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Operator
Good day, ladies and gentlemen, and welcome to the Landec Corporation second-quarter fiscal-year 2017 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, Molly Hemmeter, President and CEO of Landec Corporation.
Please go ahead.
Molly Hemmeter - President, CEO
Thanks, Jonathan.
Good morning and thank you for joining Landec's second quarter of fiscal-year 2017 earnings call.
With me on the call today is Greg Skinner, Landec's Chief Financial Officer.
During today's call, we may make forward-looking statements that involve certain risks and uncertainties that could cause 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 2016.
Our results in the second quarter and the first six months of fiscal 2017 demonstrate our progress in the transformation of our two operating businesses.
The transformations taking place at both Apio and Lifecore are twofold, first, a clear focus on building internal innovation capabilities to drive a shift in our product mix to higher value items and, second, the expansion into adjacent high-growth markets to ensure we are positioned for long-term sustainable growth.
For the second quarter, our consolidated gross margin increased 160 basis points to 13.9% compared to the second quarter of fiscal 2016.
And for the first six months, consolidated gross margin increased 220 basis points to 14.9%.
We are on our way to achieving our full fiscal-year 2017 net income growth guidance of 50% to 70%.
These improvements in consolidated gross margin, along with operating income increases of 16% in the second quarter and 30% for the first six months, generated net income and earnings-per-share results that were consistent with our guidance, even though consolidated revenues in the second quarter and first six months of fiscal 2017 were lower than expected.
Consolidated revenues declined 3% in both the second quarter and the first six months, primarily due to our strategic decision to reduce low margin business in our packaged fresh vegetables business beginning in the second half of fiscal 2016.
The packaged fresh vegetables business revenues were also impacted by an unexpected much lower market growth for salad kits in the Canadian retail market than what we were projecting, which partially resulted from a recall of a competitor's salad product in January of last year, and also from Costco deciding to move to a multi-sourcing strategy for salad kits.
It is interesting to note that the Costco decision to move to multi-sourcing of salad kits may provide new opportunities for Eat Smart salads in Costco in the future.
Importantly, for the first six months of fiscal 2017, Lifecore is on track to achieve a record year.
Lifecore revenues for the first six months of fiscal 2017 increased 27% to $24.3 million and operating income increased 46% to $4.7 million, compared to the first six months of last year, due primarily to a favorable product mix resulting in an increased percentage of revenue derived from high-margin fermentation sales.
Lifecore's growth has been fueled by a dramatic evolution in its business model from that of an HA supplier to a fully integrated contract development and manufacturing organization, or CDMO.
As a fully integrated CDMO, Lifecore offers expertise and capabilities in fermentation, specialty formulation, aseptic filling, and final packaging of both devices and drugs for hard-to-handle materials.
Over the many years working with highly viscous HA product, Lifecore has developed innovative processes and handling techniques for these materials that are also useful in adjacent injectables markets.
These unique capabilities and Lifecore's dedication to creating a culture of pharma elegance has broadened its appeal to a much wider customer base.
The evolution of Lifecore to a fully integrated CDMO has expanded its markets, materials, products, and services to go beyond the HA market.
As such, revenues and operating income are expected to continue to grow on average at lower double digits for the foreseeable future.
Apio is also having a good year, despite lower revenues compared to a year ago.
At Apio, we are focused on transforming the business from a commodity business to a branded packaged fresh vegetable company differentiated in the market through innovation.
Over the last several years, we have also expanded our business from the traditional core vegetable bags and trays to the adjacent high-growth, more profitable salad kit segment, thereby increasing our size of the market in which we compete from $1.3 billion to $3.2 billion.
At Apio overall, even with revenues down 5%, gross margin was up 200 basis points, gross profit was up 13%, and operating profit was up 9%, a considerable improvement during the first six months of fiscal-year 2017 compared to the same period last year, reflecting the continuing shift in product mix to innovative higher-margin products, normal raw materials sourcing conditions, and increasing operating efficiencies.
We have positioned both of our businesses to benefit from the favorable market trends, driven by people making choices to live healthier lives.
Apio delivers packaged fresh vegetable products that make it convenient and delicious to eat healthy.
Lifecore helps to bring FDA-approved drugs and medical devices to market that enhance the ability to stay active.
We will continue to differentiate ourselves through innovation and build our internal innovation capabilities within our branded food products and biomaterials businesses to deliver new products that consumers and customers value.
Before I go into more details on our progress and plans for the rest of fiscal 2017 and our strategic objectives over the next three to five years, let me turn the call over to Greg for some financial highlights.
Greg Skinner - CFO, VP Administration
Thank you, Molly, and good morning, everyone.
Revenues in the second quarter of fiscal 2017 decreased 3% to $135.9 million from $140.4 million in the year-ago quarter.
The decrease was primarily due to a 9% decrease in revenues in Apio's packaged fresh vegetables business, partially offset by a 16% increase in revenues at Lifecore and a 16% increase in Apio's export business.
Net income in the second quarter of fiscal 2017 was $1.3 million or $0.05 per share, compared to $1.9 million or $0.07 per share in the year-ago quarter.
Net income was negatively impacted by a one-time nonrecurring $1.2 million writeoff of unamortized debt issuance costs, $1 million of which was non-cash, from the refinancing of Landec's debt during the quarter.
Excluding this one-time expense, our earnings per share for the quarter would have been $0.08 per share or $0.01 higher than the second quarter of last year.
