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LANDEC CORP \CA\ - 10-Q/A - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the unaudited consolidated financial statements and accompanying notes included in Part I-Item 1 of this Form 10-Q and the audited consolidated financial statements and accompanying notes and Management's Discussion and Analysis of Financial Condition and Results of Operations included in Landec's Annual Report on Form 10-K for the fiscal year ended May 27, 2012. Except for the historical information contained herein, the matters discussed in this report are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Potential risks and uncertainties include, without limitation, those mentioned in this Form 10-Q and those mentioned in Landec's Annual Report on Form 10-K for the fiscal year ended May 27, 2012. Landec undertakes no obligation to update or revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. Critical Accounting Policies and Use of Estimates There have been no material changes to the Company's critical accounting policies which are included and described in the Form 10-K for the fiscal year ended May 27, 2012 filed with the Securities and Exchange Commission on August 8, 2012. The Company Landec Corporation and its subsidiaries ("Landec" or the "Company") design, develop, manufacture and sell polymer products for food and agricultural products, medical devices and licensed partner applications that incorporate Landec's patented polymer technologies. The Company has two proprietary polymer technology platforms: 1) Intelimer® polymers, and 2) Hyaluronan ("HA") biopolymers. The Company's polymer technologies, along with its customer relationships and trade names, are the foundation, and a key differentiating advantage, upon which Landec has built its business. Landec has three core businesses - Food Products Technology, Food Export and HA-based Biomaterials - each of which is described below. Our wholly-owned subsidiary, Apio, operates our Food Products Technology business, combining Landec's proprietary food packaging technology with the capabilities of a large national food supplier and value-added produce processor. In Apio's value-added operations, produce is processed by trimming, washing, mixing, and packaging into bags and trays that incorporate Landec's BreatheWay® membrane technology. The BreatheWay membrane increases shelf life and reduces shrink (waste) for retailers and, for certain products, eliminates the need for ice during the distribution cycle and helps to ensure that consumers receive fresh produce by the time the product makes its way through the supply chain. Apio also licenses the BreatheWay technology to Chiquita Brands International, Inc. ("Chiquita") for packaging and distribution of bananas and avocados and to Windset Farms for packaging of greenhouse grown cucumbers, peppers and tomatoes. -24- -------------------------------------------------------------------------------- Apio also operates the Food Export business through its Cal Ex Trading Company ("Cal-Ex"). The Export business purchases and sells whole fruit and vegetable products to predominantly Asian markets. Our wholly-owned subsidiary, Lifecore, operates our HA-based Biomaterials business and is principally involved in the development and manufacture of products utilizing hyaluronan, a naturally occurring polysaccharide that is widely distributed in the extracellular matrix of connective tissues in both animals and humans. Lifecore's products are primarily sold to three medical segments: (1) Ophthalmic, (2) Orthopedic and (3) Veterinary. Lifecore also supplies hyaluronan to customers pursuing other medical applications, such as aesthetic surgery, medical device coatings, tissue engineering and pharmaceuticals. Lifecore leverages its fermentation process to manufacture premium, pharmaceutical-grade hyaluronan, and its aseptic filling capabilities to deliver HA finished goods to its customers. Lifecore also manufactures and sells its own HA-based finished goods on a private label basis through third parties. Lifecore is recognized in the medical segments as a premium supplier of HA. Its name recognition allows Lifecore to acquire new customers and sell new products with a modest marketing and sales investment. Landec also develops proprietary polymer technologies and applies them in a wide range of applications including seed coatings and treatments, temperature indicators, controlled release systems, drug delivery, pressure sensitive adhesives and personal care products. These applications are commercialized through partnerships with third parties resulting in licensing and royalty revenues. For example, Air Products and Chemicals, Inc. ("Air Products") has an exclusive license to our Intelimer polymers for personal care products and Nitta Corporation ("Nitta") licenses Landec's proprietary pressure sensitive adhesives for use in the manufacture of electronic components by their customers. Landec was incorporated on October 31, 