Lifecore Biomedical Inc (LFCR) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Landec first-quarter fiscal 2014 earnings conference call.

(Operator Instructions)

As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Mr. Gary Steele, Chairman and Chief Executive Officer of Landec Corporation. Please go ahead.

Good morning and thank you for joining Landec's first quarter of fiscal year 2014 earnings call. I have with me today 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 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 2013.

For the first quarter of fiscal year 2014, we exceeded our revenue plan and met our operating plan despite weather-related sourcing issues. During the first quarter, revenues increased 7% to $109.5 million, and net income increased 9% to $4.8 million, or $0.18 per share. Also during the quarter, the change in the fair market value of our Windset investment contributed $5.4 million of pretax income. This amount however was $2.3 million lower than we had budgeted because of a change in the timing of when the projected increase in our Windset investment for all of fiscal year 2014 will be recognized. The change in the timing of the income recognition will result in approximately $0.06 per share shifting from the first quarter to the remaining three quarters of fiscal year 2014. While it is difficult to predict with precision, we continue to expect to recognize a 35% to 40% increase during fiscal year 2014 in the fair market value change of our Windset investment compared to the fair market value change in fiscal year 2013.

Gross profit in Apio's value-added vegetable business was lower in the first quarter of fiscal year 2014 compared to the first quarter last year because of shortages of certain commodities, mainly green beans and broccoli as a result of weather-related sourcing issues. This resulted in produce sourcing costs that exceeded our expectations by approximately $2 million and reduced Apio's value-added gross margin by 250 basis points in the first quarter.

In addition during the first quarter, Apio experienced product mix changes such as an increase in the lower margin food service sales compared to the first quarter of last year. Also, during the first quarter, Apio launched additional product offerings in its family of new super food products, and Windset completed construction of an additional 64 acres of hydroponic greenhouses in Santa Maria, California. Windset has already begun harvesting tomatoes and cucumbers in its new Phase 3, the first 32 acres of new expansion, and they expect to begin harvesting tomatoes in Phase 4, the next 32 acres within two months. Both phases are several months ahead of plan. This 64-acre expansion has doubled Windset's capacity in California to 128 acres, or 6 million square feet of greenhouse operations. Let me turn it over to Greg who will take us through more of the financial details for the quarter.

Thank you, Gary, and good morning, everyone. We reported yesterday that for the first quarter of fiscal 2014, revenues increased $7.4 million to $109.5 million compared to $102.1 million in the year-ago quarter. This increase was due to a 16%, or $10.8 million increase in revenues in Apio's value-added business and a $614,000, or 8% increase in revenues at Lifecore. These increases in revenue were partially offset by an expected $4 million decrease in revenues in Apio's export business due to a decline in volume sales primarily resulting from Indonesian export quotas on fruit.

Net income in the first quarter of fiscal 2014 increased by 9%, or $386,000, to $4.8 million, or $0.18 per share compared to $4.4 million, or $0.17 per share in the year ago quarter. The increase in net income was driven by a $5.4 million increase in the fair market value of our investment in Windset compared to a $4.3 million increase recorded in the year-ago quarter, and a $121,000 decrease in the pretax loss at Apio -- I mean at Lifecore. The increase in net income in the first quarter were partially offset by a $1 million decrease in pretax income in Apio's value-added vegetable business due primarily to an increase in lower margin food service sales, higher than expected produce sourcing costs, and the discontinuation of the Chiquita minimum purchases of BreatheWay membranes in December 2012 when the agreement changed from exclusive to non-exclusive rights.

Cash and marketable securities totaled $10.2 million at the end of the quarter. Landec generated $4.5 million in cash flow from operations and purchased $4.3 million of capital equipment for capacity expansion at both Lifecore and Apio during the quarter. The Company also paid down debt by $4.3 million during the quarter, and after the quarter, we paid off the remaining balance of our line of credit. Gary, back to you.

Thanks, Greg. We are pleased with the sales growth in our food business in the first quarter. Sales did increase 16% year over year. The reception of our new products is strong, and we continue to add new retail customers for our salad line, and club store demand continues to be high.

