Mission Produce, Inc. Q1 FY2022 Earnings Call

Good afternoon. And welcome to the Mission Produce Fiscal First Quarter 2022 Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please also note today’s event is being recorded. At this time, I’d like to turn the conference 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 earnings release, which can be found on our 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 2021 first quarter earnings call. Our first quarter results were disappointing and do not demonstrate the level of execution that defines our business and its founding. On November 1, 2021, we implemented a new ERP system that impacted our entire Marketing & Distribution segment. As every company that has undergone an ERP implementation knows, this is a highly complex exercise that requires extensive planning and testing, all designed to mitigate implementation risks. However, despite the countless hours we spent planning and preparing for this conversion, we nevertheless experienced significant challenges with the implementation. As a result, we were unable to drive the per-unit margins in the first quarter that we have historically delivered. While we believe we’ve addressed the most acute issues that we faced in the first quarter, there’s more work to be done before we get back to the level of efficiency and execution that we have come to expect of ourselves. And perhaps most importantly, despite the challenges, our team was able to quickly adjust to the disruption and largely protect our customers from any extended impact. It is our commitment to customer service that has been Mission’s hallmark for nearly four decades. As we’ve stressed time and again, our greatest competitive advantage is our ability to provide our diverse customer base with a year-round supply of avocados from our vertically integrated farms and global network of growers while also providing customized value-added services that precisely fit their needs. As simple as this sounds, it is anything but when you consider the sheer volume of fruit we’re moving through the supply chain on any given day. On a weekly basis, we can move between 240 and 300 truckloads of fruit through our network. And to move that kind of volume, you need extensive operational capabilities, which is precisely what we have. Our network covers four packing houses in California, Mexico, and Peru, and 12 forward distribution and ripening centers with operations across nine countries on four different continents to serve customers in over 25 different countries. Mission has built a set of unique capabilities over the last 30 years piece-by-piece, asset-by-asset to become the global leader we are today. But growth has complexities. For many years, it has been apparent that our organization would need to upgrade our ERP infrastructure to be able to execute on our strategic growth plans. The new ERP system provides the necessary infrastructure for our growing business and establishes a security and control environment we need now that we are a public company. It was also designed to enhance our operational visibility so that we can scale our businesses to support an even greater breadth of customers across larger geography while maintaining our unparalleled standard of service. While we weren’t naive to the risk of disruption to the business, the extent and magnitude were greater than we anticipated. I’ll provide a few examples of how the ERP implementation impacted our operations in the first quarter. First, there was a lack of sufficient visibility into on-hand inventory, which resulted in considerable fruit that was moved at below-average returns or not fit for sale. In addition, due to the struggles with visibility on inventory, we sourced a disproportionately large amount of fruit from third-party providers where we typically do not recognize meaningful margins to fulfill customer commitments. Separately, first-quarter results were also negatively impacted by the smaller Mexican harvest and difficulties with sourcing the needed size curve and grades which led to significant use of expensive co-packer fruit to meet the demands. Although we largely met amendments to our customers, which is our first priority, the result of these operational complexities was exceptional margin erosion and working capital inefficiencies. So what are we doing about it? As I noted at the top of my remarks, we believe the worst is behind us. As part of our preparation for the ERP conversion, we hired a third-party firm to work with us on the implementation. They remain actively engaged with our teams on a daily basis to identify and remediate remaining issues. Additionally, we have activated additional protocols and developed new processes to enhance the needed functionality and reporting capabilities that provide visibility and insight into key aspects of the business. At the same time, we deployed our operational excellence teams to our distribution centers to assist with training and execution. Importantly, we have also heavily ramped up our cross-functional communication and collaboration so that the entire enterprise is on the same page and moving in the same direction at an accelerated pace. We are making progress. During the month of February, our per-box margins have returned to historical levels. Despite the challenges, the fundamentals of our business remain intact. The trend supporting the industry and our business continues to be decidedly favorable, the demographics are advantageous, and our ability to help retailers and food service customers capture demand for avocados will be a key element of driving consumption trends and growth markets such as Europe and Asia, which are at fractions of what we experience here in North America. 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. In summary, we in our business remain resilient despite the challenges we faced with the ERP implementation. We continue to believe that the ERP conversion was a necessary step as we further scale our global footprint. We are focused on our long-term strategy of generating consistent growth and enhancing market share by increasing capabilities and capacities while continuing to mitigate and adapt to industry dynamics. We are excited about what’s ahead, 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 first quarter performance ended January 31, 2022, and touch on some of the drivers within our two 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 and how performance is tracking in February. Total revenue for the first quarter of fiscal 2022 increased 25% to $216.6 million, as compared to $173.2 million for the same period last year. Growth was driven by a 50% increase in average per unit avocado sales prices due to lower industry supply out of Mexico, as well as inflationary pressures. Partially offsetting price gains was an 18% decrease in avocado volume sold, which was primarily driven by lower supply. In the first quarter, industry supply was negatively impacted by the smaller Mexican harvest. Our estimates indicate that Mexican supply to the U.S. market was approximately 10% lower than the prior year, which was consistent with the reduction we experienced in our own domestic volumes. In addition, the industry continued to experience challenges with abnormal grading and sizing of harvested fruit. To provide further perspective on the Mexican supply situation, approximately 97% of U.S. distributed volume was Mexican fruit in the first quarter. While Mission’s global footprint provides sourcing advantages relative to the industry as a whole, there are not ample sources of fruit available at this time of the year to meaningfully offset the