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Note 1 - Organization, Basis of Presentation, and Summary of Significant Accounting Policies
 12 Months Ended
May 27, 2012
Organization, Consolidation and Presentation of Financial Statements Disclosure [Text Block]
1.           Organization, Basis of Presentation, and Summary of Significant Accounting Policies

Organization

Landec Corporation and its subsidiaries (“Landec” or the “Company”) design, develop, manufacture and sell polymer products for food and agricultural products, medical devices and licensed partner applications that incorporate Landec’s patented polymer technologies.  The Company has two proprietary polymer technology platforms:  1) Intelimer® polymers, and 2) hyaluronan (“HA”) biopolymers.  The Company’s HA biopolymers are proprietary in that they are specially formulated for specific customers to meet strict regulatory requirements. The Company’s polymer technologies, along with its customer relationships and trade names, are the foundation, and a key differentiating advantage upon which Landec has built its business.  The Company sells specialty packaged fresh-cut vegetables and whole produce to retailers, club stores and foodservice operators, primarily in the United States, Canada and Asia through its Apio, Inc. (“Apio”) subsidiary, HA-based biomaterials through its Lifecore Biomedical, Inc. (“Lifecore”) subsidiary, and Intellicoat® coated seed products through its Landec Ag LLC (“Landec Ag”) subsidiary.

Basis of Presentation

Basis of Consolidation

The consolidated financial statements are presented on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles and include the accounts of Landec Corporation and its subsidiaries, Apio, Lifecore and Landec Ag.  All material inter-company transactions and balances have been eliminated.

Arrangements that are not controlled through voting or similar rights are reviewed under the guidance for variable interest entities (“VIEs”). A company is required to consolidate the assets, liabilities and operations of a VIE if it is determined to be the primary beneficiary of the VIE.

An entity is a VIE and subject to consolidation, if by design: a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders or b) as a group the holders of the equity investment at risk lack any one of the following three characteristics: (i) the power, through voting rights or similar rights to direct the activities of an entity that most significantly impact the entity’s economic performance, (ii) the obligation to absorb the expected losses of the entity, or (iii) the right to receive the expected residual returns of the entity. The Company reviewed the consolidation guidance and concluded that the non-public companies in which the Company holds equity investments are not VIEs.

Reclassifications

Certain reclassifications have been made to prior year financial statements to conform to the current year presentation.

Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make certain estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. The accounting estimates that require management’s most significant and subjective judgments include revenue recognition; sales returns and allowances; recognition and measurement of current and deferred income tax assets and liabilities; the assessment of recoverability of long-lived assets; the valuation of intangible assets and inventory; the valuation of investments; and the valuation and recognition of stock-based compensation.

These estimates involve the consideration of complex factors and require management to make judgments. The analysis of historical and future trends, can require extended periods of time to resolve, and are subject to change from period to period.  The actual results may differ from management’s estimates.

Concentrations of Risk

Cash and cash equivalents, marketable securities, trade accounts receivable, grower advances and notes receivable are financial instruments that potentially subject the Company to concentrations of credit risk.  Our Company policy limits, among other things, the amount of credit exposure to any one issuer and to any one type of investment, other than securities issued or guaranteed by the U.S. government.  The Company routinely assesses the financial strength of customers and growers and, as a consequence, believes that trade receivables, grower advances and notes receivable credit risk exposure is limited.  Credit losses for bad debt are provided for in the consolidated financial statements through a charge to operations.  A valuation allowance is provided for known and anticipated credit losses.  The recorded amounts for these financial instruments approximate their fair value.

Several of the raw materials we use to manufacture our products are currently purchased from a single source, including some monomers used to synthesize Intelimer® polymers, substrate materials for our breathable membrane products and raw materials for our HA products.  

During the fiscal year ended May 27, 2012, sales to the Company’s top five customers accounted for approximately 45% of total revenue with the top customer from the Food Products Technology segment accounting for approximately 17% of total revenues.  In addition, approximately 36% of the Company’s total revenues were derived from product sales to international customers, one of whom individually accounted for more than 5% of total revenues.  As of May 27, 2012, the top customer from the Food Products Technology segment represented approximately 11% of total accounts receivable.