In addition to the $1.2 million writeoff, net income for the quarter was also reduced by a $1.2 million increase in operating expenses, primarily at Apio, resulting from additional headcount hired during the past year in areas of sales and financial analysis and from no change in the fair market value of our Windset investment during the quarter, compared to a $200,000 increase during the second quarter of last year.
These decreases in net income were partially offset by, first, a $2 million or 20% increase in gross profit in Apio's packaged fresh vegetables business, due to a favorable product mix shift to a higher percentage of revenues derived from salad kit sales and from favorable operating cost variances, specifically lower produce sourcing costs and improved labor efficiencies in the Company's processing plants, and, second, from a $376,000 decrease in income taxes.
Revenues in the first six months of fiscal 2017 decreased 3% to $268.3 million from $275.8 million in the same period last year.
The decrease was primarily due to an 8% decrease in revenues in Apio's packaged fresh vegetables business, partially offset by a 27% increase in revenues at Lifecore and a 10% increase in Apio's export business.
Net income in the first six months of fiscal 2017 was $4.6 million or $0.17 per share, compared to $4.8 million or $0.18 per share in the first six months of fiscal 2016.
The decrease in net income was due to, first, a $2.9 million increase in operating expenses, primarily from headcount added during the last 12 months; second, a $1.2 million writeoff of unamortized debt issuance costs from the refinancing of debt during the second quarter; third, a $290,000 decrease in operating income at corporate due to the completion of a 15-month licensing agreement during the first quarter of fiscal 2017; and, fourth, no increase in the fair market value of the Company's Windset investment during the first six months of fiscal 2017, compared to a $1 million increase in the first six months of last fiscal year.
These decreases in net income during the first six months of fiscal 2017 were partially offset by $2 million or a 24% increase in gross profit at Lifecore from increased revenues and from a $3.2 million or 14% increase in gross profit in Apio's packaged fresh vegetables business, due to a favorable product mix, favorable sourcing costs, and operational productivity improvement initiatives during the first six months of fiscal 2017.
Turning to our financial position, at the end of the second quarter of fiscal 2017, cash totaled $2.6 million after generating $5.5 million in cash flow from operations, paying off $6.7 million of debt, and investing $4.7 million in property and equipment, primarily for capacity expansion during the quarter.
At November 27, 2016, we had $98.5 million available to borrow under our line of credit.
Let me turn the call back over to Molly.
Molly Hemmeter - President, CEO
Thanks, Greg.
We have made and will continue to make appropriate and timely investments in both Apio and Lifecore to expand our higher-margin product portfolios through innovation in the coming years.
Over the last five years, we have invested in new products and capacity that are the foundation for our current and future growth.
We have doubled our processing capacity at Apio and tripled our aseptic filling capacity at Lifecore to meet existing product demand and in anticipation of growing demand up for our products, while simultaneously investing in product development at both Apio and Lifecore.
Lifecore's demand and capacity have expanded dramatically over the past six years, from manufacturing 1 million syringes per year to 3.5 million syringes per year today, with a projection of increasing to 7 million syringes per year over the next three years.
And within the next 18 months, Lifecore will be adding significant vial filling capacity to prepare for potential new products in its product development pipeline.
Lifecore continues to be the preferred viscoelastic supplier to global ophthalmic market leaders, while now as a fully integrated CDMO broadening its services to grow beyond the HA market.
As such, revenues and operating income are expected to continue to grow on average at lower double digits for the foreseeable future.
In October 2016, we announced that Lifecore would be initiating a targeted investment of up to $17 million to expand its vial configurations for aseptic-filled finished products, providing Lifecore with a manufacturing capacity to deliver the anticipated growth in its long-term plan.
This capital investment is specifically designed to align Lifecore's capability with the market expectations of our current and prospective customers.
As mentioned in the October press release, $5 million in capital has been approved for this project, with up to $12 million in additional capital expenditures to be approved contingent upon meeting specific milestones and ROIC, or return on invested capital, targets.
In addition to the tailwinds from positive healthy living trends, Lifecore is also benefiting from a growing trend among both mature and start-up pharmaceutical and other medical material companies to outsource specialty services and manufacturing.
With a growing number of products in the industry seeking FDA approval, Lifecore is well positioned as a fully integrated CDMO to augment its pipeline with new projects to fuel its long-term growth.
In our Apio business, we are benefiting from the continued shift among consumers to healthier eating, as the categories in which we participate continue to grow.
Our products are on trend, and we are investing capital and adding resources to develop new products that continue to meet the needs of today's consumers.
We are committed to deepening our innovation capabilities to ensure continued growth in this business.
We project that the Eat Smart salad business will resume growing in the second half of 2017 and continue through 2018, serving as a growth platform for several years thereafter as we continue to launch innovative new salads and penetrate the key retailers in the US.
Apio Eat Smart salad kits are highly penetrated in US club stores, Canadian club stores, and in Canadian retail stores.
We will continue to grow within these accounts as we deliver more innovative products to them.
However, penetrating key US accounts in the grocery and mass channels provides the most significant growth opportunity.
Most recently, we have seen significant year-over-year salad kit growth in both Sam's Club and Walmart.
Sam's Club has expanded distribution of Sweet Kale Salad to all club stores, increased promotional spend to drive sales of this item, and recently tested the new Eat Smart Strawberry Harvest salad.
