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Landec Corporation (NASDAQ:LNDC)

F2Q10 Earnings Call

January 6, 2010 11:00 am ET

Executives

Gary Steele – Chairman, Chief Executive Officer

Gregory Skinner – Chief Financial Officer

Analysts

Anton Brenner – Roth Capital Partners

Peter Black – Winfield Capital

Morris Ajzenman – Griffin Securities

Chris Krueger – Northland Securities

Nick Genova – B. Riley & Co.

William Lauber – Sterling Capital Management

Nelson Obis – Winfield Capital

[Greg Pyringer – Wells Capital Management]

Operator

Welcome to the Landec’s second quarter fiscal year 2010 earnings release conference call. (Operator Instructions) I would now like to introduce your host for today’s program, Mr. Gary Steel, Chairman and CEO of Landec Corporation.

Gary Steele

Good morning and welcome to Landec’s second quarter fiscal year 2010 earnings call. I have with me today Greg Skinner, Landec’s Chief Financial Officer.

This call is being webcast by Thompson 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 February 5, 2010. A reply 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 1420830.

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 and Exchange Commission including the company’s Form 10-K for fiscal year 2009.

As reported in yesterday’s press release, for the second quarter of fiscal year 2010 revenues increased 5% to $60.9 million from $58 million during last year’s second quarter and net income was virtually unchanged at $1.5 million or $0.06 per share.

For the first six months of fiscal year 2010 revenues decreased to $121.9 million compared to revenues of $129.8 million for the same period a year ago. Net income for the first six months decreased to $3.7 million or $0.14 per diluted share compared to $4.3 million or $0.16 per diluted share for the same period last year.

Overall, Landec generated $4.2 million in operating cash flow during the first six months of fiscal year 2010 and ended the quarter with $68.1 million of cash and marketable securities with no debt, continuing to maintain our positive financial position.

Importantly, revenues from Apio’s value added fresh cut vegetable business which accounts for 68% of Landec’s second quarter revenues increased $4.4 million or 12% during this year’s second quarter compared to last year’s second quarter.

Also during the second quarter we modified our licensing agreement with Monsanto Company; more on this later.

Notably, for the six months ended November 29, 2009 compared to the same period a year ago, Apio unit volume sales in the fresh cut vegetable category increased 14% while according to syndicated market data, the overall industry unit volume sales in the fresh cut vegetable category increased 2% during the six months ended November 29, 2009, compared to the same period a year ago.

For the month of November 2009, compared to November 2008, the industry unit volume sales in the fresh cut vegetable category grew 8%. As a result, we believe that industry unit volume sales in the fresh cut vegetable category will continue to grow during the second half of our fiscal year 2010 assuming the economy continues to improve and consumers continue to return to buying fresh, nutritious and conveniently packages produce products.

As a reminder, our guidance for fiscal year 2010 was that both revenues and net income are projected to be flat to slightly higher in fiscal year 2010 compared to fiscal year 2009. We still expect net income to be flat to slightly higher.

However, at this point in time, we now expect revenues to be flat to slightly lower primarily because of the significant unexpected $5.3 million decrease in revenues from Apio’s lower margin trading business in the first six months of fiscal year 2010 due to shortages that we experienced for exporting fruit produce to Asia.

Both our original and current guidance include growth in revenues and net income to replace several significant non recurring sources of revenues and income that we reported in the last year’s fiscal year 2009.

Despite the lower than expected export revenues during the first half of fiscal 2010, and even with the challenge of replacing the non recurring revenues in income from fiscal year 2009, we believe we can achieve flat to slightly lower revenues and flat to slightly higher net income this year. We will update you on our progress during our third quarter conference call.

Let me turn this over to Greg for details.

Gregory Skinner

Thank you Gary and good morning everyone. In yesterday’s news release Landec reported total revenues for the second quarter of fiscal 2010 of $60.9 million versus revenues of $58 million for the second quarter of last year.

The increase in total revenues during this year’s second quarter compared to last year’s second quarter was due to $4.4 million increase in revenues from Apio’s value added fresh cut vegetable business primarily as a result of increased market share.

This increase in revenues was partially offset by $1.3 million or 7% decrease in revenues from Apio’s commission trading business as a result of decreased export sales primarily due to a shortage of export fruit produce.

For the second quarter of 2010 the company reported net income of $1.5 million or $0.06 per share, the same as the second quarter of last year. There were several offsetting reasons resulting in flat net income.

