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Edited Transcript of LNDC earnings conference call or presentation 1-Aug-18 3:00pm GMT

Q4 2018 Landec Corp Earnings Call

MENLO PARK Aug 13, 2018 (Thomson StreetEvents) -- Edited Transcript of Landec Corp earnings conference call or presentation Wednesday, August 1, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gregory S. Skinner

Landec Corporation - CFO and VP of Fincance & Administration

* Molly A. Hemmeter

Landec Corporation - President, CEO & Director

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Conference Call Participants

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* Alexander B. Scharf

Maxim Group LLC, Research Division - Equity Research Associate

* Christopher Walter Krueger

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Gerard J. Sweeney

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* John Butler Walthausen

Walthausen & Co., LLC - Portfolio Manager

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Landec Corporation Fourth Quarter and Fiscal Year-End Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Molly Hemmeter, Landec Corporation President and CEO. Please go ahead.

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [2]

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Thank you. Good morning, and thank you for joining Landec's Fourth Quarter and Fiscal Year-End 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 the 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 2017.

As a leader, a leading innovator in diversified health and wellness solutions, Landec is comprised of Lifecore, our contract development and manufacturing, or CDMO business; and our Landec natural foods business, which now includes 3 brands, Eat Smart packaged fresh vegetables, O Premium Olive Oil & Vinegars; and the new brand specifically target to the growing population of plant-forward consumers called Now Planting.

We are introducing this new brand to our investment community today in conjunction with this earnings release, and we'll talk more about Now Planting after we discuss fiscal year 2018 results.

Landec continues to drive growth in each of its 3 strategic growth platforms, Lifecore, Eat Smart salads and natural food products. In fiscal year 2018 and compared to last fiscal year, Lifecore revenues grew 10%, Eat Smart salad revenues grew by a tremendous 23% and natural food product revenues grew 12%.

As a result, Landec's consolidated revenues for fiscal year 2018 grew 12% compared to fiscal year 2017. For fiscal 2018, Landec's earnings per share from continuing operations, excluding the onetime tax benefit from recently enacted tax reform, grew by 14% from $0.36 per share in fiscal 2017 to $0.41 per share for fiscal 2018.

Let's first talk about Lifecore, Landec's CDMO business. Lifecore has completed its transition beyond its historical capabilities as a premium supplier of hyaluronic acid, or HA, to become a fully integrated contract development and manufacturing organization. As a CDMO, Lifecore is providing differentiated fermentation as well as formulation, aseptic filling and final packaging services for difficult-to-handle pharmaceutical products. Lifecore had an outstanding fourth quarter with revenues of $16.2 million and gross profit of $8.2 million, representing gross margins of 51%.

Revenues increased 40% and gross profits doubled compared to fourth quarter of last year.

For the full year of fiscal 2018, Lifecore revenues increased 10%, exceeding our original expectations of 6% to 8% growth, while gross profit increased 7% and operating income increased 9% compared to fiscal year 2017.

The installation of Lifecore's new $16 million multi-purpose filling line is complete, and validation will begin during the second quarter of fiscal 2019, with commercial production projected to begin in late fiscal 2019 or early fiscal 2020.

The new line will further enhance Lifecore's growth strategy as a CDMO, which is specifically designed to align Lifecore's capabilities with the growing needs and market expectations of its partners. This investment provides Lifecore the incremental capacity to fill commercial quantities of drug products in vials, which expands the breadth of products and markets that Lifecore will be able to address.

Although the new line will be primarily utilized to fill vials, it can also be used to fill syringes, which provides significant versatility and increased capacity utilization. At full capacity, the new dual filling line has the potential to generate $40 million to $50 million of new product revenue annually. Revenues and net income contribution will vary due to product mix manufactured on the line during any given year.

In our Landec natural foods business, we are transforming Apio's package fresh vegetable business into an innovative natural foods company comprised of 3 brands: Eat Smart, O and the new Now Planting brand. The natural foods business has a unique combination of capabilities that makes it truly differentiated from other companies in the market. With proven internal innovation capabilities, a refrigerated supply chain and a direct produce sales force, Landec's natural foods business is uniquely positioned to deliver on-trend, plant-based and fresh solutions to consumers.

We continue to invest in development programs and capital to make this transformation successful. These investments will negatively impact profits in our natural foods business in the short term, but are establishing a path to meaningful profit growth and enhanced shareholder value in the long term.

