Lifecore Biomedical, Inc. (LFCR) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Landec Second Quarter Fiscal 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to hand the conference over to your host for today, Molly Hemmeter, President and CEO of Landec Corporation. Please go ahead.

Good morning. And thank you for joining Landec's second quarter of fiscal year 2016 earnings call. With me on the today is Greg Skinner, Landec's Chief Financial Officer. During today's call, we may make forward-looking statements that involve certain risks and uncertainties that could cause actual results to differ materially. These risks are outlined in our filings with the Securities and Exchange Commission, including the Company's Form 10-K for fiscal 2015. In the fiscal 2016 second quarter consolidated revenues increased 6% to $140.4 million due to the 23% increase in revenues at Lifecore and the 4% increase at Apio compared to the year ago period. Severe produce shortages at Apio significantly impacted second quarter consolidated operating income, which decreased 28% to $2.8 million and consolidated net income which decreased 42% to $0.07 a share. Notably these produce shortages did not impact our salad kits as Apio was able to supply all demand for this product. Our Lifecore biomaterials business had another remarkable quarter. In addition to revenues growing 23%, operating income grew nearly 400% reflecting the anticipated improvement for Lifecore's business in fiscal 2016. At Apio revenues in its packaged fresh vegetable business increased 5%, with quarter-over-quarter revenue increase of 34% for our Eat Smart salad kit product. The severe produce shortages during our second fiscal quarter resulted in excess unanticipated raw material cost of approximately $4.7 million, resulting in gross margin 9.3% in our Apio packaged fresh vegetable business which was a decrease of 160 basis points from the second quarter of last year. The produce shortages would have been a much more significant impact on our gross margin had it not been for the continued growth of our salad kits. Gross profit in Apio packaged fresh vegetable business would have increased $3.5 million from the year ago period if not for the $4.7 million in excess produce cost. This $3.5 million increase would have been in line with our original projections for the quarter and the gross margin in our packaged fresh vegetable business would have increased 280 basis points to 13.7%. The severe produce shortages during the quarter were due to unseasonably warm weather in California and Mexico during October and most of November which resulted in very poor yields in quality to the extent not seen in Apio's 35 year history. Many experts in the western vegetable industry have commented that they have never seen vegetables in such short supply which led to exorbitant prices and low quality for many crops. In addition, heavy rains flooded fields in Southern Florida during November resulting in severe shortages of green beans during the last few weeks of the quarter. Net income was further negatively impacted by $1 million lower increase in the fair market value of our Windset investment as Windset also had production volumes impacted by the unusually warm weather in California and Mexico but primarily from its Mexican grower marketing programs which were down considerably from contracted volumes. Importantly, Lifecore continues to deliver double digit growth and demand for our products at Apio remains strong particularly for salad. Once we return to full supply we are well positioned for sustained profitable growth. Before I discuss the outlook for the rest of the year, let me turn the call over to Greg for some financial highlights.