Regarding our export business, the Indonesian government's restriction on produce imports continues. Indonesia has been a large buyer of North American produce products, including ours, over the years. While their government restrictions affect our export sales volumes, it is not affecting our export profits as lower margin volumes -- we're shipping lower volumes, but the prices are still quite high. We have made substantial progress in expanding our Apio California facilities putting in additional capacity for our new salad lines, adding green bean processing capability on the West Coast in our Santa Maria facility, and adding vegetable processing capacity in our Bowling Green facility. These investments provide us with flexibility and scale for future growth.

Lifecore Biomedical had a good quarter with 8% revenue growth, and their outlook for the year remains solid. We continue to add sterile filling capacity at our Chaska, Minnesota facility. This allows us to offer our key customers the ability to fill and finish hyaluronic acid and non-hyaluronic acid products in a syringe device format for our customers who can then sell the product directly to customers such as doctors and surgeons worldwide.

We continue to seek and find ways to move up the value-added curve. Accordingly, we have stepped up our effort to identify additional customers for our services especially pharmaceutical companies that have drugs in development that are highly viscous and hard to fill in syringe format, an area where Lifecore has unique expertise. We are impressed with the progress that our strategic investment partner Windset Farms is making not only in Santa Maria, California, in their hydroponic facilities in California, but overall as a Company. Windset is now growing tomatoes and cucumbers hydroponically in California, and demand continues to exceed supply for their branded products.

As adverse weather-related issues continue to affect produce sourcing for all of us throughout the US, and in our Apio business, we increasingly believe that Windset's hydroponic greenhouse expertise will be invaluable to customers who seek long-term stability in sourcing supply. We are also excited to see new products that Windset is launching using our BreatheWay packaging technology. Stay tuned on updates over the next several quarters.

Looking ahead, we continue to face challenges concerning adverse weather events throughout North America and Mexico which affect both the quantity and the quality of produce that we contract to buy from growers. This past quarter, the severe rain storms on the East Coast negatively impacted our cost of green beans. In California, periods of mixed hot and cold temperatures persisted through the summer in California's Central Coast growing region and have affected farmers' yields, and for reasons not totally clear to the farming community, farmers have also experienced increased pest pressures in the July through September time frame. And, Mexico has had recently two severe hurricanes.

We will continue to diversify growing regions and modify our contracting levels to deal with these challenges. We continue to focus on managing and mitigating sourcing issues. For several produce categories, we are a very large consumer, given our huge appetite for buying and processing over 200 million pounds of produce annually, and when supplies are short, we feel the pain as do our customers. To deal with these sourcing challenges, we will continue to diversify growing regions, and as I said earlier, modify our contracting practices.

Looking forward, we are certainly pleased that Americans are eating better as they seek better health and longevity. We can see this trend in the overall growth in the fresh-cut vegetable category which grew 11% in the past 12 months. We are well positioned to capitalize on this category growth long term. We are at this point reiterating our financial guidance for fiscal year 2014, which is to grow revenues by approximately 6% and net income by approximately 20%, after excluding the $3.9 million positive earn-out adjustment in fiscal year 2013, and barring any significant weather-related negative events during the remainder of our fiscal year.

Our top priority, as you can imagine for the next several quarters, is stabilizing our sourcing requirements and making sure we can deliver reliable quantities of healthy pre-cut, pre-packaged produce products to retailers, club stores, and food service operators. For the long term, our charter is very clear. We want to develop and commercialize new products for healthy living applications in the food and biomaterials markets. We want to bring healthy, nutritious, specially packaged fresh-cut products to consumers in North America. We believe healthy eating leads to healthy living.

Through our Apio food business, we want to do our part to enable people to enjoy a higher quality of life as they age. Our polymer-based Lifecore injectable Biomedical Materials for ophthalmic and orthopedic markets enable people to stay more active as they age. We plan to leverage our market leadership positions and provide improved products to meet increasing demand and opportunities generated by the robust health and growth in the healthy living space. We're now open for your questions.

(Operator Instructions)

Our first question comes from the line of Reed Anderson from Northland Securities.

Good morning. Thanks for taking my questions. Gary, probably start with you. Just focusing on Apio and particularly the value add. You had a real nice quarter there in terms of growth. Remind us, what do you think -- for the full year, what do you think the growth rate is going to shake out in that value-add piece? And then, secondly, related to that, do you think -- will there be some quarters that are more up or down versus that? Or, do you think it will be fairly even across the balance of the three quarters?

