Calavo Growers Inc Q4 FY2021 Earnings Call

Good afternoon and welcome to the Fourth Quarter and Fiscal Year 2021 Calavo Growers Earnings Conference Call and Webcast. I will now turn the conference over to your host, Julie Kegley, Investor Relations for Calavo. Thank you. You may begin.

Good afternoon and thank you for joining us today to discuss Calavo Growers fourth quarter and fiscal year 2021 financial results. This afternoon, we issued our earnings release and it is available in the Investor Relations Section of our website at ir.calavo.com. With me on today’s call are Steve Hollister, Interim Chief Executive Officer of Calavo and Mariela Matute, Chief Financial Officer. We will begin with their prepared remarks and then open up the call for your questions. Before we begin, I would like to remind you that today's comments will include forward-looking statements under the Federal Securities Laws. Forward-looking statements are identified by words, such as will, be, intent, believe, expect, anticipate or other comparable words and phrases. Statements that are not historical facts, such as statements about expected improvements in revenue and operating profit are also forward-looking statements. Our actual results may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause the material difference in our results compared to these forward-looking statements are contained in our SEC filings, including our reports on Form 10-K and 10-Q. With that, I'll now turn the call over to Steve Hollister.

Thank you, Julie, and good afternoon, everyone. We appreciate you joining us today. 2021 was a difficult and challenging year, but we finished the year strong and were off to a good start in fiscal 2022. As we entered the fourth quarter, market conditions that we experienced in the third quarter continued. Labor shortages, suboptimal raw materials at higher prices and high freight costs weighed on the business. Throughout the quarter, as we predicted, market conditions improved along with our ability to manage them. We saw sequential improvement from August through October and we continue to see this improvement as we sit today about halfway through Q1. Despite the difficult year, we remain committed to paying a dividend. We announced the $1.15 per share annual dividend, consistent with last year and continued the tradition of paying a dividend every year since the company became public in 2002. Now, I'd like to spend some time discussing the overall trends affecting each of our business segments. Trends for our core avocado business were favorable. U.S avocado demand continues to grow with per capita consumption exceeding 9 pounds per person, which is double the consumption rate from 10 years ago. We believe that healthy eating trends will continue in the U.S and that avocados with their favorable nutrition profile will continue to be popular among health-conscious consumers. We also believe that year-round availability of imported avocados and changing U.S demographics will favor increased demand. As an example, approximately 19% of the U.S population is Hispanic, and that population count is expected to double by 2050. With avocados being a staple among Hispanic consumers, overall avocado consumption is expected to continue trending upward, which would naturally benefit our Fresh and Food segments. Value-added fruits and vegetables have also continued to grow faster than their broader produce categories. We continue to see improved demand for our products that are popular with health-conscious and time-constrained consumers who place a premium on convenience foods like those produced in our RFG segment. In addition, our guacamole and salsa products, while being affected by the pandemic in the foodservice channel, have strong long-term prospects as well. Due to some recent news, a couple of weeks ago, the state of Michoacan, Mexico was verbally approved to ship fresh avocados into the United States beginning around the middle of next year. And as many of you know, Calavo has a state-of-the-art packing facility in Jalisco. From what we understand, individual growers and packing sheds will have to be recertified before shipments are allowed, and we believe only certain Mexican states that currently have the facilities that comply with certification requirements. While we have international customers for the avocados packed from Jalisco, opening up to the U.S will give us more flexibility to manage the changing market dynamics by better balancing supply with demand, which should translate into higher margin opportunities. I would now like to provide an update on Project Uno, which picked up speed in the fourth quarter. To date, key actions have included realizing price increases across our RFG and foods customer base; continued unification of our supply chain across our three divisions to drive synergies from operating as one company; eliminating approximately 5% of less profitable SKUs and consolidating RFG's food processing operations in Florida into our Georgia facility, which will improve capacity utilization. We're optimistic about our Project Uno initiatives as we are beginning to see improvements in systems with automation and sourcing. We expect the total annualized EBITDA increase of $70 million compared to the current run rate, which we expect to be fully realized by early to mid-fiscal 2023. As I said on our last call, the total one-time cost of the program is expected to be approximately $30 million, which includes professional fees, restructuring costs, and capital investments. On the corporate governance front, we confirmed our plans to reduce the size of our Board over time, from 11 to 9 Directors from a higher 13, which is more in line with a company of our size. We recently welcomed Adriana Mendizabal to our Board as an Independent Director, and Scott Van Der Kar has decided to retire from the Board effective January 3, after 27 years of service. I know many of you listening today are interested in our search for a new CEO. The process is nearly complete, as we are in the final rounds of interviews with several strong candidates, all with impressive skills and experience. I'm honored to serve as interim CEO as long as I’m needed, but I believe we will have a new leader in place in the very near future. And finally, I would like to welcome two new members to Calavo's Executive Leadership team. Graciela Montgomery, our first Chief Human Resources Officer, and Mariela Matute, our new Chief Financial Officer. Graciela brings 30 years of HR experience to the table and she will play a key role in our next major phase of growth. Mariela Matute has an impressive background of financial expertise and agricultural and food industry experience that uniquely qualifies her for the role of Calavo's CFO. Mariela is already making changes and has embraced Project Uno by streamlining processes and procedures within the finance group. She is focused on improving our methods of planning, forecasting and measuring results to enable the long-term growth of Calavo. We're very happy she joined our team, and we're glad to have her with us on the call today. With that, I'll now turn the call over to Mariela.

