LIFECORE BIOMEDICAL, INC. \DE\ (LFCR) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Company’s Consolidated Financial Statements contained in Item 8 of this report. Except for the historical information contained herein, the matters discussed in this report are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Potential risks and uncertainties include, without limitation, those mentioned in this report and, in particular, the factors described in Item 1A. “Risk Factors”. Please see “Note About Forward Looking Statements”.
Overview
Landec Corporation and its subsidiaries (“Landec”, the “Company”, “we” or “us”) design, develop, manufacture, and sell differentiated products for food and biomaterials markets, and license technology applications to partners. Landec has three reportable business segments – Curation Foods, Lifecore, and Other which are described below. Landec’s biomedical company, Lifecore Biomedical®, is a fully integrated contract development and manufacturing organization ("CDMO") that offers highly differentiated capabilities in the development, fill and finish of sterile, injectable pharmaceutical products in syringes and vials. As a leading manufacturer of premium, injectable grade Hyaluronic Acid, Lifecore brings 36 years of expertise as a partner for global and emerging biopharmaceutical and biotechnology companies across multiple therapeutic categories to bring their innovations to market.
Landec’s natural food company, Curation Foods is focused on innovating and distributing plant-based foods with 100% clean ingredients to retail, club and foodservice channels throughout North America. Curation Foods is able to maximize product freshness through its geographically dispersed family of growers, refrigerated supply chain and patented BreatheWay® packaging technology. Also included in the Curation Foods segment operating results are the dividends and Landec’s share of the change in the fair market value of the Company’s 26.9% investment ownership of Windset, a leading edge grower of hydroponically-grown produce.
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Included in the Other segment is Corporate, which includes corporate general and administrative expenses, non-Curation Foods and non-Lifecore interest income and income tax expenses.
Strategy
The Company’s strategy is to maximize the value of our business portfolio by improving operating margins at Curation Foods, investing in growth to drive momentum at Lifecore while driving profitable growth across the organization with consumer insights driven innovation. Each of our business segments are in different life stages and have clear strategic priorities.
Lifecore
Lifecore is the Company’s FDA approved CDMO business, which is focused on driving profitable growth with product development and manufacturing of sterile injectable products. Lifecore seeks to expand its presence in the CDMO marketplace by partnering with biopharmaceutical and biotechnology companies to bring their unique therapies to market. Lifecore’s goal of continuing success will be to execute on its three strategic priorities:
1) Managing Business Development Pipeline: Accelerate product development activities for small and large biopharmaceutical and biotechnology companies in various stages of the product lifecycle, spanning clinical development stage to commercialization, which aligns with the business’ overall product development strategy.
2) Maximizing Capacity: Meet customer demand by maximizing capacity in the syringe and vial multi-purpose filler production line to significantly increase the number of products produced.
3) Advancing Product Commercialization: Continue to seek out opportunities to advance customers’ late-stage product development activities by supporting their clinical programs and commercial process scale-up activities.
Curation Foods
Curation Foods, the Company’s natural food business, is focused on transforming its business to improve operational performance. The Company launched Project SWIFT which aims to strengthen Curation Foods by simplifying the business. The Company believes that the decisive actions of Project SWIFT will help improve the Company’s operating cost structure, enhance profitability, and strengthen its balance sheet with an overall aim to deliver long-term value to shareholders. Curation Foods intends to continue to deliver high levels of product quality and safety, while successfully executing on its customer, grower, and partner commitments. Project SWIFT will continue to be implemented throughout fiscal 2022, with three strategic priorities designed to improve Curation Foods’ overall financial performance and profitability:
1) Network & Operational Optimization: Streamline the organization to maximize efficiency and productivity by continuous improvement in plant operations with lean manufacturing practices. This included the consolidation and centralization of Curation Foods various offices into its Innovation Center headquarters in Santa Maria, California in fiscal 2020.
2) Focus on Strategic Assets: Simplify the business by divesting non-core assets. In fiscal 2020 the Company initiated the strategic sale process of the Company’s Ontario, California salad dressing manufacturing facility, which had yet to become operational and a review of strategic options for its legacy core vegetable bag and tray business. In the first quarter of fiscal year 2021, the Company sold its interest in Ontario for net proceeds of $4.9 million. In June 2020 the Company began exploring opportunities for the divestiture of its underutilized Hanover manufacturing facility, and during the second quarter of fiscal year 2021, the Company sold the Hanover building and assets related thereto for net proceeds of $8.0 million.
3) Organizational Redesign: Redesigning the organization so that it is the appropriate size for the Company’s future direction. In fiscal 2021, the Company focused on redesigning strategic initiatives, developed and elevated internal talent and reduced overall headcount to improve efficiencies.
During May 2021 we entered into a transportation management, warehousing, and transportation services agreement with Castellini Company, LLC to outsource Curation Foods’ fresh packaged salads and vegetables logistics management, including transportation, warehousing and distribution. We expect to benefit from engaging with a strategic logistics partner to increase our distribution reach into markets that we do not currently serve, improve efficiency by increased distribution frequency in existing markets and reduce our overall operating costs, thereby bringing greater value to our stockholders.
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The COVID-19 Pandemic
There are many uncertainties regarding the COVID-19 pandemic, including the scope of scientific and health issues, the anticipated duration of the pandemic, and the extent of local and worldwide social, political, and economic disruption it may cause. The COVID-19 pandemic has had and we believe will continue to have significant adverse impacts on many aspects of the Company’s operations, directly and indirectly, including with respect to sales, customer behaviors, business and manufacturing operations, inventory, the Company’s employees, and the market generally, and the scope and nature of these impacts continue to evolve each day. The Company expects to continue to assess the evolving impact of the COVID-19 pandemic, and intends to continue to make adjustments to its responses accordingly.
