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Landec Corporation (NASDAQ:LNDC)

F3Q08 Earnings Call

April 10, 2008 11:00 am ET

Executives

Gary Steele – Chairman, President and Chief Executive Officer

Gregory Skinner – Chief Financial Officer and Vice President of Finance and Administration

Analysts

William Gibson - Nollenberger Capital

Jonathan Lichter - Sidoti & Company

Operator

Good day, ladies and gentlemen, and welcome to the Landec Corporation nine months and third quarter of fiscal year 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 instructions will be given at that time. (Operator Instructions) And as a reminder, this conference call is being recorded.

I would now like to introduce your host for today’s conference, Mr. Gary Steele, Chairman and Chief Executive Officer of Landec Corporation.

Gary Steele

Good morning and welcome to Landec’s first nine months and third quarter of fiscal 2008 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 May 10, 2008. A replay of the teleconference will be available for one week by calling 888-266-2081 or 703-925-2533. The access code for the replay is 1226274.

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 2007.

Regarding recent events, we announced last week our need to delay our third quarter release in order to give our new accounting firm, McGladrey & Pullen, time to complete their review of the accounting relating to a few past transactions.

McGladrey has received feedback from both the company and Ernst & Young, and while McGladrey continues to discuss the Monsanto transactions and the Apio sub option transaction with management and Ernst & Young. McGladrey has now completed its review of the company’s third quarter financial statements without any changes.

There are some open issues that still remain with our new accounting firm regarding accounting interpretations and treatments. It is our hope that we can resolve any remaining issues by the time McGladrey completes its audit of the company’s financial statements for the fiscal year ended May 25, 2008.

At this point, we cannot predict when and how these issues will be resolved. We are working diligently along with outside experts to reach resolution on these issues as quickly as possible and we continue to focus on and advance our operating results.

Let’s turn to our operating results. Landec had a very good third quarter and we achieved our internal goals. We are on track for meeting our financial and operating goals not only for the third quarter but also for the full fiscal year 2008.

Our business has grown to the stage where we are now generating considerable cash flow from operations based on continuing progress in our value-added vegetables specialty packaging business and our multiple licensing partnerships. Overall, Landec generated $15.1 million in operating cash flow during the first nine months of fiscal year 2008.

As reported in yesterday’s press release, for the first nine months of fiscal year 2008, overall revenues increased 14% to $181 million while overall gross profits increased 25% from the year ago period.

Net income excluding $18.8 million of non-recurring operating income recognized during the first nine months of last fiscal year, increased $10.2 million during the first nine months of this fiscal year, up from $6.0 million during the first nine months of fiscal year 2007.

Notably, during the first nine months of fiscal year 2008, Apio’s value-added specialty packaging vegetable products business grew 10% to $125.5 million and value-added gross profits increased 12% to $18.6 million.

The gross margin and the value-added business for the first nine months of 14.8% is slightly higher than the 14.6% gross margin recognized during the first nine months of last fiscal year.

In our Apio Packaging business for the first nine months, revenues increased 63% to $2.2 million while the gross profit increased 65% to $2.1 million, primarily due to increased minimum payments in the Chiquita banana program.

In our Technology Licensing business for the first nine months, revenues increased 95% to $5.1 million while the license fee gross profit increased 110% to $2.7 million compared to the same period last year, primarily due to the Intellicoat license agreement with Monsanto signed in December 2006.

Based on the results for the first nine months of fiscal year 2008, we are on track for achieving our revenue and net income goals for fiscal year 2008. Accordingly, we are not changing our original guidance for fiscal year 2008, which is to increase revenues by 10% to 15%, and after excluding the $18.8 million of non-recurring operating income from last year, to increase this year pre-tax net income by 45% to 55% and net income after tax by 30% to 40%.

When comparing the fiscal year to the prior fiscal year, we need to point out that virtually all of the income tax expense in fiscal year 2007 was recognized in the third quarter upon the sale of Fielder’s Choice Direct with the effective tax rate for the fiscal year 2008 being 8%.

However, during fiscal year 2008, our current fiscal year, the income tax expense has been recognized more evenly over all the quarters based on an estimated effective tax rate for this year of 28%. As a result, the income tax expense for the fourth quarter of this year will be considerably higher than the fourth quarter of last year.

