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LANDEC CORP \CA\ - 10-K - 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 Company's Consolidated Financial Statements contained in Item 8 of this report. Except for the historical information contained herein, the matters discussed in this report are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Potential risks and uncertainties include, without limitation, those mentioned in this report and, in particular, the factors described in Item 1A. "Risk Factors." Landec undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. - 23 --------------------------------------------------------------------------------- Overview Landec Corporation and its subsidiaries ("Landec" or the "Company") design, develop, manufacture and sell differentiated products for food and biomaterials markets and license technology applications to partners. The Company has two proprietary polymer technology platforms: 1) Intelimer® polymers, and 2) hyaluronan ("HA") biopolymers. The Company's HA biopolymers are proprietary in that they are specially formulated for specific customers to meet strict regulatory requirements. 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. The Company sells specialty packaged branded Eat Smart and GreenLine and private label fresh-cut vegetables and whole produce to retailers, club stores and foodservice operators, primarily in the United States, Canada and Asia through its Apio, Inc. ("Apio") subsidiary and sells HA-based biomaterials through its Lifecore Biomedical, Inc. ("Lifecore") subsidiary. Landec has three core businesses - Food Products Technology, Food Export, and HA-based Biomaterials. The Food Products Technology segment combines the Company's BreatheWay packaging technology with Apio's branded Eat Smart and GreenLine and private label fresh-cut and whole produce business. The Food Export business is operated through Apio's Cal-Ex export company which purchases and sells whole fruit and vegetable products to predominantly Asian markets. The HA-based Biomaterials business sells products utilizing HA in the ophthalmic, orthopedic and veterinary segments and also supplies HA to customers pursuing other medical applications, such as aesthetic surgery, medical device coatings, tissue engineering and pharmaceuticals. See "Business - Description of Core Business". As of May 25, 2014, the Company's retained earnings were $72 million. The Company may incur losses in the future. The amount of future net profits, if any, is uncertain and there can be no assurance that the Company will be able to sustain profitability in future years. Critical Accounting Policies and Use of Estimates Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make certain estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. The accounting estimates that require management's most significant and subjective judgments include revenue recognition; sales returns and allowances; recognition and measurement of current and deferred income tax assets and liabilities; the assessment of recoverability of long-lived assets; the valuation of intangible assets and inventory; the valuation of investments; and the valuation and recognition of stock-based compensation. These estimates involve the consideration of complex factors and require management to make judgments. The analysis of historical and future trends can require extended periods of time to resolve, and are subject to change from period to period. The actual results may differ from management's estimates. Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The allowance for doubtful accounts is based on review of the overall condition of accounts receivable balances and review of significant past due accounts. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Inventories Inventories are stated at the lower of cost or market. If the cost of the inventories exceeds their expected market value, provisions are recorded currently for the difference between the cost and the market value. These provisions are determined based on specific identification for unusable inventory and an additional reserve, based on historical losses, for inventory currently considered to be usable. - 24 --------------------------------------------------------------------------------- Revenue Recognition Revenue from product sales is recognized when there is persuasive evidence that an arrangement exists, title has transferred, the price is fixed and determinable, and collectability is reasonably assured. Allowances are established for estimated uncollectible amounts, product returns, and discounts based on specific identification and historical losses. Apio's Food Products Technology revenues generally consist of revenues generated from the sale of specialty packaged fresh-cut and whole value-added processed vegetable products that are generally washed and packaged in our proprietary packaging and sold under Apio's Eat Smart and GreenLine brands and various private labels. Revenue is generally recognized upon shipment of these products to customers. The Company takes title to all produce it trades and/or packages, and therefore, records revenues and cost of sales at gross amounts in the Consolidated Statements of Comprehensive Income In addition, Food Products Technology 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 and from the sale of BreatheWay packaging to license partners. Revenue is recognized on the vegetable cooling operations as cooling and storage services are provided to our customers. Sales of BreatheWay packaging are recognized when shipped to our customers. Apio's Food Export revenues consist of revenues generated from the purchase and sale of primarily whole commodity fruit and vegetable products to Asia by Cal-Ex. As most Cal-Ex customers are in countries outside of the U.S., title transfers and revenue is generally recognized upon arrival of the shipment in the foreign port. Apio records revenue equal to the sale price to third parties because it takes title to the product while in transit. Our HA-based Biomaterials business 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 60% of Lifecore's revenues in fiscal year 2014, (2) Orthopedic, which represented approximately 20% of Lifecore's revenues in fiscal year 2014 and (3) Veterinary/Other. The vast majority of revenues from our HA-based Biomaterials business are recognized upon shipment. A small amount of revenues from our HA-based Biomaterials business is related to contract research and development (R&D) services and multi-element arrangement services with customers where we provide products and/or services in a bundled arrangement. Contract revenue R&D is recorded as earned, based on the performance requirements of the contract. Non-refundable contract fees for which no further performance obligations exist, and there is no continuing involvement by the Company, are recognized on the earlier of when the payments are received or when collection is assured. For