Critical Accounting Policies and Use of Estimates
Use of Estimates
The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) requires management to make certain estimates and judgments that affect the amounts reported in the financial statements and accompanying notes to the Consolidated Financial Statements. The accounting estimates that require management’s most significant and subjective judgments include revenue recognition; loss contingencies, sales returns and credit losses; recognition and measurement of current and deferred income tax assets and liabilities; the assessment of recoverability of long-lived assets (including intangible assets) and inventory; the valuation of investments; the valuation and recognition of stock-based compensation; and the valuation and recognition of contingent liabilities.
These estimates involve the consideration of complex factors and require management to make judgments. The analysis of historical and future trends can require extended periods of time to resolve, and are subject to change from period to period. The actual results may differ from management’s estimates. Our accounting policies are more fully described in “Note 1 – Organization, Basis of Presentation, and Summary of Significant Accounting Policies” to our consolidated financial statements. Management has discussed the development and selection of these critical accounting policies and estimates with our Board of Directors.
Revenue Recognition
The Company follows the five step, principles-based model to recognize revenue upon the transfer of promised goods or services to customers and in an amount that reflects the consideration for which the Company expects to be entitled in exchange for those goods or services. Revenue, net of estimated allowances and returns, is recognized when or as the Company satisfies its performance obligations under a contract and control of the product is transferred to the customer.
Curation Foods
Curation Foods’ standard terms of sale are generally included in its contracts and purchase orders. Revenue is recognized at the time shipment is made or upon delivery as control of the product is transferred to the customer. Shipping and other transportation costs charged to customers are recorded in both revenue and cost of goods sold. Curation Foods has elected to account for shipping and handling as fulfillment activities, and not as a separate performance obligation. Curation Foods’ standard payment terms with its customers generally range from 30 days to 90 days. Certain customers may receive cash-based incentives (including volume rebates, discounts, and promotions), which are accounted for as variable consideration to Curation Foods’ performance obligations. Curation Foods estimates these sales incentives based on the expected amount to be provided to its customers and reduces revenue recognized towards its performance obligations. The Company has not historically had and does not anticipate significant changes in its estimates for variable consideration.
Lifecore
Lifecore generates revenue from two integrated activities: CDMO and fermentation. CDMO is comprised of aseptic and development services. Lifecore’s standard terms of sale are generally included in its contracts and purchase orders. Shipping and other transportation costs charged to customers are recorded in both revenue and cost of goods sold. Lifecore has elected to account for shipping and handling as fulfillment activities, and not as a separate performance obligation. Lifecore’s standard payment terms with its customers generally range from 30 days to 60 days.
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Aseptic
Lifecore provides aseptic formulation and filling of syringes and vials with precisely formulated medical grade HA and non-HA materials for injectable products used for medical purposes. In instances where our customers contract with us to aseptically fill syringes or vials with our HA, the goods are not distinct in the context of the contract. Lifecore recognizes revenue for these products at the point in time when legal title to the product is transferred to the customer, which is at the time that shipment is made or upon delivery of the product.
Development Services
Lifecore provides product development services to assist its customers in obtaining regulatory approval for the commercial sale of their drug product. These services include activities such as technology development, material component changes, analytical method development, formulation development, pilot studies, stability studies, process validation and production of materials for use within clinical studies. The Company’s customers benefit from the expertise of its scientists who have extensive experience performing such tasks.
Each of the promised goods and services are not distinct in the context of the contract as the goods and services are highly interdependent and interrelated. The services described above are significantly affected by each other because Lifecore would not be able to fulfill its promise by transferring each of the goods or services independently.
Revenues generated from development services arrangements are recognized over time as Lifecore is creating an asset without an alternate use as it is unique to the customer. Furthermore, the Company has an enforceable right to payment for the performance completed to date for its costs incurred in satisfying the performance obligation plus a reasonable profit margin. For each of the development activities performed by Lifecore as described above, labor is the primary input (i.e., labor costs represent the majority of the costs incurred in the completion of the services). The Company determined that labor hours are the best measure of progress as it most accurately depicts the effort extended to satisfy the performance obligation over time.
Fermentation
Lifecore manufactures and sells pharmaceutical-grade sodium hyaluronate (“HA”) in bulk form to its customers. The HA produced is distinct as customers are able to utilize the product provided under HA supply contracts when they obtain control. Lifecore recognizes revenue for these products at the point in time when legal title to the product is transferred to the customer, which is at the time that shipment is made or upon delivery of the product to our customer.
Impairment Review of Goodwill and Indefinite-Lived Intangible Asset
The Company tests its goodwill and trademarks with indefinite lives annually for impairment in the fiscal fourth quarter or earlier if there are indications during a different interim period that these assets may have become impaired.
On a quarterly basis, the Company considers the need to update its most recent annual tests for possible impairment of its indefinite-lived intangible assets and goodwill, based on management’s assessment of changes in its business and other economic factors since the most recent annual evaluation. Such changes, if significant or material, could indicate a need to update the most recent annual tests for impairment of the indefinite-lived intangible assets during the current period. The results of these tests could lead to write-downs of the carrying values of these assets in the current period.
With respect to goodwill, the Company has the option to first assess qualitative factors such as macro-economic conditions, industry and market environment, cost factors, overall financial performance of the Company, cash flow from operating activities, market capitalization, litigation, and stock price. If the result of a qualitative test indicates a potential for impairment of a reporting unit, a quantitative test is performed. The quantitative test compares the carrying amount of a reporting unit that includes goodwill to its fair value. The Company determines the fair value using both an income approach and a market approach. Under the income approach, fair value is determined based on estimated future cash flows, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of the Company and the rate of return an outside investor could expect to earn. Under the market-based approach, information regarding the Company is utilized along with publicly available industry information to determine earnings multiples that are used to value the Company. A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit.
