walls and the foundation to enable long-term growth. But we’re only installing equipment as we need that capacity.

Okay.

And keep in mind we’re not just adding salad kit capacity there, we’re shipping some of our baggage capacity, vegetable bag capacity from the West Coast to the East Coast and this is going to enable us to serve us our East Coast customers more readily, right to be closer to them. And so we’ll be adding a new salad line in Hanover, Pennsylvania and as our salad kits continue to grow we have capacity to continue to add more lines.

Okay. And then I really appreciate the detail in the Q&A part of your press release, but particularly on the produced program, I appreciate the detail, I was curious you are sourcing more from Texas and Mexico, I mean where - how much, what percentage roughly do you source from those two geographies and where do you think that’s heading?

Pretty small, it’s typically 10% to 20% and it’s more to give us a diversity to reduce our risk. It gets weather in the more prolific areas of California and where we would typically grow. So it’s a small amount, but at the same time it helps us diversify our risk and serve our customers when we do have weather issues in other areas.

Okay. And then just last question on Lifecore. So with 25% growth call it $50 million kind of range, that’s up about 9% from where you were in fiscal ‘14, which obviously take away last year, which was unusual year because of the eventual customers signed and [ph] orders. But that’s only 9% growth over two year period. I thought the growth rate of Lifecore be a little bit higher, is there anything that happened in those two years besides the obvious that would have slowed down what I thought would be typically at 9% or 10% type of growth rate?

We’ve got a fairly significant effort with some collaborative partners who are pharmaceutical companies they’ve got the FDA and clinical trial gauntlet to run and so we had a lot of development work with them, development revenues and the first partnership is expected to have FDA approval and launch of their products which will really we’re going to be the exclusive manufacture, that won’t come until very late in FY16. So that we were hoping that would come faster, you know as well as I do. You’ve got clinical trial data; you’ve got FDA reviews things like that. But that big uptick really doesn’t start to kick in until late FY16. So that is a big factor in the revenue share.

Okay, alright. Thank you, that was very helpful.

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

Hi, Morris.

Molly congratulations.

Thank you.

Turning to Windset the permitting issue, you touched on it earlier in the call and clearly has an impact on the non-operational side non-operating income, can you just put a little more meat on, you touched on it, but again why a 12 month delay what is it more specifically again you touched on, but just you kind of bring this more to speed. And then a question for Greg, we talked about in the past, but again the fair market value accounting for the investment of Windset when do you think that’s going to change as far as accounting in that manner down the road? So those are my two questions.

Yeah Morris there is two parts of that question, I’ll do the first Greg will do the second. You’ve been to the facility, you’ve seen the state-of-the-art facilities you’re familiar with the land mass around it et cetera, et cetera. So they were anticipating building this new capability land contiguous to the land that they’re on. But instead of being in the city of Santa Maria it moved into the county of Santa Barbara. And they anticipated that there would be no new permitting requirements et cetera and they were unpleasantly surprised to learn that with this new government jurisdiction of the county. They late in the game they learned that extensive permitting was required. And so that’s what we’re dealing with. And you can’t argue with government officials, the way they want to do it that’s why we have to do it. So and it’s a - that county is particularly noted for long lengthy permitting process. So that’s what we’re living with that’s what they're living with, I wish I could tell you that we could - to move this forward much faster, but they don’t anticipate that they can’t. So that’s the permitting issue it’s a new jurisdiction a new body of people. And they are doing some new approaches in terms of fiscal structures and new approaches in terms of hydroponic growing as you know we’ve been stating for some time that that was one of the objectives was to look at a totally new state-of-the-art approach and look at some new crop charges. So the reality is it’s going to be a year delay and there is not much we can do about it. So I’ll give the second part over to Greg.

Yeah Morris, this will be the last year, FY16 will be last year that we will be using projections to determine our fair market value of our Windset investment. As you recall, there is a protocol associated with our agreement with Windset that’s effective on or after February 15, 2017. At that point in time, the value of our Windset investment is going to be based on a formula that is predetermined in the agreement, they can be along the lines of a 12 month look back of EBITDA, times of multiple plus cash minus debt and equity. That establishes the value of Windset in total then you times that value by our 27% ownership that then is the value of our investment. So once we get the vast point in time which will be the third quarter of fiscal ‘17 the volatility on a quarter-to-quarter basis is going to drop dramatically. And you should see a fairly steady increase or I can’t say increase quarter-over-quarter, but increase each quarter at a fairly steady rate at that time and going forward.