During the fiscal year ended May 29, 2011, sales to the Company’s top five customers accounted for approximately 44% of total revenue with the top customer from the Food Products Technology segment accounting for approximately 16% of total revenues.  In addition, approximately 38% of the Company’s total revenues were derived from product sales to international customers, two of whom individually accounted for more than 5% of total revenues.  As of May 29, 2011, the top customer from the Food Products Technology segment represented approximately 14% of total accounts receivable.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Recoverability of assets is measured by comparison of the carrying amount of the asset to the net undiscounted future cash flow expected to be generated from the asset. If the future undiscounted cash flows are not sufficient to recover the carrying value of the assets, the assets’ carrying value is adjusted to fair value.

The Company regularly evaluates its long-lived assets for indicators of possible impairment.  On July 16, 2010, Aesthetic Science sold the rights to its Smartfil™ Injector System.  The Company evaluated its cost method investment for impairment, utilizing a discounted cash flow analysis under the terms of the purchase agreement.  Based on the terms of the agreement, the Company has determined that its investment was other than temporarily impaired and therefore recorded an impairment loss of $1.0 million during the year ended May 30, 2010.

Financial Instruments

The Company’s financial instruments are primarily composed of marketable debt securities, commercial-term trade payables, grower advances, and notes receivable, as well as long-term notes receivables and debt instruments.  For short-term instruments, the historical carrying amount closely approximates fair value.  Fair values for long-term financial instruments not readily marketable are estimated based upon discounted future cash flows at prevailing market interest rates.  Based on these assumptions, management believes the fair market values of the Company’s financial instruments are not materially different from their recorded amounts as of May 27, 2012 and May 29, 2011.

Accounts Receivable and Allowance for Doubtful Accounts

The Company carries its accounts receivable at their face amounts less an allowance for doubtful accounts.  On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts, sales discounts and estimated losses resulting from the inability of its customers to make required payments.  The allowance for doubtful accounts is determined based on review of the overall condition of accounts receivable balances and review of significant past due accounts.  The allowance for doubtful accounts is based on specific identification of past due amounts and a general reserve for accounts over 90-days past due.  The changes in the Company’s allowance for doubtful accounts are summarized in the following table (in thousands).

   
Balance at beginning of period
   
Additions from acquisitions and additions from charges to costs and expenses
   
Deductions
   
Balance at end of period
 
Year ended May 30, 2010
  $ 165     $ 68     $ (44 )   $ 189  
Year ended May 29, 2011
  $ 189     $ 209     $ (56 )   $ 342  
Year ended May 27, 2012
  $ 342     $ 248     $ (78 )   $ 512  

Revenue Recognition

Revenue from product sales is recognized when there is persuasive evidence that an arrangement exists, title has transferred, the price is fixed or determinable, and collectability is reasonably assured.  Allowances are established for estimated uncollectible amounts, product returns, and discounts based on specific identification and historical losses.

The Company takes title to all produce it trades and/or packages, and therefore, records revenues and cost of sales at gross amounts in the Consolidated Statements of Income.  Revenue recognition for produce generally occurs when the customer receives the product or at the time title passes to the customer.  Customers generally do not have the right to return product unless damaged or defective.   Net sales is comprised of gross sales reduced by customer returns and, consumer promotion allowances,

Licensing revenue is recognized in accordance with accounting guidance.  Initial license fees are deferred and amortized to revenue over the period of the agreement when a contract exists, the fee is fixed and determinable, and collectability is reasonably assured.  Noncancellable, nonrefundable license fees are recognized over the period of the agreement, including those governing research and development activities and any related supply agreement entered into concurrently with the license when the risk associated with commercialization of a product is non-substantive at the outset of the arrangement.

Contract revenue for research and development (R&D) is recorded as earned, based on the performance requirements of the contract.  Non-refundable contract fees for which no further performance obligations exist, and

there is no continuing involvement by the Company, are recognized on the earlier of when the payments are received or when collection is assured.