To determine the fair value of a reporting unit as part of its quantitative test, the Company uses a discounted cash flow ("DCF") method under the income approach, as it believes that this approach is the most reliable indicator of the fair value of its
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businesses and the fair value of their future earnings and cash flows. Under this approach, which requires significant judgments, the Company estimates the future cash flows of each reporting unit and discounts these cash flows at a rate of return that reflects their relative risk. The cash flows used in the DCF method are consistent with those the Company uses in its internal planning, which gives consideration to actual business trends experienced, and the broader business strategy for the long term. The other key estimates and factors used in the DCF method include, but are not limited to, future volumes, net sales and expense growth rates, and gross margin and gross margin growth rates. Changes in such estimates or the application of alternative assumptions could produce different results.
For trademarks and other intangible assets with indefinite lives, the Company performs a quantitative analysis to test for impairment. When a quantitative test is performed, the estimated fair value of an asset is compared to its carrying amount. If the carrying amount of such asset exceeds its estimated fair value, an impairment charge is recorded for the difference between the carrying amount and the estimated fair value. The Company uses the income approach to estimate the fair value of its trademarks. This approach requires significant judgments in determining the royalty rates and the assets’ estimated cash flows as well as the appropriate discount rates applied to those cash flows to determine fair value. Changes in such estimates or the use of alternative assumptions could produce different results.
During fiscal year 2020, the Company recorded an impairment charge of $1.1 million and $3.5 million related to its O and Yucatan Foods trademarks, respectively. The Company also recorded an impairment charge of $5.2 million and $2.7 million related to its O and Yucatan Foods goodwill, respectively. The O impairment charges were primarily a result of the recently updated (lowered) financial outlook for the O reporting unit, related to a recent shift in strategic focus within the Curation Foods business segment. The Yucatan Foods' impairment charges were primarily a result of an increase in the Yucatan Foods carrying value and an in increase in the discount rate, as a result of uncertainty in forecasting the effects of COVID-19 and general economic uncertainties. These impairment charges are included in the line item “impairment of goodwill and intangible assets” on the Consolidated Statements of Operations, and both are in the Curation Foods business segment. There was no impairment charge during fiscal year 2021.
Income Taxes
The Company accounts for income taxes in accordance with accounting guidance which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax basis of recorded assets and liabilities. The Company maintains valuation allowances when it is likely that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the Company’s income tax provision in the period of change. In determining whether a valuation allowance is warranted, the Company takes into account such factors as prior earnings history, expected future earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect utilization of a deferred tax asset, carryback and carryforward periods and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset.
In addition to valuation allowances, the Company establishes accruals for uncertain tax positions. The tax-contingency accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. The Company’s effective tax rate includes the impact of tax-contingency accruals as considered appropriate by management.
A number of years may elapse before a particular matter, for which the Company has accrued, is audited and finally resolved. The number of years with open tax audits varies by jurisdiction. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, the Company believes its tax-contingency accruals are adequate to address known tax contingencies. Favorable resolution of such matters could be recognized as a reduction to the Company’s effective tax rate in the year of resolution. Unfavorable settlement of any particular issue could increase the Company's effective tax rate in the year of resolution. Any resolution of a tax issue may require the use of cash in the year of resolution. The Company’s tax-contingency accruals are recorded in Other accrued liabilities in the accompanying Consolidated Balance Sheets.
Recent Accounting Pronouncements
Refer to Note 1 - Organization, Basis of Presentation, and Summary of Significant Accounting Policies in the notes to our consolidated financial statements for a description of recent accounting pronouncements and our expectation of their impact, if any, on our results of operations and financial condition.
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Results of Operations
Revenues:
Curation Foods revenues consist of revenues generated from (1) the sale of specialty packaged fresh-cut and whole processed vegetable products and salads that are washed and packaged in most cases in the Company’s proprietary BreatheWay packaging and sold primarily under the Eat Smart brand and various private labels, (2) O olive oils and wine vinegars, and (3) Yucatan and Cabo Fresh branded guacamole and avocado products. In addition, the Curation Foods reportable business segment includes the revenues generated from the sale of BreatheWay packaging to license partners.
Lifecore generates revenues from the development and manufacture of pharmaceutical-grade sodium hyaluronate (“HA”) products and providing contract development and aseptic manufacturing services to customers. Lifecore generates revenues from two integrated activities: (1) CDMO and (2) fermentation.
| (In thousands, except percentages) | Year Ended | Change | Year Ended | Change | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| May 30, 2021 | May 31, 2020 | Amount | % | May 31, 2020 | May 26, 2019 | Amount | % | ||||||||||||||||||||
| Curation Foods | $ | 446,074 | $ | 504,533 | $ | (58,459) | (12)% | $ | 504,533 | $ | 481,686 | $ | 22,847 | 5% | |||||||||||||
| Lifecore | 98,087 | 85,833 | 12,254 | 14% | 85,833 | 75,873 | 9,960 | 13% | |||||||||||||||||||
| Total Revenues | $ | 544,161 | $ | 590,366 | $ | (46,205) | (8)% | $ | 590,366 | $ | 557,559 | $ | 32,807 | 6% |
Curation Foods
The decrease in Curation Foods’ revenues for fiscal year 2021 compared to fiscal year 2020 was primarily due to a $57.7 million decrease in revenues in the fresh packaged salads and vegetables product line, which was primarily due to (1) a $35.5 million planned shift away from non-strategic revenue streams, including packaged vegetables in bags and trays, (2) an $11.6 million decrease in green bean revenues driven by a decrease in demand from food service customers during the COVID-19 pandemic, and (3) a $6.9 million decrease in salad revenues driven by a decrease in demand during the COVID-19 pandemic.
