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Landec Corporation (NASDAQ:LNDC)

F4Q09 (Qtr End 05/31/09) Earnings Call Transcript

July 29, 2009 11:00 am ET

Executives

Gary Steele – Chairman and CEO

Greg Skinner – VP, Finance and CFO

Analysts

Tony Brenner – Roth Capital

Peter Black – Winfield Capital

Chris Krueger – Northland

Nick Genova – B. Riley & Company

Bill [ph] – Sterling Capital

Morris Ajzenman – Griffin Securities

Operator

Good day, ladies and gentlemen, and welcome to Landec fourth quarter and fiscal year 2009 earnings release conference call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator instructions) As a reminder, this program is being recorded. I would now like to turn the conference to your host for today, Mr. Gary Steele, Chairman and CEO of Landec Corporation. Mr. Steele, please begin.

Gary Steele

Good morning and welcome to our fourth quarter and fiscal year 2009 earnings call. With me today is Greg Skinner, Landec’s Chief Financial Officer. This call is being webcast by Thomson CCBN and can be accessed at Landec’s website at www.landec.com on the Investor Relations page. The webcast will be available for 30 days through August 28th, 2009. A replay of the teleconference will be available for one week by calling 888-266-2081 or 703-925-2533. The access code for the replay is 1376482.

During today’s call we may make forward-looking statements that involve certain risks and uncertainties that could cause actual results to differ materially. These risks are outlined in our filings with the Securities & Exchange Commission including the Company’s Form 10-K for fiscal year 2008 and Form 10-Q for the quarter ended March 1st, 2009.

As reported in yesterday’s press release, for fiscal year 2009, Landec’s revenues decreased 1% to $235.9 million compared to revenues of $238.5 million in fiscal year 2008.

Net income for fiscal year 2009 decreased to $7.7 million or $0.29 per diluted share compared to net income of $13.5 million or $0.50 per diluted share last year. Of the $5.8 million in net income 55% is attributable to the combination of our higher tax rate and lower yields on our cash investments. Also, during fiscal year 2009, we generated $9.4 million in cash flow from operations and achieved a record cash balance of $66.0 million.

For our fourth quarter, revenues were $52.2 million versus $57.3 million in the fourth quarter last year. And our net income for the fourth quarter was $1.9 million or $0.07 per diluted share versus $3.4 million or $0.13 per diluted share for last year’s fourth quarter.

For both the year and the fourth quarter of fiscal year 2009, Landec continued to generate net income and positive cash flow from operations. Notably, during our fourth fiscal quarter, relative to our third fiscal quarter we were able to improve gross profits, operating income, and net income as well as our gross margin and operating margin.

For the first time since we started commercial sales in the fresh-cut vegetable business beginning in the year 2000 overall industry unit volume shipments for the fresh-cut category have turned negative and have stayed negative for eight straight months through June, 2009. We began witnessing the decline in the overall fresh-cut vegetable category starting in our second fiscal quarter driven by the deterioration of the U.S. financial community, higher unemployment, and corresponding slump in consumer demand.

The overall fresh-cut vegetable category declined 8% during both the fourth fiscal quarter and for all of fiscal year 2009. There is no doubt that the downturn in the U.S. economy and the impact it is having on consumers is adversely affecting purchases of fresh-cut vegetable products. But less so for Landec than the overall market.

For both the fourth quarter and all of fiscal year 2009, Landec continued to increase its market share. While the overall industry category unit volumes declined 8% for the three and 12 month periods ended May 31st, 2009, Landec unit volumes declined more moderately by 2% and 1% for the same periods.

Although (inaudible) softening consumer demand in the category will continue to affect us in the short term, we have recently seen a slowing in the rate of decline in the fresh-cut vegetable industry category. And it appears that the declines in the upcoming couple of months will be less than what the industry has experienced since November, 2008.

We believe that the fresh-cut vegetable category will return to positive growth late in our fiscal year 2010 or early in our next fiscal year 2011. Importantly, we see this as a time to further strengthen our market position in the fresh-cut vegetable category by using our strong trade brand, Eat Smart, our BreatheWay packaging technology, our low-cost position, and our strong balance sheet to further grow market share.

Let me turn to Greg for details of our results.

Greg Skinner

Thank you, Gary, and good morning everyone. As outlined in yesterday’s news release, Landec reported total revenues for fiscal year 2009 of $235.9 million versus revenues of $238.5 million for the same period a year ago. The decrease in total revenues during fiscal year 2009 was due to a $2.2 million or 1.3% decrease in revenue from Apio’s value-added vegetable business, and from a $769,000 decrease in revenues from Apio Packaging due to the expected contractual decrease in the minimums paid by Chiquita.

