NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization, Basis of Presentation, and Summary of Significant Accounting Policies
Organization
Lifecore Biomedical, Inc. and its subsidiaries (“Lifecore Biomedical” or the “Company”, previously Landec Corporation) design, develop, manufacture, and sell differentiated products for food and biomaterials markets, and license technology applications to partners.
Lifecore Biomedical’s biomedical company, Lifecore Biomedical Operating Company, Inc. (“Lifecore”), is a fully integrated contract development and manufacturing organization (“CDMO”) that offers highly differentiated capabilities in the development, fill and finish of sterile, injectable-grade pharmaceutical products in syringes and vials. As a leading manufacturer of premium, injectable grade Hyaluronic Acid, Lifecore brings 37 years of expertise as a partner for global and emerging biopharmaceutical and biotechnology companies across multiple therapeutic categories to bring their innovations to market. Lifecore recognizes revenue in two different product categories, CDMO and Fermentation.
Lifecore Biomedical previously operated a natural food company, through its wholly owned subsidiary, Curation Foods, Inc. (“Curation Foods”), which was previously focused on the distribution of plant-based foods to retail, club and foodservice channels throughout North America, which was presented in Lifecore Biomedical’s prior financial statements as the Curation Foods segment. However, upon the sale of Yucatan Foods on February 7, 2023 (see “Yucatan Disposition and Discontinued Operations” below) and O Olive Oil & Vinegar (“O Olive”) on April 6, 2023, (refer to Note 10), the Company has ceased to operate the Curation Foods business. Accordingly, commencing in the fourth quarter of fiscal year 2023, the Curation Foods segment of Lifecore Biomedical will be presented as a discontinued operation in its entirety.
On November 14, 2022, the Company filed an amendment to the Certificate of Incorporation to change the Company’s name from Landec Corporation to Lifecore Biomedical, Inc. (the “Name Change”), which was approved by the board of directors of the Company and became effective on November 14, 2022. In connection with the Name Change, the Company’s common stock began trading under its new NASDAQ ticker symbol, “LFCR”, on November 15, 2022. References to “Landec” or “Landec Corporation” refer to operations and/or transactions of the Company prior to the Name Change.
Yucatan Disposition and Discontinued Operations
On February 7, 2023 (the “Closing Date”), Company, Camden Fruit Corp., a direct wholly owned subsidiary of Curation Foods and an indirect wholly owned subsidiary of the Company (“Camden” and together with the Curation Foods and the Company, the “Sellers”), Yucatan Foods, LLC, a wholly owned subsidiary of the Camden (“Yucatan”), and Yucatan Acquisition Holdings LLC, a wholly owned subsidiary of Flagship Food Group LLC (“Buyer” and together with Yucatan and the Sellers, the “Parties”) completed the sale (the “Yucatan Disposition”) of the Company’s avocado products business, including its Yucatan® and Cabo Fresh® brands, as well as the associated manufacturing facility and operations in Guanajuato, Mexico (the “Business”), pursuant to the terms of a securities purchase agreement executed by the Parties on February 7, 2023 (the “Securities Purchase Agreement”). Pursuant to the Securities Purchase Agreement, Buyer acquired all of the outstanding equity securities of Yucatan for a purchase price of $17.5 million in cash, subject to certain post-closing adjustments at closing, including selling costs, net working capital and other adjustments amounting to $5.0 million. The Company recognized a loss on the Yucatan Disposition of $21.0 million in the third quarter ended February 26, 2023. The loss on the Yucatan Disposition is recorded in loss from discontinued operations in the Consolidated Statement of Comprehensive (Loss) Income.
The accounting requirements for reporting the Yucatan Foods business as discontinued operations were met when the Yucatan Disposition was completed on the Closing Date. Accordingly, the consolidated financial statements and notes to the consolidated financial statements reflect the results of the Yucatan business as a discontinued operation for the periods presented. Refer to Note 9 - Discontinued Operations for additional information.
Securities Purchase Agreement
On November 25, 2022, the Company entered into a Securities Purchase Agreement (the “Wynnefield Purchase Agreement”) with entities affiliated with Wynnefield Capital, Inc. (the “Purchasers”). Pursuant to the Wynnefield Purchase Agreement, the Company agreed to sell an aggregate of 627,746 shares of its common stock (the “Shares”) for aggregate gross proceeds of approximately $5.0 million (the “Offering”). The purchase price for each Share was $7.97. The Offering closed on November 25, 2022. Pursuant to the Wynnefield Purchase Agreement, the Company granted the Purchasers certain piggyback registration rights and agreed, among other things, to indemnify such parties under any registration statement filed that includes the Shares from certain losses, claims, damages and liabilities.
Series A Convertible Preferred Share Purchase Agreement
On January 9, 2023, the Company simultaneously signed and closed a Securities Purchase Agreement (the “Preferred Share Purchase Agreement”) with a group of certain accredited investors. Refer to Note 2 – Convertible Preferred Stock for additional information.
Amendment to Credit Agreements
On January 9, 2023, the Company entered into certain amendments to its existing Credit Facilities (defined below). Refer to Note 6 – Debt and Note 10 – Subsequent Events for additional information.
Basis of Presentation
The accompanying unaudited consolidated financial statements of Lifecore Biomedical have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring accruals) have been made which are necessary to present fairly the financial position of the Company at February 26, 2023, and the results of operations and cash flows for all periods presented. Although Lifecore Biomedical believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information normally included in financial statements and related footnotes prepared in accordance with GAAP have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). The accompanying financial data should be reviewed in conjunction with the audited financial statements and accompanying notes included in Lifecore Biomedical’s Annual Report on Form 10-K/A for the fiscal year ended May 29, 2022 (the “Annual Report”).
The Company’s fiscal year is the 52- or 53-week period that ends on the last Sunday of May with quarters within each year ending on the last Sunday of August, November, and February; however, in instances where the last Sunday would result in a quarter being 12-weeks in length, the Company’s policy is to extend that quarter to the following Sunday. A 14th week is included in the fiscal year every five or six years to realign the Company’s fiscal quarters with calendar quarters.
The results of operations for the three and nine months ended February 26, 2023 are not necessarily indicative of the results that may be expected for an entire fiscal year because there is some seasonality in the order patterns of Lifecore’s customers which may lead to significant fluctuations in Lifecore Biomedical’s quarterly results of operations.
Basis of Consolidation
The consolidated financial statements are presented on the accrual basis of accounting in accordance with GAAP and include the accounts of Lifecore Biomedical and its subsidiaries, Lifecore and Curation Foods. All material inter-company transactions and balances have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with GAAP 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; loss contingencies; sales returns and credit losses; recognition and measurement of current and deferred income tax assets and liabilities; the assessment of recoverability of long-lived and indefinite lived assets (including intangible assets and goodwill), and inventory; 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.
Going Concern Update
As disclosed in the Company’s previous filings, the Company had previously determined that there were factors, which was principally the result of our noncompliance with financial covenants, that raised substantial doubt about its ability to continue as a going concern. Since that time, the Company has taken measures to strengthen its financial position, including the repayment and termination of the Prior Term Loan Facility, and the entry into the Refinancing Transactions (defined below), in each case, on May 22, 2023. The Refinancing Transactions provided the Company with additional liquidity, eliminated the Company’s noncompliance with its financial covenants under Credit Facilities (including granting the Company applicable waivers under the Revolving Term Loan Facility), reduced the Company’s near-term debt service costs, and eliminated certain financial covenants that existed under the Prior Term Loan Facility. In addition, the completion of the Company’s sale of the Yucatan and O Olive business, and the entry into an amended and restated supply agreement with Alcon Research, LLC (“Alcon”) to extend and expand its prior supply agreement, as further described in Note 10 – Subsequent Events, also provided the Company with additional liquidity. The cash provided under the Refinancing Transactions, completed divestitures of remaining Curation Foods businesses, and the lower debt service costs under our Refinancing Transactions provide improved forecasted cash flow from operations that allow sufficient liquidity over the next 12 months to meet our obligations as they come due.
Based on the foregoing, management believes that our cash position as of the date of filing these financial statement (the “Filing Date”) and forecasted cash flow from operations is sufficient to meet capital and liquidity requirements for at least the next 12 months. As a result, there is no longer substantial doubt about the Company’s ability to continue as a going concern.
Cash and Cash Equivalents
The Company records all highly liquid securities with three months or less from date of purchase to maturity as cash equivalents. Cash equivalents consist mainly of money market funds. The market value of cash equivalents approximates their historical cost given their short-term nature.