sales arrangements that contain multiple elements, the Company splits the arrangement into separate units of accounting if the individually delivered elements have value to the customer on a standalone basis. The Company also evaluates whether multiple transactions with the same customer or related party should be considered part of a multiple element arrangement, whereby the Company assesses, among other factors, whether the contracts or agreements are negotiated or executed within a short time frame of each other or if there are indicators that the contracts are negotiated in contemplation of each other. The Company then allocates revenue to each element based on a selling price hierarchy. The relative selling price for a deliverable is based on its vendor-specific objective evidence (VSOE), if available, third-party evidence (TPE), if VSOE is not available, or estimated selling price, if neither VSOE nor TPE is available. The Company then recognizes revenue on each deliverable in accordance with its policies for product and service revenue recognition. The Company is not typically able to determine VSOE or TPE, and therefore, uses estimated selling prices to allocate revenue between the elements of the arrangement. - 25 --------------------------------------------------------------------------------- The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services or future performance obligations or subject to customer-specific cancellation rights. The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. A deliverable constitutes a separate unit of accounting when it has stand-alone value, and for an arrangement that includes a general right of return relative to the delivered products or services, delivery or performance of the undelivered product or service is considered probable and is substantially controlled by the Company. The Company considers a deliverable to have stand-alone value if the product or service is sold separately by the Company or another vendor or could be resold by the customer. Further, the revenue arrangements generally do not include a general right of return relative to the delivered products. Where the aforementioned criteria for a separate unit of accounting are not met, the deliverable is combined with the undelivered element(s) and treated as a single unit of accounting for the purposes of allocation of the arrangement consideration and revenue recognition. The Company allocates the total arrangement consideration to each separable element of an arrangement based upon the relative selling price of each element. Allocation of the consideration is determined at arrangement inception on the basis of each unit's relative selling price. In instances where the Company has not established fair value for any undelivered element, revenue for all elements is deferred until delivery of the final element is completed and all recognition criteria are met. Licensing revenue is recognized in accordance with prevailing accounting guidance. Initial license fees are deferred and amortized to revenue over the period of the agreement when a contract exists, the fee is fixed and determinable, and collectability is reasonably assured. Noncancellable, nonrefundable license fees are recognized over the period of the agreement, including those governing research and development activities and any related supply agreement entered into concurrently with the license when the risk associated with commercialization of a product is non-substantive at the outset of the arrangement. From time to time, the Company offers customers sales incentives, which include volume rebates and discounts. These amounts are estimated on a quarterly basis and recorded as a reduction of revenue. A summary of revenues by type of revenue arrangement as described above is as follows (in thousands): Year ended Year ended May 25, 2014 May 26, 2013 Recorded upon shipment $ 398,938 $ 359,518 Recorded upon acceptance in foreign port 69,710 78,442 Revenue from license fees, R&D contracts and royalties/profit sharing 1,354 1,975 Revenue from multiple element arrangements 6,811 1,773 TOTAL $ 476,813 $ 441,708 Goodwill and Other Intangibles The Company's intangible assets are comprised of customer relationships with an estimated useful life of twelve to thirteen years and trademarks/trade names and goodwill with indefinite lives (collectively, "intangible assets"), which the Company recognized in accordance with accounting guidance (i) upon the acquisition of GreenLine by Apio in April 2012, (ii) upon the acquisition of Lifecore in April 2010 and (iii) upon the acquisition of Apio in December 1999. Accounting guidance defines goodwill as "the excess of the cost of an acquired entity over the net of the estimated fair values of the assets acquired and the liabilities assumed at date of acquisition." All intangible assets, including goodwill, associated with the acquisition of Lifecore was allocated to our HA-based Biomaterials reporting unit and the acquisitions of Apio and GreenLine were allocated to our Food Products Technology reporting unit pursuant to accounting guidance based upon the allocation of assets and liabilities acquired and consideration paid for each reporting unit. As of May 25, 2014, the HA-based Biomaterials reporting unit had $13.9 million of goodwill and the Food Products Technology reporting unit had $35.7 million of goodwill. The Company tests its indefinite-lived intangible assets for impairment at least annually, in accordance with accounting guidance. For non-goodwill indefinite-lived assets, the Company performs a qualitative analysis in accordance with ASC 350-30-35. For goodwill, the Company performs a quantitative analysis in accordance with ASC 350-20-35. - 26 --------------------------------------------------------------------------------- Application of the impairment tests for indefinite-lived intangible assets requires significant judgment by management, including identification of reporting units, assignment of assets and liabilities to reporting units, assignment of intangible assets to reporting units, and the determination of the fair value of each indefinite-lived intangible asset and reporting unit based upon projections of future net cash flows, discount rates and market multiples, which judgments and projections are inherently uncertain. During the fiscal quarter ended February 23, 2014, the Company voluntarily changed the date of its annual goodwill and indefinite-lived intangible assets impairment testing from the last day of the fiscal month in July to the first day of the fiscal fourth quarter. This voluntary change is preferable under the circumstances as it provides the Company with additional time to complete its annual goodwill and indefinite-lived intangible asset impairment testing in advance of its year-end reporting and results in better alignment with the Company's strategic planning and forecasting process. The voluntary change in accounting principle related to the annual