Lifecore Biomedical Inc (LFCR) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Landec Corporation's Second Quarter Fiscal Year 2018 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, Landec's President and Chief Executive Officer.

Please go ahead.

Good morning, and thank you for joining Landec's Second Quarter Fiscal Year 2018 Earnings Call.

With me on the call is 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 2017.

As a leading innovator in diversified health and wellness solutions, Landec continues to drive solid growth within its 3 strategic growth platforms: Eat Smart salads, natural food products and Lifecore biomaterials.

Each of these businesses are projected to meet or exceed our original growth projections for this fiscal year.

That being said, gross profit and net income during our second fiscal quarter were negatively impacted in our packaged fresh vegetable business by the aftermath of the hurricanes and tropical storms, resulting in $3.9 million of unexpected higher produce sourcing cost during our second fiscal quarter.

As outlined in the company's press release on November 29, 2017, the most significant factor driving higher sourcing cost was the supply and quality of green beans, leading to extensive green beans shortages throughout the industry.

As green beans return to more normal sourcing patterns, we will continue to monitor supply and to fulfill our customer needs to the best of our ability.

It is important to note that there have been no disruption to the supply of vegetables for our Eat Smart packaged salads during this time, nor does management expect future disruptions in its ability to meet demand for its salad product offering.

At Apio, our Eat Smart packaged fresh vegetable business is off to a robust start as revenues increased 9% and 8% in the second quarter and first half of fiscal 2018, respectively, compared to the same periods last year.

This growth is due to increased sales of Eat Smart salads, which increased 29% in the second quarter and 22% in the first half of fiscal 2018 compared to the same periods last year.

The growth in salads was primarily driven by a 64% increase in salad revenues from the U.S. retail channel.

The U.S. retail All Commodity Volume, or ACV, for Eat Smart multi-serve salad kits for the 52 weeks ending October 28, 2017, doubled from 17% to 34% and sequentially was up 600 basis points from 28% for the 52 weeks ended July 29, 2017.

This increase in ACV was driven by expanded distribution in key U.S. accounts such as Walmart, Kroger, Market Fresh and others.

We are pleased to announce that Target Corporation is our newest Eat Smart salad customer.

Starting this month, Target will begin offering 9 Eat Smart salad products, including 5 single-serve Shake-Ups!

salads and 4 multi-serve salad kits to approximately 330 of Target's top-selling stores in the U.S.

During calendar year 2017, we entered the single-serve salad category with 3 products.

Due to their success, 2 additional single-serve salads, the Sweet Kale Salad and the Asian Sesame salad are now available in the Eat Smart Salad Shake-Ups!

offering.

As our distribution continues to grow, we will be able to reach more consumers with easy and delicious ways to eat vegetables and to grow awareness of the Eat Smart brand.

Lifecore met expectations through the first 6 months of fiscal 2018 with revenues of $26.3 million and operating income of $3.1 million.

Lifecore's growth is being fueled by the expansion of its business beyond its historical capabilities as a premium supplier of hyaluronic acid, or HA, to become a fully integrated contract development and manufacturing organization, or CDMO, providing differentiated fermentation, formulation and aseptic fill services for difficult-to-handle medical materials.

At O Olive, operating performance was consistent with expectations with revenues of $2.2 million for the first 6 months of fiscal 2018 and an operating loss of $242,000.

We are currently focused on integrating the Eat Smart sales force with the O Olive organization to leverage the Eat Smart customer base and relationships throughout North America to gain new customers and new distribution for O Olive.

Before I go into more detail about our plans for fiscal 2018 and beyond, let me turn the call over to Greg for some financial highlights.

Thank you, Molly, and good morning, everyone.

Revenues in the second quarter of fiscal 2018 were essentially flat at $136.5 million compared to $135.9 million in the year ago quarter.

The slight increase was primarily due to a $9.2 million or 9% increase in revenues in Apio's packaged fresh vegetables business and a $2.2 million or 18% increase in revenues at Lifecore.

These increases were offset by $11.7 million or 46% decrease in Apio's lower-margin export business, which was greater than planned, but consistent with our strategy to transition to higher margin business.

Net income in the second quarter of fiscal 2018 was $487,000 or $0.02 per share compared to $1.3 million or $0.05 per share in the year ago quarter.

The decrease was a result of first, a $2.6 million decrease in gross profit in Apio's packaged fresh vegetable business due to a $3.9 million in incremental cost -- sourcing cost as a result of the hurricanes and tropical storms during the quarter; second, a $1 million decrease in export gross profit due to lower export revenues; and third, a $617,000 increase in consolidated operating expenses due to increase in R&D activities, partially offset by lower SG&A expenses.