1986. We completed our initial public offering in 1996 and our Common Stock is listed on The NASDAQ Global Select Market under the symbol "LNDC." Our principal executive offices are located at 3603 Haven Avenue, Menlo Park, California 94025 and our telephone number is (650) 306-1650. Description of Core Business Landec participates in three core business segments: Food Products Technology, Food Export and Hyaluronan-based Biomaterials. [[Image Removed]]Food Products Technology Business The Company began marketing its proprietary Intelimer-based BreatheWay® membranes in 1996 for use in the fresh-cut produce packaging market, historically one of the fastest growing segments in the produce industry. Landec's proprietary BreatheWay packaging technology when combined with fresh-cut or whole produce results in packaged produce with increased shelf life and reduced shrink (waste) without the need for ice during the distribution cycle. The resulting products are referred to as "value-added" products. During the fiscal year ended May 27, 2012, Apio shipped nearly sixteen million cartons of produce to leading supermarket retailers, wholesalers, foodservice suppliers and club stores throughout the United States and internationally, primarily in Canada. There are four major distinguishing characteristics of Apio that provide competitive advantages in the Food Products Technology market: Value-Added Supplier: Apio has structured its business as a marketer and seller of fresh-cut and whole value-added produce. It is focused on selling products under its Eat Smart and GreenLine brands and private label brands for its fresh-cut and whole value-added products. As retail grocery chains, club stores and food service operators consolidate, Apio is well positioned as a single source of a broad range of products. -25--------------------------------------------------------------------------------- Reduced Farming Risks: Apio reduces its farming risk by not taking ownership of farmland, and instead, contracts with growers for produce and selectively enters into joint ventures with growers for produce. The year-round sourcing of produce is a key component to the fresh-cut and whole value-added processing business. Lower Cost Structure: Apio has strategically invested in the rapidly growing fresh-cut and whole value-added business. Apio's 136,000 square foot value-added processing plant in Guadalupe, CA, is automated with state-of-the-art vegetable processing equipment. A large majority of Apio's value-added products utilize Apio's proprietary BreatheWay packaging technology. Apio's strategy is to operate one large central processing facility in one of the lowest cost growing regions in California, the Santa Maria Valley, for the majority of its non-green bean vegetable business, use its packaging technology for nationwide delivery and use its East Coast facilities acquired with the acquisition of GreenLine for green bean processing and to meet the "next day delivery" needs of customers for its historical value-added, fresh-cut products. Expanded Product Line Using Technology: Apio, through the use of its BreatheWay packaging technology, is introducing new value-added products each year. These new product offerings range from various sizes of fresh-cut bagged products, to vegetable trays, to whole produce, to vegetable salads and snack packs. During the last twelve months, Apio, excluding the products acquired in the acquisition of GreenLine, has introduced six new products. Apio established its Apio Packaging division in 2005 to advance the sales of BreatheWay packaging technology for shelf-life sensitive vegetables and fruit. The Company's specialty packaging for case liner products extends the shelf life of certain produce commodities up to 50%. This shelf life extension can enable the utilization of alternative distribution strategies to gain efficiencies or reach new markets while maintaining product quality to the end customer. Apio Packaging's first program has concentrated on bananas and was formally consummated when Apio entered into an agreement to supply Chiquita with its proprietary banana packaging technology. This global agreement applies to the ripening, conservation and shelf-life extension of bananas. In addition, Apio provides Chiquita with ongoing research and development and process technology support for the BreatheWay membranes and bags, and technical service support throughout the customer chain in order to assist in the development and market acceptance of the technology. Chiquita provides marketing, distribution and retail sales support for Chiquita® bananas sold worldwide in BreatheWay packaging. To maintain the exclusive license, Chiquita must meet quarterly minimum purchase thresholds of BreatheWay banana packages. In fiscal year 2008, the Company expanded the use of its BreatheWay technology to include avocados and mangos under an expanded licensing agreement with Chiquita. Commercial sales of avocados packaged in Landec's BreatheWay packaging into