testing date will not delay, accelerate, or avoid an impairment charge. This change is not applied retrospectively as it is impracticable to do so because retrospective application would require application of significant estimates and assumptions with the use of hindsight. Accordingly, the change will be applied prospectively. The Company tested its indefinite-lived intangible assets for impairment as of February 24, 2014 and determined that no adjustments to the carrying values of these assets were necessary as of that date. On a quarterly basis, the Company considers the need to update its most recent annual tests for possible impairment of its indefinite-lived intangible assets, based on management's assessment of changes in its business and other economic factors since the most recent annual evaluation. Such changes, if significant or material, could indicate a need to update the most recent annual tests for impairment of the indefinite-lived intangible assets during the current period. The results of these tests could lead to write-downs of the carrying values of these assets in the current period. The Company uses the discounted cash flow ("DCF") approach to develop an estimate of fair value for goodwill. The DCF approach recognizes that current value is premised on the expected receipt of future economic benefits. Indications of value are developed by discounting projected future net cash flows to their present value at a rate that reflects both the current return requirements of the market and the risks inherent in the specific investment. The market approach is not used to value the Company's reporting units because insufficient market comparables exist to enable the Company to develop a reasonable fair value due to the unique nature of each of the Company's reporting units. The DCF associated with the annual goodwill impairment analysis for the Food Products Technology reporting unit is based on management's five-year projection of revenues, gross profits and operating profits by fiscal year and assumes a 36% effective tax rate for each year. Management takes into account the historical trends of the Food Products Technology reporting unit and the industry categories in which it operates along with inflationary factors, current economic conditions, new product introductions, cost of sales, operating expenses, capital requirements and other relevant data when developing its projection. The estimated fair value of the Food Products Technology reporting unit as of February 24, 2014 was 136% of its book value at that date, therefore, no goodwill impairment was deemed to exist. For the test performed as of July 21, 2013, the projected cash flow from operations for determining the DCF for fiscal year 2014 was $10.1 million for the Food Products Technology reporting unit. The actual cash flow from operations for fiscal year 2014 was $10.5 million. The DCF associated with the annual goodwill impairment analysis for the HA-based Biomaterials reporting unit is based on management's five-year projections of revenues, gross profits and operating profits by fiscal year and assumes a 36% effective tax rate for each year. Management takes into account the historical trends of HA-based Biomaterials reporting unit and the industry categories in which it operates along with inflationary factors, current economic conditions, new product introductions, cost of sales, operating expenses, capital requirements and other relevant data when developing its projection. The estimated fair value of the HA-based Biomaterials reporting unit as of February 24, 2014 was 176% of its book value at that date, therefore, no goodwill impairment was deemed to exist. For the test performed as of July 21, 2013, the projected cash flow from operations for determining the DCF for fiscal year 2014 was $6.3 million for the HA-based Biomaterials reporting unit. The actual cash flow from operations for fiscal year 2014 was $10.2 million. The difference of $3.9 million is primarily due to timing of working capital changes and lower than planned intercompany charges for income taxes. - 27 --------------------------------------------------------------------------------- Income Taxes The Company accounts for income taxes in accordance with accounting guidance which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax basis of recorded assets and liabilities. The Company maintains valuation allowances when it is likely that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the Company's income tax provision in the period of change. In determining whether a valuation allowance is warranted, the Company takes into account such factors as prior earnings history, expected future earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect utilization of a deferred tax asset, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. At May 25, 2014, the Company had a valuation allowance of $881,000 against deferred tax assets. In addition to valuation allowances, the Company establishes tax-contingency accruals for uncertain tax positions. The tax-contingency accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. The Company's effective tax rate includes the impact of tax-contingency accruals as considered appropriate by management. A number of years may elapse before a particular matter, for which the Company has accrued, is audited and finally resolved. The number of years with open tax audits varies by jurisdiction. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, the Company believes its tax-contingency accruals are adequate to address known tax contingencies. Favorable resolution of such matters could be recognized as a reduction to the Company's effective tax rate in the year of resolution. Unfavorable settlement of any particular issue could increase the effective tax rate. Any resolution of a tax issue may require the use of cash in the year of resolution. The Company's tax-contingency accruals are presented in the balance sheet within accrued liabilities. Stock-Based Compensation The Company's stock-based awards include stock option grants and restricted stock unit awards (RSUs). The estimated fair value for stock options, which determines the Company's calculation of compensation expense, is based on the Black-Scholes pricing model. In addition, the accounting guidance requires the estimation of the expected forfeitures of stock-based awards at the time of grant. As a result, the Company uses historical data to estimate pre-vesting forfeitures and records stock-based compensation expense only for those awards that are expected to vest and revises those estimates in subsequent periods if the actual forfeitures differ from the prior estimates. Fair Value Measurements The Company uses fair value measurement accounting for financial assets and liabilities and for financial instruments and certain other items measured at fair value. The Company has elected the fair value option for its investment in a non-public company (see Note 4 