UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
   
þ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period endedSeptember 30,December 31, 2005
   
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ___ to ___
Commission File Number0-4136
Lifecore Biomedical, Inc.
(Exact name of registrant as specified in its charter)
   
Minnesota 41-0948334
   
(State or other jurisdiction of
incorporation or organization)
 (IRS Employer Identification No.)
incorporation or organization)
   
3515 Lyman Boulevard  
Chaska, Minnesota 55318
   
(Address of principal executive
offices)
 (Zip Code)
offices)
Registrant’s telephone number, including area code:952-368-4300
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yesþ Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, (as definedor a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).Act. (check one):
YesLarge accelerated filero       Accelerated filerþ      NoNon-accelerated filero
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
The number of shares outstanding of the registrant’s Common Stock, $.01 par value, as of November 4, 2005February 2, 2006 was 13,156,16013,176,471 shares.
 
 

 


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
FORM 10-Q
TABLE OF CONTENTS
     
  Page
Financial Information    
     
Financial Statements    
     
Condensed Consolidated Balance Sheets at September 30,December 31, 2005 and June 30, 2005  2 
     
Condensed Consolidated Statements of Operations for Three Months and Six Months Ended September 30,December 31, 2005 and 2004  3 
     
Condensed Consolidated Statements of Cash Flows for ThreeSix Months Ended September 30,December 31, 2005 and 2004  4 
     
Notes to Unaudited Condensed Consolidated Financial Statements  5-11 
     
Management’s Discussion and Analysis of Financial Condition and Results of Operations  12-1812-20 
     
Quantitative and Qualitative Disclosures About Market Risk  1921 
     
Controls and Procedures  1921 
     
Other Information    
     
20
  
 21
  22 
     
Submission of Matters to a Vote of Security Holders  23 
Exhibits24
Signatures25
Exhibit Index26
1996 Stock Option Plan
 Certification of CEO Pursuant to Section 302
 Certification of CFO Pursuant to Section 302
 Certification of CEO Pursuant to Section 906
 Certification of CFO Pursuant to Section 906

1


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
CONDENSED CONSOLIDATED BALANCE SHEETSSTATEMENTS OF OPERATIONS
(Unaudited)
                
 September 30, June 30,  December 31, June 30, 
 2005 2005  2005 2005 
ASSETS  
Current Assets  
Cash and cash equivalents $18,504,000 $18,508,000  $18,323,000 $18,508,000 
Accounts receivable, less allowances 9,739,000 10,171,000  11,033,000 10,171,000 
Inventories 11,234,000 9,456,000  11,671,000 9,456,000 
Deferred income taxes 4,560,000 4,190,000  5,236,000 4,190,000 
Prepaid expenses 1,026,000 780,000  970,000 780,000 
          
Total current assets 45,063,000 43,105,000  47,233,000 43,105,000 
  
Property, plant and equipment      
Land, building and equipment 47,877,000 47,400,000  48,356,000 47,400,000 
Less accumulated depreciation  (24,657,000)  (24,211,000)  (25,100,000)  (24,211,000)
          
 23,220,000 23,189,000  23,256,000 23,189,000 
  
Other Assets      
Intangibles 5,270,000 4,799,000 
Intangibles, net 5,265,000 4,799,000 
Inventories 2,265,000 2,409,000  2,186,000 2,409,000 
Deferred income taxes 5,207,000 6,062,000  3,766,000 6,062,000 
Other 343,000 302,000  357,000 302,000 
          
 13,085,000 13,572,000  11,574,000 13,572,000 
          
 $81,368,000 $79,866,000  $82,063,000 $79,866,000 
          
  
LIABILITIES AND SHAREHOLDERS’ EQUITY  
Current Liabilities  
Current maturities of long-term obligations $285,000 $285,000  $285,000 $285,000 
Accounts payable 3,443,000 3,418,000  2,395,000 3,418,000 
Accrued compensation 1,355,000 1,920,000  1,592,000 1,920,000 
Accrued expenses 1,396,000 1,293,000  1,141,000 1,293,000 
          
Total current liabilities 6,479,000 6,916,000  5,413,000 6,916,000 
  
Long-term obligations 5,019,000 5,089,000  4,949,000 5,089,000 
  
Shareholders’ equity 69,870,000 67,861,000  71,701,000 67,861,000 
          
 $81,368,000 $79,866,000  $82,063,000 $79,866,000 
          
See accompanying notes to condensed consolidated financial statements.

2


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
                        
 Three months ended September 30,  Three months ended December 31, Six months ended December 31, 
 2005 2004  2005 2004 2005 2004 
Net sales $13,425,000 $12,305,000  $15,209,000 $14,218,000 $28,634,000 $26,523,000 
Cost of goods sold 5,063,000 5,096,000  6,108,000 5,455,000 11,171,000 10,551,000 
              
Gross profit 8,362,000 7,209,000  9,101,000 8,763,000 17,463,000 15,972,000 
  
Operating expenses  
Research and development 999,000 848,000  970,000 1,171,000 1,969,000 2,019,000 
Marketing and sales 4,009,000 3,215,000  4,020,000 3,837,000 8,029,000 7,052,000 
General and administrative 1,787,000 1,467,000  1,923,000 1,579,000 3,710,000 3,046,000 
              
 6,795,000 5,530,000  6,913,000 6,587,000 13,708,000 12,117,000 
              
  
Operating income 1,567,000 1,679,000  2,188,000 2,176,000 3,755,000 3,855,000 
  
Other income (expense)          
Interest income 135,000 10,000  157,000 32,000 292,000 42,000 
Interest expense  (56,000)  (113,000)  (60,000)  (55,000)  (116,000)  (168,000)
Bond retirement expense   (290,000)     (290,000)
Currency transaction gains (losses)  (24,000) 85,000   (49,000) 113,000  (73,000) 198,000 
Other  (14,000) 2,000   (5,000) 250,000  (19,000) 252,000 
              
 41,000  (306,000) 43,000 340,000 84,000 34,000 
              
  
Income before income taxes 1,608,000 1,373,000 
Income before income tax expense 2,231,000 2,516,000 3,839,000 3,889,000 
  
Income tax expense 563,000 94,000  840,000 136,000 ��1,403,000 230,000 
              
  
Net income $1,045,000 $1,279,000  $1,391,000 $2,380,000 $2,436,000 $3,659,000 
              
  
Net income per share  
Basic $0.08 $0.10  $0.11 $0.18 $0.19 $0.28 
              
Diluted $0.08 $0.10  $0.10 $0.18 $0.18 $0.28 
              
  
Weighted average shares outstanding  
Basic 13,059,567 12,932,606  13,163,429 12,945,903 13,111,498 12,939,254 
              
Diluted 13,460,056 12,965,549  13,685,687 13,270,519 13,571,202 13,115,195 
              
See accompanying notes to condensed consolidated financial statements.

