Lifecore Biomedical, Inc. (LFCR) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Landec Corporation First Quarter Fiscal Year 2018 Earnings Conference Call. [Operator Instructions] As a reminder, today’s program is being recorded. And now I would like to introduce your host for today’s program, Molly Hemmeter, President and Chief Executive Officer of Landec Corporation. Please go ahead.

Thanks, Jonathan. Good morning and thank you for joining Landec’s first quarter fiscal year 2018 earnings call. With me on the call today is Greg Skinner, Landec’s Chief Financial 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 2017. Landec had a solid first quarter, meeting expectations for revenues and exceeding expectations for net income. Our natural foods business, which includes Apio and O Olive as well as our Lifecore biomaterials business, delivered strong operating performance. At Apio, our Eat Smart packaged fresh vegetable business is off to a robust start, with first quarter revenues increasing 7% or $6.6 million and gross profit increasing 4% or $609,000 compared to the first quarter last year. This performance was driven by the launch of the Eat Smart Salad Shake-Ups and significant salad distribution gains from Walmart, Kroger, Market Fresh and other accounts, resulting in a 72% increase in Eat Smart salad sales within the U.S. retail market compared to the year ago quarter. This demonstrates substantial progress in our stated objective to grow Eat Smart salads in the U.S. retail market. Growth in salad sales within U.S. retail is essential to Apio achieving its long-term growth objectives. The U.S. retail market for multi-serve salad kits is approximately $1.4 billion or over 80% of the total $1.7 billion North American multi-serve salad kit market. Total Eat Smart salad sales increased by 15% compared to first quarter of last year, setting us well on our way to achieving our goal of low double-digit salad growth for fiscal year 2018. The U.S. retail all commodity volume, or ACV for Eat Smart multi-serve salad kits increased by 13 percentage points from 15% to 28% for the 52-week period ending July 29, 2017 and was up 4 percentage points sequentially from 24% for the 52 weeks ended May 27, 2017. We expect the Eat Smart U.S. retail ACV to continue to increase over the coming months as our salads continue to fill the shelves of new customers. In Canada, the retail ACV for Eat Smart multi-serve salad kits is approximately 81%. Consistent with our strategy, Apio, through its Eat Smart brand, is committed to innovating products that make it easy and delicious to eat healthy. In our ongoing efforts to make Eat Smart products available to all consumers, we are aligning ourselves with strong partners in all channels, including the growing online marketplace. It is important that we partner strategic with these customers to service changing consumer purchasing behaviors with Eat Smart innovative products. We are currently selling packaged fresh vegetables to several direct-to-consumer meal kit companies, including Hello Fresh and online retailers, such as Amazon Fresh. Earlier this month, Apio announced the launch of its own online shopping initiative at EatSmartAtHome.com. This new service offers Eat Smart vegetable bags, trays and salads in a premium online shopping experience and is available on select Western States, including all of Nevada and Arizona, most of California, Idaho and Utah and parts of Oregon, Wyoming, Colorado, New Mexico and Texas. EatSmartAtHome.com provides people who live in geographic areas where Eat Smart products are not currently offered at retail, but is a convenient way to access our produce. The home delivery service also makes it easy for consumers to ensure fresh vegetables are available in their homes at all times. The site offers a broad assortment of vegetables that are washed, trimmed and available throughout the year, with unique recipes on the package or the website to make vegetables taste delicious. With 1-day or 2-day delivery from Apio headquarters in Guadalupe, California, consumers receive their fresh products within 72 hours of being washed, trimmed and packaged, with nearly 2 weeks of remaining refrigerated shelf life. Just think of that, vegetables that stay fresh in your refrigerator for nearly 2 weeks. The home delivery service, combined with Apio’s patented BreatheWay packaging technology, delivers extreme freshness and extended shelf life to consumers. With a commitment to sustainability, the EatSmartAtHome.com delivery box installation and ice packs are all 100% curbside recyclable. You can access the site by going directly to EatSmartAtHome.com or visiting EatSmart.net and clicking on the Shop Online tab. Our EatSmart.net website has also been updated with new content that can be found by visiting the main navigation menu and clicking on the Core Values, Sustainability, Giving Back and Nutrition tabs. Lifecore exceeded first quarter revenues and operating income expectations, which anticipated lower gross profit and operating income due to a high margin shipment at Lifecore last year that was moved from the second quarter to the first quarter, resulting in much higher gross profit and operating income that is typical for the first quarter at Lifecore. Most importantly, Lifecore has expanded its business beyond its historical capabilities as a premium supplier of hyaluronic acid, or HA to become a fully integrated contract development and manufacturing organization, or CDMO, providing differentiated fermentation, formulation and aseptic field services for difficult-to-handle medical materials. Lifecore continues to add new product development projects in customers for both HA and non-HA products that will continue to fuel future growth. At O Olive, operating performance was consistent with expectations, with revenues for the quarter of $1 million and net loss of $132,000. We are starting to gain new customers and new distribution at O Olive and still expect O Olive to increase revenues by $5 million to $6 million and to achieve profitability this year. Before I go into more detail about our plans for fiscal 2018 and beyond, let me turn the call over to Greg for some financial highlights.

