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

Good afternoon and thank you for joining Landec's business update call. With me on the call today is Dr. Albert Bolles, Landec's Chief Executive Officer. Brian McLaughlin, Landec's Chief Financial Officer; and Mr. Jim Hall, President of Lifecore, are both available to answer questions. 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 year 2019. Let me now turn the call over to Mr. Al Bolles. Thank you, sir. You may begin.

Hello, everyone. I hope each of you are safe and well. Thank you for joining me today to review our preliminary fiscal fourth quarter financials and progress related to our shareholder value creation program, Project SWIFT. Project SWIFT is designed to transform the Curation Foods business through network optimization, maximizing strategic assets, rightsizing the organization and improving our balance sheet. We created this framework to provide a pathway for Curation Foods to not only develop achievable goals but meet those goals through a disciplined approach. As a team, we are working closely together managing through new and challenging times and adhering to clear ROI objectives for all capital expenditures to build a sustainable and profitable future. Today, we are taking an important planned next step in Project SWIFT. With the announced consolidation of our Hanover, Pennsylvania food manufacturing operations into our Bowling Green, Ohio and Guadalupe, California manufacturing operations. We are targeting a date of September 1, 2020, to ramp up production in Hanover. This sets in motion our appraisal and sale process. The proceeds from the future sale of the facility and associated assets will be used to pay down debt and improve our balance sheet. This decision is part of a network optimization analysis that we've been working on as part of Project SWIFT. In July of 2016, Curation Foods tripled the size of this facility. And our analysis shows, this facility has utilized only 40% of its manufacturing capacity. This decisive move will improve customer service and productivity across our network with minimal capital investment. We expect the outcome of these strategic actions and others announced today will provide for operational efficiency with annualized cost savings of approximately $11 million and further support our broader goal to significantly improve Curation Foods' margin profile in the short to intermediate term. In addition to production overhead and SG&A savings, we will live up to our strategic promise of streamlining the organizations and focusing our efforts on our plant-based food innovation and driving operational excellence. Our daily work is focused on driving continuous improvement in employee engagement. We have an internal program that we refer to as ZEST. This program provided the platform for our team to deliver on our target 28% gross margin run rate for the avocado products business in fiscal fourth quarter. I am pleased to report that we have achieved our cost-out goals and have delivered over $21 million in projects to improve the cost structure of our organization. I am very proud of our team's focused efforts, improving productivity and employee engagement throughout our organization. As we move into fiscal 2021, these improvements will translate to greater earnings consistency and higher margin rates, something we are very excited about. With respect to our preliminary unaudited fiscal 2020 fourth quarter results ended May 31, we generated approximately $156.1 million in revenue, approximately $12.6 million to $14.6 million in adjusted EBITDA and approximately $0.01 to $0.06 in adjusted EPS, at the midpoint of the range we provided today. I'm proud of both our teams at Lifecore and Curation Foods for delivering against our revenue guidance into fiscal '20 fourth quarter. This was no easy task, particularly in light of the disruption that was brought about by the global pandemic. However, we didn't escape the volatility unscathed. The combination of unpredictability of consumer shopper patterns for fresh food and the temporary manufacturing inefficiencies at Lifecore associated with COVID-19 pandemic had a temporary negative impact on our gross margins which negatively impacted our overall profitability, which came in below plan. Despite the fourth quarter disruption, we expect that Curation Foods will still deliver fourth quarter adjusted EBITDA that is greater than its entire contribution in fiscal '19, a feat that I view as a significant accomplishment given the extensive turnaround effort that were implemented this past year. During fiscal fourth quarter, as a result of COVID-19 pandemic, Curation Foods experienced extreme customer order volatility and product mix shifts that temporarily compressed our gross margin delivery. The impacts cascaded through the supply chain. For example, we had acres of fresh product that there was no longer a demand for and canceled orders from retailers for finished goods in our warehouse. We were not alone in these challenges as this was a widely publicized issues for the fresh food industry. However, we did take a proactive approach to ensure that much of this food did not go to waste. For example, through partnerships with our growers, harvest teams and the California Association of Food Banks, we were able to harvest crops that we no longer had demand for and deliver approximately 400,000 pounds of broccoli to food-insecure families. This is the equivalent of 27 truckloads of fresh produce from the field. Access to real food is a basic human right, and I'm proud of our team to react quickly and identify smart solutions that serve our communities in need and eliminate food waste, which is a core sustainability goal. At Lifecore, the increased need for social distancing and safety protocols in this highly controlled manufacturing environment required some changes that needed to be implemented. The new controls accounted for the temporary manufacturing inefficiencies that have now been accommodated for. As with most business, we were learning and implementing best practices every day to keep our employees and communities safe. Today, Lifecore's productivity is back to pre-pandemic levels, and we are looking forward to another solid year of consistent contribution to Landec's financial performance. Net, fiscal '20 was an important transitional year for our business and was successful on many fronts. We streamlined our operations, we turned around our underperforming avocado business, we got closer to our customers and achieved our cost-out goals and, most importantly, our teams have come together as a stronger, more efficient unit in the face of adversity. We are moving forward together and are poised to build upon this momentum and continue to demonstrate sound execution in fiscal 2021. We will provide our formal year-end results for fiscal year '21 in early August. This plan will incorporate new disciplines and forecasting to build a solid achievable plan from the ground up with a focus on a more strategic approach to account for raw material volatility and accounting for potential impacts of COVID-19 as the pandemic continues to impact our nation. We will have the advantage of a full year of our more efficient operations, following the significant improvements that were generated in fiscal '20 across all our businesses. We will also account for raw material sourcing variability properly and reflect an appropriate amount of conservatism for the potential ongoing impact of the COVID-19 pandemic. I look forward to sharing the details with you in connection with our fiscal fourth quarter earnings reporting. Until then, we will be focused on operational excellence at each of our businesses in an effort to improve results and drive shareholder value. That concludes my remarks. Operator, please open the line for questions.