Due to the positive consumer acceptance of the Strawberry Harvest salad, Sam's will be expanding this salad to all doors beginning this week.
During our previous earnings release call, we shared that Walmart tested our Sweet Kale Salad in 400 stores starting in May 2016.
Due to its high performance, Walmart expanded distribution of this salad to 1,400 stores in October.
Our next opportunity to expand in Walmart will be during their next store reset in April 2017.
To further differentiate Apio, we have invested in new, more robust market data analytics platforms.
Apio completed the transition from Nielsen perishable FreshFacts data to the Nielsen Answers data platform last month, which will significantly improve the insights we gather to manage and drive innovation, as well as pricing, promotional, and merchandising decisions with our customers.
Nielsen Answers provides many advantages over the previous system.
Data is collected from approximately twice the number of stores.
We also now have access to store-specific product, pricing, and promotional data and can break down the data among different banners, geographies, and stores to enable Apio to build more effective pricing and promotional strategies.
Importantly, we have also added Nielsen's Homescan panel, which provides consumer scan data and shopper insights for all stores, including Costco.
We have already started to share strategic trend and innovation data with certain key customers.
Our goal is to share shopper insight data and product analytics with those strategic customers who choose Apio as their innovation partner, to drive growth and profitability for both parties.
Using our new database for the 52 weeks ending October 29, 2016, Apio's market share in North America in club and retail stores for packaged fresh vegetables was 17%.
For the same time period, Apio's North American market share for salad kits in club and retail stores with 13%.
In the retail market only for salad kits, Apio salads have a 44% market share in Canadian retail and a 3% market share in US retail, highlighting our potential growth opportunity in the US.
In US retail, Eat Smart salad kit ACV is approximately 17%, while in Canadian retail ACV for Eat Smart salad kits is 84%.
Moving forward, we are focused on three primary growth platforms.
First, our Lifecore Biomedical business is growing at double-digit rates, with new syringe filling capacity coming online over the next several months and vial filling capacity within the next 18 months, both of which will be needed in the future to meet the demand we expect from our deep pipeline of development programs, along with continuing growth from our existing business.
Second, our Eat Smart salad products are on trend with the fast-growing healthy living space, and we expect this product segment at Apio to resume growth again beginning in fiscal 2018.
Third, we are exploring new ways to leverage the national refrigerated infrastructure network at Apio to bring new healthy food products to market in the future.
Landec's top priorities for the next 12 to 24 months are, number one, continuing to innovate new products at Apio to shift our product mix to higher-margin products; number two, expanding distribution of Apio's Eat Smart salads in retail by gaining new US customers and broadening our offering within existing US and Canadian customers in order to fill the additional capacity recently added in Hanover, Pennsylvania; three, evaluating new food products outside of produce that Apio can offer through new product development and/or strategic acquisitions through its refrigerated supply chain; four, executing on our Lifecore programs with existing customers and securing new partnerships utilizing our CDMO strategy, supported by the new capacity at Lifecore; five, increasing the return on invested capital by maximizing returns on each capital allocation decision; and, six, supporting Windset in its expansion plans to build new hydroponic-controlled atmosphere structures using new growing methods for new crops.
In summary, our focus is on developing innovative products at Apio and Lifecore to deliver value to our customers, consumers, and our shareholders.
We are now open for questions.
Operator
(Operator Instructions).
Mitch Pinheiro, Wunderlich Securities.
Mitch Pinheiro - Analyst
So, couple questions.
Just two questions first.
Let's start with Lifecore.
Of the growth at Lifecore in this quarter, how would you break that down between the core HA business and new business, non-HA business?
And then, how does that look (multiple speakers) -- I'm sorry.
Greg Skinner - CFO, VP Administration
Sorry, go ahead, Mitch.
Mitch Pinheiro - Analyst
I was just going to say, and then how would you look at as you look at your double-digit -- low double-digit growth forecast going out, how does that break down as well?
Greg Skinner - CFO, VP Administration
Well, as you recall last year, the non-HA portion was about 25% of Lifecore's revenues.
This year, that percentage just as a result of the business development work that was done last year and the fact that some -- it is transitioning from business development to commercialization is expected to decrease some, it should be somewhere in the 15% in total for the year, which is pretty close to what it was for the first six months of the year.
One of the major drivers in the first half of growth was really from existing customers and existing business, specifically our fermentation revenues, which are some of the highest margin revenues that we have in the Company.
And so, that was a main contributor to their growth in the first half of the year.
Mitch Pinheiro - Analyst
Okay, so of those (multiple speakers)
Molly Hemmeter - President, CEO
(multiple speakers).
Going forward, we do see a lot of the growth in future years.
You mentioned the double-digit growth going forward is going to be in our non-HA area as we start to commercialize those opportunities that are in product development and as the one we just recently commercialized grows.
Mitch Pinheiro - Analyst
Okay, so of the Lifecore double-digit growth, say, 10%, you expect 8%-ish to be coming from core HA and 2% coming from new business?
Is that --
Molly Hemmeter - President, CEO
I would say -- let me give you some ranges.
We haven't finished our -- we haven't given guidance, obviously, for next year, but I can give you some broad ranges.
Let's take say 5% to 8% of growth from HA business, and then to get to the double digits it is another 5% to 8% on top of that with non-HA business.
Mitch Pinheiro - Analyst
Okay.
In terms of that syringe capacity you had mentioned, the 1 million going to 3.5 million to 7 million, where are you now with capacity?
