Lifecore Biomedical, Inc. (LFCR) Earnings Call Transcript & Summary

Good day and welcome to the Landec Corporation conference call regarding the company's plan to explore strategic options for its Curation Foods' vegetable bag and tray business as part of Project SWIFT. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, President and CEO of Landec Corporation, Dr. Albert Bolles, please go ahead.

Thank you for joining our conference call today. As a leading innovator in diversified health and wellness solutions, Landec is comprised of 2 operating businesses: Lifecore Biomedical and Curation Foods. Landec designs, develops, manufactures and sells products for the food and pharmaceutical industry. Today, I am announcing strategic initiatives related to Project SWIFT, a value creation program that charge a focused path forward rooted in solid, achievable goals to improve Curation Foods' operating cost structure, enhanced profitability and strengthen Landec's balance sheet. These goals have positive financial outcomes, which I'll review later in my remarks, and are being provided today to help investors outstand our near-term opportunity as we move more deeply into Project SWIFT. In conjunction with these steady-state financial goals, we are also announcing that we are lowering guidance for fiscal 2020 to account for an acceleration and a reduction in our core vegetable and tray business, unanticipated legal fees and increased spending to generate consumer awareness and trials in support of our Yucatan Squeeze innovation. The update to full year guidance includes an update to fiscal third quarter guidance as well. We are lowering our expectations for third quarter fiscal 2020 to account for a shift in timing of revenue at Lifecore from fiscal third quarter to fiscal fourth quarter. However, it should be noted that Lifecore remains on target to meet its goals for the fiscal year. Our updated fiscal year 2020 guidance, which excludes restructuring and nonrecurring charges, now calls for revenues from continuing operations to grow 4% to 6% compared to fiscal 2019, in the range of our $580 million to $590 million; earnings per share of $0.16 to $0.20; and consolidated EBITDA to be in the range of $30 million to $34 million. Our updated fiscal third quarter 2020 guidance, which excludes restructuring and nonrecurring charges, now calls for revenues from continuing operations to be in the range of $147 million to $151 million, earnings per share of $0.02 to $0.06 and consolidated EBITDA to be in the range of $5 million to $9 million. The turnaround at Curation Foods is in process and delivering tangible results. Following the completion of a detailed review of the business, we now have a clear understanding of the issues and have created a solid foundation and achievable plan with which to move forward. With Project SWIFT, we have transformed the culture of the company to focus on profitable growth to drive greater EBITDA, free cash flow generation and operational excellence. Of critical importance, we have the right team in place in one central location with the discipline and experience to deliver the measurable changes that can be seen in the earnings lift that we continue to project in the second half of this fiscal year. Today, we also provided our outlook for annualized savings from Project SWIFT, centered on network and operational optimization, a focus on maximizing strategic assets and redesigning the organization to the appropriate size to compete. We believe that these collective actions will create total annualized savings of approximately $5 million, which includes the $3.7 million of planned savings that we previously announced in our fiscal second quarter. Further, we also announced that we have started the process to explore strategic alternatives for our legacy $160 million revenue vegetable bag and tray commodity business, which includes a potential divestiture of that business. We have accelerated our planned downsizing of this business to focus our resources on our higher-margin product lines and our innovation pipeline. As I like to say to the team, we have to become smaller to grow bigger. And by that, I mean, we will focus on streamlining our Curation Foods business to grow profitably. As we move forward, we are taking a close look and refining product mix, differentiation, margin structure and logistics, which also benefits the commodity business and contributes to making the commodity business attractive for a potential sale. Importantly, I want to make sure I reinforce that during this transformation across all Curation Foods' product lines, we will remain fully committed to providing our customers, grower partners and consumers with the highest level of service and continuity. Project SWIFT is focused on delivering operational excellence as a cornerstone to improving financial performance. By way of example, we have made extraordinary progress in turning around the avocado products operation. Today, this is now a profitable business with a very attractive profile, and we have put the necessary operational processes and infrastructure in place to ensure that these improvements are permanent. Consider that when I joined the company at the start of fiscal 2020, Curation Foods projected its avocado products business would contribute substantial profits in FY '20. However, this business, despite generating $30 million in revenue during the first half of the fiscal year, radically underperformed with breakeven margins due to manufacturing inefficiencies and supply chain issues. The avocado products business has now been turned around. The team has implemented lean manufacturing principles that have significantly improved the cost structure and the profitability of the business. For example, our highest delivered cost per case price in the first half of fiscal '20 for avocado products was nearly $19 per case. Today, we are realizing a delivered cost per case of approximately $8, which is nearly a 60% reduction in our cost. This is the basis for the transformation in the avocado products business' gross margin and gives us confidence in accelerating from 0% to 28% by the end of this fiscal year, with additional room for upside as we further optimize operations and generate revenue growth. Our updated fiscal year 2020 guidance continues to stress strong second half, and we expect to generate substantial profits at Curation Foods in the third and fourth quarters of fiscal 2020, driven by the steep improvement in profitability within our avocado products business, while sourcing favorability across our product lines and our team hitting their aggressive cost out targets. This extensive work around Project SWIFT has allowed us to recalibrate our expectations for Curation Foods, which brings us to a steady-state financial targets that we are introducing today. As we look forward the full implementation of Project SWIFT, we see a path towards significantly improved financial performance for Curation Foods that we believe we can achieve on a run rate basis by the end of fiscal year 2021. We are targeting Curation Foods' annualized organic revenue growth of 5%, gross margins of 11% to 14% and EBITDA margins of 4% to 6%. As I mentioned at the top of my remarks, we are not changing any assumptions associated with Lifecore's annual forecast in fiscal 2020. Lifecore remains on track to meet its 10% to 12% revenue growth goal, and $21 million to $23 million EBITDA target after corporate allocations for fiscal 2020. We continue to expect Lifecore to generate, on average, low to mid-teen revenue growth over the next 5 years as they expand sales to the new and existing customers and continue to commercialize products that are currently in its development pipeline. In fact, we recently received positive news regarding one of our products in our development pipeline that is currently under review at FDA. As part of the new drug application review and approval process for one of our key partners, Lifecore was recently reinspected by the FDA with no 483 observations and a recommendation by the FDA inspector for approval of Lifecore's site. We are pleased with the positive outcome of the FDA reinspection of our facility, which is a key step in our partner's approval process, currently projected during calendar year 2020. Looking further out to the future, Lifecore is targeting approximately one regulatory product approval annually and is on track to achieve this cadence beginning in fiscal 2022. In summary, we will continue to demonstrate our commitment to drive shareholder value by focusing on maximizing the value of our portfolio of businesses. At Lifecore, we will continue to invest in growth to drive top line momentum. For Curation Foods, in the short term, we are seeing the positive effects of the turnaround of Project SWIFT and expect to generate substantial profits at Curation Foods in the second half of fiscal 2020. In the intermediate term, we are enthusiastic about the steady-state growth and margin goals for Curation Foods that we have outlined. I am confident that we are well on our way to achieving these goals and look forward to reporting against them in the coming quarters. Operator, please open the call for questions.