[Operator Instructions] Our first question comes from the line of Gerry Sweeney with ROTH Capital.

I had a few questions, just want to parse through some of the stuff. Start with Curation, obviously, it sounds like there were some ordering -- order volatility and cancelations going on there with some of the business. But curious if the higher margin, the salads, Yucatan and just the clean, healthier foods, how was that business overall through the pandemic? And do we -- should we anticipate any shifts going forward for the next couple of quarters as far as you can see today?

Yes, Gerry. The -- it was really interesting. In April, we saw salads really have an uptick when the pandemic first hit. And then the avocado products were tapering off. And I really was concerned about our higher -- because we were just into the higher-margin products that we have been working on all year that, that was going to be a product line that was going to be hurt through this social distancing because guacamole is sort of a product that we share with people, right? Well, in May and March -- in April and May, it came back. And it's running right at our budgeted numbers, and it's at a higher margin. So that was good news. We just saw volatility in fresh salads as people were staying at home, foot traffic was down in the stores and -- but we saw like an uptick in things like broccoli in our core veg business. So all of that has, for the most part, come back and we are confident that we have enough built in that we're a lot smarter now, Gerry, than we were back in April. Does that answer your question?

Yes. I just want to -- I mean, so there was some shifting around, but I mean, salads were -- I mean, so avocado is down but back up. Salads were a little volatile, but I'm not quite following you where you are today.

Yes, we got you. Yes, they were very volatile. And that's what was a big part of our miss was just the volatility of week-to-week with customers. Sometimes they'd be high, they'd be zigging and then would zag for a couple of weeks, it was very unpredictable.

Maybe I'll just jump in for a minute. So we've announced that it was -- it did zig and zag a bit, and those things are sort of more happening in April. As we came out of April and into May, things really stabilized. But you did see sort of a product mix shift. It was interesting. People were -- there was more demand on some of the core salads -- on some of the core veg salads, the lower margin items. Salads did take a little bit of a dip, but they've come back. So it's -- that moving around sort of really happened in April. But as we've come through May, things have really sort of stabilized. And I think we have a pretty good handle barring something really different that happened on sort of what the guide paths look like now.

My only issue is I think some of the data showed packaged salads being up, certainly in March and then April. I mean, were there just some -- was it a function of demand or was it a function of maybe new order patterns from some of your suppliers? Or -- I just...

Al, you want to take that?

Yes. I mean, there was a mix issue. And there were certain channels that were hurt more than others, okay? Foot traffic was down. Obviously, we got hurt with our food service business with green beans. And there was just a tremendous amount of volatility in the mass and club area.

Okay. Got it. Okay. And then the Hanover, $11 million. 2 things I just want to get a little bit more clarity. So it sounds like there's $11 million worth of savings, but there's also some other items wrapped up in there. And I'm not sure if some of those were previously announced. So I'm just wondering, can you pull out just what is Hanover so we can kind of not double count what's going on?