3


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
                
 Three months ended September 30,  Six months ended December 31, 
 2005 2004  2005 2004 
Cash flows from operating activities:  
Net income $1,045,000 $1,279,000  $2,436,000 $3,659,000 
Adjustments to reconcile net income to net cash provided by operating activities:  
Depreciation and amortization 473,000 523,000  942,000 1,038,000 
Allowance for doubtful accounts 10,000 139,000  36,000 279,000 
Deferred income taxes 485,000   1,250,000  
Stock compensation 230,000   483,000 21,000 
Accumulated currency translation adjustment 28,000 92,000  37,000 243,000 
Changes in operating assets and liabilities, net of effects of acquisitions: 
Changes in operating assets and liabilities, net of effects of acquisition: 
Accounts receivable 140,000 78,000   (1,181,000)  (676,000)
Inventories  (1,533,000)  (354,000)  (1,889,000) 17,000 
Prepaid expenses  (245,000)  (219,000)  (189,000)  (308,000)
Accounts payable 13,000  (573,000)  (1,035,000)  (817,000)
Accrued liabilities  (474,000)  (275,000)  (492,000)  (19,000)
          
Net cash provided by operating activities 172,000 690,000  398,000 3,437,000 
 
Cash flows from investing activities:  
Purchases of property, plant and equipment  (445,000)  (493,000)  (924,000)  (792,000)
Acquisitions, net of cash acquired  (322,000)  
Acquisition, net of cash acquired  (341,000)  
Refunds of security deposits  830,000   830,000 
Increase in other assets  (45,000)  (81,000)  (62,000)  (102,000)
          
Net cash provided by (used in) investing activities  (812,000) 256,000 
Net cash used in investing activities  (1,327,000)  (64,000)
  
Cash flows from financing activities:  
Payments on long-term obligations  (70,000)  (23,000)  (140,000)  (117,000)
Issuance of industrial revenue bonds  5,630,000   5,630,000 
Retirement of industrial revenue bonds   (5,986,000)   (5,986,000)
Proceeds from stock options exercised 706,000 6,000  884,000 104,000 
          
Net cash provided by (used in) financing activities 636,000  (373,000) 744,000  (369,000)
          
Net increase (decrease) in cash and cash equivalents  (4,000) 573,000   (185,000) 3,004,000 
Cash and cash equivalents at beginning of period 18,508,000 8,553,000  18,508,000 8,553,000 
          
Cash and cash equivalents at end of period $18,504,000 $9,126,000  $18,323,000 $11,557,000 
          
  
Supplemental disclosure of cash flow information:  
Cash paid during the period for:  
Interest $56,000 $156,000  $116,000 $210,000 
Taxes 21,000 68,000  154,000 262,000 
See accompanying notes to condensed consolidated financial statements.

4


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED
September 30,December 31, 2005
NOTE A – FINANCIAL INFORMATION
Lifecore Biomedical, Inc. (referred to in this report as “Lifecore” or the “Company”) manufactures biomaterials and surgical devices for use in various surgical markets and provides specialized contract aseptic manufacturing services through its two divisions, the Hyaluronan Division and the Oral Restorative Division. The Company’s manufacturing facility is located in Chaska, Minnesota. The Hyaluronan Division markets its products through original equipment manufacturers and contract manufacturing alliances in ophthalmologic, orthopedic surgery, veterinary medicine and gynecologic fields. The Oral Restorative Division markets its products through direct sales in the United States, Italy, Germany, Sweden and France and through distributors in other foreign countries.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Regulation S-X pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures are adequate to make the information presented not misleading.
In the opinion of management, the unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of the Company as of September 30,December 31, 2005, the results of operations for the three month and six month periods ended September 30,December 31, 2005 and 2004;2004, and cash flows for the threesix month periods ended September 30,December 31, 2005 and 2004. The results of operations and cash flows for the threesix months ended September 30,December 31, 2005 are not necessarily indicative of the results for the full year or of the results for any future periods. The unaudited condensed consolidated balance sheet as of June 30, 2005 has been derived from audited financial statements as of that date.
In preparation of the Company’s consolidated financial statements, management is required to make estimates and assumptions that affect reported amounts of assets and liabilities and related revenues and expenses during the reporting periods. Actual results could differ from the estimates used by management.
NOTE B – INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventories consist mainly of finished hyaluronan powder, aseptic units and oral restorative products and related raw materials. The Company’s inventory has been reduced to the lower of cost or market for obsolete, excess or unmarketable inventory. The lower of cost or market adjustment is based on management’s review of inventories on hand compared to estimated future usage and sales. The portion of finished hyaluronan powder inventory not expected to be consumed within the next 12 months is classified as a long-term asset. The finished hyaluronan inventory is maintained in a frozen state and has a shelf life of ten years. Inventories consist of the following:
                
 September 30, June 30,  December 31, June 30, 
 2005 2005  2005 2005 
Raw materials $4,351,000 $3,102,000  $4,412,000 $3,102,000 
Work-in-process 554,000 426,000  1,036,000 426,000 
Finished goods-current 6,329,000 5,928,000  6,223,000 5,928,000 
          
 11,234,000 9,456,000  11,671,000 9,456,000 
Finished goods-long term 2,265,000 2,409,000  2,186,000 2,409,000 
          
 $13,499,000 $11,865,000  $13,857,000 $11,865,000 
          

5


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED (continued)
September 30,December 31, 2005
NOTE C – INTANGIBLE ASSETS
Intangibles consist primarily of the cost of goodwill related to acquisitions, patents and distribution rights and licenses. All intangibles relate to the Oral Restorative Division.
Also included within intangibles are costs incurred to register patents and trademarks, which are capitalized as incurred. Amortization of these costs commences when the related patent or trademark is granted. The costs are amortized over the estimated useful life of the patent or trademark, not to exceed 17 years.
Goodwill is tested for impairment on a quarterly basis, or when there is an indication that an impairment has occurred, and is written down when impaired by applying a fair-valuefair value based test. Purchased intangible assets other than goodwill are amortized over their useful lives unless these lives are determined to be indefinite. There was no impairment recorded for the threesix month period ended September 30,December 31, 2005.
Intangibles consisted of the following at:
               
September 30, June 30,  December 31, June 30, 
2005 2005  2005 2005 
Goodwill $4,847,000 $4,352,000  $4,866,000 $4,352,000 
Patents 387,000 387,000  387,000 387,000 
Distribution rights and licenses 350,000 350,000  350,000 350,000 
Accumulated amortization  (314,000)  (290,000)  (338,000)  (290,000)
          
 $5,270,000 $4,799,000  $5,265,000 $4,799,000 
          
NOTE D – LINE OF CREDIT
The Company has a $5,000,000 credit facility with a bank which has a maturity date of December 31, 2006. The agreement allows for advances against eligible accounts receivable, subject to a borrowing base certificate.certificate and compliance with covenants. Under the credit facility, interest will accrue at the prime rate (6.75% at September 30, 2005) minus .5% or LIBOR (3.86% at September 30, 2005) plus 2.25%, at the Company’s option. At September 30,December 31, 2005 and June 30, 2005, there were no balances outstanding under the line of credit. The terms of the agreement require the Company to comply with various financial covenants, including minimum tangible net worth, liabilities to tangible net worth ratio and profitability. At September 30, 2005 and June 30, 2005, the Company was in compliance with all covenants.
NOTE E – STOCK BASED COMPENSATION
Commencing July 1, 2005, the Company adopted Statement of Financial Accounting Standard No. 123R, “Share Based Payment” (“SFAS 123R”), which requires all share-based payments, including grants of stock options, to be recognized in the income statement as an operating expense, based on their fair values over the requisite service period. The Company recorded $190,000$181,000 and $371,000 of related compensation expense, included in general and administrative expense, for the three-monthsthree month and six month periods ended September 30, 2005. There was no tax benefit from recording this non-cash expense.December 31, 2005, respectively. The compensation expense reduced both basic and diluted earnings per share by $0.01.$0.01 for the three month period ended December 31, 2005 and reduced basic earnings per share by $0.02 and diluted earnings per share by $0.03 for the six month period ended December 31, 2005.
As of September 30,December 31, 2005, $939,000$1,094,000 of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 2.52.9 years.