Thank you, Molly and good morning everyone. Consolidated revenues in the first quarter of fiscal 2018 decreased $9 million to $123.4 million compared to $132.4 million in the year ago quarter. The decrease in revenues was due to a $15.8 million or 68% decrease in revenues in Apio’s lower margin export business and from a $778,000 decrease in license fee revenues at corporate due to the completion of two licensing agreements during fiscal 2017. These decreases in revenues were partially offset by a $6.6 million or 7% increase in revenues in Apio’s packaged fresh vegetable system and from $1 million of revenues at O Olive, which was acquired at the beginning of the fourth quarter of fiscal 2017. Consolidated net income in the first quarter of fiscal 2018 decreased $1.2 million or $0.08 per share or to – $0.08 per share compared to $0.12 per share in the year ago quarter. The decrease was primarily a result of: first, a $1.7 million decrease in operating income at Lifecore due to an unfavorable product mix shift, which reduced its gross margin to 29% during the first quarter of this year from 41.5% during the first quarter of last year; second, a $1.2 million decrease in operating income at corporate due to completion of two licensing agreements in fiscal 2017 and an increase in G&A expenses that were primarily due to the addition of new business development personnel and increase in stock-based compensation; and third, a $544,000 decrease in export gross profit due to lower revenue. These decreases in net income were partially offset by first, a $900,000 increase in the fair market value of the company’s Windset investment during the first quarter of fiscal 2018 compared to no increase in the year ago quarter; second, a $609,000 increase in gross profit in Apio’s packaged fresh vegetables business due to higher revenues; and third, a $639,000 decrease in income tax expenses. Based on the first quarter results and our projections for remainder of fiscal 2018, we are reiterating our fiscal 2018 guidance. We continue to expect consolidated annual revenues to increase 2% to 4% in fiscal 2018 compared to fiscal 2017. This growth is based on our Eat Smart solid products growing low double digits, Lifecore growing 6% to 8% and O Olive increasing revenues by $5 million to $6 million. We continue to expect that revenues in Apio’s lower-margin core and export businesses to decrease $20 million to $25 million this year, a majority of which was realized during the fiscal first quarter with the $15.8 million decrease in revenues in Apio’s export business. For Windset, our guidance remains unchanged with the fair market value of our Windset investment estimated to increase $4 million in fiscal 2018. When combined with the $1.7 million in dividends, we expect a total contribution to pretax income from Windset in fiscal 2018 of $5.7 million. Overall, we continue to project consolidated net income to increase 35% to 55% in fiscal 2018 compared to fiscal 2017, resulting in an estimated earnings per share range of $0.52 to $0.58. We are expecting consolidated cash flow from operations of $32 million to $36 million and capital expenditures of $44 million to $48 million. For the second quarter of fiscal 2018, we are projecting revenues to be in the range of $135 million to $140 million and net income to be $0.06 to $0.08 per share. This guidance incorporates the impact of a shift in product shipments at Lifecore in fiscal 2018 from the second fiscal quarter to the third and fourth fiscal quarters. This shift has no impact on Lifecore’s fiscal year 2018 projections. Let me now turn the call back to Molly.