Do you have 7 million syringe capacity now and it is just a matter of filling it?
Greg Skinner - CFO, VP Administration
Yes.
And we would have to add maybe one more to get fully -- one more line to get fully to 7 million, but we have the facility room to do that.
Mitch Pinheiro - Analyst
Okay.
And then back to Apio, when you look at the -- on the salad kits in particular having a flattish year, how does that break down?
Is that all Costco, the loss of that piece of the Costco business?
If your US business was growing 42% ex Costco, I know it's smaller than Canada, and I know Canada -- I don't know if you said specifically, but Canada was up, what, at least in the mid-single digits somewhere, not as high as you expected, but still up.
That means Costco was the entire hit in the quarter and the upcoming quarters.
Is that correct?
Molly Hemmeter - President, CEO
You are correct.
So, let me step back and give some perspective on this, because I think a lot of people are going to have questions on this.
So when we gave our guidance this year, we were well aware that we -- that Costco Canada was going to be going to a dual sourcing strategy, and so we did lose some business in Costco.
They basically gave their smallest DC, one of their four DCs and their smallest one, to another player for their Sweet Kale Salad to do dual sourcing.
So that took us backwards in club.
But in our guidance, we assumed very high growth rates in retail that would not only overcome that backwards momentum in club, but actually still get us the double-digit growth in salad kits.
What happened since then and after we have given guidance is that Costco US also decided to give up more business.
We did not -- we will say this was a surprise.
We did not see this coming.
The US already was dual sourced with a DC in the northeast carrying Taylor Farms Sweet Kale Salad, so we did not see another move coming.
But they did give some of the business in Texas and Arizona to a third supplier.
They have assured us over and over again that they will not take away any more of our business, but felt that just from a diversity of supply that it was a corporate mandate on their -- it's basically their highest selling item and most profitable item -- to diversify in this area.
So that took us back further and that's why our guidance on the salad kits has changed this year.
That being said, we are still growing considerably in US retail and in -- to a smaller fashion in Canada, but it's not enough to overcome -- it is enough to just overcome that Costco loss.
Does that help?
It was a long answer.
Mitch Pinheiro - Analyst
Yes, it does.
It does.
(multiple speakers).
But now, are they -- how has Costco -- is this a Kirkland-branded product?
Molly Hemmeter - President, CEO
No, no, this is all -- they don't brand anything Kirkland in produce, in the produce section.
Mitch Pinheiro - Analyst
Okay, so the Sweet Kale Salad now in Texas and Arizona becomes -- it is not Eat Smart anymore, right?
It would be whoever the supplier is?
Molly Hemmeter - President, CEO
That's right.
Mitch Pinheiro - Analyst
Okay.
Molly Hemmeter - President, CEO
That's right.
Mitch Pinheiro - Analyst
So in a way, your recipe (multiple speakers) -- but it is the same basic -- has the same ingredients, same kind of salad dressing, et cetera?
Molly Hemmeter - President, CEO
Yes, it does.
Mitch Pinheiro - Analyst
Yes, that doesn't -- that somehow doesn't sound --
Molly Hemmeter - President, CEO
I will say their sales -- I will say I know that their sales have gone down since this transition and they're not happy about that, which is one reason they have assured us they won't take away any more.
Mitch Pinheiro - Analyst
And you also alluded to the fact that somehow second sourcing could help you.
Can you talk about that a little more, what you mean by that?
Molly Hemmeter - President, CEO
Yes, so with this mandate with Costco, they are basically saying on any very successful product, we're going to make sure that we have multiple suppliers to protect ourselves just from the volatility in produce.
We were hit the hardest this round for obvious reasons, because we have the highest selling salad kit, but there's other products and other salad kits and they have been adding slots, as they call them, in Costco to increase the number of salad kits that they have.
So what this means, if there is another successful product that goes in, we can actually get a share of someone else's product.
And we will see how that shakes out in the future.
So it goes both ways, right?
We may lose some business, but other business may come to us.
We are just the first ones to get hit.
Mitch Pinheiro - Analyst
It just sounds like, in terms of second sourcing -- supply sourcing strategy by Costco, it is a little convoluted and circular, but -- because I don't -- there is not new suppliers.
So everybody is just backing up the other one, so it is an interesting strategy.
And I guess just the final part of that is, did Costco at all affect gross margin?
I know your gross margin expanded at Apio.
Would it have expanded more or less excluding the impact of Costco?
Molly Hemmeter - President, CEO
It would have expanded more, because our salad kit product -- if our salad kit business overall is the most profitable business.
So, losing any salad business will affect our gross margin.
Mitch Pinheiro - Analyst
Okay, thanks for the questions.
I will pass it on.
Operator
Tony Brenner, ROTH Capital Partners.
Tony Brenner - Analyst
I will stick on Apio for a moment.
Of the 42% increase in the US, excluding Costco, how much of that did Walmart and Sam's Club account for?
Molly Hemmeter - President, CEO
Most of that.
Most of that number, Tony.
They were (multiple speakers) distribution increases.
Yes, sure.
So Sam's, I think we mentioned, had year over year -- last year, they started to expand distribution on the Sweet Kale Salad, so that year over year -- by the end of last year, we had full distribution, so we are seeing some growth, some pretty big growth, from Sam's on a year-over-year basis.
In addition, they've been heavily promoting the item.
They have really found that promoting, believe this or not, promoting just our Sweet Kale Salad not only increases the sales of that product, but actually elevates the entire produce department.