O's operating performance for the fourth quarter fell short of expectation with revenues of $0.6 million and an operating loss of $0.6 million. For the full year of fiscal 2018, operating results were also below expectations with revenues of $3.8 million and an operating loss of $1.0 million. This shortfall was primarily due to permitting delays and the impact from historic fires in Northern California during the second half of the fiscal year that resulted in nearly 7-month delay in the start-up of the new vinegar facility operation. Despite this unexpected delay in the vinegar production facility, O revenues still grew 12% in fiscal 2008 (sic) [2018] compared to the 12 months ended May 28, 2017.

O recently introduced O Organic Apple Cider Vinegar, craftfully fermented in California Sonoma Valley and in O's new in-house vinegar production facility. O Organic Apple Cider Vinegar is full of bright, fresh, apple flavor without a harsh aftertaste.

With no artificial flavors or preservatives, O Organic Apple Cider Vinegar is raw, unfiltered and contains live cultures. The market for Apple Cider Vinegar in the U.S. retail has increased rapidly over the last 3 years, reaching $245 million in U.S. consumer retail sales according to Nielsen from 52 weeks ended June 2018 and is growing at an average annual growth rate of 20%, driven by a 44% growth in organic products. O intends to penetrate this market with a better tasting organic product option. O began shipping its Organic Apple Cider Vinegar to customers in June of 2018.

Eat Smart packaged fresh vegetable revenues increased 14% in the fourth quarter and 12% in fiscal 2018 compared to the same periods last year. These increases are primarily due to the growth of Eat Smart salads kits sales, which increased 22% in the fourth quarter and 23% from full year fiscal 2018 compared to the same period last year. The Eat Smart growth from multi-serve salad kits was primarily driven by a 50% increase in salad revenues from the U.S. retail channel during 2018 compared to category growth of 10% for the same period.

The Nielsen U.S. retail all commodity volume, or ACV, for Eat Smart multi-serve salad kits for the 52 weeks ended May 26, 2018, increased 21 percentage point from 24% to 45% and increased 600 basis points sequentially from 39% for its 52 weeks ended January 27, 2018. The increase in the ACV and growth in salad revenues during fiscal 2018 was driven by new and expanded distribution in key U.S. accounts, such as Walmart, Kroger, Target and others. This incremental distribution in U.S. retail occurred more rapidly than originally anticipated, leading to the considerably higher growth of 23% versus the 10% to 12% that we originally forecasted. As some of the new salad distributions schemes, we expect it to occur in fiscal year 2019 where instead realized in fiscal year 2018.

The gross margin in our packaged fresh vegetables business was 10.8% for fiscal 2018 compared to 12.5% in fiscal 2017. The gross margin was lower in fiscal 2018 due to the negative impacts from significant weather events during the first 9 months of fiscal 2018, which resulted in significant increase to the cost of produce. These events include the aftermath of the hurricanes and tropical storms during the summer and fall of 2017, which were worsened by freezing temperatures and impacted green bean growing regions of Florida during January. And by persistent and seasonally warm temperatures in Western growing regions, that affected the sourcing cost of our lower margin vegetable-based business.

These weather events resulted in incremental produce sourcing cost of approximately $7.8 million or $0.19 per share after taxes during fiscal 2018. Excluding these excess sourcing costs, the gross margin in our packaged fresh vegetable business would have been 12.5% or the same as last year even after taking into account a 10% increase in labor rates this fiscal year compared to last fiscal year and a significant increase in promotional expenses.

In fiscal year 2019, we will focus on reducing our operational costs in our food business. Despite our best-in-class ability to understand the consumer to innovate new products, to disrupt and create new categories and ultimately to grow our top line, we cannot deny the increasing volatility and higher cost that is required to run the food business. As such, we must assume the abnormal weather is the new normal and create a lower cost basis in our food business. This will ensure that the profitability we are generating from the launch of higher-margin products is available for reinvestment back into the business or to contribute to the bottom line and not required to cover increasing operating costs or abnormal weather events.

As such, we enter fiscal year 2019 with not only a focus on top line growth, but a strong and concentrated effort on reducing cost in our food operations. Before I go into more detail about plans for fiscal year 2019 and beyond, let me turn the call over to Greg for some financial highlights.