Items increasing net income included first, a $166,000 increase in gross profit in Apio’s value added fresh cut vegetable business primarily due to gross profit on increased revenues which was partially offset by increased raw material costs for produce, second, a $192,000 decrease in operating costs and third, a $168,000 decrease in our income tax expense.

These increases in net income were offset by first, a $118,000 decrease in gross profit for Apio packaging due to the contractual decrease in Chiquita minimums and a decrease in R&D funding for Apio’s R&D agreement with the U.S. Military which was completed at the end of the second quarter of 2009; second, a $179,000 decrease in gross profit in the Technology Licensing business primarily due to the completion of the Air Product license payments during the third quarter of fiscal 2009; and third, a $189,000 decrease in interest income due to lower yields on investments compared to yields from investments in the same period last year.

For the first six months of fiscal 2010 Landec reported total revenues of $121.9 million versus revenues of $129.8 million for the same period a year ago. The decrease in total revenues during the first half of fiscal year 2010 was primarily due to there being one extra week in the first quarter of fiscal year 2009 resulting in 27 weeks in the first six months of last year compared to 26 weeks in the first six months of this year.

The extra week resulted in approximately $5 million of additional revenues in the first half last year. After excluding the extra week from last year’s first half, Apio’s trading business realized an addition decrease in revenues of $8 million due to our decision to exit virtually all of our domestically buy/sell business and due to a shortage of fruit to export.

These decreases in revenues were partially offset by $2.7 million increase in revenues from Apio’s value added fresh cut vegetable business. However, if you exclude the extra week during the first six months of fiscal year 2009, the increase in value added fresh cut vegetable revenues for the first six months of fiscal year 2010, would have been $5.8 million.

For the first six months of fiscal year 2010 the company reported net income of $3.7 million or $0.14 per share compared to $4.3 million or $0.16 per share for the same period last year. This decrease in net income during the first half of fiscal year 2010 compared to the same period last year was primarily due to first, an approximate $600,000 decrease in gross profit due to one less week in the first half of fiscal year 2010 compared to the first half of last year.

Second, a $305,000 decrease in gross profit for Apio packaging due to the contractual decrease in Chiquita minimums and a decrease in R&D funding from Apio’s R&D agreement with the U.S. Military; third, a $436,000 decrease in gross profit in the Technology Licensing business primarily due to the completion of the Air Product license during the third quarter of fiscal year 2009 and fourth, a $258,000 decrease in interest income due to lower yields on investments.

These decreases were partially offset by $798,000 reduction in our income tax expense primarily due to lower pre tax income and by $248,000 in lower operating expenses.

Turning to the Landec’s financial position, during the first six months of fiscal year 2010 the company generated $4.2 million of positive cash flow from operations. Overall, cash and marketable securities increased $2.1 million during the first half of fiscal year 2010 to $68.1 million.

For the first six months of fiscal year 2010 capital expenditures were $3.2 million and depreciation was $1.5 million.

Let me turn it back to Gary.

Gary Steele

As mentioned earlier, our current forecast is still for flat to slightly higher net income, while at this point we expect revenues to be flat to slightly lower compared to last year. Both our original and current guidance for fiscal year 2010 include replacing approximately $10.8 million of non recurring revenues and $2.5 million of non recurring pre tax income compared to last year.

We are currently forecasting that the non recurring reductions in revenues and gross profits will be replaced by increases in revenues and gross profit in our value added fresh cut vegetable business as a result of our continuing to increase market share which we are experiencing during the first half of this fiscal year.

We also expect overall operating expenses to be approximately 5% lower in the second half of fiscal year 2010 compared to the second half last year even while we are increasing R&D and business development expenses by 20%.

So where are we headed in the next 12 to 24 months? Our focus in on strengthening and sharpening our programs with our existing corporate partners, defining and staffing projects developing that result in new applications from our Polymer materials technology, identifying new corporate partners in select areas and identifying acquisition or joint venture growth opportunities. Let me just comment on those one at a time.

First, sharpening our focus with existing corporate partners; during this past quarter, we modified our agreement with Monsanto, allowing Monsanto to focus on specific seed treatment applications which are strategically important to Monsanto using Landec’s Intelecode Technology while giving us the flexibility to pursue on our own or with other partners, applications of our Intelecode Polymer Technology in seed codings outside of the Monsanto exclusive field.

Monsanto and Landec are now focused on specific target areas for seed treatments that will result in substantial yield improvements for the farmer. Monsanto wants us to exclusively focus on these significant game changing target areas and we are staffing our team accordingly.