Shipping and Handling Costs

Amounts billed to third-party customers for shipping and handling are included as a component of revenues. Shipping and handling costs incurred are included as a component of cost of products sold and represent costs incurred by Dole to ship product from the sourcing locations to the end consumer markets.

Other Accounting Policies and Disclosures

Cash and Cash Equivalents

The Company records all highly liquid securities with three months or less from date of purchase to maturity as cash equivalents.  Cash equivalents consist mainly of certificate of deposits (CDs), money market funds and U.S. Treasuries.  The market value of cash equivalents approximates their historical cost given their short-term nature.

Marketable Securities

Short-term marketable securities consist of CDs that are FDIC insured and single A or better rated municipal bonds with original maturities of more than three months at the date of purchase regardless of the maturity date as the Company views the funds within its portfolio as available for use in its current operations.  The Company classifies all debt securities with readily determined market values as “available for sale”.  The contractual maturities of the Company's marketable securities that are due in less than one year represent $0 and $21.5 million of its marketable securities and those due in one to two years represent the remaining $0 and $6.6 million of the Company’s marketable securities as of May 27, 2012 and May 29, 2011, respectively.  Investments in marketable securities are carried at fair market value.  Unrealized gains and losses are reported as a component of stockholders’ equity.  The cost of debt securities is adjusted for amortization of premiums and discounts to maturity.  This amortization is recorded to interest income.  Realized gains and losses on the sale of available-for-sale securities are also recorded to interest income and were not significant for the fiscal years ended May 27, 2012 and May 29, 2011.  During fiscal years 2012 and 2011, the Company received proceeds of $27.7 million and $27.3 million, respectively, from the sale of marketable securities.  The cost of securities sold is based on the specific identification method.

Inventories

           Inventories are stated at the lower of cost (using the first-in, first-out method) or market. As of May 27, 2012 and May 29, 2011 inventories consisted of (in thousands):

   
May 27,
2012
   
May 29,
2011
 
Finished goods
  $ 9,406     $ 10,261  
Raw materials
    9,876       7,999  
Work in progress
    2,729       1,901  
     Inventories, net
  $ 22,011     $ 20,161  

If the cost of the inventories exceeds their net realizable value, provisions are recorded currently to reduce them to net realizable value.  The Company also provides a provision for slow moving and obsolete inventories.

Advertising Expense

             Advertising expenditures for the Company are expensed as incurred.  Advertising expense for the Company for fiscal years 2012, 2011 and 2010 was $406,000, $458,000 and $557,000, respectively.

Notes and Advances Receivable

Apio makes advances to produce growers for crop and harvesting costs.  Notes and advances receivable related to operating activities are for the sourcing of crops for Apio’s business and notes and advances receivable related to investing activities are for financing transactions with third parties and there were no notes or advance at May 27, 2012.  Typically operating advances are paid off within the growing season (less than one year) from proceeds from the sale of harvested crops.  Advances not fully paid during the current growing season are converted to interest bearing obligations, evidenced by contracts and notes receivable.  These notes and advances receivable are secured by perfected liens on land and/or crops and have terms that range from six to twelve months.  Notes receivable are reviewed at least quarterly for collectability.  A reserve is established for any note or advance deemed to not be fully collectible based upon an estimate of the crop value or the fair value of the security for the note or advance.

Related Party Transactions

The Company provides cooling and distribution services to both a farm and Beachside Produce LLC ("Beachside"), a commodity produce distributor, in which the Chairman of Apio has a farming and ownership interest, respectively.   During fiscal years 2012, 2011 and 2010, the Company recognized revenues of $3.8 million, $4.1 million, and $4.6 million, respectively, which have been included in product sales and in service revenues in the accompanying Consolidated Statements of Income, from the sale of products and providing cooling services to these parties.  The related receivable balances of $323,000 and $453,000 are included in accounts receivable in the accompanying Consolidated Balance Sheets as of May 27, 2012 and May 29, 2011, respectively.