These decreases in net income were partially offset by first, a $1.3 million increase in the fair market value of the company's Windset investment during the second quarter of fiscal 2018 compared to no increase in the year ago quarter; second, a $1.2 million write-off of unamortized debt issuance cost from the refinancing of debt during the second quarter of last year; third, a $279,000 increase in gross profit at Lifecore; and fourth, a $486,000 decrease in income tax expenses.

Revenues in the first 6 months of fiscal 2018 decreased 3% to $259.8 million from $268.3 million in the same period last year.

The decrease was primarily due to a higher than expected $27.5 million or 56% decrease in revenues in Apio's export business, which was partially offset by $15.8 million or 8% increase in Apio's packaged fresh vegetable business and by a $2 million or 8% increase in revenues at Lifecore.

Net income in the first 6 months of fiscal 2018 was $2.6 million or $0.09 per share compared to $4.6 million $0.17 per share in the first 6 months of fiscal 2017.

The decrease was a result of first, a $1.9 million decrease in gross profit in Apio's packaged fresh vegetable business, primarily due to a $4 million in incremental produce sourcing cost as a result of the hurricanes and tropical storms primarily impacting the second quarter of fiscal 2018; second, a $1.6 million decrease in export gross profits due to lower export revenues; third, a $1.3 million decrease in gross profit at Lifecore due to an unfavorable product mix shift and lower overhead absorption in the first 6 months compared to the first 6 months of last year; and fourth, a $1.7 million increase in consolidated operating expenses due to an increase in R&D activities, partially offset by lower SG&A expenses.

These decreases in net income were partially offset by; first, a $2.2 million increase in the fair market value of the company's Windset investment during the first 6 months of fiscal 2018 compared to no increase in the first 6 months of last year; second, a $1.2 million write-off of unamortized debt issuance cost from the refinancing of debt during the second quarter of last year; and third, a $1.3 million decrease in income tax expenses.

Turning to our financial position.

At the end of the second quarter of fiscal 2018, cash totaled $4.4 million after generating $4.3 million in cash from operations, receiving net borrowings of $4.5 million and investing $7.4 million in property and equipment, primarily for capacity expansion during the first 6 months of fiscal 2018.

Investments in property and equipment are expected to significantly increase during the last 6 months of fiscal 2018.

At November 26, 2017, we had $93 million available to borrow under our lines of credit.

Based on our projections for the remainder of fiscal 2018, we are reiterating our fiscal 2018 guidance.

We continue to expect consolidated annual revenues to increase 2% to 4% in fiscal 2018 compared to fiscal 2017.

This growth is being driven by our 3 growth platforms: Eat Smart salads, O Olive and Lifecore.

Each of which is expected to meet or exceed its growth goals for fiscal 2018.

Partially offsetting this growth is the expected $25 million to $30 million decrease in revenues in Apio's lower-margin core and export businesses.

Almost all of this decrease was realized during the first 6 months of fiscal 2018 due to the $27.5 million decrease in revenues in Apio's export business during that period.

We also now expect that the fair market value change in our Windset investment will be $3 million to $4 million compared to our original guidance of $4 million.

We continue to project consolidated net income to increase 35% to 55% in fiscal 2018 compared to fiscal 2017, resulting in an estimated earnings per share range of $0.52 to $0.58.

We expect consolidated cash flow from operations of $30 million to $35 million and capital expenditures of $44 million to $48 million.

For the third quarter of fiscal 2018, we expect consolidated revenues to be in the range of $140 million to $145 million and consolidated net income to be $0.14 to $0.16 per share.

It should be noted that because of the new federal tax rate, which went into effect on January 1, 2018, we will have a lower tax rate in both our third and fourth fiscal quarters, resulting in an overall effective tax rate for fiscal 2018 of approximately 31% to 32%.

Therefore, we're estimating that the quarterly rate for the third quarter will be approximately 28% to 29% and the fourth quarter tax rate will be approximately 31% to 32%.

Let me turn the call back over to Molly.

Thanks, Greg.

Lifecore, one of our 3 high-growth platforms, continues to evolve its business model from being a supplier of HA to a fully-integrated CDMO.

Lifecore is benefiting from a growing trend among 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.

Due to stronger than expected performance of our Lifecore business, we are now increasing Lifecore's expected fiscal 2018 revenue growth to 8% to 10% compared to last fiscal year versus our initial guidance of 6% to 8%.

With revenues last year of $59.4 million, we are now forecasting that Lifecore will deliver revenues of $64 million to $65 million, while continuing to maintain gross margins between 40% and 45% and EBITDA over 30%.

