Earnings Call Transcript - AVO Q3 2021

Operator, Operator

Good afternoon, and welcome to the Mission Produce Fiscal Third Quarter 2021 Conference Call. All participants will be in a 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 call over to Jeff Sonnek, Investor Relations at ICR. Sir, please go ahead.

Jeff Sonnek, Investor Relations

Thank you. 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 the 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. I would now like to turn the call over to Steve Barnard, CEO.

Steve Barnard, Chief Executive Officer

Thank you for joining us for our fiscal 2021 third quarter earnings call. We are pleased with our fiscal third quarter performance amid intense industry volatility that was brought about by Mexico’s delayed timing on the transitional harvest of the new crop. Our team did an excellent job navigating this complex period and produced per-unit margins within the range of our expectations, though toward the lower end as a result of the Mexican pricing volatility. Mission’s global sourcing and distribution network, along with our owned production in Peru, proved to be a significant advantage to us during the quarter, with nearly 45% of our third quarter U.S. distributed volume being sourced outside of Mexico, which we believe is significantly greater than that of the industry. Our vertical integration was the key in our ability to significantly mitigate the influences of Mexico’s unpredictability, while also positioning us to drive an 18% increase in our distributed volume to our export markets versus the prior year. Our ability to stay nimble and manage disruptions such as the unpredictable Mexican harvest cadence in the third quarter really demonstrates the value of our cohesive, vertically integrated sourcing and distribution network. Moreover, the disruption allowed us the opportunity to demonstrate the value we provide to our customers worldwide with the consistency and quality of our Peruvian program. The consistency that we bring is critical in furthering our customer relationships, and we are taking full advantage of the situation to remind potential customers of the value that we can bring to their operations through a vertically integrated avocado program. We continue to look ahead toward the future, both domestically and abroad, to ensure that we are prepared to meet the growing global demand that’s been driven by powerful consumption trends. And as we’ve shared, our latest facility in Laredo, Texas, is a key element in our design to expand our industry leadership position. We’ve been carefully preparing for the coming seasonal ramp-up in Mexican production that will shift into full swing later this fall and carry through next spring. In advance of this, we’ve made a significant commitment to the Laredo community, both in terms of the trade that we will drive through the region as well as building our team. We’ve hired and trained approximately 70 employees so far to help us support our growing share of the nearly $1 billion avocado import business that crosses through the Port of Laredo annually. Although in the near term, we are carrying these incremental infrastructure costs as we improve our utilization rates, the long-term strategic advantages are very clear to us. This facility will enable us to better serve our customer needs throughout North America, while alleviating seasonal pressure in our other facilities, effectively rebalancing our network while adding new capabilities and capacity. In summary, Mission is in an ideal position. While the third quarter presented some challenges in terms of the pricing volatility, it showcased our diversified network. This network includes vertical integration, global logistics capabilities, and an expansive distribution network and our industry-leading team. We were able to navigate the dynamic environment, drive volumes, meet customer needs and still maintain a healthy margin profile. The growing season is very productive, and we continue to expect solid yields from our own production, which remains on track to produce the planned 95 million to 105 million pounds of fruit that we’ve guided. This puts us in a great position as we make preparations for fiscal 2022. With that, I’ll pass the call over to our CFO, Bryan Giles, for his financial commentary.