Thanks, Greg. Over the last several months, the U.S. and Mexico have faced a series of unprecedented weather and natural disaster events. Starting in June of this year, a series of tropical storms generated high humidity and excessive moisture to several growing regions within Mexico and California, further complicated by record-breaking high temperatures. This late August, Hurricane Harvey, Hurricane Irma and most recently, Hurricane Maria, have devastated the U.S. and its territories with unprecedented winds, widespread flooding, power outage and vast damage to infrastructure. Now in addition, Mexico has suffered a series of high-magnitude earthquakes. Our thoughts and prayers go out to all those whose lives have been affected by these tragedies. I am very proud that the Landec employees who have rallied and worked as a team to donate Eat Smart fresh salads to victims of the hurricanes. Our employees are currently collecting bins of personal supplies to deliver to earthquake victims in Mexico. We are extremely thankful that no Landec facilities were damaged and most importantly, that no Landec employees were harmed. Although these extreme weather conditions did cause challenges for Apio, Apio’s supply chain, sales and customer service teams worked diligently to partner with our high-quality growers throughout U.S. and Mexico to minimize disruptions to customers. As a result of preplanning, hard work and an increasingly geographically diverse grower base, we see no significant impact on our fiscal 2018 results, and as Greg said, we are reiterating our fiscal year 2018 guidance. Let me take a step back and tell more about our rapidly evolving natural foods business. This business currently consists of Apio, our packaged fresh vegetable business; and O Olive, our all-natural and premium olive oil and wine vinegar business. The transformation of our natural food business is made up of 2 distinct phases. The first phase began in fiscal year 2015 and focused on transitioning Apio from a commodity produce company to a true innovation company that is focused on identifying consumer healthy eating trends and developing value-added products to support these trends. Last fiscal year, we advanced this effort with the reorganization of our retail sales force, the addition of a new VP of Innovation and R&D, further rightsizing of our lower-margin historical core vegetable products and the launch of our innovative single-serve salads. We plan to complete the rightsizing of our historical lower-margin business in fiscal 2018 while adding new capabilities and introducing innovative products to deliver ongoing revenue and profit growth. The second phase of the transformation of our natural foods business began in fiscal year 2017 and continues in this fiscal year. The second phase involves expanding our product line from fresh packaged vegetables to include other natural food products outside of produce that meet consumer needs from higher margins and display less volatile raw material sourcing characteristics. To initiate the second phase during last fiscal year, we launched the Eat Smart 100% Clean Label initiative to ensure that all of our Eat Smart products will be made from all-natural ingredients. We also added the Landec new ventures group to focus on our natural food product strategy and to lead new product development and acquisition initiatives in this area. The acquisition of O Olive, a supplier of natural olive oils and wine vinegars, was the – one of the initial products of this group. We intend to leverage synergies with Apio to position O Olive as the innovative leader with all-natural California-grown ingredients that are fully traceable. During fiscal 2018, we are accelerating our efforts in the second phase of Apio’s transformation, in preparation for new product launches in the natural food space targeted for fiscal 2019 and beyond. Landec finds itself in a strong position in fiscal year 2018. We are excited to begin leveraging many of the investments we have made over the past 2 years in both capital and personnel to create forward momentum. During the last 2 years, we increased capacity of both Apio and Lifecore to meet future demand, and we added senior management personnel in the areas of sales, marketing, product development and business development to implement and drive our future growth strategies. This fiscal year, we expect increasing production volumes of our higher-margin products at both Apio and Lifecore to begin filling this capacity and increasing our gross margins over time. Similar to our food business, which continues to benefit from tailwinds of positive sales momentum and healthy eating trends, Lifecore is also benefiting from growing trend among pharmaceutical and other medical material companies to outsource specialty services and manufacturing. With the growing number of products in the industry seeking FDA approval, Lifecore is well positioned as a fully integrated CDMO to augment its pipeline with new products to fuel its long-term growth. This fiscal year, Landec is focused on delivering value for today and tomorrow. We will continue to innovate. At Apio, we will launch new Eat Smart products that make it easy and delicious for consumers to eat healthy. At Lifecore, we will add new processes and capabilities to meet the needs of our customers and – that have difficult-to-handle biomaterials. We are also focused on increasing production volumes in each of our facilities to drive efficiencies and increase our return on invested capital. Finally, we are defining and implementing projects that will drive future growth. For fiscal 2018, we expect capital expenditures of $44 million to $48 million. Approximately $12 million to $15 million of this spend is allotted for typical annual maintenance capital, but the remaining capital spend is needed to support existing projects to fuel our future growth. Moving forward, we are focused on three primary growth platforms. First, in our Lifecore biomaterials business, we expect revenues to grow, on average, at low double-digit rates over the next 5 years. As part of the transition to a CDMO business, Lifecore is adding new syringe-filling capacity over the next several months and new vial-filling capacity within the next 12 months, both of which will be needed in the future to meet the demand we expect from our deep pipeline of development programs, along with continuing growth from existing customers. Second, our Eat Smart Salad products are on trend within the fast-growing healthy eating space. With continued innovation and our new sales force in place, we expect revenues in our salad business to also generate low double-digit growth on average over the next 5 years. Third, we will continue to explore expansion into higher-margin natural food products, adjacent to produce, in order to leverage Apio’s national fresh food supply chain. As a first of these endeavors, we are committed to investing in growing O Olive by leveraging the sales, customer service, and purchasing and procurement capabilities of Apio to ensure that we realize a high return on our investment. In summary, we will continue to focus on developing innovative products to deliver value to our customers, consumers and shareholders. Our balance sheet remains strong and provides the resources we need for executing on our strategic objectives and reaching our financial goals. We are now open for questions.

[Operator Instructions] Our first question comes from the line of Morris Ajzenman from Griffin Securities. Your question please.

