Mission Produce, Inc. (AVO) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Mission Produce Fiscal Second Quarter 2022 Conference Call. [Operator Instructions] Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Jeff Sonnek, Investor Relations at ICR. Sir, please go ahead.

Thank you, and good afternoon. Today's presentation will be hosted by Steve Barnard, Chief Executive Officer; and Bryan Giles, Chief Financial Officer. The comments during today's call and the accompanying presentation contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts are considered forward-looking statements. These statements are based on management's current expectations and beliefs as well as a number of assumptions concerning future events. Such forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from the results discussed in the forward-looking statements. Some of these risks and uncertainties are identified and discussed in the company's filings with the SEC. We'll also refer to certain non-GAAP financial measures today. Please refer to the tables included in the press release which can be found on the Investor Relations website, investors.missionproduce.com, for reconciliations of non-GAAP financial measures to their most directly comparable GAAP measures. With that, I'd now like to turn the call over to Steve Barnard, CEO.

Thank you for joining us for our fiscal 2022 second quarter earnings call. I'm pleased with our fiscal second quarter performance, which demonstrated our ability to get the business back on track quickly following the temporary operational challenges associated with our ERP implementation. Total revenue for the second quarter of fiscal 2022 increased 18% to $278.1 million and we generated $9.2 million in adjusted EBITDA. Revenue growth was driven by a continued strong pricing environment that is being supported by resilient demand amid lower industry supply. More importantly, however, it was our ability to drive a recovery in per-box margins, which have returned to the high end of normal historical ranges. From a supply perspective, the ongoing inconsistency of Mexican supply continued during the fiscal second quarter. The industry continued to experience challenges with abnormal grading and sizing of harvested fruit. For context, approximately 76% of the U.S. distributed volume was Mexican-sourced fruit in the second quarter. We utilized alternate sources to fill demand which were primarily focused on California, which produced a larger crop this year as well as production from Colombia and Chile. While Mission's global footprint provides sourcing advantages relative to the industry as a whole, there are not enough ample sources of fruit available at this time of year to meaningfully offset the impact of the Mexican supply shortages. This is an example of why Mission has been proactive in investing in vertically integrated global supply sources to fill these supply gaps and reduce the volatility. The backdrop of constrained supply, coupled with consistent demand, continued to create sustained upward pressure on pricing through the first half of this fiscal year where prices were approximately 50% higher versus the prior year. Despite these higher prices, demand in the core U.S. markets have proven to be resilient and largely inelastic. We think this speaks to the broader health and wellness trends that underpin the avocado industry, elevating the avocado to a must-have staple in many households. In fact, in the second quarter, we distributed approximately the same amount of volume as we did 2 years ago in the second quarter of 2020 during the onset of the pandemic, yet prices are 24% higher over the same period, demonstrating the value of avocados and consumers' diets. While this dynamic isn't as strong in less-developed markets due to the lower levels of consumption per capita in those international markets, we believe we are especially well suited to address the opportunity to foster similarly resilient consumption trends in new global markets. Our ability to drive growth in these new international markets comes back to being able to provide year-round supply. Mission has played a critical role in creating greater access to avocados at your neighborhood retailer and favorite restaurant through our consistent year-round supply and value-added services. This requires foresight and a constant focus on continuously assessing opportunities to optimize our sourcing capabilities with third-party growers as well as investing in our own farms to ensure that we can control the quality and supply that our customers have come to expect. Our strategy to invest in vertical integration has proven to be an unparalleled competitive advantage. Specifically, our own Peruvian production gives us reliable access to fruit to meet customer needs on a scale and at volumes that only Mission can deliver. We are well positioned to leverage these capabilities in the second half of our fiscal year when our owned Peruvian product comes online and typically contributes to a significant step-up in adjusted EBITDA. The Peruvian growing season has been very productive, and we are expecting solid yields from our crop. However, we think it is prudent to expect some price rationalization in connection with the improving supply conditions later this fiscal year. While we expect to generate sales growth in the second half of the fiscal year, the inflationary environment is expected to mitigate some of the operating leverage that we typically expect out of our own International Farming segment. In summary, strategically investing in our own production to ensure year-round global sourcing is the key to maintaining long-term organic growth and is a key component of our long-term growth plans, and Mission continues to be in a great position. Although this year's abnormal supply environment has created some challenges, we are focused on our long-term strategy of generating consistent growth and enhancing market share by increasing capabilities and capacities while continuing to adapt to industry dynamics. Mission has a long track record of generating growth, and we believe we have an undisputed advantage with our global network of value-added assets that will drive sustainable long-term shareholder value. With that, I'll pass the call over to our CFO, Bryan Giles, for his financial commentary.