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Gregory S. Skinner, Landec Corporation - CFO and VP of Fincance & Administration [3]

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Thank you, Molly, and good morning, everyone. As a reminder, during the fourth quarter of fiscal 2018, the company discontinued its food export business. Therefore the operating results for the food export business are shown as a discontinued operation. The financial statements for the four quarters and the full fiscal years of 2018 and 2017 have been reclassified to exclude the financial results of the food export business.

Revenues from continuing operations in the fourth quarter of fiscal 2018 increased 16% to $141.1 million compared to $121.3 million in the year-ago quarter. The increase was primarily due to a $15.6 million or 14% increase in revenues in Apio's packaged fresh vegetables business and from a $4.6 million or 40% increase in Lifecore revenue.

Net income from continuing operations in the quarter was $6.7 million or $0.24 per share compared to $2.6 million or $0.09 per share in the year-ago quarter. The increase was the result of: First, a $4.1 million or 100% increase in gross profit in Lifecore; second, a $2.1 million or 14% increase in gross profit in Apio's packaged fresh vegetables business; and third, a $500,000 increase in the change in the fair market value of the company's investment in Windset for a $200,000 increase in the fourth quarter of last year to a $700,000 increase in the fourth quarter of fiscal 2018.

These increases in net income were partially offset by a $1.7 million increase in income tax expenses. The $1.7 million increase in income taxes was net of a $606,000 tax benefit from the tax reform enacted in December 2017.

For all of fiscal 2018, revenues from continuing operations increased 12% to $524.2 million compared to $469.8 million last year. The increase is primarily due to a 4. -- $46.9 million or 12% increase in revenues at Apio's packaged fresh vegetable business and from a $6 million or 10% increase in Lifecore revenues.

Reported GAAP net income from continuing operations for fiscal 2018 was $25.8 million or $0.92 per share compared to $10.1 million or $0.36 per share in the year-ago quarter or a year ago year. The increase was the result of: first, a $14.3 million or $0.51 per share onetime tax benefit from the new lower corporate income tax rate as a result of tax reform; second, a $2 million increase in the change in the fair market value of the company's investment in Windset from a $900,000 increase last year to a $2.9 million increase in fiscal 2019; third, a $1.8 million or 7% increase in gross profit at Lifecore; and fourth, a $1.2 million decrease from the loss on debt refinancing during fiscal 2017.

These increases in net income were partially offset by a $2 million 4% decrease in gross profit in Apio's packaged fresh vegetables business, primarily due to a $7.8 million of unplanned produce sourcing costs as a result of weather-related issues during the first 9 months of fiscal 2018 and an $815,000 increase in the pretax loss at O.

Shifting to fiscal 2019, we are projecting consolidated revenues from continuing operations to grow 5% to 7%, which is driven by expectations for Lifecore to grow in the range of 14% to 16% and Eat Smart salad products to grow in the range of 4% to 6%. Our projected solid growth in fiscal 2019 combined with the 23% growth of Eat Smart salads realized in fiscal 2018 implies a 2-year growth rate of approximately 14% per year.

We expect O and our Now Planting line of pure plant suite products to generate total revenues of $7 million to $9 million in fiscal '19. And we expect the revenues in Apio's core bags and trade business to increase 2% to 3%, while simultaneously shifting product in customer mix to deliver higher margins.

We are projecting consolidated net income from continuing operations to increase 10% to 20% in fiscal 2019, excluding the onetime tax benefit realized in fiscal 2018, resulting in an estimated EPS range of $0.45 to $0.50. We are projecting the cash flow from operations will be in the range of $32 million to $36 million and capital expenditures of $45 million to $50 million in fiscal 2019.

Over $15 million of the projected capital expenditures in fiscal 2019 are from projects that have been expected to be completed in fiscal 2018, but were delayed for various reasons. The remaining $30 million to $35 million will be primarily focused on capacity expansion, cost-reduction initiatives and innovation.

For the first quarter of fiscal 2019, we expect revenues to be in the $123 million to $128 million range and net income to be break even to $0.01 per share. The projected decrease in net income compared to the first quarter of last year is due to the timing of production and product mix within the fiscal year at Lifecore and from start-up expenses from the launch of Now Planting suites and O's new vinegar production facility.

I'll now turn the call back over to Molly.