to the Consolidated Financial Statements). The Company has not elected the fair value option for any of its other eligible financial assets or liabilities. The accounting guidance established a three-tier hierarchy for fair value measurements, which prioritizes the inputs used in measuring fair value as follows: Level 1 - observable inputs such as quoted prices for identical instruments in active markets. Level 2 - inputs other than quoted prices in active markets that are observable either directly or indirectly through corroboration with observable market data. - 28 ---------------------------------------------------------------------------------Level 3 - unobservable inputs in which there is little or no market data, which would require the Company to develop its own assumptions. As of May 25, 2014, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis, including cash equivalents, marketable securities, interest rate swap and its minority interest investment in Windset. The fair value of the Company's marketable securities is determined based on observable inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. Therefore, the Company has categorized its marketable securities as a Level 1 measurement. The fair value of the Company's interest rate swap is determined based on model inputs that can be observed in a liquid market, including yield curves, and is categorized as a Level 2 measurement. The Company has elected the fair value option of accounting for its investment in Windset. The calculation of fair value utilizes significant unobservable inputs in the discounted cash flow models, including projected cash flows, growth rates and discount rates. As a result, the Company's investment in Windset is considered to be a Level 3 measurement investment. The change in the fair market value of the Company's investment in Windset for the fiscal years ended May 25, 2014 and May 26, 2013 was due to the Company's 20.1% minority interest in the change in the fair market value of Windset during those periods. In determining the fair value of the investment in Windset, the Company utilizes the following significant unobservable inputs in the discounted cash flow models: At May 25, 2014 At May 26, 2013 Annual consolidated revenue growth rates 4% 3% to 9% Annual consolidated expense growth rates 4% 3% to 8% Consolidated income tax rates 15% 15% Consolidated discount rates 16% to 22 % 18% to 28% The revenue growth, expense growth and income tax rate assumptions, consider the Company's best estimate of the trends in those items over the discount period. The discount rate assumption takes into account the risk-free rate of return, the market equity risk premium and the company's specific risk premium and then applies an additional discount for lack of marketability of the underlying securities. The discounted cash flow valuation model used by the Company has the following sensitivity to changes in inputs and assumptions (in thousands): Impact on value of Windset investment as of May 25, 2014 10% increase in revenue growth rates $ 3,200 10% increase in expense growth rates $ (2,300 ) 10% increase in income tax rates - 10% increase in discount rates $ (1,500 ) Imprecision in estimating unobservable market inputs can affect the amount of gain or loss recorded for a particular position. The use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. - 29 ---------------------------------------------------------------------------------The following table summarizes the fair value of the Company's assets and liabilities that are measured at fair value on a recurring basis, as of May 25, 2014 and May 26, 2013 (in thousands): Fair Value at May 25, 2014 Fair Value at May 26, 2013 Assets: Level 1 Level 2 Level 3 Level 1 Level 2 Level 3 Marketable securities $ - $ - $ - $ 1,545 $ - $ - Investment in private company - - 39,600 - - 29,600 Total $ - $ - $ 39,600 $ 1,545 $ - $ 29,600 Liabilities: Interest rate swap - 44 - - 163 - Total $ - $ 44 $ - $ - $ 163 $ - Recent Accounting Pronouncements Revenue Recognition In May 2014, the FASB issued Accounting Standard Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The standard requires entities to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also includes a cohesive set of disclosure requirements intended to provide users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a company's contracts with customers. ASU 2014-09 will be effective beginning the first quarter of the Company's fiscal year 2018 and early application is not permitted. The standard allows for either "full retrospective" adoption, meaning the standard is applied to all of the periods presented, or "modified retrospective" adoption, meaning the standard is applied only to the most current period presented in the financial statements. Management is currently evaluating the effect ASU 2014-09 will have on the Company's Consolidated Financial Statements and disclosures. Unrecognized Tax Benefits In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, related to the presentation of unrecognized tax benefits. The update requires presentation of an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward or a tax credit carryforward in the statement of financial position. The guidance does not apply to the extent that a net operating loss carryforward or tax credit carryforward at the reporting date is not available under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position. The guidance is effective for fiscal years (and interim periods within those years) beginning after December 15, 2013, with early adoption permitted. The Company early adopted this standard in the first fiscal quarter of fiscal year 2014 and such adoption did not have a significant impact on the Company's Consolidated Financial Statements or disclosures. Results of Operations Fiscal Year Ended May 25, 2014 Compared to Fiscal Year Ended May 26, 2013 Revenues (in thousands): Fiscal Year ended Fiscal Year ended May 25, 2014 May 26, 2013 Change Food Products Technology $ 360,728 $ 320,447 13 % Food Export 69,827 78,568 (11% ) Total Apio 430,555 399,015 8 % HA-based Biomaterials 45,704 41,281 11 % Corporate 554 1,412 (61% ) Total Revenues $ 476,813 $ 441,708 8 % - 30 ---------------------------------------------------------------------------------Food Products Technology (Apio) Apio's Food Products Technology 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, and from the sale of BreatheWay packaging to license partners. The increase in Apio's Food Products Technology revenues for the fiscal year ended May 25, 2014 compared to the same period last year was primarily due to a 8% increase in unit volume sales resulting primarily from expanded product offerings and a 10% unit volume increase in the fresh-cut vegetable category, according to Nielsen, coupled with new product introductions which typically have a higher price per unit than historical offerings. Food Export (Apio) Apio's Food 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 