In making this transition from a broad but not well defined field of seed applications to a highly focused development program, we see applications and opportunities where Monsanto and Landec can both benefit.

We now have the full rights either on our own or working with others, to make and sell Intelecode products for applications and seed coding and seed treatment arenas outside of this exclusive field with Monsanto. In return, Landec will self fund the R&D work that supports the specific applications for Monsanto.

We do not expect this agreement modification with Monsanto to have any impact on our financial results for all of fiscal 2010 as we will recognize a loss in this program during the third quarter of 2010 with an estimated offsetting profit during our fourth quarter of fiscal 2010.

Of interest concerning our seed business is that we have recently returned from the largest seed trade show in North America called AFTA where we met with virtually every top seed company to inform them of our new partnering flexibility.

The last ten years in the seed business were all about seed traits and seed genetics. It is becoming increasingly clear that the next ten years will be about seed treatments, which is where our unique Polymer technology products add benefit and value in the seed business.

For example, the cost of corn seed for the farmer has risen from $50.00 per bag just a few years ago to over $200.00 per bag as more and more improved genetics and traits are added to seeds. Seed treatments that protect these very expensive seeds from fungus and insects and pests in a safe, reliable way not only help lead to increased yields, but do so in much more environmentally friendly way. We are excited about the future prospects for our unique Polymer technology in the seed business.

Regarding Chiquita, the Chiquita program continues to expand in sales. You will see more coffee shops and convenience store sites using fresh Chiquita bananas for sale. In the quick serve restaurant arena, Chiquita is still in discussions with potential quick serve restaurant customers for sale of the Chiquita to go program using our [breath-way] technology.

In our Avocado program with Chiquita, we’re excited about the advancement about this program where Chiquita is now selling to both food service companies and retail grocery chains with plans to rapidly roll out the Avocado program in 2010 as Chiquita finishes its expansion of year round sourcing and scaled up processing for Avocados.

The second focus for the next 12 to 24 months is identifying new applications for our Polymer technology. With the help of our new VP of Business Development, we have identified five to six promising development projects with unique potential applications for the proprietary and versatile properties of our materials.

As mentioned in our guidance for fiscal year 2010, we are increasing R&D and business development spending by 20% to staff these programs and we will have more to say on these efforts in the future. Our goal is to have at least one if not two new licensing deals within the 20 to 24 months.

Our third focus is identifying new corporate partners. We have a significant investment in the area of drug delivery and we are in early conversations with big pharma and medical device companies regarding testing and evaluating our materials for the delivery of small molecule drugs and for the coding of various device surfaces that might enter the human body.

Although early, it is clear to us that the bio materials area is in need of help as traditional plastics and polymers have limitations. We will need to be patient in this area, but our view is that while most of big corporate America is cutting budgets; big pharma and medical device companies do need new product innovations now more than ever in the area of material science.

Our forth focus is on acquisitions and joint ventures. We have now identified two or three promising investment opportunities and will continue to pursue these targets. We have nearly $70 million in cash and want to invest it wisely. We will talk more about this later in our fiscal year as we progress.

We believe our future obligations to our shareholders are to focus on technology innovation and new product development, to continue to support collaborative partners, and to ensure that our sizeable cash balances are protected in investments that are safe and available as needed in order to selectively pursue and take advantage of profitable growth opportunities.

In the near term, as part of advancing these goals we expect to first, to see further expansion of sales by air products, not only to L’Oreal but to new personal care company customers; second, to further expand our market share in the fresh cut vegetable category, especially now that the category seems to be making a turn, third, move our work with Monsanto to field trials in calendar year 2010 with a new focus, and fourth, start one or more research initiatives and new applications of our material science technology, and fifth, move our M&A and investment activities from the broad search to a focus on one or two specific partner candidates.

Looking at the long term, we do have proprietary technology, a low cost structure, a strong balance sheet, allowing us to capitalize on new opportunities that are likely to emerge as undercapitalized companies look for partners and as large corporations who have been cutting R&D budgets look for new products. We see this as a time of opportunity.

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 are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Anton Brenner – Roth Capital Partners.

Anton Brenner – Roth Capital Partners

I wonder if you can quantify or if you would quantify the size for potential revenues from the Avocado roll out compared to what Chiquita has been doing with its bananas.

Gary Steele

We have to rely a lot on Chiquita’s views on this. If you assume for the moment that we have limitations of entering the retail grocery store market for bananas, which is the case right now if you recall, they think the Avocado opportunity is actually larger. One of the reasons is they have about a 3% market share in Avocados.