Thank you, Steve, and good afternoon, everyone. It has been a pleasure working with Steve and the rest of Calavo's management team in the two months since I came aboard. While the company has made progress in its efforts to counter the market disruptions caused by COVID, there is more work to do. And I'm excited to lead the finance team in those efforts. I also look forward to connecting with all of you, our investors and analysts in the coming quarters as we communicate our progress towards improved profitability and return on investment. Following our press release, let me provide you with further insight. I will start with revenue. On a consolidated basis, fourth quarter revenue increased by 17% year-over-year. The increase was mainly driven by a 26% increase in the Fresh segment where we achieved a 37% increase in average selling price for avocados. This was offset by a 7% decline in volume. The higher pricing was due to a better market environment. The lower volume was due to suboptimal sizes early in the quarter, which affected our product mix. Revenue was up 7% at RFG, driven by a 2% higher volume and a 5% increase in average selling price due to both a favorable product mix and price increases. Our food segments delivered a 6% increase in sales in the quarter, mostly due to higher volume from foodservice customers in addition to price increases and a shift in certain product lines. With respect to our Project Uno pricing initiatives, as Steve mentioned, we have been successful in implementing price increases across our customer base in both RFG and Foods, which contributed to most of the benefits we recognized in the fourth quarter. We expect to see an additional revenue lift in the first quarter of 2022 from these pricing initiatives. Now turning to gross margin. Our year-over-year decline in gross profits and margins was mainly due to the same factors that affected our third-quarter results. In Fresh, it was driven by lower volume and lower per carton margins. Margins fluctuated, as we were selling fewer and smaller avocados from the end of Mexican summer crops. By the time Mexico's regular crop was in full swing and producing larger fruit, we experienced margins at the high end of our historical averages. This dynamic continued into November and December, which give us confidence that we will see improved results in our Fresh segment for the first quarter of 2022. At RFG, gross profit was down nearly $8 million year-over-year, due to market-wide pressures of higher labor, materials, and freight costs. We are starting to see positive traction from our Project Uno initiative, including price increases, SKU rationalization, and facility consolidation. This has begun to show in our results as we delivered a $5.4 million sequential improvement in gross profit compared to the third quarter. In the Food segment, margins were pressured as well, mainly due to higher year-over-year avocado and labor costs. Turning to SG&A, which was basically in line with our expectations for the quarter. After adjusting for approximately $1.7 million of restructuring expenses, which are aligned in the adjusted EBITDA reconciliation in our press release. During the quarter, we also recorded $9.7 million in charges related to asset impairment and other anticipated restructuring costs with respect to the RFG Florida facility closure as part of Project Uno. The cash component of this charge is approximately $350,000. As a result of these actions, combined with moving production to other locations, we anticipate an unrealized profit improvement of approximately $4 million to $6 million. With respect to Project Uno, we realized approximately $2 million of profit improvements in the fourth quarter from our efforts. We expect to see gradual and increasing improvement in each quarter of the current fiscal year and we will update you on a quarterly basis as we make progress. Now turning to our financial position. We ended the quarter with $141 million of cash, liquid investments, and available debt capacity. We continue to have a strong financial position and low leverage, which allows us to invest in our current infrastructure to drive future growth and improved profitability. Despite the challenging circumstances, we generated cash from operations of $13.6 million for the year, doing a good job of managing our working capital. In December, we amended our credit facility to reflect our lower adjusted EBITDA and the gradual return to historical levels of profitability. As part of the amendments, we received temporary relief in our financial covenants. In consideration for these amended terms, we agreed to a 50 basis point increase in our interest rate and pledge our Limoneira shares as collateral. As of today's date and based on the amended facility, our current liquidity is temporarily reduced by approximately $25 million, given the pledging of our Limoneira shares. Now turning to our outlook. As Steve said, the long-term outlook of our business remains favorable. With the current market conditions, it is difficult to predict when industry-wide inflationary pressures on materials, freight, and labor will ease. We believe that our operational initiatives undergoing price increases will offset these pressures. We are optimistic about the early returns that we're seeing from Project Uno and are confident that we will generate improved quarterly results on a sequential basis as we move into fiscal year 2022. With that, I will return the call to the operator for questions. Thank you.

