Lifecore Biomedical Inc. F2Q08 (Qtr End 12/31/07) Earnings Call Transcript

Lifecore Biomedical Inc. (LCBM)

F2Q08 (Qtr End 12/31/07) Earnings Call

January 15, 2008 8:00 am ET

Executives

Dennis Allingham - President and Chief Executive Officer

Dave Noel - Vice President of Finance and Chief Financial Officer

Larry Hiebert - Vice President and General Manager of Hyaluronan Division

Analysts

Arnie Ursaner - CJS Securities

Anthony Ostrea - JMP Securities

Michael Levitt - CP Management

Beth Lilly - Gabelli

Yi-Dan Wang - Deutsche Bank

Tom Johnson - Ramias

Presentation

Operator

Thank you for calling Lifecore Biomedical's Conference Call. All participants will be in a listen-only mode until the question-and-answer session. At the request of Lifecore Biomedical, this call is being recorded. If anyone has any objections you may disconnect at this time.

We will now turn the meeting over to Mr. Dennis Allingham, President and Chief Executive Officer. Mr. Allingham, you may now begin.

Dennis Allingham - President and Chief Executive Officer

Thank you, Curtis. Good morning, everybody. Before we begin I would like to remind you that today's remarks do contain forward-looking statements within the meaning of federal securities law, and these statements do not guarantee future performance and, therefore, undue reliance should not be placed on them.

As such these comments are subjects to risks and uncertainties that could cause actual results to differ materially from those projected. For example, the acquisition of Lifecore is subject to regulatory approvals and other customary conditions, and there can be no assurance that the transaction will be completed within the timeframe anticipated by management.

For additional information about various factors that could cause actual results to differ from those presented, we refer all of you to the risk factors contained in our annual report on Form 10-K for the fiscal year ending June 30, 2007, our 10-Q for the quarter ended September 30, 2007 and other more recent filings.

All information that is provided in today's call, is as of the date of this live broadcast Tuesday, January 15, 2008 and Lifecore Biomedical assumes no obligation to update any such information.

In addition, these comments are to be considered neither an offer to purchase, nor solicitation of an offer to sell shares at Lifecore. At such time as a tender offer is commenced, each Lifecore shareholder will receive a written offer to purchase shares which should be read very carefully.

Also today with me is Dave Noel, our Vice President of Finance and Chief Financial Officer and also Larry Hiebert, our Vice President who also serves as the General Manager of our Hyaluronan Division.

So let me start first with the big news, the offer. To begin with, I am very pleased to host this call today to be able to deliver news of an opportunity for a significant return on investment for our shareholders.

This return comes in the form of an agreement with Warburg Pincus to commence a tender offer for all of Lifecore's outstanding common stock at $17 per share in cash, or a deal value of $239 million.

I am particularly pleased that this transaction appropriately recognizes the value of the company, and believe it is good for all of our constituencies. The transaction was approved unanimously by the Board of Directors of Lifecore, and the Board's and management's decision together to pursue this strategic alternative was made after exploring other strategies that would best reward our shareholders. Ultimately our Board determined that the most compelling option for maximizing shareholder value was to accept an all cash tender offer at a premium to market.

So first from a shareholder perspective, we look very closely at our growth prospects and the challenges that surround those. Ultimately, the operative term how do we reward our shareholders? When we represented with the opportunity to deliver an all cash upside to our shareholders, we knew we owed it to you to pursue further, or you in this case is the shareholders to pursue it further.

The transaction affords an approximate 30% premium over the average price of Lifecore shares for the last 30 days in a market that I am sure all of you know, has been extremely volatile.

From the perspective of our customers, we believe this collaboration would enhance our attractiveness, as Warburg also owns assets of another dental business, Keystone Dental and Keystone shares are focused on product branding strategies and brings to the table a complimentary technology. We are extremely pleased to have the backing of a firm with a caliber of the Warburg Pincus fund.

Warburg Pincus, if you're not familiar with them is a leading private equity investor with approximately $20 billion in assets under management and the availability of an additional $10 billion for further investment. The firm has invested over $6.2 billion in healthcare related companies alone, including $2.7 billion in medical device companies. For the Dental business, we think our affiliation with Warburg will avail us of additional and future opportunities that we might not otherwise have access to.

We also believe that combining our talents lowers our overall risk in an increasingly crowded business, where we hold an overall 3% to 4% market share. Because of Warburg's history of success in the healthcare field, our management and the Board are highly confident that we have chosen the right partner to support Lifecore's future success.