impact of Mexico supply shortages. This is an example of why Mission has been proactive in investing in global supply sources to fill these supply gaps and reduce industry volatility. As previously mentioned, the lack of supply drove per unit prices substantially higher during the first quarter, indicating that the demand for avocados remained strong. The lower supply and higher pricing had a larger impact on the volume of fruit that we were able to sell in international markets, where demand is more sensitive to pricing than we typically see in the domestic market due to lower levels of consumption per capita in those international markets. As such, year-over-year volume reductions in international markets were more significant than those experienced in the U.S. market. So, while ERP was the overwhelming variable in our first quarter performance, I wanted to be clear on how the market is influencing the business and provide a reminder of the impact that volume has on our ability to generate per unit margin. In other words, when industry conditions limit our volume, we have less ability to absorb fixed costs. First quarter gross profit was $0.5 million versus prior year period where we generated $22.7 million. As Steve shared, we experienced extreme margin erosion due to temporary and unforeseen challenges created by the company’s ERP implementation. These challenges limited our ability to effectively manage our supply chain during the first quarter of 2022. Inventory management problems and unusually large fruit disposals coupled with the low industry volume resulted in a high reliance on both third-party fruit and co-packer fruit, which have higher price points relative to fruit we sourced directly in the field and pack in our facilities. This unfavorable sourcing mix combined with transportation inflation and lower fixed cost absorption resulted in a significant increase in per box costs, eroding gross profit. SG&A for the first quarter increased $4.1 million to $18.7 million, due primarily to non-capitalizable costs associated with the implementation of our new ERP system in the Marketing & Distribution segment, which included approximately $1 million of consulting costs incurred during the quarter. Importantly, I note that we expect this to be peak spend on the consulting component and we foresee a more rational amount of spend as we move through the second quarter and beyond. Additionally, we incurred higher professional fees, travel expenses, and certain transaction costs. Higher professional fees were primarily related to our change in SEC filer status from an emerging growth company to a large accelerated filer on October 31, 2021. I note that these cost increases will ease in the fiscal second half, as we anniversary the step up and spending associated with those items. Net loss for the first quarter was $13.4 million or $0.19 per diluted share, compared to net income of $2.2 million or $0.03 per diluted share for the same period last year. Adjusted net loss was $12.2 million or $0.17 per diluted share, compared to adjusted net income of $7.9 million or $0.11 per diluted share for the same period last year. Adjusted EBITDA was negative $10.4 million for the first quarter of fiscal 2022, compared to a positive $12.5 million for the same period last year, driven primarily by the lower gross margin and higher SG&A costs described previously. In terms of our segments, our Marketing & Distribution segment, net sales increased 25% to $212.3 million for the quarter and segment adjusted EBITDA was negative $7.7 million. The drivers for the Marketing & 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 quarters and contribute to adjusted EBITDA in a significant fashion. For the first quarter, International Farming segment net sales increased 19% to $4.3 million. Segment sales growth was driven by higher third-party service revenues. Segment adjusted EBITDA was negative $2.7 million, primarily due to higher costs associated with strategic initiatives and farming maintenance and operations that are intended to drive yield enhancements. Shifting to our financial position, cash and cash equivalents were $25.3 million as of January 31, 2022, compared to $84.5 million as of October 31, 2021. Net cash used in operating activities was $41.4 million for the first quarter of fiscal 2022, compared to $9.7 million in the same period last year. The 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 and different source regions. In addition, the company is building its growing crops inventory in its International Farm segment during the first half of the year for ultimate harvest and sale that will occur during the second half of the fiscal year. The $31.7 million change reflects the net loss in the first quarter and an unfavorable net change in working capital. Within working capital, unfavorable changes in inventory and accounts receivable were partially offset by favorable changes in grower payables. Changes in inventory were driven by higher per unit cost of Mexican fruit on hand and the buildup of growing crop inventory in Peru compared to the prior year. The growing crop increases were due to higher per acre farming costs and higher productive acreage. Changes in accounts receivable and grower payables were correlated with the pricing factors noted previously. Additionally, increases in accounts receivable were due to delayed customer payments related to automated invoicing challenges in our new ERP system. While we are still working through these accounts receivable challenges, we have seen a noticeable reduction in our day sales outstanding during February and early March. Capital expenditures were $20.9 million for the first quarter of fiscal 2022, compared to $22.4 million in the same period last year. Current year expenditures were concentrated in the purchase of farmland in Peru, as well as land improvements and orchard development in Peru and Guatemala. In terms of our near-term outlook, similar to prior practice, we are providing some context around our expectations for industry conditions to help inform your modeling assumptions, but are not providing formal guidance due to the fluidity of the market at this point in the year. We are expecting Mexico industry volumes to remain lower than the prior year during our second quarter by amounts comparable to those experienced in the first quarter, as we move through the remainder of the current year crop. Further, our current expectations are for pricing to be steady to slightly higher on a sequential basis compared to fiscal first quarter, which would imply a year-over-year increase of approximately 10% to 15%, compared to the $1.42 per pound average we experienced in the second quarter of the prior year. From a profitability perspective, absent ERP challenges that we described today, which we feel we have a handle on, we are battling the same inflationary pressures that have been well documented. These include freight, labor, and packaging among others, and we’re driving mitigating actions to help contain them. However, we’re also absorbing other costs as well, including higher public company costs and our Laredo facility, which in a lower volume environment create a headwind to our ability to drive per unit margins and adjusted EBITDA. During the month of February, our avocado volumes sold totaled approximately 42 million pounds. These figures were nominally impacted by the USDA shutdown of Mexican avocado imports during the middle of the month. As Steve mentioned earlier, our February per box margins have returned to historical levels. So the higher costs noted above will continue to pose some headwinds over the near term.

