Business Context and Reporting Period
The provided filing is Landec Corporation’s Form 10-Q for the fiscal quarter ended August 26, 2018, not a filing issued by Lifecore Biomedical, Inc. Lifecore is reported as Landec’s Biomaterials segment. The period covers the first quarter of fiscal 2019 and is compared with the three months ended August 27, 2017.
Landec operates Natural Foods, Biomaterials (Lifecore), and Other segments. The Food Export business was discontinued in fiscal 2018 and prior-period results were reclassified as discontinued operations.
Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $124.7 million | $115.8 million | Up 8% |
| Gross profit | $16.3 million | $18.8 million | Down 13% |
| Gross margin | 13.1% | 16.2% | Down 3.1 points |
| Operating income (loss) | $(0.4) million | $2.7 million | Declined |
| Operating margin | (0.4)% | 2.4% | Down 2.8 points |
| Net income applicable to common stockholders | $0.2 million | $2.1 million | Declined |
| Diluted earnings per share | $0.01 | $0.08 | Declined |
| Operating cash flow | $2.2 million | $3.5 million | Down $1.3 million |
| Capital expenditures | $14.4 million | $5.7 million | Up $8.7 million |
Natural Foods revenue increased 8% to $112.1 million, principally from a 13% unit-volume increase in salad kits and demand from existing customers. Biomaterials revenue increased 4% to $12.6 million, driven by development services and fermentation revenue, partly offset by lower aseptic shipments.
Natural Foods gross profit declined 13% because of higher labor, packaging, and freight costs. Biomaterials gross profit declined 16% because of unfavorable product mix and production and shipment timing. Research and development expense increased 4% to $2.8 million, while selling, general and administrative expense increased 4% to $14.0 million.
Cash and cash equivalents were $1.4 million at August 26, 2018, compared with $2.9 million at May 27, 2018. Including restricted cash, total cash, cash equivalents, and restricted cash were $1.7 million. Current assets were $88.3 million and current liabilities were $86.8 million, implying limited current-asset coverage.
Debt included a $39.0 million line-of-credit balance, $4.9 million of current long-term debt, $36.1 million of long-term debt, net, and $3.6 million of non-current capital lease obligations. The company had a $100 million revolving facility and a $50 million term-loan facility, both maturing September 23, 2021. Management stated that all financial covenants were met at quarter-end.
Material Changes Versus the Prior Comparable Period
- Revenue grew 8%, but gross profit fell 13% because cost inflation and mix more than offset volume growth.
- Operating results moved from $2.7 million of income to a $0.4 million loss.
- Net income applicable to common stockholders declined from $2.1 million to $0.2 million.
- Interest expense increased 88% to $0.8 million, primarily because the line-of-credit balance increased from $10.5 million in the prior-year quarter to $39.0 million at the current quarter-end.
- Capital spending increased substantially to $14.4 million, primarily for equipment supporting Natural Foods and Lifecore growth.
- Financing activities provided $10.7 million, including $12.0 million of new line-of-credit borrowings, partially offset by $1.3 million of long-term-debt payments.
- Windset-related dividend income remained $0.4 million, while the fair-value gain on the Windset investment increased to $1.0 million from $0.9 million.
- The company adopted revenue-recognition guidance under ASC 606 and restricted-cash guidance under ASU 2016-18; management reported no material revenue-recognition impact.
Guidance, Outlook, Commentary, Risks, and Unusual Items
No quantitative revenue or earnings guidance is provided in the filing. Management stated that cash from operations, together with existing cash and cash equivalents, was expected to fund operating and capital requirements for at least the next twelve months.
- Results may fluctuate because of seasonality in the Natural Foods business and customer order patterns in Lifecore.
- Management planned to launch Now Planting refrigerated soups beginning in September 2018.
- The company’s investment in Windset was carried at a $67.5 million fair value using Level 3 assumptions. The valuation is sensitive to projected growth, expenses, taxes, and discount rates.
- The company had a $4.0 million contingent consideration liability related to the O acquisition, with potential earnout payments of up to $7.5 million through fiscal 2020.
- Apio’s labor-related settlement required a final $1.8 million payment in July 2018. The company expects reimbursement of its $2.1 million receivable from Pacific Harvest through monthly payments by December 2020, subject to Pacific Harvest’s ability to pay.
- Management concluded that disclosure controls and procedures were not effective as of August 26, 2018 because remediation of a previously identified material weakness in internal control over financial reporting was ongoing.
- The effective tax rate was 25% versus 37% in the prior-year quarter. Accounting for the Tax Cuts and Jobs Act remained incomplete and the annual effective tax rate was subject to uncertainty.
- The company expects adoption of the new lease standard in fiscal 2020 to significantly increase reported long-term assets and liabilities, although it does not expect a material effect on operating-lease expense or loan-covenant compliance.
- Customer concentration remained significant: the top five customers represented 48% of quarterly sales, and Costco and Walmart represented 19% and 18%, respectively.
Investor Verification Checklist
- Confirm that the intended issuer is Landec Corporation rather than Lifecore Biomedical, Inc.
- Reconcile the sharp decline in gross margin and determine whether labor, packaging, freight, product mix, and shipment timing are temporary or structural.
- Assess liquidity after the $14.4 million capital-spending program and increased reliance on the revolving credit facility.
- Review the remediation status and potential implications of the material weakness in internal controls.
- Evaluate the recoverability and valuation sensitivity of the $67.5 million Windset investment.
- Monitor Pacific Harvest reimbursement of the $2.1 million settlement receivable and the company’s remaining legal exposure.
- Assess customer concentration, seasonality, Lifecore shipment timing, and the commercial performance of Now Planting.
- Review future effects of tax-law changes, lease accounting, interest-rate swaps, and debt maturities.