Reed, overall, we think that the value-added business will grow about 10% annually. We think that's a good, steady-state growth factor, certainly fueled by the introduction of new products and the category growth that I mentioned to you before. The category growth over the long haul is probably around 6% -- the industry category growth, and we would be above that. We do have some seasonality. We do have higher volumes in the Thanksgiving to New Year's and Super Bowl time frame, Reed, but generally speaking, I'd say 10% is a pretty good number for the value-added piece.

Okay, good. And then, in terms of if we look at that business then and take it down a notch and look at the margin side, which really outside of your control, there were just factors there that pressured you this quarter and even last quarter. But, if you think about margins in that business, again kind of looking at the full year, do you think that what we saw in the first quarter is an anomaly in terms of the magnitude of that? Just some sense of what you're planning for margins in that value-add business for the year, please.

Reed, this is Greg Skinner. For the year, obviously the sourcing in the first quarter was anomaly. We did not plan on those type of sourcing issues. Typically, we will put in a contingency for -- not typically, we do -- for the year for sourcing issues. Quite often that is loaded -- well, at least the higher portion of it is loaded toward the winter months so this was somewhat unexpected. But overall, the margins we had as a result and in our plan had planned on margins being equal to slightly higher than last year. The offsets being on the positive side -- new product introductions, higher margins -- bringing down margins slightly is the product mix. We're seeing more higher sales in the food service area, which is a lower margin business, and then just a mix issue to more bags from trays. So overall, we expect margins to be flat to slightly up this year compared to last year.

Okay. That's very helpful, thank you. Just a couple others. In terms of --- in the Lifecore business, the only question I have there is more just from an investment standpoint. Greg, of the $13 million to $15 million, I think, you're spending on CapEx this year, how much of that ends up directed at Lifecore?

About $4 million. $4 million to $5 million, right in that range.

Okay, good. And then, lastly, just from a cash flow standpoint because again earnings on a reported basis are sort of flattish, but really I think your cash flow is going to grow nicely. That's the expectation. Is that still your thinking on an operating basis, $30 million, $35 million this year?

Yes, that's in the ballpark.

Good, that's great. I'll let somebody else jump in. I'll get back in queue. Thank you very much. Good luck.

Thank you. Our next question comes from the line of Tony Brenner from ROTH Capital Partners.

Hey, Tony.

Good morning. I've got a couple of questions as well. First of all, Gary, you said that operating income met your plan. Operating income was down 35% in the quarter. I didn't realize that you had planned that big a decline. Maybe you could elaborate a little bit.

Yes, well, we had it -- Tony, this is Greg. We had planned on it. We looked at the mix issues going on. We knew what from a new product introduction when they were going to be rolling out so we had anticipated that for the first quarter, our operating income would be down. However, if you'll note for the year, we expect it to be up, and therefore, we're on track to meet our annual plan.

Okay, and why was Lifecore unprofitable in the quarter? Last year as I recall, a significant amount of shipments were deferred until the second quarter so it should have been an easier comparison.

Well, you're off a quarter. Last year, they were shipped from the second to the third quarter. Last year, they actually had a loss that was higher than this year's quarter. It's just the timing of the shipments within Lifecore, and so they actually beat their plan by $120,000. We had planned on a larger loss than what actually happened, and they had a loss in the first quarter last year. The big quarter for Lifecore will be the third quarter again.

I'm sorry, say that again?

The big quarter for Lifecore, as with last year, will be the third quarter.

And, it's all about timing of shipments, Tony. As you know, it's a batch fermentation process, and we respond to forecasts from our key customers. And, it's just a timing issue. So, the first quarter is generally their weakest quarter.

You indicated that all sales were to existing customers, but you've got some new capacity and new products. Why are there no new customers buying your sterile fill for example?

We have several new customers that are buying limited quantities, but we're also receiving development fees that are fairly sizeable. They help us underwrite the development process, so they're in the pipeline, and they will represent substantial new revenues for us in the future. Right now, it's mostly development fees.

Okay, and then, could you give us some explanation for the deferred revenue recognition on Windset, which seems particularly strange given that the new capacity came on stream several months ahead of plan?

This is -- I'm going to try my best. It's a little complicated, but the whole concept behind fair market value accounting is you look out. So, everything is based on a discounted cash flow, so we receive a forecast from Windset and say here is what we're going to do over the next five years. You then take those numbers based on analysis done by the outside appraisers and others. You then discount that back to today and say that's the value of that underlying investment, and therefore, we adjust our books accordingly.