6


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED (continued)
September 30,December 31, 2005
NOTE E – STOCK BASED COMPENSATION – (continued)
Prior to adopting SFAS 123R, the Company accounted for stock-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company has applied the modified prospective method in adopting SFAS 123R. Accordingly, periods prior to adoption have not been restated. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to the comparable periods in the prior period.fiscal year.
            
 Three months ended  Three months ended Six months ended 
 September 30, 2004  December 31, 2004 December 31, 2004 
Reported net income $1,279,000  $2,380,000 $3,659,000 
Stock-based employee compensation determined under the fair value based method, net of related tax effects  (207,000)  (208,000)  (415,000)
        
Pro forma net income $1,072,000  $2,172,000 $3,244,000 
        
  
Income per common equivalent share:  
Basic — as reported $0.10  $0.18 $0.28 
Diluted — as reported $0.10  $0.18 $0.28 
  
Basic — pro forma $0.08  $0.17 $0.25 
Diluted — pro forma $0.08  $0.16 $0.25 
The Company uses the Black-Scholes option pricing model to determine the weighted average fair value of options. The weighted average fair value of options granted during the three month periods ended September 30,December 31, 2005 and 2004 were $4.44$6.04 and $2.48,$4.32, respectively, and were $5.36 and $4.05 during the six month periods ended December 31, 2005 and 2004, respectively. The fair value of options at date of grant and the assumptions utilized to determine such values are indicated in the following table:
                        
 Three Months Ended Three Months Ended Three Months Ended 
 September 30, December 31, September 30, 
 2005 2004 2005 2004 2005 2004 
Risk-free interest rate  4.27%  3.9%  4.33%  3.9%  4.27%  3.9%
Expected volatility  69.5%  69.6%  60.8%  69.6%  69.5%  69.6%
Expected life (in years) 5.6 5.4  5.7 5.4 5.6 5.4 
Dividend yield        

7


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED (continued)
September 30,December 31, 2005
NOTE E – STOCK BASED COMPENSATION – (continued)
The Company’s stock options generally vest ratably over four years of service and have a contractual life of 10 years. The Company has authorized 5,000,000 shares for grant under the 1990, 1996 and 2003 Stock Option Plans. Option transactions under the 1990 and 1996 Stock Option Plans during the first quartersix month period ended September 30,December 31, 2005 are summarized as follows (no stock options have been granted under the 2003 Plan):
                
 Number of Weighted Average  Number of Weighted Average 
 Shares Exercise Price  Shares Exercise Price 
Outstanding at June 30, 2005 1,720,706 $10.19  1,720,706 $10.19 
Granted 41,300 10.86  41,300 10.86 
Exercised  (101,100) 7.00   (101,100) 7.00 
Canceled  (12,750) 9.35   (12,750) 9.35 
          
Outstanding at September 30, 2005 1,648,156 $10.41  1,648,156 10.41 
Granted 56,000 14.06 
Exercised  (18,233) 9.71 
Canceled  (11,400) 8.28 
          
Outstanding at December 31, 2005 1,674,523 $10.52 
     
         
  Number of Weighted Average
  Shares Exercise Price
Options exercisable at September 30, 2005  1,309,856   $10.83
         
  Number of  Weighted Average 
  Shares  Exercise Price 
Options exercisable at December 31, 2005  1,362,723  $10.72 
The following tables summarize information concerning currently outstanding and exercisable stock options.
                           
Options Outstanding
Range ofRange of Number Weighted Average Remaining Weighted AverageRange of Number Weighted Average Remaining Weighted Average 
Exercise PriceExercise Price Outstanding Contractual Life Exercise PriceExercise Price Outstanding Contractual Life Exercise Price 
$3.55  5.82 87,750 6.27 years $ 5.23
$3.55- 5.82 79,000 6.56 years $5.21 
5.83- 8.75 701,855 6.55 years 7.28 
8.76- 13.12 402,125 6.57 years 10.15 
13.13- 19.68 460,543 2.71 years 15.94 
19.69- 23.38 31,000 2.01 years 21.55 
5.83  8.75 708,563 6.79 years 7.29     
8.76  13.12 394,800 6.48 years 10.15 1,674,523 $10.52 
13.13  19.68 426,043 2.34 years 16.09     
19.69  23.38 31,000 2.26 years 21.55
    
 1,648,156 $ 10.41
    

8


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED (continued)
September 30,December 31, 2005
NOTE E – STOCK BASED COMPENSATION – (continued)
                  
Options Exercisable
Range ofRange of Number Weighted AverageRange of Number Weighted Average
Exercise PriceExercise Price Exercisable Exercise PriceExercise Price Exercisable Exercise Price
$3.55  5.82 65,125 $ 5.353.55  5.82 56,625 $ 5.34
5.83  8.75 551,938 7.235.83  8.75 598,480 7.26
8.76  13.12 242,750 10.138.76  13.12 259,575 10.06
13.13  19.68 424,043 16.1013.13  19.68 422,043 16.09
19.69  23.38 26,000 21.5819.69  23.38 26,000 21.58
        
 1,309,856 $ 10.83 1,362,723 $ 10.72
        
Issuance of Restricted Stock Awards
During fiscal 2005, the Company granted 60,000 restricted common stock awards to its officers.officers; 50,000 of the shares were awarded at a price of $9.30 and 6,667 of those shares were forfeited during the year ended June 30, 2005.2005 and 10,000 of the shares were awarded at a price of $10.79. The restricted shares will vest at the earlier of four years from the date of issuance or upon achievement of financial performance criteria for fiscal years 2005, 2006 and 2007. The Company achieved the financial performance criteria in fiscal 2005, and as a result, 20,000 shares vested. The employee forfeits unvested shares upon the termination of employment prior to the end of the vesting period. Stock compensation expense recognized related to these grants totaled $40,000 and $0$21,000 during the three month periods ended September 30,December 31, 2005 and 2004, respectively, and $80,000 and $21,000 during the six month periods ended December 31, 2005 and 2004, respectively.
NOTE F – ACCUMULATED OTHER COMPREHENSIVE INCOME
The Company has $628,000$619,000 of accumulated currency translation adjustment which reduces shareholders’ equity at September 30,December 31, 2005. Total comprehensive income was $1,073,000$1,400,000 and $1,370,000$2,532,000 for the three month periods ended September 30,December 31, 2005 and 2004, respectively, and total comprehensive income was $2,473,000 and $3,902,000 for the six month periods ended December 31, 2005 and 2004, respectively.
NOTE G – NET INCOME PER SHARE
The Company’s basic net income per share amounts have been computed by dividing net income by the weighted average number of outstanding common shares. The Company’s diluted net income per share is computed by dividing net income by the weighted average number of outstanding common shares and common share equivalents relating to stock options and restricted stock, when dilutive. For the three and six month periods ended September 30,December 31, 2005, 522,258 and 459,704 common share equivalents, respectively, were included in the computation of diluted net income per share. For the three and six month periods ended December 31, 2004, 400,489324,616 and 32,943 shares of175,941 common stockshare equivalents, respectively, were included in the computation of diluted net income per share.
Options to purchase 465,543333,543 and 490,543 shares of common stock with a weighted average exercise price of $16.39$17.41 and $16.30 for the three-month periodthree month and six month periods ended September 30,December 31, 2005, respectively, and options to purchase 1,343,978626,668 and 1,018,918 shares of common stock with a weighted average exercise price of $11.20$14.75 and $12.41 for the three-month periodthree month and six month periods ended September 30,December 31, 2004, respectively, were outstanding but were not included in the calculation of diluted net income per share because the options’ exercise prices were greater than the average market price of the Company’s common stock during those periods. Although these options were antidilutive for the periods presented, they may be dilutive in future period calculations.