Our first question is from Benjamin Bienvenu with Stephens. Please proceed with your question.

Hey, good afternoon, everybody and Mariela thanks for the color. Nice to meet you via the phone. I want to ask on following up on that commentary around gradual improvements sequentially as we move through fiscal 2022, recognizing that you do have reduced visibility at the moment. Is there any incremental disclosure or color that you could offer around how we should think about the progression as we move through fiscal '22? And then also, what are the major milestones in either Project Uno or otherwise in achieving improved profitability as we move through the fiscal year?

Hi, Ben, thank you and nice to meet you over the phone. With Project Uno to deliver proportional benefits every quarter sequentially as we roll out our pricing initiatives, our SKU rationalization program and our asset optimization. While we expect to come from low as the investments that we have to make to roll out Project Uno and realize the benefits. So I will model Project Uno benefits as a sequential improvement on a prorated basis with investment at the beginning of the program.

Hello.

Ben, do you have any more questions?

Oh, I'm sorry. Can you hear me?

Yes, we can hear you.

We can now.

Okay, perfect. Steve, you made some comments around the favorable development associated with Jalisco?

Right.

Can you give us some sense of the size of that facility? And if you are able to start to ship by the middle of next year, give us a sense of the timeline or the timeframe for ramping that facility to what you would expect to be targeted capacity utilization? Maybe just kind of unfold for us how you would expect that to mature.

Sure. Well, as it stands right now, Jalisco is going to be approved as of April next year for shipments into the United States. And as anybody who has done business down in Jalisco knows their crop matures at a different time of year than the Michoacan crop does. And in fact, April would be about the perfect time to start it up because that's when their crop is going to start hitting full stride. Now majority of the process that’s done there, and it's a large facility, but it's probably half the size of our facility in Michoacan. But that facility will still primarily handle fruit going out of the country to the far East and to Europe. And so, all it's going to do is allow us to have another avenue to come into the United States to help with maybe some irregularities in sourcing and pricing. And so we're looking at it just a total win-win for us, being able to utilize that we have growers down there that are very excited about this happening. So it's a big positive.

Okay, great. And just as a quick follow-up to that. Should we be thinking of this, even if we can't put hard numbers around it? Should we be thinking about it more as a margin opportunity for you all or a volume opportunity for you all?