Reconciliation of Cash and Cash Equivalents as presented on the Statements of Cash Flows
The following table provides a reconciliation of cash and cash equivalents and cash and cash equivalents, discontinued operations within the Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Consolidated Statements of Cash Flows:
| | | | | | | | | | | | | | | | | | | | | | | |
| (In thousands) | February 26, 2023 | | May 29, 2022 | | February 27, 2022 | | May 30, 2021 |
| Cash and cash equivalents | $ | 2,950 | | | $ | 991 | | | $ | 1,854 | | | $ | 1,159 | |
| Cash and cash equivalents, discontinued operations | — | | | 652 | | | — | | | 136 | |
| | | | | | | |
| | | | | | | |
| Cash and cash equivalents | $ | 2,950 | | | $ | 1,643 | | | $ | 1,854 | | | $ | 1,295 | |
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value and consist of the following:
| | | | | | | | | | | |
| (In thousands) | February 26, 2023 | | May 29, 2022 |
| Finished goods | $ | 14,636 | | | $ | 13,418 | |
| Raw materials | 22,554 | | | 21,329 | |
| Work in progress | 11,506 | | | 9,553 | |
| Total | $ | 48,696 | | | $ | 44,300 | |
If the cost of the inventories exceeds their net realizable value, provisions are recorded currently to reduce them to net realizable value. The Company also records a provision for slow moving and obsolete inventories based on the estimate of demand for its products.
Accounts Receivable, Sales Returns and Allowance for Credit Losses
The Company carries its accounts receivable at their face amounts less an allowance for estimated sales returns and credit losses. Sales return allowances are estimated based on historical sales return amounts.
The Company uses the loss rate method to estimate its expected credit losses on trade accounts receivable and contract assets. In order to estimate expected credit losses, the Company assessed recent historical experience, current economic conditions and any reasonable and supportable forecasts to identify risk characteristics that are shared within the financial asset. These risk characteristics are then used to bifurcate the loss rate method into risk pools. The risk pools were determined based on the industries in which the Company operates. Historical credit loss for each risk pool is then applied to the current period aging as presented in the identified risk pools to determine the needed reserve allowance. At times when there are no current economic conditions or forecasts that may affect future credit losses, the Company has determined that recent historical experience provides the best basis for estimating credit losses.
The information obtained from assessing historical experience, current economic conditions and reasonable and supportable forecasts were used to identify risk characteristics that can affect future credit loss experience. There were no significant risk characteristics identified in the review of historical experiences or in the review of estimates of current economic conditions and forecasts.
Estimating credit losses based on risk characteristics requires significant judgment by management. Significant judgments include, but are not limited to: assessing current economic conditions and the extent to which they are relevant to the existing characteristics of the Company’s financial assets, the estimated life of financial assets, and the level of reliance on historical experience in light of economic conditions. The Company will continually review and update, when necessary, its historical risk characteristics that are meaningful to estimating credit losses, any new risk characteristics that arise in the natural course of business, and the estimated life of its financial assets.
The changes in the Company’s allowance for credit losses are summarized in the following table (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Balance at
beginning of
period | | | | Provision (benefit) for expected credit losses | | Write offs,
net of
recoveries | | Balance at
end of period |
| Nine months ended February 26, 2023 | $ | 5 | | | | | $ | — | | | $ | (1) | | | $ | 4 | |
| Nine months ended February 27, 2022 | $ | 5 | | | | | $ | — | | | $ | — | | | $ | 5 | |
Debt Issuance Costs
The Company records its line of credit debt issuance costs as an asset, and as such, $0.7 million and $1.3 million were recorded as Prepaid expenses and other current assets, and Other non-current assets in the accompanying Consolidated Balance Sheets, respectively, as of February 26, 2023, and $0.7 million and $1.9 million, respectively, as of May 29, 2022. The Company records its term debt issuance costs as a contra-liability, and as such, $8.1 million and $5.5 million were recorded as a reduction to long-term debt, net and current portion of long-term debt, net in the accompanying Consolidated Balance Sheets, respectively, as of February 26, 2023 and May 29, 2022.
Financial Instruments
The Company’s financial instruments are primarily composed of commercial-term trade payables, debt instruments, and derivative instruments. For short-term instruments, the historical carrying amount approximates the fair value of the instrument. The fair value of long-term debt and lines of credit approximates their carrying value.
Cash Flow Hedges
The Company has entered into interest rate swap agreements to manage interest rate risk. These derivative instruments may offset a portion of the changes in interest expense. The Company designates these derivative instruments as cash flow hedges. The Company accounts for its derivative instruments as either an asset or a liability and carries them at fair value in Other assets or Other non-current liabilities. The accounting for changes in the fair value of the derivative instrument depends on the intended use of the derivative instrument and the resulting designation.
For derivative instruments that hedge the exposure to variability in expected future cash flows and are designated as cash flow hedges, the entire change in the fair value of the hedging instrument is recorded as a component of Accumulated other comprehensive loss (“AOCL”) in Stockholders’ Equity. Those amounts are subsequently reclassified to earnings in the same line item in the Consolidated Statements of Comprehensive (Loss) Income as impacted when the hedged item affects earnings. To receive hedge accounting treatment, cash flow hedges must be highly effective in offsetting changes to expected future cash flows on hedged transactions.
During the third quarter of fiscal year 2021, the Company discontinued its hedge accounting prospectively since it was determined that the derivatives are no longer highly effective in offsetting changes in the net investment. The derivatives continue to be carried at fair value in the accompanying Consolidated Balance Sheets with changes in their fair values from the date of discontinued hedge accounting recognized in current period earnings in Other income (expense), net in the Consolidated Statements of Comprehensive (Loss) Income. Amounts previously accumulated in AOCL during the period of effectiveness will continue to be realized over the remaining term of the underlying forecasted debt payments as a component of AOCL in Stockholders’ Equity.
Accumulated Other Comprehensive Loss
Comprehensive income (loss) consists of two components, net loss and other comprehensive income (loss) (“OCI”). OCI refers to revenue, expenses, and gains and losses that under GAAP are recorded as a component of stockholders’ equity but are excluded from net loss. The Company’s OCI consists of net deferred gains and losses on its interest rate swap derivative instruments. The components of AOCL, net of tax, are as follows:
| | | | | |
| (In thousands) | AOCL |
Balance as of May 29, 2022 | $ | (586) | |
| |
| Amounts reclassified from OCI | 586 | |
| Other comprehensive income, net | $ | 586 | |
Balance as of February 26, 2023 | $ | — | |
Assets Held for Sale
In May 2021, the Board of Directors approved a plan to sell Curation Foods’ Rock Hill, South Carolina distribution facility. There was no impairment recorded in fiscal year 2021. The asset was sold on June 9, 2021 for gross proceeds of $1.1 million. A gain of $0.6 million was recorded upon the sale and was included in loss from discontinued operations within the Consolidated Statements of Comprehensive (Loss) Income.
In May 2022, the Board of Directors approved a plan to sell the assets of Curation Foods’ BreatheWay packaging technology business. The $1.0 million carrying value of these assets ($0.9 million of inventory and $0.1 million net book value of property and equipment) are included in Prepaid expenses and other current assets on the Consolidated Balance Sheets as of May 29, 2022 and were classified as assets held for sale. These assets were sold during the first quarter of fiscal year 2023 for net proceeds of $3.1 million. A gain of $2.1 million was recorded upon the sale, which is included in Selling, general and administrative within the Consolidated Statements of Comprehensive (Loss) Income for the nine months ended February 26, 2023.
Leases
Under Topic 842, the Company determines if an arrangement is a lease at inception. Right-of-use (“ROU”) assets and liabilities are recognized at commencement date based on the present value of remaining lease payments over the lease term. For this purpose, the Company considers only payments that are fixed and determinable at the time of commencement. As most of the leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is a quoted rate based on the understanding of what the Company’s credit rating would be. Certain agreements may contain the option to extend the lease term, terminate the lease before the contractual expiration date, or purchase the leased asset. The Company, when reasonably certain to exercise the option, considers these options in determining the measurement of the lease. The Company’s lease agreements do not contain any material residual value guarantees.
The Company’s lease agreements generally contain lease and non-lease components. Non-lease components primarily include payments for maintenance and utilities. The Company combines fixed payments for non-lease components with lease payments and accounts for them together as a single lease component which increases the amount of lease assets and liabilities.
Payments under lease arrangements are primarily fixed; however, certain lease agreements contain variable payments, which are expensed as incurred and are not included in the operating lease assets and liabilities. These amounts primarily include payments affected by changes in price indices.
Long-lived and Indefinite-Lived Intangible Assets
The Company’s intangible assets are comprised of customer relationships with a finite estimated useful life of 12 years, and trademarks/tradenames and goodwill with indefinite useful lives.
During the nine months ended February 26, 2023, the Company recorded an impairment charge of $1.0 million related to Yucatan Foods indefinite-lived intangible asset related to trademarks/tradenames which is included in discontinued operations. In addition, during the nine months ended February 26, 2023, the Company recorded an impairment charge of $0.3 million related to O Olive’s indefinite-lived intangible asset for their trademarks/tradenames. The impairments were determined using the royalty savings method to estimate the fair value of its trademarks and was primarily a result of an indication of a decrease in the fair market value of the Yucatan Foods and O Olive businesses driven by lower market valuations and a decrease in projected cash flows. The O Olive impairment charge is included in the line item “Impairment of indefinite-lived intangible assets” on the Consolidated Statements of Comprehensive (Loss) Income, and is reported in the Curation Foods business segment (See Note 7).