Since Landec's acquisition of Lifecore in 2010 and with our updated fiscal year 2018 forecast for Lifecore, we expect that Lifecore revenues will have more than tripled and EBITDA will have grown from $2.8 million to over $20 million during this time period.

We also expect Lifecore to continue to generate double-digit revenue growth on average over the next 5 years as they expand sales to existing customers, add new customers and commercialize products that are currently in their development pipeline.

Eat Smart salad products represent our second high-growth platform.

Our Eat Smart salad products are on trend within the fast-growing healthy eating space, and we are making significant progress in our strategy to increase the Eat Smart share of multi-serve salad kits in the U.S. retail market.

The annual U.S. retail market for multi-serve salad kits is approximately $1.4 billion, representing over 75% of the approximate $1.8 billion North American multi-serve salad kit market, including Costco.

For the 52 weeks ended October 27, 2017, Eat Smart multi-serve salad kits in U.S. retail consumer dollars grew 61% in the U.S. retail market compared to a category growth rate of 15%.

For the same time period, the market share of Eat Smart multi-serve salad kits in the U.S. retail market increased to 5.3% from 3.8%, an increase of 150 basis points, demonstrating continuous distribution gains as well as room for additional growth.

Due to stronger than expected performance, we are increasing our guidance for the revenue growth of Eat Smart salads this fiscal year from 10% to 12% to 12% to 15% growth compared to last fiscal year.

With continued innovation and expanded distribution, we expect revenues in our salad business to also generate low-double digit growth on average over the next 5 years.

The transformation of our food business consists of 2 distinct phases.

The first phase began in fiscal year 2015 and focused on transitioning Apio from a commodity produce company to a true innovation company with a focus on identifying consumer healthy eating trends and developing value-added products to support those trends.

Last fiscal year, we advanced this effort with new additions to our leadership team, the reorganization of our retail sales force, further rightsizing of our lower-margin historical core vegetable products and export businesses and the launch of our innovative single-serve salads.

We plan to complete the rightsizing of our historical lower-margin business in fiscal 2018, while introducing innovative products to deliver ongoing revenue and profit growth.

The second phase of the transformation of our food business began last fiscal year and continues this fiscal year.

This phase involves expanding our product line from fresh packaged vegetables to include other fresh natural food products outside of produce that meet consumer needs, have higher margins and display less volatile raw material sourcing characteristics.

As seen by the effects that weather had on our business during the second quarter, this becomes an increasingly important strategic imperative.

Advancing the second phase of transformation during fiscal 2017, we launched the Eat Smart 100% Clean Label initiative to ensure that all of our Eat Smart products will be made from all-natural ingredients by the end of calendar year 2018.

We also added the Landec new ventures group to focus on our natural food product strategy and to lead new product development and acquisition initiatives in this area.

The acquisition of O Olive, a supplier of all-natural premium olive oils and wine vinegars was one of the initial projects of this group.

We intend to leverage synergies with Eat Smart to position O Olive as the innovative leader in olive oil and vinegar products with all-natural ingredients that are fully traceable and deliver great taste.

We continue to expect O Olive to meet our original guidance and for revenues to increase by approximately $5 million to $6 million in fiscal 2018 compared to last fiscal year.

Natural food products represent our third high-growth platform, which we expect to grow aggressively over the next 5 years.

This growth will come as a result of continued growth of O Olive, in addition to other natural products that we will launch as a result of internal innovation efforts and potential acquisitions that we determine can deliver a significant return on invested capital.

During fiscal 2018, we are accelerating our efforts on internal new product innovation in preparation for new product launches in the natural food space targeted for fiscal 2019.

Landec currently finds itself in a very strong position.

We are excited to begin leveraging many of the investments we have made over the past several years in both capital and personnel to create forward momentum.

During the last 2 years alone, we increased capacity at both Apio and Lifecore to meet future demand, and we added senior management personnel in the areas of sales, marketing, product development and business development to implement and drive our future growth strategies.

This fiscal year, we expect increasing production volumes of our higher-margin products at both Apio and Lifecore to begin filling this capacity and increasing our gross margins over time.

This fiscal year, Landec is focused on delivering value for today and tomorrow.

We will continue to innovate.

We will continue to launch new Eat Smart products that make it easy and delicious for consumers to eat healthy.

At Lifecore, we will continue to add new processes and capabilities to meet the needs of our customers for their difficult-to-handle biomaterials.

We are focused on increasing production volumes in each of our facilities to drive efficiencies and increase our return on invested capital, or ROIC.

Finally, we are defining and implementing projects that will drive future growth.

For fiscal 2018, we expect capital expenditures of $44 million to $48 million.