Good morning. First question here. In the release, you discussed expanded distribution and you highlight Walmart, Kroger and Market Fresh. Is that expanded distribution locations or SKUs or both?

Well, last year, as you recall, we were testing our Sweet Kale salad, starting a little over a year ago with Walmart, and we started with a few hundred doors. It was expanded to 1,000 doors. And now we are in all Walmart doors, which is approximately 2,800 doors of Walmart with Sweet Kale salad. So in the case of Walmart, it was really expanding our highest selling SKU to all of those stores. In Kroger, it was all new distribution of four new salads and we just recently finished the initial sell-in of all of those four salads to all the Kroger doors. Oh, I am sorry, well, I said 2,800 Walmart doors, it’s actually 3,800. I’m sorry, Morris.

Right. Thank you. And where are you – you have highlighted some potential new customers in the past. Any update on where you might be with that?

Well, first of all, we want to make sure we are successful in our newest customers where we just added products. So, what we want to do there is make sure that those products perform, make sure we support those products with promotions and drive consumer trial to make sure our velocities are in the top two quartiles. In addition, we are going after additional customers. As I mentioned in the script and in the press release, we still have a lot of way to go for growth in U.S. retail market. We currently have about 4.8% market share, the multi-serve salad kit in the U.S., so there is plenty of more room for growth. And to do that, we are going to expand in both our existing customers and go after additional new customers. I would say the top two targets that we will be going after for new customers are ones I have mentioned before, which are Target and Meijer.

Okay. And you have talked about it’s been a while now counties – turning to Windset, County of Santa Barbara, still working on I guess some permitting issues. That’s been going on I think for over a year. Any idea at this point? Is it close on horizon or it’s still work in progress?

It’s still – this is Greg. It is still work in progress. Their focus is on Santa Maria. On the city, they have had a very good history of being able to get projects approved. That has been the case with the most recent expansion. The 10-acre strawberry is in the city. The 30 acres of peppers is in the city. The next two phases of expansions, which are planned to begin for probably at least a year, are also in the city. There is no rush on the county. They are continuing to work through it, but I expect that, that is at least a year plus off before they get approval in the county. But it’s not – it’s not delaying any of their expansion plans as a result.

Okay. Last question and I’ll get back in queue. I think you indicated on the previous call that 15% of Lifecore revenues were non-HA, first, is that correct? And secondly, would you want to kind of venture what it might be at the end of the year?

Yes, 15%, that’s pretty accurate for last year. But going forward, I think for this year that’s probably not a bad number. Looking out, when we – and I think I mentioned this on the last call, but looking out at least 3, probably more, 5 years down the line, we expect that number to be more like 35%, 40%. So, a lot of the growth at Lifecore going forward is going to come in the area of non-HA products.

Thank you.

Thank you. Our next question comes from the line of Anthony Vendetti from Maxim Group. Your question please.

So first, on Lifecore, you mentioned that revenue in the second quarter is being pushed to the third and fourth, but the overall guidance for Lifecore revenues doesn’t change. I was just wondering was that just a customer delaying an order or what was the reason for that push?

Yes, it’s just a timing. If you look at Lifecore, if you go back at history of Lifecore, we do and they do a very good job of hitting their guidance for the year, with the exception of ‘15 where we had a customer cut their orders in half after we went out with our guidance. You throw that. You are out the window. You will note that their ability to hit – what our guidance is at the beginning of the year is very, very high. And the range of where we think – what they think they are going to come in and where they ultimately end up coming in is very tight on an annual basis. In fact, it’s ranged from 45% to approximately 48% on an annual basis over the last 5 years excluding ‘15. But when you look at the quarter and because they have much fewer, larger shipments, whereas Apio has thousands of thousands smaller shipments, Apio has a lower degree of very high volume shipments, their range on a quarter-to-quarter basis can be huge. In fact, when I look back 5 years, excluding ‘15, their quarter gross margins range from 28% on the low end to 59% on the high end, and it all comes down to mix and that’s what happened in the first quarter of this year versus last year and what we expect to happen in the second quarter pushing out to the third and fourth.

Sure. Thanks. Any update on the expansion plans? I know we were out there at the facility, we saw some of the new – the space that was being built out. Is that – everything moving on track? Any update on that?

Yes, everything is exactly on track. We plan to finish the vial fill line by the end of this fiscal year and it should be up and running in FY ‘19.

Okay, great. And then lastly on the home delivery business, do you expect that to be accretive to your current packaged fresh vegetable market or is it possible that it – did it cannibalize a little bit? And even so, if there is a little bit of cannibalization, it’s worth it because of the potential new customers?