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [4]

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Thanks, Greg. Let me go into more detail about the progress we are making in our 3 continuing growth business -- businesses, which include Lifecore, Eat Smart salads and natural food products as we position each for top line growth and enhanced profitability.

Lifecore is benefiting from a 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 projects to fuel its long-term growth. We continue to expect Lifecore to generate low- to mid-teen revenue growth on average over the next 5 years as Lifecore expands sales to existing customers, adds new customers and commercializes products that are currently in its development pipeline.

The transformation of the Apio business is evolving rapidly. In the current transformation phase, we are expanding our product line from packaged fresh vegetables to include our fresh natural food products that meet evolving consumer needs with a commitment to 100% clean ingredients. These natural products will have higher gross margins and exhibit less sourcing volatilities in our historical vegetable bag product offering.

We have been diligently working on multiple fronts to enable the realization of our natural foods vision. We've launched the Eat Smart 100% Clean Label initiative to ensure that all Eat Smart products, including salad toppings, dressings and dips, are made from all-natural ingredients with no artificial ingredients. We are on schedule to deliver this commitment by the end of calendar year 2018.

We also formed the Landec New Ventures Group to develop a natural food strategy and to lead new product development and acquisition initiatives in the natural food space. As the first step in the new ventures effort, we acquired O Olive & Vinegar a supplier of California-made all-natural and premium olive oils and vinegars. This acquisition was timely as consumers are rapidly switching from traditional olive oils and vinegars to all-natural options. The O Products also provide a unique opportunity for future innovation at Eat Smart by combining all-natural O vinaigrette dressings with our salad kit product.

In March, we completed the construction of our vinegar facility in Petaluma, California, producing our own vinegars in-house to better manage quality and reduce cost, while enabling us to more efficiently launch new product, including our O Organic Apple Cider Vinegar product.

Through extensive research of consumer motivations lifestyle eating and purchasing behaviors through North America, the Landec New Ventures Group have identified a large and underserved targeted group of consumers who define healthy eating as primarily plant-based. To meet the needs of this consumer, Landec is launching a new brand. The name of this new brand is called Now Planting. Now Planting will offer pure-plant meal solutions for the fresh refrigerated sections of retail and club stores. Landec's portfolio of natural foods will now include 3 brands, Eat Smart packaged fresh vegetables, O Premium Olive oils and vinegars and Now Planting, pure-plant meal solutions.

Plant-forward consumers are eating less meat with approximately 70% of their diet coming from plants. As this consumer segment continues to grow about the U.S. where it represents 70% of the population in Canada where it represents approximately 23% of the population, more people are searching for and finding pure plant meal solutions outside of traditional grocery. They are shopping at fast casual restaurants, through direct-to-consumer meal kit solutions and by cooking their meals at home. Landec is uniquely qualified to partner with retail and club stores to deliver pure-plant meal solutions to this consumer. Landec's entrepreneurial innovation team, refrigerated supply chain and direct produce sales force will develop and deliver fresh, pure-plant solutions to meet the needs of the plant-forward consumer and increase consumer foot traffic in retail and club stores over the coming years.

Now Planting's first product platform is a full line of fresh, pure-plant soups. These soups are extremely differentiated from anything currently in the market with a nutritious ingredient profile that does not contain dairy or animal ingredients of any kind, and it's naturally low in sodium, sugar and fat. Celebrating the natural flavors of plants with a unique combination of ingredients and toppings, each soup delivers amazing taste in a convenient, patented packaging design. Now Planting soup will begin shipping to select customers in the second quarter of fiscal year 2019.

The Landec New Ventures Group is working diligently on several other new venture projects with an additional natural foods initiative scheduled to launch during the second half of 2019. More details of this initiative will be shared in the upcoming months.

The focus of our natural foods business is on developing and offering products that are on-trend to consumers and to deliver higher margins and a higher return on investment capital. We have successfully implemented this strategy with our entry into multi-served salad kit category, our recent disruption of the single served salad kit category, the addition of O premium olive oils and vinegars and making its debut in fiscal year 2019 with our launch of Now Planting pure-plant food.

As we expand our product offering into natural food products, we must continue to closely manage the rising cost of our packaged fresh vegetable business, especially within our historical bag vegetable business. As such, we have hired a third-party consultant to work closely with our team to identify cost down initiatives that can be implemented over the next several years to lower our cost and to absorb the effects of abnormal, or shall we say, normal weather. The objective of this cost savings initiative is to enable us to continue to invest in innovation and to drop additional dollars to the bottom line. We have recently entered the initial stages of the cost dollar initiative, and we'll share more as the program progresses throughout the fiscal year.