decrease in revenues in Apio's Food Export business for the fiscal year ended May 25, 2014 compared to the same period last year was due to a 6% decrease in unit volume sales primarily as a result of new Indonesian import quotas on fruit coupled with a product mix change to lower priced export items compared to fiscal year 2013. HA-based Biomaterials (Lifecore) 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 60% of Lifecore's revenues in fiscal year 2014, (2) Orthopedic, which represented approximately 20% of Lifecore's revenues in fiscal year 2014 and (3) Veterinary/Other. The increase in Lifecore's revenues for fiscal year 2014 compared to the same period last year was due to a 32% increase in revenues in Lifecore's aseptic filling business from increased sales to existing customers partially offset by a 13% decrease in fermentation sales. Corporate Corporate revenues are generated from the licensing agreements with Air Products, Nitta and INCOTEC. The decrease in Corporate revenues for fiscal year 2014 compared to the same period of last year was not significant. Gross Profit (in thousands): Fiscal Year ended Fiscal Year ended May 25, 2014 May 26, 2013 Change Food Products Technology $ 36,318 $ 37,077 (2% ) Food Export 5,340 5,274 1 % Total Apio 41,658 42,351 (2% ) HA-based Biomaterials 20,456 19,102 7 % Corporate 450 1,307 (66% ) Total Gross Profit $ 62,564 $ 62,760 0 % - 31 --------------------------------------------------------------------------------- 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, seeds, packaging, syringes and fermentation and purification supplies), direct labor, overhead (including indirect labor, depreciation, and facility related costs) and shipping and shipping-related costs. The following are the primary reasons for the changes in gross profit for the fiscal year ended May 25, 2014 compared to the same period last year as outlined in the table above. Food Products Technology (Apio) The decrease in gross profit for the Food Products Technology business for fiscal year 2014 compared to the same period last year was primarily due to much higher than expected operating costs including higher labor costs to meet higher than expected volumes and higher raw produce sourcing costs during primarily the first six months of fiscal year 2014 resulting from lower yields and poor quality due to a variety of factors, most importantly the heavy rains in the Midwest and along the East Coast and large temperatures swings in California throughout most of the year. The higher operating costs reduced Apio's gross profit by approximately $9.3 million during fiscal year 2014 which was partially offset by the gross profit generated from the 13% increase in revenues. Food Export (Apio) Apio's Food Export business is a buy/sell business that typically realizes a gross margin in the 5-8% range. The increase in gross profit for Apio's Food Export business for fiscal year 2014 compared to the same period last year was primarily due to favorable product mix changes to higher margin products, primarily into Indonesia, which resulted in a higher gross margin percentage during fiscal year 2014 of 7.6% compared to a gross margin percentage of 6.7% during fiscal year 2013. The favorable product mix was offset by the decrease in gross profit resulting from an 11% decrease in revenues. HA-based Biomaterials (Lifecore) Lifecore operates in the medical devices industry and has historically realized an overall gross margin percentage of approximately 45-50%. The increase in gross profit for fiscal year 2014 compared to the same period last year was due to an 11%, or $4.4 million increase in revenues resulting from the increased sales of both historical products and new products to existing customers. The increase in gross profit from higher revenues was partially offset by an unfavorable product mix change to higher sales of lower margin aseptically filled products from higher margin fermentation sales. Corporate The decrease in Corporate gross profit for fiscal year 2014 compared to the same period last year was not significant. - 32 ---------------------------------------------------------------------------------Operating Expenses (in thousands): Fiscal Year ended Fiscal Year ended May 25, 2014 May 26, 2013 Change Research and Development: Apio $ 1,105 $ 1,088 2 % Lifecore 4,739 4,930 (4 %) Corporate 1,360 3,276 (58 %) Total R&D $ 7,204 $ 9,294 (22 %) Selling, General and Administrative: Apio $ 22,860 $ 21,976 4 % Lifecore 4,251 4,595 (7 %) Corporate 8,059 5,960 35 % Total S,G&A $ 35,170 $ 32,531 8 % Other operating expenses: Apio $ - $ (3,933 ) N/M Total Other Operating Expenses $ - $ (3,933 ) N/M Research and Development Landec's research and development consisted primarily of 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 a focus on extending the shelf-life of sensitive vegetables and fruit. In the Lifecore business, the research and development efforts are focused on new products and applications for HA-based biomaterials. For Corporate, the research and development efforts are focused on supporting the development and commercialization of new products and new technologies in our food and HA businesses along with developing uses for our proprietary Intelimer polymers outside of our food and HA businesses. The decrease in research and development expenses for fiscal year 2014 compared to last year was primarily due to a decrease in Corporate R&D because of the Company transitioning away from R&D and licensing collaborations to maintain focus on R&D efforts at its core food and HA businesses. Selling, General and Administrative (S,G&A) Selling, general and administrative 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 fiscal year 2014 compared to the same period last year was primarily due to an increase in accounting and tax fees, public company costs and board of director fees in fiscal year 2014. Other Operating Expenses Other operating expenses in fiscal year 2013 consisted of a $3.9 million reversal of the earn-out liability at Apio associated with the GreenLine acquisition. - 33 ---------------------------------------------------------------------------------Non-operating income/(expense) (in thousands): Fiscal Year ended Fiscal Year ended May 25, 2014 May 26, 2013 Change Dividend Income $ 1,125 $ 1,125 - Interest Income $ 260 $ 179 45 % Interest Expense $ (1,650 ) $ (2,008 ) (18 %) Other Income $ 10,000 $ 8,100 23 % Income Taxes $ (10,583 ) $ (9,452 ) 12 % Non controlling Interest $ (197 ) $ (225 ) (12 %) 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 in fiscal year 2014 compared to fiscal year 2013. Interest Income The increase in interest income for the fiscal year 2014 compared to the same period last year was not significant. Interest Expense The decrease in interest expense during fiscal year 2014 compared to the same period last year was due to the Company paying down its debt by $9.9 million during fiscal year 2014. Other Income The increase in other income