the food service industry began late in fiscal year 2008 and commercial retail sales began in fiscal 2010. Chiquita is currently evaluating the future of its avocado program due to sourcing and operational issues not related to the Company's BreatheWay technology. In June 2008, Apio entered into a collaboration agreement with Seminis Vegetable Seeds, Inc., a wholly-owned subsidiary of Monsanto Company ("Monsanto"), to develop novel broccoli and cauliflower products for the exclusive sale by Apio in the North American market. These novel products are packaged in Landec's proprietary BreatheWay packaging and a commercial sales agreement was entered into on June 12, 2012 and sales have recently started under Monsanto's Beneforte® brand to retail grocery and Club store chains. In June 2010, Apio entered into an exclusive license agreement with Windset for Windset to utilize Landec's proprietary breathable packaging to extend the shelf life of greenhouse grown cucumbers, peppers and tomatoes. Commercial sales of Windset cucumbers in BreatheWay packaging are projected to begin in fiscal year 2013. On February 15, 2011, Apio entered into a share purchase agreement (the "Purchase Agreement") with Windset. Pursuant to the Purchase Agreement, Apio purchased 150,000 senior preferred shares for $15 million and 201 common shares for $201 (the "Purchased Shares"). The Company's common shares represent a 20.1% interest in Windset. The non-voting senior preferred shares yield a cash dividend of 7.5% annually. The dividend is payable within 90 days of each anniversary of the execution of the Purchase Agreement. The Purchase Agreement includes a put and call option, which can be exercised on the sixth anniversary of the Purchase Agreement whereby Apio can exercise the put to sell its Purchased Shares to Windset, or Windset can exercise the call to purchase the Purchased Shares from Apio, in either case, at a price equal to 20.1% of the appreciation in the fair market value of Windset from the date of the Company's investment through the put/call date, plus the purchase price of the Purchased Shares. Under the terms of the arrangement with Windset, the Company is entitled to designate one of five members on the Board of Directors of Windset. -26- --------------------------------------------------------------------------------Food Export Business Food Export revenues consist of revenues generated from the purchase and sale of primarily whole commodity fruit and vegetable products to Asia through Apio's export company, Cal-Ex. The Food Export business is a buy/sell business that realizes a commission-based margin on average in the 5-8% range. Hyaluronan-based Biomaterials Business Our HA-based Biomaterials business, operated through our Lifecore subsidiary, was acquired by Landec on April 30, 2010. Lifecore uses its fermentation process and aseptic formulation and filling expertise to be a leader in the development of HA-based products for multiple applications and to take advantage of non-HA device and drug opportunities which leverage its expertise in manufacturing and aseptic syringe filling capabilities. Elements of Lifecore's strategy include the following: Establish strategic relationships with market leaders. Lifecore will continue to develop applications for products with partners who have strong marketing, sales and distribution capabilities to end-user markets. Through its strong reputation and history of providing premium HA products, Lifecore has been able to establish long-term relationships with market leading companies such as Alcon, Inc. (Alcon) and others in ophthalmology, and Musculoskeletal Transplant Foundation (MTF) and Novartis AG in orthopedics. Expand medical applications for HA. Due to the growing knowledge of the unique characteristics of HA and the role it plays in normal physiology, Lifecore continues to identify and pursue further uses for HA in other medical applications, such as wound care, aesthetic surgery, adhesion prevention, drug delivery, device coatings and pharmaceuticals. Further applications may involve expanding process development activity and/or additional licensing of technology. License HA technology from third parties. In 2007, Lifecore entered into a world-wide exclusive license and development agreement with The Cleveland Clinic Foundation to develop and commercialize Corgel™ Biohydrogel using patented HA-based cross-linking technology that can be used for products in aesthetics, orthopedics, ophthalmology and other medical fields. Lifecore has not yet developed any commercial products for this technology. Utilize manufacturing infrastructure to pursue contract aseptic filling and fermentation opportunities. Lifecore continues to evaluate providing contract services for opportunities that are suited for the capital and facility investment related to aseptic filling equipment, fermentation and purification. Maintain flexibility in product development and supply relationships. Lifecore's vertically integrated development