Does that answer your questions?

Yes it does. But I’m just curious I don’t know how you can answer this question, but if you have to move to that sort of change now with the value change materially from the fair market value accounting you’re doing now?

Well it would just from aspect that the numbers that we’re currently using are still the 12 months ended February 2017, but they’re based on a projection. Because it’s a projection you have heavy discounts against it. So if were to value it today the discounts would go away completely. So you would automatically get a pickup in the current value because the current value is a present value of future cash flows.

Okay. One last question just a little thing you mentioned here in your release here I think on fiscal ‘16 new licensing revenue for departments using the Intelemer anything more you can tell us about that? And anything that becomes advantageous from there?

Well couldn’t hear the last part say that last part.

Any incremental partners you are looking at.

Okay. So a number of years ago Morris if you remember are tracking us about four or five years ago we were doing a lot of licensing deals, it was really stretching us in many different directions and we were dependent on the partners for commercialization et cetera, yes you had the gain of short-term licensing revenues and that kind of thing. And we kind of we call turkey we stopped looking for licensing partners stop doing it. And a couple of these in the last year a couple of companies approached us made compelling arguments for us to work with them on this. One of which is just a straight licensing deal we transferred technology and get a license fee and do some work and then we’re done. The other one we do have some ongoing R&D work in which they compensate us. Let me just say that they’re in areas outside of our core food and medical business. They are one of them has some very good long-term prospects in terms of royalties that would be generated. The other one isn’t it just a paid up of royalty. We just feel it’s better that as we make progress and move towards commercialization with this one partner. We’ll let you know what’s going on we’ll tell you what it’s all about, but at this point we’ve been a little bit reticent to talk much about these because who knows how well they’re going to go. It does represent a couple of million dollars of licensing and R&D fees here this year, so it is pretty lucrative. But we are not proactively looking for outside of our core businesses. We’re not looking for licensing partners, they tend to stretch us in different directions. We're glad to have these two. Let me also mention to you that in our BreatheWay business remember the packaging technology, there is quite a bit of activity right now in terms of new licensing opportunities for our BreatheWay technology in the generally fruit application. So as you know we focus on vegetables. And you’re going to be we will talk more about that as that happens. But we’ve got boy we’ve got about five or six collaborative partners that are testing and looking to commercialize their products using our BreatheWay packaging technology, that we’re very interested in that we are actively pursuing. But these other applications these other partnerships came to us. They’re going to be few and far between over the next few years.

And these five discussions with that you just referred to now, this is a fiscal ‘16 or fiscal ‘17?

‘17 yeah this is the development phase this is when they could start commercializing in this fiscal year later in the year, but in terms of material impact it wouldn’t be until FY17.

Thank you.

Thank you.

Thank you. Our next question comes from the line of Brent Rystrom from Feltl. Your question please.

Hey, Brent.

Hey Brent.

Hello there, how are you guys?

Good.

The kind of a couple of follow-ons to a few of the previous questions. So have you kind of set with at present you’re discounting the Windset farms back from what you think that end value was going to be in February of ‘17?

Yeah well certainly our K that’s going to go out tomorrow, they don’t disclosing it and it’s no different in the third quarter. Weighted at 21% and then on top of that the discount rate the overall weighted discount. There is a lot of components that add up, but the overall weighted average is 21%. And then after you apply than you apply a lack of liquidity discount, which I think is around 15% at this point, both of those will go away. When we get to February 2017 the new discount rates are going to be zero.

And then post the February 2017, you’ll continue to have a formula calculate the value of that business and then your ownership or will you have equity in the earnings?

No it will continue to be under fair market value accounting and it will be using the contractual formula in the agreement.

Alright. Can you kind of characterize you mentioned in your prepared comments that Windset was a $0.05 impact in the fourth quarter and a $0.07 impact on the year, for the forward year would you characterize that impact of $0.07 again or would you characterize it more like $0.10 if you account for what could have been the growth?

Yeah that’s $0.10 plus.

About higher.

Yeah. We had an anticipated returning to $0.14 if not higher levels in $0.16 and that’s just not going to happen now.

Significant, Brent.