Bryan Giles, Chief Financial Officer

Thank you, Steve, and good afternoon to everyone on the call. I’ll start with a brief review of our fiscal third quarter 2021 performance ended July 31, 2021, and touch on some of the drivers within our two operating segments. Then, I’ll provide a snapshot of our strong financial position and conclude with some thoughts around our outlook for the balance of the fiscal year. Total third quarter revenue increased 4% to $246.8 million from $236.4 million in the prior year period. The increase in revenue was driven by a 2% increase in volume and a 2% increase in price. I’ll touch on the price-volume dynamics in a moment, but I would like to reiterate that our business is managed to volume targets, as we leverage our global presence to drive share of fresh avocados to our retail and food service customers. While prices fluctuate given the influences of global supply and demand, pricing is not something Mission can control or forecast with any degree of certainty. In the third quarter, the industry experienced excessive volatility in spot pricing as a result of a sporadic harvest cadence in Mexico, with the regular starts and stops, which exacerbated the usual market dynamics that dictate pricing. As we’ve noted previously, our leadership position as a global value-added marketer and distributor of fresh avocados tends to insulate our gross profits, as these sought-after value-added services such as ripening, bagging and distribution are largely unaffected by price changes. However, excessive pricing volatility can be problematic as we balance the inventory we are buying in the spot market against global customer commitments. As a result, we realized some temporary compression in our per-unit margins, but I’d note that we were still able to achieve levels that were near the bottom end of our targeted range, whereas we were above the targeted range in the prior year period. Third quarter gross profit decreased 7% compared to the same period last year, driving a gross profit margin decline of 210 basis points to 16.6% of revenue. Beyond the impact of lower per-box margins, gross profit was also pressured by incremental infrastructure costs within our Marketing & Distribution segment related to our new Laredo facility, which, as Steve mentioned, is still in the process of ramping up utilization. We estimate this impact to be approximately 50 basis points of headwind to fiscal third quarter gross margin. The negative impacts were partially offset by higher volume of avocados sold from our Company-owned farms within our International Farming segment compared to prior year. These sales generate higher gross margin than the sale from third-party growers due to our lower per-unit cost basis. SG&A for the third quarter increased $3.7 million to $17.2 million due primarily to higher professional fees and higher liability insurance premiums now required as a public company. We estimate that $1.8 million of the cost growth experienced in the fiscal third quarter is attributed to external costs associated with our public company status. The higher professional fees were amplified by the anticipated change in our SEC filer status from an emerging growth company to a large accelerated filer as of October 31, 2021, which has an impact on audit and other related costs. Net income for the third quarter of 2021 was $18.4 million or $0.26 per diluted share compared to $23.4 million or $0.37 per diluted share for the same period last year. Adjusted net income was $19.1 million or $0.27 per diluted share for the third quarter of 2021 compared to $24.4 million or $0.39 per diluted share for the same period last year. Adjusted EBITDA decreased $6.5 million or 18% to $30.1 million for the third quarter of fiscal 2021 compared to $36.6 million for the same period last year. In terms of our segment drivers, our Marketing & Distribution segment net sales increased 4% to $239.6 million for the quarter. The drivers for the Marketing & Distribution segment are similar to those that I described for the consolidated results with slight increases in both volume and price year-over-year. This is due to the fact that virtually all of our third-party revenue is generated within this segment. Segment adjusted EBITDA decreased 38% to $13.1 million due to the lower per-unit contribution margins, the added infrastructure surrounding Laredo and higher corporate expenses associated with being a public company, that I mentioned above. Our International Farming segment primarily represents our own farms that we manage in Peru. Naturally, the dynamics of this business are quite different from those in our Marketing & Distribution segment. While we are more exposed to price in this segment compared to Marketing & Distribution, this is a highly strategic initiative for Mission and its value to our enterprise was very apparent in the third quarter, as we worked to mitigate the impacts of the Mexican volatility and a smaller California crop. Our growing base of global customers requires year-round supply and today’s key growing regions can’t keep up with international demand. As a result, we made a commitment close to a decade ago to establish a presence where we control our own supply that we are able to sell to our customers through our Marketing & Distribution segment operations. As we look forward, in the short run, growth within our International Farming segment will be dictated by yield improvement within our maturing orchards. We expect longer-term growth to be supported by additional producing acreage that will come on line and subsequently mature. As a reminder, the avocado harvest season for Peruvian farms typically runs from April through August of each year. And as a result, you see the International Farming segment emerge in third and fourth quarters and contribute adjusted EBITDA in a significant fashion. For the third quarter, International Farming segment sales increased 22% to $66.1 million, driven by higher fruit volumes resulting from improved harvest yields at our maturing orchards. Segment adjusted EBITDA improved by $1.4 million to $17 million, primarily due to the revenue drivers noted above, partially offset by higher costs associated with strategic initiatives in farming maintenance and operations that are intended to drive yield enhancements. Shifting to our financial position. Cash and cash equivalents were $70.9 million as of July 31, 2021, compared to $124 million as of our prior fiscal year-end on October 31, 2020. Our 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. In addition, we are building our growing crop inventory in the 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. While these increases in working capital can cause operating cash flows to be unfavorable in individual quarters, it is not indicative of operating cash performance that we expect to realize for the full year. Net cash provided by operating activities was $15.2 million for the nine months ended July 31, 2021, compared to $32.9 million in the same period last year. The $17.7 million change was primarily driven by unfavorable net change in working capital and concentrated within inventory. Changes in inventory were driven by a combination of a buildup of growing crop inventory in Peru as well as higher per unit cost of Mexican fruit on hand compared to prior year. The growing crop increases were due primarily to higher per acre farming cost to drive higher production yields. Additionally, contributing to the buildup of crop inventory were timing differences, with a lower percentage of the estimated seasonal crop that was harvested and sold through fiscal third quarter relative to the prior year. As we move through the remainder of the Peruvian season in the fiscal fourth quarter, we expect to see a continued reduction in working capital, which will aid in our ability to drive higher cash from operations. Capital expenditures were $61.3 million for the 9 months ended July 31, 2021, compared to $40.4 million for the same period last year. Capital expenditures for fiscal 2021 have been concentrated in land improvements and orchard development in our Peru and Guatemala farming operations and on completing construction of our distribution facility in Laredo, Texas. With that, I’ll shift to our outlook, which we are updating to reflect the lower-than-anticipated third quarter results, and latest pricing and margin view for our fourth quarter. Full-year fiscal 2021 net sales are now expected in the range of $890 million to $910 million, which is a revision of $10 million compared to prior guidance. This assumes total annual volume in the range of 655 million pounds to 665 million pounds, which is lower than our prior guidance by approximately 15 million pounds, partially due to a smaller size curve on Mexican fruit. Expectations for avocado production from our owned farms remains unchanged in the range of 95 million pounds to 105 million pounds. Full year fiscal 2021 adjusted EBITDA is expected in the range of $88 million to $94 million, but may be influenced by future pricing and margin dynamics. The reduction in adjusted EBITDA from prior guidance is due primarily to the shortfalls we experienced in Q3, combined with continued pressure on per-unit gross margins that are extending into the early part of the fiscal fourth quarter, due to challenging supply conditions in Mexico. That concludes our prepared remarks. Operator, now over to you. Please open the call to Q&A.