Alright. So, we are not going to – we are not projecting any incremental revenue this year from this business. I think we are going to use the year. First of all, it’s only for a portion of the country. We are going to use this year to really learn the business. We don’t want to put any big marketing spend in it, but we will be doing some social media campaigns to just let people be aware that it is out there. We have generated a pretty long list of e-mail addresses from loyal Eat Smart consumers over the last several years that we have been actively engaged with social marketing. So, we will be e-mailing them about this new opportunity to order our products. But right now, it’s not something we are going to sink money into marketing and we are going to seek what orders come in and really use the year to make sure that we are having an optimal consumer experience and a very efficient operational experience on the back-end. So right now, I expect no incremental dollars from that.

Okay, great. Thanks, Molly. Thanks, Greg.

Yes, thank you.

Thank you. Our next question comes from the line of Colin Radke from Wedbush Securities. Your question please.

Hi, good morning. I think you came in a few cents above your guidance for Q1, but obviously, with the full year unchanged. Is that just conservatism or is there anything that you are thinking about as potential offset to that?

Right now, Colin, we are just keeping that the same and that’s what we are seeing for the rest of the year, so just no change to the current forecast.

And it’s prudent to do at this point, because remember that the winter season is – can be the tougher sourcing season and that begins here in the next months. So it’s always good to be prudent at the end of the first quarter.

Okay, makes sense. Just in terms of the Salad Shake Ups I mean, the press release talks about 3,000 doors. For context, how many doors are you in today? And when do you expect to hit that 3,000 number? And then are there any velocity or any other metrics you want to share willing to share with how those businesses are performing thus far?

Yes, just – so we are actually in 3,000 doors now. So the data we gave in the Q&A was – that we are in, I think, about 22 customers and 3,000 doors currently, so that’s not a target. Our target is to grow that much, much higher over the next year. In terms of velocity, we do not have that data yet. The product is a little bit too new out in the market to – for the velocity data.

Okay thank you.

You are welcome.

[Operator Instructions] Our next question comes from the line of Nelson Obus from Wynnefield. Your question please.

Hi, there. You are hearing me, right? First of all, Greg, I appreciate for the first time that we can true up in the consolidated statements of comprehensive income, the operating income number of $2.52 million, with the next chart with line of business, which is really helpful because we didn’t see that before. Because then, you can go into the line of business and find the same operating income number that’s on the P&L. I can’t underestimate how important that is – overestimate, excuse me. I will – just in the financial realm, in terms of your projections, can we – can I just make – can we just understand what cash flow from operations means? In other words, is interest expensed then subtracted from that or cash tax is subtracted from that? What – when you put that projection out there, what does that entail?

That is truly the GAAP cash flow from operations so it’s going to be our net income, which is after tax, after interest expense. So it’s got everything in there that for a GAAP net income and then you add back the non-cash items, which would be depreciation and amortization, your stock-based compensation, which is in cash. Any change in the difference between your tax rate and what you are actually paying, which would be the increase in your deferred tax liability that would be an add-back and of course, you back off the Windset investment because it’s an increase in income, but it’s not cash so those are the main components that make up the cash flow from operations so it truly is cash, not an EBITDA number.

That’s great, because that means you have maintenance CapEx, which you articulated on the call, plus growth CapEx. Okay, great. Turning operationally quickly to one thing here. Your – you have made arrangements to emphasize the high value arena, and you are expanding rapidly in Eat Smart. But as you do that and as you take advantage of these growth opportunities, what have you done on the sourcing side in case we have a repetition of some of the traumatic weather patterns that were impacting us a year ago or have we built in enough excess capacity by getting out of the commodity side, so that we really don’t have to worry about that?

Hi, Nelson. Thanks for your question. Yes, so both of those are correct. First of all, over the last several years, especially when as everybody on this call has been following Landec probably remembers El Niño, we continue to diversify our grower base into different geographic areas and I think that became very evident that we have done that when we came to these really disasters that we have seen over the last several months. So I think that work has paid off because we have increased the diversity of our grower base in the south, in the east, in the west and in Mexico to take care of that and I think that is one of the reasons that we came out so strong this quarter despite all of those weather instance the second point is we have been rightsizing our core business. And that core business is lower margin on a kind of a standards basis, but it’s also where all our volatility is and as we have decreased the amount of volume in our lower-margin business that’s more volatile, we have de-risked our business because the salads are actually not a very volatile business for us. Those crops are very sturdy they are more diverse in their growing regions, and we typically do not have disruption in our salad business, so we haven’t seen any this year or since we have been in the salad business, to tell you the truth, we have no disruption in our salad ingredients supply so we are doing it in two ways, and hopefully, over time, the financials will show this as through the diversity of our grower base and the rebalancing of our business to go to higher-margin less-volatile products, both in salads and in natural foods, we are going to see less volatility on the procurement side of the business.