for fiscal year 2014 compared to the same period last year is primarily due to the change in the fair market value of our Windset investment being $1.9 million higher in fiscal year 2014 compared to the increase in fiscal year 2013. Income Taxes The increase in the income tax expense for fiscal year 2014 was due to an increase in the effective tax rate for fiscal year 2014 to 36% compared to 30% in fiscal year 2013. The effective tax rates for last year was lower than this year as a result of the $3.9 million earn out adjustment last year which was not subject to income tax. The increase in income taxes due to the increase in the effective tax rate was partially offset by a 7% decrease in net income before taxes 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 non controlling interest for fiscal year 2014 compared to the same period last year was not significant. - 34 ---------------------------------------------------------------------------------Fiscal Year Ended May 27, 2013 Compared to Fiscal Year Ended May 27, 2012 Revenues (in thousands): Fiscal Year ended Fiscal Year ended May 26, 2013 May 27, 2012 Change Food Products Technology $ 320,447 $ 207,582 54 % Food Export 78,568 71,485 10 % Total Apio 399,015 279,067 43 % HA-based Biomaterials 41,281 34,283 20 % Corporate 1,412 4,202 (66 %) Total Revenues $ 441,708 $ 317,552 39 % Food Products Technology (Apio) Apio's Food Products Technology 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 and from the sale of BreatheWay packaging to license partners. The increase in Apio's Food Products Technology revenues for the fiscal year ended May 26, 2013 compared to the same period last year was primarily due to the following factors: (1) a $27 million increase in non-green bean value-added sales due to a 15% 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, (2) an $86 million increase in revenues from GreenLine which was acquired on April 23, 2012 and (3) a larger percentage of Apio's non-green bean value-added sales volume being generated from sales to club stores rather than retail grocery chains. These increases in revenue were partially offset by product mix changes in retail grocery chains to lower priced products from higher priced products. Food Export (Apio) Apio's Food 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 Food Export business for the fiscal year ended May 26, 2013 compared to the same period last year was primarily due to more favorable pricing for export products in fiscal year 2013 compared to fiscal year 2012 resulting in higher prices per unit sold. HA-based Biomaterials (Lifecore) 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 2013, (2) Orthopedic, which represented approximately 20% of Lifecore's revenues in fiscal year 2013 and (3) Veterinary/Other. The increase in Lifecore's revenues for fiscal year 2013 compared to the same period last year was due almost entirely to increased sales of existing aseptically filled products to existing customers and from new aseptically filled products recently approved by the FDA to existing customers in the Ophthalmic area. - 35 --------------------------------------------------------------------------------- Corporate Corporate revenues are generated from the licensing agreements with Air Products, Nitta and INCOTEC. The decrease in Corporate revenues for fiscal year 2013 compared to the same period of last year was due to the termination of the Monsanto Agreement at the end of the second quarter of fiscal year 2012. The Company recognized $2.7 million in license fees from the Monsanto Agreement during fiscal year 2012. The Monsanto license fees were partially offset by research and development revenues from Nitta. Gross Profit (in thousands): Fiscal Year ended Fiscal Year ended May 26, 2013 May 27, 2012 Change Food Products Technology $ 37,077 $ 25,237 47 % Food Export 5,274 4,900 8 % Total Apio 42,351 30,137 41 % HA-based Biomaterials 19,102 17,994 6 % Corporate 1,307 4,007 (67 %) Total Gross Profit $ 62,760 $ 52,138 20 % 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, seeds, packaging, syringes and fermentation and purification supplies), direct labor, overhead (including indirect labor, depreciation, and facility related costs) and shipping and shipping-related costs. The following are the primary reasons for the changes in gross profit for the fiscal year ended May 26, 2013 compared to the same period last year as outlined in the table above. Food Products Technology (Apio) The increase in gross profit for the Food Products Technology business for the fiscal year 2013 compared to the same period last year was primarily due to (1) the 54% increase in revenues and (2) the addition of higher margin GreenLine products. These increases were partially offset by the negative impact of produce sourcing issues which primarily occurred during the second half of fiscal year 2013. Food Export (Apio) Apio's Food Export business is a buy/sell business that typically realizes a gross margin in the 5-8% range. The increase in gross profit for Apio's Food Export business for fiscal year 2013 compared to the same period last year was primarily due to a 10% increase in revenues partially offset by higher procurement costs for certain export products. HA-based Biomaterials (Lifecore) Lifecore operates in the higher margin medical devices industry and has historically realized an overall gross margin of approximately 45-50%. The increase in gross profit for fiscal year 2013 compared to the same period last year was due to an increase in revenues of $7.0 million resulting from the increased sales of both historical products and new products to existing customers which were partially offset by the revenue increase from aseptically filled products which have a lower gross margin than Lifecore's other products. - 36 --------------------------------------------------------------------------------- Corporate The decrease in Corporate gross profit for fiscal year 2013 compared to the same period last year was due to the termination of the Monsanto Agreement at the end of the second quarter of fiscal year 2012. The Company recognized $2.7 million in license fees from the Monsanto Agreement during fiscal year 2012. The Monsanto license fees were partially offset by research and development revenues from Nitta. Operating Expenses (in thousands): Fiscal Year ended Fiscal Year ended May 26, 2013 May 27, 2012 Change Research and Development: Apio $ 1,088 $ 1,106 (2 %) Lifecore 4,930 4,671 6 % Corporate 3,276 3,848 (15 %) Total R&D $ 9,294 $ 9,625 (3 %) Selling, General and Administrative: Apio $ 21,976 $ 14,776 49 % Lifecore 4,595 4,521 2 % Corporate 5,960 7,218 (17 %) Total S,G&A $ 32,531 $ 26,515 23 % Other operating expenses: Apio $ (3,933 ) $ 871 N/M Corporate - 550 N/M Total Other Operating Expenses $ (3,933 ) $ 1,421 N/M Research and Development Landec's research and development consisted primarily of 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 a focus on extending the