Operator, Operator

Thank you. Operator instructions were provided. Our first question is from Bryan Spillane of Bank of America. Please proceed with your question.

Bryan Spillane, Analyst, Bank of America

Hi. Thank you, operator. And good afternoon, guys. So, just a couple of questions. First, on the Mexican crop and supply. By the comments, it sounded like it’s still a pressure early in the quarter, but by saying earlier in the quarter, do you expect that should begin to alleviate as you exit the fourth quarter? I’m trying to get an understanding of timing-wise: is the worst of this past, or would you expect the supply constraints to continue all the way through and as you’re exiting 4Q? Second, in terms of cost pressures — beyond supply, thinking about things like freight costs, availability of shipping containers, port congestion, the moving of product — which has been a challenge for many companies — can you give a little more color on that dynamic? Is it fully baked into the base, is it getting worse? Just trying to get an understanding of that as well.

Steve Barnard, Chief Executive Officer

Well, Bryan, if we look at history, it goes in cycles and they tend to alternate every other year. Looking back and estimating the future, I would say you’re right: it’s due to change just because we’re coming into a new flowering cycle and they tend to alternate. If it stayed the way it is today, it would be a tough road, but it never does. We believe timing will shift. We’re not certain of the exact pace, but historically these cycles change as new flowering comes in.

Bryan Giles, Chief Financial Officer

Bryan, I’ll elaborate. We're still going through the off-bloom crop at this point. We believe that we’ll start harvesting the regular bloom within the next week or two. So, we’re right at that transition point. Typically, there tends to be a lot of volume that comes into the market at that time, and we’re expecting that will be the case again this year. At that point, the supply dynamics should ease up a bit. Certainly, some of the challenges we saw at the end of Q3 continued through August, but we do expect improvement as we move through the latter half of the quarter. On freight and logistics: the freight situation is still an issue globally, with many containers constrained in various regions. Fortunately for us, starting from Mexico involves a lot less ocean freight compared to shipments out of Peru, which are mostly ocean freight. That eases some pressure on us. Much of the Mexican product is by truck into the U.S. or Canada through our Laredo facility, which should also help. You will see inflationary pressure on materials and labor. Regarding land transportation, we came through the preseason with a heavy slant toward ocean cargo and negotiated terms early on; with our scale, those terms were fairly favorable this year, so we didn’t experience big increases in ocean cargo year-over-year. As we transition to the Mexico season, land transport is significant; volumes are higher than a year ago but the market seems relatively stable over the last two to three months. Labor is another factor. With the majority of our labor in Mexico and Peru, we don’t have the same U.S. dynamics, but there have been wage increases in Peru this year that have increased costs in our farming operations. We’ve managed those changes and haven't seen them impact our ability to deliver product to customers so far.

Operator, Operator

Our next question is from Tom Palmer of JP Morgan. Please state your question.

Tom Palmer, Analyst, JP Morgan

Hey. Good afternoon. Thanks for the questions. I wanted to ask first on realized pricing. It seems like you exited last quarter and the update you gave for May was that pricing had really strengthened. It seems like for the quarter, pricing was a bit more stagnant relative to last quarter, despite calling out some supply constraints that I thought would have shown better flow-through plus the cost environment you’re facing. So, what limited that pricing, and as we look at the fourth quarter, how are you thinking about that?

Steve Barnard, Chief Executive Officer

It goes back to supply. Consumption continues to grow in this category globally — high single digits to low double digits — not just in the U.S. but in the EU as well. Avocados are alternate bearing. In Mexico there are three to four different flowering cycles you deal with, and they sometimes overlap when there is abundance and sometimes they are delayed like the situation we’re in now. When you understand this category perfectly, you’re at real risk; you have to plan with your head up and be vertically integrated like we are, having other sourcing options beyond Mexico or California. We aren't quite where we want to be on the supply timing, but we have operations in Guatemala, Colombia, and South Africa coming online. We’re working to mitigate the issue and reduce risk.