Yes, that's a good question, Ben. I would probably say both. It's going to allow us to certainly move a lot more product out of there. But the production in Jalisco is probably akin to what you would find in the United States. So it's not a volume that you would get out of Michoacan. So it will just be another avenue for us to fulfill the needs of the United States as far as shipping into the United States, but it's definitely a great step in the right direction to have another state in Mexico open up for shipments in the U.S. From our standpoint, being able to have two sources of product and if not three or four during that time of year is just going to benefit the consumer and is going to benefit us by providing a stable supply of avocados, and we work on margin anyway. We don't take positions in fruit. So, it's a positive for our organization definitely.

Okay, great. Thanks so much. Best of luck.

Thanks, Ben.

Our next question is from Mitch Pinheiro with Sturdivant. Please proceed with your question. Mitch, your line is now open. Mitch, are you there?

Can you hear me now?

Yes.

Yes, we can hear you. Go ahead with your question.

Yes, sorry about that. Regarding avocados, pricing is up and there are still some challenges, but you mentioned seeing improvement. Can you clarify if the improvement is in the mix or the grades? Where is that improvement coming from?

Right now, we are primarily focused on avocados, but the U.S. market hasn't fully launched yet; that will begin next month. Currently, we are still sourcing from Michoacan. The positive aspect is that we are well into the new crop, unlike the last earnings call when we were just starting. Prices have risen mainly because there is uncertainty regarding the size of the crop in Mexico, which tends to vary significantly between predictions and actual outcomes, influenced by numerous factors. Initially, we were seeing more small fruit earlier in the season, but as we moved into different picking areas, the fruit has matured, and we are now getting larger sizes that are more appealing. However, we haven't established a consistent picking schedule with the Mexican growers. Daily variances can be quite significant, leading to continued upward pressure on prices. We anticipate that this will improve soon as picking increases. Additionally, the upcoming Super Bowl is always a key event for the fresh avocado market.

So with the largest supply, you're anticipating that pricing may pull back a bit, but do you have decent visibility on your gross margins?

Oh, absolutely. And in fact, with prices are higher, again, we work on percentage margins. I guess theoretically, we should be making more money at higher prices. But we like to move a lot of volume. Now that lowers our packing costs and everything else too. So there's always going to be a sweet spot near that you try to hit. But I expect though as we start really getting the volume ramping up and seeing some of the other production areas around the world come in, that the added increase in volume is going to benefit at least as much as the increase in prices that we're seeing right now.

I know the projections vary, but California should see stronger year-over-year performance, which will help with volume. Is Mexico expected to have a better crop for the full year as well?

That's been actually debated quite a bit recently, whether it's going to be higher or lower or the same. So it's going to be one of those. I tend to believe it's probably going to be closer to what we've seen in the last year or two.

And what's the issue there? Is it agronomic? Is it a grower packer tug of war? What's happening? Why wouldn't Mexico be showing a little more growth than it is in volume?

I am planning to visit Mexico soon to explore the situation and meet with some growers. Currently, it seems that the factors at play are primarily agronomic. The groves in the Michoacan region are providing benefits for our plants at elevations ranging from about 5,000 to 7,500 feet. This high altitude creates significant variations in weather and microclimates. Additionally, many of these areas are naturally irrigated, which leads to fluctuations in production capacity. It's uncertain how much of this will be available for the domestic market there. Regarding Michoacan, I know that many plantings are expected to come into production soon and should start ramping up. However, other regions around the world are also increasing their production capacity.

Moving on to RFG, you've closed Jacksonville, which has increased your facility utilization. We should start to see that impact gross margin right away, or am I missing something?

No, you're correct. I don't want to take up all the time. Mariela, would you like to comment on that?

Sure. Hi, Mitch. Yes, so the savings expected from the closure are between $4 million and $6 million annualized. And you're correct, as we move the production to our Georgia facility, we will see those benefits as we serve those customers.

What are your customers saying right now? A year and a half ago, everyone was switching to pre-packaged items, and with the pandemic easing, it seems like there's been a shift back to open containers and self-serve options. Where do we stand on that? Will it be a mix? Do you benefit one way or another based on how products are delivered? Can you share some insights from a product perspective?

Mitch, yes, if I can take this one. We continue to see fruits and vegetables in these pre-packaged forms grow faster than the broader produce categories and we will capitalize on that improved demand. So over the long term, I see these as megatrends that will benefit us.