Thank you, Steve, and good afternoon to everyone on the call. I'll start with a brief review of our fiscal second quarter performance ended April 30, 2022, and touch on some of the drivers within our 2 operating segments. Then I'll provide a snapshot of our financial position and conclude with some thoughts on some of the current industry conditions that we are seeing. Total revenue for the second quarter of fiscal 2022 increased 18% to $278.1 million as compared to $234.7 million for the same period last year. Growth was driven by a 44% increase in average per unit avocado sales prices due to lower industry supply out of Mexico following a smaller Mexican harvest as well as inflationary pressures. Partially offsetting price gains was a 19% decrease in avocado volumes sold, which again was primarily driven by the smaller industry harvest. Second quarter gross profit decreased $7.3 million or 27% compared to the same period last year to $19.8 million, and gross profit percentage decreased 440 basis points to 7.1% of revenue. The decreases were primarily driven by the impact of lower avocado volumes sold in our Marketing and Distribution segment and its related impact on fixed cost absorption. In addition, we experienced gross profit decreases in the International Farming segment due to the timing of cost incurred and impact of pricing at early-stage mango farms. The lower gross profit percentage was driven by higher per unit sales prices. Margin is primarily managed on a per unit basis in our Marketing and Distribution segment, which can lead to significant movement in gross profit percentage when sales prices fluctuate. SG&A expense for the second quarter increased $2.4 million to $18.7 million due primarily to non-capitalizable costs associated with the implementation of our new ERP system in our Marketing and Distribution segment, higher employee-related costs driven by increased head count and labor inflation and higher travel expenses as COVID-related travel restrictions have eased. Net income for the second quarter was $2.4 million or $0.03 per diluted share compared to net income of $7.4 million or $0.10 per diluted share for the same period last year. Adjusted net income was $2.6 million or $0.04 per diluted share compared to $8.7 million or $0.12 per diluted share for the same period last year. Adjusted EBITDA was $9.2 million for the second quarter of fiscal 2022 compared to $16.3 million for the same period last year driven primarily by lower avocado volumes sold and higher SG&A costs, as described previously. In terms of our segments, our Marketing and Distribution segment net sales increased 18% to $273.7 million for the quarter. And segment adjusted EBITDA was $11.7 million, a 28% decrease from prior year. The drivers for the Marketing and Distribution segment are similar to those that I described for the consolidated results. Our International Farming segment primarily represents our owned farms that we manage in Peru. As a reminder, the avocado harvest season for our Peruvian farms typically runs from April through August of each year. And as a result, you see the International Farming segment emerge in the third and fourth quarter and contribute to adjusted EBITDA in a significant fashion. Furthermore, I'd highlight the influence of our mango operation on our segment financial results as the timing of the mango harvest is concentrated in the fiscal second quarter, and as a result, mangos have a more pronounced impact on segment financial performance during this time frame. For context, we operate approximately 300 hectares of planted mangos in Peru that are largely in an early stage of production, with approximately 60% of those acres producing fruit. This compares to the approximately 3,000 productive hectares of avocados that we operate in Peru. While small in relative terms, our presence in the mango category has several operational synergies that are important for our broader growth ambitions. Chief among these is supporting our labor pool with year-round work and leveraging our existing infrastructure investments. So with this in mind, for the second quarter, International Farming segment net sales increased $2.1 million or 91% due to higher mango harvest volumes as well as higher third-party service revenue compared to the same period last year. Segment adjusted EBITDA was negative $2.5 million primarily due to the timing of costs incurred and impact of pricing at early-stage mango farms. Yields are commensurate with the stage of maturity of our mango production. And as this improves over time and volumes increase, we would expect a corresponding improvement in adjusted EBITDA generation. Shifting to our financial position. Cash and cash equivalents were $21.4 million as of April 30, 2022, compared to $84.5 million as of October 31, 2021. Net cash used in operating activities was $37 million for the first half of fiscal 2022 compared to $20.2 million in the same period last year. Company's operating cash flows are seasonal in nature and can be temporarily influenced by working capital shifts, resulting from varying payment terms to growers in different source regions and prevailing market prices. In addition, the company is building its growing crops inventory in its International Farming segment during the first half of the year for ultimate harvest and sales that will occur during the second half of the fiscal year. The $16.8 million change versus prior year reflects the net loss for the first half of the year, partially offset by favorable net change in working capital. Within working capital, favorable changes in grower payables were partially offset by unfavorable changes in inventory. Changes in grower payables were due to higher fruit prices compared to prior year. Changes in inventory were due to increased per-box value of fruit on hand in North America and higher growing crop inventory in Peru driven by inflationary pressures on farming costs and additional productive acreage compared to last year. Capital expenditures were $29.1 million for the first half of fiscal 2022 compared to $46.8 million in the same period last year. Current year expenditures were concentrated in the purchase of farmland in Peru as well as land improvement and orchard developments in Peru and Guatemala. As a reminder, in the year ago period, we had incremental capital expenditures associated with the Laredo, Texas facility that is now operational. In terms of our near-term outlook, we are providing some context around our expectations for industry conditions to help inform your modeling assumptions. The industry is expecting third quarter volumes to increase sequentially but remain approximately 10% to 15% lower versus the prior year period primarily due to ongoing supply constraints in Mexico that are not expected to fully alleviate until the fiscal fourth quarter. More specifically, we expect to see some increased volume from California and early Peruvian crop to help fill the void as Mexico transitions from its primary to its off-bloom crop. The general expectation is for volumes to then increase further in fiscal fourth quarter as Peru will be in full swing and Mexico's off-bloom crop starts to hit the market. With this expectation for improving volumes, we believe that the pricing environment should rationalize in turn through the balance of this fiscal year. We continue to battle the same inflationary pressures that have been well documented. These include freight, labor and packaging costs, among others, which, in a lower volume environment, creates additional headwinds to our ability to drive higher per unit margins and adjusted EBITDA. That concludes our prepared remarks. Operator, now over to you. Please open the call to Q&A.