Bryan Giles, Chief Financial Officer

Tom, I’ll give more detail on the numbers. In Q2 our average per pound price for the quarter was $1.42; that period was building up to a peak at the end of the quarter. In Q1 we averaged $1.04 per pound. Leading into Q3, pricing in May remained fairly close to those strong levels but came down in June and July, resulting in a Q3 average of about $1.43 per pound for the quarter as a whole. The size curve from Mexico matters: smaller fruit tends to sell for a lower per pound price than larger fruit, and we saw a shift toward smaller fruit during the quarter, which caps pricing. For Q4, our internal model sees pricing for the quarter remaining relatively stable with Q3, probably around $1.40 to $1.42 per pound. We came into August with pricing a bit higher than where we were at the end of July; it feels like we’ll peak in September, and then the expectation is that when the new crop meaningfully impacts the market in October, prices will start to come back down.

Tom Palmer, Analyst, JP Morgan

Great. Thank you for all that detail. To follow up, on the Peru harvest: any split on how we should think about volumes in the third quarter relative to the fourth quarter?

Bryan Giles, Chief Financial Officer

We’re still holding to the annual production guidance. We are expecting a heavier portion of the Peruvian fruit to be recognized in the fourth quarter this year, on a percentage basis heavier than in prior periods. Somewhere in the neighborhood of 60% plus of the Peruvian fruit will be sold through during Q4 this year.

Operator, Operator

Our next question is from Ben Bienvenu of Stephens. Please state your question.

Ben Bienvenu, Analyst, Stephens

Hey. Thanks. Good afternoon. I want to follow up on the comments regarding the Laredo facility. I think you said it was about a 50 basis-point headwind to margins in the quarter. Can you talk about the duration of that headwind and the ramp to maturity? Should we be thinking of that as a net positive to margins in the next fiscal year, or will it take longer than that? Give us some sense of the ramp of that facility. Also, I have a question on SG&A expense. The SG&A was up a lot year-over-year. I know there are strange comparisons because of the IPO. Could you help us think about what a baseline SG&A is and what a reasonable rate of growth is going forward, so we can calibrate margins appropriately?

Steve Barnard, Chief Executive Officer

It’s volume-based. We aren’t anywhere close to the volume we will see in, say, January going through Laredo, and it will continue to increase, probably in the next couple of weeks and peak in January and then remain substantial until it starts slowing in late spring. That whole dynamic is driven by volume. Right now volume isn’t where it will be, but it’s out there — it’s just delayed in the harvest timing this year based on different flowering.

Bryan Giles, Chief Financial Officer

Ben, during Q3 we knew volumes running through Laredo would be lower because Q3 is traditionally our low point for imports from Mexico, although Mexico still makes up more than 50% of product sold into the U.S. even in that period. The lower Q3 volumes gave us a chance to work out operational kinks when things weren’t as stressful. As we move into higher-volume times of year, the facility should have less of an impact on margin. That said, during Q3 we introduced substantial new capacity in Laredo while North American volumes were relatively flat year-over-year. To truly get the throughput needed from that facility, we’ll need to continue to see growth over time. This investment positions Mission for the future; it was not intended to maximize short-term profits, but we believe it will keep us in the driver’s seat long term. On SG&A: in Q3 we saw a $3.7 million increase in SG&A, of which more than 50% we believe is attributed to public company costs. It’s difficult to estimate exactly how much of that will persist, but I would estimate that of the $1.8 million of public company-related costs, at least about $1.0 million is an ongoing baseline expense that will not go away. The remaining approximately $800,000 is likely to come down over a multiyear period as one-time or ramp-up costs for SOX and internal audit programs and initial D&O insurance charges come down. Beyond public company costs, SG&A includes selling and growth investments that will likely grow at a rate somewhat above inflation as we invest in long-term strategic initiatives, such as adding resources for international expansion, new product lines, or other growth activities. So, SG&A is not expected to be completely static; it will include some ongoing elevated costs plus targeted investments in the business.

Ben Bienvenu, Analyst, Stephens

Yes. Okay, makes perfect sense.

Operator, Operator

At this time, I’m showing no further questions. I’d like to end the question-and-answer session and turn the conference call back over to management for any closing remarks.

Steve Barnard, Chief Executive Officer

We see a great opportunity ahead, as we always do. Consumption of avocados continues to grow globally. We continue to invest in our business and the industry — not only on the sourcing side but also to diversify so we’re not subject to supply issues. Overall consumption around the world presents a huge opportunity, and we plan on being a major player globally. So, stay tuned.

Operator, Operator

Ladies and gentlemen, that concludes today’s conference call. We do thank you for attending. You may now disconnect your lines.