Additionally, unrelated to the revenue transactions above, the Company purchases produce from the farm in which the Chairman of Apio has an ownership interest, Beachside, and Windset (see Note 3) for sale to third parties. During fiscal years 2012, 2011 and 2010, the Company recognized cost of product sales of $5.6 million, $3.6 million and $3.4 million, respectively, which have been included in product sales and in service revenues in the accompanying Consolidated Statements of Income, from the sale of products purchased from these parties.  The related accounts payable of $776,000 and $300,000 are included in accounts payable, related party in the accompanying Consolidated Balance Sheets as of May 27, 2012 and May 29, 2011, respectively.

All related party transactions are monitored quarterly by the Company and approved by the Audit Committee of the Board of Directors.

Property and Equipment

Property and equipment are stated at cost.  Expenditures for major improvements are capitalized while repairs and maintenance are charged to expense.  Depreciation is expensed on a straight-line basis over the estimated useful lives of the respective assets, generally three to thirty years for buildings and leasehold improvements and three to seven years for furniture and fixtures, computers, capitalized software, capitalized leases, machinery, equipment and autos.  Leasehold improvements are amortized on a straight-line basis over the lesser of the economic life of the improvement or the life of the lease.

The Company capitalizes software development costs for internal use in accordance with accounting guidance.  Capitalization of software development costs begins in the application development stage and ends when the asset is placed into service.  The Company amortizes such costs using the straight-line basis over estimated useful lives of three to seven years.  During fiscal years 2012 and 2011, the Company did not capitalize any software development costs.

Intangible Assets

Property, plant and equipment and finite-lived intangible assets are reviewed for possible impairment whenever events or changes in circumstances occur that indicate that the carrying amount of an asset (or asset group) may not be recoverable. The Company’s impairment review requires significant management judgment including estimating the future success of product lines, future sales volumes, revenue and expense growth rates, alternative uses

for the assets and estimated proceeds from the disposal of the assets. The Company conducts quarterly reviews of idle and underutilized equipment, and reviews business plans for possible impairment indicators. Impairment occurs when the carrying amount of the asset (or asset group) exceeds its estimated future undiscounted cash flows and the impairment is viewed as other than temporary. When impairment is indicated, an impairment charge is recorded for the difference between the asset’s book value and its estimated fair value. Depending on the asset, estimated fair value may be determined either by use of a discounted cash flow model or by reference to estimated selling values of assets in similar condition. The use of different assumptions would increase or decrease the estimated fair value of assets and would increase or decrease any impairment measurement.

The Company’s intangible assets are comprised of customer relationships with an estimated useful life of twelve to thirteen years and trademarks/trade names and goodwill with indefinite lives (collectively, “intangible assets”).  Accounting guidance defines goodwill as “the excess of the cost of an acquired entity over the net of the estimated fair values of the assets acquired and the liabilities assumed at date of acquisition.”  All intangible assets, including goodwill, associated with the acquisitions of Lifecore, Apio and GreenLine, were allocated to our HA-based Biomaterials reporting unit and our Food Products Technology reporting unit, respectively, based upon the allocation of assets and liabilities acquired and consideration paid for each reporting unit.  As of May 27, 2012, the HA-based Biomaterials reporting unit had $13.9 million of goodwill and the Food Products Technology reporting unit had $35.7 million of goodwill.

The Company tests its indefinite-lived intangible assets for impairment at least annually.  When evaluating indefinite-lived intangible assets for impairment the Company compares the fair value of the asset to its carrying value to determine if there is an impairment loss. When evaluating goodwill for impairment the Company first compares the fair value of the reporting unit to its carrying value to determine if there is an impairment loss.  If the fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired; thus application of the second step of the two-step approach under accounting guidance is not required.  Application of the intangible assets impairment tests requires significant judgment by management, including identification of reporting units, assignment of assets and liabilities to reporting units, assignment of intangible assets to reporting units, and the determination of the fair value of each indefinite-lived intangible asset and reporting unit based upon projections of future net cash flows, discount rates and market multiples, which require significant judgments and estimates.