These decreases were partially offset by a $318,000 increase in revenues from our Technology Licensing business, primarily due to the expected contractual increase in minimums paid by Air Products during fiscal year 2009.

For fiscal year 2009, the Company reported net income of $7.7 million or $0.29 compared to $13.5 million or $0.50 for last fiscal year. This decrease in net income during fiscal year 2009 compared to fiscal year 2008 was due to, first, a $3.6 million decrease in gross profit in Apio’s value-added vegetable business, primarily due to decreases revenues and from increased raw material cost for produce and packaging.

Second, an increase in income tax expenses of $2.3 million due to an increase in Landec’s effective tax rate to 42% in fiscal year 2009 from 20% in fiscal year 2008.

Third, a $913,000 or 41% decrease in interest income due to the Company’s decision to invest only in FDI-insured certificates of deposits, U.S. government-backed instruments, and AA or better rated municipal bonds, all of which have yields that are considerably lower than those the Company realized from its investments in the same period last year.

And fourth, an $879,000 decrease in gross profit from Apio Packaging due to the decrease in minimums paid by Chiquita.

These decreases in net income were partially offset by, first, a $1.4 million decrease in operating cost, primarily due to lower selling and marketing expenses at Apio and lower general and administrative expenses at corporate.

Second, a $318,000 increase in gross profit from our Technology Licensing business, primarily due to the increase in minimums paid by Air Products during fiscal year 2009. And third, a $208,000 increase in gross profit for Apio’s Commodity Trading business.

It should be noted that only $900,000 or 16% of the $5.6 million book income tax expense recorded in fiscal year 2009 is expected to be paid in cash because of the cash tax benefit from the repurchase of subsidiary options in fiscal years 2007 and 2008.

For the fourth quarter or fiscal year 2009, Landec reported total revenues of $52.2 million versus revenues of $57.3 million for the same period a year ago. The decrease in total revenues during the fourth quarter of fiscal year 2009 was due to, first, an $874,000 or 2.1% decrease in revenues from Apio’s valued-added vegetable business due to the continuing decline in the fresh-cut vegetable category during the fourth quarter.

Second, a $621,000 decrease in revenues from Apio Packaging due to the decrease in minimums paid by Chiquita. And third, a $4 million decrease in revenue from Apio Commodity Trading business due to a decrease in trading sales volumes.

These decreases were partially offset by a $422,000 increase in revenues from our Technology Licensing business, primarily due to an increase in minimums paid by Air Products during the fourth quarter of fiscal year 2009.

For the fourth quarter of fiscal year 2009 the Company reported net income of $1.9 million or $0.07 per diluted share compared to a net income of $3.4 million or $0.13 per diluted share in the same period last year. This decrease in net income during the fourth quarter of fiscal year 2009 compared to the fourth quarter last year was due, first, to a $315,000 decrease in gross profits in Apio’s value-added vegetable business, primarily resulting from lower revenues and higher cost per produce.

Second, a $670,000 decrease in gross profit from Apio Packaging due to the decrease in minimums paid by Chiquita. And third, a $2.1 million increase in income tax expenses.

These decreases in net income were partially offset by a $1.3 million decrease in operating cost due to lower selling and marketing expenses at Apio and lower general and administrative expenses and corporate, and by a $422,000 increase in gross profit from the Technology Licensing business, primarily due to an increase in minimums paid by Air Products during the fourth quarter.

Turning to the balance sheet, during fiscal year 2009, our cash and marketable securities balance has increased by $6.9 million to a record level of $66 million. The increase in cash and marketable securities was primarily due to generating $9.4 million in cash flow from operations and due to a $1.9 million tax benefit from the repurchase of subsidiary options.

These increases were partially offset by $4.6 million in capital expenditures in fiscal year 2009, primarily for the purchase of property, plant, and equipment for our fresh-cut vegetable business. Gary?

Gary Steele

As we look to provide guidance for our current fiscal year that started on June 1st, we believe that the U.S. faces a prolonged and deep recession that most likely will last through all of our fiscal year 2010. As we look to our revenue prospects, we believe that continuing weak economy will make revenue growth more difficult. Additionally, we are scaling back our marginally profitable buy/sell business this year, which will reduce our revenues by about by about $4 million without much adverse effect on margins.

As we transition from the fiscal year 2009 to our new fiscal year 2010, we will experience several contractually planned reductions in overall gross profit, totaling about $1.8 million, including an expected $600,000 reduction from the ending of our license fee arrangement with Air Products, plus an expected $1.2 million annual reduction in contractual minimum payments from Chiquita and Air Products.