Sorry about that, I have a dog here. So regarding packaged sandwiches and wraps and similar products, is that still a growth area for you? Are we observing some SKU rationalization in these categories?

I'll take care of that, Mariela. Mitch, what we do is, all of our plants are equipped to handle a variety of different products that our retail partners would want, from just cut veggies and fruits to prepare for fruits and vegetables and meals and things like that. So the consumers have made it known that they like the convenience foods; they just like healthy options when it comes to that. And so I don't think we're ever going to go backwards in that regard. In fact, we plan for that in some of our strategy. We see it with our competitors out there as well and our retail partners are asking us for more and more solutions. So we're hoping it comes down to a margin thing. So we're all trying to deal with the increased costs that we're having to address on a regular basis. We know our competitors are as well. So it's something that everybody is trying to get their hands on at this point in time to figure out exactly where we're all going to make money in this regard. The SKU rationalization had to do with a number of items that maybe we weren't selling very much of and you take a look at the contribution margins, a number of different things. But it's really been a very good cooperative relationship with our retail partners and ourselves as to coming to profitability things that work for them and also work for us.

And just one more is just on the Calavo Foods business. When should we expect to see that margin normalize? You typically have been pushing a 30% gross margin in that business. And I know for a variety of factors, the last couple of quarters it's been below that. But is this something where we just need to see food costs come down?

Well, let me take a swing at that one. Obviously, food costs is one of our two major components that and labor down in Mexico and the ability to get fruit in there. Again, that kind of stretches back to what I was talking about with fresh avocados as well, is being able to get a real steady supply of fruit in there. We can deal with pricing fluctuations and the cost of the fruit. But when it's constantly changing and without having the ability to in real time to go to your retail partners and change the pricing that you need, it's taken us a little while to adapt to this realization. But what we're seeing right now, we're approaching where we were historically. And we're looking forward to getting back to that on a regular basis.

Yes, if I can add, it's moving in the right direction.

Thank you. Our next question is from Ben Klieve with Lake Street Capital Markets. Please proceed with your question.

Thanks for taking my questions. I have a couple. First, could you elaborate on the Jalisco opportunity and whether that facility is currently operating at or near capacity? Additionally, does this news impact your capital expenditure outlook for that segment, specifically regarding any potential to increase utilization or capacity at that plant?

Let me discuss the plant's utilization, and then Mariela will cover the CapEx aspect. We have partnered with the growers for several years, and the plant has not been running close to its capacity. There are many more opportunities to add value-added products to our offerings, especially as we expand internationally, which this facility is well-suited for. In the U.S., we can begin to increase operations and use it as an additional outlet. The potential for growth in this area is significant, certainly more than what we have previously capitalized on.

And for the capital investments question, we have a plan to invest up to the levels we have invested in the last year. Most of the investments are planned for increasing automation across our facilities both in Mexico and the U.S.

Got it. Got it. Perfect. And the only other question for me on kind of high level here, with all these various initiatives that you're undertaking, what are you and the Board comfortable doing currently versus maybe waiting until you have a permanent CEO in place? Is there anything that you guys are holding back on from a restructuring perspective here until you have a full CEO in place? Or is it kind of full steam ahead and whoever you bring in will just inherit whatever has been done?

Well, let me take an answer at that one. When I came in and sat on the desk, my goal was to further the Project Uno things that are already begun. And to keep things moving forward, I just didn't want to be a warm body in the chair. So we've been at full speed ahead, trying to make all the improvements necessary to increase our profitability, reduce our expenses, all the things that a good business would do on a regular basis. My goal was to have those initiatives all in place up and running, so that when we have a new CEO come in, which I think will be very soon, that he would be able to just take the reins, and take it and put his stamp on it moving forward. So all the things that we've talked about are already underway.

Ben, if I could add to Steve's comment that we do have in the ground more than 40 initiatives resulted from our Project Uno, and we're not waiting. So one of my primary priorities is to execute on Project Uno and they are all profit improvements initiative that will make RFG and the entire network stronger for what's coming.