When we went into this year we did a -- let's call it a what if, for lack of a better term -- on what we thought the changes in investment would be for all of fiscal '14. We derived a number. That's the number that went into our plan. It's also the number that's in our guidance. I then went in -- and I can take full blame for this -- and gave my best guesstimate of how it was going to fall out by quarter and kind of looking at history, I said two-thirds of the change or thereabouts for the entire year will occur in the first quarter. Well, instead, if you look at the numbers and based on what we put in the press release, it was closer to 50% occurred in the first quarter.

And what's that variable?

You've got their forecast, what changes there. You've got the timing of when things come on line. You've got the discount rates. I mean, there are multiple variables that go into this, and so I was just -- my estimate was off for when it would fall out during the year. But the $0.06 that we thought -- the extra $0.06 that didn't happen in the first quarter will happen, based on what we know today, over the next three quarters. So, we're still going to hit the annual number. It's just the timing of when it's going to occur.

Okay, and that should be evenly distributed?

That's my best guess at this point. You're probably asking the wrong person given my estimate for the first quarter. That would be reasonable, Tony. That would be a reasonable assumption, yes.

Why should investors be comfortable with your full-year projection given you're off by 40% on a quarterly basis?

I can't answer that well. I can just tell you we're still confident of the annual number. We're getting better at this. This is relatively new. This is not straightforward. It's not like shipping a product and knowing -- oh gee, we'll recognize revenue on that. We know what our profit is. There's a lot of variables. You're using outside assistance to come up with your numbers.

Well, last year in the first quarter it was exactly the opposite. You wound up having to restate upwards by what -- 150% from what you originally reported, and the explanation as I recall was that you had to recognize immediately increases -- projected increases for the full year.

Yes, and that undoubtedly skewed my thought process on why I thought it would be so high this year given what happened last year. I kind of overcorrected, if you will.

Tony, the way I'd look at it is, we expect the increase from year to year and the change in fair market value to be 35% to 40%. With their new forecast, with their being ahead of plan in terms of starting up Phase 3 and 4 was some solidification of pricing. With their yields, we're very confident that that increase will happen.

Okay. Thank you.

Thank you.

Thank you. Our next question comes from the line of Peter Black from Wynnefield Capital.

Yes. Hi, Peter.

Hi, guys, how are you doing? Just to follow-up on one of Tony's questions, revolving around Lifecore. I think going back a few quarters, if I remember correctly you spoke about having received -- or your customer having received, one of your customers -- FDA approval for several new products. But, you didn't really address that in the earnings release? So, I'm just wondering what we should expect from kind of new product introductions because it seemed like the growth of the business was a little bit light. So, I'm just wondering if you could talk about that a little.

Yes. Hi Peter, this is Greg again. Yes, that's part of their growth. When we said 10% to 15% growth this year, it was factoring in that about a year ago they received these new FDA approvals. You obviously don't start shipping the day after you get the approval, and so it has been building up in their system. And now, this year, we expect a full year's worth of shipments from those new approvals, in addition to what they've been doing in the past, and that's one of the key drivers to their growth this year.

Okay, and are those products in the ophthalmology market? Or, are they in a different --?

No, they are in the ophthalmology market. That's their franchise. That's their strength. That's their sweet spot, and they are HA-based. And then, what I mentioned earlier in terms of products in development, they are non-HA-based and very much utilize the expanded sterile filling capacity that we have put in place.

Hi, this is Nelson sitting next to Peter. I just had a different question, having to do with sourcing. It looks as though you wound up with the quantity that you needed, and earlier you said that when you have problems with the weather, you have shared pain in regard to the growers. I'm just curious, since you are such a large market for them -- you're not defining shared pain, but maybe just to put some color on that? There are certainly many models out there where the initial producer bears the brunt of the pain so that it doesn't affect your P&L, so to speak, or someone positionally where you are? Can you in general terms talk about that?

Yes, when you have weather-related events, everybody shares in the pain actually. The growers have adverse yields. They just can't get enough product off the acre that they've planted, and we have to go out -- to serve our customers, we have to go out sometimes and buy product on the open market which is not a lot of fun because obviously in shortages the prices are higher. And then, the issue -- and sometimes we have to call our customers and say we have to allot you. We have to scale back your needs. And so, everybody is dealing with the adverse effects of weather. So, the grower has lower yields, therefore, they're transferring less volume. They get fewer dollars. We've got the issue of going out in the open market, paying higher dollars for the scarce resources, and the customers are dealing with issues that have to do with allotments. That's what happens in these situations, Nelson, so everybody has got skin in the game.