[Operator Instructions] Our first question is from Ben Bienvenu with Stephens.

It's Jim Salera stepping in for Ben today. If I can ask a couple of questions on the supply environment. So as the new supply comes online from Peru and California, can you maybe talk about the matchup with pricing? Is that going to be enough to alleviate prices in the third quarter? Or is that something that isn't really going to fully satisfy the demand until more into the fourth quarter?

I would say, at the earliest, it will be the end of the third quarter, primarily in the fourth quarter. Mexico really won't get started, from what we can tell, until probably the second or third week of July. And by the time it gets in the system, you're looking at, realistically, probably the 1st of August or so. Peru could affect that to some degree, but the demand is pretty good. So I would think it will have to take Mexico to change the thing dramatically.

The one thing we didn't have in Peru that we will have in Q3 is some meaningful Peruvian volume. So I think while volume would be up sequentially, it will still be down year-over-year. I'd expect a higher pricing environment than we saw a year ago at this time but should start to trend lower from what we've seen over the last few months.

Perfect. I was just going to ask, in terms of the reliability of the supply, specifically the fruit health itself, in Peru and California versus what you guys have been seeing in Mexico, is there any concerns around that?

Well, Peru has got a pretty good supply this year. What we're bringing in here is mostly contracted, but there will be more supplies coming as the weeks go on. They're pretty much going full blast down there now. But by the time it gets up here, it will be 3, 4 weeks from now. But that will help. California has really peaked where it is today on volume. It will start slowing down here probably towards the end of the month. Not stopping, but slowing down. And then Mexico, from what we know, they're going to start with a new crop, they say early July, but it appears like it could be delayed a little bit.

Okay. And then if I could sneak in one more question on the demand side. Have you guys seen any consumer demand, also like a price umbrella, where once the fruit prices hit a certain point, they either swap out of the category or the volume sees decrement not related to supply but just related to consumer pricing power, specifically maybe at some of the QSR restaurants like Chipotle?

Well, it's out there. I think the tide keeps rising from what we're seeing. I mean, with these prices, the industry is still moving 55 million pounds a week or so between all sources. Compared to this situation years ago, the stability is really impressive on what's happening. I mean 55 million pounds a week, even 5 to 7 years ago, we would not be seeing these prices. So I think the overall category is very strong. There's a limit. We just don't know where it is yet. It keeps moving.

Yes. I mean I would say that this is a pretty good example of the laws of supply and demand at work. As supply decreases, price increases correspondingly until those lines intersect. And I think that's what we've seen happen. I think the demand curve has proven to be steeper, particularly in the U.S. market, than maybe people had thought. I mean with pricing rising at a much faster rate, or at a much faster rate than volume has declined, I think we view that as a positive that demand is strong out there. We certainly don't want it to remain in this environment for an extended period of time because then I believe that there could be concerns over long term, how it could impact consumption over the long haul. But I don't believe over the short term that that's going to have a meaningful impact. Again, the hope is get volume back on track relatively soon, see some alleviation on where the price is at today. And I think we'll be happy with the market at that point.