Thank you, Molly. And good morning, everyone. Revenues in the second quarter of fiscal 2016 increased 6% to $140.4 million from $132.7 million in the prior year quarter. The increase was primarily due to 23% increase in revenues at Lifecore and 5% increase in Apio's packaged fresh vegetables business. Net income in the second quarter of fiscal 2016 was $1.9 million or $0.07 per share compared to $3.2 million or $0.12 per share in the prior year quarter. The decrease in net income was due to, first, a $1.2 million decrease in gross profit in Apio's packaged fresh vegetable business as detailed by Molly. Second, a $1.8 million increase in Apio operating expenses to drive sales of our existing and new salad kits product and from additional headcount hired over the past year. And third, a $1 million lower increase in the change in the fair market value of our Windset investment. The decreases in net income in the second quarter were partially offset by $1.9 million increase in pretax income at Lifecore due to increased revenues and an increase in its gross margin due to a favorable product mix change compared to the second quarter of fiscal 2015, and from $716,000 decrease in income taxes. Revenues in the first six months of fiscal 2016 increased 4% to $275.8 million from $266.3 million in the same period last year. Excluding the extra week during the first six months of fiscal 2015, which resulted in approximately $9 million in additional revenues last year, revenues for the first six months of fiscal 2016 increased 7% compared to the prior year, year-to-date. The increase without the extra week from last year was due to a 26% increase in revenues at Lifecore and a 4% increase in Apio's packaged fresh vegetable business revenues. These increases were partially offset by a 9%, or $4.2 million decrease in Apio's export business revenues. Net income in the first six months of fiscal 2016 was $4.8 million, or $0.18 per share, compared to $5.6 million, or $0.20 per share in the first six months of fiscal 2015. Net income was significantly impacted by the $6 million of excess costs related to the severe produce shortages at Apio, which were more than offset by a $6.2 million increase in gross profit in Apio's packaged fresh vegetable business due to increased revenues and a favorable product mix to a higher percentage of revenues being derived from salad kit sales. The decrease in net income was also due to, first, a $3.9 million increase in Apio's operating expenses to drive the growth of our existing and new salad kit products and from additional headcount hired over the past year. Second; a $400,000 lower increase in the change in the fair market value of our Windset investment. And third a $927,000 increase in the pretax loss at Corporate due to the reversal of the $677,000 long-term incentive plan accrual in the first six months of last year and from an increase in stock based compensation expenses as a result of stock option and RSU grants in May 2015. The decreases in net income during the first six months of fiscal 2016 were further partially offset by $3.9 million increase in pretax income at Lifecore, and from $326,000 decrease in income taxes. Turning to financial position. At the end of the second quarter of fiscal 2016 cash totaled $6 million after generating $2.2 million in cash flow from operations receiving $5.7 million in net borrowings and investing $15.2 million in property and equipment, primarily for capacity expansion during the first six months of fiscal 2016. The company has $36.8 million available under its lines of credit as of November 29, 2015. Let me now turn the call back to Molly.