With regard to our employees, we believe, it will give us the flexibility to invest in our long-term strategic direction, without the constraints that delivering quarterly profitability, as a public company demands. Warburg Pincus and its affiliates have expressed great confidence in Lifecore's future; their vast experience allows them to recognize the benefit of supporting trained and talented people. They are also willing and able to support the organization during those challenging years of clinical development and the need for progressively investing in product innovation.

If we look back on the past several years, I can say that this management team is extremely proud of what we have accomplished. Since 2004 when I took over as Lifecore's CEO and the stock was hovering around $5 a share. We have been able to take two very different businesses, grow each of them by double-digits.

Today, the Dental Division is a $50 million business and growing, the Hyaluronan Division exceeds over $20 million and is growing. Our management team setout to deliver value to our shareholders and today I am pleased to provide you with that well earned upside.

If we look at the present state of the company, we know that Lifecore's future earnings growth would be compromised in order to meet the investment necessary to achieve continued success. And as I am sure you know inconsistent earning patterns are not typically rewarded on Wall Street.

As I mentioned, other alternatives for maximizing shareholder value were accessed. We looked at stock buybacks. We looked at the competitive landscape on the Dental side of the business for potential acquisitions. All as ways or means, to deploy our cash that would provide long-term growth to the company.

Of all the options considered none of them delivered the significant or cash reward for our shareholders that this opportunity affords, while eliminating the valuation risks associated with further investment into the future.

I take just a minute and briefly explain the terms, the next steps associated with consummating this transaction; most of the closing conditions are customary. They do of course include certain regulatory approvals. In addition, Lifecore has 30 days now to solicit superior proposals from third parties. We intend to have our investment banker commence that solicitation immediately.

Should a superior proposal be accepted, we are obligated to pay $1.5 million break-up fee to Warburg Pincus. And during this 30 day period, its important to note, we will not be making any statements or comments on the process, unless and until our Board has made a decision regarding any alternative proposals.

So this covers the highlights of the transaction. With that, I'm going to turn the call over Dave to review the second quarter financial results.

Dave Noel - Vice President, Finance and Chief Financial Officer

Thank you, Dennis. Since you've all presumably seen the release of our financial results that we've put out earlier this morning, I'll just briefly cover the top and bottom line highlights of the quarter.

Net sales for the second fiscal quarter of 2008 were $17.3 million, up 4% over the net sales of $16.6 million a year ago. Of the $17.3 million in net sales for the quarter, $4.9 million was from the HA division and $12.4 million was from the Dental division.

Quarter-over-quarter sales of the Prima Implant System were up 19%, driving the Prima line to more than 40% of our overall Dental division sales.

Net income for the second fiscal quarter of 2008 was $1.24 million or $0.09 per diluted share, compared with net income of $1.36 million, or $0.10 per diluted share in the same quarter a year ago. Our cash and cash equivalent balance at December 31, 2007 was $43.9 million.

Turning to our previously provided financial guidance. We are suspending all forward-looking financial guidance at this time. This suspension is not related to our financial condition, and should not be interpreted as such. Our decision is based solely on the basis that we think the suspension or withdrawal of guidance make sense due to the pending tender offer.

Now, let's open the call up for questions, and I'll turn it back to Curtis. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Arnie Ursaner from CJS Securities. Your line is now open.

Arnie Ursaner

Dennis, congratulations.

Dennis Allingham

Thanks, Arnie. Good morning.

Arnie Ursaner

First thing as it relates to Warburg, you mentioned they owned Keystone Dental where they've got a technology that you believe would be very complimentary to what you are doing. Could you expand a little bit more on that please?

Dennis Allingham

Yeah. My understanding is that Keystone is in the process of developing a Single-Stage Implant System, which of course, we do offer one today, but I've also made comments in other calls that our product offering on the Single Stage side, which we introduced back in 1999 really needs to refreshed. Keystone, I understand also has a line of regenerative products that I think would be complimentary to the line of regenerative products that we sell. So, I believe there is some synergies there between the two businesses.

Arnie Ursaner

My other question is, in your prepared remarks you mentioned that you as a company had looked at some other strategies to enhance shareholder value and I am sure they’ll all be covered in detail in the proxy when it becomes available. But can you give us a little bit of an understanding of what some of the other strategies you had looked at were and perhaps expand on that a little?

Dennis Allingham

Sure, I think the key thing is and, of course, this has been the $64 question at virtually a number of calls, what are you going do with the cash? And so the very obvious one is, should we pay a dividend? And we determined not to. Should we look at a stock buyback? And that to me always and certainly our Board considered it but has short term improvement but perhaps not long term.