Okay. Great. If I could sneak in one more question on the inflation front. Just anything that you guys are seeing that might lead to, I'll say, if not a return to normal, at least a sequential slowing in kind of the inflation rate. Or is it this is a step-up that's pretty much locked in and this is the normal moving forward?

I think some of it's going to come back. One of the things that's going to probably have a more meaningful impact the second half of the year is the inflation on our farming product. I think that things around ocean transport are much higher than what it was last year. At this time, some of the controlled atmosphere containers, we're seeing costs that are close to double what we experienced in last year's market. I don't think those are going to remain at that level. I think that the capacity constraints will get resolved over time. Hopefully, fuel prices will settle in at a lower level, and those will come back. I think some of the other things, we look at our farming operations with fertilizers, other types of raw materials that go into the crop, we've seen inflationary pressures there as well. Those may stick a little bit longer. I think it's more difficult. I think that may have a little more to do with some of the other things that are at play in the world right now. But I think we're hopeful that at a minimum, they stabilize, if not revert, over time.

Our next question is from Tom Palmer with JPMorgan.

Maybe first, just a check-in on the Peru harvest. I guess we're getting to the point where you're starting to get some visibility on supply. It sounds like you're counting on that to make up some of the shortfall from other regions like Mexico. But maybe a little more specific, I mean are you expecting the harvest to be larger than last year? Just anything on the size that we should expect from your company-owned farming operations.

Yes, our particular crop, Tom, is the largest we've ever had just because the trees are getting bigger and we continue to plant year after year in different locations, targeting specific harvest periods. But yes, we're going to have the most we've ever had by, I don't know, 5% or 10%, probably, increase. That is going to be spread around the world. But most of it will come to the U.S., which will help build the supply to the offsets from California and Mexico. So we're in a great position and leading that space as far as being vertically integrated around the world.

Great to hear. And then switching gears a little bit. You'd mentioned per-box margins back to the high end of historic ranges. I just wanted to make sure I understood this math. Because you also noted some added costs, right? I think shrink's probably still a little bit high, you've got freight, fixed cost to leverage as Laredo ramps up. So when you talk about per-box margins, is that an all-in number when we look, for instance, at the Marketing and Distribution segment? Or is that before considering some of these maybe costs that are spread across the volume base?

Tom, it's an all-in number that we're referring to. So you could argue that with the fact that we are carrying higher costs in certain areas, that the margin that we're making on the fruit is even better than it's been historically because we're coming in with a blended rate that's at the high end despite those pressures. I think that we've told people in the past a goal of somewhere between $3.50 to $4 a box margin. That's where we try to operate. And yes, we came out of a quarter where we were operating kind of just above the high end of that. I think as we move forward, our goal is to kind of stay within that range. I don't see anything in the near term that we're looking at right now that would cause us to think that that's not achievable.

Our next question is from Bryan Spillane with Bank of America.

Maybe just a follow-up on Tom's question, and we've fielded this a few times, just getting back to a normalized unit profit or profit per box. In terms of just the most important driver to that, is it really just going to come down to having supply and supply coming from the most optimal places? So we're kind of really going to be looking at what the harvest is like in Mexico, I guess, next year. Or are there other that we should be thinking of? But just simplistically, like what's the biggest driver, I guess, to kind of get us back to those historic norms?

Well, supply, having enough supply to meet demand, demand continues to grow. As I mentioned a second ago, this Peruvian crop is growing every year. Our numbers are up about 20% and still planting in areas to kind of fill the gaps. So who knows where this demand is going? If you look at the prices today and the fact that we're moving 55 million pounds a week, there's a lot of room there. I mean if this thing comes down to a little lower level, I don't know, it could be 65 million pounds a week at a pretty steady pace going forward in the next year just looking at the history.

I'd add on top of that, Bryan, that having sources of fruit from multiple markets at any given time, the variety of options on countries of origin helps us lever one off the other. I think when we're heavily dependent on one supply market and that market gets upside down on supply or it's not there, it creates challenges for us. So I think as we transition into times of the year when we have multiple countries of origin available, that flexibility certainly helps us with price and enable us to kind of balance out those different markets and lever them off one another.

And I guess, just if we're thinking about the shorter term, maybe the next 12 months, from a supply perspective, is Mexico the most important kind of variable as we sort of look at trying to have more supply?

