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Landec Corp. (NASDAQ:LNDC)

F2Q08 Earnings Call

January 4, 2008 11:00 am ET

Executives

Gary T. Steele - Chairman,Chief Executive Officer, and President

Gregory S. Skinner -Chief Financial Officer, Principal Accounting Officer, VP of Admin., and VP ofFin.

Analysts

Tony Brenner - RothCapital Partners

Bill Gibson -Nollenberger Capital Partners

JonathanLichter - Sidoti & Company, LLC

Steve Denault -Northland Securities

Saloman Kamalodine -B. Riley & Co.

Craig Pieringer -Wells Capital Management

Shawn Boyd - WestcliffCapital Management

Jeff Osher - JMPAsset Management

Operator

Good day, ladies andgentlemen and welcome to the Landec Corporation’s first half and secondquarter of fiscal 2008 earnings conference call. At this time all participants are in a listen-only mode. Later we’ll conduct a question and answer session and instructionswill be given at that time. (Operator Instructions) As a reminder, this conference call is beingrecorded. I would now like to introduceyour host for today’s conference, Mr. Gary Steele, President and CEO of LandecCorporation. Sir, you may begin.

Gary T. Steele

Good morning andwelcome to Landec’s first half and second quarter of fiscal year 2008 earningscall. I have Greg Skinner with me today, Landec’s Chief FinancialOfficer. This call is being webcast byThomson CCBN and that can be accessed at Landec’s website at www.landec.comon the Investor Relations page. The webcast will be available for 30 days through February 2, 2008. A replay of the teleconference will be available for one week by calling888-266-2081 or 703-925-2533. The access code for the replay is 1176307.

During today’s callwe may make forward-looking statements that involve certain risks anduncertainties 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 2007.

As reported in yesterday’s press release, for the first six months of fiscal year 2008, overall revenuesof $121.6 million increased 14% while overall gross profit increased 29% from the year ago period. Net income increased to $6.2 million compared to $122,000 in the first six months of last year. Notably during the first six months of fiscal year 2008, Apio value addedspecially packaging vegetable products grew 11% to $78.7 million and valueadded gross profit increased 11% to $12.1 million. The gross margin in the value added business for the first six months of 15.4% is consistent with the year ago six months gross margin in the value added business.

In our technology licensing business for the first six months, revenues increased by $2.3 millionwhile the license fee gross profit increased by $2.5 million compared to the same period last year, which was primarilydue to the Intellicoat license agreement with Monsanto signed in December 2006. Overall, Landec generated $4.8 million in operating cash flow during the first six months of fiscal 2008. Based on the results for the first six months of fiscal year 2008, we are on track for achieving our revenue and netincome goals for fiscal year 2008. Accordingly, we are not changing our original guidance for the fiscal year 2008 which is to increaserevenues by 10% to 15% and, after excluding $18.8 million of non-recurringevents from fiscal year 2007, to increase pre-tax net income by 45% - 55%, andincrease net income after tax by 30% - 40% compared to fiscal year 2007results.

As a reminder from our last call, during the first six months of fiscal year 2008, we expanded ourjoint technology license and supply agreement with Chiquita. The expanded agreement includes additionalexclusive fields for bananas. In addition, Landec and Chiquita entered into a new exclusive license using Landec’sBreatheWay packaging technology for avocados, for which market tests for foodservice applications are already underway.

Under this agreement,in exchange for expanding the exclusive license fields for bananas andadding an exclusive license for avocados, the minimum gross profit amounts from the purchase of BreatheWay packaging by Chiquitawill increase by a total of $2.1 million over Landec’s next fiscal years to $2.9 million in fiscal year 2008 and to $2.2 million in fiscal year 2009.

All in all, we are tracking well, and barring any significant and extended adverse weatherconditions during the second half of fiscal year 2008, our progress is in line with our internal plan for meeting ourgoals for fiscal year 2008. Let me turn to Greg Skinner for details of ourresults.

Gregory S. Skinner

Thank you, Gary,and good morning, everyone. As outlined inyesterday’s newsrelease, Landec reported total revenues for thefirst six months offiscal year 2008 of $121.6 million versus revenues of $106.3 million for thesame period a yearago. Theincrease in totalrevenues during thefirst half of fiscal year 2008 was due to first, an11% or $7.8 million increase inrevenues from Apio’s value added vegetable business, second, a14% or $4.9 million increase inrevenue’s from Apio’s commission trading business, and third, a$2.3 million increase inlicense fee revenues primarily due to revenues from theIntellicoat license agreement with Monsanto.

For thefirst six months offiscal year 2008, thecompany reported net income of $6.2 million or $0.23 pershare compared to net income of $122,000 for thesame period last year. This increase innet income during thefirst half of fiscal year 2008 compared to thesame period last year was due primarily to first, a$1.2 million increase ingross profits inApio’s value added vegetable business, second, a$2.5 million increase inlicensing gross profits as aresult of theIntellicoat license agreement with Monsanto, and third, theelimination of $5.5 million of operating losses incurred by Landec Ag inthe first sixmonths of fiscal year 2007 as aresult of the sale ofFielder’s Choice Direct to Monsanto inDecember 2006, and thefact that under theIntellicoat license agreement, Monsanto is currently paying for allof Intellicoat’s operating costs.