I got to tell you that’s the first time that I understood that broccoli is more volatile than say lettuce. I think that’s really an interesting little fact. By the way, I might be really wrong about this but didn’t we have some headwinds specifically in Canada? Am I wrong about that in terms of the sell-through? If I am wrong, just forget about the question, but?

I am not sure I think what you are recalling is last year, we talked about a little bit of a softening in growth in Canada and that was a lot because of a recall from a competitor and the exchange rate. And so the high currency – it still hasn’t – it’s still growing at a nice clip, and the business is still doing really well. But we are not seeing the – prior to all that happening, we were seeing 44% growth rates in the salad business there. I think we are past that now, and I don’t see that coming back. I think it’s in the mid-single digits right now for growth. So it’s still a strong business, and that’s kind of held steady for quite a while now.

I see. That’s okay. Part of it’s a law of – the law of small numbers when you are coming off a slower base. So that – as far as O Olive is concerned, and you expressed on the call the idea that, that was sort of a prototype of what you would like to find out there are you seeing a deal flow that embodies some of the characteristics, enough of the characteristics of olive oil that you are giving it a serious look, in relationship not only to what its expectations could be but what you would have to pay for it? Or are we possibly looking at internal developments or extensions that we do ourselves?

So we are constantly looking at acquisition opportunities that being said, a lot of the values out there are still exceptionally high. You see a lot of the M&A that’s going on at extremely high multiples. And unless we believe that we can deliver a strong ROI on an M&A, we are not going to proceed. So we are not going to stop looking. I think we learned a lot in the process and you never know when we will find another one like O Olive. But that being said, a lot – those multiples are still very high. Right now, we are very, very heavily focused on internal product development and as I stated in my words earlier, we are looking to launch new products in the natural foods space as a result of internal development in fiscal year ‘19.

Got it. My last question involves Lifecore and I just want to make this – I want to get this clear because we know there’s volatility we have seen it and we know mix is involved but I just want to make sure I understand this. When we talk about revenue mix in the first quarter – or revenue volatility, excuse me, first quarter ‘17 versus first quarter ‘18, it’s really not there. I mean, I was – it’s kind of 12 plus versus 12 plus, it’s down maybe 2% but the operating income is down more like 75%. So it sounds like there’s a lot of – so this is not a timing issue on revenues. This is 100% a timing issue on mix. And I am just – if we could dig into that a little bit, what HA products are particularly profitable? And what aren’t or did we have something special going for us in terms of, I don’t know, royalty payment or it’s really – there is a lot of volatility there. And I wonder from a notational perspective, what type of operating margin in the long run and not quarter-to-quarter, but year-by-year could we expect for Lifecore?

Well, I mean, you are correct. The revenues were relatively flat, but margins were down conservatively quarter-over-quarter and all – it’s 100% due to mix. Lifecore basically has three revenue producers from services: one is from product development, so this is when we are developing a product with an existing or a new customer; one is fermentation services where we make or ferment a product for a customer; and then lastly is our aseptic filling business. All of those have considerably different margins. And so dependent on the mix, in any one quarter, you are going to get a big fluctuation. As I said earlier on the call, on a quarter-to-quarter basis, looking back over the last 5 years, excluding FY ‘15, which is an anomaly, the quarterly margins range from 28% to 59%. But on an annual basis, it was extremely tight, 45% to 48% and they managed their business, so that they get the desired mix between those three revenue generators in order to be able to achieve an annual gross margin of around 45% and we literally will make decisions on what we – what products we take, what customers we take on in order to be able to maintain that margin, so that...

Got it. That’s very helpful. I am sorry. I mean, my only follow-up would be obviously research is going to be high margin, because you are working in conjunction providing a lot of IP for your customer and may even get a forward payment, but fermentation versus aseptic, I would – and I won’t go any further with this, but I would assume that fermentation is a higher margin business. Am I right or wrong?

Yes, because if there is a little connection...

What? Okay. So that’s what I wanted to know.

And I got to admit, I don’t have the operating percentages in front of me. I usually think more along the lines of gross margin, but I can certainly answer that question offline.

Yes. I just wanted to get a sense, because I mean as the company expands, maybe they build on the fermentation side and it will just help us understand a little more again what the growth opportunities are, but thanks.

Thank you. [Operator Instructions] Our next question comes from the line of Victoria Konstantinova from THB, Inc. Your question please.

Hi, thank you for taking my questions. I have a quick follow-up on the Amazon relationship. Can you maybe give us a little bit more about the opportunity there on online sales? Which markets are you currently selling in Amazon? And is there a possibility there to go nationwide?

