Lifecore Biomedical, Inc. \de\: Form 10-Q for the period ended Aug 25, 2024

(All dollar values are in thousands, unless otherwise noted)

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and accompanying notes included in Part I, Item 1, of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the fiscal year ended May 26, 2024 (the “2024 Annual Report”).

This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbor created under the Private Securities Litigation Reform Act of 1995 and other safe harbors under the Securities Act of 1933, as amended, and the Exchange Act. Words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “might,” “will,” “should,” “can have,” “likely” and similar expressions are used to identify forward-looking statements. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected. Potential risks and uncertainties include, without limitation, the timing and expenses associated with operations, the ability to achieve acceptance of new products in the marketplace, government regulations affecting our business, the timing of regulatory approvals, the impact of adverse and uncertain economic conditions in the U.S. and international markets, the mix between domestic and international sales, and those other risks mentioned in this report and the 2024 Annual Report.

We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. Accordingly, our actual results could differ materially from those projected in the forward-looking statements for many reasons, including the risk factors listed in Item 1A. “Risk Factors” of this report and in the 2024 Annual Report.

All forward-looking statements attributable to us are expressly qualified in their entirety by these cautionary statements as well as others made in this report, the 2024 Annual Report, and hereafter in our other SEC filings and public communications.

You should evaluate all forward-looking statements made by us in the context of all risks and uncertainties described with respect to our business. We caution you that the risks and uncertainties identified by us may not be all of the factors that are important to you. Furthermore, the forward-looking statements included in this report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

The Company

The Company is a fully integrated contract development and manufacturing organization (CDMO) that offers highly differentiated capabilities in the development, fill and finish of complex sterile injectable pharmaceutical products in syringes, vials, and cartridges under contract for product sponsors, along with producing premium, injectable grade sodium hyaluronate (HA) for use as an active pharmaceutical ingredient (API). Lifecore uses its experience in handling of viscous, complex products to be a technical leader in contract development services to create a manufacturable, scalable and compliant production process for many types of medicinal products. These services include activities such as formulation technology development, material component definition, analytical method development, filling optimization, packaging design, stability studies, process validation, clinical production and ultimately production of commercially approved products. The Company has more than 40 years of expertise as a partner for global and emerging biopharmaceutical and biotechnology companies across multiple therapeutic categories to bring their innovations to market.

Built over many years of experience, Lifecore separates itself from its competition based on its five areas of expertise, including but not limited to Lifecore’s ability to:

Establish strategic relationships with market leaders:

Lifecore continues to develop and manufacture products with partners who have strong marketing, sales, and distribution capabilities, reaching the patients they serve. Through its strong reputation and history of providing pharmaceutical grade HA and products, Lifecore has established long-term relationships with global and emerging biopharmaceutical and biotechnology companies across multiple therapeutic categories and leverages those partnerships to attract new relationships in other medical markets.

Expand medical applications for HA:

Due to the growing knowledge of the unique characteristics of HA and Lifecore’s unique strength and history as a trusted manufacturer of pharmaceutical injectable grade HA products, Lifecore continues to identify and pursue opportunities for the use of HA in other medical applications, such as wound care, aesthetic surgery, drug delivery, next generation orthopedics and device coatings, and through sales to academic and corporate research customers. Further applications may involve expanding process development activity and/or additional licensing of technology.

Utilize manufacturing infrastructure to meet customer demand:

Lifecore has made strategic capital investments in its CDMO business focusing on extending its formulation and filling capacity and capabilities to meet increasing partner demand and regulatory expectations and to attract new contract filling opportunities.

Maintain flexibility and speed in product development and supply relationships:

Lifecore’s vertically integrated development and manufacturing capabilities and strong Quality systems allow it to quickly move a product from development to commercial production. Lifecore’s role extends from supplying HA raw materials to providing technology transfer and development services to manufacture aseptically filled, finished sterile products, and assuming full supply chain responsibilities (from raw material management through packaging and serialization).