Looking to fiscal year 2019 and beyond, we will continue to innovate. At Eat Smart, we will continue to launch new packaged fresh vegetable products that make it easy and delicious for customers to eat healthy. We will continue to grow distribution of our O products, including the new O Organic Apple Cider Vinegar. We will launch a new brand, Now Planting focused on the plant-forward consumer with a new internally developed line of pure-plant soup.

At Lifecore, we will continue to add new processes and capabilities to meet the needs of our customers for their difficult-to-handle pharmaceutical and medical materials, and we will begin filling products in vials in addition to syringes.

We are also focused on increasing production volumes in each of our business to drive efficiencies and increase our return on invested capital. And finally, we are focused on increasing efficiencies and driving down cost in our food business in order to offset the rising cost of continued -- and continued weather volatility that is affecting that business.

In summary, we will continue to focus on developing innovative products to deliver value to our customers, consumers and shareholders. As we continue to transform our businesses, we will focus on growing our 3 platforms, Lifecore, Eat Smart salads and natural food products while simultaneously reducing cost and increasing efficiencies. And finally, our balance sheet remains strong and provides us with the resources for executing our strategic objectives and reaching our financial goals.

We are now open for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Alexander Scharf with Maxim Group.

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Alexander B. Scharf, Maxim Group LLC, Research Division - Equity Research Associate [2]

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So when you think about fiscal year '19 salad kit growth you are guiding to 4% to 6%, how much of that -- can you quantify how much of that is expected to be from organic growth within existing doors? And how much from incremental points of distribution?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [3]

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Right, so we are very focused in fiscal year '19 on making sure that the distribution that we gained in fiscal year '18 is selling through. So our focus was going to be primarily on investing in trial and driving velocity in the products that we gained last year. So a lot of -- some of that -- a lot of that will be the year-over-year growth from the distribution that we gained last year. And we really want to spend our time on making sure consumers get to know our brand in those new geographic areas. They love our products. We drive trial, and we are building relationships with our strategic accounts by executing with excellence. So most of these sales are going to be from just making the best of the new distribution that we just gained.

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Alexander B. Scharf, Maxim Group LLC, Research Division - Equity Research Associate [4]

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Got it. And then in regards to the first quarter at Lifecore, you've talked about unfavorable timing and mix. Are you expecting lower revenue, lower margins or both? And then will the magnitude of that be similar to what we have seen in past week or quarters? Or is this going to be an especially unusual quarter for Lifecore?

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Gregory S. Skinner, Landec Corporation - CFO and VP of Fincance & Administration [5]

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Yes, we don't expect the top line to shrink. The top probably should be relatively flat with the first quarter last year. It's -- as I said, it's more of a production and mix. In quarters where they don't produce as much product, particularly in the fermentation side, instead of that costing up in the balance sheet on your inventory, it ends up pushing through cost of sales. So it impacts your margins in the quarters where production is down, and that is what we're seeing in the first quarter this year. And in the first quarter last year, they had a fairly major movement of a couple of shipments from the second quarter to the first. So I would say half of that change year-over-year is coming from the product mix and production at Lifecore.

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Alexander B. Scharf, Maxim Group LLC, Research Division - Equity Research Associate [6]

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Great. And then just lastly, based on your fiscal year '19 guidance, you have a gap at exceeding operating cash flow by about $13 million to $14 million. Do you expect to fund that gap by drawing down your line of credit?

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Gregory S. Skinner, Landec Corporation - CFO and VP of Fincance & Administration [7]

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Right now, yes. We're planning that. We will be using our line of credit to pay for that excess.

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Operator [8]

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And our next question comes from Chris Krueger with Lake Street Capital.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [9]

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Just a couple of quick ones. On your new product rollout, whether its salad kits or the new soup products, what's the timing on that? Should we expect a new salad kit introduction every quarter like we have the last couple of years? Or what?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [10]

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I would say that's a good approximation. Keep in mind that we are constantly developing new products for rotations in some of our club stores, sometimes this is a complicated question to ask. Our retail partners typically have 2 launches per year; 1 in the fall and another one in the spring. So -- and we usually launch multiple SKUs during that time. So there's usually kind of 2 ways of new products from the salads. But on average, it's usually 1 per quarter. That's a good way to think about it.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [11]

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Okay. On the new Now Planting soup product, could you give us a little bit more of a description of it? Is it going to be sold in the produce section? Is it a canned soup? I don't think you gave a lot of detail in the press release.