These increases innet income were partially offset by one-time net proceeds of $1.5 million from aninsurance settlement received during thefirst six months oflast year which was reported as areduction of general and administrative expenses inthe prior year, andfrom the increase inthe book income taxexpense of $2.4 million during thefirst half of fiscal year 2008 compared to thesame period last year.

Itshould be noted thatonly $150,000 of the$2.4 million of thebook income tax expense is expected to bepaid in cash because therepurchase of Apio’s options resulted ina tax deduction of$19.7 million which reduced Landec’s cash tax liability to theminimum owed under Federal AMT. However,for book purposes, the$19.7 million is not considered adeduction when calculating theincome tax expense because theoptions that were repurchased had never been included inprior periods as anexpense for book purposes.

For thesecond quarter of fiscal year 2008, Landec reported total revenues of $59million versus revenues of $55.2 million for thesame period a yearago. Theincrease in totalrevenues during thesecond quarter of fiscal year 2008 was due to a10% or $3.5 million increase inrevenues from Apio’s value added vegetable business and a$940,000 increase inlicense fee revenues, primarily due to revenues from theIntellicoat license agreement with Monsanto. These increases inrevenues were partially offset by a$761,000 or 4% decrease inrevenues from Apio’s commission trading business due to thetiming of the exportshipments.

Thegrowth in overallrevenues during thesecond quarter of fiscal year 2008 was lower than theoverall revenue growth during thefirst quarter of fiscal year 2008 due to thetiming of Apio’s trading revenues which aresubject to seasonal fluctuation. During thesecond quarter of this fiscal year, Apio trading revenues decreased 4% comparedto the second quarterof last year, whereas during this year’s first quarter, trading revenuesincreased 36% compared to thefirst quarter last year.

For thesecond quarter of fiscal year 2008, thecompany reported net income of $3.1 million or $0.12 pershare compared to net income of $108,000 thesame period last year. This increase innet income during thesecond quarter of fiscal year 2008 compared to thesecond quarter last year was primarily due to a$1 million increase inlicense and gross profits which is primarily due to theIntellicoat licensing agreement with Monsanto and theelimination of $3.1 million of operating losses incurred by Landec Ag inthe second quarter offiscal year 2007 which is non-recurring due to theMonstanto deal.

These increases innet income were partially offset by first, theincrease in incometaxes of $1.2 million during thesecond quarter of fiscal year 2008 compared to thesame period last year; second, a$391,000 decrease ingross profits inApio’s value added vegetable business, primarily due to seasonal produce supplyshortages during thesecond quarter of fiscal year 2008 which required Apio to purchase some produceon the open market atprices above contracted prices, compared to theyear ago quarter whenshortages were insignificant, and third, a$188,000 decrease ingross profits for thetrading business primarily due to thetiming of export shipments.

As Garymentioned, during thesecond quarter of fiscal year 2008, gross margins for thevalue added vegetable business were 15.4%, which is inline with historical gross margins for thebusiness. Inthe second quarter oflast fiscal year, when there were virtually no supply shortages, thevalue added business generated gross margins of 17.9%, which is well above thehistorical average for Apio’s value added business.

Turning to thebalance sheet, during thefirst six months offiscal year 2008, our cash balance decreased by $17.4 million to $45.3million. Cash balances primarily decreasedbecause of therepurchase of all of theoutstanding common stock and options of Apio’s not owned by Landec for $20.8million, and thepurchase of 1.5 million of value added property and equipment. This decrease incash was partially offset by $4.8 million of cash generated fromoperations. That concludes my formalpresentation. Gary?

Gary T. Steele

Thanks, Greg. Ourfirst half results show thebenefits of Landec’s increased focus on its two corebusinesses, the Apiofood business and thetechnology licensing business. Inthe food business, thefocus is on selling value added specially packaged vegetable products and onselling BreatheWay packaging to keypartners for high value perishable produce products. Inthe technologylicensing business, thefocus is on licensing and commercializing Landec’s patented polymer materialsto key partnersoutside of food applications.

During thefirst half we benefited first from normal weather patterns, second fromincreased demand for our specially packaged fresh cut food products, third fromour licensing arrangement with Monsanto, fourth from increased interest incomefrom the cash receivedfrom the sale ofFielder’s Choice Direct to Monsanto inDecember 2006, and fifth from theabsence of losses from Landec Ag which had historically occurred during thefirst six months ofeach fiscal year.

As we look forward inour Apio business, a keydriver of future revenue growth is to continue growth inour value added specialty packaged fresh cut product business to retail grocerystores, club stores,and food service outlets. To date, ourbusiness has grown atrates above market category growth and we have been able to take market shareusing our proprietary BreatheWay packaging technology that extends shelf lifeof perishable products. As consumersmake better choices about their health and eating habits and continue to lookfor healthy fresh-prepared food products, we envision our category continuingto grow.

Turning to our non-food technology licensing business, we arebusy first with our partnerships with Monsanto and AirProducts as well as our internally-funded corporate R&D efforts focused onour unique polymer chemistry. We areexpanding our R&D staff and filing more patents. Inimplementing our licensing strategy, we aredependent on our partners such as Chiquita, Monsanto, and AirProducts to develop, launch, and market new products using our technology.