Deliver consistent quality:

Lifecore has built a world class quality and regulatory system that is demonstrated in its results, processes and customer relationships. With over 38 years of a superior track record with global regulatory bodies (FDA, EMA, ANVISA, etc.), Lifecore is the partner of choice for companies looking for proven experience in delivering QbD, cGMP compliance, and manufacturing excellence with pharmaceutical elegance and quality. Lifecore’s world class quality and regulatory system and excellent track record with the global regulatory bodies ensure partners that they will safely bring innovative therapies to market.

We are focused on driving profitable growth with new product development along with clinical and commercial manufacturing of sterile injectable products. Lifecore seeks to expand its presence in the CDMO marketplace by partnering with biopharmaceutical and biotechnology companies to bring their unique therapies to market. Lifecore’s goal of continuing success will be to execute on its three strategic priorities:

1) Managing Business Development Pipeline: Accelerate product development activities for virtual, small and large biopharmaceutical and biotechnology companies in various stages of the product lifecycle, spanning clinical development stage to commercialization, which aligns with the business’ overall product development strategy.

2) Maximizing Capacity: Meet customer demand by maximizing capacity in the syringe, vial and cartridge multi-purpose filler production line to significantly increase the number of products produced.

3) Advancing Product Commercialization: Continue to seek out opportunities to advance customers’ late-stage product development activities by supporting their clinical programs and commercial process scale-up activities.

Reportable Segments

The Company operates as one reportable segment. This is based on the objectives of the business and how our chief operating decision maker, the President and Chief Executive Officer, monitors operating performance and allocates resources.

Related Party Transactions

For a discussion of significant related party transactions, refer to Related Party Transactions within Note 1 to the condensed consolidated financial statements elsewhere in this Quarterly Report on Form 10-Q.

Results of Operations

Revenues and Gross Profit:

Lifecore generates revenues from two integrated activities: CDMO and HA manufacturing. Lifecore generates revenues from the development and manufacture of HA products and provides contract development and aseptic manufacturing services to customers.

Numerous factors can influence gross profit, including HA manufacturing product mix, customer mix, manufacturing costs, timing of production, volume, sales discounts, and charges for excess or obsolete inventory, among others. Many of these factors influence or are interrelated with other factors. The Company includes in cost of goods sold all of the following costs: raw materials (including packaging, syringes, fermentation and purification supplies), direct labor, overhead (including indirect labor, depreciation, and facility-related costs), and shipping and shipping-related costs.

The increase in total revenues for the three months ended August 25, 2024, compared to the same period last year, was due to a $1.5 million increase in HA manufacturing revenues from our largest customer due to timing of shipments, partially offset by a $1.3 million decrease in CDMO revenues primarily as a result of one customer working down inventory levels built in the prior year period.

The increase in gross profit for the three months ended August 25, 2024, compared to the same period last year, was due primarily to a favorable sales mix between customers and price increases to our customers within CDMO revenues as evidenced by a favorable rate variance of $2.7 million detailed further below.

The 1,068 basis points (“bps”) improvement in the Gross Profit Percentage is due to a $3.6 million or 1,429 bps increase in CDMO revenue gross profit, of which $2.0 million or 887 bps increase results from a favorable sales mix and $1.6 million or 542 bps increase is due to price increases to our customers, both of which are in CDMO revenues and a $0.2 million or 68 bps increase resulting from the increase in HA manufacturing revenues partially offset by a $1.1 million or 429 bps decrease primarily due to writing down inventories to their net realizable value.

Operating Expenses:

Research and Development (“R&D”)

R&D expenses consist primarily of product development and commercialization initiatives. R&D expenses are focused on new products and applications for HA-based and non-HA biomaterials. R&D expenses for the three months ended August 25, 2024 was consistent with the prior period.

Selling, General, and Administrative (“SG&A”)

Selling, general and administrative expenses consist of salaries and related costs for administrative, public company and business development functions as well as legal fees, and consulting fees. Public company costs include compliance, audit, tax, insurance and investor relations.