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. 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.
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 February 26, 2023 and May 29, 2022, the Company held certain assets and liabilities that are required or it elected to be measured at fair value on a recurring basis, including its interest rate swap contracts.
As of May 29, 2022, related to the assets of Curation Foods’ BreatheWay packaging technology business, the Company had $1.0 million in Prepaid expenses and other current assets within the Consolidated Balance Sheet meeting the criteria of held for sale. These assets are recognized at the lower of cost or fair value less cost to sell using market approach. The fair value of these assets are classified as level 3 in the fair value hierarchy due to a mix of unobservable inputs utilized such as independent research in the market as well as actual quotes from market participants.
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.
The following table summarizes the fair value of the Company’s assets and liabilities that are measured at fair value on a recurring and nonrecurring basis (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Fair Value at February 26, 2023 | | Fair Value at May 29, 2022 |
| Assets: | Level 1 | | Level 2 | | Level 3 | | Level 1 | | Level 2 | | Level 3 |
| Assets held for sale - nonrecurring | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 1,027 | |
| Current assets, discontinued operation | | | | | | | | | | | |
| Property & equipment | — | | | — | | | — | | | — | | | 3,500 | | | — | |
| Customer relationship | — | | | — | | | — | | | — | | | — | | | 1,400 | |
| Tradenames | — | | | — | | | — | | | — | | | — | | | 4,000 | |
| Total assets | — | | | — | | | — | | | — | | | 3,500 | | | 6,427 | |
Revenue Recognition
The Company follows the five step, principles-based model to recognize revenue upon the transfer of promised goods or services to customers and in an amount that reflects the consideration for which the Company expects to be entitled in exchange for those goods or services. Revenue, net of estimated allowances and returns, is recognized when or as the Company satisfies its performance obligations under a contract and control of the product is transferred to the customer.
Lifecore
Lifecore generates revenue from two integrated activities: CDMO and Fermentation. CDMO is comprised of aseptic and development services. Lifecore’s standard terms of sale are generally included in its contracts and purchase orders. Shipping and other transportation costs charged to customers are recorded in both revenue and cost of goods sold. Lifecore has elected to account for shipping and handling as fulfillment activities, and not as a separate performance obligation. Lifecore’s standard payment terms with its customers generally range from 30 days to 60 days.
Aseptic
Lifecore provides aseptic formulation and filling of syringes and vials with precisely formulated medical grade HA and non-HA materials for injectable products used for medical purposes. In instances where our customers contract with us to aseptically fill syringes or vials with our HA, the goods are not distinct in the context of the contract. Lifecore recognizes revenue for these products at the point in time when legal title to the product is transferred to the customer, which is at the time that shipment is made or upon delivery of the product.
Development Services
Lifecore provides product development services to assist its customers in obtaining regulatory approval for the commercial sale of their drug product. These services include activities such as technology development, material component changes, analytical method development, formulation development, pilot studies, stability studies, process validation and production of materials for use within clinical studies. The Company’s customers benefit from the expertise of its scientists who have extensive experience performing such tasks.
Each of the promised goods and services are not distinct in the context of the contract as the goods and services are highly interdependent and interrelated. The services described above are significantly affected by each other because Lifecore would not be able to fulfill its promise by transferring each of the goods or services independently.
Revenues generated from development services arrangements are recognized over time as Lifecore is creating an asset without an alternate use as it is unique to the customer. Furthermore, the Company has an enforceable right to payment for the performance completed to date for its costs incurred in satisfying the performance obligation plus a reasonable profit margin. For each of the development activities performed by Lifecore as described above, labor is the primary input (i.e., labor costs represent the majority of the costs incurred in the completion of the services). The Company determined that labor hours are the best measure of progress as it most accurately depicts the effort extended to satisfy the performance obligation over time.
Fermentation
Lifecore manufactures and sells pharmaceutical-grade sodium hyaluronate (“HA”) in bulk form to its customers. The HA produced is distinct as customers are able to utilize the product provided under HA supply contracts when they obtain control. Lifecore recognizes revenue for these products at the point in time when legal title to the product is transferred to the customer, which is at the time that shipment is made or upon delivery of the product to our customer.
Curation Foods
Curation Foods’ standard terms of sale, both prior to and following the Eat Smart Disposition and Yucatan Disposition, are generally included in its contracts and purchase orders. Revenue is recognized at the time shipment is made or upon delivery as control of the product is transferred to the customer. Shipping and other transportation costs charged to customers are recorded in both revenue and cost of goods sold. Curation Foods has elected to account for shipping and handling as fulfillment activities, and not as a separate performance obligation. Curation Foods’ standard payment terms with its customers generally range from 30 days to 90 days. Certain customers may receive cash-based incentives (including: volume rebates, discounts, and promotions), which are accounted for as variable consideration to Curation Foods’ performance obligations. Curation Foods estimates these sales incentives based on the expected amount to be provided to its customers and reduces revenues recognized towards its performance obligations. The Company has not historically had and does not anticipate significant changes in its estimates for variable consideration.
The Company disaggregates its revenue by segment based on how it markets its products and services and reviews results of operations. The following tables disaggregate segment revenue by major product lines and services:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| (In thousands) | Three Months Ended | | Nine Months Ended | |
| Lifecore: | February 26, 2023 | | February 27, 2022 | | February 26, 2023 | | February 27, 2022 | | | |
| Contact development and manufacturing organization | $ | 17,809 | | | $ | 24,799 | | | $ | 52,088 | | | $ | 63,951 | | | | |
| Fermentation | 8,521 | | | 10,009 | | | 19,635 | | | 17,756 | | | | |
| | | | | | | | | | |
| Total | $ | 26,330 | | | $ | 34,808 | | | $ | 71,723 | | | $ | 81,707 | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| (In thousands) | Three Months Ended | | Nine Months Ended | |
| Curation Foods: | February 26, 2023 | | February 27, 2022 | | February 26, 2023 | | February 27, 2022 | | | |
| Olive Oil and vinegars | $ | 1,270 | | | $ | 2,169 | | | $ | 6,025 | | | $ | 7,016 | | | | |
| Technology | — | | | 422 | | | — | | | 1,417 | | | | |
| Total | $ | 1,270 | | | $ | 2,591 | | | $ | 6,025 | | | $ | 8,433 | | | | |
Contract Assets and Liabilities
Contract assets primarily relate to the Company’s conditional right to consideration for work completed but not billed at the reporting date. The Company’s contract assets as of February 26, 2023 and May 29, 2022, were $4.7 million and $10.2 million, respectively.
Contract liabilities primarily relate to payments received from customers in advance of performance under the contract. The Company’s contract liabilities as of February 26, 2023 and May 29, 2022, were $2.7 million and $0.9 million, respectively. Revenue recognized during the three and nine months ended February 26, 2023, that was included in the contract liability balance at the beginning of fiscal year 2023, was $0.1 million and $0.5 million, respectively.
Shipping and Handling Costs
Amounts billed to third-party customers for shipping and handling are included as a component of revenues. Shipping and handling costs incurred are included as a component of cost of products sold and represent costs incurred to ship product from the processing facility or distribution center to the end consumer markets.
Legal Contingencies
In the ordinary course of business, the Company is involved in various legal proceedings and claims.
The Company makes a provision for a liability relating to legal matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least each fiscal quarter and adjusted to reflect the impacts of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. Legal fees are expensed in the period in which they are incurred.
Compliance Matters and Related Litigation
On December 1, 2018, the Company acquired all of the voting interests and substantially all of the assets of Yucatan Foods (the “Yucatan Acquisition”), which owns a guacamole manufacturing plant in Mexico called Procesadora Tanok, S de RL de C.V. (“Tanok”).
On October 21, 2019, the Company retained Latham & Watkins LLP to conduct an internal investigation relating to potential environmental and Foreign Corrupt Practices Act (“FCPA”) compliance matters associated with regulatory permitting at the Tanok facility in Mexico. The Company subsequently disclosed to the U.S. Securities and Exchange Commission (“SEC”) and the U.S. Department of Justice (“DOJ”) the conduct under investigation, and these agencies have commenced an investigation. The Company has also disclosed the conduct under investigation to the Mexican Attorney General’s Office, which has commenced an investigation, and to Mexican regulatory agencies. The Company is cooperating in the government investigations and requests for information. The conduct at issue began prior to the Yucatan Acquisition, and the agreement for the Yucatan Acquisition provides the Company with certain indemnification rights that may allow the Company to recover the cost of a portion of the liabilities that have been and may be incurred by the Company in connection with these compliance matters. On September 2, 2020, one of the former owners of Yucatan filed a lawsuit against the Company in Los Angeles County Superior Court for breach of employment agreement, breach of contract, breach of holdback agreement, declaratory relief and accounting, and related claims. The Plaintiff seeks over $10 million in damages, including delivery of shares of his stock held in escrow for the indemnification claims described above. On November 3, 2020, the Company filed an answer and cross-complaint against the Plaintiff and other parties for fraud, indemnification, and other claims, and seeking no less than $80 million in damages.