Thanks, Greg. Consistent with our revised guidance in our release on December 8, 2015 for all of fiscal year 2016 we are projecting that revenues will increase 3% to 6%, operating income 25% to 35% and net income 10% to 20% compared to fiscal year 2015. The revised guidance for fiscal 2016 includes a record year at Lifecore and significant reduction in the projected increase in our Windset investment from our original guidance. Our guidance also includes the significant contingency for sourcing issues at Apio during the second half of fiscal year 2016. That being said, produce shortages have continued throughout December and into January which have exceeded our expectations for this time period. Therefore as El Nino rains have a larger impact on supply in California and Mexico than we have anticipated, or heavy rains in Florida persist, this contingency may not be sufficient and results could be further affected. We are currently estimating that more than half our annual net income will occur during our fiscal fourth quarter due to improve supply conditions during our fourth quarter versus that of our third quarter. We also have plans in place to recover some of the unplanned cost we are incurring through a list of cost reduction and productivity improvement initiative. Thus, we are reiterating our revised guidance. Regarding Windset, we are estimating that Windset's lower production volume during our fiscal second quarter will reduce the increase in the fair market value of our investment in our Windset to an increase of $1.2 million to $1.4 million in fiscal 2016, down from our original projection of approximately $4 million. Including the lower fair market value increase for this year than originally projected, by fiscal year end 2016 we have well have realized a 24% annual return since our original investment in Windset in February of 2011. Windset is still working on permitting issues with the County of Santa Barbara for a new type of greenhouse structure to be used for new crop Windset is not currently selling commercially. Concurrently in the event the approval from the County of Santa Barbara is further delayed, Windset is working with city of Santa Maria to obtain permit on owned city land to ensure commercial harvesting of a new crop begin in the fall of 2016. Our strategic initiative to develop new products and new customers expand capacity to meet anticipated demand and shift our product mix to higher margin products are working at the Lifecore and Apio. At Lifecore we have an expanding the accepted filling capacity and preparing for more HA business from existing and new customers. When completed in the summer of 2016, Lifecore will have sufficient accepting filling capacity to meet its growth plan for commercialized development opportunities that are consistent with its long term projection. Lifecore is having a record year after a down year last year. Compared to fiscal 2015, we now expect Lifecore revenues to increase approximately 25% in fiscal 2016 and operating income to increase 130% to 140%, up from prior guidance for revenue growth of 20% to 25% and operating income growth to more than double. And we now expect gross margin to return to historical levels of approximately 45%. We also expect double digit revenue and operating income growth from this business next year and for the foreseeable future. We are extremely excited about Lifecore's future prospect given the potential growth of our existing business partnership and the multitude of potential new business in its pipeline. At Apio our investments over the last three years in new product development to create highly nutritious salad kits made from super fit vegetables packed in our BreatheWay technology are paying off. Salad kits revenue increased 78% during the 12 months ended November 2015. Had we had adequate supply of produce during the first six months of fiscal year 2016, Apio's packaged fresh vegetable business would have realized the 20% increase in gross profit and gross margin would have increased to 250 basis points to 13.9% which is in line with our strategic focus at innovating on trend products for consumers. If you recall we have previously mentioned that we may be walking away from selected low margin business. Due to our inability to meet all demand in Apio during this time of severe produce shortage which is continued into December, we do expect to lose some of these customers during the second half of fiscal year 2016 due to our inability to service their need, which is reflected in our revised guidance. The loss of these customers will have an impact on revenues during the second half of fiscal year 2016, but should not have a material impact on net income in the second half. As we respond to short -term sourcing challenges at Apio, it is important to reaffirm Apio's long-term strategy for growth. Our overall plan at Apio is to understand consumer trends and to innovate and launch new products that are healthy, delicious and convenient and deliver value to consumers as well as to our customers. Approximately three years ago we launched the Sweet Kale Salad which has become the number one salad kit among club and retail stores throughout North America. Since that time we have about several new salad kits products to the product line. Combined our salad kits products are now generating $2.7 million to $3 million of revenue per week with margins considerably above our core vegetable product. Using the combination of 52 yields in data and internal estimate, we estimate that the North American market for salad kits still like club stores and retail stores is approximately $1.6 billion in retail dollar, which means the dollars that are received by the retailer. In a short three year time period, Apio salad kits have grown from 0% to 50% market share in North America, North American retail club stores. This market share is up 100 basis points since last quarter. In the retail channel for salad kits in the Canadian market Eat Smart salad kits have reached the number one market leadership position with a 38% market share over the last 52 weeks. In the US retail market, Apio salad kits have gained a 3% retail market share providing a large opportunity for future growth. We plan to continue to grow our market share in the salad kits category through innovation and new Eat Smart vegetable based salad kits that offer fresh, nutritious ingredient and unique never before offer combinations and flavors that make it easy and delicious for consumers to eat healthy. In addition, we are significantly increasing capacity for producing both Apio's core vegetable products and the n new salad kits products by more than tripling the size at our processing plant at Hanover, Pennsylvania. We expect the construction to be completed in early calendar year 2016 with new processing lines out and running shortly thereafter. In summary, our strategic initiative developing new products, expand capacity to meet anticipated demand and shift our product mix to higher value added products are working at both Lifecore and Apio. Over time these strategies will continue to deliver value to our customers and consumers and shareholders. Our continuing priorities are: Number one, investing in facility expansion and equipment, meet future anticipated demand at both Apio and Lifecore. Two, shifting our product mix to higher value added products at both Apio and Lifecore. Three, focusing on new BPO strategy and business development on researching the natural food product segment to identify areas where Landec can enter through new product development and/or strategic acquisitions or investment. Four, innovating the salad kits to broaden and strengthening our product line. Five, advancing our Lifecore programs with key customers and development partners. And finally number six, supporting Windset in its expansion plan to build new hydroponics controlled atmosphere structure using new growing methods for new crops. We are now open for questions.

[Operator Instructions] Our first question comes from the line of Doug Cooper from Sidoti.

Yes, good morning, Molly and Greg. Happy New Year. Just quickly if you could talk a little bit more about Lifecore. You seemed to be slightly ahead of revenue guidance for the first half here and behind on gross margin. Can you give additional color on the back half of 2016 and what do you expect to get you to your guidance?