We are currently forecasting that these reductions in revenues and gross profits will be offset by increases in revenues and gross profit in our fresh-cut vegetable business as a result of increasing our market share. For example, we just added a significant new customer, the entire SuperValu chain, which includes Acme, Albertsons, Cub, Jewel, and Shaw’s. Accordingly, we’ve projected both revenues and net income for fiscal year 2010 will be flat to slightly up compared to fiscal year 2009.

We will update our outlook if the economy recovers more quickly than we anticipate or if we obtain the business of another major grocery store chain, but at this point we believe it is more prudent to remain conservative in our guidance.

Looking to long term, Landec is well-positioned to take advantage of our proprietary technology, its low-cost structure, and a strong balance sheet, to not only weather the current recession, but also to capitalize on new opportunities that are likely to emerge as under-capitalized companies look for partners in large corporations who are slashing their R&D budgets, look for new products.

We see this as a time of opportunity. We’ll also be placing greater emphasis on consolidating our already strong position in the fresh-cut produce arena, searching for acquisition targets in and outside the food arena, and stepping up our out-licensing activities with new partners.

We are increasing our combined R&D and business development year-over-year spending by 20% and we have hired Molly Hemmeter as our new V.P. of Business Development and Global Marketing. Additionally, we plan to increase capital expenditure investments by 30% to 40% to slightly over $6 million in fiscal year 2010.

Major capital expenditures in this fiscal year include the expansion of our value-added processing facility by 40,000 square feet in order to meet long term projected increases in market share, but also these include investments in equipment and productivity-enhancing initiatives.

We believe our future obligations to shareholders are the focus on technology innovation and new product development, continuing to support our collaborative partners such as Chiquita, Monsanto, and Air Products, and ensure that our sizable cash balances are protected in investments that are safe and available, as needed, to pursue and take advantage of profitable growth opportunities.

In order to successfully advance our priorities, our plan over the next couple of year includes the following initiatives

continuing to generate income and positive cash flow; maintain a strong balance sheet; evaluate synergistic and accretive acquisition opportunities that utilize or complement our technology; complete new partnership agreements where they make sense; expand the sales of our packaging technology with Chiquita and others; expand the seed coating field trials now underway with Monsanto; and start at least one new initiative in a promising area of material science outside of our food technology business.

Over the next 24 months, we plan to take advantage of broad applications for our unique polymer technology to grow and diversify our business and generate increased shareholder value. In the near term, as part of advancing these goals, we expect to, first, seek expansion of sales with L'Oreal and new initiatives with other major personal care companies, which have already begun.

Second, seek further progress, including expanded field trials in the Monsanto program, particularly in the area of controlled release of pesticides and fungicides and new coatings that enhance plant vigor. Third, further expand our market share in the fresh-cut vegetable category, and negotiate lower input cost, particularly produce cost, with our grower suppliers and non-grower suppliers.

Fourth, start one of or more research initiatives in the new applications arena for our material science technology. And fifth, move our M&A activities and/or our investment activities from the broad search to a focus on one or two specific partner candidates.

Our near term and 24-month goals are driven by our focus on achieving our long term objectives for revenue growth with profitability and positive cash flow. We believe that over the next five year our pre-tax margin mix can begin to change with the increasing contribution to sales and pre-tax margin from our non-food Technology Licensing business, which currently generates higher margins, and which is expected to grow faster than the continuing growth in our value-added specialty packaging vegetable business.

If our partners execute in a timely way and if we continue to implement our plans well, we should see both gross margins and net margins increasing over a three- to five-year timeline.

We are now ready for your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Tony Brenner with Roth Capital.

Gary Steele

Good morning, Tony.

Tony Brenner -- Roth Capital

Good morning. A couple of questions, first of all, the planned decline in you buy/sell business in fiscal 2010 is – will that be in your export business or in your domestic Wal-Mart business?

Gary Steele

It’s on the domestic side of things. We had a key customer ask us to help them in a very specific produce category and we did. And it – so we gave him the help. We are done, it’s over with, and it was very marginally profitable for us and so that will reduce revenues by about $4 million without affecting margins. And we are just glad it’s done. So, we helped them out, it was a key customer, and that’s over.

Tony Brenner -- Roth Capital

Okay. The expansion of Apio’s processing facility, the 40,000 square feet, as I recall one of your priorities had been to obtain distribution capacity and possibly processing capacity on the east coast. Is that no longer true?