They feel that the Chiquita brand is a great fit for Avocados and with our ability to allow them to process Avocados such that they’re fully ripened and held in the fully ripened and ready to eat state for ten days, they’re telling us that they believe it’s a bigger opportunity than bananas.

What those dollar amounts are Tony is very hard for us to say because this is a totally new business not only for us but for them. But for them it’s many millions of dollars.

Anton Brenner – Roth Capital Partners

Let’s put it this way, if they’re going to roll out Avocados in fiscal calendar 2010, do you think by the end of the year that business would be big enough for Chiquita to be exceeding its contractual minimums for you?

Gary Steele

Can I give you maybe? I think it’s up to them. Our technology is working. I think they now have these infrastructure things in place. I would not be surprised if that’s the case. I would hope that’s the case. I would expect that to be the case. But it’s up to their speed of roll out. But certainly the market is there. The opportunity is there.

Anton Brenner – Roth Capital Partners

Can you give an idea as to the outlook for the revenues of the [Courtback] business of Landec ag over the near term?

Gary Steele

Can you say that question again please?

Anton Brenner – Roth Capital Partners

This is your cash from Monsanto which you can now sell the Landec ag business. What kind of revenue potential is there from that?

Gregory Skinner

In the near term we’ve got the Polymer Plus which was ongoing during the Monsanto three year period. So those revenues will continue. We’re hoping to dramatically expand those. We think we could get that in the near term, this next year up to close to $1 million in sales and then we’re going to try to resurrect and/or add to that.

If you recall we had an early plan several years ago. We had relay cropping and we’re looking at other applications that we hope to add, probably not this planting season, but the planting season after that.

But to answer your question, in the near term probably close to $1 million this next year.

Anton Brenner – Roth Capital Partners

Relating to your reduction in revenue guidance, it seems to me that three things have changed since your previous guidance. One is that the export revenues declined an additional $1.3 million. Secondly, you’re getting close to that much back from Landec ag, and thirdly the value added fresh cut vegetable business has turned up and the industry has turned up well in excess and ahead of what you had anticipated earlier, and it seems like you’re not assuming that improvement in your forecast.

Gregory Skinner

Our original forecast was assuming several things; one that value added was going to come back and it was going to grow. Remember if you call from the press release and the conference call earlier, we were in a hole of $11 million to begin with.

Anton Brenner – Roth Capital Partners

I’m reading from your last quarter release which said, “We expect weakness in the fresh cut vegetable category to continue through most of our fiscal year 2010.”

Gregory Skinner

At the end of last quarter we were looking at it saying, “You know there’s a good opportunity that if export could turn around, the ag category starts growing, we can make up this shortfall in the first quarter.”

Well, then we got to the end of the second quarter, export hasn’t turned around. It doesn’t look like if the second half of export as you know is very low, so we’re not going to pick up anything there, so we felt this was the time to say it could be tough to make up the $8 million that we’re behind through the first half of the year in the second half.

But there’s still a shot. That’s why we’re saying flat to slightly down.

Operator

Your next question comes from Peter Black – Winfield Capital.

Peter Black – Winfield Capital

If you excluded the new business as super value, would your vegetable revenues, your fresh cut vegetable revenues still have grown at a rate higher than the category? Do you have that type of information?

Gregory Skinner

Not right off the top of my head but slightly. But it gave us a real good boost.

Peter Black – Winfield Capital

And you were saying I think in your commentary that November you’ve seen an uptick as we got later into the quarter, right?

Gregory Skinner

Yes, the category is, we’ve got to be a little careful here. But the category has definitely made a turn in this recent quarter. This mix is still off. The trade volumes which are pretty profitable products for us is still off from the past because people are just not gathering as many family and friends together.

But the category seems to be taking a turn and we’ll be watching it every month. But we’re hopeful.

Peter Black – Winfield Capital

It was encouraging to hear you talk about the Avocado business and that potentially be the end of the year that might generate enough revenues to get you over the minimum payments you’re receiving.

Gregory Skinner

As you know Peter, when you’re in these licensing deals, you’re hoping for the best, but it’s in their hands. So they had some infrastructure things they had to put together. We’re told that those are now together, so let’s step on the accelerator.

Peter Black – Winfield Capital

Could you just give us more of an update on air products where we stand there, if they’re still moving more slowing than you’d hoped or if things are starting to pick up?