Got it. That’s good to hear from both of you. Very good. That does it for me. I'll jump back in queue. Best of luck here in the new year.

Great. Thanks a lot.

Our next question is from Eric Larson with Seaport Research Partners. Please proceed with your question.

Thank you, everyone, for the question. Mariela, congratulations to you. I'm excited to work with you and wish you the best of success at Calavo. My first question is more strategic. Under your previous CEO, you initiated Project Uno just before COVID began. What's the timing for consolidating three supply chains into one? Was that merely a timing issue, or was it a favorable timing? Can you provide insight into where you'd stand without Project Uno? I realize it's a broad question, but essentially, was starting Project Uno good or poor timing?

Let me address that briefly, and then Mariela can add her thoughts if she wishes. We initiated Project Uno while we were already under a plan to unify everything under the Calavo brand, which included integrating our various business units and streamlining some management and SG&A expenses. When we started Project Uno, I simply suggested that there might be other areas we should examine, and it seemed like an appropriate moment to do so. With the unforeseen impact of COVID and the subsequent supply chain challenges we faced, we needed to adapt. However, we also recognized the potential advantages of engaging with Teneo for a thorough evaluation of our processes and a comprehensive review of our business to identify areas for enhancement. From my perspective, being closely involved in this initiative, it has proven to be a highly valuable project for us. Although it hasn't been the least expensive endeavor, we anticipate that the benefits of their contributions will serve us well for many years ahead. Therefore, I believe the timing was indeed favorable for us, and we continue to view it positively.

So, Steve, when you mention it hasn't been inexpensive, could you clarify whether that refers to capital costs, margins, or growth? Please elaborate on what you meant by inexpensive.

When I said it hasn't been inexpensive. Its cost closing facilities are never easy, and they're never something that you do on haste because it affects people's lives as well as your customers and everybody involved. But sometimes we have to do things like that in order to make a step forward. That's been what we've recognized with the Jacksonville facility is that we were able to move the production there up to our Georgia facility and now that facility is operating at full speed. And what I also meant as far as Costco, when you hire a consulting company to come in, there's costs associated with that. But they're also giving you the ability to focus on things that you would in your normal day-to-day activities, just because you're trying to run a business. And so we've utilized them to help us get a better understanding of all the things that go into our RFG operation as well as some of the other things we do regarding transportation and the like. The cost, as we outlined is projected to be $30 million over two years. A fair amount of that has already been recognized. So closing facilities and looking at our CapEx expenditures. So we're well underway. The results you're seeing are taking into account some of those costs that we had already told you we were going to be bearing.

Is part of your ability to reduce labor costs related to RFG? One of the major components of your business is fresh avocado, where you've demonstrated your capability to manage through both inflationary and deflationary periods. RFG operates a bit differently, as it typically has gross margins significantly lower than your fresh margins, and well below the average in the packaged food industry. With rising labor costs and your ongoing pricing adjustments, are you planning to maintain or improve the average margins of 7%, 8%, or 9% in RFG? Is there a structural issue we should be aware of that hasn’t been discussed?

We take advantage of automation whenever possible and continually assess new equipment that offers a solid return on our invested capital. However, many of our processes, as well as those of our competitors, still require hand-cutting and hand-processing, meaning automation cannot fully address all tasks. Regarding our efforts to manage costs and labor, labor expenses have indeed risen. Since our last earnings call three months ago, our workforce has returned to more normal levels after experiencing significant departures during COVID, and it has stabilized to some extent. In terms of costs, all our retail partners have agreed to the price increases, acknowledging the actual costs involved. Our responsibility is to ensure we manage their funds wisely as well as our own, acting prudently to be the best partner possible.

All right, thank you. I appreciate the comments.

My pleasure.

We have reached the end of the question-and-answer session. And I will now turn the call over to Mr. Steve Hollister for closing remarks.

Thank you. I'd like to thank everybody for attending our conference today. We were pleased to be able to present our quarterly results and fiscal year results and looking forward to visiting with you all again in the new year with the next quarterly earnings call. Thanks again. We'll talk to you soon.

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.