9


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED (continued)
September 30,December 31, 2005
NOTE H – INCOME TAXES
Provision for income taxes was $563,000$840,000 and $94,000$136,000 for the three monthsmonth periods ended September 30,December 31, 2005 and 2004, respectively, and the provision for income taxes was $1,403,000 and $230,000 for the six month periods ended December 31, 2005 and 2004, respectively. The effective rate for the prior year period wasperiods were significantly lower than the comparable 2005 periodperiods due to recognizing a tax benefit for a partial release inreversing the deferred tax assetfull valuation allowance for therelated to domestic net operating losses utilized in 2004. The full domestic valuation allowancewhich was fully reversedrecorded in the fourth quarter of last fiscal year.2005. As a result, the company’sCompany’s statement of earnings will reflect more normal tax charges though outthroughout fiscal 2006 and beyond. However, with the exception of the Alternative Minimum Tax and certain state taxes, the companyCompany will not use cash for domestic income taxes until theirits net operating losses are fully realized on theirits tax returns.
NOTE I–I – SEGMENT INFORMATION
The Company operates in two business segments. The Hyaluronan Division manufactures, markets and sells products containing hyaluronan and provides contract aseptic packaging services. The Oral Restorative Division produces and markets various oral restorative products to the area of implant dentistry. Currently, products containing hyaluronan are sold primarily to customers pursuant to ongoing supply agreements. The Company’s Oral Restorative Division markets products directly to clinicians and dental laboratories in the United States, Germany, Italy, Sweden and France and primarily through distributorship arrangements in other foreign locations.
Segment assets and the basis of segmentation are consistent with that reported at June 30, 2005. Segment information for sales and income from operations are as follows:
                        
 Three months ended September 30,  Three months ended December 31, Six months ended December 31, 
 2005 2004  2005 2004 2005 2004 
Net sales  
Hyaluronan products $4,661,000 $4,644,000  $4,631,000 $4,527,000 $9,292,000 $9,171,000 
Oral restorative products 8,764,000 7,661,000  10,578,000 9,691,000 19,342,000 17,352,000 
              
 $13,425,000 $12,305,000  $15,209,000 $14,218,000 $28,634,000 $26,523,000 
              
  
Income from operations  
Hyaluronan products $1,116,000 $1,319,000  $896,000 $853,000 $2,012,000 $2,172,000 
Oral restorative products 451,000 360,000  1,292,000 1,323,000 1,743,000 1,683,000 
              
 $1,567,000 $1,679,000  $2,188,000 $2,176,000 $3,755,000 $3,855,000 
              
NOTE J – ACQUISITION OF BARDO-BIOTECH SAS
Effective August 12, 2005, the Company acquired 100% of the stock of Bardo-Biotech SAS, a privately-owned distributor of the Company’s Oral Restorative products located in Beauzelle, France. The transaction was treated for accounting purposes as a purchase and accordingly the Company included the operating results of Bardo-Biotech SAS in the financial statements from August 1, 2005.
In conjunction with this acquisition, the consideration paid was $401,000 in cash and $362,000 in debt forgiveness. The acquisition resulted in estimated goodwill of $495,000,$514,000 pending completion of the final determination of intangible asset allocation, a portion of which is deductible for tax purposes. Approximately $43,000 of the purchase price was placed in a bank guarantee account in the event there are any loss claims or asset valuation adjustments that should arise.

10


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (continued)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED (continued)
September 30,December 31, 2005
NOTE K – AGREEMENTS
On September 20, 2004, the Company secured worldwide marketing rights to its ferric hyaluronan adhesion prevention product from Ethicon, Inc. Lifecore’sThe Company’s product, which was previously marketed by Gynecare, a division of Ethicon, Inc. (“Gynecare”), under the trademark GYNECARE INTERGEL Adhesion Prevention Solution, was voluntarily withdrawn from the market by Gynecare on March 27, 2003 to assess information obtained from its usage in the treatment of patients. Under the agreement, Gynecare will have no responsibility for any aspect of the future manufacture, marketing, sale or distribution of the product nor will it derive any financial benefit therefrom. A payment of $250,000, included in other income, was received during the second quarter of fiscal 2005 from Ethicon, Inc. in conjunction with the above mentioned agreement.
NOTE L – LEGAL PROCEEDINGS
LifecoreThe Company is named as a partydefendant in 7574 pending lawsuits, all of which allege that the plaintiffs suffered injuries due to the defective nature of INTERGEL Solution manufactured by Lifecorethe Company and marketed by ETHICON. Under the terms of its Conveyance, License, Development and Supply Agreement dated August 8, 1994 with ETHICON, ETHICON is obligated to indemnify and hold Lifecorethe Company harmless from all claims related to the sale and use of INTERGEL Solution, unless it is ultimately determined that a plaintiff’s injuries were caused by a breach of Lifecore’sthe Company’s limited contractual warranty to Ethicon. LifecoreETHICON. The Company believes that ETHICON will beis obligated to fully indemnify Lifecorethe Company in connection with all of the pending claims relating to INTERGEL Solution. LifecoreThe Company also has product liability insurance that it believes would cover its exposure, if any, related to these claims.
NOTE M – RECLASSIFICATIONS
Certain 2004 amounts have been reclassified to conform to the 2005 presentation.

11


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions in certain circumstances that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the Company’s financial statements. Management bases its estimates and judgments on historical experience, observance of trends in the industry, information provided by customers and other outside sources and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
Revenue Recognition:
The Company recognizes revenue when the product is shipped or otherwise accepted by unaffiliated customers, pursuant to customers orders, the price is fixed and collection is reasonably assured. The Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition” provides guidance on the application of generally accepted accounting principles to selected revenue recognition issues. The Company has concluded that its revenue recognition policy is appropriate and in accordance with generally accepted accounting principles and SAB No. 101.
Allowance for Uncollectible Accounts Receivable:
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The Company extends credit to customers in the normal course of business but generally does not require collateral or any other security to support amounts due. Management performs on-going credit evaluations of the Company’s customers and bases the estimated allowance on these evaluations.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out method) or market and have been reduced to the lower of cost or market for obsolete, excess or unmarketable inventory. The lower of cost or market adjustment is based on management’s review of inventories on hand compared to estimated future usage and sales.
Goodwill, Intangibles and Other Long-Lived Assets:
Intangibles and certain other long-lived assets with a definite life are amortized over their useful lives. Useful lives are based on management’s estimates of the period that the assets will generate revenue.
The Company reviews goodwill for impairment on a regular basis, at least quarterly, or upon a triggering event.
Management has reviewed goodwill and other intangibles for impairment and has concluded that such assets are appropriately valued at the financial statement dates.
Accounting for Income Taxes:
Income taxes are accounted for under the provisions of Statement of Financial Accounting Standards, or SFAS No. 109, “Accounting for Income Taxes.” Under this method, deferred tax assets and liabilities are determined based upon the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The tax consequences of events