Sure. Thank you for your question. So we are currently working with Amazon Fresh and we are selling on both our core vegetable products, the vegetables and bags like broccoli, brussels, sprouts, etcetera. And we recently started selling them our salad products as well. We are primarily on the East Coast at this time and the goal is to go national.

So currently, like are the Eat Smart kale packages and the salad kits on Amazon like a full line rollout or are you just starting to launch those?

It’s just starting to launch with several – it’s not just one product though it’s several solid SKUs and specific regions in the East.

Great, thank you.

You are welcome.

Thank you. Our next question comes from the line of Francesco Pellegrino from Sidoti & Company. Your question please.

Good morning, guys.

Hello.

It looks as if you took the calling hit really big in Apio exports something you guys have done a great job in just transcribing to The Street. I was wondering if you could just comment on the cadence of Apio export for the remainder of the year?

Well, for the remainder of the year, as we have said in the press release, we expect that the hit was taken in the first quarter, because what – the business that we basically got out of was the fruit business. And you could imagine that – and most of that happens to be in the area of stone fruit, red plums, kumquats, peaches those type of things. And their season is basically the first quarter. So by getting out of that business, you are going to take most of your hit in the first quarter. For the rest of the year, we find it to be relatively flat with last year, maybe down slightly. As we said, we think the hit for – in total for the year right now looks to be somewhere between where we were at the end of the first quarter, in $20 million. Could that be flat the rest of the year? Yes. Could it be down another $3 million to $4 million? Yes. It’s going to be somewhere in that ballpark.

So, it seems that this product seasonality worked out that a lot of the calling happened in the first quarter will get it bounced back in Apio export, sequentially speaking, in the second quarter relative to the first. I am just a little bit concerned about what the read-through is and it just seems that the seasonality just sort of played its hand that the big hit was the first quarter and we will get the bounce back, if that’s correct?

Yes. Sequentially, it will be up in the second quarter over the first quarter.

Okay. Just want to do a little bit of math with you guys because your guidance – you always provide guidance for Lifecore for revenue growth of right now at 6% to 8%. What O Olive is going to contribute, you provide dollar value growth? And then all of a sudden, we get like this big range of low double-digit growth for Apio. And if total – so, the way I am backing into this right now, if you are reiterating fiscal 2018 guidance, you are looking for 2% to 4% revenue growth. That gets you to a range of $550 million to $560 million of revenue for the full year. We back out $6 million for O Olive, we back out Lifecore revenue, which is going to be anywhere between $54 million to $55 million based upon the 6% to 8% revenue growth that you have given us. We get Apio full year revenue of $490 million to $500 million. We back out the $110 million that you reported. And we are looking at like $380 million to $390 million. That imply like Apio revenue growing at 8.5% to 12%. Does that sound correct?

Well, you have to remember the double-digit growth is salads only.

And I am getting there. I guess maybe...

We haven’t given the guidance that Apio will grow at double – Apio revenue will grow at double-digits, only the salad part of the business will grow at double-digits. And the core part of the business is with export is going slightly down, right.

Right. Completely on board with you. So that would imply that for the remainder of the year, the last three quarters, total Apio revenue is going to be like $380 million to $390 million. $10 million still needs to be called. We back out the remaining three quarters of the export business and we are left with $330 million to $340 million of Apio value-added. You back out like $200 million of core packaged fresh vegetables and I am getting to a salad kit growth number of 15% to 25% for the rest of the year. And that just seems really sensitive math.

No, that’s too high.

We could take this offline. But I can tell you what you are missing is the number you threw out for Lifecore, for instance, that 6% to 8% growth is off a $59.4 million number. So I am not sure where your $50 million came from. So if that’s the case, you are missing probably $14 million in revenues right there.

Okay. So then, we should really be looking for a salad kit growth somewhere between like 10% to 15%?

That’s right.

Exactly. And remember, we said that overall low core – lower margin business that Apio was going to go down $20 million, $25 million, I said probably $20 million of that’s export. That means the core is going down $5 million, right. So when you start running all those numbers – when we are done with the call, I can walk you through the math.

Yes, that’s fine. I am looking forward to the data. That’s something you will simplify it for me instead of me having to do the back of the napkin math. So I appreciate...

We are working on that.

Yes, we are working on it.

Okay. And I guess can you just talk about the product development pipeline for Lifecore and how we should be thinking about it? Because obviously, a year ago, the big talk was about hyaluronan transitioning that to aseptic filling business. And when I start thinking about your product development pipeline, should I be thinking of the number of trials that you guys currently have, the number of Phase 3 trials compared to Phase 2? Is there any incremental insight you can give us into that development pipeline right now?