So they have been promoting and demoing, and demoing meaning they taste it in store, the Sweet Kale Salad, on a pretty regular basis, which is really driving awareness of our product and our sales.
Because of the success of that, they have been partnering with us more closely on innovation and tried another salad.
And remember, they are a club format so they don't have as many facings as retail would, but they decided to open up another slot.
They tested our Strawberry Harvest, which I believe we said we launched last quarter.
It did extremely well, and so starting this week they are expanding that to all doors.
So this growth in Sam's is helping to overcome some of the backward movement we saw in Costco.
And then on the Walmart front, we started with the 400 doors.
We went to 1,400 just in October, and what I can say about that is the data so far is looking promising.
We are in discussions with them and their next reset is not until April, so I won't have any news until then.
Tony Brenner - Analyst
Okay.
Can you talk about other new prospective accounts that (multiple speakers)
Molly Hemmeter - President, CEO
We've had some other distribution of new products into some regional players and in the US, but they are just not as the magnitude of those -- as high as the magnitude of those two accounts.
Tony Brenner - Analyst
Okay.
Sticking on salad kits, can you break down Canada versus the US in terms of those revenues?
Molly Hemmeter - President, CEO
We typically don't disclose our revenues by geography, but what I can do is give you a little sense of market size.
So if you step back, the salad kit market in North America, including club and retail, is $1.6 billion.
That comes from Nielsen.
If you look at the club business, meaning primarily Costco, the total potential there is about $250 million.
Let's call it $200 million.
Canadian retail is also about $200 million.
So US retail is $1.2 billion of the overall $1.6 billion market (multiple speakers)
Tony Brenner - Analyst
I am sorry, US retail (multiple speakers).
US retail is what?
Molly Hemmeter - President, CEO
US retail, $1.2 billion of the $1.6 billion.
Tony Brenner - Analyst
Okay.
Molly Hemmeter - President, CEO
So when we say we are focused, so we have very high penetration in both Canadian retail and Costco, but if you look at the market size by those channels, right, the big opportunity is really in US retail and we have an extremely small share right now, about 3% prior to this Walmart expansion.
And so, that's where -- obviously, our focus is on maintaining and growing our Canadian retail business and our Costco business, but we are also very focused on penetrating US retail.
Tony Brenner - Analyst
Got it.
And my last question, Lifecore's margins for the six months were up sharply, but they were down fairly sharply in the second quarter.
I know that some products ship sporadically.
Is that what happened in the second quarter and what kind of forward impact is that going to have?
Greg Skinner - CFO, VP Administration
Yes, Tony, it is purely a timing issue and a shift.
As you know, third quarter is Lifecore's biggest quarter of the year, when they have the majority of their fermentation sales shipments for the year.
As far as the first and second, they actually had a rather large shipment shipped from the second to the first, which had a pretty dramatic impact on margin.
So, it is purely timing.
Tony Brenner - Analyst
Okay, thank you very much.
Operator
Zack Ajzenman, Griffin Securities.
Zack Ajzenman - Analyst
First question on salad kits and new salad kits, introductions for new salad kits.
Can you give us a little more handle on timing and what to expect, because it really sounds like it could certainly help either, A, take market share in some of these increased slot opportunities in club and retail and, B, just help with overall penetration in the salad kit market?
Molly Hemmeter - President, CEO
Definitely.
So last year, at the end of last year, we discussed that we launched two new salad kits.
It was the Asian Sesame Salad and the Southwest Salad.
This year, in the first quarter, we launched the Strawberry Harvest and we're just launching another new kit called Sunflower Kale.
It has a Dijon dressing.
So I want to step back and talk about -- use this opportunity to talk about our sales force.
So, we have talked about we need to go into the major US accounts.
I want to emphasize the major transformation that we've been going through at Apio, and I said in the opening remarks that we are really shifting the Company and transforming it from a commodity company to a true innovation company.
And to do that, we started in marketing and product development and really started to create these internal innovation capabilities.
What we also found is we had to do the same kind of transformation in our sales force, and we did not have the capabilities in our sales force at the time to really get into these highly competitive and sophisticated key US accounts who are holding multiyear contracts with some of our competitors.
And to do that, it is a much more sophisticated sell with analytics and you have to show constant innovation.
And so, it was in about May of last year that we hired our new Chief Customer and Sales Officer.
We did not do it prior to that because if he would have come in and made some big sales, we didn't have the capacity.
We had to expand Hanover first.
So, in order, we made sure that we were expanding the capacity of our salad business in Hanover.
Then we hired a new head of sales who since May has been transforming the sales organization in both people capabilities and systems.
And this is just going to take some time.
But, immediately, they were able to get into Walmart, make the sale, make this market test happen.
We are in active discussions with Kroger, and that is what we are going through right now.
So if you pair the innovation capabilities we have been bringing to the table and we have a very nice pipeline of new products that are really set up for the next several years, and now you pair that with a sales force who is able to enter those key accounts with the analytics, the vision of being a differentiated innovation player, and a three-year product development pipeline that we can put in front of these large customers, that sets us up for future growth.
At the same time, that's going to take time, because it takes time to displace competitors and it takes time to build these relationships and get new systems in place, but the momentum that is happening right now with our sales force is very promising.
Zack Ajzenman - Analyst
Got it.
Thanks for the extra color.