Inour food business, our business plan does make provision for some weathervariability issues, but not for extreme conditions such as prolonged freezingor heat waves. We areworking to stay ahead inour markets and applications through innovation, uniqueness, and newproducts. We arepleased about our expanded relationship with Chiquita that does include awide range of license applications for bananas using our BreatheWaytechnology. We areimpressed with Chiquita’s brand, logistical support, customer relationships,international presence, and strength intechnology development. Although theChiquita-To-Go program is still relatively small, Chiquita nearly doubled theunit volume sales incalendar 2007 compared to 2006. Chiquita’s focus is to aggressively expand theChiquita-To-Go convenience store program inNorth America and Europe to identify quick-serve restaurant chainsthat can benefit from having bananas on their menu and to continue to develop anarray of products that will allow asuccessful roll out ofretain products to grocery store chains.

Inavocados, our focus with Chiquita is to package avocados to extend theshelf life of ripe and ready-to-eat avocados. Chiquita recently started food service market trials for avocados packedin our BreatheWaytechnology and retain grocery store product designs for avocados arenow in development. InNovember 2007, Chiquita announced amajor reorganization and restructuring of its company with theobjective of reducing annual operating expenses $30 to $40 million peryear to increase thefocus of the companyon innovation and technology. Chiquita hastold us that Landec’s BreatheWay technology is their number one priority forcreating value added businesses for bananas and avocados for both food serviceand retail markets. Thereorganization initiatives atChiquita appear to bepositive for Landec. Inthe short term, thereis going to be atransition period while Chiquita completes its reorganization and thus itwill take some time for thenew team to come fully up to speed as itrelates to our retail grocery store banana applications. We will keep you posted on Chiquita’sprogress.

Our work with Monsanto is progressing well. Monsanto is inearly stages of assessing how Landec’s polymer technology can beused for seed coatings inbroad areas including corn, soybeans, cotton, and canola. Inaddition, Monsanto is interested inevaluating how active ingredients such as insecticides, fungicides, andpesticides can beeffectively delivered as acomponent within our Intellicoat coatings. We areobviously preparing for spring trials.

We stated earlier inthis year that we would beseeking new partners or expanding current partnership agreements for sellingour BreatheWay packaging technology for new product targets. Our first such agreement is theexpanded agreement with Chiquita to collaborate on avocados and that’s ourfirst move outside ofbananas. We doexpect to enter into anadditional technology partnership arrangement with anew partner this fiscal year and hopefully during our third fiscal quarter.

Looking forward, we continue our search for possibleacquisition targets inthe food arena thatcan utilize or aresynergistic with our technology and that uses our channels ofdistribution. We will bevery selective in oursearch and as stated earlier inthis year, we areexpanding our R&D efforts with thefocus on delivering unique polymer systems that can deliver large and smallmolecules based on changesin temperature, time,and PH.

Thank you and we arenow ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. (OperatorInstructions) Our first question comes from Tony Brenner of Roth Capital Partners. Your question, please.

Tony Brenner - Roth Capital Partners

Thank you. Gary, can you indicate what the reason for the auditor change was?

Gary T. Steele

Tony, it’s economicsand solely economics. I’ve worked withErnst & Young or Arthur Young, the predecessor for over 20 years, so this was not done casually but we just foundthat the fees were well above what we wanted to pay and we are going with the what would be called the number five accounting firm in the country, McGladrey, who has much more reasonable fees. We have no disagreements with Ernst &Young whatsoever. This is strictlyeconomics and we felt this was in the best interests of shareholders to work withMcGladrey, so we made the decision and made the change.

Tony Brenner - Roth Capital Partners

Okay. One balance sheet question. What’s the reason for the increase in the accumulated deficit year over year?

Gregory S. Skinner

That was the repurchase of the Apio options. That’s where it was recorded. Recall that it’s a tax deduction but not a book deduction so it didn’t go through the income statement. Everything was balance sheet so you had a debit to your gained earnings and a credit to cash.

Tony Brenner - Roth Capital Partners

Gary, judging from your comments regarding Chiquita, itsounds like at leastover the short termthat business is ramping up ata moderate pace. Does that mean they’ll bewriting a check inthe fourth quarter tomeet their guarantee?

Gary T. Steele

Yes.

Tony Brenner - Roth Capital Partners

Okay and last question. As I recall, atthe time you signedthat revised licensing agreement with Chiquita, you indicated that thatagreement was included inyour guidance but additional licensing deals were not. Sowhen you announced this new licensing deal, I’m assuming itinvolves some sort of up front fee or ongoing licensing fee. Would that bejust added into your guidance?

Gregory S. Skinner

Let mejust say that thecollaboration that we’re working on and we hope to consummate is very orientedtowards technology access for Landec and it’s not something that would beupfront license fees and itwould not be thereforeincremental to our guidance.

Tony Brenner - Roth Capital Partners

Can you say anything more about the agreement?

Gregory S. Skinner

No.

Tony Brenner - Roth Capital Partners

Thank you.

Gregory S. Skinner

Thanks, Tony.