and manufacturing capabilities allow it to establish a variety of relationships with global corporate partners. Lifecore's role in these relationships extends from supplying HA raw materials to manufacturing of aseptically-packaged, finished sterile products to developing and manufacturing its own proprietary products. Other Non-Core Businesses Seeds Business - Intellicoat Seed Coatings and Landec Ag Landec's Intellicoat seed coating applications are designed to control seed germination timing, increase crop yields, reduce risks and extend crop-planting windows. These coatings are currently available on male inbred corn used for seed production. In fiscal year 2000, Landec Ag launched Pollinator Plusâ coatings, which is a coating application used by seed companies as a method for spreading pollination to increase yields and reduce risk in the production of hybrid seed corn. In 2012, Pollinator Plus was used by eight seed companies on more than 20% of the seed corn production acres in the U.S. This business was sold to INCOTEC Holding North America, Inc. ("INCOTEC") on June 24, 2012 (see Note 4 to the Consolidated Financial Statements). -27- --------------------------------------------------------------------------------Non-Seed Business The Company believes its technology has commercial potential in a wide range of industrial, consumer and medical applications beyond those identified in our other segments. For example, our core patented technology, Intelimer materials, can be used to trigger release of catalysts, insecticides or fragrances just by changing the temperature of the Intelimer materials or to activate adhesives through controlled temperature change. In order to exploit these opportunities, we have entered into and will enter into licensing and collaborative corporate agreements for product development and/or distribution in certain fields. However, given the infrequency and unpredictability of when the Company may enter into any such licensing and research and development arrangements, the Company is unable to disclose its financial expectations in advance of entering into such arrangements. Industrial Materials and Adhesives Landec's industrial product development strategy focuses on coatings, catalysts, resins, additives and adhesives in the polymer materials market. During the product development stage, the Company identifies corporate partners to support the ongoing development and testing of these products, with the ultimate goal of licensing the applications at the appropriate time. Intelimer Latent Catalyst Polymer Systems Landec has developed latent catalysts useful in extending pot-life, extending shelf life, reducing waste and improving thermoset cure methods. Some of these latent catalysts are currently being distributed by Akzo-Nobel Chemicals B.V. pursuant to our licensing agreement with Air Products. The rights to develop and sell Landec's latent catalysts and personal care technologies were licensed to Air Products in March 2006. Personal Care and Cosmetic Applications Landec's personal care and cosmetic applications strategy is focused on supplying Intelimer materials to industry leaders for use in lotions and creams, as well as color cosmetics, lipsticks and hair care. The Company's partner, Air Products, is currently shipping products to L'Oreal, Mentholatum, Louis Widmer, Aris Cosmetics and other companies for use in lotions and creams. The rights to develop and sell Landec's polymers for personal care products were licensed to Air Products in March 2006 along with the latent catalyst rights. The Company's Intelimer polymers are currently in over 50 personal care products worldwide. Results of Operations Revenues (in thousands): Three months Three months ended 8/26/12 ended 8/28/11 Change Apio Value Added $ 68,144 $ 42,818 59 % Apio Packaging 487 545 (11 %) Food Technology 68,631 43,363 58 % Apio Export 25,358 21,355 19 % Total Apio 93,989 64,718 45 % HA 7,973 7,121 12 % Corporate 112 1,462 (92 %) Total Revenues $ 102,074 $ 73,301 39 % -28---------------------------------------------------------------------------------Apio Value Added Apio's value-added revenues consist of revenues generated from the sale of specialty packaged fresh-cut and whole value-added processed vegetable products that are washed and packaged in our proprietary packaging and sold under Apio's Eat Smart and GreenLine brands and various private labels. In addition, value-added revenues include the revenues generated from Apio Cooling, LP, a vegetable cooling operation in which Apio is the general partner with a 60% ownership position. The increase in Apio's value-added revenues for the three months ended August 26, 2012 compared to the first quarter of last year was primarily due to the following factors: (1) $19.9 million of revenues from GreenLine which was acquired on April 23, 2012 and (2) a 22% increase in unit volume sales to existing non green bean customers resulting primarily from expanded product offerings, gaining additional distribution