Thank you very much. We have a first question from Ben Bienvenu with Stephens. Please go ahead.

Hey. Thank you. Good afternoon.

Hi, Ben.

So I want to ask, as it relates to the ERP challenges that you faced. When you think about the go-forward from here, you described it as you’ve got your arms around it, maybe there are still some lingering issues. There are advisory consulting costs that you’re paying? Is there any way to quantify what sort of lingering impact we should see, either as a result of expenses you’re paying to fix the issue or lingering issues associated with the ERP system that we should see in the subsequent quarter? And then should we expect it to extend beyond this? That’d be helpful. It’s my first question.

Sure. Thanks, Ben. I think that the issues that caused us to lose gross margin have substantially been resolved at this point. I think that there are things that we still need to do to improve efficiency and how the system is being used, but we’ve got our arms around the day-to-day problems that caused the losses we had before, and I don’t anticipate that we’ll continue to see erosion of gross margin as a result of the inability to make quick decisions with information that’s at hand. I do think we will continue to incur some costs, or we will certainly continue to incur some costs with outside consultants to get us through. We made reference in the call that we incurred about a million dollars during Q1. That number will taper off in Q2. It will be less than that and then should continue to taper down thereafter. We are beginning to scale back the level of support effort that we’re getting from that group at this point as we’re transitioning more of that work to in-house resources and getting many of those issues resolved.

My second question is about your comment on February per box margins returning to historical averages. Is that influenced by the current market conditions? Do you expect margins to stay within that range? Regarding your comments about February, was the suspension of imports from Mexico a positive factor that could support those margins, suggesting that the actual underlying metrics might be somewhat weaker, or is that not accurate? How should we consider our progress towards equilibrium in relation to the market you are currently navigating?

Ben, towards the end of the month, we saw a slight increase due to the higher price environment. While it wasn't significant, it certainly contributed positively. When we refer to returning to a range, we mean that for February, we likely exceeded our historical ranges slightly. Looking ahead to March and April, it's uncertain whether the margins will remain at that elevated level. However, we are confident that they will stay relatively close to our historical range. The bigger challenge moving forward will be volume. Until we get through the current Mexico crop, which has been lower in Q1 and will continue to impact Q2, we'll face volume issues and the related cost absorption problems. The investments we've made in capacity within our network over the past year, especially for Mexican fruit, combined with the first year experiencing volume declines for fruit entering the U.S. market, have created challenges. Nonetheless, we believe this will not affect the long-term importance of Laredo for our business. We just need to navigate this unusual decline in volumes during the current harvest season, a situation we haven't encountered to this extent during my time at Mission.

Okay. Understood. Thank you.

But there are…

Yeah. Go ahead, Steve.

I want to mention that these are alternate bearings, which tend to follow cycles. Take Mexico as an example; a year ago, the supply decreased slightly, leading to increased prices, and that trend has persisted. However, as we approach the latter half of 2022, we expect a reversal because this year's late crop is larger compared to last year's. Consequently, we anticipate a shift in the market in the coming months.