Yes. The way I would think about it is the change in the product development pipeline that happened at Lifecore has really been a transition from HA-only materials to non-HA materials, in addition to their HA materials. So what’s going to happen is their product development pipeline has grown tremendously, and we see it continuing to be robust over the next 5 years because they are supporting their existing customers with new product development, but also adding new customers into their product development. I think it would be really hard to think of like phases because we don’t give any information about what the product development products are, and we don’t communicate what phase they are in and this is due to the exclusivity of agreements we have with our customers we are bound not to discuss that kind of information so it would be hard for you to track that way. I think one of the ways you can track this is we usually publish the percentage of the revenues that are in R&D, and that’s a good forecast for new commercial revenue to come in the future so as you track R&D revenues and the question earlier asked about margin, those margins are nice and high. And as we have a lot of development products in the pipeline driving development revenue, that’s a good foreshadowing of the commercial opportunities we have in the years to come and that’s kind of the only predictor, I think, you have now you also see us spending money on capital, right? And as we spend money on capital we are doing that because we foresee what’s coming in the pipeline at some of our products going from development to commercialization, and we need to be ready. So when we are telling you about capital expenditures at Lifecore, we are telling you we are putting new lines, some that are finishing in the first half of this year and some at the end of the year, that’s also telling you that more products are either existing products or growing or we are commercializing some of our development products.

And just last question on Windset. So you saw on the press release that Windset allocated like 10 acres to growing strawberries and I was wondering, so I guess, Village Farms, there was an interview that their CEO did the other day, and he talked about the core greenhouse business or operations being a single-digit EBITDA margin business and Windset’s talking strawberries, and Village Farms expanding into marijuana growing and they are talking about potentially like a 40% to 45% EBITDA margin for that product. And I was just wondering if there’s any bigger catalyst or bigger conversations that might need incremental funding for Windset that might be able to drive greater margin expansion for the business since margins are – appeared to be so tight just in the industry right now?

Right. So I will say that Windset has fully looked at that opportunity and opted out for a number of very good reasons so they are not going to be going down that path. I will say that Windset’s different if you looked at Windset’s P&L versus Village Farms’, they have an extremely strong and profitable business in the current business they are doing. There is more demand for their products than there is supply and so I think they are in a little bit different position, and they are really poised for some strong profitability and growth in the future so they have decided just not to take that route.

Alright, that’s perfect. Thank you so much for your time.

Thank you.

Thank you. Our next question comes from the line of Chris Krueger from Lake Street Capital. Your question please.

Good morning. Just two questions. First, on Costco, I know it’s been I think about a year since they went to multi-sourcing and – with their salad products. Can you give us an update on that and whether or not you have made progress trying to sell in with other products besides the Sweet Kale?

Sure. So no good – no news is good news on that front. We have our stable business with them, with our Sweet Kale Salad. And then we are continuing to sell with Costco U.S. and Canada on our salad rotation program. So one of the things we do with Costco is we are bringing them new salads constantly, and they rotate them in and out. And this is great for us because it’s a win-win. So Costco really tries to provide that treasure hunt experience for their consumers and it allows us to really innovate and custom up our new salad concept and get those in stores with clubs. So we are continuing to do that is actually a very rapid innovation to keep up with those demands and it’s good it keeps our innovation team strong so we are continuing to innovate salad and other products for Costco and if they do a rotation and the sales are just stellar, they will consider keeping it in if they have enough space at clubs, they only can carry so many SKUs but if we do have one of these casual rotations where the velocity is extremely high, there’s always a chance of keeping it longer.

Okay. Then my other question as it relates to the Eat Smart At Home announcement you guys made, how you guys went about like driving awareness that, that’s out there and marketing it? Is there anything on the packaging or anything to drive consumer awareness?

Yes. We are going to start putting this, so probably it won’t be until – we have to redo the packaging, so it probably won’t be until later but we are going to start putting it on our packaging but most of it’s going to be through social media we don’t want to spend a lot of SG&A on it this year we have a nice space of existing Eat Smart consumers that have provided their e-mails we will be doing direct e-mail and social media campaigns at a very low cost and we are just going to use this fiscal year to learn about the consumer buying behavior we want to make sure the consumer experience is optimized and we want to work on it on the back end there is a lot of systems integrations and operational processes that we had to set up to do this we have never been a direct-to-consumer business before so you can imagine from a consumer service and an operations point of view, packing single boxes, it’s a different operation and so this year, it’s just really about social media and [indiscernible].

Alright, very good. Thank you.

Yes.

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

Thanks, Jonathan. And thanks, everyone, for joining us today to talk about Landec. I think we have a lot of growth and excitement in the years to come in our 3-growth platforms, which are Lifecore, Salads and Natural Foods. And we look forward to talking to you next time. Thanks for your time.

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