[Operator Instructions] Our first question comes from Mitch Pinheiro with Sturdivant & Co.

I had a couple of questions, sort of short term here on some of the guidance and a couple longer-term things. First, how -- so just looking at the third quarter, so I understand what the new revenue guidance, how much -- how -- what part of that -- of the reduced guidance is the acceleration in the reduction of your bag and tray business?

Oh, in -- I'm sorry, in...

Q3.

In Q3.

Yes.

In Q3, yes.

In Q3, it does not have as much of an impact. The greater factor in Q3 is simply the movement of the operating income and the revenue from Lifecore from a timing standpoint over into Q4. Where you're seeing the impact of the accelerated core veg is in Q4. And so they're -- we're anticipating just some further acceleration in that program as we rationalize and go through the process of taking a look at that business and following on to some of the options that Al referred to.

Okay. So -- and so in Q4, I mean, are we talking a couple of million dollars of acceleration? Is it $5 million?

Yes. So if I look at Q4 over Q4 a year ago, we're actually, at this point, looking at something that's more in the range of a few million dollars decrease. And a corresponding margin at standard that goes with that. That's probably somewhere in the roughly $1 million range, or about $0.03 right there so.

Okay. So looking sort of the bigger picture here, and -- so the businesses that you're looking at the strategic options, that's $160 million of revenue, correct?

Right.

How much -- is that profitable revenue? Is there any positive EBITDA to that business?

No. No, it's a breakeven.

At best.

At best.

With a lot of volatility, Mitch.

Right.

Okay. And then how integrated was that -- were those -- are those business lines with your remaining businesses, like the salads? I know a lot of times, there was a lot -- there was some cross benefits of having the legacy business. Is that going to have any impact on your salad manufacturing?

Not at all, Mitch. I think you might have been led in the past. I think it was really embedded and we really have taken several months of deep study into this, for lack of a better word. And there really is no impact at all for us to produce salads. And just remember, we only produce our core veg in our Guad facility. So just that. And just to clarify, Mitch, we are keeping our green bean business. That is a very profitable business for us. So that is not part of the reduction and/or potential sale of the core veg.