As a reminder from our last quarterly call, during the first nine months of fiscal year 2008, we expanded our joint technology license and supply agreement with Chiquita. The expanded agreement includes additional exclusive fields for bananas.

In addition, Landec and Chiquita entered into a new exclusive license agreement using Landec’s BreatheWay packaging technology for avocados for which market tests for food service applications are underway.

Under this agreement, in exchange for expanding the exclusive license fields for bananas and adding an exclusive license for avocados, the minimum gross profit amounts from the purchase of BreatheWay packaging by Chiquita will increase by $2.1 million over Landec’s next two 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 extended adverse weather conditions during the last two months of our fiscal year 2008, our progress is in line with our internal plan for meeting our goals for fiscal year 2008.

Let me turn this over to Greg Skinner for details of our results.

Gregory Skinner

Thank you, Gary, and good morning everyone. As outlined in yesterday’s news release, Landec reported total revenues for the first nine months of fiscal year 2008 of $181.2 million versus revenues of $159.3 million for the same period a year ago.

The increase in total revenues during the first nine months of fiscal year 2008 was due to:

First, a 10% or $11.7 million increase in revenues from Apio’s value-added vegetable produce business;

Second, a 17% or $6.9 million increase in revenues from Apio’s commission trading business;

And third, a $2.5 million increase in license fee revenues primarily due to revenues from the Intellicoat license agreement with Monsanto.

For the first nine months of fiscal year 2008, the company reported net income of $10.2 million or $0.38 per diluted share compared to net income of $24.8 million or $0.92 per diluted share for the same period a year ago.

Included in net income for the first nine months of fiscal year 2007 was $18.8 million of non-reoccurring operating income, primarily from the gain on the sale of Fielder’s Choice Direct to Monsanto Corporation during the third quarter of fiscal year 2007.

Landec’s net income for the first nine months of fiscal year 2008 increased to $10.2 million from $6 million during the first nine months of fiscal year 2007 after excluding the $18.8 million of non-reoccurring operating income from last year.

This increase in net income during the first nine months of fiscal year 2008, compared to the same period last year after excluding the $18.8 million non-reoccurring operating income, was due to:

First, a $2 million increase in gross profit in Apio’s value-added vegetable business, primarily due to increased volumes and revenues;

Second, a $2.7 million increase in licensing gross profit as a result of the Intellicoat license agreement with Monsanto;

Third, an $835,000 increase in Apio Packaging gross profit as a result of an increase in the minimums paid by Chiquita;

And fourth, an $840,000 increase in interest income due to the cash received from the sale of Fielder’s Choice Direct.

These increases in net income were partially offset by the increase in the book income tax expense of $1.8 million during the first nine months of fiscal year 2008 compared to the same period last year.

It should be noted that only $225,000 of the $3.9 million book income tax expense for the first nine months of fiscal year 2008 is expected to be paid in cash because the repurchase of the Apio options resulted in a tax deduction of $19.7 million, which reduced Landec’s cash tax liability to a minimum owed under Federal AMT.

However, for book purposes, the $19.7 million tax deduction is not considered a deduction when calculating the income tax expense because the options that were repurchased had never been included in prior periods as an expense for book purposes.

For the third quarter of fiscal year 2008, Landec reported total revenues of $59.6 million versus revenues of $53 million for the same period a year ago, an increase of 13%.

The increase in total revenues during the third quarter of fiscal year 2008 was due to:

First, a 9% or $3.8 million increase in revenues from Apio’s value-added vegetable business;

Second, a 28% or $2 million increase in revenues from Apio’s commission trading business;

And third, a 44% or $575,000 increase in Apio Packaging revenue due to the increase in minimums paid by Chiquita plus revenues from Apio’s research and development agreement with the U.S. military which started at the beginning of fiscal year 2008.

For the third quarter of fiscal year 2008, the company reported net income of $4 million or $0.15 per diluted share compared to net income of $24.6 million or $0.92 per diluted share for the same period last year.

Included in net income for the third quarter of fiscal year 2007 was $22.3 million of non-reoccurring operating income primarily from the gain on the sale of Fielder’s Choice Direct to Monsanto Corporation during the third quarter of fiscal year 2007.