Okay, just to drill down a little further, it seems like ultimately you wound up with what you needed. That's true, correct?

Well, we went out in the open market.

No, I understand that so that's the second part of my question. Are you large enough to essentially say to whatever the open market is that when you need -- when we need to access you, we will expect a lower price? Or, does that not work?

No. We're not large enough. No, that doesn't work.

Okay, thanks.

Thanks, Nelson.

Thank you. Our next question comes from the line of Matt Sherwood from Cooper Creek Partners.

Hey, Matt.

Hey, how are you guys doing?

All right.

Great. Just first of all, just had a housekeeping -- I'm a little bit confused on the Windset thing. Because if you just take a step back and you say, hey, we thought Windset was going to grow 2.8% to 3.2% pre-tax for the year in your Q4 press release, and it grew 1.1% in Q1 and you thought it was going to grow another 2.3%, that implies that Windset was going to be negative year-on-year for the rest of the year? Which just seems like a little bit of an extreme assumption, so just trying to reconcile that?

Well, the total growth -- remember last year, you've got to add last year with that -- the value of Windset grew $8.1 million. We said -- let's round it -- it's going to grow $3 million this year, so you're up to $11.1 million, right? So, we're saying of that $11.1 million, approximately 60%, two-thirds, is going to happen in the first quarter so you can do the math. And then, the rest would be over the last three quarters. Instead, it came out to be closer to 50%. It grew $5.4 million so now we're saying $5.5 million to $5.9 million is going to happen in the second half of the year. So, I think when you do the math that way, you'll see it works out.

Okay. Then, in terms of -- I mean, the other thing you just said on the call is, hey, we have a sourcing allowance for bad weather. And then, we used it up in Q1 so does that imply then that if there's bad weather in the winter, you're going to have to reduce your guidance for the year?

No. If I said that then I misspoke. We didn't use it up in quarter one. The amount we allotted to quarter 1, we underestimated. Well, the weather was worse than what we typically see in quarter 1, and so therefore, we expended $2 million more than what we had set aside for Q1. No, when we set up our plan, the lion's share of our contingency for produce sourcing issues is allotted to the winter months, and that is still there.

Okay, so it's still there. Okay, and then, third question. I just have -- it just seems to me that the bean business sourcing in contracts work a little bit differently from the way that they do in your broccoli business, where in the bean business, you're taking risk on the price, and you're getting a fixed price from the grocer. Whereas in the broccoli, you have contracts, and obviously, if there's a disastrous sourcing issue, then you get hit. But, the bean business just seems like weather is a part of the business. It's volatile. Private equity had problems with that. You're having problems with that. It's just part of the business. Can you sort of just argue against that? Why it's not part of the business for beans?

Well, it's certainly part of the business. I can't argue against that. This is Greg again, but it does go the other way. Perfect example was the third quarter of last year, you expect prices to be very high during the winter months, and Florida weather was fantastic during that time frame. We were actually getting beans at much less than what we had thought we would be getting at them for, and it was a very big positive. Unfortunately, that turned around in the fourth quarter, and it's all working out to be fairly even over the course of the year. But, that's just the nature of the business. It is different in the fact that there is a green bean market, and therefore, the product that you're getting from your growers is based on the market whereas our crops out here in California are based on a contracted price. So, the bigger issue out here is volume, but volume obviously also affects the green bean business; lower volumes, higher price. So, therefore, we're paying a higher price.

Right. So, it just seems like this sourcing, putting it in your press release every time -- you couldn't have put it in 3Q, hey, sourcing positively impacted us, back that out. It just seems like it's part of the business in beans which doesn't make it a worse business, it's just a different business.

Yes, and then over time, we're looking at aligning our contracting approach and sourcing approaches so that they're more similar with what we're doing in California. So, that will be over a time period of a couple years.

Fair enough. All right. Great.

Thanks.

Thank you. Our next question comes from the line of Daniel Rizzo from Sidoti & Company.

Yes. Good morning, Dan.

Good morning, guys. How are you?

Good.

So, the third quarter is going to be the strongest again for Lifecore. Is there something about that quarter, or the way the business works, where it's always going to be coming in the third quarter? Or, is it just a coincidence the last two years?