Operator

Your next question is from Bill Gibson of Nollenberger Capital. Your question, please.

Bill Gibson - Nollenberger Capital Partners

I’m going to headinto Chiquita’s well and the retail. They completed the initial market in consumer testing and they’re movingforward. Are they still using the technology in the test markets or has this come to a complete halt? What’s the nature of this?

Gary T. Steele

Thefirst phase was finished and soright now we’re indevelopment of new product formats and new configurations socurrently as we speak we’re not inthe test mode but whenwe go back into thetest mode, they’re clearly going to beusing Landec’s BreatheWay technology.

Bill Gibson - Nollenberger Capital Partners

And arethe number of marketslikely to expand?

Gary T. Steele

When you saynumber of --

Bill Gibson - Nollenberger Capital Partners

I think that ifChiquita was testing in three markets, do we have a five, do we have a ten?

Gary T. Steele

Well Bill, I’ll haveto tell you that I don’t know and part of that answer is that there are some new players and some new peopleinvolved in our collaboration. It looks like they’re going to be the right folks focused on the right things but there is a transition here with Chiquita that is goingto take about a quarter or two for some of this to sort out. Will they go into moreexpanded trials? I don’t know. I would guess they’d start with about the same number that we left off with which wasabout 80 store sites, but I really don’t know for sure, Bill, and we’ll knowmore in the next quarter.

Bill Gibson - Nollenberger Capital Partners

Okay. Thanks, Gary.

Gary T. Steele

Thank you.

Operator

Your next questionis from Jonathan Lichter of Sidoti & Company. Your question, please.

Jonathan Lichter - Sidoti & Company, LLC

Good morning. You mentioned it would take a quarter or two to sort out. Does that mean that we’re looking at some time in ’09 before they could possibly roll this out to supermarkets?

Gary T. Steele

Areyou referring to fiscal year or calendar?

Jonathan Lichter -Sidoti & Company, LLC

Calendar year.

Gary T. Steele

I would hope it’s earlier than that. It’s hard for meto tell, Jonathan, with this transition, but I think our hope and expectationis that it could besooner than that.

Jonathan Lichter - Sidoti & Company, LLC

Okay. How many locations is Chiquita-To-Go in currently?

Gary T. Steele

You know, I don’tknow. They just reported that they’vedoubled or nearly doubled their sales volume, unit volume. I’m not sure what the sites are and so I hate to give you a bad number, but I think the last time they reported, I’m trying toremember... Greg, can you remember the last time they publicly reported sites?

Gregory S. Skinner

I’d say conservatively over twelve so that would indicate 12,000.

Gary T. Steele

Over 12,000sites. So they’re in more than that, Jonathan, but we don’t have a precise number right now.

Jonathan Lichter - Sidoti & Company, LLC

Okay. Can you break out how much of that $177,000is from Chiquita versus from the military?

Gregory S. Skinner

It’s about 50-50.

Jonathan Lichter - Sidoti & Company, LLC

Okay. Should we read anything into the fact that you reported the six month results before the Q2 results?

Gary T. Steele

No, other than to say that what we’ve said all along is that we’re trying to buildshareholder value over the long term and the way we measure ourselves and the way we run the business is to meet annual goals and we’rejust not a quarter-by-quarter company. Anybody that gets too worked up on a quarterly basis really this is not us. So our format going forward will be to report first and foremost year-to-dateresults which is consistent with the way we’re running the company and then we’ll report the quarterly results so I wouldn’t read anything into it other than that.

Jonathan Lichter - Sidoti & Company, LLC

Thank you.

Gary T. Steele

Thank you.

Operator

(OperatorInstructions) Our next question is fromSteve Denault of Northland Securities. Your question, please.

Gary T. Steele

Good morning, Steve.

Steve Denault - Northland Securities

Good morning,everyone. The management turnover within Chiquita, didthat fall after or before the new fields of bananas where that agreementwas struck and the avocado agreement was struck?

Gary T. Steele

Theorder was the newagreement was struck and then thereorganization was announced inearly November and itwas significant, and Fernando Aguirre, theCEO of Chiquita’s charter, which hehas been very clearabout, is to revitalize Chiquita into aninnovation company and acompany focused on value added products and less sofrom commodity businesses, sothe order was theagreement was struck, some time went by and then they reorganized and announcedthat reorganization inNovember, but I amsure the senior teamknew about thereorganization at thetime of doing our deal.

Steve Denault - Northland Securities

Okay. How recent was their decision to trialintelligent polymer within the food service channel?

Gary T. Steele

You mean ourpackaging technology for bananas?

Steve Denault - Northland Securities

Yeah, and then foodservice.

Gary T. Steele

They’ve beenactually, this Chiquita-To-Go program which we referred to that almost doubled in the last year is really food service so they’ve been at that for over 18 months, maybe 24 months,and they focus on convenience stores, coffee chains, mini mart gas stations, so that would all be viewed as food service. So they’ve been at that for a while. Their focus now, actually they’regoing to continue to roll that out, their focus now is to really go after some large quick-serverestaurant chains which you might call fast food outlets et cetera, so that’s a priority for them, and then the other priority is to learn from the market research that we did in the last couple of quarters for retail grocerystores, get that information incorporated into some new product configurations, newproduct formats, and then get that back into testing as soon aspossible. So that’s their list of priorities.