Approximately $12 million to $15 million of this spending is allotted for typical annual maintenance capital, while the remaining capital is needed to support existing projects to fuel our future growth.

In summary, we will continue to focus on developing innovative products to deliver value to our customers, consumers and shareholders.

Our balance sheet remains strong and provides the resources for executing on our strategic objectives and reaching our financial goals.

We are now open for questions.

(Operator Instructions) Our first question comes from the line of Francesco Pellegrino from Sidoti.

So I was hoping, could you quantify maybe what the impact of higher procurement cost for green beans is going to be in the second half related to the hit to gross profits?

Well, in the second half, as of now, we're not seeing any issues from green beans.

Okay, so a return to normal gross margin for the green bean product line could be expected?

Yes, as long as the freeze line stays above Homestead, Florida, it's getting pretty cold back there.

Well, it looks as if you guys did everything you possibly could after Hurricane Irma, so it just looks like a case of bad luck.

But on the previous earnings call, I brought up to you that I thought your guidance for the salad kit product line was conservative, it proved to be conservative, and you're raising revenue guidance now.

But when I look at all the key account wins you had during the second quarter, the increase in the market share.

In the second half of 2017 last year, your salad kit revenue was only up 1%, so we're lapping a very easy comp.

Your implied guidance for the second year implies revenue growth for the salad kit product line of only 3% to 8% after a really impressive first half of 2018.

Like, what's happening?

Right.

So remember, at the end of last year -- in the second half of last year is when we got our additional Walmart expansion.

So it actually was a big quarter.

And simultaneously to that, the reason it didn't increase that quarter was because in the previous second half of the year, we had lost a couple of DCs in Costco.

And so it's kind of the growth that you saw last year was minimal not because we didn't increase our distribution in retail considerably, but because we lost some of Costco.

And we're going to see how the -- yes, so there's kind of some competing factors in there which gets us to the 12% to 15%.

And we'll see how things go with our newest customer, Target, and with our other customers.

And we'll see how things turn and see what we can do in the second half of the year, but we feel comfortable with this guidance that we're giving.

Okay.

And would you also mind then just jumping over to Lifecore.

Just walking us through, because when I think of Lifecore and how you want to start onboarding new business, I think of you bringing on a product mix that over the course of the year will average out to about like a 45% gross margin.

Through the first half, we're at 33%.

I understand that some lower cost -- overhead cost absorption has led to the lower margins, but this would almost imply that you would need 55% gross margin in the back half of 2018, but your citing in the press release that you're going to be bringing online more aseptic fill business, which should theoretically continue to be a drag to segment margins even though it's going to have greater cost absorption.

Could you give me a little color on that?

So your question is, do we expect margins in the second half to be 50%-plus.

The answer is, yes.

Reason being, if you look historically and it's true this year, the lion's share of their fermentation shipments and sales, which is one of their higher margin products, happens in the second half of the year.

They're picking -- and business development is picking up as the year goes on.

And yes, the aseptic is also picking up but a lot of that is coming in the area of non-HA products, which has a higher margin within the aseptic group than the HA products.

So the combination of all the positives in the second half, so you're going to see a significant increase in the revenues in the second half, but yes, their margins should be 50%-plus in the second half of the year.

Since we're looking historically, I mean, I'm looking back, you guys have never had 2 consecutive quarters in the second half of -- in excess of 50% gross margins in Lifecore, and I know we're going to be incurring some lumpiness in the third quarter and the fourth quarter because Lifecore 3Q fiscal '17 revenue was up 50% and 4Q was down 26%.

Can you give us some cadence for the second half of the year as well?

Yes, there are some shifts that are going on that have historically happened in the third quarter that's going to be in the fourth quarter this year.

So actually our fourth quarter margins should be or could be, at least, higher than our third quarter margins and that is an aberration, if you look at history.

Okay.

And just the last question from me.

Just taking a step back from everything that's occurring, when I look at Apio, historically, you guys have sort of explained the evolution of Apio as a phase 1 and phase 2 progression.

We're in phase 1. And it looks like whenever we take like 1 step forward, we go 2 steps back.

Initial calling guidance was for a range of $20 million to $25 million.

We're already at $27 million.

You raised the calling guidance from $25 million to $30 million.

Where are we in phase 1?

Bridge me to Phase 2?

And then why can't -- it just seems as if there might be more initiatives you guys could take in Apio that this might not just be the year of rightsizing, that it could potentially extend into 2019.

And I don't know if maybe potentially getting rid of the entire Apio export channel is being considered, because it doesn't seem like it's worth keeping around, maybe the contribution margin's high.