At this stage, the ultimate outcome of these or any other investigations, legal actions, or potential claims that may arise from the matters under investigation is uncertain and the Company cannot reasonably predict the timing or outcomes, or estimate the amount of net loss after indemnification, or its effect, if any, on its financial statements. Separately, there are indemnification provisions in the purchase agreement that may allow the Company to recover costs for fraud or breach of the purchase agreement from the seller. Because recovery of amounts are contingent upon a legal settlement, no amounts have been recorded as recoverable costs for the three and nine months ended February 26, 2023.
During the third quarter of fiscal year 2021 the Company reached a resolution with its insurance carrier that resulted in a recovery of $1.6 million which is recorded as a reduction of Selling, general and administrative in the Consolidated Statements of Operations for the fiscal year ended May 30, 2021. Absent further material developments in the investigation, the Company does not expect additional material recovery from the insurance carrier.
Accounting Pronouncements
On January 9, 2023, upon the issuance of the Series A Convertible Preferred Stock (as defined in Note 2– Convertible Preferred Stock), the Company adopted ASU No. 2020-06, “Debt — Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40)”. This ASU simplified the accounting for certain financial instruments with characteristics of liabilities and equity. The FASB reduced the number of accounting models for convertible debt and convertible preferred stock instruments and made certain disclosure amendments to improve the information provided to users.
2. Convertible Preferred Stock
On January 9, 2023, the Company issued an aggregate of 38,750 shares of the Series A Convertible Preferred Stock, par value $0.001 per share (the “Convertible Preferred Stock”), all of which are convertible into shares of common stock at the election of the holders of the Convertible Preferred Stock, subject to the exchange and beneficial ownership limitations described below. The Convertible Preferred Stock ranks senior to the Company’s common stock with respect to dividends, distributions and payments on liquidation, winding-up and dissolution. Upon issuance, the shares of the Convertible Preferred Stock are fully paid and non-assessable, which means that its holders have paid their purchase price in full and are not required to pay additional funds.
Dividends
The holders of Convertible Preferred Stock are entitled to dividends on the Liquidation Preference (as defined below) at the rate of 7.5% per annum, payable in-kind (“PIK”). The Company may, at its option, pay such dividends in cash from and after the earlier of June 29, 2026, or the termination or waiver of the restriction on cash dividends and/or redemptions that is set forth in the Credit Facilities (such earlier date, the “Applicable Date”). The holders are also entitled to participate in dividends declared or paid on the common stock on an as-converted basis.
Liquidation and Redemption
Upon a liquidation, dissolution, winding up or change of control of the Company, each share of Convertible Preferred Stock will be entitled to receive an amount per share of Convertible Preferred Stock equal to the greater of (i) the purchase price paid by the purchaser at issuance, plus all accrued and unpaid dividends (the “Liquidation Preference”) and (ii) the amount that the holder of Convertible Preferred Stock (each, a “Holder” and collectively, the “Holders”) would have been entitled to receive at such time if the Convertible Preferred Stock had been converted into common stock immediately prior to such liquidation event. Upon certain bankruptcy events, the Company is required to pay to each Holder an amount in cash equal to the Liquidation Preference being redeemed. From and after the Applicable Date, each Holder shall have the right to require the Company to redeem all or any part of such Holder’s Convertible Preferred Stock for an amount equal to the Liquidation Preference. At the time of a redemption, if the Company does not have sufficient funds to redeem any preferred shares submitted for redemption, each holder is entitled to receive interest on the unpaid portion of the redemption at 1% per month until fully paid (the “1% contingent interest”). As of February 26, 2023, the aggregate liquidation preference of the Convertible Preferred Stock approximated $39.2 million.
Conversion
Each Holder has the right, at its option, to convert its Convertible Preferred Stock, in whole or in part, into fully paid and non-assessable shares of common stock at an initial conversion price equal to $7.00 per share. The conversion price is subject to customary anti-dilution adjustments, including in the event of any stock split, stock dividend, recapitalization or similar events, and is also subject to adjustment in the event of subsequent offerings of common stock or convertible securities by the Company for less than the conversion price. Pursuant to the terms of the Certificate of Designations of the Convertible Preferred Stock filed by the Company with the Delaware Secretary of State on January 9, 2023, unless and until approval of the Company’s stockholders is obtained as contemplated by NASDAQ listing rules, no Holder may convert shares of Convertible Preferred Stock through either an optional or a mandatory conversion into shares of common stock if and solely to the extent that the issuance of such shares of common stock would exceed the aggregate number of shares of common stock that is equal to 19.99% of the amount of common stock of the Company outstanding on the date on which we issued the Convertible Preferred Stock (the “Exchange Limit”). Additionally, subject to certain exceptions and waiver by each Holder, the Company will not issue any shares of common stock to any respective Holder to the extent that such issuance of common stock would result in such Holder beneficially owning in excess of 9.99% of the then-outstanding common stock (together with the Exchange Limit, the “Conversion Limits”). Subject to certain conditions, the Company may from time to time, at its option, require conversion of all or any portion of the outstanding shares of Convertible Preferred Stock to common stock if, for at least 20 consecutive trading days during the respective measuring period the closing price of the common stock was at least 150% of the conversion price (the “Mandatory Conversion Right”). The Company may not exercise this Mandatory Conversion Right unless certain conditions with regard to the shares of common stock to be issued upon such conversion are satisfied.
Voting
Each Holder is entitled to vote with the holders of the shares of common stock on all matters submitted for a vote of holders of shares of common stock (voting together with the holders of shares of common stock as one class). Each Holder is entitled the whole number of votes equal to the number of shares of common stock into which such Holder’s shares of Convertible Preferred Stock would be convertible on the record date for the vote or consent (subject to the Conversion Limits).
Registration Rights Agreement
On January 9, 2023, in connection with the issuance of the Convertible Preferred Stock, the Company and the Holders also entered into a Registration Rights Agreement (the “Registration Rights Agreement”) pursuant to which, among other things, the Company granted the Holders certain registration rights with respect to the shares of common stock issuable upon conversion of the Convertible Preferred Stock. The Registration Rights Agreement contains monetary penalties if the registration statement is not declared effective by the SEC within 90 days of the issuance of the Convertible Preferred Stock on January 9, 2023, or if earlier, the fifth business day after the SEC notifies the Company that the registration statement is not subject to further review. The Registration Rights Agreement also contains monetary penalties if the Company fails to maintain the effectiveness of the
registration statement once deemed effective by the SEC. As of the date of this Quarterly Report on Form 10-Q, the Company has incurred approximately $0.8 million in monetary penalties under the Registration Rights Agreement.
Classification
The Convertible Preferred Stock is redeemable contingent upon the occurrence of an event that is not probable. Accordingly, the Company has presented the Convertible Preferred Stock outside of permanent equity. The Convertible Preferred Stock was recorded at its issuance date fair value of the net proceeds raised and will not require subsequent measurement until it becomes probable of being redeemable.
The Company recorded proceeds of $38.8 million, net of costs associated with the issuance of the Convertible Preferred Stock of approximately $0.7 million approximating $38.1 million. As of February 26, 2023, the Company recorded PIK dividends of approximately $0.4 million as a reduction to Additional Paid in Capital and an increase to the Convertible Preferred Stock balance to $38.5 million. As of February 26, 2023, there were approximately 39,200 shares of Convertible Preferred Stock outstanding.
3. Stock-based Compensation and Stockholders’ Equity
Stock-Based Compensation Activity
The estimated fair value for stock options, which determines the Company’s calculation of stock-based compensation expense, is based on the Black-Scholes option pricing model. Restricted stock units (“RSUs”) are valued at the closing market price of the Company’s common stock on the grant date. The Company uses the straight-line method to recognize the fair value of stock-based compensation arrangements.
During the three months ended February 26, 2023, the Company granted no options to purchase shares of common stock and awarded 77,098 RSUs. During the nine months ended February 26, 2023, the Company granted 743,050 options to purchase shares of common stock and awarded 336,186 RSUs.
As of February 26, 2023, the Company has reserved 3.4 million shares of common stock for future issuance under its current and former equity plans.
Stock-Based Compensation Expense
The Company’s stock-based awards include stock option grants and RSUs. The Company records compensation expense for stock-based awards issued to employees and directors in exchange for services provided based on the estimated fair value of the awards on their grant dates and is recognized over the required service periods, generally the vesting period.