The increase in Curation Foods’ revenues for fiscal year 2020 compared to fiscal year 2019, was primarily due to (1) the addition of Yucatan Foods, which was acquired on December 1, 2018, that contributed a comparative increase of $34.9 million in revenues, (2) a $12.7 million increase in salad revenues, and (3) a $3.1 million increase in BreatheWay revenues. These increases were partially offset by a $17.3 million planned decrease in revenues from packaged vegetables in bags and trays, and a $9.0 million decrease in green bean revenues due to weather-related events that resulted in lower yields.
Lifecore
The increase in Lifecore’s revenues for fiscal year 2021 compared to fiscal year 2020 was primarily due to a $10.5 million increase in CDMO revenues resulting from increased demand from existing customers that drove an increase in aseptic filling commercial shipments, and a $1.7 million increase in fermentation sales due to higher sales to existing customers.
The increase in Lifecore’s revenues for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $10.4 million increase in CDMO revenues from an increase in development services activities and an increase in aseptic filling commercial shipments, primarily due to higher sales to existing customers, partially offset by a $0.4 million decrease in fermentation sales to existing customers.
Gross Profit:
There are numerous factors that can influence gross profit including product mix, customer mix, manufacturing costs, volume, sales discounts and charges for excess or obsolete inventory, to name a few. Many of these factors influence or are interrelated with other factors. The Company includes in cost of sales all of the following costs: raw materials (including produce, seeds, packaging, syringes and fermentation and purification supplies), direct labor, overhead (including indirect labor, depreciation, and facility-related costs), and shipping and shipping-related costs.
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| (In thousands, except percentages) | Year Ended | Change | Year Ended | Change | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| May 30, 2021 | May 31, 2020 | Amount | % | May 31, 2020 | May 26, 2019 | Amount | % | ||||||||||||||||||||
| Curation Foods | $ | 43,209 | $ | 42,105 | $ | 1,104 | 3% | $ | 42,105 | $ | 49,305 | $ | (7,200) | (15)% | |||||||||||||
| Lifecore | 38,265 | 32,883 | 5,382 | 16% | 32,883 | 31,698 | 1,185 | 4% | |||||||||||||||||||
| Total Gross Profit | $ | 81,474 | $ | 74,988 | $ | 6,486 | 9% | $ | 74,988 | $ | 81,003 | $ | (6,015) | (7)% |
Curation Foods
The increase in gross profit for the Curation Foods business for fiscal year 2021 compared to fiscal year 2020 was primarily due to an increase in gross profits from avocado products driven by the sale of products in fiscal 2021 produced with lower cost avocados than those used for products sold in fiscal 2020, which was partially offset by (1) the decrease in gross profits primarily driven by the decrease in revenues from our planned shift away from non-strategic fresh packaged salads and vegetables segment revenue streams (primarily packaged vegetables in bags and trays), (2) the decrease in gross profits driven by a decrease in royalty revenue of $1.6 million due to nonrecurring royalty transactions, and (3) business interruption insurance recoveries received in fiscal year 2020.
The decrease in gross profit for the Curation Foods business for fiscal year 2020 compared to fiscal year 2019 was primarily due to (1) the sale of avocado products that were produced during the fourth quarter of fiscal 2019 and first quarter of fiscal 2020 when the costs of avocados were substantially higher than current production costs, (2) adverse weather-related events impacting raw material supply during fiscal year 2020, and (3) lower gross profit driven by a planned de-emphasis of packaged vegetables in bags and trays. These decreases were partially offset by an increase in gross profits from the increase in BreatheWay revenues.
Lifecore
The increase in Lifecore’s gross profit for fiscal year 2021 compared to fiscal year 2020 was primarily due to a 14% increase in revenues, as well as a favorable product mix change in fiscal year 2021. As a result, Lifecore’s gross margin increased to 39.0% in fiscal year 2021 from 38.3% in fiscal year 2020.
The increase in Lifecore’s gross profit for fiscal year 2020 compared to fiscal year 2019 was primarily due to a 13% increase in revenues partially offset by temporary manufacturing inefficiencies in the fourth quarter of fiscal year 2020 associated with new safety protocols primarily due to the COVID-19 pandemic. As a result, Lifecore's gross margin decreased to 38.3% in fiscal year 2020 from 41.8% in fiscal year 2019.
Operating Expenses:
Research and Development (R&D)
R&D expenses consist primarily of product development and commercialization initiatives. R&D expenses in our Curation Foods business are primarily focused on innovating our current product lines and on the Company’s proprietary BreatheWay membranes used for packaging produce, with a focus on extending the shelf-life of sensitive vegetables and fruit. In the Lifecore business, the R&D expenses are focused on new products and applications for HA-based and non-HA biomaterials. For Other, the R&D expenses are primarily focused on creating and developing new innovative lines of products.
| (In thousands, except percentages) | Year Ended | Change | Year Ended | Change | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| May 30, 2021 | May 31, 2020 | Amount | % | May 31, 2020 | May 26, 2019 | Amount | % | ||||||||||||||||||||
| Curation Foods | $ | 4,064 | $ | 5,142 | $ | (1,078) | (21)% | $ | 5,142 | $ | 5,444 | $ | (302) | (6)% | |||||||||||||
| Lifecore | 6,157 | 5,910 | 247 | 4% | 5,910 | 5,085 | 825 | 16% | |||||||||||||||||||
| Other | — | 47 | (47) | (100)% | 47 | 937 | (890) | (95)% | |||||||||||||||||||
| Total R&D | $ | 10,222 | $ | 11,099 | $ | (877) | (8)% | $ | 11,099 | $ | 11,466 | $ | (367) | (3)% |
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The decrease in R&D expenses for fiscal year 2021 compared to fiscal year 2020 was primarily due to (1) a $1.1 million decrease in our Curation Foods segment primarily driven by a decrease in consulting and other professional services related to a packaging redesign and brand restage, partially offset by (2) an increase in Lifecore’s R&D expenses primarily due to higher salary and benefit expenses, including increased headcount.