But at the end of the day, it just seems as if it poses more of an earnings risk than it does as a potential reward?

Yes, all right.

So let me just step through phase 1 and phase 2 transformations of Apio.

Phase 1 really was about creating an innovation culture at Apio.

This involved bringing in new leadership and it involved putting more resources in R&D, marketing and sales and throughout the company to support that innovation.

And that's what we've been focused on and the result of that should be launches of innovative on-trend products that are increasing the top line, but also growing our gross margin, and we are seeing that.

At the same time, some of the numbers do not show the actual progress I feel that we're making because at the same time, we are letting go of a lot of our lower-margin business.

So 2 things are happening.

We're letting go of our lower-margin business, which is kind of hiding the actual revenue growth that we're experiencing in our salad high-growth platform and the other reason is our supply challenges, our sourcing problems.

Our procurement is -- even though we are increasing our gross margin from product mix, we're not seeing those effects due to the sourcing challenges that we've had this year.

The underlying business is extremely strong, but those procurement challenges this year, again, are -- and the letting go of some of the core lower-margin business are hiding in the financials, some of the advancements that we are making.

If I look at the second phase and this gets to curing some of those problems in the first phase is we want to transition our product line not just from vegetables to include natural products outside of vegetables.

And a lot of this is, let's say, to increase gross margin further, but also to get in product lines that have less volatility.

So our long-term strategy is to continue to diversify our product line away from high volatility raw material sourcing instances.

And let's take what we've done in just the last few years.

I mean, we have a $150 million-plus salad business where we have seen little to no volatility whatsoever.

4 years ago, we did not have that business and we've diversified our product line from just the core bags and trays to include a very nonvolatile salad business.

Now we're looking to diversifying our product line even more through our natural food strategy into higher-margin, less volatile products from there.

So that over the next 3 to 5 years, we do have a diversified portfolio of plant-based products without the degree of volatility we're seeing and that's the overall strategy.

So I hope that helps.

Our next question comes from the line of Morris Ajzenman from Griffin Securities.

Question relates to the guidance and how next couple of quarters play out.

You kept full year guidance at $0.52 to $0.58, though you guided to Q3 EPS of $0.14 to $0.16, which by math would put the fourth quarter anywhere between $0.25 and $0.30 just to get to the lower end of the range.

So my question is, well, help us walk through this, what's happening in Q3?

My presumption is, and I look at the estimates out there that your guidance is below Street estimates which you really never put out there for Q3.

But what's happened in Q3 that's being pushed out to Q4 that you can help us bridge this near-term gap and help us put a better road map together on the near term?

All right.

Well, the impact -- the biggest impact between the 2 quarters and this is like you mentioned, the numbers that were out there were not our numbers.

So actually the numbers that we disclosed were within our expectations for the third and fourth quarter.

But the biggest shift is the shift in Lifecore where there's products shipments that I think historically and probably what was modeled out that have occurred in the third quarter are going to happen in the fourth quarter this year.

That's by far the biggest shift.

And then I think the other unknown was in -- we disclosed it in the press release is that Windset we're expecting to not -- in the first half of the year, we did $2.2 million, second half it's somewhere $800,000 to maybe $1.5 million.

But most of that is probably going to occur in the fourth quarter.

So those are the 2 biggest items that are impacting the shift.

And then if you just focus on the third quarter, yes, we're going to have a very positive -- the primary positive from the tax rate is going to happen in the third quarter.

But we had some known sourcing issues coming into the third quarter for December and January that are going to offset that tax benefit.

So that's how it all works out.

That's why we feel we can still reiterate guidance for the year, but those are the shifts between the third and fourth quarter.

And one other thing, the core margin business in Apio, how much do you think that will decline this year?

The...

The export business?

The core business, the low-margin business.

What sort of revenue decline do you expect for this fiscal year?

Yes, I think the total is going to be what we said, the $25 million to $30 million.

But right now, because of some business that we've actually picked up in core, most all of that decrease is going to be in export.

We actually expect quarter to be flat, maybe even slightly up this year now.

That was not our original estimate, by the way.

Well, let me ask differently.

How much business have you walked away from in core this year?

None.

None.

None.

And that was pretty much done last year.

Our next question comes from the line of Anthony Vendetti from Maxim Group.

So just to follow on the Lifecore.

So it sounds like there are some large contracts that are getting bumped from fiscal third quarter to fiscal fourth.

Can you quantify the total amount that's being moved?

Is it $3 million, $5 million?

Yes, I could tell you off-line.

I do not have that number in my head.

Okay, no worries.

That's all right.

And then the new Target win for the Eat Smart salad line is great.