The following table summarizes stock-based compensation by income statement line item:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine months ended |
| (In thousands) | February 26, 2023 | | February 27, 2022 | | February 26, 2023 | | February 27, 2022 |
| Continuing operations: | | | | | | | |
| Cost of product sales | $ | 109 | | | $ | 75 | | | 307 | | | $ | 177 | |
| Research and development | 31 | | | 51 | | | 173 | | | 151 | |
| Selling, general and administrative | 763 | | | 488 | | | 2,316 | | | 1,575 | |
| Discontinued Operations: | | | | | | | |
| Cost of product sales | — | | | 8 | | | — | | | 25 | |
| Total stock-based compensation | $ | 903 | | | $ | 622 | | | $ | 2,796 | | | $ | 1,928 | |
As of February 26, 2023, there was $5.0 million of total unrecognized compensation expense related to unvested equity compensation awards granted under the Lifecore incentive stock plans. Total expense is expected to be recognized over the weighted-average period of 2.14 for stock options and 1.95 years for RSUs.
Stock Repurchase Plan
On July 14, 2010, the Board of Directors of the Company approved the establishment of a stock repurchase plan which allows for the repurchase of up to $10.0 million of the Company’s common stock. The Company may still repurchase up to $3.8 million of the Company’s common stock under the Company’s stock repurchase plan. The Company may repurchase its common stock from time to time in open market purchases or in privately negotiated transactions. The timing and actual number of shares repurchased is at the discretion of management of the Company and will depend on a variety of factors, including stock price, corporate and regulatory requirements, market conditions, the relative attractiveness of other capital deployment opportunities and other corporate priorities. The stock repurchase program does not obligate Lifecore Biomedical to acquire any amount of its common stock and the program may be modified, suspended or terminated at any time at the Company’s discretion without prior notice. During the nine months ended February 26, 2023 and February 27, 2022, the Company did not purchase any shares on the open market or in privately negotiated transactions.
4. Diluted Earnings Per Share
The following table sets forth the computation of diluted earnings per share:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended | | |
(In thousands, except per share amounts) | February 26, 2023 | | February 27, 2022 | | February 26, 2023 | | February 27, 2022 | | | | |
| Numerator: | | | | | | | | | | | |
| Net loss | $ | (40,192) | | | $ | (13,086) | | | $ | (63,992) | | | $ | (61,116) | | | | | |
| Denominator: | | | | | | | | | | | |
| Weighted average shares for basic net loss per share | 30,304 | | | 29,482 | | | 29,838 | | | 29,459 | | | | | |
| Effect of dilutive securities: | | | | | | | | | | | |
| Convertible preferred stock | — | | | — | | | — | | | — | | | | | |
| Stock options and restricted stock units | — | | | — | | | — | | | — | | | | | |
| Weighted average shares for diluted net loss per share | 30,304 | | | 29,482 | | | 29,838 | | | 29,459 | | | | | |
| | | | | | | | | | | |
| Basic and Diluted net loss per share | $ | (1.33) | | | $ | (0.45) | | | $ | (2.14) | | | $ | (2.07) | | | | | |
Due to the Company’s net loss for the three and nine months ended February 26, 2023 and February 27, 2022, the net loss per share includes only the weighted average shares outstanding and thus excludes RSUs, stock options and Convertible Preferred Stock, as such impact would be antidilutive. See Note 2 for more information on outstanding convertible preferred stock and Note 3 for more information on outstanding RSUs and stock options.
5. Income Taxes
The provision for income taxes from continuing operations for the nine months ended February 26, 2023 and February 27, 2022, was an (expense)/benefit of $(78) thousand and $5.6 million, respectively. The effective tax rate for the nine months ended February 26, 2023 and February 27, 2022 was 0.2% and 32.0%, respectively. The effective tax rate for the nine months ended February 26, 2023, was lower than the statutory federal income tax rate of 21% primarily due to the valuation allowance recorded against certain deferred tax assets, partially offset by the federal and state research and development tax credits.
As of both February 26, 2023 and May 29, 2022, the Company had unrecognized tax benefits of $1.0 million. Included in the balance of unrecognized tax benefits as of both February 26, 2023 and May 29, 2022, is $0.9 million of tax benefits that, if recognized, would result in an adjustment to the Company’s effective tax rate. The Company does not expect its unrecognized tax benefits to change significantly within the next twelve months.
The Company has elected to classify interest and penalties related to uncertain tax positions as a component of its provision for income taxes. The Company has accrued an insignificant amount of interest and penalties relating to the income tax on the unrecognized tax benefits as of February 26, 2023 and May 29, 2022.
Due to tax attribute carryforwards, the Company is subject to examination for tax years 2013 forward for U.S. tax purposes. The Company is also subject to examination in various state jurisdictions for tax years 2012 forward, none of which were significant.
6. Debt
Long-term debt, net consists of the following:
| | | | | | | | | | | |
| (In thousands) | February 26, 2023 | | May 29, 2022 |
Term loan | $ | 107,079 | | | $ | 103,712 | |
| Total principal amount of long-term debt | 107,079 | | | 103,712 | |
| Less: unamortized debt issuance costs | (8,115) | | | (5,534) | |
| Total long-term debt, net of unamortized debt issuance costs | 98,964 | | | 98,178 | |
| Less: current portion of long-term debt, net | — | | | (98,178) | |
| Long-term debt, net | $ | 98,964 | | | $ | — | |
On December 31, 2020, the Company refinanced its previously existing term loan and revolving credit facility by entering into (1) a credit agreement Goldman Sachs Specialty Lending Group, L.P. (“Goldman”) and Guggenheim Credit Services, LLC (“Guggenheim”), as lenders, which provided the Company, Curation Foods and Lifecore, as co-borrowers, with term loan borrowings of up to $170.0 million (the “Prior Term Loan Facility”), and (ii) a credit agreement with BMO Harris Bank, N.A. (“BMO”) as lender, which provided the Company, Curation Foods and Lifecore, as co-borrowers, with an up to $75.0 million revolving line of credit (the “Revolving Credit Facility” and together with Prior Term Loan Facility, the “Credit Facilities”). The Revolving Credit Facility is, and the Prior Term Loan Facility was, guaranteed, and secured by, substantially all of the Company’s and the Company’s direct and indirect subsidiaries’ assets.
In April 2022 the Company amended the Credit Facilities to make available an additional $20.0 million of term debt that had been previously repaid. In connection with this amendment, the Company incurred debt issuance costs from the lender of $0.7 million.
On January 9, 2023, the Company entered into further amendments to the Credit Facilities to, among other things, provide for the limited waiver from events of default under the Credit Facilities related to certain financial covenant requirements, as well as a waiver of certain existing terms and covenants under the Prior Term Loan, including with respect to the fixed coverage ratio leverage ratio and minimum liquidity covenants, 2% increase of annual interest rate, which was payable in kind, and a one-time amendment fee in an amount equal to 3% of the principal amount as of January 9, 2023.
This amendment also reduced the maximum commitment under the Revolving Credit Facility from $75.0 million to $60.0 million, which was further reduced to $50.0 million upon the sale of Yucatan.
The Prior Term Loan Facility would have matured on December 31, 2025. The Revolving Term Facility matures on December 31, 2025.
Interest on the Revolving Credit Facility is based upon the Company’s average availability, at a per annum rate of either (i) SOFR rate plus a spread of between 2.00% and 2.50% or (ii) base rate plus a spread of between 1.00% and 1.50%, plus a commitment fee, as applicable, of 0.375% and plus (iii) for the period from December 1, 2022 until January 31, 2023, additional 2% per annum. Interest on the Prior Term Loan Facility was at a per annum rate based on either (i) the base rate plus a spread of 7.50% or (ii) the SOFR rate plus a spread of 8.50%. The Prior Term Loan Credit Facility also provided that in the event of a prepayment of any amount other than the scheduled installments within twelve months after the closing date, a penalty will be assessed equal to the aggregate amount of interest that would have otherwise been payable from date of prepayment event until twelve months after the closing date plus 3% of the amount prepaid.
The Revolving Credit Facility contains, and the Prior Term Loan Facility contained, customary financial covenants and events of default under which the obligations thereunder could be accelerated and/or the interest rate increased in specified circumstances.
In connection with the January 2023 amendments to the Credit Facilities, the Company incurred debt issuance costs from the lender and third-parties of $1.1 million and $62.5 thousand, respectively, during the nine months ended February 26, 2023.
As of February 26, 2023, the Company had $16.0 million in borrowings outstanding under the Amended Revolver Credit Facility, at an effective annual interest rate of 7.2%. As of February 26, 2023, the Company had $107.0 million in borrowings outstanding under the Prior Term Loan Facility, at an effective annual interest rate of 13.2%. As the Company was able to refinance the Term Debt with New Term Debt subsequent to February 26, 2023 but prior to the filing of this Quarterly Report on Form 10-Q, we have classified the obligation as long term as of our balance sheet date.
As of February 26, 2023, the Company was not in compliance with all financial covenants under the Credit Facilities. As further described in Note 10 – Subsequent Events, on May 22, 2023, the Company entered into the New Term Loan Facility, and concurrently therewith, terminated the Prior Term Loan Facility and repaid the borrowings outstanding thereunder, and entered into a further amendment to the Revolving Credit Facility, at which time the Company was in compliance with all financial covenants under the New Term Loan Facility and the Revolving Credit Facility.