The decrease in R&D expenses for fiscal year 2020 compared to fiscal year 2019 was primarily due to (1) a $0.9 million decrease in our Other segment primarily due to discontinuing most R&D activities at corporate, (2) a $0.3 million decrease in our Curation Foods segment driven by a decrease in legal and other professional services, partially offset by (3) an increase in Lifecore’s R&D expenses primarily due to higher salary and benefit expenses driven by an increase in headcount related to increased development activities.
Selling, General and Administrative ("SG&A")
SG&A expenses consist primarily of sales and marketing expenses associated with Landec’s product sales and services, business development expenses, and staff and administrative expenses.
| (In thousands, except percentages) | Year Ended | Change | Year Ended | Change | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| May 30, 2021 | May 31, 2020 | Amount | % | May 31, 2020 | May 26, 2019 | Amount | % | ||||||||||||||||||||
| Curation Foods | $ | 38,624 | $ | 46,130 | $ | (7,506) | (16)% | $ | 46,130 | $ | 43,828 | $ | 2,302 | 5% | |||||||||||||
| Lifecore | 8,305 | 7,688 | 617 | 8% | 7,688 | 6,618 | 1,070 | 16% | |||||||||||||||||||
| Other | 18,435 | 18,370 | 65 | —% | 18,370 | 11,616 | 6,754 | 58% | |||||||||||||||||||
| Total SG&A | $ | 65,364 | $ | 72,188 | $ | (6,824) | (9)% | $ | 72,188 | $ | 62,062 | $ | 10,126 | 16% |
The decrease in SG&A expenses for fiscal year 2021 compared to fiscal year 2020 was primarily due to a $7.5 million decrease at Curation Foods primarily due to cost savings driven by our restructuring efforts associated with Project SWIFT and lower salary and related expenses. These decreases were partially offset by a $0.6 million increase at Lifecore due to increased salary and benefit expenses, including increased headcount.
The increase in SG&A expenses for fiscal year 2020 compared to fiscal year 2019 was due to (1) a $6.8 million increase in our Other segment primarily due to a (a) $6.0 million increase in legal fees related to compliance and other legal matters and (b) a $3.0 million greater reduction of the earn out liability (reduction of SG&A costs) associated with the O acquisition in the same period last year compared to the current period, and (c) a $1.8 million decrease in salaries and related benefits due to a decrease in headcount and bonus expense, (2) a $2.3 million increase in our Curation Foods business primarily due to (a) $3.0 million of increased SG&A at Yucatan Foods, which is primarily due to a full year of SG&A expenses in fiscal 2020 compared to a partial year in fiscal 2019, net of merger and acquisition costs incurred, in the same period last year, (b) the $1.2 million reserve for the receivable from Pacific Harvest, partially offset by, (c) a $1.6 million decrease in consulting fees, most of which was associated with Curation Foods’ cost saving initiatives, and (3) a $1.0 million increase in our Lifecore business SG&A due to higher salary and benefit expenses driven by an increase in headcount.
Impairment of Goodwill and Intangible assets, Legal Settlement Charge, and Restructuring Costs
| (In thousands, except percentages) | Year Ended | Change | Year Ended | Change | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| May 30, 2021 | May 31, 2020 | Amount | % | May 31, 2020 | May 26, 2019 | Amount | % | ||||||||||||||||||||
| Impairment of Goodwill and Intangible Assets | $ | — | $ | 12,953 | $ | (12,953) | (100)% | $ | 12,953 | $ | — | $ | 12,953 | 100% | |||||||||||||
| Legal Settlement Charge | 1,763 | — | 1,763 | 100% | — | — | — | —% | |||||||||||||||||||
| Restructuring Costs | 17,621 | 17,285 | 336 | 2% | 17,285 | — | 17,285 | 100% |
During fiscal year 2020, the Company recorded an impairment charge of $1.1 million and $3.5 million related to its O and Yucatan Foods trademarks, respectively. The Company also recorded an impairment charge of $5.2 million and $2.7 million related to its O and Yucatan Foods goodwill, respectively. The O impairment charges were primarily a result of the recently updated (lowered) financial outlook for the O reporting unit, related to a recent shift in strategic focus within the Curation Foods business segment. The Yucatan Foods impairment charges were primarily a result of an increase in the Yucatan Foods carrying
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value and in increase in discount rate, as a result of uncertainty in forecasting the effects of COVID-19 and general economic uncertainties. These impairment charges are included in the line item “impairment of goodwill and intangible assets” on the Consolidated Statements of Operations, and both are in the Curation Foods business segment. Refer to Note 1 - Impairment Review of Goodwill and Indefinite-Lived Intangible Asset in the notes to our consolidated financial statements for more information.