Gregory Skinner

They are starting to pick up and there is a big show in April in Europe and that’s a big launch for us for some new products that we’ve been working on with them over the last year, and we are in trials with new customers beyond L’Oreal. We’re expanding with L’Oreal. So there is some momentum there.

Peter Black – Winfield Capital

You touched on M&A. How far along are you in discussions? Do you expect to hear something in the next six months and what type?

Gregory Skinner

That’s such a speculative category. You can be very close and think you’re very close and you’re not. So I would expect that we’ll have something to say in the next six months.

Operator

Your next question comes from Morris Ajzenman – Griffin Securities.

Morris Ajzenman – Griffin Securities

I wanted clarification. The industry unit volume you gave for fresh cut vegetables, you said the industry, was it the second fiscal quarter was up 2% and you’re up 14%?

Gregory Skinner

No, for the first six months.

Morris Ajzenman – Griffin Securities

Do you have that for the second quarter though?

Gregory Skinner

We have preliminary data. We beat the category, but when we were looking at it, we’re somewhat questioning the information and we haven’t had time to finalize our analysis, but it is up higher than 2% during the quarter. But we still beat it based on the information we received which like I said, we’re questioning because it just doesn’t look right.

Gary Steele

It looks to us like they may have left out a couple of key customers in the Neilson data, but it looks like it’s higher than the 2% that we said for the overall six months.

Morris Ajzenman – Griffin Securities

So basically from the first quarter to the second quarter was improving trends for the industry and for the company, is that fair?

Gary Steele

And remember we said that at November, one year. You’ve got to be careful with data, but November was year over year as well.

Morris Ajzenman – Griffin Securities

That’s the industry, 8% right? But you didn’t comment on your number.

Gregory Skinner

I don’t have it. We’ll have to call you on that.

Morris Ajzenman – Griffin Securities

I’m just curious to see that trend. It looks like you're running; I mean just arbitrarily 6% to 7% higher than the industry trends. Is that still a fair fun rate you’re running in addition? I mean in the first half it’s much higher than that.

Gregory Skinner

Yes.

Morris Ajzenman – Griffin Securities

On the free cash flow or operating cash flow, $4.2 million first half, I presume the second quarter was flat to down? Do you have that number?

Gregory Skinner

Yes, it was down about $200,000. It’s a quarter where we invest a lot for the busy season and the fact that we have to invest a lot in the crops because we have to go down to the desert to get a good proportion of our broccoli and cotton. It’s during the winter months where we have to do some investing.

Morris Ajzenman – Griffin Securities

In the third and fourth quarter do you expect to be cash flow positive again?

Gregory Skinner

Yes, in the second half. You’ve got cut off issues with working capital and all that to say third versus fourth, but the second half should be positive.

Morris Ajzenman – Griffin Securities

You had cash exiting the previous quarter of $69.5 million and now it’s at $68.1 million so you cashed about $1.4 million even though you used $200,000, it’s just a reflection of working capital?

Gregory Skinner

It was a result of finishing our 40,000 square foot expansion.

Gary Steele

We’re pretty much complete with that and that was mostly second quarter activity.

Morris Ajzenman – Griffin Securities

But the CapEx is $6 million for the year, right?

Gregory Skinner

Right, we’re half way there.

Morris Ajzenman – Griffin Securities

So you’re not completed.

Gregory Skinner

No. Now we’ve got to put stuff in that to cash it.

Gary Steele

The infrastructure, the walls and the ceilings and things like that and the panels, that’s done.

Operator

Your next question comes from Chris Krueger – Northland Securities.

Chris Krueger – Northland Securities

You talked about gaining market share in the quarter on a fresh budget category. Can you give us what you believe your market share is approximately?

Gary Steele

It varies from trays and bags but roughly in the high 20’s to 30%.

Chris Krueger – Northland Securities

As far as you just kind of touched on how the winter months are different for sourcing. Can you give us signs of progress there? Does it feel like a typical year right now or what can you say on that?

Gary Steele

I’m glad we’re not growing produce on the east coast, but so far it looks like a typical year.

Chris Krueger – Northland Securities

As far as the expansion goes, can you refresh my memory on the timing of that and when that will be in use?

Gary Steele

I think third quarter we’ll be in good shape. We were storing a lot of our raw materials offsite. It’s pretty expensive to do that, and this is an efficiency improvement to bring our raw materials onsite right next to our processing plant. So that was one of the primary drivers for doing this. So we’ll be up and running fully in the fourth quarter.