Well, over a period of the next 12 months, definitely. I mean they were generally 72% to 73% of the U.S. consumption. The Peruvian product we'll have here until September, late September, maybe October, there'll be an overlap, of course. And then California, we'll have some product here for the next 60 days with volume or maybe a little longer. So we've got options in the short term.

Yes. And then just one last question for me, given how there's just stretching the source product maybe from different places or make up some of the gaps that we've seen, has it affected the quality of the fruit that is especially in, I guess, supermarkets? Are you selling more? Or is the industry selling more maybe lower quality fruit than it normally would just because, at this point, it's just a matter of having fruit at all versus being able to separate grade or quality?

I would say, to a degree, you're right. I mean this Mexican crop has been drugged out over the past couple of months where some of the maturity is high and I think the shelf life is a little lower than the other, say, Peru or California. So it kind of depends on what product you're getting and what the source is. At this time of the year, I mean it changes as we move forward. They're going to start with new crop here in about a month or so. So just it's a moving target on the source and the timing of the year.

Our next question is from Gerry Sweeney with ROTH Capital.

A question just on the Peru fruits. Looking at previous years, it sort of falls 40-60 Q3, Q4. Is that the way you see the volume kind of falling out again this year?

I think that it might be a little bit lower than that this year. I think that for Q3 versus Q4, certainly, we would like to harvest as soon as possible. But some of that is dictated by the maturity of the fruit on the tree. The harvest started a few weeks later than I think we really would have liked to begin the harvest this year. So I think that it won't be dramatically different from that 40-60 split. But if I had to estimate, I'd say I'd take the under on that, that we'll likely have a little bit less of a sell-through in Q3 this year. I will note that last year, we had about 36% of our crop sell-through in Q3. So I think that something like that is probably a reasonable target.

Got you. And then you mentioned maybe price rationalizing in the fourth quarter. And this is probably not an easy question. But obviously, I mean, it's off-bloom harvest out of Mexico and then you had the Peru fruit coming in. What does rational pricing mean? I mean California is out, Mexico is off-bloom and then, obviously, Peru is coming through but not nearly as big as Mexico. How much of a change in pricing could we see?

Well, I haven't been downstairs this morning, but it's been in the $60 range for Mexican fruit and/or California fruit per lug at source, which is extremely high. Retail has been pretty high to match that. Peru's coming in, those are mostly contracts, so they're a little bit lower, but they're stable throughout the season. And I think once we get substantial supply coming out of Mexico, you'll see a reduction in the price, but I think it will be higher than it has been. In other words, it's going to back off a little bit. But as we see this demand continuing to grow, the floor keeps rising. So in the past, if we were in the low 30s for an FOB price, that was pretty average, I would say, it could be a little higher than that as an average.

Got you. And then on the inflation side, I mean, to some degree, you're a price taker, I guess, but is there any ability to pass on some of the prices? Or does some of this get baked into the final sales price? And then anything you can do to sort of mitigate it or manage it.

Gerry, I think on the marketing distribution side of our business, the advantage we have there is that we have 2 variables. We can either recover inflation by pushing a lower cost back to our fruit supplier or we can drive it via a higher price with our customer. I think depending on the circumstance, we could utilize either one of those strategies or sometimes both. So I think with a third-party, that gives us more flexibility. With the farming side, we don't have that on the supply side. It really is just the price that we have to work with. And while inflation may impact the floor price at which avocados will be sold, the true price that we end up settling in at is more driven off supply and demand than it is on the inflationary pressures. So I think that in a market like we're in right now, we've got inflationary pressures on the cost side. And while many of the parties that are marketing avocados are dealing with that, the pricing, in some ways, is independent, to some extent, of that unless if it were to get to a very low level where you're actually losing money. And we're not anywhere near those levels right now.

Got it. Okay. And then just ERP, obviously, a big issue before. Were there any sort of short-term costs or transitionary costs in this quarter from the ERP side that we're not going to see either maybe move into the third quarter or sort of exit in the third or fourth quarter, et cetera?

We're seeing some costs on the SG&A side related to our non-capitalizable ERP costs that are still there related to consulting and support, and they're trending down. But I don't believe, or we don't believe, that there was a meaningful impact within our gross margin as a result of operational issues or inefficiencies that were created by ERP during the quarter.

Ladies and gentlemen, at this time, there are no further questions. I'd like to end the question-and-answer session and turn the conference back to Mr. Barnard for any closing comments.

Well, thank you for your interest in Mission Produce and we look forward to speaking to you again soon. Thank you for your time.

Thank you. This concludes today's conference call. You may now disconnect your lines.