Yes. Within Lifecore because of the just order patterns of their customers, things can move from quarter-to-quarter, so we expect that and that obviously happen so the original guidance or the new guidance of 25% increase which we put in the $50 million to $51 million is still on. So the difference will be recognized in the second half. And as -- and if you look historically you would see that their biggest quarter is historically been the third quarter that's when their shipments, their higher margin powder, HA powder occurs and that will be the case this year except for this year it's going to be spread more over both the third and the fourth quarter. So you're going to see a pick up in both gross margin and revenues in the second half to achieve the goal for the year.

Okay. Just if I got that correctly pick up in revenue since you are in the second half of the year because you're already ahead of guidance in the --

The revenue shift is going to be the higher margin products so you are going to see an increase in their gross margins in the second half and their revenues in the second half will also pick up to meet that $50 million to $51 million increase for the year, or I hope for the year.

Then on the Apio side of the business you ran another promotional program to stimulate trial purchase of the Eat Smart salad kits during the quarter and just wondering if you could give a sense on how successful that was and how it might have contributed to any lift or to sales in the quarter?

Yes. So we did run that promotion; we ran it through the end of December. And we do not have all the data back. Nielsen is a little bit lagged on their data. So I am going to have to report that out next quarter. We have some data on things like number of email addresses we collected and kind of online statistics but as far as lift we don't have that yet.

Thank you. And our next question comes from the line of Morris Ajzenman from Griffin Securities.

Hi Molly. Hi Greg. Could you give us some sort of estimate of how much business you think you will be walking away from in fiscal 2016 as it relates to Apio?

Well, at this point we do not have an estimate from that. This is a tough time for everyone. I'll step back a second and just kind of talk about the larger sourcing dynamics if I could Morris. Through the summer and then really into October and November we had very warm weather as you know in California. And what happened was it really sped up the growing of some of the crop; simultaneously we’ve had cold weather in the desert. And that's slowed down those crops. So we ended with a gap over the holidays. And so this was industry wide, this wasn't just Apio. And so during the holidays it became very emotional period where there is very little product to put on stores to shelf. And so right now there is a bit of emotion in the market and with our customers and so some customers have verbally told us kind of in a reactionary way that they will be leaving. But we need to see how things shake out and see kind of what really happens.

And if this does play out, will this result in an increase in the healthy salad line and the Eat Smart? I think from the first fiscal quarter to the second fiscal quarter, your weekly run rate was unchanged. Correct me if that's wrong. And is there a step up in the run rate going forward if you do walk away or lose customers?

Yes. Right now we are not anticipating losing any of our salad kits business. We have been able to supply all of that demand. To answer your other question so typically in salad kits we were flat from our first quarter to our second quarter, but that is actually predicted and anticipated. The reason is salad kits are very seasonal and the first two quarters are much, much lower in volume than the second two quarters of the year. So in that -- so if you look at our second, first two quarters last year, they had a much lower run rate but they were also the same, quarter one and quarter two were approximately the same as well. So we're going to expect an uptick in the salad kits in the next -- the coming next two quarters.

One more question and I'll get back in queue. Can you explain the difference as far as the permitting for the County of Santa Barbara versus going forward County of Santa Maria? Is this a similar structure? Would this be something different if Santa Maria to go forward in the fall 2016 if Santa Barbara continues in I guess requesting permitting issues or whatever? How does this differ going forward with Santa Maria versus what you want to do with Santa Barbara?

Well, Morris, obviously there are different jurisdictions. The County of Santa Barbara is a new jurisdiction for Windset. They currently do not have any structures in Santa -- just Santa Barbara County. Their current structure which you have been to and is in the city of Santa Maria. So they've already obviously gone through the full permitting process on the huge glass structures that they have there. So these new structures which are more like a hoop type of structure on city land will be much easier to get the permits through the city since they've already gone through the process. This is a first process, so first time and gone through the permitting process with the Country of Santa Barbara. And it's just taking a lot longer than they anticipated. They do anticipate getting approval at some point but if they are not just going to sit around and wait for the County to give them a thumbs up, they are concurrently moving and getting approval from the city so that if the County just keeps delaying permitting they will end up putting their new structures on their own city land. And eventually there will be structure to put on the county land because they have leased 106 acres across the street in the current structure and they plan to use it.