The Company tested its indefinite-lived intangible assets and goodwill for impairment as of July 22, 2012 and determined that no adjustments to the carrying values of the intangible assets were necessary as of that date.  On a quarterly basis, the Company considers the need to update its most recent annual tests for possible impairment of its intangible assets, based on management’s assessment of changes in its business and other economic factors since the most recent annual evaluation.  Such changes, if significant or material, could indicate a need to update the most recent annual tests for impairment of the intangible assets during the current period.  The results of these tests could lead to write-downs of the carrying values of the intangible assets in the current period.

The Company uses the discounted cash flow (“DCF”) approach to develop an estimate of fair value.  The DCF approach recognizes that current value is premised on the expected receipt of future economic benefits. Indications of value are developed by discounting projected future net cash flows to their present value at a rate that reflects both the current return requirements of the market and the risks inherent in the specific investment.  The market approach is not used to value the Food Products Technology and the HA-based Biomaterials reporting units (the “reporting units”) because insufficient market comparables exist to enable the Company to develop a reasonable fair value of its intangible assets due to the unique nature of each of the Company’s Reporting Units.

The DCF approach requires the Company to exercise judgment in determining future business and financial forecasts and the related estimates of future net cash flows. Future net cash flows depend primarily on future product sales, which are inherently difficult to predict. These net cash flows are discounted at a rate that reflects both the current return requirements of the market and the risks inherent in the specific investment.

The DCF associated with the Food Products Technology reporting unit is based on management’s five-year projection of revenues, gross profits and operating profits by fiscal year and assumes a 37% effective tax rate for each

year.  Management takes into account the historical trends of Apio and the industry categories in which Apio operates along with inflationary factors, current economic conditions, new product introductions, cost of sales, operating expenses, capital requirements and other relevant data when developing its projection. The estimated fair value of the Food Products Technology reporting units as of July 22, 2012 exceeded its net book value by 118% and therefore, no intangible asset impairment was deemed to exist.  For the test performed as of July 24, 2011, the projected cash flow from operations for determining the DCF for fiscal year 2012 was $21.7 million for the Food Products Technology reporting unit.  The actual cash flow from operations for fiscal year 2012 was $19.4 million.  The difference of $2.3 million was primarily due to the timing of working capital changes.

The DCF associated with the HA-based Biomaterials reporting unit is based on management’s five-year projections of revenues, gross profits and operating profits by fiscal year and assumes a 37% effective tax rate for each year.  Management takes into account the historical trends of Lifecore and the industry categories in which Lifecore operates along with inflationary factors, current economic conditions, new product introductions, cost of sales, operating expenses, capital requirements and other relevant data when developing its projection. The trade name intangible asset was valued using the relief from royalty valuation method and the customer relationship intangible asset was valued using the multi-period excess earnings method. The fair value of goodwill was calculated as the excess of consideration paid, including the fair value of contingent consideration under the terms of the purchase agreement, over the fair value of the tangible and intangible assets acquired less liabilities assumed.  The Company updated its analysis of the fair value of the indefinite-lived intangible assets and goodwill as of its annual impairment analysis date, concluding that the fair value of the Hyaluronan-based Biomaterials reporting unit, as determined by the DCF approach, exceeded its net book value by 143%, and therefore, no intangible asset impairment was deemed to exist.  For the test performed as of July 24, 2011, the projected cash flow from operations for determining the DCF for fiscal year 2012 was a negative $5.0 million (due to the projected earn out payment, see Note 2) for the HA-based Biomaterials reporting unit.  The actual cash flow from operations for fiscal year 2012 was a positive $5.6 million.  The difference of $10.6 million is primarily due to Lifecore paying the $10 million earn out payment in June 2012 rather than in May 2012, as originally forecasted.

Investment in Non-Public Company

The Company’s investment in Aesthetic Science is carried at cost and adjusted for impairment losses.   Since there is no readily available market value information, the Company periodically reviews this investment to determine if any other than temporary declines in value have occurred based on the financial stability and viability of Aesthetic Science.