Chris Krueger – Northland Securities

On the recent announcement on Monsanto and your ability to start marketing your other products again, I know there’s a large seed show in Chicago in mid December right before the holidays. I was just wondering if there’s any inkling of progress or any kind of feedback you can provide following that show.

Gary Steele

I can refer to it briefly. As you know we went to AFTA. We met with all the majors and informed them that we had a new flexibility, and everybody understood. So what really came out of it in our minds is how important seed treatments are going to be in the next few years.

So we have follow up meetings with all the majors basically, and our hope is since we’re a small company and have limited resources, we’d like to find one partner outside of Monsanto that we can work with on a target or two that really is substantial. So that’s our plan.

Our first focus of course is to advance the Monsanto program and to get it into field trials this year.

Chris Krueger – Northland Securities

On that note, what’s the attitude at Monsanto? Has there been more deeper planning initiatives put in place to move that along?

Gary Steele

Yes. I think that it took us a couple of years to understand what they wanted. We now know exactly what they want. They want us to keep that specific target confidential, but for them it’s a really big deal. They have formed a seed treatment business that is basically a branding business and using their marketing muscle to be selling seeds now with insecticides and pesticides on the seed, and they needed a carrier, something that would help deliver those materials.

And that’s why we got together. Now we know where they want to go and we’re focused on that, and it’s a big deal for them.

Chris Krueger – Northland Securities

I might have missed this on the call but what is the CapEx and depreciation for the quarter or for the six month period?

Gregory Skinner

For the six months CapEx was about $3.2 million and depreciation was about $1.5 million.

Operator

Your next question comes from Nick Genova – B. Riley & Co.

Nick Genova – B. Riley & Co.

Have you quantified the savings potential with that facility expansion?

Gary Steele

Yes, roughly. It’s about $200,000 to $300,000 a year depreciation.

Nick Genova – B. Riley & Co.

On the margin side, what’s the longer term trend there? You had some relief in the lower oil costs, that’s coming back up and you haven’t really seen the mix shift improve yet, but what’s kind of your longer term sense on the margin side?

Gary Steele

Well you know there’s seasonality to the margins and during the winter months the margins are historically down.

Nick Genova – B. Riley & Co.

I’m talking about outside of seasonality.

Gregory Skinner

Outside of seasonality we had the cost increase at the beginning of this year. We’re not seeing that at least for the next calendar year. So I would say going into next year we see margins being relatively flat to this year.

There’s an opportunity obviously if the mix changes for margins to go up but you just can’t predict that. Trays versus bags have been down for a long time now. If that shifts, then margins will go up.

Operator

Your next question comes from William Lauber – Sterling Capital Management.

William Lauber – Sterling Capital Management

You probably haven’t had a chance to look at this but I think Monsanto this morning has a press release out and they’re highlighting their R&D pipeline and I guess they’re mentioning 11 different projects in there. I can’t tell if you’re involved in that. I’m guessing you haven’t had a chance to see that yet?

Gary Steele

No, I heard about it but we haven’t seen it yet. Boy I would be surprised if they spoke to it explicitly because we’re sworn to secrecy and at risk of death if we talk about specific targets. But I’ll be interested in looking at it but I would suspect that there would be something in the seed treatment area on that list, but I wouldn’t think they would be very explicit about what we’re doing with them.

William Lauber – Sterling Capital Management

You addressed the CapEx and I guess the cash flow, what’s you’re projection for the end of this fiscal year on your cash balance?

Gregory Skinner

As we said in the press release we expect cash flow to be flat to slightly up from last year and then we expect that our CapEx will be in that $6 million range so free cash flow should be somewhere around $3 million to $4 million. For cash balance, add $3 million to $4 million from where we were at the end of last year, roughly about $70 million.

Operator

Your next question comes from Nelson Obis – Winfield Capital.

Nelson Obis – Winfield Capital

Just go over this one time. In regard to the modified agreement, you say in the press release that Landec will recognize a loss during the third quarter of 2010 that will be turn around with an offsetting profit during the fourth quarter of 2010. What’s going on there?

Gary Steele

In our modified agreement with Monsanto, quid pro quo is we get a highly focused, well defined field definition which we’ve been seeking for the last couple of years. Remember we started out with the world and the universe of applications in seed codings. So now in this new agreement we know exactly where we’re focused.

They have exclusive rights to it. The terms of the agreement are essentially the same as before except that we will self fund the R&D and the reason we’re willing to do that is it’s very synergistic with some other work we were doing here.