So I guess my question -- I am sorry if wasn't clear. Is this facility at the County of Santa Maria is, the same sort of structure that we referred --

Yes.

Okay. So this would be a move forward with the same larger structure also at Santa Maria while waiting for Santa Barbara going forward, so this is something new that you are putting out there for us.

What they -- what is currently going to be on the city land which you literally see here within the next 30 days if you go down there is a trial structure of 5 to 7 acres of this new hoop found type of structure. That will be on city land that their trial assuming they get approval from the County that same structure will be on the County property, it will just be much, much larger. It will be more like 40 to 50 acres versus 5 to 7 acres. If they don't get the approval soon from County, they will put that 40 to 50 acres of the much larger structure on city land, so they still plan to begin harvest of the new crop that will end of these new hydro product structures in fall this year. Is that answers your question?

Yes. Thank you.

Thank you. And our next question comes from the line of Tony Brenner from ROTH Capital Partners.

Thank you. Good morning. Just to clarify I thought Molly in your prepared remarks, you indicated that salad kit sales increased sequentially quarter-to-quarter 34%, and I think in the last question you indicated it was flat quarter-to-quarter.

Oh the 34% was second quarter of last year compared to second quarter of this year. And the last -- referred quarter one of this year versus quarter two of this year.

Got it. Sourcing is now transitioning to the desert. I believe that's already beginning to happen. And could you just comment on -- I know it's January 6 but -- on to what extent supply is easing up and what's beginning to happen with respect to prices?

So we are in the desert now, we are harvesting from the desert. We still harvest in California too. We don't have 100% of our things ever just in the desert. And like I said in the desert we have --we've been having much cooler temperatures, we're just getting hit on all front this year. We are having much cooler temperatures than desert which has delayed the harvesting in many crops. So some of the harvests are starting to come through. We see, we feel like will be in kind of full supply of our broccoli and cauliflower more towards mid to end of January. And at that time the delayed crop should be coming to fruition. And did you have a specific question on pricing?

Well compared to the $40 cauliflower prices you were encountering, for example, and to the extent to which broccoli went up, has there been easing yet or is that still to come?

Yes. It's actually very volatile. So at some days it's still at that high but there are days where it is coming down. And I think we're going to see over the next few weeks it's going to come down to more historical levels.

And do you pass that on immediately or to those accounts you raise prices?

We've been starting to lift --we talked about earlier about a surcharge in our previous release and we have started to lift that surcharge now.

And remember lot of our crops down, well, virtually all other crops, cauliflower and broccoli are under contract. So those are prices are locked in stone. The prices we are talking about if we can't get full demand from our growers then we have to go on the open market and try to buy the difference.

And you realize there hasn't been much product to buy on the open market. So when the prices get above $40 and $45 it really reflects that there is nothing to buy. So that we are even able to go spend all that money because they can say that's the market price but we can't find any quality product.

Regarding Windset, you've indicated that you would begin harvesting crops from hoop house or houses next fall. Does that mean from a test facility, or do you expect one way or the other the larger two hoop houses to be completed and harvesting produce in nine months?

Right. So we are expecting the larger part one way or the other whether on city or county to be harvesting in the next fall.

The test facility, they will start harvesting this spring, but it's only 5-7 acres. So we are not talking about product-- it was more of exactly that a test plot

Test variety

To see what variety is grow well in this type of structures, whether they yields, what are their cost, how are those cost compared to field so on and so forth.

And my last question. What are the plans on that Santa Maria property to construct another glass greenhouse? What's the anticipated timing of that event?

Well, right now it's kind of predicate on what happens on the county land. If they just see that this going to be continually delayed, they are going to use their city land that they own for these new structures. And so for any future glass structures then they would have to expand their land ownership probably north of their current facility. [Multiple speakers]

And are there contingency plans to do that?

Yes. There is discussion but there is old current plan right now for new glass greenhouse in the near term.

Near term means fiscal 2017?

Yes, exactly.