Derivative Instruments
On November 1, 2016, the Company entered into an interest rate swap contract (the “2016 Swap”) with BMO at a notional amount of $50.0 million. The 2016 Swap had the effect of changing the Company’s previous term loan obligation from a variable interest rate to a fixed 30-day LIBOR rate of 1.22%. The 2016 Swap matured in September 2021.
On June 25, 2018, the Company entered into an interest rate swap contract (the “2018 Swap”) with BMO at a notional amount of $30.0 million. The 2018 Swap had the effect on the Company’s previous debt of converting the first $30.0 million of the total outstanding amount of the Company’s 30-day LIBOR borrowings from a variable interest rate to a fixed 30-day LIBOR rate of 2.74%. The 2018 Swap matured in September 2021.
On December 2, 2019, the Company entered into an interest rate swap contract (the “2019 Swap”) with BMO at a notional amount of $110.0 million which decreases quarterly. The 2019 Swap had the effect on our previous debt of converting primarily all of the $110.0 million of the total outstanding amount of the Company’s 30-day LIBOR borrowings from a variable interest rate to a fixed 30-day LIBOR rate of 1.53%. The 2019 Swap matured in November 2022.
7. Business Segment Reporting
The Company historically operated using three strategic reportable business segments, aligned with how the Chief Executive Officer, who is the chief operating decision maker (“CODM”), manages the business: the Lifecore segment, the Curation Foods segment, and the Other segment.
The Lifecore segment sells products utilizing hyaluronan, a naturally occurring polysaccharide that is widely distributed in the extracellular matrix of connective tissues in both animals and humans, and non-HA products for medical use primarily in the Ophthalmic, Orthopedic and other markets.
The Curation Foods business included activities from three natural food brands, including O Olive Oil & Vinegar, Yucatan Foods, and Cabo Fresh. The Curation Foods segment includes sales of olive oils and wine vinegars under the O brand, and sales of avocado products under the brands Yucatan Foods and Cabo Fresh. In December 2021, the Company completed the Eat Smart Disposition and on February 7, 2023 the Company completed the sale of the avocado products business, including its Yucatan® and Cabo Fresh® brands. As a result, the Company met the requirements of ASC 205-20 to report the results of the Eat Smart and Yucatan Foods businesses as discontinued operations. The operating results for the Eat Smart and Yucatan Foods businesses, in all periods presented, have been reclassified to discontinued operations and are no longer reported in the Curation Foods business segment. See Note 1 – Organization, Basis of Presentation, and Summary of Significant Accounting Policies – Yucatan Foods and Discontinued Operations for further discussion.
The Other segment includes corporate general and administrative expenses, non-Lifecore and non-Curation Foods interest expense, interest income, and income tax expenses. Corporate overhead is allocated between segments based on actual utilization and relative size.
All of the Company’s assets are located within the United States of America.
The Company’s international sales by geography are based on the billing address of the customer and were as follows, excluding discontinued operations:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended | | |
| (In millions) | February 26, 2023 | | February 27, 2022 | | February 26, 2023 | | February 27, 2022 | | | | |
| Switzerland | $ | 6.8 | | | $ | 8.2 | | | $ | 14.8 | | | $ | 13.6 | | | | | |
| Canada | 0.7 | | | 0.2 | | | 1.9 | | | 1.4 | | | | | |
| Czech Republic | 0.7 | | | 0.7 | | | 2.4 | | | 2.4 | | | | | |
| Ireland | 1.1 | | | 0.5 | | | 2.9 | | | 1.3 | | | | | |
| Australia | 1.1 | | | — | | | 1.1 | | | — | | | | | |
| United Kingdom | 0.6 | | | 0.9 | | | 1.4 | | | 2.2 | | | | | |
| All Other Countries | 0.2 | | | 1.6 | | | 0.4 | | | 1.9 | | | | | |
Operations by business segment consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | |
| (In thousands) | Lifecore | | Curation Foods | | Other | | Total |
| Three Months Ended February 26, 2023 | | | | | | | |
| Net sales | $ | 26,330 | | | $ | 1,270 | | | $ | — | | | $ | 27,600 | |
| Gross profit | 6,072 | | | (94) | | | — | | | 5,978 | |
| Net (loss) income from continuing operations | 851 | | | 280 | | | (16,592) | | | (15,461) | |
| Loss from discontinued operations, net of tax | — | | | (22,802) | | | (1,929) | | | (24,731) | |
| Depreciation and amortization | 1,878 | | | 243 | | | 10 | | | 2,131 | |
| | | | | | | |
| Interest income | 16 | | | — | | | 6 | | | 22 | |
| Interest expense | — | | | — | | | 5,818 | | | 5,818 | |
| Income tax (benefit) expense | 268 | | | (3,019) | | | 2,821 | | | 70 | |
| Corporate overhead allocation | 739 | | | 241 | | | (980) | | | — | |
| | | | | | | |
| Nine Months Ended February 26, 2023 | | | | | | | |
| Net sales | $ | 71,723 | | | $ | 6,025 | | | $ | — | | | $ | 77,748 | |
| Gross profit | 18,847 | | | 723 | | | — | | | 19,570 | |
| Net (loss) income from continuing operations | 2,269 | | | (1,974) | | | (35,008) | | | (34,713) | |
| Loss from discontinued operations, net of tax | — | | | (27,350) | | | (1,929) | | | (29,279) | |
| Depreciation and amortization | 5,492 | | | 2,637 | | | 31 | | | 8,160 | |
| Dividend income | — | | | — | | | — | | | — | |
| Interest income | 47 | | | — | | | 6 | | | 53 | |
| Interest expense | — | | | 1 | | | 13,714 | | | 13,715 | |
| Income tax (benefit) expense | 717 | | | (4,135) | | | 3,496 | | | 78 | |
| Corporate overhead allocation | 2,799 | | | 858 | | | (3,657) | | | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| (In thousands) | Lifecore | | Curation Foods | | Other | | Total |
| Three Months Ended February 27, 2022 | | | | | | | |
| Net sales | $ | 34,808 | | | $ | 2,591 | | | $ | — | | | $ | 37,399 | |
| Gross profit | 12,905 | | | (39) | | | — | | | 12,866 | |
| Net (loss) income from continuing operations | 5,054 | | | (5,380) | | | (6,312) | | | (6,638) | |
| Loss from discontinued operations, net of tax | — | | | (3,407) | | | (3,041) | | | (6,448) | |
| Depreciation and amortization | 1,674 | | | 304 | | | 18 | | | 1,996 | |
| | | | | | | |
| Interest income | 18 | | | — | | | 2 | | | 20 | |
| Interest expense | — | | | 26 | | | 4,079 | | | 4,105 | |
| Income tax (benefit) expense | 1,596 | | | (1,678) | | | (5) | | | (87) | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Corporate overhead allocation | 1,175 | | | 289 | | | (1,464) | | | — | |
| | | | | | | |
| Nine Months Ended February 27, 2022 | | | | | | | |
| Net sales | $ | 81,707 | | | $ | 8,433 | | | $ | — | | | $ | 90,140 | |
| Gross profit | 30,384 | | | 1,249 | | | — | | | 31,633 | |
| Net (loss) income from continuing operations | 11,317 | | | 4,640 | | | (27,340) | | | (11,383) | |
| Loss from discontinued operations, net of tax | — | | | (46,692) | | | (3,041) | | | (49,733) | |
| Depreciation and amortization | 4,894 | | | 364 | | | 70 | | | 5,328 | |
| Interest income | 57 | | | — | | | 9 | | | 66 | |
| Interest expense | — | | | 300 | | | 13,577 | | | 13,877 | |
| Income tax (benefit) expense | 3,574 | | | (13,422) | | | 4,257 | | | (5,591) | |
| Corporate overhead allocation | 3,389 | | | 778 | | | (4,167) | | | — | |
| | | | | | | |
During the nine months ended February 26, 2023 and February 27, 2022, the Company had sales concentrations of 10% or greater from two customers. The Company’s top two customers, from the Lifecore segment, accounted for 37% and 15% of total revenues for the nine months ended February 26, 2023, and 17% and 13% for the nine months ended February 27, 2022. The Company had accounts receivable concentrations of 10% or greater from two customers accounting for 47% and 10% of accounts receivable as of February 26, 2023, and two customers as of February 27, 2022 accounting for 25% and 19%.
8. Restructuring Costs
During fiscal year 2020, the Company announced a restructuring plan to drive enhanced profitability, focus the business on its strategic assets and redesign the organization to be the appropriate size to compete and thrive. This includes a reduction-in-force, a reduction in leased office spaces and the sale of non-strategic assets.