Okay. And then as -- I mean you're making great progress. I was just curious why in the Curation Foods guidance, sort of the run rate guidance for the end of fiscal '21, the gross margin range, it's not wide, but I wonder what separates the bottom end from the top end of the range on a run rate basis. I thought perhaps you could get to the bottom end and maybe even in the full year.

Yes, so there's a couple of things there. That range is a steady-state range, so just assume for the year. We're not sure how this option is going to play out in terms of selling the business versus significantly rationalizing it around a very strategic set of customers. And so on the lower end of that range, it assumes that we're going to keep a significantly reduced, but still a chunk of the core business. It's a low-margin business, but we're keeping the higher end of the margin. We think it's more stable. It's a margin structure that allows us to absorb and live with whatever volatility may go with that, while at the same time, significantly reducing the volatility that would otherwise hit the P&L. At the upper end of that range, it assumes a full sale and exit of core veg. Did that help or?

It's terrific. Yes, that was -- yes, very helpful. I will get back in the queue.

Our next question comes from Mike Morales with Walthausen & Company.

One of the things, Al, that you mentioned in the release and you touched on was some unanticipated legal costs. Can you just shed some color on what that's related to?

Yes. We have a -- we're being sued by one of our packaging suppliers. That was some work that was done before I got here, and so we're working through that. And then the second one is, I think you remember, we had an outside firm who handled our...

Labor.

Yes, labor in our facilities here in California, that we had to take a $1.2 million write-off because they couldn't pay us, and we're actually -- do not understand why they are suing us. They're claiming it's -- we did something. We just don't understand it at all. So these are 2 things that we're going to have to spend money on, and I really can't comment much more in detail. But we put some reserves in Q4, anticipating that we'll be spending some legal.

Sure. And then maybe this is for Brian. As you think about the reduced third quarter guidance and then looking at the fiscal '20 guidance, has there been any discussions with your banks as it relates to covenants that have been taking place?

Yes. Yes, we're -- we have a very solid relationship with the banks. I've been very close to them over the last couple of months, working with them. At this point, we are -- I'm actually working with them looking out third quarter, fourth quarter and actually all through fiscal year '21. And where we're going as a company and as a Board, we are sort of committed to a path of deleveraging the company from where it is today. And so we are -- I'm working very closely with the bank group. It's very constructive. It's working very well, and so I'm very confident in terms of how that is sorting out.

Our next question comes from Gary Sweeney (sic) [ Gerry Sweeney ] with Roth Capital Partners.

I had a question around, obviously, one of the main questions was, what would happen to salad sales with the veggie trays and bags coming out. But what about the assets? Obviously, you have a lot of distribution assets. I think you also have a facility in Pennsylvania for packaging, et cetera. What does this strategic alternatives do to that footprint on the asset side? Do some of those assets go with this revenue?

Yes, Gerry, the only place we produce core veg is California at our Guad facility. So the eastern assets primarily just due to the balance in green beans for us. So there's really no impact there. And yes, we have assets in place, equipment that we will be downsizing and potentially be able to sell some of the equipment.So I mean, my understanding also was -- this business was -- absorbed a lot of overhead. So what happens to margins with this -- the absorption on a go-forward basis if this business is, in fact, sold?

Well, let me just address it first, and then Brian can give you more of the financial detail. We did, as I said, several months' studies on this and it just played out that it wasn't as difficult, I think, as other people were led to believe, including myself, to pull up the core veg. It wasn't as embedded as, I think, people were told in the past. So I'll have Brian give you the numbers, but they're pretty telling.

Yes. No, actually, I'll try to stay away from the numbers, but I think the bottom line is the same. That -- so we spent quite a bit of time with the Hackett Group, who is very experienced in this segment. I've worked with them very closely in over the past 20, 25 years in prior lives. And so they very much understand the segment, the cost structure and such. And so we, over a period of months, went through a very detailed process with them, looking at those areas where we could actually eliminate costs in conjunction with exiting this segment and got to where we actually have a very -- should we end up selling it and exiting completely, we have a very detailed plan that gets us back to even and does not have the cost structure tumbling over onto our other products segment. We actually think we have a shot at having that breakeven be positive. And so -- anyway, so we spent a number of months on that. It was very cross-functional across the entire company so.

And I guess, the key there, if you get back to breakeven, it removes a ton of volatility from -- what we've seen [ over the last couple of years ]?

Absolutely. Absolutely. That's the...

Yes, that was one of the drivers.

I can't predict...

Yes, every hurricane that came along, right? It's just like what is it going to do now?