Thank you. And our next question comes from the line of Brent Rystrom from Feltl.

Thank you. Good morning guys. A couple of quick questions. Just to clarify on Santa Maria, the Santa Maria location, the City of Santa Maria, is that an SLO? And then other property is in Santa Barbara County?

No. It's all in Santa Barbara County. It's just they are different jurisdictions as far as who you go to, to get your permitting. And the land across the street is not part of Santa Maria the city. So it's just part of the County now. What city that is I should probably know but I don't.

It's probably a township, so --

I think incorporated area of Santa Barbara County.

All right. Thank you. That's helpful. On the shelf offering and acquisitions could you clarify again Molly what you said? What sort of areas you're looking for your new strategy and development process?

Sure. So we are just starting to kind of delve into this area so this is a new area for us. But we I mean when we step back and we look at what's happening in the US it's pretty amazing the dramatic shift that's occurring with consumers to eat healthier. And you can see this in the big CPG companies and a lot of new startup companies that are coming out with clean ingredients and natural products. And so we want to start looking into better for you product not necessarily in that are produce products and we think we can enter this segment. We have an amazing infrastructure at Apio. We've got refrigerator, warehouses, we have our own logistics and our trucks. We have strong customer relationship with over 70% of stores penetrated. And we think that we can leverage this infrastructure to launch new and different products. So that the strategy is to enter into this new product segment. And we will do through either innovating ourselves to organic growth and going into these products on our own or through acquisitions. But as you know the acquisitions are extremely pricy right now. It's definitely a sellers market and multiples are high. So we don't want to be depended on acquiring companies to enter the space. So we're going to just start looking into building the strategy to both acquire or enter the space through our innovation effort. And this will take time. So we are just starting to think about this. We are just starting to research this. So it will evolve over time.

Okay. That's great. My final question has to do with the Eat Smart line. You had mentioned earlier in response to another question that it's fairly common for Eat Smart sales to be a little soft in the first and second quarter, and then build I think you were implying in the second half of the year. And I want make sure I understand that from a clarification perspective. So when I look back at my notes and I look at the press releases, last year in the first quarter which was a 14 week quarter, you said you were at about a $1.5 million run rate which would be about $21 million. So if you back out that $1.5 million and that extra week, you were probably $19.5 million, so down a little bit from where you were in the fourth quarter. But sequentially in the second quarter then, you said you were at a $2 million run rate which would imply about $26 million. So when you said the first half is generally flat were you implying that last year was kind of an aberration, or did I hear that wrong?

No. I am sorry. So what I am saying is the first quarter of this year compared to the second quarter of this year has remained relatively flat. We are -- if you compare this quarter to last quarter we were up 34%. Okay --

This quarter compared to last year's quarter.

Second quarter.

Yes.

So this second quarter compared to fiscal year 2015 second quarter were up 34%. And that's why I am not concerned, it's just that the question I had previously was comparing quarter one of this year to quarter two of this year. And so just because -- so I am not concerned because we are still year-over-year growing extremely fast and by the way remember when I said it's lower I am speaking specifically of the salad. It's the salad -- sorry the vegetable that have lower sales in these two quarters compared to the second two quarters. And then also realize that we are going through with produce shortages right. So our volumes, if we are not shipping to all the demand our volumes are going to be down now as well in all our products.

So then final quick follow-on to that and then I'm done and you can hop back on to the next one. Over the next couple of quarters, is it going to be new product introductions? I know you mentioned it will be a combination of new product introductions and some other stuff. But what is the catalyst in your mind the next couple of quarters to get that sequential growth accelerating again?

Right. So we do expect seasonality first of all. I mean I mentioned early seasonality is going to kick in, it's a new year, everybody goes crazy over salad and hits on their fresh face, and they get healthy again. So we do see in the next two quarter an uptick to the seasonality and we also will be launching new products. So it's a combination of the two. We have a new product it's launching in February and a new salad kits launching and so we hope to gain significant distribution on that. And so the combination of new products and seasonality will add kicker to the second half of the year.

Thank you. And our next question comes from the line of Chris Krueger from Lake Street Capital.