Landec’s net income in fiscal year 2008’s third quarter increased to $4 million from $2.3 million during last year’s third quarter, excluding the $22.3 million in non-reoccurring operating income recognized during the third quarter of fiscal year 2007.

This increase in net income during the third quarter of fiscal year 2008 compared to the same period last year, after excluding the $22.3 million in non-reoccurring operating income from the third quarter last year, was primarily due to:

First, a $780,000 increase in gross profits in Apio’s value-added vegetable business, primarily due to increased revenues;

Second, a $591,000 increase in Apio Packaging gross profit as a result of increase in minimums paid by Chiquita plus from the gross profits from Apio’s research and development agreement with the U.S. military;

And third, a $234,000 increase in licensing gross profit as a result of increased gross profit from Landec’s collaboration with Air Products.

Before turning to the balance sheet, I wanted to mention that capital expenditures and R&D spending for the first nine months of fiscal year 2008 are in line with our internal plans and are consistent with our revenue and net income guidance for fiscal year 2008.

Turning to the balance sheet, during the first nine months of fiscal year 2008, our cash balance decreased by $7.3 million to $55.3 million.

Cash balances primarily decreased because of the repurchase of all of the outstanding common stock and options of Apio not owned by Landec for $20.8 million and the purchase of $2.4 million of value-added vegetable property and equipment.

These decreases in cash were partially offset by $15.1 million of cash generated from operations.

That concludes my presentation.

Gary Steele

Thanks Greg. Our first nine months and third quarter results reflect the benefit of Landec’s focus on its two core businesses: the Apio food business and the technology licensing business.

In the food business, the focus is on selling value-added specially packaged vegetable products and on selling BreatheWay packaging to key partners for high value perishable produce products such as fruit targets.

In the technology licensing business the focus is on licensing and commercializing Landec’s patent polymer materials to keep polymers outside of the food applications such as our work with Monsanto and Air Products.

During the first nine months of fiscal year 2008, we have benefited from:

First, the normal weather patterns;

Second, increased demand for our specially packaged fresh-cut food products;

Third, our licensing arrangement with Monsanto;

Fourth, increased interest income from cash received from the sale of Fielder’s Choice Direct to Monsanto in December of 2006;

And fifth, the absence of losses from Landec Ag, which had historically occurred during the first eight months of each fiscal year.

We have hit our internal goals for revenue and income and we are pleased that both our Apio foods technology business and our corporate licensing partnerships are growing and progressing.

Let me review some highlights thus far in current fiscal year 2008. First, regarding Chiquita, the Chiquita-To-Go program has expanded to well over 15,000 sites in North America, up from 7,500 sites at the same time last year last year.

Chiquita has also commercially launched Chiquita bananas and our packaging to three European countries. In addition, Chiquita has recently commenced quick serve restaurant store trials in several cities and retail grocery store product development efforts continue to advance.

Further, under our new exclusive licensing agreement with Chiquita, using Landec’s BreatheWay packaging technology, market sales of avocados and food service applications have commenced and our retail consumer package designs and product development for avocados are underway.

Following our expanded agreement with Chiquita announced in September 2007, Chiquita implemented a significant internal reorganization and restructuring.

We had been aware that this reorganization could adversely affect the development efforts of our retail grocery program, and it did slow down the retail grocery store program, but we are now back on track with a Chiquita leadership team that is highly committed to our collaborative effort and we expect the next round of retail banana grocery market and consumer tests to begin late this summer.

Second, Monsanto announced in February their newly formed seed treatment business and our seed coating programs are included in that business. It is our hope that our polymer coating technology will be a key and integral part of Monsanto’s plan for building a branded seed treatment business.

The current Landec focus with Monsanto is to develop a broad based technology platform that utilizes Landec’s Intellicoat seed coating technology as a delivery system for seed treatments. This is a relatively new focus for them and for us and we will keep you apprised of our progress.

As we look to the fourth quarter, we expect to achieve our internal plans and meet revenue and earning growth targets for the entire fiscal year 2008 that we set at the beginning of the year.

We are now turning our sights to the process of planning and budgeting for next fiscal year 2009, beginning in June. We, like others, are concerned about the U.S. economy and about the tough choices for the consumer in the face of much higher energy and housing costs.