Alright, thank you. On sourcing a lot of this is new for me timing wise since I’ve known you because I have not known you through an El Nino cycle. What are your people telling you as far as what typically happens in California and now your alternate sourcing markets of Mexico and Texas and then Florida when it comes to sourcing in a heavy El Nino, supposedly we are in that heaviest El Nino since ‘98-99 can you give us some thought of the impact on El Nino weather typically has on your sourcing?

Yeah. You can have flooded fields and first of all every Californian is praying for big El Nino year, but it can adversely affect us and the El Nino we're talking about would be West Coast so when affect we don’t think is going to Florida, but you are right.

For all in theory Florida gets fewer hurricanes so…

That's good, okay that’s good. But they are projecting that this could be the big El Nino year and so anyway we again you’ve got to have a diversity and sourcing you have to be prepared for this. And it could adversely affect. So there is just no question about it we shouldn’t dance around the problem, but we did have challenges in the last El Nino year which I can barely remember because it’s been so long ago, but it would affect everybody and everybody on the West Coast and agriculture if there were torrential rains you just know that you can't what can you do about it. Now that’s why long-term Windset has the answer, that's the long-term answer is to move things inside and do it the way they do it. But we are preparing for it we’re anticipating it might happen. So we just have to breathe forward.

Different topic the expectations for debt growth in 2016, do you see debt continuing to grow faster than the balance sheet and equity or do you see that slowing a bit?

Well we are going we set lines; it will grow basically with the growth of our CapEx, we intend given the current interest rate environment and how cheap that is to ahead and borrow the money if we need to cover our CapEx. So we think a lot $40 million, $45 million.

Okay.

And as previously stated Brent we have a good cash flow from operations year that we are anticipating.

Alright. And then just a couple of technical questions probably more for Molly on the salad kit side, do you know what the mix of $1.2 billion of sales for these kit is by channel?

I do.

And just a rough idea and I am just trying to thinking of the margins of different categories trying to back in then what the purchasing market is as oppose to the selling side of the market?

Right. Well we typically look at it those numbers the $1.2 billion includes U.S., Canada, club stores and retail.

Okay.

So, we can look at it a couple of different ways. We can look at it on retail and club, the retail - well let’s look at North America and divided by U.S. and Canada first of that most of this almost all of it is for salad kit is in the U.S. So if you look at the salad kit market I am going to estimate I am talking off the top of my head here. I am going to estimate about $900 million of the salad kit market is actually in the U.S. with the other 300 million being in Canada.

And other split between club stores and retail?

Yeah. So if you give me a second here I had it written down.

And Brent as you know that the food service is not the user of salad kit. So we're not counting that this is a strictly club store and retail. And if Molly if you can’t find it we can get back to Brent.

It’s mostly all in retail, so the club salad kit business might be around $60 million it’s that small in retails dollars where the retail business is really driving a lot of those dollars.

Okay. And then by implication Molly, Canada is about 10% of the U.S. population. So is Canada in your mind a mature market now or is it growing as fast as the U.S. is…

What’s been happening in Canada? I am sorry go ahead.

Yeah does that imply to $300 million benefit, $3 billion U.S. market if Canada is indeed a measure of maturation.

It’s been pretty incredible what’s been happening in Canada and the growth we’ve seen. So the salad kits are growing in the high 30s and 40s in Canada. So, and to tell you truth Eat Smart is driving all of that growth of course it’s a much lower base so as we have $300 million so that growth isn’t going to be as much of the impact as you’re going to see in the U.S. I hope that that is a measure of what can continue to happen in the U.S. and we can continue to grow awareness of salad kits even the category that we can continue to grow the category in the U.S. and that’s what I would hope to happen, if that awareness continues to grow and we bring more consumers into the salad kit category as people are looking to eat healthier.

And then my final question Molly is could you define for us any broader sense with that $1.2 billion as part of it, is the $1.2 billion part of a broader packaged produced category or what’s the parent category above that and how would you describe it?

Well, the $1.2 billion represents specifically salad kits and that includes vegetable salad kits as well as latest salad kits so a season salad kit would be in that $1.2 billion. Alright, and a kit is defined as something that has a master pack in it, if that helps. So we have addressing or you have something in the kit in addition to topping and dressing. So that’s the salad kit market. There is a much broader market out there within produced and fresh cut vegetables we measure around more of the $2.4 billion and that’s going to include everything from all our fresh cut vegetable bags and our trays and our green beans.

Thank you very much. That helps.

Thanks, Brent.

Thank you.

Thank you. Our next question comes from the line of Nelson Novus with Winfield Capital.