The increase in total SG&A expenses for the three months ended August 25, 2024, compared to the same period last year, was primarily due to increases in (i) professional fees of $4.7 million, consisting primarily of $2.4 million in audit fees and legal fees of $2.3 million; and (ii) non-cash stock-based compensation expense, primarily due to the impact of performance stock unit grants of $0.9 million.

Included within SG&A for the three months ended August 25, 2024 were higher professional fees than we expect to incur on a normalized basis of approximately (a) $3.6 million of reorganization costs consisting primarily of (i) $1.6 million of audit fee overages related to the completion of the Company’s FY 2024 quarterly and annual reporting as a result of switching auditors; (ii) $1.1 million of legal fees related to civil litigation involving the former owners (and sellers) of Yucatan Foods; and (iii) $0.8 million of consulting costs to support the Company’s FY 2024 audit; and (b) $1.2 million of legal fees related to the stockholder activist settlement.

Included within SG&A in the prior year three month period ended August 27, 2023 were approximately $2.8 million of costs that we do not expect to incur on a normalized basis consisting primarily of (i) $1.2 million of reorganization costs related to the sale of the food businesses; (ii) $0.8 million of costs related to the Company’s strategic alternatives review that was completed in the 4th quarter of FY 2024; (iii) $0.4 million of audit fee overages primarily related to the Company’s accounting for the sale of the food businesses in FY 2023; and (iv) $0.2 million of consulting costs to support the Company’s FY 2023 audit.

Other Non-Operating Items:

Interest Expense, net

The increase in interest expense, net for the three months ended August 25, 2024, compared to the same period last year, was primarily a result of $997 increased interest expense related to Alcon term loan debt, primarily related to amortization of the debt discount. There was also a reduction in capitalized interest of $258 due to completed projects in the current year.

Change in fair value of debt derivative liability, related party

The change in fair value of debt derivative liability, related party for the three months ended August 25, 2024, compared to the same period last year, was primarily due to the change in the market credit spread. There were no changes in the probability factors related to the timing of a change in control and an event of default on the supply agreement with Alcon for the three months ended August 25, 2024.

Other Expense, net

Other Expense, net included $275 and $250 in monetary penalties related to the late registration statement filings as contained in the Registration Rights Agreement (excluding interest) for the three months ended August 25, 2024 and August 27, 2023, respectively, and was the primary cause of the increase period over period.

Income Taxes

The income tax provision primarily consist of valuation allowances recorded against certain deferred tax assets, partially offset by the impact of federal and state research and development tax credits and the changes in provisions between the periods were not significant.

Liquidity and Capital Resources

As of August 25, 2024, the Company had cash of $5,520, a net decrease of $2,942, from the $8,462 balance as of May 26, 2024. The decrease in cash for the three months ended August 25, 2024 and August 27, 2023, were attributed to the following:

(1) The primary reasons for this source of cash were a $6.0 million decrease in total accounts receivable and a $3.6 million increase in operating accounts payable, partially offset by an increase in inventories.

(2) The primary reason for this use of cash is a $4.2 million decrease in accounts payable.

Contractual Obligations

The Company’s material contractual obligations for the next five years mainly relate to its debt and lease obligations.

The Company’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 the Company to establish and maintain new licensing arrangements; the costs associated with employment-related claims; any decision to pursue acquisition opportunities; 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 the Company’s currently available funds, together with the internally generated cash flow from operations are not sufficient to satisfy its capital needs, the Company would be required to seek additional funding through other arrangements with collaborative partners, sale of real estate or other assets, additional debt or bank borrowings and public or private sales of its securities. There can be no assurance that additional funds, if required, will be available to the Company on favorable terms, if at all.

The Company believes that its cash from operations, potential equity offerings, along with existing cash, availability under its Revolving Credit Facility and the Securities Purchase Agreement executed on October 3, 2024 will be sufficient to finance its operational and capital requirements for at least the next twelve months.