locations and growth in the fresh-cut vegetable category. These increases in revenue were partially offset by a product mix change in retail grocery chains to lower priced products from higher priced products. Apio Packaging Apio packaging revenues consist of Apio's packaging technology business using its BreatheWay membrane technology. The first commercial application included in Apio packaging is our banana packaging technology. The decrease in Apio packaging revenues for the three months ended August 26, 2012 compared to the same period last year was not significant. Apio Export Apio export revenues consist of revenues generated from the purchase and sale of primarily whole commodity fruit and vegetable products to Asia by Cal-Ex. Apio records revenue equal to the sale price to third parties because it takes title to the product while in transit. The increase in revenues in Apio's export business for the three months ended August 26, 2012 compared to the same period last year was due to a 3% increase in unit volume sales and more favorable pricing for export products during the first quarter of fiscal year 2013 compared to the same period last year. Hyaluronan-based ("HA") Biomaterials Lifecore principally generates revenue through the sale of products containing HA. Lifecore primarily sells products to customers in three medical areas: (1) Ophthalmic, which represented approximately 65% of Lifecore's revenues in fiscal year 2012, (2) Orthopedic, which represented approximately 20% of Lifecore's revenues in fiscal year 2012 and (3) Veterinary/Other. The increase in Lifecore's revenues for the three months ended August 26, 2012 compared to the same period last year was due to a 15% increase in revenues in Lifecore's aseptic filling business and an 8% increase in revenues in Lifecore's fermentation business, primarily for Ophthalmic products. Corporate Corporate revenues consist of revenues generated from the licensing agreements with Air Products and Nitta. The decrease in Corporate revenues for the three months ended August 28, 2011 compared to the same period of the prior year was due to the termination of the Monsanto Agreement at the end of the second quarter of fiscal year 2012. The quarterly revenues and gross profit for Corporate from Monsanto had been $1.35 million per quarter prior to the termination. -29- -------------------------------------------------------------------------------- Gross Profit (in thousands): Three months Three months ended 8/26/12 ended 8/28/11 Change Apio Value Added $ 9,499 $ 5,655 68 % Apio Packaging 444 404 10 % Food Technology 9,943 6,059 64 % Apio Export 1,342 1,014 32 % Total Apio 11,285 7,073 60 % HA 2,366 2,715 (13 %) Corporate 112 1,462 (92 %) Total Gross Profit $ 13,763 $ 11,250 22 % General There are numerous factors that can influence gross profit including product mix, customer mix, manufacturing costs, volume, sale discounts and charges for excess or obsolete inventory, to name a few. Many of these factors influence or are interrelated with other factors. The Company includes in cost of sales all of the costs related to the sale of products in accordance with U.S. generally accepted accounting principles. These costs include the following: raw materials (including produce, casein, seeds and packaging), direct labor, overhead (including indirect labor, depreciation, and facility related costs) and shipping and shipping-related costs. The following are the primary reasons for the changes in gross profit for the three months ended August 26, 2012 compared to the same period last year as outlined in the table above. Apio Value-Added The increase in gross profit for Apio's value-added vegetable business for the three months ended August 26, 2012 compared to the same period last year was primarily due to the 59% increase in revenues coupled with a small favorable product mix change. Apio Packaging The increase in Apio packaging gross profit for the three months ended August 26, 2012 compared to the same period last year was not significant. Apio Export Apio's export business is a buy/sell business that realizes a commission-based margin in the 5-8% range. The increase in gross profit for Apio's export business during the three months ended August 26, 2012 compared to the same period last year was due to the 19% increase in revenues. The 19% increase in revenues was lower than the growth in gross profit because of favorable product mix changes to higher margin products which resulted in a higher gross margin during the first quarter of fiscal year 2013 of 5.3% compared to a gross margin of 4.7% during the first quarter of fiscal year 2012. HA-based Biomaterials The decrease in gross profit during the three months ended August 26, 2012 compared to the same period last year was due to the timing of production within the fiscal year resulting in lower overhead absorption. Although there was a 12% increase in revenues, lower overhead absorption resulted in a lower gross margin during the first quarter of fiscal year 