Hi, Nelson.

Yeah. Hi there. I just had a couple of questions. Going back to the first question that was asked on the call, I believe by Tony in regard to the SG&A increase, I am assuming that what you put in place there is a capability to grow beyond fiscal 2016, I mean is that fair to say that you’ve created a capability that will take us beyond the current fiscal year and we won’t see that kind of gearing up again?

That’s correct, Nelson. I mean that SG&A increase comes in two parts. One it is an increased spent in our innovation to work on new products and do consumer testing and to market directly to consumers online so you have higher expense. But we’ve also added people, just a year ago we hired a new VP of Marketing, we’ve added a couple of new people in the marketing department to be able to help us all these projects. We’ve also added a new VP of Procurement and a new VP of Quality. So we’re really trying to step up to add the capability like you said going forward to take us to the next stage of growth.

Okay, good. And there are couple of things that are thrown around maybe I am mixing some metrics there let me just get it straight, we have a 12%, as I read about a 12% market share in the salad kit area, which I think you described as $1.2 billion entity, but somewhere else it says that we are the market share leader throughout North America in branded fresh cut packages vegetables and also in the conference call it says that we’re an emerging participant. So, my question is does the 12% make us number one? Or am I mixing apples and oranges in here.

A little bit so let’s talk about actually what Brent brought before is we are participating in a larger market in fresh cut vegetables, okay and that’s about I think that’s a $2.4 billion to $2.7 billion, in that market so let me describe what that market includes, it includes the U.S. and includes Canada and then includes our specific product lines and which we compete which our salad kit green bean, vegetables and tray. So that is the larger value added fresh-cut vegetable market of about 2.7 billion, in that market we are the leading branded player. We have about - Apio has about 18% share in that total market and this includes both club stores and retail stores.

And the legacy business. I got it.

Yeah. So it's all the product segment we are in, one segment of that is obviously the salad kit market. That is $1.2 billion of about 2.7 and that's why entering this market was such a big deal for us because we considerably added to our market opportunity. Right, so just the salad kit market in North America and club and retail is 1.2 billion. That is the market where we are new in trend and we are currently at about 12% and we're going to be striving to increase our share in that.

Nelson our angle for entering that salad kit segment as you probably know is that the vast majority of that 1.2 billion is made from leaf lettuce base products. You are going to start they all look pretty much the same, you've got lower nutrition levels, we've coming with salads made from vegetable components nutrient rich. We've had unique and interesting mixology in terms of the mixture of these vegetables. We combine it with the BreatheWay packaging technology and we are using our platform of being in 70% of retail stores our launching platform.

Okay.

And if I had to tell you what the stunning surprise has been, we've been surprised by how fast this has been taken up and also how fast Canada has grown. Canada is just shockingly high growth area and so that I think it's this unique approach of really being focused on the nutrient part of this and vegetables are in favorite these days.

Doing that sub-category we have a much higher market share.

Yeah.

Yeah.

Just to clarify one thing with Windset, did they expand into an area that they weren't in before or was it a whole new jurisdiction created?

So you know the site. You could literally if you are standing on their tower you could see the property it is, it's adjacent. But it moves from city jurisdiction to county jurisdiction and let's just say that there is different players, different procedures, different permitting. What should have been straight forward in our minds and their minds evidently is in the eyes of the county. So it's close by. It's going to obvious place to expand. But it moved them into a different jurisdiction.

Just because that where the property was.

Yeah.

Across the street.

I understand, I know that county and you got a lot of pie in the sky and liberals down Santa Barbarian and then up where you guys are, there is some real entrepreneur. So it is a bad neighborhood to walk into. I hope that when you say a year because I mean these guys don't understand business and they are able to kick it around forever particularly if there is water involved or whatever. Do you feel pretty comfortably years what you need or I mean do you have a - in Santa Barbara or somebody there?

Yeah. There our comfort house to be based on their comfort. We've meet with them extensively obviously we were planning on this being in the fair market calculations and when we’re talking about higher expectations foreign expert share this was all go. They are confident that a year is appropriate and realistic.

But your operation up in Santa Maria is to create jobs in the private sector, that's a bad thing for the people down South. Anyway, the R&D partner funding that comes in here. I'm a little bit obviously I thought licensing. Just what part of the company is that coming out of?

Okay. Let me make sure I understand. We have....