12


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
income. The tax consequences of events recognized in the current year’s financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities, equity, revenue, expenses, gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax bases of assets or liabilities and their reported amounts in the financial statements. Because it is assumed that the reported amounts of assets and liabilities will be recovered and settled, respectively, a difference between the tax basis of an asset or a liability and its reported amount in the balance sheet will result in a taxable or a deductible amount in some future years when the related liabilities are settled or the reported amounts of the assets are recovered, hence giving rise to a deferred tax asset. Management must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent that recovery is not likely, a valuation allowance must be established.
In fiscal 2005, management determined that it was appropriate to release a substantial portion of the deferred tax valuation allowance based upon the Company’s then-current and expected level of profitability, and the belief that it is more likely than not that the deferred tax assets will be utilized before they expire. The remaining valuation allowance is provided for foreign net operating losses. As part of the process of preparing the consolidated financial statements, income taxes are required to be estimated. This process involves estimating actual current tax exposure together with assessing temporary differences that may result in deferred tax assets or liabilities. Management judgment is required in determining any valuation allowance recorded against deferred tax assets. Any such valuation allowance would be based on our management’s estimates of future taxable income and the period over which deferred tax assets would be recoverable.
Overview
The Company manufactures biomaterials and medical devices for use in various surgical markets and provides related specialized contract aseptic manufacturing services. The Company operates through two business units, the Hyaluronan Division and the Oral Restorative Division.
The Company’s Hyaluronan Division is principally involved in the development and manufacture of products utilizing hyaluronan, a naturally occurring polysaccharide that is widely distributed in the extracellarextracellular matrix of connective tissues in both animals and humans.
The Hyaluronan Division primarily sells into three medical segments: 1) Ophthalmic, 2) Orthopedic, and 3) Veterinary. In addition, the Company developed and owns the global marketing rights for a product using its patented ferric hyaluronan adhesion prevention technology. The product, FeHA, (formerly labeled as GYNECARE INTERGEL Adhesion Prevention Solution (“INTERGEL Solution”)Solution), has been clinically proven to reduce the incidence of post-surgical adhesions following surgical trauma. The product was voluntarily withdrawn from the market in March 2003 in order to assess information obtained from postmarketing experience with the product. The Company is currently evaluating regulatory requirements and opportunities for distribution partners to market the FeHA product.

13


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
LifecoreThe Company also supplies hyaluronan to customers pursuing other medical applications, such as wound care, aesthetic surgery, medical device coatings, tissue engineering, drug delivery and pharmaceuticals. The Company leverages its hyaluronan manufacturing expertise to provide expanded hyaluronan product offerings and specialized aseptic manufacturing of hyaluronan products.
The Company’s Oral Restorative Division develops and markets precision surgical and prosthetic devices for the restoration of damaged or deteriorating dentition and associated support tissues. The Company’s dental implants are permanently implanted in the jaw for tooth replacement therapy as long-term support for crowns, bridges and dentures.
The Oral Restorative Division also offers innovative bone regenerative products for the repair of bone defects resulting from periodontal disease and tooth loss. Additionally, the Oral Restorative Division provides professional support services to its dental surgery clients through comprehensive education curricula as provided in the Company’s various Support PlusÔ programs and surgical courses. These professional continuing education programs are designed to train restorative clinicians and their auxiliary teams in the principles of tooth replacement therapy and practice management. The Company’s Increasing Case Acceptance Program (“ICA”) offers clients the marketing and consultative tools and training to foster higher patient acceptance of dental implants.
The Oral Restorative Division’s products are marketed in the United States through the Company’s direct sales force. Internationally, the Division’s products are marketed through direct subsidiaries in Italy, Germany, France and Sweden, and through 25 national distributors covering 3437 additional countries.
Acquisition of Bardo-Biotech SAS
Effective August 12, 2005, the Company acquired 100% of the stock of Bardo-Biotech SAS, a privately-owned distributor of the Company’s Oral Restorative products located in Beauzelle, France. The transaction was treated for accounting purposes as a purchase and accordingly the Company included the operating results of Bardo-Biotech SAS in the financial statements from August 1, 2005.
In conjunction with this acquisition, the consideration paid was $401,000 in cash and $362,000 in debt forgiveness. The acquisition resulted in estimated goodwill of $495,000,$514,000 pending completion of the final determination of intangible asset allocation, a portion of which is deductible for tax purposes. Approximately $43,000 of the purchase price was placed in a bank guarantee account in the event there are any loss claims or asset valuation adjustments that should arise.

14


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Results of Operations
Three Months Ended September 30,December 31, 2005 Compared to Three Months Ended September 30,December 31, 2004:
                                                
 Hyaluronan Oral Restorative    Hyaluronan Oral Restorative   
 Division Division Consolidated  Division Division Consolidated 
 2005 2004 2005 2004 2005 2004  2005 2004 2005 2004 2005 2004 
Net sales $4,661,000 $4,644,000 $8,764,000 $7,661,000 $13,425,000 $12,305,000  $4,631,000 $4,527,000 $10,578,000 $9,691,000 $15,209,000 $14,218,000 
Cost of goods sold 2,052,000 2,093,000 3,011,000 3,003,000 5,063,000 5,096,000  2,344,000 2,108,000 3,764,000 3,347,000 6,108,000 5,455,000 
                          
Gross profit 2,609,000 2,551,000 5,753,000 4,658,000 8,362,000 7,209,000  2,287,000 2,419,000 6,814,000 6,344,000 9,101,000 8,763,000 
  
Operating expenses  
Research and development 607,000 604,000 392,000 244,000 999,000 848,000  580,000 895,000 390,000 276,000 970,000 1,171,000 
Marketing and sales 176,000 92,000 3,833,000 3,123,000 4,009,000 3,215,000  95,000 150,000 3,925,000 3,687,000 4,020,000 3,837,000 
General and administrative 710,000 536,000 1,077,000 931,000 1,787,000 1,467,000  716,000 521,000 1,207,000 1,058,000 1,923,000 1,579,000 
                          
 1,493,000 1,232,000 5,302,000 4,298,000 6,795,000 5,530,000  1,391,000 1,566,000 5,522,000 5,021,000 6,913,000 6,587,000 
                          
  
Operating income $1,116,000 $1,319,000 $451,000 $360,000 $1,567,000 $1,679,000  $896,000 $853,000 $1,292,000 $1,323,000 $2,188,000 $2,176,000 
                          
Net Sales. Net sales for the quarter ended September 30,December 31, 2005 increased $1,120,000$991,000 or 9%7% as compared to the same quarter of last fiscal year. Hyaluronan Division sales increased $17,000,$104,000, and Oral Restorative Division sales increased $1,103,000$887,000 or 14%9%.
Hyaluronan Division sales for the current quarter increased to $4,661,000$4,631,000 from $4,644,000$4,527,000 in the same quarter of last fiscal year due to increased sales to veterinaryorthopedic customers offset partially by lower sales to ophthalmic customers.
Oral Restorative Division sales for the current quarter increased to $8,764,000$10,578,000 from $7,661,000$9,691,000 in the same quarter of last fiscal year. Domestic sales increased 22%15% due to the continued expansionaddition of our sales representatives, sales of the RENOVA Internal Hex Implant System and continued sales growth of the STAGE-1 Single Stagenewly launched Prima Implant System. Sales in the international markets increased by 6%3%.
Gross profit. Consolidated gross profit, as a percentage of net sales, was 62%60% in the current quarter and 59%62% in the same quarter of last fiscal year. The gross profit for the Hyaluronan Division increaseddecreased to 56%49% in the current quarter from 55%53% in the same quarter of last fiscal year; 3.3a 2.8 percentage point changedecrease was due to product mix and a 1.2 percentage point decrease was due to an increase in unused manufacturing capacity charges associated with increaseddecreased hyaluronan production, offset by a 2.1 percentage point change due to product mix.production.
Gross profit for the Oral Restorative Division increaseddecreased to 66%64% in the current quarter from 61%65% in the same quarter of last fiscal year of which 3.6 percentage points wereprimarily due to a favorable shift in sales mix from lower margin products to higher margin productsnew product launch promotions and 1.3 percentage points were due to fixed costs spread over a larger sales base.product mix.