No, it's the timing of their shipment to one of their large -- their largest customer, and the timing of that when the customer wants it is in the third quarter. And so, it's based -- now, if they ever shifted and said we want it in the second quarter or we want it in the fourth quarter, well then that would impact it. But, at least for the last couple of years, they've wanted their product shipped in the third quarter.

But, I guess my question is -- based on -- is it the nature of the business that makes it necessary in the third quarter? Or, is it again just one of those things where those two years that's when they wanted it? Is it something we should expect --?

No, I don't think there's any more cataract surgeries by example, Dan, in the third and fourth quarter. I think it's just the way they manage their inventory, and under our ownership, it's this large customer has been the third quarter. So, I don't think there's any particular market reason other than their buying practices.

Okay, and then with Windset and the expansion which is going so well -- after this is said and done, where else, if anywhere, would they be looking to expand? Is there adjacent fields there? Or, they would have to go to a different state? How would that work?

Absolutely not go to a different state. When you find the ideal site, which they took 2.5 years to identify, which is in Santa Maria, California. I think I've mentioned before it's ideal because you have cool nights, not cold nights. You have warm days, not hot days. And, they have learned -- they had some competitors that just absolutely fell on their swords by building facilities in Texas and Arizona, probably the worst place, you can imagine. So, they have bought land in the surrounding area, and they have substantial opportunities to expand. And, they have the infrastructure in place in Santa Maria.

That's why I think they were able to finish these two new phases ahead of time because the infrastructure was already in place. They were up on the learning curve, and the yields there are remarkable -- absolutely remarkable yields so why would you want to go someplace else? So, they have either bought the land or have options to adjacent land to expand, and they will expand.

Those adjacent lands -- is it roughly the same size as what they have? Or, is it smaller? What's the scale there?

Roughly about the same.

About the same.

Okay. All right. Thank you, guys.

Thanks, Dan.

Thank you. Our next question comes from the line of Scott Rudmann from Nectar Capital.

Hi, guys. Morning. Thanks for the time on the call today. I wanted to see if I could encourage you to touch base on something that you skimmed over a little bit in your remarks, and that is the Chiquita banana contract and that commercial relationship. Can you give us a little update on how that's going?

And, as a follow on to that, the Company's core intellectual property asset -- among several of them -- but one very important one is the BreatheWay technology which is in many ways revolutionary and has potentially -- expansion potential of enormous size. How are you guys doing on licensing that technology to other providers? And also, there was some talk of developing the application for usage in fruits and berries. It would be very interesting to hear how that's going.

Scott, first of all on the Chiquita transition, we went from exclusive to non-exclusive. And, if you follow Chiquita, they had some Company challenges. They had a change in leadership. From what I can see from a distance, those changes have been positive. But, it just made sense. They were paying us a substantial check every year for the right to stay exclusive, and they were lowering their headcount. They were moving their headquarters, and so that transition made sense for them. In retrospect, it made sense for us.

We continue to ship to them substantial numbers of membranes for the banana business. It gave us an opportunity to work with and approach others in the banana area of which we are doing with one Company which may or may not pan out. It also allowed us to -- it freed up some other fields where we are working with some other partners. One of which we can talk about which is Windset Farms, and you will be seeing the use of the membrane technology -- the BreatheWay technology on products such as peppers and cucumbers, and you'll start seeing that in the next couple quarters.

We also have initiated development programs with several other potential customers in what I call high-value applications for the use of the membrane technology. Berries is a -- I will tell you the berry family is a tougher one. I've mentioned this in the past, Scott, that berries has the problem that when you put it into a sealed package -- that's why berries are typically sold in a little basket and not sealed. When you put them in a sealed package, they tend to collect moisture, and it exacerbates the mold that is already on the berries when they're grown in the field. So, that one has been a tough one for us and for others. So, we're going after targets where the sealed package approach, the use of the BreatheWay technology really does substantially and dramatically improve shelf life. So, we have a number of these programs that are well in development, and I would expect to see them in commerce in addition to Windset in the next 12 months. Does that represent a material impact on revenues in the short term? No. Is it a nice addition to profitability in the middle term? Yes. So, stay tuned on that. We will keep you posted.

Okay, thanks.

Thank you. Our next question comes from the line of Will Lauber from Sterling Capital.