$2.3 million of quote R&D partner funding and I have a feeling that doesn't have much to do with Inteleco whatever with...

Okay. So these two new partnerships. Thank you referring to which we could generate $2.5 to $3 million is that what we said. These are two companies neither of whom were in the food or the inject-able medical materials business. So therefore there outside are core business. They approached us. Once of which we agree to license them, the Intelemer technology, remember that’s the side chain for sizable polymers that have temperature activation that that the stuff that we were founded on. So it's a straight royalty prepaid royalty license one set of dollar send to us we're done. The other is an ongoing collaboration where they are funding R&D they are paying us for an exclusive licensing feels as licensing dollars. We've defined an exclusive field in which they can use our technology in that field. And so involves upfront license fees R&D payments and eventually royalties. So it's there is two different approaches two different companies of both outside. We didn't we were not seeking these partnerships they came to use. They made sense for us it's if they're not hugely distractive we can still focus on our core businesses and that's why we did it.

Yeah my specific question have to do with page 5 of the - number four towards the top. New licensing revenue from two new partners using our - polymer technology in two new fields of use very clear. Then a couple of senses below it talks about a balance of here in terms of recent equity grants from increases salaries and bonuses partially offset by an approximate $2.3 million increase partner funded R&D and licensing revenues. Those are both referring to the same that you just did, that's apples and apples right.

Apples and apples.

They will all fall under corporate in our segment report.

Yeah okay just one other. I think I have one last question, I mean I wanted to go into a whole a lot of I'm just kind a reading this between the lines. But it looks as though your new procurement guy is doing a lot of meteorological data dump and it sounds like a lot of complicated metrics of these feeding in this --so what does he were appointed had and have a lot of data that he puts into machines and comes out with thought of where you should be putting your where you should be putting your relationships because there seem to be a number variables that you're looking at historical meteorological patterns et cetera that weren't being done before. Is this am I on the right track.

You said you wanted the short answer and the answer is no. That were appointed and he's not doing that. What he is doing is question and has challenge to us on the contractual approaches we have with growers so that our incentives and outcomes are better aligned with growers. And so when we win the grower wins et cetera et cetera. So that's the main change she's making in terms of looking at different approaches to grow our relationships in contracts. In terms of using data and state-of-the-art techniques, everybody is trying to do that else. And so it's not so he's doing something different and unique there which is studies bringing good business practices to Apio. And we're benefitting from it so far. And he's if we have the - it will certainly be challenged by that.

Got it. Thanks, that's all I got.

All right. Thank you.

Thank you. Our next question comes from the line of Rick Fetterman from Fetterman Investments.

Yeah hey Rick.

Good morning. Congratulations Molly.

Thank you Rick.

Couple of questions Greg for you everything else is have been answered. But can you tell me what the average rate on our debt is and is it fixed rate?

Yeah virtually all of its fixed Lifecore is not in some floater, but it's around 2% it will have a paid off in a year. As the average is high 3s, if you were to blend all of the debt that we have.

Okay and my other question was also regarding the debt, but you said you might borrow some additional funds to grow with your to fund the CapEx. And that did you say it could grow to $40 million or $45 million or you didn't say by $40 million or $45 million. You said to $40 million or $45 million?

No it could grow by that is. That we wanted to keep our powder dry keep our cash better opportunity for cash then putting equipment. And you could borrow the money at 3% rate, in which after-tax is you're in the ones. That seems like a good use of your learning is to borrow the money to fund your future. And if you Rick we have a lots of unused debt capacity.

My last question is In fact we hope that the issues with Santa Barbara County resolve within 12 months is correct the press release said you expected production to be in October of ‘15 so is it reasonable to say late third or fourth quarter of ‘16 at this point?

Yeah that’s exactly what the thought process is right now.

All right everything else I had has already been asked. Thank you very much.

Thank you.

Thank you.

Thank you our next question comes from the line of Chris Kruger from Lake Street Capital.

Good morning Chris.

Morning Chris.

Hey Greg, two quick questions earlier you mentioned that at the new protein salads are on a rotation plan can you update us on the sweet potato chips are they permanent slots in Costco?

They are, they’ve been in a couple of two years in almost all source, we started three years ago and it gradually ramped up so yes they have a permanent slot in Costco.

Okay and other question is on Windset last quarter I think on the call you guys mentioned I can’t remember what was it, it was some kind of investment in Nevada or some kind of plan there can you update us on that?