Moving over to Canada, it sounds like the whole salad kit market had a really difficult year in 2016.
But why is it that it really seems to only affect your results in the most recent quarter?
Molly Hemmeter - President, CEO
Yes, that's a great question.
We have been studying the Canadian retail market very closely and really just trying to figure it out.
So I see two things that have happened.
One is the competitive recall that happened last January.
There was a dramatic decline in growth rate right after that recall, and we haven't completely recovered from that, even though it was a while ago.
And typically, we see recoveries much faster.
So this is a little speculation, but we are talking to our buyers in Canada and they believe there is a lot of macroeconomic issues going on as well, with unemployment, the oil industry, and the exchange rate, that their sales -- overall store sales and higher premium items are down right now.
So I think there is a couple different things going on, and with the Dole recall, it really made a bigger difference.
That being said, why haven't we seen it earlier?
I think we were still expanding a lot of distribution in the first half of the year.
We were still gaining ground with new products and seeing sales from just filling shelves versus higher velocity from consumers.
That's the insight I have as far as we continue to study that market and the macroeconomics of what's happening.
Zack Ajzenman - Analyst
Thanks, that's all for me.
Operator
Anthony Vendetti, Maxim Group.
Anthony Vendetti - Analyst
Just to follow up more on the Costco situation, so in fiscal 2016 Costco was about 20% of revenues, and now that there is three sources in the US, are you getting more than one-third of that business?
It sounds like you are.
And right now, based on what you are seeing in terms of the run rate, is Costco going to be 15% or so of revenues unless that situation changes in terms of the number of sources they are using?
Molly Hemmeter - President, CEO
Right, so that's a great question.
So Costco, instead of being about 20%, because of the recent moves is down to about 17% of our business.
This is a double-edged sword, right, because obviously we never want to lose business at Costco and they are a very strong partner of ours, but we have been highly dependent on Costco, and with our growth in retail, I think diversifying our customer base over the long term will be positive for the overall Company.
So that's how I see it playing out.
Again, I would rather not lose that business and we are going to continue to work with Costco to strengthen our business with them.
But that's -- I think it is going to drop to about 20% to 17%.
Anthony Vendetti - Analyst
Okay, and Molly, just on the --
Molly Hemmeter - President, CEO
We do have over -- and we do -- to your other question, we do have over one-third of the business.
We still have way more than the majority in Canada, in the Costco Canada business, and more than one-third in the US.
Anthony Vendetti - Analyst
Okay, so you're still the primary for both of those (multiple speakers).
And I guess the opportunity that you're talking about is to grow that, one is Costco could decide maybe they don't need three sources everywhere.
But also with the rollout of your new salad kits, that's another way for you to grow the market share within Costco, even if they keep three sources in certain locations, correct?
Molly Hemmeter - President, CEO
That's right.
We put items in front of them all the time.
They have a salad rotation program and we're always trying to make sure we are one of their number one suppliers in that program.
So there is opportunities for more slots.
That being said, they only have a few slots.
It is not like retail where you could get up to 10 facings one day.
So, as I mentioned earlier, the market size -- the total potential of Costco if you look at US and Canada is a fixed amount and it is much smaller than the overall market opportunity we see in US retail, by 10 fold.
Anthony Vendetti - Analyst
Just to understand how the market declined, the market opportunity for -- in Canada due to a competitor's product recall, is it because -- it wasn't an opportunity for you to gain more share; it was just there was less demand for those products because of the recall across all products, because people weren't able to -- consumers weren't able to differentiate what product.
They just knew that salad kits were recalled and so they purchased less?
Is that why it declined?
Molly Hemmeter - President, CEO
Two things, yes, so first of all, we are never happy when there is a recall anywhere in the industry.
It is not good for anyone.
So, we never want to see obviously ourselves or a competitor have a recall because it does in fact effect the entire category for a time.
Usually, that time is months.
This one seems in Canada to be taking a little longer, but that being said, this competitor had a pretty large market share, so I think it had a bigger effect on the market.
There was a question earlier that said why was our share still growing in the first part of the year, and I think we did take over some of that space from the competitor in the first half of the year and that's why we got some distribution gains there.
But now that's evened out, taking over the new distribution space, and just the category overall is not turning as quickly.
Again, still mid-single digit growth, so this isn't like a declining segment, but we are seeing not the high growth rates in the 30s and 40s that we were seeing a little over a year ago.
Anthony Vendetti - Analyst
Understood, understood.
And just to quantify the Walmart opportunity, I assume, because Walmart has put such pressure on their suppliers, that it is not as high-margin business as other vendors maybe would be, but the salad kits are high margin for you guys in general.
But what is the opportunity within Walmart?
I know it comes up in April 2017.
Is it possible at that point to decide to expand to all their stores or it is more likely an incremental step again before a potential national expansion?
Molly Hemmeter - President, CEO
Obviously with our new sales force, we are extremely bullish, so we're letting them know that it should go to all stores.
Anthony Vendetti - Analyst
Correct.
Molly Hemmeter - President, CEO
So that's definitely the goal and what we hope is the next step.
As far as the scale of opportunity, I think in the last earnings call instead of being specific about that side of the business, if we were to get Sweet Kale Salad, that one SKU, in all doors of Walmart for a year, that would be a $5 million to $7 million business.
Okay, so it wouldn't be $5 million to $7 million year over year, because we had some this year, but a total of $5 million to $7 million for that one SKU.