Yes. Go ahead, Brian. You want to take that overhead for us?

Yes. So we had announced earlier that we had somewhere in the range of $5 million, $5 million-plus in annualized savings from the restructurings previously announced. As we've come through the fourth quarter, there were some other sort of restructuring, but the majority of that annualized savings that -- or that difference, that additional $5 million or $6 million, the vast majority of that would be the annualized production overhead number that goes with the closure of Hanover, so the 2 of them together.

And then just staying with Hanover, was this move in any way impacted by you're either going to sell or shrink the core veg business? And I know you had at least 5 people sort of taking a look at it. Anything you can provide on that front?

No, this move wasn't based on that. Core veg is all made in California, Guadalupe. This was just a facility that was built for a much, much larger salad business than what we are at. It's just back -- as I mentioned, back in 2016, what this certainly does for us, though, by shutting it down, the benefits that Brian mentioned, certainly the fact that we can -- it's a very nice facility, and we should be able to sell that and help pay down debt. It's really going to help us become -- and really sweat our assets more in the Guad and Bowling Green. And we can get more production to the lines. Project ZEST is helping us through our lean manufacturing processes, Gerry. That's what helped us turn around the avocado products business. That program we're now putting in our U.S. facilities. So we're going to really sweat the assets more, become far more efficient and not have to spend as much capital as we have in the past.

Any comment on the -- where the process is or insight into whether we're going to shrink or sell?

We're still working the process on all fronts, Gerry. But we are -- we have made significant progress on rightsizing the business. And as I mentioned, we had a big year on cost-out and all those things are going to help us in terms of what decision that we decide to do.

Our next question comes from the line of Mitch Pinheiro with Sturdivant.

Just following up on some of Gerry's thoughts on Hanover. So I visited Hanover. It was clearly -- it was built to -- I thought partly from logistics, it enabled you to access the East Coast in a lot more efficient manner. It was right up the street from green bean growing territory. I know it's bigger than you spent than -- it was built with room to grow. So are we saying here -- and by folding it into Bowling Green, which I'm not sure where the capacity is, are we saying that packaged salads are not -- we just don't need that much more capacity there? Or do you have ample capacity in the system without Hanover?

We have ample capacity without Hanover. And we're running our -- we're running, as I mentioned earlier, running our lines to get more out of what we have through Project ZEST. It's I think 200 miles from Bowling Green, but we process a lot of green bean in Bowling Green. So it just -- the numbers just work for us that it made sense for us to shut down Hanover and distribute the product line across Guadalupe and Bowling Green.

Does Bowling Green do salads?

Yes.

Yes. Okay, the only other thing I would throw in here is the cost-out. Many of the cost-out projects were about automation, improved throughput and, in essence, getting more out of the platform than we had before. So again, just to echo Al's comment on there being ample capacity in the system, we actually created some of that through the cost-out, allowing us to do that this year.

And Mitch, we've also -- a couple of years back, we built a new warehouse, a big warehouse in Bowling Green, which was built for logistics and for customers can come and directly pick up from there. So we have made investments in Bowling Green along the way as well.

Do you sell the equipment in Hanover or do you keep the equipment?

We will pick some that we want. But in general, there's a fair amount of assets that we will be selling.

Okay. And in terms of selling the facility. What -- are we talking -- can you get -- I mean is this a couple of million dollars net proceeds, mid-single digit million? How much are we looking at in terms of debt payment?

So -- yes. Yes, I would -- yes, it's in the, I would say, in the high 7, low 8 range. Bigger range. So this is what we believe.

Got it. Okay. And then when it comes to -- so when I'm looking at what your results, your preliminary results look like, revenue was actually better than expected, both and particularly in Curation, in my model. So it doesn't look like you had a revenue problem in my view. It was a mix problem, but that's certainly not a revenue problem. So I'm not sure. So while I sort of understand that there's a lot of volatility in orders in the channel, maybe mass and club were a little more volatile. It looks like a cost issue here. I mean, it looks like -- I mean, it was -- that's what I sort of don't understand. Can you give insight on...

Al, can I take a crack at that?

Yes. Go ahead, Brian.