So in the third quarter we’re self funding and we don’t have the revenues yet from what we call the Pollinator Plus program which we got back from Monsanto. Those come in the fourth quarter. So in the third quarter we’re self funding. There are no offsetting revenues. In the fourth quarter, we sell a bunch of these Pollinator Plus seeds to industry leaders and that more than offsets our expenses for the second half.

So third quarter loss, fourth quarter profit; it evens out. So for this year we see no financial impact.

Nelson Obis – Winfield Capital

So you have visibility on the Pollinator Plus.

Gary Steele

It’s ours. We’ve got about 20% of the acres, what’s called seed corn acres and a number of our customers are major seed companies. So that’s back in our fold but we’re not recognizing any of those revenues in the third quarter.

Nelson Obis – Winfield Capital

In regard to air products, what’s the longer term view there? Are you finished one phase with them? I know there have been some ups and downs there, but last time I think you spoke, things didn’t look that bad down the road, but it’s hard to tell from the press release.

Gary Steele

We had some; I think I mentioned in one of the earlier conference calls for their products, this was a new business for them. They expected that they were going to buy the capability of formulation and sales and marketing of cosmetics and personal care products through acquisition. That did not materialize so they had to start growing that themselves and put a team in place. So that really kept things in a slow mo mode for several years.

Now that they have that team in place we see momentum, and it’s all about new products and expanding beyond L’Oreal. So that’s where we are and that’s why we’re feeling more optimistic about this program.

Nelson Obis – Winfield Capital

So the timing on that, when? Next year maybe?

Gary Steele

I think it’s already happening now and as I said the show in April is a big launching pad for us to introduce some new productions. By the time those really get kicked in you’re really starting to see the benefits of that in our next fiscal year which begins June 1.

Operator

Your next question comes from [Greg Pyringer – Wells Capital Management]

[Greg Pyringer – Wells Capital Management]

You’ve been more forthcoming in talking about your significant investment in drug delivery and the need by big pharma for this type of application which is a positive from your past comments yet you council us on patience on how slowly that may develop. Is that an outgrowth of your past experience with some of these licensing deals or could you be a little bit more specific on your gut feel for how these talks may develop?

Gary Steele

It’s a function of a couple of things. We are bringing a new technology platform which frankly scares people initially because in the drug delivery area you like tried true things that have been around for a long time and there’s no perceived toxicology or safety issues and things like that, so we have to jump that hurdle.

Secondly, it’s a new area for us and we didn’t have a business development person until recently and along with our COO we now have some focus on that. What we’re seeing is benefits, I think I’ve talked a little bit about and that is, typically in a drug release profile, you’re going to see an initial burst of a lot of the active being released and then it dissipates pretty quickly.

So we are seeing very little to no burst effect in our technology. Our polymer materials grab the active. They hold it in and then slowly dispense it, so that lack of burst effect is a positive. We can get very high loadings. We can put a lot of drug in our polymer if you need it, and that’s good.

We can deal with some insoluble molecules that are very difficult for the pharmaceutical industry to deal with because more and more drug actives are in what’s called the insoluble range. And then the ultimate goal is that you have no burst effect. You have high loadings and you can release over very long periods of time.

So that takes trials not only in-vitro but in-vivo trials. So you’re seen the drill. You know the story. It takes some time to develop the data, to get the tox package so that everybody is feeling comfortable about safety, and then to make it know that Landec actually has something unique and differentiable.

Also, we’ve been very busy in terms of filing broad patent coverage on this. It’s very important in this field. People respect and honor patents. So that’s what takes the time. But we think it’s an interesting area.

Plus, we feel that our materials might be useful is in certain types of material surfaces for devices that are going into the human body. So those are the two areas that we’re looking at.

[Greg Pyringer – Wells Capital Management]

So when you say your goal is to strike one or two licensing deals, I forget your exact language, within the next 12 to 24 months, is this potentially one of them?

Gary Steele

Yes, absolutely.

[Greg Pyringer – Wells Capital Management]

Aesthetics scientists seems to be plugging along. You talked a little more positively about this stem product.

Gary Steele

It’s not a stem product; it’s called the Smart Fill system. I want to be really cautious about this one. This is a company that was funded by a couple of venture capital firms. We licensed the technology to them in the field of dermal fillers, aesthetic, getting rid of wrinkles and things like that.

It’s been a very passive investment for us. We don’t engage in R&D or anything like that. We’re not on the Board. And, it’s at a point where I think the venture backers have said, “Hey look, we’ve put our initial money in. Now get a deal either by selling the Smart Fill rights or by licensing them.”