Gary Steele

That is – that’s still a strategic goal of ours. We’d rather I mean use this extra, we’d rather rent versus build on the east coast, and this is really just to deal with a certain segment of the market that we are not addressing today, which we call the next day delivery market. So this expansion in California does not in any way diminish our interest in having a toehold on the east coast to deal with that next day delivery. And we’ll talk about the steps that we will take to deal with the east coast situation in the next couple of quarters, Tony. So, it does not change our thinking at all.

Tony Brenner -- Roth Capital

Okay. But you are still looking for that--?

Gary Steele

Yes.

Tony Brenner -- Roth Capital

--rental space service?

Gary Steele

Yes.

Tony Brenner -- Roth Capital

Okay, last question. Could you explain why in your partnership agreements contractual minimum amounts declined rather with an increase over time particularly as your partners have exclusive use of technology in their relationship areas? It’s intuitively, one would think that it’s an incentive to improve, other reasons the opposite would be true.

Gary Steele

You want to--?

Greg Skinner

Yes. May be we’ll both address this. For – let’s talk about Air Products. The minimums were kind of tied to our involvement on the R&D side. So as we were contractually obligated to support them to a certain level the increase in their payments or the minimums kind of tracked with that contractual obligation. And after the third year, once license fees were over, our obligation from an R&D standpoint decreased and the minimums decreased accordingly. Now, at the time we entered into the agreement three years ago, we assumed that by the time we got to year four we’d be exceeding minimums, but we couldn’t forecast the decline in the worldwide economy. So, at this point, we are just saying let’s -- for conservatism reasons let’s assume that they will get their minimums next year, which are $0.5 million lower than they were in fiscal 2009.

As far as Chiquita, Gary?

Gary Steele

The thought process there, and Tony, we are negotiating these things, the thought process there was to make sure that you had strong incentives for them to develop the market and to roll out products and so we had some fairly substantial minimums in the earlier years. And then the thought process was that with that momentum you’d be exceeding minimums and so that could start to diminish somewhat over time. So, that was the – that’s what’s going on, Tony.

Tony Brenner -- Roth Capital

Okay. Thank you.

Gary Steele

Tony, thank you.

Operator

Our next question comes from Peter Black with Winfield Capital.

Peter Black -- Winfield Capital

Good morning, guys.

Gary Steele

Good morning, Pete.

Peter Black -- Winfield Capital

How are you doing?

Gary Steele

Good.

Peter Black -- Winfield Capital

A couple of questions. When you were speaking about you growth initiatives for the next year, then you spoke about Monsanto and L'Oreal and M&A, but you didn’t mention, I think, the program with Chiquita, and their potential rollout into retail stores, which in the past was described as a growth driver. So to the extent that that program being indefinitely on hold becomes permanent, do you have the ability to work around Chiquita? I mean can you partner with Dole or some other banana producers?

Gary Steele

There are some checkpoints in the next year, Peter, where the parties will sit down and talk about whether they want to stay in a exclusive or non-exclusive relationship. We’ll be looking at and they will too – I mean both of us should look at this real hard and say are we better in the exclusive situation versus the non-exclusive, and taking into those considerations at least for us will be whatever our odds of being able to address the retail market with the consumer bag [ph], do we feel that we would have more penetration if we were working with several partners in a non-exclusive relationship versus one. So, all those things have to be taken into account. I can't tell you right now where that’s going to end up. But there will be, yes, there will be an opportunity in the next 12 months to make that type of decision for both parties.

On the avocado side, which we’re – everybody is getting very excited and bullish about, I wouldn’t see any reason to not – to change anything. Chiquita is investing a lot of money in getting their infrastructure in place and their sourcing and their processing and their marketing and sales and we are supporting them. So, on that one I would say full speed ahead.

Peter Black -- Winfield Capital

Okay. And then – and you talked about the dynamics of your gross margins and how over time those should grow. Just in terms of – and not more of a short term look at them, from the value-added packaging side, I realize that produce costs are moving up, but in terms of your oil-based packaging cost -- and oil is down about 50% last year and I know you were kind of working through some higher cost inventory -- would you expect now that at least from a trend point of view the gross margins at the value-added portion of the business should be stable at these levels?

Gary Steele

Let me – yes, but let me just point out that the packaging component of our product line represents only about 10% of our cost.

Peter Black -- Winfield Capital

Okay.

Gary Steele

And so – and then a vast [ph] some portion of that is the film or petroleum based. So, I wouldn’t want to – for you to think that it’s bigger than it really is. The real cost drivers in our business are the produce themselves. And that’s driven by land cost in California, which have continued to go up for land that is irrigated and available for vegetable farming. That part is the driver of our cost going up. And that’s the worry on the margin side.