Aesthetic Science sold the rights to its Smartfil™ Injector System on July 16, 2010.  As a result, Landec evaluated its cost method investment for impairment, utilizing a discounted cash flow analysis.  Based on the terms of the agreement, the Company determined that its investment was other than temporarily impaired and therefore, recorded an impairment loss of $1.0 million as of May 30, 2010, which is classified as part of other operating expenses in the Consolidated Statements of Income.  The Company’s carrying value of its investment in Aesthetic Sciences, net of the impairment loss, is $793,000 at May 27, 2012 and May 29, 2011.

On February 15, 2011, the Company made an investment in Windset Holdings 2010 Ltd., a Canadian corporation (“Windset”), which is reported as an investment in non-public company, fair value, in the accompanying Consolidated Balance Sheets as of May 27, 2012 and May 29, 2011.  The Company has elected to account for its investment in Windset under the fair value option (see Note 3).

Deferred Revenue

Cash received in advance of services performed (principally related to upfront license fees) are recorded as deferred revenue.  At May 27, 2012, $162,000 was recognized as advances from customers.  At May 29, 2011, $2.3 million was recognized as deferred license fee revenues and $357,000 as advances from customers.

Comprehensive Loss

Comprehensive loss consists of net income and other comprehensive loss and is reported as a component of stockholders’ equity.

Prior to May 23, 2012, the Company accounted for its interest rate swap as a cash flow hedge and included the fair market value of the swap in comprehensive loss.  As discussed in Note 9, on May 23, 2012, the Company extinguished its debt with Wells Fargo but did not terminate the swap.  As a result of extinguishing the debt, the swap was no longer an effective hedge and therefore, the fair value of the swap at the time the debt was extinguished of $347,000 was reversed from other comprehensive income and recorded in other expense.  For the fiscal year ended May 29, 2011, the comprehensive loss from the unrealized loss on the interest rate swap, net of $159,000 of income taxes, was $267,000.  For the fiscal year ended May 30, 2010, the comprehensive loss from the unrealized loss on the interest rate swap, net of $105,000 of income taxes, was $179,000.

Non Controlling Interest

The Company reports all non controlling interests as a separate component of stockholders’ equity, the reporting of consolidated net income (loss) as the amount attributable to both the parent and the non controlling interests and the separate disclosure of net income (loss) attributable to the parent and to the non controlling interests.

In connection with the acquisition of Apio, Landec acquired Apio’s 60% general partner interest in Apio Cooling, a California limited partnership.  Apio Cooling is included in the consolidated financial statements of Landec for all periods presented.  The non-controlling interest balance of $1.8 million at May 27, 2012 and $1.7 million at May 29, 2011 is comprised of the limited partners’ interest in Apio Cooling.

Income Taxes

The Company accounts for income taxes in accordance with accounting guidance which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax basis of recorded assets and liabilities.  The Company maintains valuation allowances when it is likely that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the Company’s income tax provision in the period of change. In determining whether a valuation allowance is warranted, the Company takes into account such factors as prior earnings history, expected future earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect utilization of a deferred tax asset, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. At May 27, 2012, the Company had $419,000 valuation allowance against deferred tax assets.

In addition to valuation allowances, the Company establishes accruals for uncertain tax positions.  The tax-contingency accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. The Company’s effective tax rate includes the impact of tax-contingency accruals as considered appropriate by management.

A number of years may elapse before a particular matter, for which the Company has accrued, is audited and finally resolved. The number of years with open tax audits varies by jurisdiction. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, the Company believes its tax-contingency accruals are adequate to address known tax contingencies. Favorable resolution of such matters could be recognized as a reduction to the Company’s effective tax rate in the year of resolution. Unfavorable settlement of any particular issue could increase the effective tax rate. Any resolution of a tax issue may require the use of cash in the year of resolution. The Company’s tax-contingency accruals are presented in the balance sheet within accrued liabilities.

Per Share Information

Accounting guidance requires the presentation of basic and diluted earnings per share.   Basic earnings per share excludes any dilutive effects of options, warrants and convertible securities and is computed using the weighted average number of common share outstanding.  Diluted earnings per share reflects the potential dilution if securities or other contracts to issue common stock were exercised or converted into common stock.  Diluted common equivalent shares consist of stock options using the treasury stock method.