And we’ve got on our books a $1.8 million investment that came with the licensing of our technology. We didn’t actually put any cash in the company. If they can’t get a deal, and if the venture capitalists don’t want to put any more money in it, we’ll need to write that off. And so we want to give everybody a heads up that that possibility exists.

But they’re in discussions with several companies, so at this point let’s be optimistic and hope that one of those deals is consummated and we go forward and we see this Smart Fill system commercially launched not only in the U.S. but globally.

[Greg Pyringer – Wells Capital Management]

And your equity ownership there is 20% or so is that correct?

Gary Steele

It’s about 17%. There was a second round that we did not participate in, so it’s about 17%.

Operator

Your next question comes from Morris Ajzenman – Griffin Securities.

Morris Ajzenman – Griffin Securities

One more go around with the modification with Monsanto. You referred to a third quarter loss offset by a fourth quarter gain. Are those numbers going to be immaterial or should be aware of that for our modeling purposes?

Gregory Skinner

Immaterial.

Operator

Your next question comes from William Lauber – Sterling Capital Management.

William Lauber – Sterling Capital Management

Just following up on the drug delivery; I remember probably three years ago that one of you had mentioned I guess one of the positives from your long ago relationship with Alcon on the dry eye product, but you had already had some regulatory approval for body use. Could you explain what kind of advantage that might be for your negotiations with a partner in drug delivery?

Gary Steele

It gets you in the door. The fact that you’ve gone through some toxicology and safety work, this was a material that went into the eye if you recall, for dry eye. You’re not fighting this credibility question up front when you’re dealing with medical companies.

On the other hand, if you’re talking about drug delivery, you’re talking about a material that either has to dissipate fully and exit the body over time in a safe way, or you have to explain it. You have to take it back out.

So there’s still plenty of toxicology and safety questions that a partner would need to address with us if we were putting this in humans as a drug delivery system. So it’s helpful to say and to know that we’ve got data already, but it’s not sufficient to say that we’ve got all the data.

William Lauber – Sterling Capital Management

It helps you get in the door but does it speed up the regulatory process at all?

Gary Steele

Yes. When we get to that point it will.

William Lauber – Sterling Capital Management

Any kind of estimate? Obviously whenever you get a deal here it’s going to be I would imagine, I won’t put words in your mouth because I don’t really know, but when you strike a deal how long would you estimate before it would be commercially viable?

Gary Steele

Years, because of the regulatory and clinical environment. That doesn’t mean to say that our revenue stream has to be years because as you know, in the pharma area, you are able to, if things are working for you and your patent protection is good, you can have some sizeable revenues from licensing and milestone payments that things like that.

But in reality, anybody that’s been in the drug world knows that these things take years.

William Lauber – Sterling Capital Management

I guess with this deal as well as the other deals, your preference is to get upfront fees when you sign a deal. Is that fair to say that that’s pretty high on your priority list?

Gary Steele

Let me just say we’re newcomers to this field so we’ve got to be realistic that this is a new territory for us. It’s not as though we have a long history. But if you look at our history, generally when we license things exclusively and that’s generally the preferred choice for the partner, and frankly for us, we’re getting upfront money. So our history has been to get upfront money.

Operator

There are no further questions at this time. I would like to turn the program back to management for any further remarks.

Gary Steele

I think Tony Brenner asked a good question. I don’t think we answered it as crisply as we can. Greg why don’t you repeat Tony’s questions and then address that question.

Gregory Skinner

Tony asked in the first quarter we had stated that revenues would be flat to slightly up knowing that we had this $11 million hurdle that we had to jump over, and why now are we saying that revenues will be flat to slightly down.

Upon further thinking about it, after my initial response, what I said earlier is factual, but a piece that was missing was that we actually expected that at the end of the first quarter that the trading revenue would be higher in our second quarter because we expected, we were looking at, we thought the stone fruit which is a major export item for us, was delayed in the stone fruit.

As it turned out, it wasn’t a delay is was actually reduced yields so the fruit wasn’t there to export and as a result, instead of trading being up during the second quarter, it was actually down $1.3 million which was a fairly significant swing to where we thought we were going to be at the end of the first quarter and hence the change in our guidance. So hopefully, that clarifies.

Gary Steele

We appreciate everybody being with us today. Thank you very much. We look forward to keeping you up to date on our progress. Many thanks.

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Source: Landec Corporation F2Q10 (Qtr End 10/29/09) Earnings Call Transcript
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