I was wondering if you could talk about what's already in Target and what's the opportunity?

It's -- it looks like it's going to start with 330 of their top-selling stores.

It's all 5 of the salad kits, the 2 new ones, plus your 3 original ones on the single-serve.

So what's the overall opportunity at Target?

So Target has -- we've had some great meetings with Target.

Target's been expanding really their play in fresh.

And I think when we came to Target with our clean salads, we really led with the clean message.

We're 100% clean, which to us means no preservatives, no artificial preservatives, flavors or ingredients.

So they really latched on to that and they want to really go with that message.

So we were united on that strategic front.

Right now -- so we're going to be taking advantage of that unite -- unison in strategy.

They have about 1,800 total doors.

We'll see how our products perform and see how we expand.

And we want to go into those stores that are right for us.

That are right and target our consumer.

So we're going to -- we'll see after we get these first ones in and see how our products turn, what our expansion possibility is.

Okay.

And then, Molly, maybe just update us a little bit.

I know you're expanding in Walmart and Kroger.

Can you talk about specifically how that expansion is going and how those customers are doing?

Right.

So at Walmart, we have the Sweet Kale Salad in all Walmart doors.

That product is trending extremely well, and so we're just watching that and hoping -- trying to work with Walmart, so that one day we can add more products to those shelfs.

And then at Kroger, the same thing.

I think we had announced that we added 4 new SKUs to about 2,000 doors at Kroger.

That's still very new.

That's only been a few months now and we've started promoting just in the last 1 to 2 months and the promotions really helped.

We saw a huge uptick in velocity with our promotions, and we're going to continue those promotions to drive trial and awareness of Eat Smart.

We also saw a sustained lift after those promotions at Kroger of about 9%.

And so as we drive trial and drive awareness, and we believe that our products tastes great as they did in all our consumer taste testing.

We're going to try to work our way with Kroger and if these customers will let us, we'll continue to try to penetrate with more products.

If we can help them, if our products are helping them also become more profitable and grow their category.

Some of the companies we follow are saying that Amazon's one of their fastest growing customers.

And I know you're selling some of the Eat Smart salad kits online on your own website.

Can you talk about any new developments with Amazon or Amazon Fresh?

How that relationship is evolving?

Right.

So we're continuing to work with Amazon Fresh mostly on the East Coast with our core and salad products.

So again, we just recently gained new distribution with them and are looking at turns and trying to figure out how we can expand our program with them.

And as far as our online, our personal eatsmartathome.com, again, that's just a test this year.

We're really working on our operational efficiencies, our consumer service and trying to learn the back-end processes of that.

So we don't expect any big revenue from that this year.

We're applying no marketing dollars to that.

Okay.

And then just on the -- I know there was the labor issue that you guys resolved, the labor practice issue that you guys resolved.

Has there been any ongoing shortage of labor workers for your Apio line?

No.

We've been able to pretty much fill the spots on that.

We did have some labor rate increases, and we're extremely competitive in the market with our labor rate increases.

We've also put incentives in place that will help our production -- productivity measures that they can actually increase their wage beyond their base wage rate and those measures have really improved our ability to attract and retain our workers.

Our next question comes from the line of Nelson Obus from Wynnefield Capital.

Question about the trays and the relationship to the $3.9 million shortfall.

By the way your -- Greg, your comment about revenues, it looks as though that business was up almost 10% in the quarter, if I read it right.

So all the loss in the core, in terms of revenues, came from export.

So -- but anyway, the $3.9 million, was that all allocated to trays?

I assume it wasn't allocated to export, because you just wouldn't export.

Am I right about that?

No.

And the -- usually when we have the sourcing issues, it's related to our bags, because that's where the majority of what -- because this quarter the issue was green beans.

We only sell green beans in bags and then some West Coast products, which are primarily broccoli and some brussel sprouts those are also bag products.

So it's really associated with our bag products, which includes green beans, not for our trays, not for our salads.

Well, okay.

I see.

So what's the economics of that business?

I mean, it sounds as though you're almost in a take-or-pay situation.

I know one of the prior callers talked about getting out of export altogether.

I mean, what's the argument for simply shrinking Apio so it's only doing the value-added Eat Smart?

Because it seems like we've run into these problems -- they're one-off except when they happen 5 quarters in a row or 5 years in a row, then they become normal.

Right.

So, obviously, we are continually evaluating which businesses that we should dissolve or reduce in size, rightsize as we have this higher -- we see this higher volatility.

So it's been about $50 million worth of business in the last couple of years that we've walked from.

Export is a unique business in the fact that we do walk -- we're walking from $25 million to $30 million in that, that was extremely low margin.