Steve Denault - Northland Securities

Okay and remind me again, Chiquita does the apple bites for which QSR?

Gary T. Steele

I think they do it for McDonald’s, don’t they?

Gregory S. Skinner

I think Subway also.

Gary T. Steele

Subway andMcDonald’s. So yeah, that’s Chiquita.

Steve Denault - Northland Securities

Okay. Considering that we’re I guess well into the third quarter, there’s a little bit in the way of sourcing shortages in the second quarter, how is the sourcing looking through the quarter to date?

Gary T. Steele

Well, it was looking really good. We’ve got in the Northern California area we’ve got four days of horrendous storms. We had a contingency plan here in case our power went out, what we were goingto do with this call. Whether that makes its way and affects the central growing areas, we won’t know for a while, but so far the sourcing has been just fine, Steve.

Steve Denault - Northland Securities

Okay, and then if Icould ask one final question. Withinvalue added, if we look at the 9% or 10% growth, how much of it was organic versus new distribution, if youknow what I mean?

Gary T. Steele

Could you elaboratejust a little? I think the growth was 10% but when you say organic, sometimes we get confused with organic produce.

Steve Denault - Northland Securities

Right, right. Meaning how much of it was, what would the same store sale number have been versus newdoors of distribution?

Gary T. Steele

Let me get back to you because Greg and I don’t knowthat. It’s a fair question. We owe you an answer. I just don’t have it right now.

Gary T. Steele

Okay.

Gary T. Steele

I understand your question and we’ll getback to you.

Steve Denault - Northland Securities

Okay, thank you.

Operator

Thenext question is from SalomanKamalodine of B. Riley & Company. Your question, please.

Saloman Kamalodine -B. Riley & Co.

Hey guys. Can youcomment on your licensing pipeline beyond this deal that you expect to announcebefore the end ofFebruary?

Gary T. Steele

Thelicensing in myexperience, and I’ve done itfor a lot of years, iskind of a bumpy... It comes infits and starts and we have been focusing on this next technology accesslicense for some time sothat’s been a priorityfor us. I would saythat of our priorities, obviously we have other things that we’re working on,but I don’t know if any of those would materialize this year and I would askyou not to expect those, not this fiscal year, but we’re putting more attentionand time into theM&A area and sothat’s a priority forus, but we’re going to bedarn picky and choosy about that. Soif I had to steer you, I’d sayimagine that more and more of our emphasis and focus is inthe M&A area rightnow because we see anopportunity to extend and expand our technology more quickly that way.

Saloman Kamalodine -B. Riley & Co.

Would that take theform of acquiring acompany that is currently generating revenue or would you bebuying patents or what should we think about?

Gary T. Steele

No, our orientation is to real companies making realearnings, which is part of thechallenge because there area lot of companies outthere that are justone year away from making money if you know what I mean.

Saloman Kamalodine -B. Riley & Co.

Right, but where thetechnology would becomplimentary --

Gary T. Steele

We would have -- our technology could bedirectly applied thenext day. That’s what we’re looking for.

Saloman Kamalodine -B. Riley & Co.

Okay, and as far as what you’re looking attoday, do youinternally the way youwork, do you justfocus on one or two large opportunities or atany given time do youhave several opportunities that you’re involved in?

Gary T. Steele

Arewe still in theM&A area or --

Saloman Kamalodine -B. Riley & Co.

No, this is just thelicensing.

Gary T. Steele

Okay. We look broadlyand as I mentioned earlier, we’re stepping up R&D spending and we’re reallyinterested in how ourtechnology... To date our technology hasbeen primarily relying on thetriggering of atemperature switch, anon/off switch that in thecase of packaging is helping us control anatmosphere as we go through avolatile temperature cycle through thecoal chain and thedistribution cycle. We’re increasingly finding that we can dosimilar types of things with changesin PHor changes intime and so we’reputting more emphasis inour R&D on expanding our patent estate and looking for newapplications. By theway, some outside of thefood area. Not allare inthe food area. Sothat’s a stepped upemphasis for us and I gave guidance to that earlier inthe year that we’d bedoing this and we are.

Saloman Kamalodine -B. Riley & Co.

Okay. Can you give usa little bit ofguidance on what thetake or pay paymentwill be from Chiquitanext quarter?

Gary T. Steele

Well, for theentire year, Saloman, as we reported, it’s $2.9, and as you can seebased on the resultsfrom Apio packaging or thefirst half of the yearthere was very little, soyou can assume that most of that $2.9 is going to occur inthe second half and Ithink it would besafe to say it’s about50-50 third quarter and fourth quarter.

Saloman Kamalodine -B. Riley & Co.

Okay, and then finally can you comment on theopportunities that you have infront of you to expand themargins at Apio valueadded on a longer termbasis either by sourcing maybe south of theborder or anything of that sort?