In fiscal year 2021 the Company executed a settlement agreement related to a legal matter with Pacific Harvest, Inc. and Rancho Harvest, Inc., In connection with the settlement agreement, the Company recorded a $1.8 million charge after considering the total settlement amount and insurance recoveries, and this amount is included in legal settlement charge in the Consolidated Statements of Operations for the fiscal year ended May 30, 2021. Refer to Note 10 - Commitments and Contingencies - Legal Contingencies in the notes to our consolidated financial statements for more information.
During fiscal year 2020, the Company announced a restructuring plan to drive enhanced profitability, focus the business on its strategic assets and redesign the organization to be the appropriate size to compete and thrive. This includes a reduction-in-force, a reduction in leased office spaces and the sale of non-strategic assets. The Company recorded $17.6 million and $17.3 million in fiscal years 2021 and 2020, respectively, related to the restructuring plan. Refer to Note 14 - Restructuring Costs in the notes to our consolidated financial statements for more information.
Other:
| (In thousands, except percentages) | Year Ended | Change | Year Ended | Change | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| May 30, 2021 | May 31, 2020 | Amount | % | May 31, 2020 | May 26, 2019 | Amount | % | ||||||||||||||||||||
| Dividend Income | $ | 1,125 | $ | 1,125 | $ | — | —% | $ | 1,125 | $ | 1,650 | $ | (525) | (32)% | |||||||||||||
| Interest Income | 48 | 103 | $ | (55) | (53)% | 103 | 145 | (42) | (29)% | ||||||||||||||||||
| Interest Expense | (15,344) | (9,603) | $ | (5,741) | 60% | (9,603) | (5,230) | (4,373) | 84% | ||||||||||||||||||
| Loss on Debt Refinancing | (1,110) | — | $ | (1,110) | —% | — | — | — | —% | ||||||||||||||||||
| Other Income (Expense) | (11,689) | (4,395) | $ | (7,294) | 166% | (4,395) | 1,600 | (5,995) | N/M | ||||||||||||||||||
| Income Tax (Expense) Benefit | 7,801 | 13,116 | $ | (5,315) | (41) | 13,116 | (1,518) | 14,634 | N/M |
Dividend Income
Dividend income is derived from the dividends accrued during each period on the Company’s previously held $15.0 million Senior A and $7.0 million Senior B preferred stock investment in Windset, which each yielded a cash dividend of 7.5% annually. There was no change in dividend income for the fiscal year ended May 30, 2021 compared to May 31, 2020. The decrease in dividend income for fiscal year 2020 compared to fiscal year 2019 was due to the sale of the Company’s previously held $7.0 million Senior B preferred stock to Windset in the fourth quarter of fiscal year 2019.
Subsequent to fiscal year end 2021, the Company sold its remaining investment in Windset on June 1, 2021.
Interest Income
The decrease in interest income in fiscal year 2021 compared to fiscal year 2020, and 2020 compared to fiscal 2019 was not significant.
Interest Expense
The increase in interest expense during fiscal year 2021 compared to fiscal year 2020 was primarily the result of (i) an increased interest rate, due to the Company's increased Total Leverage Ratio (as defined in the Credit Agreement), combined with our debt refinancing in December 2020 at higher interest rates, (ii) an increase in deferred financing costs from those incurred in connection with the Company's amendments to the Credit Agreement since May 31, 2020 combined with our debt refinancing in December 2020, and (iii) an increase in total outstanding debt from $190.3 million as of May 31, 2020 to $193.9 million as of May 30, 2021.
The increase in interest expense during fiscal year 2020, compared to fiscal year 2019, was the result of an increase in total debt from $149.0 million as of May 26, 2019 to $190.3 million as of May 31, 2020. The increase in debt was primarily due to additional borrowings to fund working capital requirements and new equipment purchases during fiscal year 2020.
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Loss on Debt Refinancing
The loss on debt refinancing was due to a write-off of unamortized debt issuance costs in connection with the Company refinancing its debt in December 2020.
Other Income (Expense)
The decrease in other income (expense) for fiscal year 2021 was primarily the result of the change in fair value of the Company’s previously held investment in Windset, which decreased $11.8 million for the twelve months ended May 30, 2021, compared to a decrease of $4.2 million for the twelve months ended May 31, 2020.
The decrease in other income (expense) for fiscal year 2020 was a result of the change in the fair value of the Company’s previously held investment in Windset, which decreased $4.2 million for the twelve months ended May 31, 2020, compared to an increase of $1.6 million for the twelve months ended May 26, 2019.
Subsequent to fiscal year end 2021, the Company sold its investment in Windset on June 1, 2021.
Income Tax (Expense) Benefit
The change in income tax (expense) benefit for fiscal year 2021 compared to fiscal year 2020 was primarily due to the Company’s reduction in net loss before income taxes and the Company’s effective tax rate decreasing to 19% in fiscal year 2021 from 26% in fiscal year 2020. The effective tax rate differs for fiscal year 2021 from the statutory federal income tax rate of 21% as a result of several factors, including the Company’s benefit of federal and state research and development credits, and the change in valuation allowance established against federal, California, and other state attributes expected to expire prior to recognition.
The change in income tax (expense) benefit for fiscal year 2020 compared to fiscal year 2019 was primarily due to the decrease in the Company’s profit before income taxes, carryback of net operating losses driven by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), and the benefit of federal and state research and development credits.
Liquidity and Capital Resources
As of May 30, 2021, the Company had cash and cash equivalents of $1.3 million, a net increase of $0.9 million from $0.4 million at May 31, 2020.
Cash Flows from Operating Activities
Net cash provided by operating activities during fiscal year 2021 was $15.0 million compared to the use of $17.0 million of cash from operating activities during fiscal year 2020. The primary sources of net cash provided by operating activities during fiscal year 2021 were from (1) Lifecore’s net income from continuing operations and (2) a net decrease of $8.9 million in working capital. These sources of cash were offset by Curation Foods and Other operating loss from continuing operations.