The following table sets forth the computation of diluted net income per share (in thousands, except per share amounts):

   
Fiscal Year Ended
May 27, 2012
   
Fiscal Year Ended
May 29, 2011
   
Fiscal Year Ended
May 30, 2010
 
Numerator:
                 
Net income applicable to Common Stockholders
  $ 12,696     $ 3,920     $ 3,984  
Denominator:
                       
   Weighted average shares for basic net income per share
    25,849       26,397       26,382  
Effect of dilutive securities:
                       
Stock options and restricted stock units
    277       229       251  
Weighted average shares for diluted net income per share
    26,126       26,626       26,633  
                         
Diluted net income per share
  $ 0.49     $ 0.15     $ 0.15  

Options to purchase 1,855,167, 2,032,867 and 1,016,239 shares of Common Stock at a weighted average exercise price of $6.72, $6.67 and $7.62 per share were outstanding during fiscal years ended May 27, 2012, May 29, 2011 and May 30, 2010, respectively, but were not included in the computation of diluted net income per share because the options’ exercise price were greater than the average market price of the Common Stock and, therefore, their inclusion would be antidilutive.

Cost of Sales

           The Company includes in cost of sales all the costs related to the sale of products in accordance with generally accepted accounting principles.  These costs include the following: raw materials (including produce, seeds, packaging, syringes and fermentation and purification supplies), direct labor, overhead (including indirect labor, depreciation, and facility related costs) and shipping and shipping related costs.

 
 Research and Development Expenses

           Costs related to both research contracts and Company-funded research is included in research and development expenses.  Costs to fulfill research contracts generally approximate the corresponding revenue.  Research and development costs are primarily comprised of salaries and related benefits, supplies, travel expenses, consulting expenses and corporate allocations.

Accounting for Stock-Based Compensation

The Company records compensation expense for stock-based awards issued to employees and directors in exchange for services provided based on the estimated fair value of the awards on their grant dates and is recognized over the required service periods. The cash flows resulting from the tax benefit due to tax deductions in excess of the compensation expense recognized for those options (excess tax benefit) are classified as financing activities with the statement of cash flows.  The Company’s stock-based awards include stock option grants and restricted stock unit awards (RSUs).

During the fiscal year ended May 27, 2012, the Company recognized stock-based compensation expense of $1,872,000 which included $826,000 for restricted stock unit awards and $1,046,000 for stock option grants. During

the fiscal year ended May 29, 2011, the Company recognized stock-based compensation expense of $1,951,000 which included $857,000 for restricted stock unit awards and $1,094,000 for stock option grants.  During the fiscal year ended May 30, 2010, the Company recognized stock-based compensation expense of $1,016,000 which included $474,000 for restricted stock unit awards and $542,000 for stock option grants.

The following table summarizes the stock-based compensation by income statement line item:

   
Fiscal Year Ended
May 27, 2012
   
Fiscal Year Ended
May 29, 2011
   
Fiscal Year Ended
May 30, 2010
 
Research and development
  $ 530,000     $ 565,000     $ 185,000  
Sales, general and administrative
    1,342,000       1,386,000       831,000  
Total stock-based compensation expense
  $ 1,872,000     $ 1,951,000     $ 1,016,000  

The estimated fair value for stock options, which determines the Company’s calculation of compensation expense, is based on the Black-Scholes option pricing model.  The Company uses the straight line single option method to calculate and recognize the fair value of stock-based compensation arrangements.  In addition, the Company uses historical data to estimate pre-vesting forfeitures and records stock-based compensation expense only for those awards that are expected to vest and revises those estimates in subsequent periods if the actual forfeitures differ from the prior estimates.

As of May 27, 2012, May 29, 2011 and May 30, 2010, the fair value of stock option grants was estimated using the Black-Scholes option pricing model. The following weighted average assumptions were used:

   
Fiscal Year Ended
May 27, 2012
 
Fiscal Year Ended
May 29, 2011
 
Fiscal Year Ended
May 30, 2010
Expected life (in years)
    3.76       3.76       3.56  
Risk-free interest rate
    0.59%       1.16%       1.47%  
Volatility
    0.53       0.52       0.52  
Dividend yield
    0%       0%       0%  

The Black-Scholes option pricing model requires the input of highly subjective assumptions, including the expected stock price volatility.