Gary T. Steele

Let mecut to the chase andtell you that our goal and objective is to maintain thecurrent margins. We’ve got quite abit of pressure on thecost side. I don’t need to tell you about fuel costsgoing up and how that affects farming, et cetera. Sowe’ve got quite a bitof pressures to offset costincreases so while wewould love to expand margins on theexisting fresh cut specialty package VA veg business, I think realistically ourgoal and objective is to try to maintain those. Where we want to changethe margin mix for thecompany is by having ahigher percentage of our future margins coming from licensing revenues androyalties and from our packaging only business where we’re selling onlypackaging at very highpercentage margins to partners such as Chiquita sowithin the VA vegbusiness, realistically, we sure would like to try to maintain that as we facethese increasing costs, but overall over time, we want themargin mix to changeto help increase theoverall margins of thecompany as I mentioned.

Saloman Kamalodine -B. Riley & Co.

Sure. Okay, thanks.

Gary T. Steele

Thank you.

Operator

Our next question comes from Tony Brenner of Roth Capital Partners. Your question, please.

Tony Brenner - Roth Capital Partners

Thanks. You answered half of this regarding thirdquarter sourcing but it seems to me it’s kind of unusual for you to have sourcing problems in the second quarter. What was the nature of that?

Gary T. Steele

There weren’t any major sourcing problems. Maybe we confused you alittle bit. If you’re referring to maybethe export revenuesbeing down? There weren’t any hugesourcing problems in thesecond quarter, Tony. Itwas more related to thetiming of export. We had ahuge first quarter export, I think itwas up something like 34% or 36% and inthe second quarter itwas down 4% and it’s just thetiming of when shipments arerecorded.

Tony Brenner - Roth Capital Partners

In theApio value added business you referred to seasonal supply shortages whichcaused you to have to purchase some product on theopen market and which hurt your profit margins.

Gregory S. Skinner

If you look atit Tony, our margins areactually in line withwhat the first quarterwas. We fact or inthat we’re going to have produce shortages. I mean, that’s just thenature of thebusiness. Thereal issue is when you compare itto last year’s second quarter.

Tony Brenner - Roth Capital Partners

What was the issue with the shortage? I’m not quite --

Gregory S. Skinner

It was just normal shortages. It’stypical. Our average margin in this business is around 15%. We did 15.425%. The issue is when you compare it to last year’s second quarter when all the stars were aligned and everything is perfectand we had virtually no shortages. Ourmargins were almost 18% which is well above the historical average, so it’s --

Tony Brenner - Roth Capital Partners

My question was thatit’s unusual for you to have those shortages in the second quarter. What then caused that?

Gregory S. Skinner

Nothingspectacular. It was modest, very modest impact. It could be for anything, just timing of products comingout or maybe the yields were down in some fields. A year ago we got hit in the first quarter. That doesn’tnormally happen. It’s just the nature of the business. It was in the normal range and that’s why our margins are 15.4% which is historical average.

Tony Brenner - Roth Capital Partners

Okay, thank you.

Gary T. Steele

Thank you, Tony.

Operator

Our next question isfrom Craig Pieringer of Wells Capital Management. Your question, please.

Craig Pieringer - Wells Capital Management

Good morning, Garyand Greg. At the end of your prepared comments and you justaddressed this with the last caller, I perked up when you started to talk about temperature timeand PH for the large and small molecules, but I didn’tcatch the context of what you delivered that, Gary.

Gary T. Steele

I’m just saying thatwe’re increasing our R&D spending, filing more patents, and what we’rediscovering is that there is more breadth to the technology than perhaps we realized. We’ve been totally dependent over the years and focused on the use of the temperature activation feature and we’refinding that there’s some things that we can do and we can make our polymers water lovingand oil loving and turn them on and off and go back and forth which gives ussome interesting applications in terms of time release. We now learned that we can pull things andnot release them at one PH and release them at a different PH and so that gets you into some interesting thoughtsas to how you might be delivering a drug or a catalyst or an insecticide or a food ingredient, et cetera, et cetera, withthese different triggers, and so this... and I want to caution that this is in R, this isn’t D&S, but you can’t get the D unless you do the R. So I mentioned early in the year that we felt it was time to invest more in our technology and we’re discovering that it has more breadth than perhaps we realized.

Craig Pieringer - Wells Capital Management

You answered prettymuch what I was asking without me asking it, which it sounds exactly like a pharmaceutical delivery technology so you’re onto that.

Gary T. Steele

You’ve always beenvery insightful.

Craig Pieringer - Wells Capital Management

Thank you.

Operator

Our next questioncomes from Shawn Boyd of Westcliff Capital Management. Your question, please.

Shawn Boyd -Westcliff Capital Management

Hi Gary, Hi Greg. Just a few foryou. If I could, Greg, I want to comeback to the minimumpayment to Chiquita. Did I hear you saythat we should think about that being split 50-50 inthe February and Mayquarters?

Gregory S. Skinner

Yes.

Shawn Boyd -Westcliff Capital Management

Okay, and that’s related to theexpansion of the dealbecause of theavocados?

Gregory S. Skinner

Well, it’s mainly theexpansion of thefields for bananas is theprimary reason for theincrease to $2.9 million this year, but there is asmaller component inthere for avocados, yes.

Shawn Boyd -Westcliff Capital Management

Okay, but versus sayprevious years where itall hit inthe February quarter?

Gregory S. Skinner

Exactly.