And I think the thing that we explored was and it's more really by myself and our management team is what is out there that we could acquire to really truly help drive the growth of either of our business segments, either the Dental or the Hyaluronan.

And the difficult part was there really wasn't anything that we could see at least that would fit. And I think what we came back to is certainly we believe we've set forth the right strategies for the long-term growth of the company. We felt that we could invest cash into the growth of both sides of the business.

But balancing that investment with the need to drive these short term results each quarter, we just felt that it was in better interest of the shareholders to go strike a deal and get the value back to them.

Arnie Ursaner

And final question if I can is, Warburg have a reasonable or obvious strategic fit with the hyaluronic acid side?

Dennis Allingham

We believe so. Again, based on preliminary conversations and diligence by both parties, this is a strategic buy for them. I realized that often times when you're focused in talking to private equity firms that you'll view them from an financial side, but I think Warburg's decision to do a startup if you will in the dental side of the business was a strategic decision on their part.

I don't want to go too far in that regard, because they, Warburg, should speak for themselves. But I think when an entity makes an investment like that, it really truly is strategic, and I think their interest in Lifecore is partially our dental business.

But in the same regard, I think the attractiveness of the Cleveland Clinic technology platform and the potential that that provides in the medical device arena, which of course Warburg has been a strong player in for a number of years.

Arnie Ursaner

Again congratulations.

Dennis Allingham

Thank you, Arnie.

Operator

Our next question comes from Anthony Ostrea with JMP Securities. Your line is now open.

Anthony Ostrea

Hey Dennis, Dave congratulations.

Dennis Allingham

Thanks Anthony.

Dave Noel

Good morning.

Anthony Ostrea

Good morning. Dennis, can you just run through I guess that timelines again. So you have 30 days essentially to solicit offers. I guess the question there is, in the past have there been other offers either from other companies in the dental space or other offers such as Warburg Pincus'? And also [coning] the 30 days, can you just walk us through the timelines there?

Dennis Allingham

Let me start first with the timeline. Of course, the window starts today and we do have a 30-day go-shop, so as I mentioned our bankers are ready to go. That 30-day go-shop will end say mid-February. Let me not count actual days. Let me just use rough timeframes. And then basically the tender offer will start five days after the go-shop period ends.

The operative thing during the tender offer and, of course, the first step is to get to 50%. I think if the 50% plus one share threshold is crossed, in all likelihood the tender offer would be extended with the idea that certainly the quickest way is if it gets to 90%, then Warburg would be in a position to do a short-form merger and close rather quickly. What's rather quickly? I think, in the release we indicated, it is conceivable, if everything went according to plan that this transaction could possibly close by the end of the first quarter of '08, or certainly shortly thereafter.

I think, the second part of that process is the fact that, we do have the go-shop provision in the event that there are other interested parties, we will have the option to negotiate with them and proceed down that path, subject of course to the break-up fee. If it's a party that's identified during the go-shop period and again, this all be in the offering documents. But the break-up fee is $1.50 million. If it's somebody that arises after that, then our break-up fee is $3 million.

I think, to your other question, Anthony, in terms of, has there been any other interest et cetera, I don't think it's appropriate to comment on that at this time. I believe that our Board is both loud and clear that they've considered this. We've evaluated other options and our Board voted unanimously to support this all cash offer of $17.

Anthony Ostrea

Okay. And then just maybe on, just a question on the industry right now, just looking at your results for the quarter, Dennis, maybe can you just characterize what you see is going on in each of your businesses. HA was pretty strong, Dental was weaker than expected, may be if you can just focus on the dental dynamics in the industry right now? I know, you said, Prima is doing really well, but maybe overall, maybe characterize what's going on in the dental implant space?

Dennis Allingham

Okay, I certainly don't want to hold myself out as an expert on the dental implant business, but I will offer my insight in terms of what I think, is happening out there. I do believe and I have in previous calls, said that we were not seeing the impact of the economy affect our business.

I think to some degree now if that has happened and I don't know that I would suggest it to be a long-term affect. I think, it's rather a short-term affect because of, just the economy in general and the implication of the sub-prime issues that have affected peoples incomes.

I still believe this is a rather robust growth industry. I still stand behind those numbers that I have used historically 15% to 16%, 17% annual growth. So, I think from an industry perspective, while perhaps we've had a little bit of a slowdown, I still think it's going to be robust for the long-term.