Sure you got to worry about the fertilizer cost, which have petroleum impact to it, but at the end of the day it’s land cost and it’s not really so much the films and the plastics that are driving our costs. So, that’s the worry for us because those costs, the produce costs have been going up at a fair (inaudible) this last year.

Peter Black -- Winfield Capital

And I would imagine this is an environment where you can easily raise prices for your retail customers?

Gary Steele

Oh, it’s tough.

Peter Black -- Winfield Capital

Yes.

Gary Steele

It’s – I don’t need to tell this group that it’s tough for retailers out there. Everybody is very cost conscious. The consumer is very concerned about their own budgets and discretionary spending. And that’s why for us we’ve had more impact on our trade business than we have on our bag business. The bag business is doing pretty well. The trade business is more discretionary, and people are having less family gatherings and friends over. So – and that, by the way, that’s a good margin business for us. So we hope to see some relief in that area this next 12 months.

Peter Black -- Winfield Capital

Okay, thanks.

Gary Steele

Thank you.

Operator

Our next question comes from Chris Krueger with Northland.

Chris Krueger -- Northland

Hi, good morning, guys.

Gary Steele

Good morning, Chris.

Chris Krueger -- Northland

Hi. It’s first call I’ve been on here, so hopefully I am not making you answer questions you’ve already answered before. But you mentioned in your comments that you’ve won business with SuperValu. Is that a recent win, are you already providing to them or is this something that’s been going on for quite some time?

Gary Steele

We – Chris, we had some business with them -- the Albertsons division in our trade business. But this is really a full rollout of the whole organization, 1800 stores. A sizable account. And they have Acme, they have Shaw’s, they have Cub, they have Jewel, they have Albertsons. So, this is very recent for us. I’d think we are now pretty much fully rolled out in the last few week and--

Chris Krueger -- Northland

So, it’s really in the first quarter 2010 where you should really start to feel the benefit there?

Gary Steele

First – well, we are in our first quarter right now. We are in the – I’d say--

Chris Krueger -- Northland

The second quarter really to feel the fall, okay.

Gary Steele

Probably the second quarter. So, June, July, August, is our first quarter, so I’d say since we have been rolling out this first quarter you’ll probably see it more in the second quarter.

Chris Krueger -- Northland

Okay. And then as far as gaining market share in the fresh-cut veggie, obviously you’ve indicated that the last several quarters or throughout the last year, is that come primarily from wins like that and gaining – getting into more stores or is there something else that plays a role in that as well?

Gary Steele

Well, in terms of market share, it’s things like SuperValu, and we’ve also expanded our – one of our major customers up in Canada, as an example. But our growth drivers include market share gains, new product introductions, looking at new segments, such as Deli, looking at – looking internationally, we have trials going on in South America right now. It’s looking at expanding our packaging-only business in our fruit segment. We are working on a couple of activities there as well. So there is about four or five growth drivers beyond market share that we are working on.

Chris Krueger -- Northland

Okay. On you Air Products business I think in your stated comments, you’ve indicated they have stepped up their sales and marketing efforts recently. Can you give us some examples of that or which products you are pushing or just a little more insight on that, overall?

Gary Steele

Yes, yes, Chris, I’d like – maybe I’d like to explain a little history here. I don’t know if I’ve done that on a conference call. But you know we joined forces with Air Products about two and a half years ago. At that time, they had indicated a very strong interest into being the major supplier to the personal care cosmetics field. Why? High margins, growth market. And they were looking at getting very strong presence in that space through acquisition and through possible investments in technology for a variety of reasons. That – by the way, through the acquisition route, they would have had the ability to have worldwide marketing and sales access immediately.

The acquired company who have that capability would have had formulation capability. For a variety of reasons that acquisition has not happened. And so we are all kind of in a little bit of a wait mode, when is that going to happen. And as a result of waiting and not seeing that come, Air Products has decided to start to build its own internal capabilities in marketing and sales both in Europe and the U.S., North America. And so they have been doing that, putting a small team together of people in Europe and in the U.S. that call on the S D Lotters [ph] and the Procter and Gambles and the Avons and the L'Oreals, and a very small formulation team. So, it’s been slow go, not because of poor intent, but just because they have been frustrated in their attempts to try to get instant access to the market through acquisition. So, it’s a kind of a home-grown approach.

And so right now we are in roughly I believe it somewhere between eight to 10 products of the L'Oreal family of products. Our ingredients are in the Veeshe [ph], the Keels [ph], the Land Comb [ph], and the L'Oreal product lines. And so we have additives in those materials – in those products. So, the key of course, is to start to expand the market with other customers.