Debt

As of August 25, 2024 and May 26, 2024, the Company had $161,245 and $157,313 in borrowings outstanding under the Term Loan Credit Facility, at an effective annual interest rate of 22.5% for both periods.

As of August 25, 2024 and May 26, 2024, the Company had $21,605 and $19,691, respectively, in borrowings outstanding under the Revolving Credit Facility, at an effective annual interest rate of 8.35% for both periods.

As of August 25, 2024 and May 26, 2024, the Company was in compliance with all financial covenants under the Term Loan Credit Facility and Revolving Credit Facility and had approximately $4,500 available for borrowing under the Revolving Credit Facility.

Critical Accounting Estimates

There have been no material changes to the Company’s critical accounting estimates from those disclosed in the Company’s 2024 Annual Report. For a discussion of our critical accounting estimates, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Use of Estimates” in Part II, Item 7 of the Company’s 2024 Annual Report.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) of the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based upon the evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were not effective as of August 25, 2024, due to the material weaknesses in internal control over financial reporting that were disclosed in the 2024 Annual Report. The Company is in the process of determining a plan for the remediation of the material weaknesses in internal control over financial reporting.

Management’s Plan for Remediation of the Material Weaknesses

Management, with the oversight of the Audit Committee, is committed to remediating the control deficiencies. The remediation efforts are intended to both address the identified material weaknesses and to enhance our overall control environment.

Steps taken by management to date include the following:

• Engaged a third-party consultant to assist with remediation efforts, including enhancing our risk assessment, evaluating gaps in current processes and controls, and developing a remediation plan.
• We have committed to adding a sufficient number of qualified personnel within our accounting and finance team with the appropriate qualified experience in financial reporting, consolidations, technical accounting, and application of U.S. GAAP.

In addition to the above efforts undertaken, the Company plans to initiate the following steps intended to remediate the material weaknesses described above and strengthen its internal control over financial reporting:

• Performing an updated risk assessment responsive to changes in the business and establishing processes to update timely for future changes.
• Implementing new and enhanced controls and procedures responsive to our risk assessment at an appropriate level of precision related to management review and the completeness of controls required to support the financial reporting framework.
• Conducting broad-based training over the application of the 2013 COSO Framework for key process owners and control operators.
• Implementing a Section 302 sub-certification program by business leadership and process owners to reinforce the Company’s culture of compliance.
• Evaluating accounting policies and procedures by performing a detailed review of the Company’s policies against GAAP and SEC reporting checklists.
• Establishing and implementing a SOX Steering Committee.
• Implementing a process to identify and maintain the information required to support the functioning of internal controls over financial reporting.
• Enhancing reviews of non-recurring transactions, including preparing technical accounting memos and consulting with subject matter experts, as needed.
• Expanding the Internal Audit function to perform timely assessment of design and operating effectiveness of controls and evaluation of remediation of control deficiencies.

The material weaknesses will not be considered remediated until management designs and implements effective controls that operate for a sufficient period of time and management has concluded, through testing, that these controls are effective. As we continue to evaluate operating effectiveness and monitor improvements to our internal control over financial reporting, we may take additional measures to address control deficiencies or modify the remediation plan described above.

Changes in Internal Control over Financial Reporting

Except for the remediation planning efforts described above, there have been no changes in our system of internal control over financial reporting during the quarter ended August 25, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

You should carefully consider the risks described in Part I, Item 1A, “Risk Factors” of the 2024 Annual Report, as our business, financial condition and results of operations could be adversely affected by any of the risks and uncertainties described therein and herein. Some statements in this report, including statements in the risk factors, constitute forward-looking statements. These risks are not the only risks that may affect us. Additional risks that we are not aware of or do not believe are material at the time of this filing may also become important factors that adversely affect our business. There have been no material changes to our risk factors as previously disclosed under Part I, Item 1A “Risk Factors” in the 2024 Annual Report.