Hi, Will.

Hi. My question is on Windset. I have a couple of questions. I just wanted to understand the process of how you come up with the fair market value. Windset -- I guess they will send their financials to you every quarter, and those are audited? Is that accurate?

It's not every quarter per se; it's when they have an update. And, those numbers will go directly to our appraiser that we use so we don't touch them. And then, based on just market information that's out there -- what's the risk profile of Windset? Does it change quarter to quarter? The timing between now and the put-call date which is for purposes of a discounted cash flow, that is the potential liquidity date. It's a date at which we could put it to them, and they could call so everything goes out to that date. It has been discounted back from that date to the current period, and therefore as you get closer to that date, the amount that you're discounting it back is less. And therefore, just automatically, if nothing else changes, your value would go up just from a time value of money perspective.

But, as far as Windset's financial statements, are those audited every year? Or, how is that --?

Yes, they have an annual audit that is performed.

And the appraisal goes to an outside independent appraiser. It is reviewed by our accounting firm, Ernst & Young, in terms of their appraisal group so it has got multiple external eyes and reviews.

Okay, and then in the annual report, you had broken out for your discounted cash flow models on 2012 versus 2013 -- I guess your assumptions for the growth and expense growth rates came down, and your discount rate went up fairly substantial. Could you -- I guess the first question on that is can you just say why you did that? Or, what the assumptions were? And then, are you using the same in 2014 as you were in 2013?

Well, the growth rates are driven by what they have in their plan, and the reason for the big variance is they typically have a relatively low growth rate for things like their buy/sell program. Windset's revenues are generated from three different sources; buy/sell, where they just go out and buy it on the open market from other greenhouse growers. They have a substantial number of grower marketing agreements where they will work with another greenhouse grower who maybe has 10, 20 acres under glass, not large enough to justify a processing center. So therefore, their product is marketed under the Windset name. And then, of course, what they grow themselves up in Canada and here in the US. So, really they have three different businesses, each of which could have different revenue projection rates, and that's reflected in these numbers.

As far as the discount rate goes, if you look at it on a year-over-year basis, the primary driver of that increase is the fact that 3 and 4 was coming online, but the construction wasn't completed. So, you didn't know if you were going to come in on budget in that. They didn't really know at the time we were doing at year-end the exact crop they were going to be planting in 3 and 4. There were just a lot of unknowns associated with 3 and 4 which was a fairly substantial increase in their projections. They obviously had 3 and 4 coming online within the next four years which is what you look out in the projections. That was the primary driver for the range and the increase in that range for the discount rate.

So, would it be safe to assume for 2014 the discount rate will come down?

Yes.

Yes.

Okay, and then kind of more of a big picture question here, and I know you're only one party to it. But, it seems like this Windset investment -- the portion that's not the dividend -- the fair market value is I guess somewhat clouded because its non-cash earnings. And, I'm just wondering, I guess, when -- do we wait until 2017 before this is somewhat monetized? Or, is maybe an IPO for Windset in the future? Or, you possibly buying more of Windset? If you could just talk about some of your plans?

First of all, there's two parties involved here. The Newell family and the Landec family are extremely close in terms of working relationships. We do a number of things together. We buy their tomatoes. They're using our membranes, et cetera, et cetera. We do some things jointly. So, we're highly interested in their success.

I would say that, first of all, the monetizing is February of 2017 in terms of the put-call. There is no anticipation on either party's side to bring that forward, and of the options you mentioned, in terms of them selling out to a private equity firm or going public or selling more to us, I would put my money on us increasing our stake over time. We are not interested in controlling the Company at this point. We think they're doing a super job. We think they've got strong leadership. It's even getting stronger and deeper. So, I don't think that they're thinking IPO. I don't think they're thinking of selling. I think they are thinking of how do we keep building this. So, if anything, we would like to own more.

I don't want to say anymore at this point. But, just know that that's our interest. I don't think they're opposed to it at all. So, I think that's the route, and because of some of the things that are in our contract in terms of our having first rights, et cetera, et cetera. I think it's reasonably likely that we will increase our ownership stake because we think they're hitting the ball out of the ballpark. I don't need to tell you that we think about weather a lot, and they don't worry about it. They've got that part pretty much figured out. So, over time, we think that they've got the answer to the weather issue, and I don't need to tell this group of people that weather has been getting weird around the world, especially in North America.