Hi, good morning. You guys had mentioned both on the call and in your recent press releases that produce sourcing for broccoli, cauliflower and green beans have been particularly -- has been particularly difficult. How important are those three items to your salad kits?

That’s a great question. So we don't typically have green beans or cauliflower in our salad kits. We do have broccoli's dot. So we don't use the florets in our salad kits but we use the broccoli stock. So as broccoli has been coming in we've just made sure we've been able to get enough stock to cover our salad kits and use the floret to supply the rest of business.

Okay. And then other areas that we know are important, like kale for instance, how has sourcing been for that?

We haven't had a problem with Kale or cabbage not really with detail I mean it might be on a day or certain few days we do but in the big picture we haven't had any supply issues with this crop.

Okay. Moving on to Lifecore, I know I've driven by the building, can see the expansion occurring. I think you stated in the press release it should be completed by I think you said the summer. When will this be actually producing sales?

Well, some of this expansion is build and it will come and we are confident, otherwise we wouldn't be spending this kind of money. So several things are in the works why our business development revenue is so much year-over-year. And we expect that as these go from business development to commercialization we will be using the space, I think realistically you're probably talking the beginning of calendar 2017.

Thank you. [Operator Instructions] Our next question comes from the line of Mitch Pinheiro from Wunderlich Securities.

Hello there. A quick question. First, why would exports be flat if you're having produce sourcing issues?

Well last year was -- they have lot of issues last year. We had the longshoremen strike so there is lots of thing going last year. And they are across that they export are completely different than the crops that we sell our value added business. It's almost all fruit and quite a bit of it is sourced from areas outside of California like all the apples come from -- well not but most of them come from Washington. You've got grapes out of Chile so on so forth. So it's apples and oranges. So --

You're doing apples and oranges. Okay. So as far as -- I didn't understand really your initial remarks. So you had higher raw material costs, $4.7 million. And so I understand that. But wouldn't you have had lower absorption rates because you had lower volumes? I mean I would've expected gross margin to be maybe even worse than it was.

Yes. There have been some absorption issues because volumes were certainly off but the biggest impact that $4.7 million was the cost to get the product in the door. So you are still getting product in but not the full now but you are still getting products in. But it costs you a lot more because you are happened to buy whatever you can on the open market for prices that could be 2x, 3x your contract right. So that is the biggest part of that $4.7 million.

But you are right, Mitch. We are having a lot of overhead and inefficiencies in the plan because of the lower volume. And we have to do lot of more work at the plan to pick out the good quality product. I think which also affecting this is the other efforts that are going on. So at the same time we are spending more, we are also have a lot of cost reduction initiatives and productivity improvements going on. And so our labor rates are improving because of productivity measures even they are more inefficient because of the situation we are in weather.

So the gross margin you cited of $13.7 million adjusted for the produce shortage. That could even be a little higher than that if you back into some of the -- or if you have better capacity utilization. Is that --

Absolutely

Yes.

Okay. And then my final question is did I hear you correctly on Lifecore, Molly? You think next year you're going to see double-digit revenue and operating income growth?

The Lifecore has put together very strong five year plan and we are not obviously ready to give guidance for next year yet. But just kind of in a bigger picture the five year plan that we have today they are showing on average a double digit growth rate of top and bottom line.

Thank you. And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Landec management for any additional comments.

Thank you. Let me just end with the couple thoughts. First of all, as we have been discussing we've had some severe challenges in our Apio business. That being said, we will get through this and it is in a point of time and we are more focused on is really make sure that our three growth engines are all progressing as planned to ensure the long-term profitability of Landec. And these three growth engines are the continued growth of our Eat Smart salad kits, the second one if Lifecore. Our investment in Lifecore is paying off and they have a strong business plan going into the future with new products and new customers. And our third is we are going to begin to research this natural food segment to see if we can enter that market through either acquisition or internal innovation. So with that I'd like to just thank you for joining us today on our call. And thank you for continued interest in Landec.

Thank you. Ladies and gentlemen, thank you for participation in today's conference. This does conclude the program. And you may now disconnect. Everyone have a good day.