We will provide more information regarding our plans for the next fiscal year as part of our fiscal year year-end 2008 results release.

We stated earlier in the year that we are seeking a new strategic partner. Our expanded agreement with Chiquita to collaborate on avocados is our first such agreement and is our first move for BreatheWay packaging technology, outside of bananas.

We expect to enter into an additional technology partnership arrangement with a new partner before the end of this fiscal year.

In summary, we are on plan through the first nine months and we anticipate a solid fourth quarter and the accomplishment of our fiscal year goals. Our core businesses and operations are growing and progressing well, as we continue to focus on opportunities in those businesses and on increasing shareholder value.

Thank you, and we are now ready for questions.

Question-and-Answer Session

Operator

Our first question is from Jonathan Lichter - Sidoti & Company.

Jonathan Lichter - Sidoti & Company

I notice that it looked like there was a little bit more revenue in the Packaging area this quarter. I think you had mentioned on the last call that it was going to be split roughly evenly between the $2.7 million. What occurred there?

Gary Steele

In a nutshell, it was our best estimate at the time at the end of the second quarter. And as it turns out, approximately $300,000 which we had expected to hit in the fourth quarter actually ended up being revenue in the third quarter.

Jonathan Lichter - Sidoti & Company

So, what can we expect in the fourth quarter?

Gary Steele

It would be the difference between the $2.9 million. I mean right now we are assuming we will achieve the minimums for the year, versus what we’ve recognized to date. Included in the Apio Packaging number is approximately $80,000 per quarter from the U.S. military. So you could quickly do the math based on those numbers.

Jonathan Lichter - Sidoti & Company

Okay. And what’s your best guess as to when we could exceed the minimums from Chiquita?

Gary Steele

That’s a tough one. Jonathan, we’re going to go into our planning and budgeting cycle for next year assuming we’re going to hit the minimums only for next year. And the reason is, we should be conservative because the next round of retail grocery store banana trials will not start until late summer, number one.

Number two, the first quick serve restaurant chain store trials are just commencing as we speak. So, we don’t have any better estimates of what that tracking will be, the growth rates will be, what the store sales will be.

So we’re just going to stay on the conservative side until these trials are completed and we have better numbers. So I would just put in the model, the minimums for next year.

Jonathan Lichter - Sidoti & Company

Okay. Anything on the horizon for acquisitions?

Gary Steele

Let’s just say that we’ve said in the past that we’re interested in acquisitions. We’re looking for those things that use our technology, are synergistic with our channels of distribution.

Let me just say that we have identified several targets that meet our criteria, and so that tells you that you we’re still interested in acquisitions and that we’re making some progress. But I probably should stop there.

Jonathan Lichter - Sidoti & Company

Thank you.

Operator

Our next question is from William Gibson - Nollenberger Capital.

William Gibson - Nollenberger Capital

Good morning. One area I want to zero in on and has to do with the expansion of the Chiquita agreement. You talked about the leadership team and retail stores, but what about shipping to the stores? Is Chiquita looking at using BreatheWay in the 40 lb boxes?

Gary Steele

Interesting question. The answer is they are starting to. All of the attention, as you know, was initially going to what they’ve identified as 200,000 potentially alternative sites. That was the first program to validate and demonstrate the technology and their ability to deal with fairly challenging logistics, because you’re going to convenience stores and coffee chains, et cetera.

And then they said they wanted to turn their attention, because it was relatively similar packaging design to quick serve restaurants and that’s where they’ve turned their attention next. In parallel, they’ve been working on the retail consumer package which would be a smaller package.

But, recently the issue of how could the technology be used in the more traditional 40 lb boxes has reappeared. And there is interest in that and I would suspect that as we move through some of these other programs that will be on the drawing boards as well, Bill.

William Gibson - Nollenberger Capital

Okay. Just as an outsider looking at it, it seems to me that would sure be a faster rollout if they decided to go that route.

Gary Steele

That’s a very good thought.

Operator

Sir, at this time I’m showing no further questions.

Gary Steele

Okay. We thank everybody for their interest. We’ll keep you apprised of our progress, as well as the progress with the accounting issues and thank you very much for joining us on this call today. We appreciate it.

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