And so, it’s about a two to three year process before you – by the time you make a call, you have samples that start to get evaluating, they go through safety and toxicology testing, and then they go through what’s called the coding process, c-o-d-i-n-g, coding process, and then it’s got to be scaled. So, there is a lag time on that. It’s – fortunately it’s faster than drug development, but it’s certainly a couple of year. And so that’s a process we are in right now.

So, there is a small team in Europe, there is a small in the U.S. calling on customers. There is a small formulation team. We still support Air Products with R&D, with new product development. And our hope is that now that we have this small team in place we can start to build some momentum.

Chris Krueger -- Northland

Alright. Last, could you tell me – when you talk about acquisition opportunities -- I know you can't get specific on it, but do you have, I mean I am sure you look at dozens of companies, but is it narrowed down to a handful of companies you are truly honing in on where potential you could see something happen in the next few quarters?

Gary Steele

No--

Chris Krueger -- Northland

Okay.

Gary Steele

We are seeing candidate companies that don’t make sense for us, just to be perfectly hones with you. We are pretty picky and we have our boxes that have to be checked off, and we are seeing – we are looking at more companies, but no we are not – in don’t want to give you the impression that we are a couple of quarters away from doing something because we are not. And we’ve got the cash, we’ve got the ability to do these things, but it’s not burning a hole in our packet. We don’t feel like we have to go spend it. We certainly are going to spend it on R&D, business development, and increases in CapEx in the mean time. But we are not close to having that, “I got you!” It’s just not there yet.

Chris Krueger -- Northland

Okay. That’s all I’ve got. Thanks.

Gary Steele

Thank you, Chris.

Operator

Our next question comes from Nick Genova with B. Riley and Company.

Gary Steele

Good morning, Nick.

Greg Skinner

Hi, Nick.

Nick Genova -- B. Riley & Company

Good morning guys. First on margins within Apio value-added, the margins improved sequentially from Q3 and that was in spite of – I mean it sounds like the raw material or the produce costs are still high. Can you talk about – besides the slight benefit you might have gotten from packaging, what else was at play there?

Gary Steele

Well, the primary cause between quarters is in the third quarter we are souring a lot of our product from the desert area, so not only are – the cost of the product greater for – from a growing standpoint, but being have to freight it from literally the Mexican border all the way up to our plant in Gualala Bay [ph], California, and then process it and then ship it across the North America. So that significantly adds cost during the third quarter. You will see, if you go back, for several years that the third quarters typically are our lowest margin quarter for the value-added business. That plus just some good operating efficiencies during the quarter, good quality produce coming out of the Santa Maria Valley, our primary sourcing, that – those are the main reasons for the sequential increase in gross margin.

Nick Genova -- B. Riley & Company

Okay. So overall looking at into fiscal year 2010, maybe we can build in some sort of increase there, but nothing dramatic.

Gary Steele

Yes, you are going to continue to see the higher cost that are already in place for produce. This last quarter was close to 14%, you know that’s on average it’s been about where our value-added business has been. I don’t see it dramatically change – increasing from that or even marginally increasing from that given that, that the higher produce costs are already locked in for this fiscal year.

Nick Genova -- B. Riley & Company

Okay. And then moving on to a couple of the higher margin opportunities, first, going back to the avocado business, is that some thing that – I mean can you compare that to the banana business just in terms of the potential size of the market?

Gary Steele

I can give you just a real rough one. I think the – given the fact that the retail opportunity for a consumer package for bananas is somewhere between not now and never, I would say that the – Chiquita believes that the avocado opportunity is bigger than the banana opportunity right now. I know that sounds surprising, but – they are already a major player in bananas and they are a relatively small player in avocados, and they see the pathway to be a major player in avocados, which is a billion dollar a year commodity. It’s the fastest growing produce category in North America. People are in love with avocados and they are healthy and nutritious. So, I think if Chiquita were on the line here, they would probably say it’s probably a bigger opportunity right now. Unless the retail opportunity re-emerges with the change in the economy, I would agree with them.

Nick Genova -- B. Riley & Company

Okay. And then on the Monsanto trials, those are going on it sounds like this summer—I am sorry.

Gary Steele

Go ahead.

Nick Genova -- B. Riley & Company

I was just going to say I mean do you guys have a sense for when those will be completed, when you will get the results from that, and how that will be disseminated?