The following table summarizes the restructuring costs recognized in the Company’s Consolidated Statements of Comprehensive (Loss) Income, by Business Segment, excluding discontinued operations. There were no restructuring costs recognized on the Lifecore segment.
| | | | | | | | | | | | | | | | | | | |
| (in thousands) | Curation Foods | | | | Other | | Total |
| Three Months Ended February 26, 2023 | | | | | | | |
| | | | | | | |
| Employee severance and benefit costs | $ | 683 | | | | | $ | 1,679 | | | $ | 2,362 | |
| Lease costs | 43 | | | | | — | | | 43 | |
| Other restructuring costs | 175 | | | | | 161 | | | 336 | |
| Total restructuring costs | $ | 901 | | | | | $ | 1,840 | | | $ | 2,741 | |
| | | | | | | |
| (in thousands) | Curation Foods | | | | Other | | Total |
| Nine Months Ended February 26, 2023 | | | | | | | |
| Employee severance and benefit costs | 927 | | | | | 1,679 | | | 2,606 | |
| Lease costs | 88 | | | | | — | | | 88 | |
| Other restructuring costs | 494 | | | | | 1,423 | | | 1,917 | |
| Total restructuring costs | $ | 1,509 | | | | | $ | 3,102 | | | $ | 4,611 | |
Employee severance and benefit costs
Employee severance and benefit costs are costs incurred as a result of reduction-in-force driven by our restructuring plan and closure of offices and facilities. These costs were driven primarily by reduction-in-force related to our Curation Foods segment.
Lease Costs
In August 2020, the Company closed its leased Santa Clara, California office and entered into a sublease agreement. In the fourth quarter of fiscal year 2020 the Company closed its leased Los Angeles, California office and plans to sublease the office. The Company approved a plan to explore opportunities to sub lease its Santa Maria office and expects to complete the sublease plan within the next 12 months.
Other restructuring costs
Other restructuring costs are primarily related to consulting costs incurred in connection with the execution of the Company’s restructuring plan to drive enhanced profitability, focus the business on its strategic assets, and redesign the organization to be the appropriate size to compete and thrive.
The following table summarizes the restructuring costs recognized in the Company’s Consolidated Statements of (Loss) Income, by Business Segment, since inception of the restructuring plan in fiscal year 2020 through the nine months ended February 26, 2023, excluding discontinued operations:
| | | | | | | | | | | | | | | | | | | |
| Curation Foods | | | | Other | | Total |
| (in thousands) | | | | | | | |
| Asset write-off costs, net | $ | 7,552 | | | | | $ | 418 | | | $ | 7,970 | |
| Employee severance and benefit costs | 1,486 | | | | | 2,463 | | | 3,949 | |
| Lease costs | 2,306 | | | | | 26 | | | 2,332 | |
| Other restructuring costs | 817 | | | | | 6,321 | | | 7,138 | |
| Total restructuring costs | $ | 12,161 | | | | | $ | 9,228 | | | $ | 21,389 | |
The total expected cost related to the restructuring plan is approximately $23.0 million.
9. Discontinued Operations
As discussed in Note 1 – Organization, Basis of Presentation, and Summary of Significant Accounting Policies – Yucatan Disposition and Discontinued Operations, on February 7, 2023, we completed the Yucatan Disposition. Yucatan Foods represented a component of the business within the Curation Foods segment and its sale represents a strategic shift in the Company going forward. Accordingly, concurrent with the execution of the Securities Purchase Agreement, Yucatan meets the accounting requirements for reporting as discontinued operations for all periods presented. The Discontinued Operations includes the operations of Eat Smart prior to its sale.
There were no assets or liabilities of Yucatan Foods as of February 26, 2023. The assets and liabilities of Yucatan as of May 29, 2022 were as follows (in thousands):
| | | | | | | | |
| | |
| | May 29, 2022 |
| ASSETS | | |
| Cash and cash equivalents | | $ | 652 | |
| Accounts receivable, less allowance for credit losses | | 8,078 | |
| Inventories | | 22,545 | |
| Prepaid expenses and other current assets | | 1,869 | |
| Total current assets, discontinued operations | | 33,144 | |
| Property and equipment, net | | 3,500 | |
| Operating lease right-of-use assets | | 2,061 | |
| Trademarks/tradenames, net | | 4,000 | |
| Customer relationships, net | | 1,400 | |
| Other assets | | 102 | |
| Total other non-current assets, discontinued operations | | 11,063 | |
| Total assets, discontinued operations | | $ | 44,207 | |
| | |
| LIABILITIES | | |
| Accounts payable | | $ | 2,814 | |
| Accrued compensation | | 297 | |
| Other accrued liabilities | | 800 | |
| Current portion of lease liabilities | | 434 | |
| Total current liabilities, discontinued operations | | 4,345 | |
| Long-term lease liabilities | | 1,627 | |
| Non-current liabilities, discontinued operations | | 1,627 | |
| Total liabilities, discontinued operations | | $ | 5,972 | |
The key components of income from discontinued operations for the three and nine months ended February 26, 2023 and February 27, 2022 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | February 26, 2023 | | February 27, 2022 | | February 26, 2023 | | February 27, 2022 |
| Product sales | | $ | 10,811 | | | $ | 29,234 | | | $ | 42,820 | | | $ | 234,773 | |
| Cost of product sales | | 12,571 | | | 29,041 | | | 44,812 | | | 222,948 | |
| Gross profit | | (1,760) | | | 193 | | | (1,992) | | | 11,825 | |
| Operating costs and expenses: | | | | | | | | |
| Research and development | | — | | | 159 | | | 2 | | | 1,981 | |
| Selling, general and administrative | | 1,902 | | | 3,245 | | | 5,216 | | | 19,804 | |
| Impairment of intangible asset and goodwill | | — | | | — | | | 1,000 | | | 32,057 | |
| Loss on sale of Eat Smart | | — | | | 235 | | | — | | | 235 | |
| Loss on Sale of Yucatan | | 21,039 | | | | | 21,039 | | | |
| Restructuring costs | | 30 | | | 3,209 | | | 30 | | | 4,642 | |
| Total operating costs and expenses | | 22,971 | | | 6,848 | | | 27,287 | | | 58,719 | |
| Operating loss | | (24,731) | | | (6,655) | | | (29,279) | | | (46,894) | |
| | | | | | | | |
| Interest expense | | — | | | (204) | | | — | | | (2,682) | |
| | | | | | | | |
| Loss from discontinued operations before taxes | | (24,731) | | | (6,859) | | | (29,279) | | | (49,576) | |
| Income tax benefit (expense) | | — | | | 411 | | | — | | | (157) | |
| Loss from discontinued operations, net of tax | | $ | (24,731) | | | $ | (6,448) | | | $ | (29,279) | | | $ | (49,733) | |
| | | | | | | | |
| | | | | | | | |
Cash provided by operating activities by the Yucatan business totaled $0.1 million and $2.9 million for the nine months ended February 26, 2023 and 2022, respectively. There was no cash used in investing activities from the Yucatan business for the nine months ended February 26, 2023 and $2.5 million cash used in investing activities from the Yucatan business for the nine months ended February 27, 2022. Depreciation and amortization expense of the Yucatan business totaled $0.1 million and $0.8 million for the three months ended February 26, 2023 and 2022, respectively, and $0.5 million and $2.8 million for the nine months ended February 26, 2023 and 2022, respectively. There were no capital expenditures of the Yucatan business for the nine months ended February 26, 2023 and $2.5 million of capital expenditures for the nine months ended February 27, 2022.
There was no cash used, provided by, nor any capital expenditures of, the Eat Smart business for the nine months ended February 26, 2023. Cash used in operating activities and cash provided by investing activities by the Eat Smart business totaled $5.5 million and $117.8 million for the nine months ended February 27, 2022, respectively. Depreciation and amortization expense of the Eat Smart business totaled $0.3 million and $5.1 million for the three and nine months ended February 27, 2022. Capital expenditures of the Eat Smart business totaled $1.9 million for the nine months ended February 27, 2022.
10. Subsequent Events
Sale of O Olive Oil and Vinegar Business
On April 6, 2023, the Company completed the sale of its O Olive Oil and Vinegar Business. (“O Olive Sale”) for an aggregate purchase price of $6.2 million, subject to certain customary post-closing adjustments, consisting of approximately $3.1 million in cash and $3.1 million seller's note. The seller’s note matures on March 31, 2026, accrues interest at a rate of 12% payable in kind beginning on October 31, 2023, and is prepayable by the buyer at any time. Net proceeds from the transaction were used to repay borrowings under the Company’s credit facilities. The results of operations related to the O Olive business will be reported as discontinued operations beginning in the fourth quarter ended May 28, 2023. The Company is in the process of analyzing the results of the O Olive Sale, however it expects to recognize a loss on the O Olive Sale in the fourth quarter ended May 28, 2023. A potential range of losses cannot be estimated at this time.
Alcon Supply Agreement
On May 3, 2023, the Company entered into an Amended and Restated Supply Agreement (the “Supply Agreement”), dated May 3, 2023, with Alcon, which amended and restated certain existing supply agreements entered into between the Company and Alcon-Couvreur N.V., an affiliate of Alcon, related to the Company’s manufacture and supply of sodium hyaluronate (“HA”) for Alcon.