15


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Research and development. Consolidated research and development expenses consist of personnel costs, contract services, facility and equipment charges and materials consumed in the development of new products or enhancements to existing products. Research and development activities include: pilot plant operations, development of new formulations, design and testing of new products, regulatory services and clinical evaluation. Research and development expenses increased $151,000decreased $201,000 or 18%17% in the current quarter as compared to the same quarter last fiscal year. The increasedecrease is due to additionallower regulatory consulting expenses associated with new product development in the Oral RestorativeHyaluronan Division.
Marketing and sales. Consolidated marketing and sales expenses increased by $794,000$183,000 or 25%5% in the current quarter as compared to the same quarter of last fiscal year. The increase was due mainly to costs associated with the timinglaunch of tradeshows,the new Prima Implant System, the expansion of the oral restorative’s domestic sales force and international operations.
General and administrative. Consolidated general and administrative expenses increased by $320,000$344,000 or 22% in the current quarter as compared to the same quarter of last fiscal year. The increase is primarily related to $190,000$181,000 of compensation expense associated with the adoption of SFAS 123R and higher insurance costs.
On June 16, 2005 the Company accelerated of the vesting of 74,375 stock options which had an exercise price greater than the closing price on that date. The accelerated vesting enabled the Company to avoid recognizing in its income statement compensation expense associated with these options in future periods upon the adoption by the Company of FASB Statement No. 123(R) “Share-Based Payment” in July 2005.
Other income (expense). Net other income, as shown on the Consolidated Statements of Operations, increased $347,000decreased $297,000 for the current quarter as compared to the same quarter of last fiscal year. The increasedecrease is due to no bond retirement expensethe Ethicon, Inc. payment of $290,000$250,000 received during the second quarter of fiscal 2005 and decreases in currency transaction gains realized on Euro denominated intercompany transactions of $162,000, offset by an increase in interest income of $125,000 resulting from a higher cash balance, offset by decreases in currency transaction gains realized on Euro denominated intercompany transactions of $110,000.balance.
Provision for income taxes.Provision for income taxes was $563,000$840,000 and $94,000$136,000 for the three months ended September 30,December 31, 2005 and 2004, respectively. The effective rate for the prior year period wasperiods were significantly lower than the comparable 2005 periodperiods due to recognizing a tax benefit for a partial release inreversing the deferred tax assetfull valuation allowance for therelated to domestic net operating losses utilized in 2004. The full domestic valuation allowancewhich was fully reversedrecorded in the fourth quarter of last fiscal year.2005. As a result, the company’sCompany’s statement of earnings will reflect more normal tax charges though outthroughout fiscal 2006 and beyond. However, with the exception of the Alternative Minimum Tax and certain state taxes, the companyCompany will not use cash for domestic income taxes until theirits net operating losses are fully realized on theirits tax returns. We accountThe Company accounts for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.”
Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to affect taxable income. We believeThe Company believes that in fiscal 2006 ourits tax rate will be approximately 35%37%, even though the actual amount of taxes paid will be reduced significantly by the utilization of the net operating loss carryforward.

16


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I — FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Six Months Ended December 31, 2005 Compared to Six Months Ended December 31, 2004:
                         
  Hyaluronan  Oral Restorative    
  Division  Division  Consolidated 
  2005  2004  2005  2004  2005  2004 
Net sales $9,292,000  $9,171,000  $19,342,000  $17,352,000  $28,634,000  $26,523,000 
Cost of goods sold  4,396,000   4,201,000   6,775,000   6,350,000   11,171,000   10,551,000 
                   
Gross profit  4,896,000   4,970,000   12,567,000   11,002,000   17,463,000   15,972,000 
                         
Operating expenses                        
Research and development  1,187,000   1,499,000   782,000   520,000   1,969,000   2,019,000 
Marketing and sales  271,000   242,000   7,758,000   6,810,000   8,029,000   7,052,000 
General and administrative  1,426,000   1,057,000   2,284,000   1,989,000   3,710,000   3,046,000 
                   
   2,884,000   2,798,000   10,824,000   9,319,000   13,708,000   12,117,000 
                   
                         
Operating income $2,012,000  $2,172,000  $1,743,000  $1,683,000  $3,755,000  $3,855,000 
                   
Net Sales. Net sales for the six months ended December 31, 2005 increased $2,111,000 or 8% as compared to the same period of last fiscal year. Hyaluronan Division sales increased $121,000, and Oral Restorative Division sales increased $1,990,000 or 11%.
Hyaluronan Division sales for the current period increased to $9,292,000 from $9,171,000 in the same period of last fiscal year due to increased sales to orthopedic customers offset partially by lower sales to ophthalmic customers.
Oral Restorative Division sales for the current period increased to $19,342,000 from $17,352,000 in the same period of last fiscal year. Domestic sales increased 18% due to the addition of sales representatives, sales of the RENOVA Internal Hex Implant System and sales of the newly launched Prima Implant System. Sales in the international markets increased by 4%.
Gross profit. Consolidated gross profit, as a percentage of net sales, was 61% in the current period and 60% in the same period of last fiscal year. The gross profit for the Hyaluronan Division decreased to 53% in the current period from 54% in the same period of last fiscal year; a 2.3 percentage point decrease was due to product mix, offset by a 1.3 percentage point increase due to a decrease in unused manufacturing capacity charges associated with increased hyaluronan production.
Gross profit for the Oral Restorative Division increased to 65% in the current period from 63% in the same period of last fiscal year of which 1.3 percentage points were due to a favorable shift in sales mix from lower margin products to higher margin products and 0.3 percentage points were due to fixed costs spread over a larger sales base.
Research and development. Consolidated research and development expenses consist of personnel costs, contract services, facility and equipment charges and materials consumed in the development of new products or enhancements to existing products. Research and development activities include: pilot plant operations, development of new formulations, design and testing of new products, regulatory services and clinical evaluation. Research and development expenses decreased $50,000 or 2% in the current period as compared to the same period last fiscal year. The decrease is due to lower regulatory consulting expenses in the Hyaluronan Division.