Yeah. I would agree with Steve there. I think some of the things in the past, some of that’s been buffered by the fact that there’s been a lot of new acreage coming online. I think that’s muted the impact of some of that off berry nature. So, but, yeah, they typically do have that feature to that similar to what you see in California.

Okay. Thanks very much.

Thank you.

Thank you. We have the next question from Tom Palmer with JPMorgan. Please go ahead.

Hey, Steve and Bryan. Thanks for the question.

Yeah. Sure. Thank you.

I guess just to start off, maybe talking about the sourcing environment. What point do you start to move past the current Mexico crop? Is it not really until the third quarter? Is there flexibility to maybe push that up a little bit and sourcing maybe an early harvest from other areas? Just trying to get a picture of maybe how long does this supply overhang might last?

Yeah. Well, we’re looking at now is the Peru crop more than we are Mexico. Mexico is pretty well set based on their schedule, but we’ve got a pretty good amount of hectares up in the North of Peru that could start coming off around the 1st of April. I’m not sure exactly what week it is, because we haven’t started testing yet. But there’s that possibility that would help complement the supply base here a little earlier than just waiting on Mexico at this time.

I think it will probably be Q3 before we see a substantial impact.

Yeah.

I think in Q2, we’re looking at areas like California. We do believe that there’ll be an earlier harvest. We will look for opportunities to accelerate Peru and look for other countries of origin. But when we in the big scheme of things, the magnitude of Mexico just overwhelms it. So, I think we’ll see increases in these other markets during Q2, but a 10% decline in Mexico will wipe out a 30% or 40% increase in some of these other areas.

Yeah.

Yeah. Understood. Thanks for that. And then I just want to confirm, you have really talked on the supply side about volume headwinds. What are you seeing on the demand side? It seems like that wasn’t mentioned as much in the prepared remarks. But you mentioned internationally some price sensitivity, but is domestic demand making up for that, it sounds like you have seen pricing rising here in recent months?

Well, let’s just take the U.S. here for a minute. Mexico, after the stoppage there for a week and even beforehand was shipping between 50 million pounds a week and 55 million pounds a week into the U.S., plus with California was picking, which I don’t know the exact number there, but it was probably 5 million or 7 million at very high prices. I mean, prices today are around $60 or better. So, I mean, it’s showing that there’s increased demand for product with numbers of that magnitude on volume to still have a high price level at $60 compared to, I’m not sure what we were about a year ago, but it’s probably in the $30s. So we are seeing growth in this space in the category. But just trying to even it out with a supplier is the trick and that’s why we continue to invest in vertical integration around the world to help have options when certain crops are down or up in certain spots.

Definitely areas like Colombia and Guatemala would have filled in the calendar at this time of the year. That’s their harvest window. So I think the investments we’re making there not only will support International markets but, over time, should be able to support the U.S. market as well. But I did want to make a quick comment on the International. I think what tends to happen is that the U.S. market is more inelastic, the demand is more inelastic. They’ll continue to pay higher pricing here. So a larger proportion of the Mexico crop just ends up coming into the U.S. market and it leaves less fruit available to go into those International markets. That probably has a greater impact on a company like Mission that has a global reach and has a bigger international or export program with Mexico product than it does with some of the other marketers that maybe are focused solely on the U.S. So I think what we’re trying to say is that programs we had prior to say South America or to Asia were cut back dramatically because of where the price points you’re at and that fruit ended up coming to the U.S. market instead.

Okay. Understood. Thank you for all that detail guys.

Thank you. We have the next question from the line of Ben Bienvenu with Stephens. Please go ahead.

Hey, guys. Just a follow-up question for me. You alluded to in your press release some customer wins and the addition that might contribute to volume as we move forward. Can you put any magnitude or quantification around what sort of contribution that looks like the duration of it if it is bound by a term? And then, if you can talk about either who it is or which end markets they come from? That’d be helpful. Thank you.

Like, I don’t want to tell you the name, but they’re major retailers that we have been doing business with before, but we’ve just picked up at a distribution center actually. It’s started during that shutdown in Mexico. I mean, we’ve been working on them to add to our list and we picked those up because we actually had product and were able to ripen and distribute to it. The good thing about this to these three distribution centers we picked up again are major retailers and they want to prove program on top of that. So it was a double win for us. They are on the East Coast.

Thank you. And ladies and gentlemen, at this time, I am showing no further questions. I’d like to end the question-and-answer session and turn the call back over to management for closing remarks. Over to you gentlemen.

Well, thanks everyone for your interest in Mission. Obviously, we had a challenging quarter, but we’ll get this thing turned around and be back in the game soon. Thank you for your interest. Thank you for your time.

Thank you very much, ladies and gentlemen. That concludes today’s conference call. We thank you for attending. You may now disconnect your lines.