Shawn Boyd -Westcliff Capital Management

Got it. Okay and on thevalue added I think on thegross margins we hit that pretty well. Ijust want to go to thegross. We’ve talked inthe past about 10% to15% revenue growth on this business. We’re just ahair under themidpoint, kind of the lowend of that for thefirst half of theyear, and I’m looking back and I’m seeing, well, you know, first half of ’07was 17% to 18% growth, sois it kind of anissue of difficult year over year compares here and then we would expect to seethat maybe a littleabove the midpoint inthe back half of theyear?

Gary T. Steele

Good question. Therecould be acombination of things here, Shawn, and it’s hard for us to judge, but one of thechallenges is when you’re getting up inthe market shareterritory that we’re in, each new customer and each new share gain is alittle tougher, sothere may be some ofthat going on. I can’t tell you ifthere’s any impact from folks worrying about recession, et cetera, et cetera,and how we’ll beimpacted by that or areimpacted by that, but itcould just be acombination of things. We’ve also gotsome tough competitors out there who want to dothings on a regionalbasis and say, “Hey, I can getit to you thenext day” so I thinkthere’s a combinationof things going on here that we have to address inorder to keep thegrowth engine going.

Shawn Boyd -Westcliff Capital Management

Got itand at this point, is itstill a 10% to 15%growth business?

Gary T. Steele

Well ithas been, let’s justput it this way,historically we getwhat’s called Nielsen data which is fairly, it’s very reliable actually. To date ithas been. Does that predict thefuture? No. Thegood news is peopleeven in recessionsneed to eat and theywant to eat ina healthy way soI think that’s going for us.

Shawn Boyd - WestcliffCapital Management

And maybe on that point, interms of consumer spending, your industry data showing your competitors, kindof showing thecategories we think about prepackaged produce and fresh cut produce, areyou seeing any slow down on theindustry data, not just Landec?

Gary T. Steele

There was one quarter where therewas a slow down andour guys warned us that you can’t really make any predictions based on onequarter, but there was, I think itwas a couple quartersago, there was a slowdown in thecategory, but it was aheadscratcher, Shawn. We ought to askthis question next quarter and let mesee if we’ve got somebetter data on that.

Shawn Boyd -Westcliff Capital Management

Got it. Moving toanother point, thefirst half on operating expenses, Greg, would you saythat the run ratethat we’ve got now on SG&A and R&D for thefirst half, are thosefair proxies for thesecond half or given thecommentary on increasing R&D we should bethinking about that being up alittle bit second half?

Gregory S. Skinner

Itwill be up alittle bit in thesecond half for thereason you just --

Shawn Boyd -Westcliff Capital Management

Okay. SG&A?

Gregory S. Skinner

SG&A should pretty much track thefirst half.

Shawn Boyd -Westcliff Capital Management

Okay. Thank you andmoving back for asecond, Gary, could you give us... I came onto thecall late and I apologize, but maybe you could address alittle bit more detail on where we arenow with the militaryand kind of timing on what you seeon commercial development there and then also with airproducts?

Gary T. Steele

Military testing this year, I mean you know, we know thetechnology works, soit’s the issue of how doyou get our technologythrough their distribution channels ina practical way. If aship is deploying, how does that allwork? Where does theproduce and thepackaging come together? Where is itstored? Those types of things. Theview this year is thepractical testing of our technology inreal people’s hands, not inlaboratories and then hopefully that would lead to commercialization, not thisyear, and I’m talking about calendar year, not this calendar year, but thenext calendar year. Itcould happen faster, I don’t know. Airproducts is we’re growing thebusiness. I will tell you honestly it’sslower than I’d like to see. They’regood folks. We’re developing newproducts for them. Inthe personal carearea, it’s not as awful as drug development but it’s apretty tedious process of going through safety and tox studies and goingthrough what’s called thecoding process where ithas to beaccepted by thecustomer and go into their system. Soit takes time and we’dlike to turn on theafterburners here but there’s just aprocess you have to go through. Sothe sales areexpanding, there’s still relatively small for us, bbut they’re positive and we’re positive, and allwe can do is crank outnew materials and that’s what we’re doing.

Shawn Boyd -Westcliff Capital Management

So inthe meantime, we’vegot the minimum from airproducts and then maybe just alittle beyond?

Gary T. Steele

Right.

Shawn Boyd -Westcliff Capital Management

And then last point, theM&A discussion that we had earlier, Gary,I just want to think about this alittle bit more. You mentioned you wantreal revenues and real earnings, places where Landec technology can beapplied day one. We’ve talked inthe past about thefrustrations over our partners moving fairly slowly. Is this another example of where you’retrying to acquire apartner so to speak?Not anything of this size when we’re talking about Chiquita, but somethingwhere you would have more control going forward over thetime table and being able to accelerate thecommercialization of your technology?

Gary T. Steele

I like theway you stated that. I know alot of our investors and shareholders like licensing deals and I dotoo and I think it’s good to have agood healthy mix of that. Ithelps us improve and our margin mix over time and I think that we’re working onthat and I think we’re getting agood mix in ourrevenue and margins but I still like having parts of our business where we arein control of ourdestiny and we have that today inour much of our Apio business and inthe targets inwhere we’re looking inacquisition would put thenew acquisition if we ever doit into thebucket where we’re controlling our destiny. So to answeryour question, yes, that’s our focus. Will ithappen? Don’t know. Got to bethe right target, gotto be theright time, the rightterms. But we sure arefocusing on it.