17


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I — FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Marketing and sales. Consolidated marketing and sales expenses increased by $977,000 or 14% in the current period as compared to the same period of last fiscal year. The increase was due mainly to costs associated with the launch of the new Prima Implant System, the expansion of the oral restorative’s domestic sales force and international operations.
General and administrative. Consolidated general and administrative expenses increased by $664,000 or 22% in the current period as compared to the same period of last fiscal year. The increase is related to $371,000 of compensation expense associated with the adoption of SFAS 123R and higher insurance costs.
Other income (expense). Net other income, as shown on the Consolidated Statements of Operations, increased $50,000 for the current period as compared to the same period of last fiscal year. The increase is due to no bond retirement expense of $290,000 and an increase in interest income of $250,000 resulting from a higher cash balance, offset by decreases in currency transaction gains realized on Euro denominated intercompany transactions of $271,000 and the Ethicon, Inc. payment of $250,000 received during the second quarter of fiscal 2005.
Provision for income taxes.Provision for income taxes was $1,403,000 and $230,000 for the six months ended December 31, 2005 and 2004, respectively. The effective rate for the prior year periods were significantly lower than the comparable 2005 periods due to reversing the full valuation allowance related to domestic net operating losses which was recorded in the fourth quarter of fiscal 2005. As a result, the Company’s statement of earnings will reflect more normal tax charges throughout fiscal 2006 and beyond. However, with the exception of the Alternative Minimum Tax and certain state taxes, the Company will not use cash for domestic income taxes until its net operating losses are fully realized on its tax returns. The Company accounts for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.”
Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The Company believes that in fiscal 2006 its tax rate will be approximately 37%, even though the actual amount of taxes paid will be reduced significantly by the utilization of the net operating loss carryforward.

18


LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I — FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources
The Company’s Annual Report on Form 10-K, as amended, for the year ended June 30, 2005 contains a detailed discussion of Lifecore’sthe Company’s liquidity and capital resources. Investors should read the 2005 Form 10-K, as amended, in conjunction with this Quarterly Report on
Form 10-Q.
For the threesix month period ended September 30,December 31, 2005, the Company had negative cash flow of $4,000.$185,000 due to an inventory build related to the new product launch and the timing of customer payments. The Company has had positive cash flow in fiscal years 2005, 2004 and 2003. Charges for unused manufacturing capacity associated with the Company’s hyaluronan production have continued to negatively impact operating results in the current fiscal year. Also, marketing and sales expenses for the oral restorative products are expected to continue at a high level due to continued international expansion and increased personnel costs associated with expanding the sales force.
The Company has a $5,000,000 credit facility with a bank which has a maturity date of December 31, 2006. The agreement allows for advances against eligible accounts receivable, subject to a borrowing base certificate.certificate and compliance with covenants. Under the credit facility, interest will accrue at the prime rate (6.75% at September 30, 2005) minus .5% or LIBOR (3.86% at September 30, 2005) plus 2.25%, at the Company’s option. At September 30,December 31, 2005 and June 30, 2005, there were no balances outstanding under the line of credit. The terms of the agreement require the Company to comply with various financial covenants, including minimum tangible net worth, liabilities to tangible net worth ratio and profitability. At September 30, 2005 and June 30, 2005, the Company was in compliance with all covenants.
On August 19, 2004, the Company issued variable rate industrial revenue bonds. The proceeds from these bonds were used to retire the existing 10.25% fixed rate industrial revenue bonds on September 1, 2004. The aggregate principal amount of the new bonds iswas $5,630,000, and the bonds bear interest at a variable rate set weekly by the bond remarketing agent (2.75%(3.51% as of September 30,December 31, 2005). In addition, the Company pays an annual remarketing fee equal to .125% and an annual letter of credit fee of 1.0%. The bonds are collateralized by a bank letter of credit which is secured by a first mortgage on the facility. The Company is required to make monthly principal and interest payments to a sinking fund. The terms of the agreement require the Company to comply with various financial covenants including minimum tangible net worth, liabilities to tangible net worth ratio and net income (loss). As of September 30,December 31, 2005 and June 30, 2005, the Company was in compliance with all covenants.
The Company’s ability to generate positive cash flow from operations and achieve ongoing profitability is dependent upon the continued expansion of revenue from its hyaluronan and oral restorative businesses. Growth in the Hyaluronan Division is unpredictable due to the complex governmental regulatory environment for new medical products, the early stage of certain of these markets and the uncertainty associated with the future market status of the Company’s adhesion prevention product. Similarly, expansion of the Company’s Oral Restorative Division sales is also dependent upon increased revenue from new and existing customers, as well as successfully competing in a more mature market. The Company expects its cash generated from anticipated operations and the available funds under the line of credit to satisfy cash flow needs in the near term. No assurance can be given that the Company will maintain positive cash flow from operations. While the Company’s capital resources appear adequate today, the Company may seek additional financing in the future. If additional financing is necessary, no assurance can be given that such financing will be available and, if available, will be on terms favorable to the Company and its shareholders.
The Company does not have any material “off-balance sheet” financing activities.
Seasonality
The Company’s business is seasonal in nature. Historically, sales onfor the Oral Restorative Division are lower in the first quarter than throughout the rest of the year, as a result of European holidays during the summer months.

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LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Cautionary Statement
Statements included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Form 10-Q, in future filings by the Company with the Securities and Exchange Commission and in the Company’s press releases and oral statements made with the approval of authorized executive officers, that are not historical or current facts, should be considered “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may, among other things, relate to market acceptance and demand for the Company’s products, future product development plans and timing, the results of clinical trials, FDA clearances and the related timing of such, the potential size of the markets for the Company’s products, future product introductions, future revenues, expense levels, tax rates and capital needs and the Company’s ability to successfully negotiate acceptable agreements with its corporate partners. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The following important factors, among others, in some cases have affected or in the future could affect the Company’s actual results and could cause its actual financial performance to differ materially from that expressed in any forward-looking statement: (i) obtaining the necessary regulatory approvals for new hyaluronan and oral restorative products; (ii) the Company’s reliance on corporate partners to develop new products on a timely basis and to market the Company’s existing and new hyaluronan products effectively; (iii) intense competition in the markets for the Company’s principal products; and (iv) the uncertainty associated with the future market status of the Company’s adhesion prevention product. Investors are referred to a more detailed discussion of the risks presented in Exhibit 99.1 to the Company’s Annual Report on Form 10-K, as amended, for the fiscal year ended June 30, 2005.