Yeah they based on leasing a facility in Nevada four years and they got an opportunity to buy it and they jumped on it that’s why the reasons we gave them $7 million a year ago or almost a year ago. And they are in a process of doing the renovations that are required so they can grow their yield around, when they are leasing it they were only growing there seasonally. They were not growing there in summer and you can imagine why. But they are now putting in well basically new equipment, new technologies so they can grow yield around that should go live and start producing product sometime this fall.

All right all my other questions have been answered. Thanks.

Thanks Chris.

Thank you our next question comes from the line of Craig [ph] from Wells Capital Management.

Hey Craig.

Good morning everybody is on here. Two quick questions of course you mentioned that 2017 date for the change of fair market accounting but you also mentioned the quit call feature of that date or coincident with that date and wouldn’t that be the right time to discuss with the elder new goals your percentage of ownership with Windset and can you give us any color on that?

Yes and we’ll just see how things go way as many people on this call may know we have the opportunity to provide some liquidity for the senior new roles and they took that opportunity and I think that - what was it about 7%...

7%.

7% more and we left from 20% to 27% win for them win for us they still have ownership in the company and so that it’s a kind of thing where it’s an ongoing thought process Craig and we want to respect what they want to accomplish but that would be a logical conversation to continue to have with them. So if they’re interested they will approach us we’ll continue to indicate our interest and increasing ownership without tampering their ability to continue to grow the company, they’re doing a good job, we’re happy with them. So absolutely let me also mention that if anybody has any doubts the likelihood of anybody exercising this put or call at this point is close to zero I mean we want to stand they want us to stand so I see us continuing our partnership.

Great thanks. And giving your projections for radically increasing revenues and profitability at Lifecore but also combined with the lack of overlap of your Intelemer technology at Lifecore probably can’t trade what you thought maybe going into that business. Wouldn’t the board consider some sort of action to become more of a food products company a pure food products company? Much along the lines is dock resins and field choice and I date myself here.

Sure yeah I mean that’s actually it’s a conversation that board and the management team including the management of Lifecore has on an ongoing basis but you also have noted how much we’ve been investing in the business in the last couple of years and we’re adding cash 20-30,000 square feet of formulation and finishing capabilities, we’re about to lease significant warehousing space. So they have presented to us as recently as couple of weeks ago a vision plan of very impressive growth over the next five years while maintaining these very attractive margins and right now they throw off a lot of cash for us. They help us in the sense by green line. They have excellent margins. We like their growth prospect, we like the fact that they are diversified in terms of these partnering arrangements, we like the fact that they are moving up to value added chain by not just selling HA powder and liquids but now finished products to some of these to the most major and largest pharmaceutical ophthalmic companies in the world. So we do have that conversation periodically but at this point we're investing and now we'd say I won't see any motivation our part to do anything differently in the next couple of years. We like what they are doing and these investments really start to kick in big time in FY17. So yes we'll - certainly we have for this year responsibilities shareholders to look at a pure play in the food business and we'll continue to have those conversations. But right now I don't see it's changing.

Great thanks. And then finally off course congratulations to you Molly. You may remember me mentioning it was a strong container to be a CEO as long as three years ago you may or may not remember that?

I do thank you.

If -as the first person and to do that and dually noted we give you credit for that.

Alright. Thank you very much.

Thank you. Your next question comes from the line of Will Lauber from Sterling Capital Management.

Hi Will.

Hello. First question is for Molly what are you guys get in on your in customers because just with the Sal kits obviously it's a lot different than bag of cut up broccoli and so how are you getting information on the end customers?

On the consumer how we are growing. So that is a major initiative for us just I think there is last year now let's say two years ago. We won't - any money on the consumer we are very much at trade marketing organization. Really only putting our marketing and relationships through the trade and over the last couple of years we've realized we really need to focus on the consumer on consumer trends on future expense and the top of this these things to further innovation. So we have real several programs going on this year. Obviously we launched our new consumer website for eat smart and that eatsmart.net and we're starting to get a lot more traffic on that website. We're having a lot more personnel interactions with our customers through our website. We have a Facebook page we have twitter. We also have a large blogger program are starting so we are actually contact with over 200 bloggers throughout North America and as we launched products we are shipping products samples to this bloggers and asking them to write about us. Our PR efforts in other areas are also bit increased. Obviously we're going to start doing more banner advertising - call we did a banner advertising pilot last year. It has incredible statistics we gained - we're amp lift in the North East of 20% which was a much higher than any of us expected. So we have not started that this year we're going to look to start that in the October, November time frame this year to help push sales. We're also doing a lot to gain market consumer inside through market research. So we're starting to do a lot more consumer testing. We're doing consumer segmentation work. And this is all our results because we've been able to bringing that new talent in the marketing department with our VP marketing and the couple of your product and then just have been able to bring in that talent and lead way in this area.