Gary Steele

Yes. We have a general sense. Generally – obviously it was planted in the spring. Monsanto spends a lot of money on trials. These are not trivial types of investments for them. And we are looking at things like plant vigor, we are looking at the qualitative and quantitative aspects of this, is the root structure improved, is the stem coming up and looking healthy. But eventually, it’s at the harvest where you really make your final determinations. You start looking for yield improvements, et cetera, et cetera. Usually, data is collected and evaluated and analyzed and usually available in the November, December timeframe.

So, I would think that that’s when we are going to be learning about this and inevitably if it’s generally positive, you do it again, and hopefully we go down and we’ll obviously be doing some things down in South America and then we’ll come back and do it next spring. So you need to go through a few cycles to really see enough data, get the statistics working for you. So, I would think that we’d start to get some hunches on how things are looking in early in October and then start to see some real data in November.

Nick Genova -- B. Riley & Company

Hey, great, that’s helpful. Thanks a lot.

Gary Steele

Thank you, Nick.

Operator

Our next question comes from Will Lauber with Sterling Capital.

Gary Steele

Good morning, Will.

Greg Skinner

Good morning, Will

Bill – Sterling Capital

Good morning. This is Bill [ph]. Will is also here.

Greg Skinner

Oh, hi Bill.

Gary Steele

Hi Bill and Will, good morning.

Bill – Sterling Capital

Gary, I think you probably answered this question or addressed it one way or another, but I am going to ask it anyway. Is it – is this fair to say that today the relationships with Air Products and Chiquita have been somewhat disappointing?

Gary Steele

Let’s – let me distinguish, and I am not trying to be politically correct here, but let me distinguish relationship versus results. Relationships are good. The people are great. They are working hard, both cases. The Air Products has been much lower than we wanted and I tried to give a little background, if you heard earlier, about their earlier intents and the fact that they were expecting to have a much stronger worldwide presence in serving the personal care industry through acquisition. It did not happen and so they had to go to kind a of a homegrown approach.

So, that explains a lot of the slowness, but how could we possibly not be – we would like to see things further along, we would like to see that we are in customers other than L'Oreal right now. And there were some other factors going on here with our relationship with L'Oreal that slowed us down a little bit. So, my view is the relationship is terrific. The people are great. And Air Products is a winner. I mean that’s a winning company.

On the Chiquita side, I think they are as disappointed as we are that the retail side has been – we were planning on going to trials this last fall. The retailers pushed back. Consumers are frankly not interested in new premium products, they are interested in surviving.

On the McDonald's side, I think both Chiquita and we – and Chiquita has worked their tails off trying to get into quick-serve restaurant chains. And if you are following McDonald's, you will know that their push last year for more nutritious products just seems to have gone away. I mean, Boy! They are having a good time during this recession. Things are going well for them. And they are selling lots of Quarter Pounders.

So, our relationship is very strong, very positive, but disappointing, disappointing on both cases. So, what do we do about it? What we do about it is you start moving along the avocado program, which none of us had even thought about when we first got together and Boy! That one looks really good. If you can take avocados and deliver them in a ripe-and-ready-to-eat format in our packaging, that looks like a real winner.

What you do with Air Products is you say, look, let’s home-grow it now, let’s get going, and let’s start calling on other customers, which we are doing. So, I would say we are dealing with it as best we can, but so far it’s been, in both case, less than what we expected.

Bill – Sterling Capital

I was particularly referring to the results. Well, if there is three factors here that might be affecting results and certainly the economy is one, two, your partnerships, and the people that you’ve partnered up with, companies, and number three, Landec and the viability of the technology. I would like to think that – well, I am not going to put words in your mouth, can you address that?

Gary Steele

The three, or the third one?

Bill – Sterling Capital

The third one.

Gary Steele

Oh! There are – in terms of Landec, I would say we are never fully satisfied with our own execution, but I am trying to think what the heck we could be doing better and differently in the Chiquita relationship. I just can't come up with anything right now other than that provide them with strong support, which we have.

On the technology itself, there are some practical limitations that go beyond the breathability of our films and membranes. There are some fruit targets that we’ve looked at that are more challenging than perhaps we wanted them to be, because when you put them in a sealed package, molds starts to grow. We capture water in a sealed package. It is part of respiration and so we’ve got to figure out how to get that films that are more transferable in terms of moisture, vapor transfer rates, those types of things. So you just kind of knock them out as you hit those obstacles. The technology is – it works. I don’t think we got SuperValu because we were just better-looking people. I think we earned it by our results and higher quality as well as good performance in terms of serving customers. So I’d say for those things that we can control, Bill, I think we are executing reasonably well. Love to always do better.