Now what I don't want people to do is say, oh, if you get more SKUs, just double and triple that, because Sweet Kale Salad velocity is so high, right, that having that in all doors is much greater revenue potential than having any other SKU in all doors.
Matter of fact, the Sweet Kale Salad right now is the number one velocity SKU of all salad kits in North America retail.
That's an amazing feat, okay?
So, we can't say, oh, $5 million to $7 million for Sweet Kale Salad; if we would ever get one more SKU, you double that.
But that being said, it gives you a feel for the scale of the business.
Anthony Vendetti - Analyst
Sure, it makes sense, makes sense.
Okay, great, thank you.
Operator
(Operator Instructions).
Brent Rystrom, Feltl.
Brent Rystrom - Analyst
Just a couple quick questions to follow up on a few of the other things.
Can you give us proportionately a sense of how big the Sweet Kale Salads are as a percent overall of your salad kit sales?
Molly Hemmeter - President, CEO
No, we don't give out by product, just like we don't give out customer, except for our largest customer.
We typically don't give out financials by product or by customer.
Brent Rystrom - Analyst
All right, so maybe a different way of asking, how do you guys feel about Sweet Kale Salad?
I know right now it sounds like you feel very bullish.
I was looking at some stuff that came out of Rabobank, their end-of-year summary of some of their surprising thoughts and trends from people in the consumer packaged food business, the products business, and other areas, retailers.
And one of the themes was people were surprised by how quickly the Sweet Kale Salad market was matured.
Are you sensing that market has matured?
Not your share, but the market itself?
Molly Hemmeter - President, CEO
I guess you can say it's maturing if we're seeing slowing growth rates in Canada.
I am hoping that the US retail growth rates still stay very robust for quite some time, in the double digits.
Sweet Kale Salad specifically is interesting because you look at different product life cycles, and every product has a lifecycle, right, so some might really hit it big and be on trend and be more of a niche and be big for two years and then fade away.
Sweet Kale Salad has had an unbelievably long -- it has been out four years now and it is still growing in distribution tremendously and we are still seeing velocity increase.
So I think -- the way I view Sweet Kale Salad is it is becoming more of a staple, like a Caesar salad is or a garden blend salad is.
It is becoming more of a staple for people, and they're using it not just as a salad, but as an ingredient in a lot of different ways to fix vegetables, whether it is in smoothies or stirfries, et cetera.
So what I'm hoping is that it continues to mature.
We have a lot of distribution gains that we can get in the US with this product, and as awareness and household penetration grows, we will continue to see this grow.
Our mind will always be -- I am always optimistically cautious.
We also got to keep our eye on the lifecycle of this and make sure we are coming out with new products to follow behind it, because -- to make sure we have the next big thing.
I got to tell you our Strawberry Harvest Salad is doing extremely well.
The turns are very promising and we're looking to see that follow behind the Sweet Kale Salad as another high seller.
Brent Rystrom - Analyst
And I would imagine even if it is maturing, you are, if not the largest, one of the largest players.
There would be substantial opportunity to consolidate even in a slower growth environment, right?
Molly Hemmeter - President, CEO
I am not sure I understand that question.
Brent Rystrom - Analyst
So if they [read a] growth in the category for kale product is starting to slow considerably, you would still have opportunity to take market share as just one of leading participants, to squeeze out -- and I am sure there's a lot of people who tried to jump into the category and don't have the scale of business that you have.
Molly Hemmeter - President, CEO
Okay, I see your point.
So the point is as the overall category growth is slowing, we -- instead of getting an extra slot, which we did, with Sweet Kale Salad.
It was a new, innovative item.
A lot of people put it in right away because they found another place and expanded the category space.
If category starts to grow, we're going to have to go after share, but I can't think of a better story to go after share than we are the highest velocity item and we're going to make you the most revenue and profit of any other SKU on that shelf.
And so, that's what we'll have to do.
We will have to take share from another salad kit.
Brent Rystrom - Analyst
And then, I have two final questions.
One is just a simple one.
I missed what you said, the new product coming out this quarter is.
I knew you said it was something and kale and I didn't hear what the first part was.
Molly Hemmeter - President, CEO
It is called a Sunflower Kale.
It actually is very similar to the Sweet Kale Salad in the vegetable blend.
The vegetable blend is similar to Sweet Kale Salad.
I believe it doesn't have the brussels sprouts and it has a very popular Dijon mustard dressing.
Brent Rystrom - Analyst
Okay.
Molly Hemmeter - President, CEO
One of the other high-selling SKUs in the category is a mustard Dijon type of salad, and so we came out with our own version of that, capitalizing on the favorability of the Sweet Kale Salad vegetable blend, but combining it with a very popular dressing flavor that we are seeing in the market right now.
Brent Rystrom - Analyst
Thank you.
My final question, then, is just on Costco.
If you look at Costco outside of the regions where the second source was added, will the rest of Costco US grow?
And you may have said this; I apologize if you did.
Molly Hemmeter - President, CEO
I don't think I have that number.
I didn't say what our Costco US specific growth is, outside of those in same-store sales with Sweet Kale Salad.
I actually don't have that number available.
Brent Rystrom - Analyst
Thank you much, guys.
Operator
Chris Krueger, Lake Street Capital.
Chris Krueger - Analyst
One more question on Costco and their multi-sourcing strategy.
Do you have an advantage with your BreatheWay membrane with those products or is Costco's product turnover so quick it doesn't matter?