shelf-life of sensitive vegetables and fruit. In the Lifecore business, the research and development efforts are focused on new products and applications for HA-based biomaterials. For Corporate, the research and development efforts are focused on supporting the development and commercialization of new products and new technologies in our food and HA businesses along with developing uses for our proprietary Intelimer polymers outside of our food and HA businesses. The decrease in research and development expenses for fiscal year 2013 compared to the same period last year was primarily due to the decrease in research and development expenses incurred by Corporate during fiscal year 2012 at the Company's former seed corn business which was sold in June 2012. Selling, General and Administrative (S,G&A) Selling, general and administrative 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 fiscal year 2013 compared to the same period last year was primarily due to: (1) a $4.6 million increase in S,G&A expenses at Apio from GreenLine which was acquired on April 23, 2012 and (2) a $2.6 million increase in SG&A at Apio, excluding GreenLine, due to the amortization of the customer base intangible acquired in the acquisition of GreenLine and additional sales and marketing expenses associated with the increase in revenues. These increases were partially offset by a $1.3 million decrease in S,G&A at Corporate due primarily to no Corporate bonuses being earned in fiscal year 2013 compared to $1.0 million of Corporate bonuses earned in fiscal year 2012 and from S,G&A expenses at the Company's former seed corn business in fiscal year 2012 which was sold in June 2012. - 37 --------------------------------------------------------------------------------- Other Operating Expenses Other operating expenses in fiscal year 2013 consisted of a $3.9 million reversal of the earn-out liability at Apio associated with the GreenLine acquisition. Other operating expenses in fiscal year 2012 consisted of expenses incurred as a result of the acquisition of GreenLine. Non-operating income/(expense) (in thousands): Fiscal Year ended Fiscal Year ended May 26, 2013 May 27, 2012 Change Dividend Income $ 1,125 $ 1,125 - Interest Income $ 179 $ 180 (1 %) Interest Expense $ (2,008 ) $ (929 ) 116 % Other Income $ 8,100 $ 5,331 52 % Income Taxes $ (9,452 ) $ (7,185 ) 32 % Non controlling Interest $ (225 ) $ (403 ) (44 %) 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 in fiscal year 2013 compared to fiscal year 2012. Interest Income The decrease in interest income for the fiscal year ended May 26, 2013 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 fiscal year 2013 compared to the same period last year was due to interest on the $32 million of debt incurred in the acquisition of GreenLine. This increase was partially offset by decreases in interest expense at Lifecore due to paying down its debt by $3.3 million during fiscal year 2013. Other Income The increase in other income for fiscal year 2013 compared to the same period last year is primarily due to the change in the fair market value of our Windset investment being $2.3 million higher in fiscal year 2013 compared to the change in fiscal year 2012. Income Taxes The increase in the income tax expense for fiscal year 2013 is due to a 59% increase in net income before taxes compared to the same period last year. The effective tax rate for fiscal year 2013 was 30% compared to 36% for the same period last year primarily because the $3.9 million reversal of the earn-out liability during fiscal year 2013 related to the GreenLine acquisition was not subject to income taxes and various to other tax deductions and credits in fiscal year 2013, such as the return of the R&D credit and the change in the Company's state apportionment factors due to the addition of GreenLine, which resulted in a lower effective tax rate for fiscal year 2013. - 38 --------------------------------------------------------------------------------- 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 non-controlling interest for fiscal year 2013 compared to the same period last year was due to a decrease in Apio Cooling revenues. Liquidity and Capital Resources As of May 25, 2014, the Company had cash and cash equivalents of $14.2 million, a net increase of $525,000 from $13.7 million at May 26, 2013. Cash Flow from Operating Activities Landec generated $21.0 million of cash from operating activities during fiscal year 2014 compared to generating $21.2 million from operating activities during fiscal year 2013. The primary sources of cash from operating activities during fiscal year 2014 were from (1) $19.3 million of net income, (2) $8.5 million of depreciation/amortization and stock-based compensation expenses and (3) a $5.6 million net increase in deferred tax liabilities. The primary uses of cash from operating activities were from the $10.0 million non-cash increase in the Company's investment in Windset and a net increase of $2.7 million in working capital, excluding the portion of the increase in income taxes receivable which is attributable to the tax benefit from stock-based compensation. The primary factors which increased working capital during fiscal year 2014 were a $8.0 million increase in receivables primarily due to May 2014 revenues for Apio and Lifecore being $5.3 million and $1.7 million higher, respectively, than Apio's and Lifecore's May 2013 revenues. These increases in working capital were partially offset by a $3.1 million increase in income taxes receivable due to overpayments and a $3.2 million increase in current liabilities resulting primarily from the timing of invoices at Apio. Cash Flow from Investing Activities Net cash used in investing activities for fiscal year 2014 was $13.3 million compared to $10.4 million for the same period last year. The primary uses of cash in investing activities during fiscal year 2014 were for the purchase of $14.9 million of equipment primarily to support the growth of the Apio value-added and Lifecore businesses. Cash Flow from Financing Activities Net cash used in financing activities for fiscal year 2014 was $7.2 million compared to $19.3 million for the same period last year. The net cash used in financing activities during fiscal year 2014 was primarily due to the $9.9 million of net payments on the Company's lines of credit and long-term debt offset by $2.3 million received from proceeds from the sale of Common Stock. The primary use of cash from financing activities during fiscal year 2013 was from a $10 million earn out payment made related to the Lifecore acquisition, $9.7 million of which was recorded as a contingent liability at the time of the acquisition and was therefore classified as a financing activity. Capital Expenditures During the fiscal year ended May 25, 2014, Landec continued its expansion of Apio's value-added processing facility and purchased vegetable processing equipment as well as made facility modifications and equipment