2013 of 30% compared to a gross margin of 38% during the first quarter of fiscal year 2012. Corporate The decrease in Corporate gross profit for the three months ended August 26, 2012 compared to the same period of the prior year was due to the termination of the Monsanto Agreement at the end of the second quarter of fiscal year 2012. The quarterly revenues and gross profit for Corporate from Monsanto had been $1.35 million per quarter prior to the termination. -30- --------------------------------------------------------------------------------Operating Expenses (in thousands): Three months Three months ended 8/26/12 ended 8/28/11 Change Research and Development: Apio $ 328 $ 270 21 % HA 1,149 1,086 6 % Corporate 727 977 (26 %) Total R&D $ 2,204 $ 2,333 (6 %) Selling, General and Administrative: Apio $ 5,485 $ 3,350 64 % HA 1,272 994 28 % Corporate 1,799 1,700 6 % Total S,G&A $ 8,556 $ 6,044 42 % Research and Development Landec's research and development expenses consist primarily of expenses involved in product development and commercialization initiatives. Research and development efforts at Apio are focused on the Company's proprietary BreatheWay membranes used for packaging produce, with recent focus on extending the shelf life of bananas and other shelf-life sensitive vegetables and fruit. In the HA business, the research and development efforts are focused on new products and applications for HA-based biomaterials. In Corporate, the research and development efforts are focused on uses for the proprietary Intelimer polymers outside of food and HA. The decrease in research and development expenses for the three months ended August 26, 2012 compared to the same period last year was primarily due to the sale of Landec Ag to INCOTEC which reduced the research and development expenses in Corporate. Selling, General and Administrative Selling, general and administrative ("S,G&A") expenses consist primarily of sales and marketing expenses associated with Landec's product sales and services, business development expenses and staff and administrative expenses. The increase in S,G&A expenses for the three months ended August 26, 2012 compared to the same period last year was primarily due to the following factors: (1) $1.3 million of S,G&A expenses at GreenLine which was acquired on April 23, 2012, (2) an $800,000 increase in SG&A at Apio, excluding GreenLine, due to the amortization of the customer base intangible acquired in the acquisition of GreenLine, an increase in salary and bonus expenses and additional sales and marketing expenses associated with the increase in revenues, (3) a $278,000 increase at Lifecore due to the timing of the recognition of certain S,G&A expenses within the fiscal year and (4) a $170,000 increase at Corporate due to increased accounting fees. Other (in thousands): Three months Three months ended 8/26/12 ended 8/28/11 Change Dividend Income $ 281 $ 281 - Interest Income $ 26 $ 76 (66 %) Interest Expense $ (541 ) $ (176 ) 207 % Other Income (Restated) $ 4,259 $ 9 N/M Income Taxes (Restated) $ (2,565 ) $ (1,110 ) 131 % Non controlling interest $ (97 ) $ (141 ) (31 %) -31---------------------------------------------------------------------------------Dividend Income Dividend income is derived from the dividends accrued on our $15 million preferred stock investment in Windset which yields a cash dividend of 7.5% annually. There was no change in dividend income for the three months ended August 26, 2012 compared to the same period last year. Interest Income The decrease in interest income for the three months ended August 26, 2012 compared to the same period last year was primarily due to lower cash balances reflecting our use of cash to buyback shares of the Company's common stock during fiscal year 2012 and to purchase GreenLine. Interest Expense The increase in interest expense during the three months ended August 26, 2012 compared to the same period last year was due to interest on the debt incurred in the acquisition of GreenLine. This increase was partially offset by decreases in interest expenses at Lifecore due to paying down its debt by $4.1 million since the end of the first quarter of fiscal year 2012. Other Income (Expense) The increase in other income is due to the $4.3 million (restated) increase in the fair market value of our Windset investment. Income Taxes The increase in the income tax expense is due to a 129% (restated) increase in net income before taxes during the three months ended August 26, 2012 compared to the same period last year. Non controlling Interest The non controlling interest consists of the limited partners' equity interest in the net income of Apio Cooling, LP. The decrease in the non controlling interest for the three months ended August 26, 2012 compared to the first quarter of last year was not significant. Liquidity and Capital Resources As of August 26, 2012, the Company had cash and cash equivalents of $10.0 million, a net decrease of $12.2 million from $22.2 million at May 27, 2012. Cash