So there was a surge up in our revenues. And then there was this [ volatile ] things moving around back and forth. So that there were a few weeks in there were a little bit like this [ sought to ] thing going on. And what happens in that period is we have acreage in the ground that's supposed to come out every week for 52 weeks a year. And when the customers were going through this period of trying to understand themselves what was happening during that -- just that interesting period in April primarily, there were orders that were coming in on a Friday which meant we were harvesting in the field, we were adding value, we were putting it on a truck, we were getting it to the cooler, we're making finished goods and then they would cancel the order on Tuesday. And so it was just that sort of stuff. So when you looked at the overall quarter, you had these weeks, particularly with the surge where things went up. They sort of more than covered the weeks when things were zigzagging around on the cost and supply chain side. It was wreaking havoc in terms of getting product out of the field, do you walk by a product this week, and guess what, that means it's not available next week. So we're seeing it on the cost side, but it was in direct response to the zigging and zagging, if that makes sense. And Al, if you want to add to that.

We -- Mitch, just my spin on what Brian said, just to clarify for you. We have a 120-day growing cycle for some of these items. And if the customer doesn't take it or the order isn't there, we own it, we own the acreage, and that was a big part of the problem. Not just it's a chain effect that when the owners don't hit what's forecasted for what we planted, we own it, and that cost us money. That was a big part of this.

It's funny. Most of the time, you can't get your hands on a product or you have to pay through the nose for it, now you can't use it. It's like one way or the other. It's always something. But the last thing I just want to ask you about Lifecore. When I look at it compared to my model based on what your preliminary results, it looks like there was about $2 million of extra costs, which seem to be high. I mean, so it's not necessarily -- my estimate could be off here. But was the effect -- was the COVID-related costs and inefficiencies, was it as much as $2 million?

Yes. I'll let -- I'll say a few comments and I'll let Jim add some color. I mean, the Curation side was between $7 million and $8 million we've had in terms of the hit. And there was about close to $2 million on the Lifecore side due to -- in my comments, I talked about the [ alignment ] inefficiencies, the social distancing they had to do all had an impact. Jim, would you like to add some more color there for Mitch?

Sure. Mitch, yes, like Al said, the things we had to implement remain open and operational, keep our employees safe and healthy, such as split shifts, smaller work groups, cleaning in between shifts. We can only let one person go in at a time to go in the core areas. Things like that, just to promote social separation really caused inefficiency in our production output. So to give you an order of magnitude, we were built and prepared to deliver, say, 10 batches a week. And for a period of time, we were only delivering 5 or 6, so a little bit less than 60% of our capacity. And so everything we were making in that period of time cost us a lot more than it typically does. And over a 6-, 7-week period, through practice and trials and tribulation, we were able to implement the correct -- and correct some of the inefficiencies, get used to working in those conditions. And so it was temporary, and we're back up to 100% throughput like we had planned for the last half of Q4. So things should be back in line moving forward as we sell through some of that higher-priced inventory.

And -- sorry, just one more. Just are we -- are things back on track as we look at Q1? I mean, is there anything lagging here or are we sort of back to relatively normal for your operations, for your cost and revenue outlook?

For both businesses, Mitch? Is that what you...

Yes.

Yes. Short answer is yes. We're back on track. And we have a lot of exciting things to talk about in August.

[Operator Instructions] Our next question comes from the line of Mike Petusky with Barrington Research.

So what -- I guess, what gives you confidence that the, sort of, the issues on the -- particularly on the Curation side don't reoccur given the way COVID trends have sort of seem to have heated up here in 3 quarters of the United States the last 2 or 3 weeks, I mean, in terms of the irregular customer order stuff, the mix shift and all the rest of it. Why -- it sounds like you're essentially saying, "Hey, we're in good shape going forward." But I guess I'm wondering why you feel you have that visibility given the backdrop and what sort of you believe caused the issues in Q4?

Yes, Mike, we've -- like I said, the businesses have come back. We're seeing more normal ordering patters. We have built in -- we think we have learned a lot about the effect of COVID on fresh food shopping. And as we move forward, we think we have the right amount of risk built in.

Yes. And I would just add to that, that we -- things were pretty turbulent in May, and when you look at different parts of the country in New York and California, whatever. So we were already living with that. And we are already seeing our volumes stabilize. I think one of the other big learnings here is that the retailers figured this out, Costco, Krogers and those sorts of folks. And I think the consumer figured it out a little bit more when back in late March, everybody was surge buying. And then in April, the first couple of weeks in April, they didn't want to go to the store. And so I mean, I think you're asking a great question. But I think that there's a lot that all of us across the system, consumers, retailers and producers have learned here. And again, we're just simply looking at the patterns going forward that were already established in May when there was quite a bit of turbulence.