If we look specifically at Lifecore, I think again, we have deployed the right strategy and I offer the success and the acceptance in the market of the Prima system as an indication and in indication of that. Clearly Prima continues to gain certainly some share from our competitors, but probably now we are seeing more cannibalization of our existing business, and I stand behind the strategy that this is a great system and we just need to keep working at it.

I think, the second part of that statement is I've talked before over the last couple of years that it was clearly my intent to reposition Lifecore and move us away from the pricing type player that used cloned or knocked off products to transition it to a premium priced offering where we went after the specialist, and I still stand by that strategy. I think its the right thing to do. I think, the fact that Prima was up 19% over the quarter of a year ago also as an indicator. I think, the reality however is it's taking longer to really execute that than perhaps we had originally anticipated.

Anthony Ostrea

Thanks, that's all I have. I'm sorry, go ahead.

Dennis Allingham

No, that’s fine. I was going to say does that address it.

Anthony Ostrea

It does. That’s all I had, and again congratulations Dennis and Dave.

Dennis Allingham

Thank you.

Dave Noel

Thank you Anthony.

Operator

Our next question comes from Michael Levitt with CP Management. Your line is now open.

Michael Levitt

Thank you. First of all congratulation on the deal.

Dennis Allingham

Thanks Michael.

Michael Levitt

The second thing I wanted to ask is, you mentioned and you people have touched on this, I just wanted to clarify, but during your exploration of other strategic options, did you at all forfeit other proposals or was Warburg the first person you talked to?

Dennis Allingham

We're not disclosing that information. That will be covered as needs be in terms of any of the offering documents. Again, I stand behind the part of the process that our Board has been very diligent in this effort, we certainly had legal counsel review of things, we have a financial advisor that we hired to take a look at things. And that's how we evaluated the offer from Warburg and unanimously recommended that we go do that.

Michael Levitt

Okay, I guess I was just surprised that there is still a go-shop provision if you've already done that.

Dennis Allingham

Well that's the deal we negotiated.

Michael Levitt

Okay. Well, thank you very much.

Dennis Allingham

Alright.

Operator

Our next question comes from Beth Lilly with Gabelli. Your line is now open.

Beth Lilly

Good morning Dennis and Dave.

Dennis Allingham

Good morning Beth.

Dave Noel

Good morning.

Beth Lilly

Congratulations.

Dennis Allingham

Thank you.

Beth Lilly

You may not -- I don’t know if you can address this. But can you give a little insight into, did you hire -- as you talked about early in the call, you've explored other strategies, with this option to enter into this negotiation with Warburg was -- did you first decide to explore options and then the Warburg offer came or can you just give just give a little insight into the background on just the whole process that you went through?

Dennis Allingham

Warburg approached us.

Beth Lilly

Okay. So and then as a result of them approaching you, did you then think about other options?

Dennis Allingham

Well, I think I would phrase it this way. I think our Board and again dovetailed into the proverbial question, what you are going to do with the cash. I think, our Board, we have been actively focused on this subject for quite sometime now.

And I think this was just a part of the entire process that that certainly when you look at a business being fully cognizant of our need to drive shareholder value what is the best way to do that and certainly Beth, you and I have had the conversation, I didn't feel a stock buyback was the right answer nor did our Board.

But in the same regard when we looked at this, we just basically were very candid and said how do we give the shareholders the best value?

And while again, I believe we deployed the appropriate growth strategies over the long-term for both businesses, the HA business as well as the Dental business. When you are sitting here to-date and being able to give the shareholders $17 after a few years, we felt that was the right thing to do.

Beth Lilly

Okay. As you know what I am trying to understand, Dennis is, just the timing and everything in the sense of -- it sounds like as you were evaluating all the different options available in terms of the use of the cash and the growth of the business. Warburg knocked on your door and said we want to do a deal?

Dennis Allingham

No, I probably won't make it that constrictive. Again, I have always had questions and the questions have always been, would you consider any and all options and absolutely I said I would. So, I think that, yes, Warburg is the one that surfaced, but other options were looked at.

Beth Lilly

Yeah, okay, that's great. Well congratulations, you’ve done a tremendous job in your short-term tenure as CEO and, we're just delighted. So thank you.

Dennis Allingham

Thanks, Beth. Curtis?

Operator

Our next question comes from Yi-Dan Wang with Deutsche Bank. Your line is now open.

Yi-Dan Wang

Hi, good morning everyone and congratulations on your deal.

Dennis Allingham

Thank you, good morning.

Yi-Dan Wang

Good morning. I hope you can help me with a few numbers. Would you be able to give me the growth rate of your US Dental business and the constant currency growth rate of your Dental business outside US?