In terms of picking the partners, I would still say that the selection of Chiquita was absolutely the right selection. We were talking to some other companies who frankly told us that they didn’t like the technology because the garbage can was their biggest customer. So we knew they weren’t the right fit. So, I would say the partners – I would like to see more. We are somewhat frustrated, but we just have to keep going. You don’t – let’s move on and let’s find the new opportunities, which is why we are stepping up R&D. That’s why we are looking for other partnerships. That’s why we are looking in the M&A area. That’s why we are investing heavily in business development. And that’s why we think we are going to prosper long term.

Bill – Sterling Capital

(inaudible) how would you describe I mean in terms of the potential commercial usage of you technology maybe in and outside the food category, you don’t think that – you don’t – are you as optimistic about your technology as you were, say, two or three years ago in terms of developing other applications?

Gary Steele

Yes, I am, and what’s happened in the last two years is the recognition that we have to move beyond our food business and look outside for new innovations. And so that’s why we are investing in new coatings, new drug delivery systems. That’s why we are investing in the R&D of control release systems. That’s why we are stepping up R&D. That’s why Molly Hemmeter has been hired because it’s time to match those R&D investments with some partnering. So, if we weren’t optimistic we wouldn’t be making these investments.

Bill – Sterling Capital

Okay. Fair enough. Thank you.

Gary Steele

Thank you.

Operator

Our next question comes from Morris Ajzenman with Griffin Securities.

Morris Ajzenman -- Griffin Securities

Hi guys.

Gary Steele

Hi, Morris, good morning.

Greg Skinner

Good morning, Morris.

Morris Ajzenman -- Griffin Securities

Hi. You gave us enough sort of objective [ph] information that we look at the fiscal 2010, depending on what happens in the second half of the year revenues overall could be under pressure versus 2009, again, depending on what happens to the – actually the rate of decline moderating this second half is I guess the key to that. But then, you talked about SuperValu being a large new customer being added. Is that enough to have the full year revenues being up year-over-year with that client being brought on list? It’s tough to get a handle on how big the client’s act [ph] could be. And I have a totally unrelated question.

Gary Steele

The answer is yes. It’s enough to – tell me what’s going to happen with the U.S. economy and I will tell you exactly how to answer that, but the uncertainty for us is what is the American consumer going to do, are they going to come back to fresh-cut produce, it’s a good value for them, it’s nutritious, it’s healthy, it’s convenient, all that. But right now they are in – there is by – you tell me what you think the U.S. employment rate is, it’s pretty ugly. But the SuperValu brings in substantial incremental dollars for us, both at the top line and bottom line, and that will represent year-over-year growth for us if we are able to have a category, fresh-cut category that stays flat. But we don’t know if that’s going to stay flat. It’s been declining for a number of quarters. So, that’s the uncertainty, Morris. But, yes, the SuperValu is a nice shot in the arm, it really is.

Morris Ajzenman -- Griffin Securities

The other question is – moving to the cash flow line, (inaudible) for next year, you told us R&D – you kind of give 20% versus ’09, CapEx up 30% to 40%. (inaudible) all the right things to do to invest into the future for the company, but cash flow for this past year on a per share basis was about $0.35 a share. Can we – and you are talking about (inaudible) cash flow. With these incremental investments, can we still generate cash – free cash flow for fiscal 2010?

Greg Skinner

Yes, absolutely. The plan is this year we did $7.7 million bottom line. We re now fully taxed. So, you don’t have the issues with – Gee, you are going from a 8% tax rate to a 22% this year, 42%. It will be comparable next year. And we are generating $9.4 million in operating cash this year. And we anticipate that given our projections of being flat to slightly up on net income, that our cash flow should follow that. And given the estimate of that $6 million in CapEx, you are talking about generating free cash flow somewhere in the $3 million-$3.5 million range if that guidance turns out to be true.

Morris Ajzenman -- Griffin Securities

And that $9.4 million, is that operating, is that free cash flow after CapEx, working capital--?

Greg Skinner

No, that’s operating – I mean the CapEx this year was $4.6 million, so you would have to take that off of it.

Morris Ajzenman -- Griffin Securities

Obviously your free cash flow is more about four – about, okay, less $4.6 million, okay. Thank you.

Greg Skinner

Thank you, Morris.

Gary Steele

Thank you, Morris.

Operator

I am not showing any other questions at this time.

Gary Steele

We appreciate your being on the call. Thank you very much and we look forward to keeping you posted on our progress and plans. Many thanks.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the conference. You may now disconnect. Good day.

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Source: Landec Corporation F4Q09 (Qtr End 05/31/09) Earnings Call Transcript
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