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LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company invests its excess cash in money market mutual funds, bank certificates of deposits and highly rated short-term corporate debt securities. All investments are held to maturity. The market risk on such investments is minimal.
Receivables from sales to foreign customers are denominated in U.S. dollars. Transactions at the Company’s foreign subsidiaries are denominated in European Euros at Lifecore Biomedical SpA, Lifecore Biomedical GmbH and Lifecore Biomedical SAS and are denominated in Swedish Krona at Lifecore Biomedical AB. The Company is exposed to foreign currency exchange rate risk arising from transactions in the normal course of business from sales to its foreign subsidiaries. Because the Company’s products are manufactured or sourced primarily from the United States, a stronger U.S. dollar generally has a negative impact on results from operations outside the United States while a weaker dollar generally has a positive effect. The Company does not use derivative financial instruments to manage foreign currency fluctuation risk.
On August 19, 2004, the Company issued variable rate industrial revenue bonds. The proceeds from these bonds were used to retire the existing 10.25% fixed rate industrial revenue bonds on September 1, 2004. The aggregate principal amount of the new bonds was $5,630,000, and the bonds bear interest at a variable rate set weekly by the bond remarketing agent (2.75%(3.51% as of September 30,December 31, 2005). A ten percent change in this variable rate would result in approximately $15,000$18,000 of additional interest expense annually.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a – 15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective.
(b) Changes in internal control over financial reporting.
During the fiscal period covered by this report, there has been no change in the Company’s internal control over financial reporting (as defined in Rule 13a – 15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Lifecore has beenThe Company is named as a defendant in 75 product liability74 pending lawsuits, alleginginvolving alleged injuries to 77 women. As of January 30, 2006, Lifecore has been served in all but one of the cases, on dates ranging from September 15, 2003 until December 28, 2005. Fifty-eight of the pending cases are proceeding in Florida state court. The balance of the pending lawsuits have been filed in various states including California, Connecticut, Louisiana, Minnesota, New Jersey, Pennsylvania and Wisconsin.
The lawsuits allege that the plaintiffs suffered injuries due to the defective nature of GYNECARE INTERGEL Adhesion Prevention Solution (“INTERGEL Solution”) which was developed and manufactured and marketed by Lifecore.the Company. The other defendants in these lawsuits are ETHICON, Inc., which was Lifecore’sthe Company’s exclusive worldwide marketing partner for INTERGEL Solution through its division, GYNECARE Worldwide;Worldwide, and Johnson & Johnson, the parent company of ETHICON. ManyMost of the lawsuits also name Vital Pharma, Inc. as a defendant; Vital Pharma acted as the contract packager for the INTERGEL solution. The plaintiffs in these actions are individuals who were patients in medical procedures during which INTERGEL Solution was used and who were allegedly injured due to the defective nature of INTERGEL Solution.
LifecoreThe Company anticipates that the lawsuit captionedRenee Contratto v. Ethicon, Inc., d/b/a Gynecare Worldwide, Johnson & Johnson, Lifecore Biomedical, Inc. and Vital Pharma, IncInc.., which was the first such lawsuit served on Lifecore,the Company, will be the first of these lawsuits to go to trial. TheContratto case was filed in U.S. District Court for the Northern District of California and was served on Lifecorethe Company on September 15, 2003. As of October 15, 2005, Lifecore had been served in 72 of the 75 lawsuits on dates ranging from September 15, 2003 to October 3, 2005. Fifty-eight of these lawsuits were filed in Florida state court. The balance of the lawsuits served on Lifecore have been filed in various states including Connecticut, Kansas, Louisiana, Minnesota, New Jersey, Pennsylvania and Wisconsin.
ETHICON began marketing INTERGEL Solution outside the United States in June 1998 for reducing the incidence of post-surgical adhesions. INTERGEL Solution was approved by the FDA for the U.S. market in November 2001. INTERGEL Solution was voluntarily withdrawn from the market by ETHICON in March 2003 in order to assess information obtained from postmarketing experience with the product, including allegations of adverse events associated with off-label use in non-conservative surgical procedures (such as hysterectomies).
ETHICON is defending Lifecorethe Company in all of these lawsuits. Under the terms of Lifecore’sthe Company’s Conveyance, License, Development and Supply Agreement dated August 8, 1994 with ETHICON, ETHICON is obligated to indemnify and hold Lifecorethe Company harmless from all claims related to the sale and use of INTERGEL Solution, unless it is ultimately determined that a plaintiff’s injuries were caused by a breach of Lifecore’sthe Company’s limited contractual warranty to ETHICON under that agreement. LifecoreThe Company believes that ETHICON will be obligated to fully indemnify Lifecorethe Company in connection with all of the pending claims relating to INTERGEL Solution.
LifecorePursuant to the terms of its agreement with Vital Pharma, the Company’s insurer is covering Vital Pharma’s defense costs. This has been done with a full reservation of rights by the Company. The Company has also asserted that ETHICON is obligated to pay for Vital Pharma’s defense costs, pursuant to the agreement between ETHICON and the Company.
The Company has also received four claim letters alleging claims similar to the lawsuits. ETHICON is responding to the claim letters on behalf of Lifecore.the Company.

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LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART II OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 17, 2005, the Company held its Annual Meeting of Shareholders. At the meeting, the shareholders elected directors Dennis J. Allingham (with 11,741,021 affirmative votes and 28,259 votes withheld), Joan L. Gardner (with 11,550,501 affirmative votes and 218,779 votes withheld), Thomas H. Garrett (with 11,750,730 affirmative votes and 18,550 votes withheld), and John E. Runnells (with 11,726,100 affirmative votes and 43,180 votes withheld).
The shareholders also approved amendments to the Company’s Amended and Restated Articles of Incorporation and Amended Bylaws to eliminate the classified Board structure (with 11,487,799 affirmative votes, 258,887 negative votes, 22,594 votes abstained and no broker non-votes).
The shareholders also ratified and approved the appointment of Grant Thornton LLP as independent certified public accountants of the Company for the current fiscal year ending June 30, 2006 (with 11,641,284 affirmative votes, 115,319 negative votes, 12,677 votes abstained and no broker non-votes).

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LIFECORE BIOMEDICAL, INC. AND SUBSIDIARIES
PART II — OTHER INFORMATION
ITEM 6. EXHIBITS
3.1 Amended and Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 19(a) to Amendment No. 1adopted on Form 8, dated July 13, 1988, to Form 10-Q for the quarter ended December 31, 1987), as amended by Amendment No. 2January 18, 2006 (incorporated by reference to Exhibit 3.1 to the Current Report on Form 10-K for the year ended June 30, 1997)8-K filed on January 24, 2006)
3.2 Amended Bylaws, as adopted on January 18, 2006 (incorporated by reference to Exhibit 3.2 to the Current Report on Form 10-K/A for the year ended June 30, 1995)8-K filed on January 24, 2006)
4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to 1987 S-2 Registration Statement [File No. 33-12970])
4.2 Form of Rights Agreement, dated as of May 23, 1996, between the Company and Norwest Bank Minnesota, National Association (incorporated by reference to Exhibit 1 to the Company’s Form 8-A Registration Statement dated May 31, 1996)
10.1 1996 Stock Option Plan, as amended to date
10.2Description of the Company’s program permitting directors to receive monthly retainer fees in the form of the Company’s common stock (incorporated by reference to the program description set forth under Item 1.01 in the Current Report on Form 8-K filed on December 13, 2005)
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
   
  LIFECORE BIOMEDICAL, INC.
   
  By:
   
Dated: NovemberFebruary 9, 20052006 /s/ Dennis J. Allingham
   
  Dennis J. Allingham
  President, Chief Executive Officer, Secretary and Director
  (duly authorized officer)
   
Dated: NovemberFebruary 9, 20052006 /s/ David M. Noel
   
  David M. Noel
  Vice President of Finance and Chief Financial Officer
  (principal financial and accounting officer)

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Exhibit Index
3.1 Amended and Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 19(a) to Amendment No. 1adopted on Form 8, dated July 13, 1988, to Form 10-Q for the quarter ended December 31, 1987), as amended by Amendment No. 2January 18, 2006 (incorporated by reference to Exhibit 3.1 to the Current Report on Form 10-K for the year ended June 30, 1997)8-K filed on January 24, 2006)
3.2 Amended Bylaws, as adopted on January 18, 2006 (incorporated by reference to Exhibit 3.2 to the Current Report on Form 10-K/A for the year ended June 30, 1995)8-K filed on January 24, 2006)
4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to 1987 S-2 Registration Statement [File No. 33-12970])
4.2 Form of Rights Agreement, dated as of May 23, 1996, between the Company and Norwest Bank Minnesota, National Association (incorporated by reference to Exhibit 1 to the Company’s Form 8-A Registration Statement dated May 31, 1996)
10.1 1996 Stock Option Plan, as amended to date
10.2Description of the Company’s program permitting directors to receive monthly retainer fees in the form of the Company’s common stock (incorporated by reference to the program description set forth under Item 1.01 in the Current Report on Form 8-K filed on December 13, 2005)
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

2326