The primary factors for the decrease in working capital during fiscal year 2021 were (1) a $7.9 million decrease in prepaid expenses and other current assets primarily due to the Company’s receipt of income tax refunds related to fiscal year 2020’s net loss from continuing operations before taxes and carrybacks of net operating losses related to the CARES Act, (2) a $5.8 million decrease in accounts receivable driven by an decrease in Curation Foods’ revenues in the fourth quarter of fiscal year 2021 compared to fiscal year 2020 coupled with timing of customer payments, and (3) a $3.3 million increase in accrued compensation primarily related to the amount and timing of bonus payments and deferred payroll taxes under the CARES Act. These decreases in working capital during 2021 were partially offset by (1) a $6.0 million decrease in accounts payable primarily due to the timing of cash payments and (2) a $3.4 million increase in inventory primarily to support the planned sales growth at Lifecore.
Cash Flows from Investing Activities
Net cash used in investing activities for fiscal year 2021 was $10.9 million compared to $23.9 million for the same period last year. The use of cash in investing activities for fiscal year 2021, was primarily due to the purchase of $23.8 million of equipment to support the growth of the Company’s Lifecore and Curation Foods businesses, partially offset by the receipt of $12.9 million primarily related to the sale of Curation Foods’ factories in Hanover, Pennsylvania and Ontario, California.
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Cash Flows from Financing Activities
Net cash used in financing activities for fiscal year 2021 was $3.4 million compared to $40.0 million of net cash provided by financing activities for the same period last year. The net cash used by financing activities during fiscal year 2021 was primarily due to the $48.4 million net pay down on the Company’s revolving line of credit and $10.5 million of debt issuance costs incurred to refinance the Company's term loan and revolving line of credit. The net cash used by these financing activities was primarily offset by the $55.9 million of net cash received from the increase in the Company’s refinanced term loan.
Capital Expenditures
Landec incurred $23.8 million of capital expenditures during fiscal year 2021, which were primarily represented by continued facility modifications and expansions and equipment purchases intended to increase production capacity to support the growth and increased production efficiency of the Lifecore and Curation Foods businesses. Capital expenditures incurred during fiscal year 2020 were $26.7 million.
Debt
On September 23, 2016, the Company entered into a Credit Agreement with JPMorgan, BMO Harris Bank N.A. ("BMO"), and City National Bank, as lenders (collectively, the “Lenders”), and JPMorgan as administrative agent, pursuant to which the Lenders provided the Company with a $100.0 million revolving line of credit (the “Revolver”) and a $50.0 million term loan facility (the “Term Loan”), guaranteed by each of the Company’s direct and indirect subsidiaries and secured by substantially all of the Company’s assets, with the exception of the Company’s investment in Windset.
On November 30, 2018, the Company entered into the Fourth Amendment to the Credit Agreement, which increased the Term Loan to $100.0 million and the Revolver to $105.0 million.
On October 25, 2019, the Company entered into the Sixth Amendment to the Credit Agreement, which increased the Term Loan to $120.0 million and decreased the revolver to $100.0 million. Both the Revolver and the Term Loan mature on October 25, 2022, with the Term Loan requiring quarterly principal payments of $3.0 million and the remainder continuing to be due at maturity.
On March 19, 2020, the Company entered into the Seventh Amendment to the Credit Agreement (the “Seventh Amendment”), which among other changes, retroactively increased the maximum Total Leverage Ratio (as defined in the Credit Agreement as the ratio of the Company’s total indebtedness on such date to the Company’s consolidated EBITDA for the period of four consecutive fiscal quarters ended on or most recently prior to such date) to 5.75 to 1.00 for the fiscal quarter ended February 23, 2020, which decreases back to 5.00 to 1.00 for the fiscal quarter ending May 31, 2020. The maximum Total Leverage Ratio thereafter decreases by 25 basis points each subsequent fiscal quarter thereafter, until it reaches 3.50 for the fiscal quarter ending November 28, 2021, and then remains fixed through maturity. The Seventh Amendment also introduced additional financial covenants that remain in effect through May 31, 2020, including minimum cumulative monthly Unadjusted EBITDA thresholds and maximum capital expenditures, as well as additional reporting requirements and frequencies. Interest on both the Revolver and the Term Loan continues to be based upon the Company’s Total Leverage Ratio, at a per annum rate of either (i) the prime rate plus a spread of between 0.25% and 3.00% or (ii) the Eurodollar rate plus a spread of between 1.25% and 4.00%.
On July 15, 2020, the Company entered into the Eighth Amendment to the Credit Agreement (the “Eighth Amendment”), which among other things, (i) modified the definition of EBITDA to increase the limit on permitted exclusions for certain unusual, extraordinary or one-time cash items for each fiscal quarter ending on or after February 28, 2021, to a maximum of 20% of EBITDA, and (ii) restricted the Company from making Capital Expenditures over certain thresholds. Interest continued to be based on the Company’s Total Leverage Ratio, at a revised per annum Applicable Rate of either (i) the prime rate plus a spread of between 0.75% and 3.50% or (ii) the Eurodollar rate plus a spread of between 1.75% and 4.50%, plus, in each case, a commitment fee, as applicable, of between 0.15% and 0.55%, as further described in the Eighth Amendment.