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [12]

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Yes, we didn't because we are kind of holding back a little bit, to tell you the truth. We are going to be starting to ship this to select customers in Q2. It will be sold in the produce aisle, which is very much a disruption. So right now, soups are primarily full, obviously, in the center of the island cans or in deli. But because of the nutritional profile, these soups, which are very much plant-based and do have the lower sodium and other nutritional benefits, we truly believe that the consumer, who will buy these soups, is the one shopping in produce, not deli. And our partners that we have already sold this into strongly agree with us. So we are going to be learning a lot here. We're going to be taking this launch 1 step at a time. We are going to place these in produce, and we are going to go after that plant-forward consumer. This is not in a can. It is in a patented package, but I'm going to kind of let the rest evolve since we haven't launched it yet.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [13]

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Okay. And last question, last couple of years, you've had a lot of volatility in sourcing, whether it be droughts, floods, hurricanes, things like that, that's completely out of your control. How do you look at that in your guidance for the following year? Do we assume at least some unknown negative factor? Or how should we look at that?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [14]

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Right. So as you've just stated, we've had these abnormal weather conditions for multiple years. And internally, what we're saying to ourselves right now is we need to we quit calling these abnormal and we need to call these normal. We need to plan our business accordingly. So this year is a huge investment year on multiple fronts. It's an investment year in the food business on many new ventures. It's an investment year in systems, but it's also an investment year in cost out. And right now, we are working to get cost out of the system. And in fiscal year '19, that means any cost out that we can get above our plan is going to go towards these potential weather events that are going to happen in the winter. So we are trying to create cost out events this year to help counteract any of those and set us up for next year, so that we have basically more contingencies in our budget. And count on these happening, so that it doesn't affect our guidance. So that's how we're looking at this year and that is how we are going to approach it in fiscal year '19.

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Operator [15]

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Our next question comes from Gerry Sweeney with Roth Capital.

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Gerard J. Sweeney, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [16]

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I wanted to maybe look at the natural -- or the Landec natural foods ventures sort of from a funnel perspective. Obviously, you have Eat Smart now, you have O and then Now Planting. What's your sort of internal process of looking at opportunities? I'm sure you're look at maybe analytics potential growth, but maybe you can walk us through how you look at opportunities and maybe what the pipeline potentially could be for ideas maybe from rough ideas to something in the next couple of years, if that makes sense.

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [17]

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Yes, it does. Thank you. So as most people on the phone know, we started our new ventures group just in 2017. So it's a very new group. It's only -- we just have -- it's been just growing a little over a year, 1.5 years and yet, they've been extremely busy. And really the first thing we did was to look out at the consumer. It all starts with the consumer. And we really immersed ourselves in what is going on with the consumer as we know just eating habits are changing considerably. And so the first half was to define who is that consumer and get not only the demographics, but the psychographics and mindset of this consumer. That's where it all started. When we started to understand that consumer, we started to come up with a plethora of different ideas. So that was 1 development path. There's also another path in our new ventures group that we look at our existing capabilities and technologies, and we say how do we leverage those to bring new ideas to the market. And so that comes from an entirely different thought process. So as those ideas come into a funnel, and believe me we have no shortage of ideas, that's what's great about this group and this entire company, we then have a set of criteria that we use. And we develop business cases to say which -- where are the ideas that have the biggest return on investment. And that's how we prioritize all the ideas that we have. So just over the last couple of years, we've created a significant pipeline of new venture ideas. These have required investment. So the investment you are going to see this in our SG&A. You are going to see this in our capital. A lot of the capital that we are investing in, in fiscal year '19 is for innovation, and it's for innovations we have not yet mentioned because they are not yet public. But we did get for a business case and as a result, we believe that we are investing at the right level. And these will reap the benefits over the next several years. So this quarter are bigger launches. I mean, this half of the year, are big launches. As you said, it's Now Planting. And the second half of fiscal year '19, we have another initiative. I'm being very vague on purpose, but we have another initiative that we will be announcing in the second half of fiscal year '19. And we'll talk more about it then. But I think we are poised to grow the natural foods business. Now in the short term, specifically fiscal year '19, that means we are dropping less to the bottom line because we are investing heavily in these ideas. But I think we're going to start to reap the benefits of these investments starting in fiscal year '20 and beyond. And that's really key point is that these investments will start to turn around in fiscal year '20.