The weighted average estimated fair value of Landec employee stock options granted at grant date market prices during the fiscal years ended May 27, 2012, May 29, 2011 and May 30, 2010 was $2.65, $2.42 and $2.52 per share, respectively.  No stock options were granted above or below grant date market prices during the fiscal years ended May 27, 2012, May 29, 2011 and May 30, 2010.

Fair Value Measurements

The Company uses fair value measurement accounting for financial assets and liabilities and for financial instruments and certain other items at fair value.  The Company has elected the fair value option for its investment in a non-public company (see Note 3).  The Company has not elected the fair value option for any of its other eligible financial assets or liabilities.

The accounting guidance established a three-tier hierarchy for fair value measurements, which prioritizes the inputs used in measuring fair value as follows:

Level 1
 – observable inputs such as quoted prices for identical instruments in active markets.

Level 2
 – inputs other than quoted prices in active markets that are observable either directly or indirectly through corroboration with observable market data.

Level 3
 – unobservable inputs in which there is little or no market data, which would require the Company to develop its own assumptions.

As of May 27, 2012, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis, including cash equivalents, marketable securities, interest rate swap and liability for contingent consideration in connection with the acquisition of GreenLine and its minority interest investment in Windset.

The fair value of the Company’s cash equivalents and marketable securities is determined based on observable inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. Therefore, the Company has categorized its cash equivalents and marketable securities as Level 1.

The fair value of the Company’s interest rate swap is determined based on model inputs that can be observed in a liquid market and key inputs include yield curves and are categorized as Level 2 inputs.

The fair value of the Company’s liability for contingent consideration is based on significant inputs not observed in the market and thus represents a Level 3 measurement.  The Company determined the fair value of the liability for the contingent consideration based on a probability-weighted discounted cash flow analysis, as further discussed in Note 2 to the Consolidated Financial Statements.

The Company has elected the fair value option of accounting for its investment in Windset. The fair value of the Company’s investment in Windset utilizes significant unobservable inputs in the discounted cash flow models, including projected cash flows, growth rates and the discount rate, and is therefore, considered Level 3, as further discussed in Note 3.

Imprecision in estimating unobservable market inputs can affect the amount of gain or loss recorded for a particular position.  The use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Recent Accounting Pronouncements

Intangibles-Goodwill and Other

In September 2011, the FASB issued new guidance that will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this amendment, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendment includes a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The guidance is effective for fiscal years beginning after December 15, 2011 with early adoption permitted. The Company does not expect that the adoption of this update will have a material impact on its consolidated financial statements.

Presentation of Comprehensive Income

In December 2011, the FASB issued new guidance that improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments in this standard require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under either method, adjustments must be displayed for items that are reclassified from other comprehensive income ("OCI") to net income, in both net income and OCI. The standard does not change the current option for presenting components of OCI gross or net of the effect of income taxes, provided that such tax effects are presented in the statement in which OCI is presented or disclosed in the notes to the financial statements. Additionally, the standard does not affect the calculation or reporting of earnings per share. For public entities, the amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and are to be applied retrospectively, with early adoption permitted. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.

Fair Value Measurement

In May 2011, the FASB issued new guidance which is effective for annual reporting periods beginning after December 15, 2011. This guidance amends certain accounting and disclosure requirements related to fair value measurements. Additional disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy.  The new guidance will become effective for the Company on December 1, 2012.  The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements, however, presentation of disclosures around fair value measurements will be expanded to conform to the requirements of the new guidance for all periods presented.

Disclosures about Offsetting Assets and Liabilities

In November 2011, the FSB issued new guidance which is effective for annual reporting periods beginning January 1, 2013.  This guidance amends the disclosure requirements around offsetting to enable users of the financial statements to understand the effect of those arrangements on its financial position.   Entities are required to disclose both gross and net information about the instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement.  The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.