I would imagine that could something that would not be easily copied by the competitors of you build up that knowledge based?

Right. I mean we are the brand in the market that is focused on innovation and it's all about growing your gross margin so you have more money to invest in these activities and its - processing.

One of the reasons Molly is doing this we're really starting to better understand the value of our trademark, trademark has a lot a cash to it and the question is how useful might it be in other food products et cetera not necessarily respiring perishable produce. So this initiative has more value than just supporting our current business.

All right. The next thing was on Windset. I saw that I guess they're working I guess with the good government guys out there and the Santa Maria to open local customs office. Can you provide any update on that?

Have no idea what's you're no I have no idea. Customs office no I don't know.

At the public airport there?

You're again ahead of us. But we're look into it but that's best news for us. So thanks for giving us.

I'll send you something but.

I just don't break - if you can get to that customs office when he goes down there so.

Okay and lastly just a comment on the - Santa Barbara I guess. I can understand whether less water, less electricity and more jobs must be a bad thing.

Yeah it's a head scratcher as well. It's a head scratcher.

If you want to know my behalf do you want to send a couple of week old back - without the breed way packaging had appreciated.

Good idea okay.

Thank you. Our next question is a follow up from the line of Nelson Opus with Winsel Capital [ph].

I'm just wondering if structure now in that Molly's moved on to CEO what the team looks like in the eat smart packaging or If it's clearly the spectrum of her responsibilities are going to be much wider and just how would you restructure that.

Okay now so first of all the new organization will take effect as we said in the press release in October 15 just as a reminder. We are going to be flattening organization. Of it so I will pick on the CEO of Landec as well but I will be having four of the lead executives at Apio reporting directly to me as well as Lifecore as well as obviously the corporate functions with Greg and our new EVP of business development.

And so where Ron will fit into all this at COO.

COO so he's well I should have included him in the Landec. He will be reporting directly to me as well. And then three other Apio executive who have sales reporting to me marketing reporting to me and finance reporting to me.

And Ron will be sort of the operating guy.

He's going to take care of everything in the supply chain continue to be our representative on the Windset board. And he has very important relationships throughout the industry in the - industry and with the trade organization that he will continue to play that role.

And as announced he will become Landec's COO.

No I got it. Thank you. Now I don't wanted my last question I don't want to run into the rapid share with accounting. But its strikes me that what you've been doing in Windset is. you've been presenting evaluating a future assumption of growth and then putting a discount in addition to its almost a double discount because when your present value it implies a discount and then you putting a discount on that is that correct.

That is exactly correct.

So but when you here is what I'm having trouble. You implied that we will likely see an increased valuation strictly from doing things on a historical basis, but since we've been since we have been discounting a future growth to begin with and even though we've put an additional discount on that. Why should going historical lead to any kind of a step-up. If you're not sure where it's going to end up that's fine but I thought you said you were pretty sure there would be a step up just from that accounting treatment which - me a little confused.

No yeah maybe misspoke or maybe people that understand. I said that I expected the increase to continue. I didn't say who's going to increase year-over-year higher this is our value our investment will continue to increase but it would be much more stable quarter-over-quarter. And don't have the huge swings that we have right now. I mean.

The initial transition do you have any opinion on that now that's a neat but I'm just curious how that works. I mean --.

Not at this point because there on we they've got a lot of expansion plans that currently aren't factored into another forecast. So it would be believe that we are guessing at this point.

Well I do certainly I'm be very happy to put things on historical basis I think it simplify.

Wait it will make life a lot easier.

This is the accounting that there is a - for this transaction have the timing and why supported though. So we're looking for to that transition ourselves in that.

And that's it's unusual it’s the accounting. I wouldn't say from hell but from the boarder hell okay. Anyway I'll be glad to say you a goodbye thank you.

All right.

Thanks.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to management for any further remarks.

Yeah very much appreciate you being on the call today. We look forward to keeping you priced and thanks for your ongoing support.

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