The initial term of the Supply Agreement expires December 31, 2033. Following the initial term, the Supply Agreement automatically extends for an additional two-year term unless Alcon provides the Company with a notice of non-renewal prior to the expiration of the initial term. The Supply Agreement also contains certain termination provisions which provide that the agreement may be terminated (a) by Alcon upon six months’ written notice to the Company, or (b) by either party if the other party fails to perform or otherwise breaches any of its material obligations under the Supply Agreement, the non-breaching party notifies the breaching party of its intent to terminate the Supply Agreement, and the breaching party fails to cure such breach.
The Supply Agreement contains terms and provisions customary for transactions of this type, including product warranties and confidentiality and indemnification obligations. Orders of HA pursuant to the Supply Agreement are based on customary forecasting mechanics and are payable by Alcon based on certain prices that are subject to annual index-based adjustments. Pursuant to the Supply Agreement, the Company is also required to commit certain HA manufacturing capacity based on Alcon’s forecasts. Alcon and the Company have also agreed to negotiate in good faith to finalize a plan to increase the Company’s HA manufacturing capacity to meet the anticipated volumes. In the event the Company is unable to supply the agreed-upon volumes and safety stock pursuant to the Supply Agreement, under certain circumstances, Alcon will be entitled to certain rights with respect to the manufacturing and supply of HA for Alcon.
New Term Loan Credit Facility
On May 22, 2023, the Company, Curation and Lifecore Biomedical (together with the Company and Curation, the “Borrowers”), certain of the Company’s other subsidiaries, as guarantors, and Alcon, as administrative agent, collateral agent and lender, entered into that certain Credit and Guaranty Agreement (the “New Term Loan Credit Facility”). The New Term Loan Credit Facility refinanced in full all obligations of the Borrowers and their subsidiaries under the Prior Term Loan Credit Facility, which was terminated upon the entry into the New Term Loan Credit Facility and all noncompliance with debt covenants was thereby cured.
The New Term Loan Credit Facility provides for up to $140.0 million in term loans, subject to certain adjustments based on the post-closing adjustments to the Purchase Price (as defined in the Equipment Sale and Leaseback Agreement, defined below), which were funded in full on May 22, 2023. The obligations under the New Term Loan Credit Facility mature on May 22, 2029. The New Term Loan Credit Facility is secured by the same collateral that secures the Revolving Credit Facility (as defined below), with relative priorities in respect thereof, as set forth in the Intercreditor Agreement (as defined below).
The loans under the New Term Loan Credit Facility have a fixed interest rate equal to 10% per annum. Interest is payable-in-kind until the third anniversary of the closing date and following the third anniversary of the closing date is payable at a rate equal to 3% per annum in cash with the remainder payable-in-kind, in each case, unless otherwise elected by the Borrowers to pay a greater proportion in cash. The New Term Loan Credit Facility contains customary affirmative covenants including, but not limited to, financial reporting requirements and maintenance of existence requirements and negative covenants, including, but not limited to, limitations on the incurrence of debt, liens, investments, restricted payments, restricted debt payments, and affiliate transactions. The New Term Loan Credit Facility contains one financial covenant, a minimum liquidity covenant, requiring $4.0 million of Consolidated Liquidity (as defined in the New Term Loan Credit Facility) as of the end of each fiscal quarter of the Company.
In connection with the New Term Loan Facility, the Company wrote off deferred financing costs amounting to $7.5 million and paid prepayment penalties of $12.9 million to our prior term loan lenders.
Pledge and Security Agreement
Also on May 22, 2023, the Borrowers and certain of the Company’s other subsidiaries, as grantors (collectively, the “Grantors”), entered into that certain Pledge and Security Agreement (the “Term Loan Security Agreement”), dated as of May 22, 2023, with Alcon, as collateral agent. Pursuant to the Term Loan Security Agreement, the Grantors secured their obligations under the New Term Loan Credit Facility by granting to Alcon, as collateral agent, a first priority security interest in certain collateral, including but not limited to equipment, fixtures, real property and intellectual property. The security interest granted by the Grantors under the Term Loan Security Agreement continues in effect until the payment in full of all of the secured obligations under the New Term Loan Credit Facility.
Amendment to Revolving Credit Agreement
On May 22, 2023, the Borrowers and certain of the Company’s other subsidiaries, as guarantors, entered into a Limited Waiver, Consent and Fifth Amendment (the “Revolving Loan Amendment”) to the Revolving Credit Facility
The Revolving Loan Amendment provides for, among other things, (i) a waiver of all known existing defaults under the Revolving Credit Agreement as of the date of the Revolving Loan Amendment, (ii) the reduction of the maximum amount available under the Revolving Credit Agreement to up to the lesser of (x) $40.0 million, less a reserve for certain secured credit
products, if any, and (y) the borrowing base (which, pursuant to the Revolving Loan Amendment, was modified to include a further reduction of the borrowing base by an additional $4.0 million), (iii) the modification of the springing minimum fixed charge coverage ratio of 1.00 to 1.00, with such covenant not tested until the fiscal quarter ending on or about February 28, 2024 and, on or thereafter, upon the earlier of the occurrence of an Event of Default or availability being less than the greater of 10% of the maximum borrowing amount and $4.0 million, (iv) cash dominion at all times the Revolving Credit Facility remains outstanding, and (v) certain other revisions to align with the terms of the New Term Loan Credit Facility and address the relative priorities and credit for borrowings related to the Company’s commercial relationships with Alcon.
In connection with the entry into the Revolving Loan Amendment, the Company also agreed to pay to BMO an amendment fee of $1.2 million, $800,000 of which is paid concurrently with the Company’s entry into the Revolving Loan Amendment, with the remaining $400,000 payable upon the earlier of (i) repayment in full of the Company’s obligations, and termination of all commitments, under the Revolving Credit Facility and (ii) the occurrence of a Change of Control (as defined in the Revolving Credit Facility).
BMO and Alcon also entered into an intercreditor agreement regarding their relative rights, as lenders, in the assets of the Company and its subsidiaries that serve as collateral for their respective credit facilities (the “Intercreditor Agreement”).
In connection with the Revolving Loan Amendment, the Company wrote off deferred financing costs amounting to $0.6 million during the fourth quarter of fiscal year 2023.
As the Company's borrowings under the Amended Loan Amendments for the next twelve months will increase to above the $16.0 million as of the balance sheet date, and scheduled repayments is not due until December 31, 2025, we have determined the line of credit to be classified as a long-term liability as of February 26, 2023.
Equipment Sale and Leaseback Agreements
On May 22, 2023, the Company entered into that certain Equipment Sale and Leaseback Agreement (the “Equipment Sale and Leaseback Agreement” and, together with the Equipment Sale Leaseback Agreement, the New Term Loan Credit Facility, the Term Loan Security Agreement, and the Revolving Loan Amendment, collectively, the “Refinancing Transactions”), dated May 22, 2023, with Alcon, wherein the Company sold $10.0 million (subject to certain post-closing adjustments) (the “Purchase Price”) of certain equipment, machinery, and other property associated with the production of sodium hyaluronate (the “Equipment”) to Alcon. The Equipment Sale Leaseback Agreement contains an option for the Company to repurchase the Equipment upon the earlier of (i) seven (7) years and (ii) the expansion of the Company’s existing production capacity with respect to sodium hyaluronate, for a purchase price equal to the Purchase Price, less the aggregate of all Paydown Payments (as defined in the Equipment Lease Agreement).
Concurrently with the entry into the Equipment Sale and Leaseback Agreement, the Company entered into that certain Equipment Lease Agreement (the “Equipment Lease Agreement”), dated May 22, 2023, with Alcon, wherein Alcon leased the Equipment back to the Company. The Equipment Lease Agreement expires upon the earlier of (i) May 22, 2033, and (ii) the date that the Equipment is repurchased by the Company pursuant to the terms of the Equipment Lease Agreement. Upon the expiration of the Equipment Lease Agreement on May 22, 2033, the Company shall automatically repurchase the Equipment for $1.00 (if not previously repurchased pursuant to the option under the Equipment Sale and Leaseback Agreement).
During the lease term, the Company is obligated to make quarterly rental payments to Alcon equal to (i) 1/40th of the Purchase Price (the “Paydown Payments”), plus (ii) 1.5% times the Purchase Price less cumulative Paydown Payments made.
The Equipment Lease Agreement contains terms and provisions (including representations, covenants and conditions) that are generally customary for a commercial lease of this nature, including obligations relating to the use, operation and maintenance of the Equipment. During the term of the lease, Alcon is not permitted to sell or encumber the Equipment. Alcon is only entitled to cancel the Equipment Lease Agreement in the event of insolvency, liquidation or bankruptcy, and its remedies for other breaches of the Equipment Lease Agreement are otherwise limited to monetary damages.