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Gerard J. Sweeney, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [18]

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And then, obviously, the Now Planting was internally developed. How about on the acquisition side, is that still an opportunity for you to go out and acquire another natural food group that may fit some of that criteria?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [19]

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We are always looking. So we are looking at acquisitions. We, again, have a very specific process that we go through to look at acquisitions. Again, it comes back to ROI. We don't want to throw a crazy multiple out there for something that we know will never return -- make a return on investment. So when we find the right company that's right for us strategically and we believe we can get it for a price that makes sense to drive shareholder value, we will jump on it. But again, it has to be -- we're not going to push -- we're not going to force it. And so we are very much focused. Our first priority is organic growth because that's under our control, and we believe we are extremely good at it. And so we are going to focus on organic growth. And opportunistically, if we find an acquisition, we'll do that as well.

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Gerard J. Sweeney, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [20]

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Okay. And then switching gears a little bit, you talked about some of the, I guess, costs out initiatives or at least exploring initiatives for that historical vegetable business. Can you give us any details or ideas what some of those initiatives may be? Or is it still too early?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [21]

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Yes, it's pretty early in the process, but let me talk to you more about the process. So first, I'm going to start with our company has always been focused on productivity enhancements and cost out. Obviously, in this kind of business with increasing prices every year, we are implementing prices. And you see that in the capital to get cost out, okay? But I think the costs are starting to grow at a faster rate than the current initiatives that we had in our pipeline. And so we have brought in a third party, it's always good. Bring in a fresh pair of eyes and say what are we missing? And so we're just starting that process. So in the first half of fiscal year '19, we are going to be focused, just like on our innovation side. To me this is innovation just the same, right? We are going to be focused on creating a funnel of ideas for cost reduction, and we have a funnel of those ideas. Now we have to go through the process of quantifying, looking at the ROI on all of those ideas, prioritizing because they will take capital and resources and creating a time line for their execution. I'm hoping some can be done quickly and they're low hanging fruit and others are going to require investment in additional automation and systems that we don't even have in our current budget perhaps. We are going to have to make some trade-offs. So that's the process we are going through. I see over the first half of this fiscal year that we are going to be defining and quantifying, and we'll be able to share more about that in the second half of the fiscal year. And then it will be a 1 to 3 -- it won't be 1 -- it will be 2 or 3 execution on these ideas, and we'll see the benefits of these cost out programs over the next 2 or 3 years.

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Operator [22]

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(Operator Instructions) Our next question comes from John Walthausen with Walthausen & Co.

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John Butler Walthausen, Walthausen & Co., LLC - Portfolio Manager [23]

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My questions were really about Lifecore. Trying to understand it better, you've made significant investment. And I take it that your capital spending this year will include more. Are these on the basis of business that you have in in-house that's been committed to you? Or is it on an expectation that the market is developing your way?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [24]

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That's a great question. The short answer is both. So we have existing customers that are growing and that we are partnering with them to expand capacity and make sure we're there for them, but we also have an extremely strong development pipeline. With, again, existing customers and new customers. The challenge in this business is that these are all FDA approved products. And so there is a pretty lengthy development time on all these -- for all these products to go through clinical trial. So what we do when we are looking at CapEx and supporting our customers is that we map out a pretty disciplined process for investing in that spending. So as a company goes through clinical trials and we see the results of those trials and we gain more and more confidence that is when we start investing to make sure that we have the capital and the capacity in place when those products are commercialized. You have to -- in the end, you have to make a bet, right, because it takes time to order equipment and get it installed and you have to be ready and have that equipment on order prior to it actually being commercialized. So there's a little bit of a bet in here, but we work extremely closely with our partners and we think we have good sight on that. And so the capital that we have in the plan is for both existing and new customers that have been in our product development pipeline.

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John Butler Walthausen, Walthausen & Co., LLC - Portfolio Manager [25]

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Is the R&D spend that goes with that segment, is that basically for qualifying on these new products. Is that where the spend is?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [26]

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Yes.