Flow from Operating Activities Landec generated $5.1 million of cash from operating activities during the three months ended August 26, 2012, compared to $4.4 million for the three months ended August 28, 2011. The primary sources of cash from operating activities during the three months ended August 26, 2012 were from (1) generating $4.5 million (restated) of net income, largely offset by the $4.3 million (restated) increase in the fair market value of Windset which is a non-cash income item, (2) $1.9 million of depreciation and amortization, and (3) a net decrease of $861,000 in working capital, excluding the decrease in income taxes receivable which is offset by the tax benefit from stock-based compensation. The primary factors which decreased working capital during the first quarter of fiscal year 2013 were (a) a $1.7 million decrease in receivables primarily due to the timing of receipts at Lifecore and (b) a $4.1 million increase in accounts payable resulting from the timing of payments at Apio. The primary factors which increased working capital during the first quarter of fiscal year 2013 were (a) a $1.5 million increase in inventories at Apio as a result of building inventory for a projected increase in revenues, (b) a $1.8 million decrease in accrued compensation as a result of paying bonuses earned in fiscal year 2012 during the first quarter of fiscal year 2013, and (c) a $1.4 million decrease in other accrued liabilities at Apio. -32- -------------------------------------------------------------------------------- Cash Flow from Investing Activities Net cash used in investing activities for the three months ended August 26, 2012 was $2.8 million compared to $5.5 million for the same period last year. The primary uses of cash in investing activities during the first quarter of fiscal year 2013 were for the purchase of $2.0 million of equipment primarily to support the growth of Apio value-added and the Lifecore businesses, and from the purchase of $756,000 of marketable securities. Cash Flow from Financing Activities Net cash used in financing activities for the three months ended August 26, 2012 was $14.4 million compared to net cash provided by financing activities of $298,000 for the same period last year. The net cash used in financing activities during the first quarter of fiscal year 2013 was primarily due to the $10 million earn out payment from the Lifecore acquisition, $9.7 million of which was recorded as a contingent liability at the time of the acquisition and is therefore classified as a financing activity, and $5.6 million of payments on the Company's lines of credit and long-term debt. Capital Expenditures During the three months ended August 26, 2012, Landec purchased equipment to support the growth of Apio value-added and the Lifecore businesses, These expenditures represented the majority of the $2.0 million of capital expenditures. Debt On August 19, 2004, Lifecore issued variable rate industrial revenue bonds ("IRBs"). These IRBs were assumed by Landec in the acquisition of Lifecore. The IRBs are collateralized by a bank letter of credit which is secured by a first mortgage on the Lifecore facility in Chaska, Minnesota. In addition, Lifecore pays an annual remarketing fee equal to 0.125% and an annual letter of credit fee of 0.75%. On April 23, 2012 in connection with the acquisition of GreenLine, Apio entered into three loan agreements with General Electric Capital Corporation and/or its affiliates ("GE Capital"), (collectively the "Apio Loan Agreements"): 1) A five-year, $25.0 million asset-based working capital revolving line of credit, with an interest rate of LIBOR plus 2%, with availability based on the monthly combination of the eligible accounts receivable and inventory balances of Apio and its subsidiaries. Apio's revolving line of credit has an unused fee of 0.375% per annum. At August 26, 2012, Apio had $7.5 million outstanding under its revolving line of credit. 2) A $12.7 million capital equipment loan which matures in seven years payable in monthly principal and interest payments of $175,356 with interest based on a fixed rate of 4.39% per annum. 3) A $19.1 million real estate loan, $1.2 million of which is due on April 23, 2013 and the remainder maturing in ten years. The real estate loan has a fifteen year amortization period due in monthly principal and interest payments of $141,962 with interest based on a fixed rate of 4.02% per annum. The principal balance remaining at the end of the ten year term is due in one lump sum on May 1, 2022. The obligations of Apio and its subsidiaries arising from the Apio Loan Agreements are secured by liens on all of the property of Apio and its subsidiaries. The Apio Loan Agreements contain customary events of default under which obligations could be accelerated or increased. Landec is guarantying all obligations of Apio and its subsidiaries to GE Capital under the loans described in clauses (2) and (3) above and has pledged its equity interest in Apio as collateral