On December 31, 2020, the Company refinanced its existing Term Loan and Revolver by entering into two separate Credit Agreements (the "New Credit Agreements") with BMO and Goldman Sachs Specialty Lending Group, L.P. (“Goldman”) and Guggenheim Credit Services, LLC ("Guggenheim"), as lenders (collectively, the “Refinance Lenders”). Pursuant to the credit agreement related to the revolving credit facility, BMO has provided the Company, Curation Foods and Lifecore, as co-borrowers, with an up to $75.0 million revolving line of credit (the “Refinance Revolver”) and serves as administrative agent of the Refinance Revolver. Pursuant to the credit agreement related to the term loan, Goldman and Guggenheim have provided the Company, Curation Foods and Lifecore, as co-borrowers, with an up to $170.0 million term loan facility (split equally between
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Goldman and Guggenheim) (the “Refinance Term Loan”) and Goldman serves as administrative agent of the Refinance Term Loan. The Refinance Revolver and Refinance Term Loan are guaranteed, and secured by, substantially all of the Company’s and the Company's direct and indirect subsidiaries' assets.
The Refinance Term Loan matures on December 31, 2025. The Refinance Revolver matures on December 31, 2025 or, if the Refinance Term Loan remains outstanding on such date, ninety (90) days prior to the maturity date of the Refinance Term Loan (on October 2, 2025).
The Refinance Term Loan provides for principal payments by the Company of 5% per annum, payable quarterly in arrears in equal installments, commencing on March 30, 2023, with the remainder due at maturity.
Interest on the Refinance Revolver is based upon the Company’s average availability, at a per annum rate of either (i) LIBOR rate plus a spread of between 2.00% and 2.50% or (ii) base rate plus a spread of between 1.00% and 1.50%, plus a commitment fee, as applicable, of 0.375%. Interest on the Refinance Term Loan is at a per annum rate based on either (i) the base rate plus a spread of 7.50% or (ii) the LIBOR rate plus a spread of 8.50%.
The New Credit Agreements provide the Company the right to increase the revolver commitments under the Refinance Revolver, subject to the satisfaction of certain conditions (including consent from BMO), by obtaining additional commitments from either BMO or another lending institution at an amount of up to $15.0 million.
The New Credit Agreements contain customary financial covenants and events of default under which the obligations thereunder could be accelerated and/or the interest rate increased in specified circumstances.
In connection with the New Credit Agreements, the Company incurred debt issuance costs from the lender and third-parties of $10.2 million.
Concurrent with the close of the New Credit Agreements, the Company repaid all outstanding borrowings under the current Credit Agreement, and terminated the Credit Agreement. In connection with the repayment of borrowings under the Credit Agreement, the Company recognized a loss in fiscal year 2021 of $1.1 million, as a result of the non-cash write-off of unamortized debt issuance costs related to the refinancing under the New Credit Agreements.
As of May 30, 2021, (i) $29.0 million was outstanding on the Refinance Revolver, at an interest rate of 3.0%, (ii) $170.0 million was outstanding on the Refinance Term Loan, at an interest rate of 9.5%, and (iii) the Company was in compliance with all financial covenants and had no events of default under the New Credit Agreements.
Contractual Obligations
The Company’s material contractual obligations for the next five years and thereafter as of May 30, 2021, are as follows:
| (in thousands) | Due in Fiscal Year Ended May | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Obligation | Total | 2022 | 2023 | 2024 | 2025 | 2026 | Thereafter | ||||||||||||||||||||
| Debt obligations | $ | 199,000 | $ | — | $ | 2,125 | $ | 8,469 | $ | 8,422 | $ | 179,984 | $ | — | |||||||||||||
| Interest payments associated with debt obligations | 73,400 | 17,197 | 17,178 | 16,860 | 13,207 | 8,958 | — | ||||||||||||||||||||
| Finance leases | 3,974 | 466 | 3,497 | 9 | 2 | — | — | ||||||||||||||||||||
| Operating leases | 32,758 | 4,850 | 4,052 | 3,263 | 2,502 | 2,015 | 16,076 | ||||||||||||||||||||
| Purchase commitments | 75,441 | 20,344 | 6,179 | 5,985 | 5,604 | 5,604 | 31,725 | ||||||||||||||||||||
| Total | $ | 384,573 | $ | 42,857 | $ | 33,031 | $ | 34,586 | $ | 29,737 | $ | 196,561 | $ | 47,801 |
Debt obligations reflect the principal amounts outstanding on the Term Loan and the Revolver at fiscal year-end. The interest payment amounts above are based on principal amounts and contractual rates at fiscal year-end. See “Note 7 – Debt” in the notes to our consolidated financial statements for further information on the Company’s loans.
The Company’s future capital requirements will depend on numerous factors, including the progress of its research and development programs; the continued development of marketing, sales and distribution capabilities; the ability of the Company to establish and maintain new licensing arrangements; the costs associated with employment-related claims; any decision to pursue additional acquisition opportunities; weather conditions that can affect the supply and price of produce, the timing and amount, if any, of payments received under licensing and research and development agreements; the costs involved in preparing, filing,
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prosecuting, defending, and enforcing intellectual property rights; the ability to comply with regulatory requirements; the emergence of competitive technology and market forces; the effectiveness of product commercialization activities and arrangements; and other factors. If the Company’s currently available funds, together with the internally generated cash flow from operations are not sufficient to satisfy its capital needs, the Company would be required to seek additional funding through other arrangements with collaborative partners, additional bank borrowings and public or private sales of its securities. There can be no assurance that additional funds, if required, will be available to the Company on favorable terms, if at all.
The Company believes that its cash from operations, along with existing cash and cash equivalents and availability under its line of credit will be sufficient to finance its operational and capital requirements for at least the next twelve months.
Off-Balance Sheet Arrangements
The Company is not a party to any agreements with, or commitments to, any special purpose entities that would constitute material off-balance sheet financing.