Dave Noel

The growth rate in our domestic Dental business was actually…

Dennis Allingham

Which timeframe were you talking about?

Yi-Dan Wang

Of the quarter just finished.

Dennis Allingham

Okay, alright.

Dave Noel

It was actually, it was down approximately 5%. And then as the far as the currency goes, the currency translation impact was approximately 7% or about $390,000 for the quarter.

Yi-Dan Wang

Okay. And then in terms of the slowdown in the US, can you indicate whether that was primarily in Q4 or was that steadily through the, I’m sorry, is primarily in December or is that steadily sort of slowdown through the quarter?

Dennis Allingham

No, that was all primarily in the -- I mean it came in the later part of the quarter, right. We started with a very robust performance in October. It carried over into November and now we did see a slowdown in, a rather significant slowdown in December.

Yi-Dan Wang

Okay, and did you see any weakness in your international business?

Dennis Allingham

No, our international business, with the exception of what I've commented before, we’ve had some [rather] fluctuations. I'll use that term. I was going to some ups and downs in Asia, and seemingly it seems like we get one part of Asia corrected and they get their inventories in line and then we have a different part of Asia that surfaces. And so we did continue this past quarter ending December to see some fluctuation in the performance of our distributors in the Asian market.

I think historically we've talked about. We had some issues in Korea because of competitive conditions. Korea seems to have resolved itself. But our business in Japan actually was down, and primarily we believe that or we attribute that to the fact that we still do not have the Prima system approved in Japan. The regulatory environment for approvals in Japan has been rather abysmal since they changed the laws two years ago.

We also saw some softness in our distributors' performance in Taiwan. And when I say softness, not that our distributor hasn’t seen good sell-through in his market, but again everybody I think is adjusting inventory levels and he clearly or they clearly made changes there.

So we did see some weakness in those particular markets. On the other hand, we had a strong performance in Europe. Our subsidiaries have been doing absolutely stellar. We saw some growth in the Latin American market. So, in general, I mean some strength markets and some not so strong markets and unbalanced, that's how the international business played out.

Yi-Dan Wang

Okay. That's very useful. I just have a couple more questions if I may. The slowdown in the US is that primarily market-driven or is that sort of due to internal factors at Lifecore?

Dennis Allingham

Well, I think, in my earlier remark to an earlier question, I do think that we saw some market conditions. The number one player in the industry has been talking about a slowdown in business because of the economic factors, for the better part of six to nine months now.

Up until this past quarter, I've always stood by the statement, we are not seeing it. But I think, in this particular quarter, we did see some of that. I think the other part of your question that I also alluded to earlier, is the fact that we have the right strategy to reposition Lifecore to sell a premium product to specialist, but the conversion rate, the execution on that is perhaps, taking longer than we had originally anticipated.

Yi-Dan Wang

Okay, thank you. And then lastly, how much of your dental sales comes from the US, please?

Dave Noel

Little bit more than 50%.

Yi-Dan Wang

Thank you very much. That's very helpful.

Operator

(Operator Instructions) Our next question comes from [Stella Young from Ramias]. Your line is now open.

Tom Johnson

Hi, this is [Tom Johnson] for Stella. I had a few question. Good morning.

Dennis Allingham

Good morning.

Tom Johnson

And congratulations. I would like to know, has Warburg provided an equity commitment whether for the entire amount of the consideration or will they be raising debt financing for this transaction? And my second question is, whether there is a reverse termination fee?

Dennis Allingham

The answer to your question is, this is an all cash deal. It is not subject to any financing conditions with regard to closing. So, it is all cash and with regard to the reverse termination fee, yes there is.

Tom Johnson

Okay. But will Warburg would be raising debt in order to finance that cash transaction?

Dennis Allingham

No.

Tom Johnson

Okay. Thank you very much.

Operator

At this time, there are no further questions. Mr. Allingham, I'll turn it back over to you for any closing remarks.

Dennis Allingham

Well. Thank you, Curtis. Well, to all of you that are on today's call, thanks for your participation. To those of you that are listening on the webcast, we appreciate your attention as well. Let me just say it very simply and close that, we are enthusiastic and we are proud of the success that we delivered this tangible upside to our shareholders.

I think, we've accomplished a great deal with this transaction. I know speaking for the Board of Directors and the entire management team that when I say, we believe this development is in the best interest to Lifecore shareholders, as well as all the other constituencies, our customers, our employees.

I do want to thank all of you for your support of our company. I look forward to the consummation of this tender offer into our next communication. So until then, again thanks for listening. Have a great day.

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