It does have a relatively fixed margin on the business, although it's very low, because they're buying and selling and they won't buy and sell unless they get the margin that they want.

That being said, that means revenues are volatile each year as well.

So we are going to be looking at the export business, what it means to us and core going forward.

But as we do that, we also need to be augmenting our less volatile product lines in the salad business and in other natural food products, so I think there's a timing that goes with all this rightsizing.

We want to make sure that we are growing in double digits our salad business, we're aggressively growing our natural foods business, and we're being smart about what business we walk away from and ultimately growing our profitability.

So (inaudible) is the answer.

So let's take the domestic bag business, okay, which seems to have been a problem.

If we walked, I mean, is this business that is tied to a relationship and if we walked from that, we would be less highly regarded in relationship to our Eat Smart initiative?

Or is it stuff that we could just leave without any consequences?

I think it's something we have to think through carefully.

We have many customers that take our bag business and our salad business.

And our bag business -- and we are dedicated to supporting them in that business.

And so with those customers, we want to continue to support them.

So -- and there's also synergies between those 2 lines in operations and in the products that we use.

For example, broccoli, we use the floret in our bag business and the stalk in our salad business.

So this isn't -- this is definitely not a simple you walk from it and this is a business that we want to -- we've committed to our customers to support this business, so it's a business that we will continue to do so unless there's a reason that really makes sense not to.

So it's something that we don't just walk.

You don't just walk.

That's where I'm driving -- yes, I mean, that's almost implied, because otherwise you wouldn't have had the $4 million excess expense.

You would have just raised prices to where you would have gotten the profit or walked away, because otherwise -- unless your covering company overhead with that.

But anyway, I think it's a worthy area to dissect as you transition your model.

The R&D number, okay, is that a total R&D number for the company?

Or does that just reflect your -- I mean, is there a larger number that would include partnerships?

And where does most of that R&D take place?

It's split primarily evenly between Apio and Lifecore at this point, a little bit still skewed towards Lifecore.

But it's -- with the addition of the new VP of R&D, him building his team, our focus on new product development, the new people we brought in for the Landec natural foods, our effort has really shifted dramatically over the last year to be very R&D focused.

And so that is the total number.

There's no net of anything that's coming from customers that's -- we don't really do contract R&D business.

Okay.

We did once in the past.

And when you look at the CapEx this year, it's an easy calculation to see that it looks as though your growth CapEx is -- has a low 30s, it's $1 million.

How do you look at that number?

I know this was a big year, but how do you look at that number going forward for fiscal '19 and '20 and out that way?

Well, our minimum for maintenance CapEx, as we said earlier, is $12 million to $15 million.

So that's a baseline going forward.

Right.

So if you subtracted that $44 million, you'd be -- you'd have a low $30 million number for growth CapEx.

But I mean, is that going to go through a [planned] expansion in fiscal '19?

Or I mean, what do you think?

And I know there were some -- there was -- look, there were expansions in Bowling Green, there were expansions in Pennsylvania, there were expansions in Lifecore, some of which had to affect this year, but when you look at '19, what are you looking at?

Right.

So when we look at the different businesses, if we look at Apio, any big capital will be in building warehouses.

So we have all the operational manufacturing space that if our demand continues to grow, we will need to continue to build warehouse space.

So that's where the -- any additional growth capital would go at Apio and additional lines.

So we're only investing in new salad lines as our salad business grows.

So you have 2 things at Apio, you have new salad equipment and you have new warehouse space.

At Lifecore, we have all the brick-and-mortar.

And we -- as the business continues to grow, we will need to invest in incremental equipment.

Again, we'll only be purchasing that equipment as the company grows.

Yes, so it sounds like there'll be less organic growth expense in '19 and that would leave an opportunity for -- well, you've always had the opportunity for acquisition, which you've gone very carefully with, which I think is very important that you've done that.

So hats off to that and...

We haven't completed our budget.

We haven't completed our budget for next year, Nelson.

So I don't have a capital number to provide yet for next year.

Yes.

I mean, this was a pretty big expansion.

By the way, you put out a package for the investors not too -- a couple of weeks ago.

And there was a map, which actually showed some things that I didn't know.

You already have a pretty impressive network of warehouses east of the Mississippi that I wasn't even aware of.

So that's something you may want to build out more, but aren't they somewhat new?

Some of the ones that are -- maybe they came from the bean company?

Yes, that's exactly right.

They came from our acquisition of GreenLine in 2012 and that was the reason, in all honestly, for that acquisition was wanted to get the infrastructure on the East Coast, because without it we could not grow, and that they had a wonderful green bean business, which is one of our higher-margin product lines, so that we were able to purchase that infrastructure with a very profitable business already operating in it.