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John Butler Walthausen, Walthausen & Co., LLC - Portfolio Manager [27]

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And that's an out-of-pocket for us. That's not a reimbursed R&D?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [28]

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Well, Lifecore is actually reimbursed for -- we could pay for all the development products projects. That's actually a revenue stream. So we typically have 3 different revenue streams. We have development products, fermentation and then our CDMO business, which includes the development and the vial and syringe formulation and fill.

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John Butler Walthausen, Walthausen & Co., LLC - Portfolio Manager [29]

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Okay. But I shouldn't take the fact that R&D has been relatively slow growth compared to the revenues. Is it an indication that we are going to see a ramp up of R&D spend and then we'll see the revenue growth? Or when you talk about the revenue growth, it's not all 3 years out type thing. It's something that as this year unfolds, it's reasonable to expect double-digit revenue growth?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [30]

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Yes. No, we are staffed for the projects we see in the pipeline and the growth projections that we are giving, which is low- to mid-teen growth on an annual basis are with those staffing in those R&D projects that we currently have.

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John Butler Walthausen, Walthausen & Co., LLC - Portfolio Manager [31]

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Right. Okay. I mean, I'm highly impressed with Lifecore's profitability and the outlook. I'm just trying to get a better understanding. If we lookout at within your timing horizon, I mean, originally this was an ophthalmic product line, basically. What would you see as the mix out 3 years?

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [32]

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The what mix?

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John Butler Walthausen, Walthausen & Co., LLC - Portfolio Manager [33]

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The mix of markets that you are servicing in Lifecore.

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [34]

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Okay. Well, the markets we tend to mention we don't mention all the markets externally. But the markets we have mentioned is the HA market, which mainly goes as ophthalmic and orthopedic. And we have a lot of other general purpose products that are in. We have some on oncology and other markets as well. So -- but we see that our non-HA business is going to be 35% to 40% of our business in about 5 years. So you see there is a dramatic shift. And just a few years ago, it's 100% HA. Now it's going to more 35% to 40% will be non-HA in 5 years. So that tells you the amount of new products that we have in the pipeline that are going after other markets using other biomaterials.

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John Butler Walthausen, Walthausen & Co., LLC - Portfolio Manager [35]

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Okay. That's just very helpful. And then sort of an accounting, as I look at, obviously, the bulk of the questions, the bulk of the sales, the bulk of the assets are all on the food side of the business. But how do you arrive at the allocation of corporate overhead? Because it seems like you are generally allocating about 1/3 to Lifecore, but it seems like it's a small product.

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Gregory S. Skinner, Landec Corporation - CFO and VP of Fincance & Administration [36]

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We have to go through a fairly detailed analysis of the corporate department. It ties in with our external SEC reporting. You are required to allocate corporate cost and how the management team looks at it to the subsidiaries. So we literally go line by line. And in the cases where it's a natural expense, like stock options, for instance, stock-based compensation, that's very easy. In other cases, we allocate. We come up with a methodology that makes sense. And so it's actually -- it's not a high-level divide everything by 1 number and apply that to the corporate. We actually go through a detailed analysis and in this particular release because we are gaining or looking for transparency, and we want to make sure that everyone can see how our numbers in detail tie back to our SEC reports. We decided to take the allocations and the numbers all the way down to net income.

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Operator [37]

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Ladies and gentlemen, that concludes our question-and-answer session for today's call. I would now like to turn the call back over to Molly Hemmeter for any further remarks.

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Molly A. Hemmeter, Landec Corporation - President, CEO & Director [38]

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Thanks. I guess when I look at fiscal year '19, I see this as, first of all, an incredible year of growth for Lifecore. And we're looking very forward to Lifecore's growth this year and beyond. And then when I look at the food business, I really look at it as in the core of our transformation, and we are making have investments in fiscal year '19 in new ventures, in cost out initiatives, in new systems in order to drive long-term growth in our natural foods company that we'll start to see in fiscal year '20. So -- and it's all part of a transformation, which isn't just words, but a substantial transformation of the business from a package vegetable company to a true value-added natural foods company, which is right on-trend. So we are extremely excited about both of our businesses, our Lifecore CDMO business and our food business and the prospects for the future. So thank you for joining us on our call today.

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Operator [39]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.