Shawn Boyd -Westcliff Capital Management

Yeah. That would bewonderful. Good enough. Soundsinteresting and I appreciate theanswer. Thank you.

Operator

Our next question is from Jeff Osher of JMP Asset Management. Your question, please.

Jeff Osher - JMP Asset Management

Hey guys. It sounds like you continue to do a good job building the R&D pipeline. With regard to one of the previous callers’ questions about an OpEx run rate, and I know that... Let me ask, what is the gross R&D? In other words, what is it, I know you onlyspend $785,000 out of your own coffers, what’s Monsanto subsidizing?

Gary T. Steele

Let memention to you to that our total R&D if you look atR&D broadly across Landec is about $4 million, $3.5 to $4 million.

Jeff Osher - JMP Asset Management

A quarter?

Gary T. Steele

No, no, that’s a year.

Jeff Osher - JMP Asset Management

In the scheme of things, that’s such a small number when you start talking aboutdrug delivery. I know you didn’t say that per se, but one of our fellow shareholdersmentioned that. Can we expect thatnumber to go up? I mean, you spent$788,000 as far as your income statement and I guess what I’m asking is was anyof that subsidized by Monsanto or is there a gross number that you don’t report on the income statement that Monsanto’s paying the delta between the gross number and the $788,000 of R&D you spent this quarter?

Gary T. Steele

Yeah, thenumber that we’re showing is strictly theLandec expense. Theamount that Monsanto’s reimbursing is anet so it’s notgrossed up here. Sothey pay for theIntellico group, that’s adirect reimbursement of costs soit doesn’t show up as anexpense.

Jeff Osher - JMPAsset Management

What’s that number?

Gary T. Steele

It’s about... It’s historically averaged about $1 million.

Jeff Osher - JMP Asset Management

Okay, but that’sdedicated solely to Intellico.

Gary T. Steele

Solely to Intellico,paid by Monsanto does not show up on our income statement at all.

Jeff Osher - JMP Asset Management

So how many engineers do we have working on product development?

Gary T. Steele

I’d say that we’ve got about 20. The whole company is 150 people, not countingour direct contracted labor in our plant. I also want to address a question that you had but I want you tofinish this point, but you had another question in there that I want --

Jeff Osher - JMP Asset Management

No, that’s reallyhelpful, Gary, that you have 20 engineers. That’s a good number.

Gary T. Steele

They’re more scientists than they areengineers. We dotolerate engineers inour buildings but... You mentioned something about how could you doanything like drug development or things like that when we allknow that those things costmany millions of dollars ayear once you get intofull development. Let mejust say that Landec hasits strengths and weaknesses but I will saythat one of our strengths is that we aregood at doing dealsand trying to shape and structure shareholder value, atleast I think we are, and we did this earlier inan area called theAesthetic Science Corporation which we came up with theidea of how it might beused in aspecialized area of dermal fillers. It’sa hotarea, it’s a growingarea, there’s some keypeople that arerunning that business that we’re attracted to this idea, some venture capitalfunders came in and wetook a 19.9% equityposition. We don’t bear any of theexpenses now. They bear allthe expenses, etcetera, et cetera. There aredifferent ways of getting programs and projects that have alot of merit to acertain point and then you spin them out or carve them out or whatever and westill capture value, sowe’re always thinking that way. We’renot expecting if Craig is right about this being drug delivery or drug development,we’re not going to bespending $20 million ayear in R&D ondrug delivery, sowe’re going to get itto a certain point andthen we’ll seek partnerships.

Jeff Osher - JMP Asset Management

Okay. That’s very helpful, that clarification and Iguess one follow up if I may. Withregard to OpEx, I know you guys manage the business on an annual basis, so is there any seasonal reason for the sequential drop in OpEx from Q1 to Q2? I guess if we would have held OpEx flat youwould have made $0.10 as opposed to the $0.115? Should we think about that OpEx run rate of $5-ish million going forward or are you guys going to continue to whittle OpExout of the company?

Gary T. Steele

Itwas just a timingissue. Remember during thefirst quarter we were going through our year-end. You’ve got accounting, you’ve got legal fees,and you get some bigpops and patents. Those can come inlittle boluses sodon’t read anything into that.

Jeff Osher - JMP Asset Management

Okay sothe $5 million then, that’s a prettygood number to model inthe back half on aquarterly basis?

Gary T. Steele

Yeah.

Jeff Osher - JMP Asset Management

Hey, thanks alot guys, keep up thegood work.

Operator

Atthis time I’m showing no further questions from theaudience.

Gary T. Steele

Thanks everybody for being on our call and we look forwardto keeping you posted on our progress and results. Many thanks.

Operator

Ladies and gentlemen, thank you for participating intoday’s conference. This concludes theprogram. You may now disconnect. Good day.

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Source: Landec F2Q08 (Qtr End 11/25/07) Earnings Call Transcript

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