Yes, I agree with you. I just think that it's quite probable now that this Windset investment is being undervalued by the market because of its non-cash earnings.

I couldn't agree with you more. I couldn't agree with you more. But, we're just -- we'll just keep going forward and supporting them, and I think -- well I'll just give you an example. Greg and I were at their facilities the other day, and we were literally -- their cucumber plants are growing six inches -- not the cucumbers, but the plant itself is growing six inches a day. The yields are remarkable in the way they do things and what they've learned in terms of learning curve from their Phase 1 and 2 in Santa Maria have now been -- to their advantage -- carried over into Phase 3 and 4. The yields are the highest in the world, and they've got this thing pretty much knocked, and so we want to be a part of that future.

My last question is, as far as I can find, the only publicly traded operation with significant greenhouse operations is Village Farms which is on the Toronto Stock Exchange. Can you give any color as to how Windset compares to them as far as operations?

They're a reputable company. We don't know them, but obviously the Newells and the Windset people do because they're neighbors up in British Columbia. They've had a tough go as I understand it. I'm telling you things from secondhand. They sited a plant in -- oh, gosh I believe it was Texas. A large facility and it turned out to be a really bad place. It was horribly damaged by hail storms, glass greenhouses, hail -- it's not a good mix. The weather was not particularly conducive for year-round growing. They sited the facility near oil and gas fields so they were having difficulty getting labor at a reasonable rate because the labor was going to the oil and gas fields and not to their plant, on and on and on. So, I think they've had a rough go of it, Will, and that's why I came back and say that location, location, location is really critical. We saw that with another Company that had been public. Eurofresh went bankrupt. They sited their facilities in Arizona, bad place, et cetera, et cetera. So, I think Windset has a unique formula, and they are off to the races as they say. I think they are blowing by their competitors.

Okay, thank you.

You're welcome.

Thank you. Our next question comes from the line of Craig Pieringer from Wells Capital Management.

Hi Craig.

Good morning. This is a good segue to my question. You mentioned that Windset doesn't worry about weather, but do they worry about the curly-top tomato virus?

Oh, yes, absolutely.

Especially since experts think there will be a larger infestation next year, and specifically, is the Windset hydroponic barrier an impenetrable defense? Or, is it possibly a risk if that barrier should be breached?

It's not impenetrable. It is a risk. It's a fear -- if everybody has fears, that's the worry for hydroponic greenhouse growing or greenhouse growing, in general. There are viruses. There are cankers. There are bacteria. There's white flies. You got all that wonderful stuff, and there are years when there are really heavy insect and pest pressures more so than others. They have -- and no one has a foolproof system, Craig, and you will see that periodically, Windset and others will have these kinds of infestations.

And, it's the issue of how they deal with it that is key and Windset -- I don't want to go into a lot of details for competitive reasons, but they've really got, I think, the best mitigation approaches. The way they have containment systems, the way that they are proactive in terms of managing pest pressures, and the fact that they have the ability -- let's pick a horrible case -- let's say they have a real bad case of it, they have these grower marketing agreements, they have these buy/sell agreements so that their customers are not without product if they had an emergency. So, no one has figured out how to eliminate this altogether, but if I had to put my money on somebody I'd put it on their systems. I think you have seen their facilities. You know the way they take seriously technology. They have imported the state-of-the-art technology in terms of dealing with not only how to get the best yields but also how to mitigate pest pressures. They really have that well under control.

What is curly-top tomato virus?

Beats the hell out of me. I don't know. I know what Botrytis is, but I don't know about curly-top tomato viruses. So, if you have anything on it please send it to us, but I couldn't tell you.

All right, thank you.

(Operator Instructions)

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to management for any further remarks.

Yes. Thanks, everybody for being on the call today. Appreciate your questions. I know there were a number of them directed to how to deal with adverse weather. We're dealing with it. What gives us encouragement and confidence in the business is that the category is growing at a double-digit rate right now. Lifecore is on track for its year. We have these new products that are being launched at higher margins. Our VA category, our sales are up, our volumes are up, and Windset as we've discussed at length has expanded and on a roll. So, we see those as positive signs, and we will have to grapple with the sourcing and weather issues as we go forward and to do that we will modify as best we can the number of geographic locations where we source and also modify to some extent the way we contract. So, thank you for being on the call, and we look forward to keeping you apprised of our progress.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.