And then we were able to expand it with the Apio salad line, to use it for our salad line expansion and to service our customers that are on the East Coast and in Canada.

All right, that's helpful.

I'm sure in the -- I'm sure with the fourth quarter, you'll have some -- you'll fill in some of that about what your thoughts are for '19 in those areas.

Our next question comes from the line of Chris Krueger from Lake Street Capital.

Just a quick question on looking at the Olive O (sic) [O Olive] business, which I haven't spent a lot of time on, I know it's pretty small right now, but potentially the growth driver going forward.

Who are their leading retail customers?

And how is their kind of pipeline of potential new customers going?

I would say, they're leading and initial customer was Whole Foods.

Whole Foods has always been extremely supportive of O Olive, and they love the premium taste with the fully natural and traceable ingredients.

So Whole Foods is one of their largest customers, and we really have begun to penetrate other parts of mainstream retail as well.

So we're going to be looking to augment that customer base using our existing sales force that we have in place with Eat Smart.

They will begin -- and we've been working in the first half of this year, they will begin selling O Olive into the same customers where they currently have relationships.

So all the same customers that we've been talking about today, we'll be entering those stores to tell them our -- the story of O Olive.

Got it.

Then on as far as product development for O Olive, how many SKUs do you have right now?

And what do you see 12 to 18 months from now?

So one of the efforts we have was actually to bring down the number of SKUs.

They had a lot of SKUs and our focus has been really on the productivity of those SKUs.

They have about 22 SKUs in their core product line, which includes both the olive oil and the wine vinegar.

So that's where we are now.

We're working on some projects to make those more accessible for retail.

So right now, we're working on some bottle redesign, so they can fit on the shelves more easily and some price point rationalization so that they are really able to, [well, ready] to go out to retail with a whole product and marketing package that makes sense.

So we're not really looking at trying to increase or proliferate the number of SKUs.

I think what we have in O Olive is the team there has been incredible with their innovation and their products are the highest quality out there.

And what we want to do is take the products they have and really expand the distribution through our capabilities at Apio.

Our next question comes from the line of Bill Nasgovitz from Heartland Advisors.

So I think it's wonderful that we're trying to cut out low margin products and so forth, and increase profitability that's certainly needed.

What type of -- what are we shooting for in terms of return on invested capital within the veggie business?

We haven't really broken it down that way, Bill.

I can tell you, overall for the company, our goal is to more than double where we're at today over the next 3 years.

I could get back to you off-line on how it breaks out between Lifecore and the food business.

Yes.

Well, having been a long-term shareholder, it's just -- and living through the -- one of the previous questioners mentioned weather.

It -- I just wonder if it's possible to consistently return adequate capital on this veggie business, because of the irregular weather patterns?

It does make it more difficult, there's no doubt about it.

And that's why we're -- we put the initiatives in place that we're putting in.

I mean, we've recognized that weather is something we can't control.

So what we can control is what products that we sell and the risk associated with those products, i.e., reducing our dependence on the higher volatile produce items that have hurt us in the past and you're doing that through salads, for instance, those have less volatility.

We've reduced our bag line, which is usually the biggest issue when it comes to produce sourcing issues and we're expanding in areas, well, soon to be announced in natural foods that doesn't have a volatility associated with raw product.

So it just takes a while.

As Molly said earlier, we've got some customers out there that are taking both our bag and our tray products.

And it's hard just to say we're not going to be selling you bag products anymore, because it could have an implication on our salad business.

Well, Landec has always intrigued us as being an asset-rich company.

But it's sort of a conundrum, how come there hasn't been any insider buying to validate that thought?

I can't answer that.

I mean, I personally have been buying.

I can only answer for myself.

But I don't have a good answer for that one, Bill.

We have had some insider buying.

And we recently launched an annual equity incentive program for our management team for that exact reason, Bill.

And we launched that this year as part of people's annual incentive.

So it's very important that we do align our senior team with their incentive against driving value for shareholders and the stock price.

And this does conclude the question-and-answer session of today's program.

I'd like to hand the program back to Molly Hemmeter for any further remarks.

Thanks, Jonathan.

I just want to thank, everyone, for participating in the call today.

Again, we see a bright future at Landec.

Our 3 growth platforms, which are the Lifecore business, our Eat Smart salads and our natural food products are meeting or exceeding our growth goals this year, and we're going to continue to focus on those to drive value for our shareholders, customers and consumers.

Thanks for joining us today.

Thank you, ladies and gentlemen for your participation in today's conference.

This does conclude the program.

You may now disconnect.

Good day.