under the loan described in (1) above. The Apio Loan Agreements contain customary covenants, such as limitations on the ability to (1) incur indebtedness or grant liens or negative pledges on Apio's assets; (2) make loans or other investments; (3) pay dividends or repurchase stock or other securities; (4) sell assets; (5) engage in mergers; (6) enter into sale and leaseback transactions; (7) adopt certain benefit plans; and (8) make changes in Apio's corporate structure. In addition, Apio must maintain a minimum fixed charge coverage ratio of 1.10 to 1.0. Apio was in compliance with all financial covenants as of August 26, 2012. On May 23, 2012, Lifecore entered into two financing agreements with BMO Harris Bank N.A. and/or its affiliates ("BMO Harris"), collectively (the "Lifecore Loan Agreements"): -33---------------------------------------------------------------------------------(1) A Credit and Security Agreement (the "Credit Agreement") which includes (a) a one-year, $8.0 million asset-based working capital revolving line of credit, with an interest rate of LIBOR plus 1.85%, with availability based on the monthly combination of Lifecore's eligible accounts receivable and inventory balances and with no unused fee (as of August 26, 2012, no amounts were outstanding under the line of credit) and (b) a $12.0 million term loan which matures in four years due in monthly payments of $250,000 with interest payable monthly based on a variable interest rate of LIBOR plus 2% (the "Term Loan"). (2) A Reimbursement Agreement pursuant to which BMO Harris caused its affiliate, Bank of Montreal, to issue an irrevocable letter of credit in the amount of $3.5 million (the "Letter of Credit") which is securing the IRBs described above. The obligations of Lifecore under the Lifecore Loan Agreements are secured by liens on all of the property of Lifecore. The Lifecore Loan Agreements contain customary covenants, such as limitations on the ability to (1) incur indebtedness or grant liens or negative pledges on Lifecore's assets; (2) make loans or other investments; (3) pay dividends or repurchase stock or other securities; (4) sell assets; (5) engage in mergers; (6) enter into sale and leaseback transactions; (7) adopt certain benefit plans; and (8) make changes in Lifecore's corporate structure. In addition, under the Credit Agreement, Lifecore must maintain (a) a minimum fixed charge coverage ratio of 1.10 to 1.0 and a minimum quick ratio of 1.25 to 1.00, both of which must be satisfied as of the end of each fiscal quarter commencing with the fiscal quarter ending August 26, 2012 and (b) a minimum tangible net worth of $29,000,000, measured as of May 28, 2013, and as of the end of each fiscal year thereafter. Lifecore was in compliance with all financial covenants as of August 26, 2012. The Term Loan was used to repay the Lifecore's former credit facility with Wells Fargo Bank, N.A. ("Wells Fargo"). The Letter of Credit (which replaces a letter of credit previously provided by Wells Fargo) provides liquidity and credit support for the IRBs. In May 2010, the Company entered into a five-year interest rate swap agreement under the credit agreement with Wells Fargo, which expires on April 30, 2015. The interest rate swap was designated as a cash flow hedge of future interest payments of LIBOR and had a notional amount of $20 million. As a result of the interest rate swap transaction, the Company fixed for a five-year period the interest rate at 4.24% subject to market based interest rate risk on $20 million of borrowings under the credit agreement with Wells Fargo. The Company's obligations under the interest rate swap transaction as to the scheduled payments were guaranteed and secured on the same basis as is its obligations under the credit agreement with Wells Fargo at the time the agreement was consummated. As mentioned in Note 11, upon entering into the new Term Loan with BMO Harris the Company used the proceeds from that loan to pay off the Wells Fargo credit facility. The swap with Wells Fargo was not terminated upon the extinguishment of the debt with Wells Fargo. As a result of extinguishing the debt with Wells Fargo as of May 23, 2012, the swap was no longer an effective hedge and therefore, the fair value of the swap at the time the debt was extinguished of $347,000 was reversed from other comprehensive income and recorded in other expense during fiscal year 2012. The fair value of the swap arrangement as of August 26, 2012 and May 27, 2012 was $305,000 and $347,000, respectively, and is included in other accrued liabilities in the accompanying balance sheet. The change in the fair value of the swap of $42,000 for the three months ended August 26, 2012 is recorded in other income in the accompanying Consolidated Statements of Income. Landec believes that its cash from operations, along with existing cash, cash equivalents and marketable securities will be sufficient to finance its operational and capital requirements for at least the next twelve months. |