Given that, I mean, do you expect when you guys hold your year-end call, I mean, do you expect to actually provide guidance for fiscal '21?

Yes. That's -- the plan is to provide '21 guidance at that time in early August.

And I guess then, just in terms of the credit agreement. So the proceeds that you get from the sale of the building, that will go against the $190 million of debt. And I mean do you -- I guess what I'm asking is, do you expect to be paying a materially higher interest rate going forward? Or where do you stand in terms of that relationship?

Well, things have changed clearly in the fourth quarter from what we expected with COVID. When you look at all the other key indicators in terms of how the company needed to perform -- was performing from a restructuring standpoint, we hit our revenue, we fixed the [ EBITDA ], we hit the cost-out numbers. So the banks see -- they see those fundamentals as being very strong. They also see that in the first 2 quarters of the year, we essentially had a very, very anemic EBITDA. In the third quarter, it was almost $7 million. In the fourth quarter here, you can sort of see the range that we've outlined. So they see that progress. They as well understand that right now, we have a leverage ratio that should be held up by 4 quarters, that's really only being held up by 2. And they can see the changes that we've made in the business model and moving into Q1 and Q2, just that natural glide path. And I think they're comfortable with the -- and we've spent a lot of time working with them and talking to them. I think they see, if nothing else, the overall leverage ratio improving as a result of dropping off the first 2 quarters of fiscal year '20. So I think they are comfortable with the changes that we've made. They see the improvement in the fundamentals. We did miss March, we got a waiver, April and May, we missed as well. So we're operating right now under a limited default agreement. As a practical matter, it is business as usual with the banks in terms of us having access to a line of credit. We're currently working with them on a Q4 May waiver. Conversations are constructive. The banks continue to be very supportive of the company's progress. As it sits today, I'm -- I have a degree of confidence that we're going to work this out in a way that's mutually satisfactory to both the banks. And I believe we are on a -- really on a glide path here and a commitment from the Board and management team as we go through fiscal year '21 to deleverage the company. Back to your question -- I guess to your point on the interest rate. As we deleverage the company, then the interest rate comes down, it's not a massive sort of engineering. And I'm confident that we're going to see improvements on the interest rate as we move through Q1 and into Q2. And I don't see it as burdening us in an unreasonable way.

Okay. Should -- when you guys sort of work this out with the bank, so it should be a bit higher and then you pay down debt and you'll have an opportunity to bring it down? Is that a fair sort of general...

It goes -- it's a tiered rate system that goes with the leverage ratios. As the leverage ratio improves, which we believe it will, it automatically goes -- improves.

Our next question comes from the line of Gerry Sweeney with ROTH Capital.

Just a couple of quick follow-ups. How much revenue is in the food service channel? I don't think too much, but just curious.

I don't have the dollar amount right off the top of my head, but it's -- let me just think here. We had a...

It's a $50 million business and it's about 1/3?

Yes. It's roughly -- yes, I wasn't -- yes, it's roughly about 1/3 of our green bean business, which is in the sort of the $50 million to $60 million range.

Yes, so $15 million to $20 million thereabouts, Gerry.

Okay. Got it. And then I think I still have 2 questions here, one of them just following up on Mitch. I think you gave some numbers for Mitch. You said Lifecore was about $2 million cost -- of cost-out. And then Curation, I think you said $7 million to $8 million in sort of cost, maybe some of it's mix, some of it was just canceled orders, et cetera, that you just -- I mean you had to eat the product but it seems still -- or it's in the warehouse, et cetera?

Yes. I mean it's PPE and sanitation. It's -- a lot of it is -- it's very much concentrated in the issues that we've already discussed. But there's some other things that sort of round it out. But the big issues, and it was generally centered really in that period, that big zaggy period back in April. And that's -- and so we're not just seeing that continuing level of issues and leakage as we move forward and things have stabilized.

No, I get it. I mean, let's face it, second half of March, April, that was sort of a free for all, I mean across the country for lack of a better word. So I think I had another question that I wrote down, but I don't have it right in front of me, but maybe I'll just call you guys.

This concludes our question-and-answer session. And I would like to turn the call back over to Dr. Bolles for any closing remarks.

Thank you for your continued interest in Landec. Everybody, have a good day, and stay healthy and safe.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.