Molly Hemmeter - President, CEO
I believe we have a definite advantage with our BreatheWay membrane.
We do use our BreatheWay membrane on that club size bag of Sweet Kale Salad.
I think it creates better quality and less shrink, and I think it is going to show in the velocity numbers.
As they have other competitors in there, I think they're going to see that ours continues to sell at a higher rate and they have less shrink.
Time will tell with the new supplier that they have added, but I believe it is a competitive advantage, yes.
Chris Krueger - Analyst
Okay, good.
Now I think you indicated that your vegetable sourcing is much better this year during the tough winter time than it was a year ago.
I think last year you even had to reduce guidance in December because of that issue.
Would you say it is back to normal or just -- it has just improved from last year?
Molly Hemmeter - President, CEO
I think it's back to normal and it has been a good sourcing year for us.
It is nice that during these calls we are not spending all the time on sourcing, right?
It has been a nice, positive topic for us this year.
Chris Krueger - Analyst
Okay.
The new efforts to expand into other food products using your refrigerated platform, do you have a time frame in mind for when that will happen?
Molly Hemmeter - President, CEO
It definitely is not this fiscal year, but we are starting -- or more than starting.
We are looking at different product segments and really starting to focus resources on specific projects.
So I'd gear up for end of next fiscal year into the next -- end of fiscal-year 2018, fiscal-year 2019 time frame is when you would start seeing some things come from that initiative, some benefits.
Chris Krueger - Analyst
All right.
Then my last question is on Lifecore.
I know you indicated in your press release that there is lower business development revenue as the FDA approved a drug product, moving a customer from development to commercial production.
Is that simply a time frame where there is a lag before you start getting more revenue from the development -- or commercialization phase?
Molly Hemmeter - President, CEO
Right, so they are in startup phase right now.
It is a startup and they are selling and they're commercializing and they're ramping up.
So, yes, I think there is going to be a little bit of a lag as we see how their product does in the market.
And the development fees from that project were pretty substantial, so they outsourced a lot of their development to us, so -- but we do see the commercialization ramping up over the next several years.
Chris Krueger - Analyst
Okay, that's all we got.
Thanks.
Operator
Colin Radke, Wedbush Securities.
Colin Radke - Analyst
Just on the salad kits, so the revenue guidance doesn't imply much of a rebound in the second half, and I appreciate everything that is going on with Costco, but at the same time you mentioned you expect a rebound in the salad kit market in Canada.
You also have another slot at Sam's.
Just wondering why there wouldn't be more of an improved growth trajectory for the second half.
Molly Hemmeter - President, CEO
I think what we are seeing a lot is just a timing issue here.
So, first of all, Costco is a big part of our business, so you have to appreciate that we -- going backwards with our Costco Sweet Kale Salad business means staying flat is a pretty dramatic increase in our retail business.
The other is just timing, and when we can get -- like for Walmart's growth, we are not going to see that.
If we grow to another slot, it won't be until April.
And with the single-digit growth in Canada right now, again, it is growth, but we have a lot to make up with that Costco, with the Costco loss.
Colin Radke - Analyst
Okay, fair enough.
Molly Hemmeter - President, CEO
So, we just see it more flat through the rest of the year, and then as we get these distribution gains, we see it kicking in again in fiscal-year 2018.
Colin Radke - Analyst
Okay, and so on Windset, what is the increase that is included in guidance for this year?
I know you said it wasn't substantial, but any way you are able to put some numbers around that or a little more granularity?
Greg Skinner - CFO, VP Administration
Yes, we can't get into specifics now, but we see as we transition to the fact that we will be looking back, we have now got their budget for next year, so we pretty much know what they anticipate.
So, think something in the $0.5 million range for the third quarter, maybe slightly higher in the fourth.
Colin Radke - Analyst
Okay.
Greg Skinner - CFO, VP Administration
It should ramp up some more (inaudible).
Colin Radke - Analyst
Got it, okay.
And just on the OpEx, in terms of the investments in the sales force and everything, I think you had talked previously about a 20% increase in the consolidated operating expenses.
It looks like you are trending well below that year to date.
So just wondering, there would have to be a pretty substantial increase in the second half.
Just wanted to confirm that is still the case and still what you are expecting.
Greg Skinner - CFO, VP Administration
I think in the first half, knowing what was going on in some other areas, we made some conscious decisions to not initiate certain projects, to delay some things.
But in the second half in order to be ready for the growth we anticipate in FY18, we're going to have to start spending some of that money.
So I am thinking that 20% increase that we talked for the whole year we will realize in the last six months compared to the prior-year six months.
So expect the operating expense to pick up in the second half of the year.
Colin Radke - Analyst
Okay, that's it for me.
Thank you very much.
Operator
(Operator Instructions).
And this does conclude the question-and-answer session of today's program.
I would like to hand the program back to management for any further remarks.
Molly Hemmeter - President, CEO
Thanks, Jonathan.
Just want to thank everyone for joining us, again.
Again, at Landec, we are focused on running a very efficient business and focusing on our three core growth platforms.
That is our Lifecore business, which is continuing to grow at double digits; our salad business; and we're going to be expanding to other food products over the next several years to leverage our Apio infrastructure.
And that's all we have, Jonathan.
Thanks so much.
Operator
Thank you, and thank you, ladies and gentlemen, for your participation in today's conference.
This does conclude the program.
You may now disconnect.
Good day.