purchases at Lifecore to support business growth. These expenditures represented the majority of the $14.9 million of capital expenditures during fiscal year 2014. - 39 --------------------------------------------------------------------------------- Debt On August 19, 2004, Lifecore issued variable rate industrial revenue bonds ("IRBs"). These IRBs were assumed by Landec in the acquisition of Lifecore (see Note 9 to the Consolidated Financial Statements). The IRBs are collateralized by a bank letter of credit which is secured by a first mortgage on Lifecore's 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 "GE Debt 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 combination of the eligible accounts receivable and inventory balances of Apio and its subsidiaries (availability was $19.8 million at May 25, 2014). Apio's revolving line of credit has an unused fee of 0.375% per annum. At May 25, 2014 and May 26, 2013, Apio had zero and $4.0 million, respectively, 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 $19.2 million real estate loan, $1.2 million of which was paid in April 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 April 23, 2022. Apio's obligations under the GE Debt Agreements are secured by liens on all of the property of Apio and its subsidiaries. The GE Debt Agreements contain customary events of default under which obligations could be accelerated or increased. The GE Capital real estate and equipment loans are guaranteed by Landec, and Landec has pledged its equity interest in Apio as collateral under the line of credit agreement. The GE Debt 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, sell stock or repurchase stock or other securities; (4) sell assets; (5) engage in mergers; (6) enter into sale and leaseback transactions; and (7) make changes in Apio's corporate structure. In addition, Apio must maintain a minimum fixed charge coverage ratio of 1.10 to 1.0 if the availability under its line of credit falls below $7.5 million. Apio was in compliance with all financial covenants as of May 25, 2014 and May 26, 2013. Unamortized loan origination fees for the GE Debt Agreements were $964,000 and $1.2 million at May 25, 2014 and May 26, 2013, respectively, and are included in other assets in the Consolidated Balance Sheets. 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"): (1) A Credit and Security Agreement (the "Credit Agreement") which includes (a) a two-year, $10.0 million asset-based working capital revolving line of credit, with an interest rate of LIBOR plus 1.85%, with availability based on the combination of Lifecore's eligible accounts receivable and inventory balances (availability was $7.9 million at May 25, 2014) and with no unused fee (as of May 25, 2014 and May 26, 2013, 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. - 40 --------------------------------------------------------------------------------- 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. Unamortized loan origination fees for the Lifecore Loan Agreements were $98,000 and $149,000 at May 25, 2014 and May 26, 2013, respectively, and are included in other assets in the Consolidated Balance Sheets. Lifecore was in compliance with all financial covenants as of May 25, 2014 and May 26, 2013. The market value of the Company's debt approximates its recorded value as the interest rates on each debt instrument approximates current market rates. The Term Loan was used to repay 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 prior 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 its obligations under the credit agreement with Wells Fargo at the time the agreement was consummated. 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 May 25, 2014 and May 26, 2013 was $44,000 and $163,000, respectively, and is included in other accrued liabilities in the accompanying Consolidated Balance Sheets. Contractual Obligations The Company's material contractual obligations for the next five years and thereafter as of May 25, 2014, are as follows (in thousands): Due in Fiscal Year Ended May Obligation Total 2015 2016 2017 2018 2019 Thereafter Income taxes $ - $ - $ - $ - $ - $ - $ - Debt principal payments 34,372 6,055 6,181 3,318 3,456 3,599 11,763 Interest payments 5,198 1,146 958 795 663 525 1,111 Operating leases 11,038 2,916 2,720 2,225 1,375 929 873 Purchase commitments 5,046 5,046 - - - - - Total $ 55,654 $ 15,163 $ 9,859 $ 6,338 $ 5,494 $ 5,053 $ 13,747 The income tax amounts above exclude liabilities associated with the accounting for uncertainty in income taxes as we are unable to reasonably estimate the ultimate amount or timing of settlement. See Note 11 in the Notes to Consolidated Financial Statements for further discussion. - 41 --------------------------------------------------------------------------------- The interest payment amounts above include: (1) the 4.39% fixed interest rate payments on the GE Capital equipment loan, (2) the 4.02% fixed interest rate payments on the GE Capital real estate loan, (3) the estimated interest rate payment on the variable Term Loan with BMO Harris based on the four year historical average 30-day LIBOR plus 2% or 2.22% and (4) the estimated interest rate payment on the variable rate IRB based on the five year historical interest rate average for the Municipal Swap Index plus 20 basis points plus the letter of credit and remarketing fees of 0.875% resulting in a estimated rate of 1.25%. Landec is not a party to any agreements with, or commitments to, any special purpose entities that would constitute material off-balance sheet financing other than the operating lease commitments. Landec's future capital requirements will depend on numerous factors, including the progress of its research and development programs; the continued development of marketing, sales and distribution capabilities; the ability of Landec to establish and maintain new collaborative and licensing arrangements; any decision to pursue additional acquisition opportunities; weather conditions that can affect the supply and price of produce, the timing and amount, if any, of payments received under licensing and research and development agreements; the costs involved in preparing, filing, prosecuting, defending and enforcing intellectual property rights; the ability to comply with regulatory requirements; the emergence of competitive technology and market forces; the effectiveness of product commercialization activities and arrangements; and other factors. If Landec's currently available funds, together with the internally generated cash flow from operations are not sufficient to satisfy its capital needs, Landec would be required to seek additional funding through other arrangements with collaborative partners, additional bank borrowings and public or private sales of its securities. There can be no assurance that additional funds, if required, will be available to Landec on favorable terms, if at all. 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. |