Good afternoon, and welcome to the Second Quarter 2022 Calavo Growers Earnings Conference Call and Webcast. All participants will be in listen-only mode. I will now turn the conference over to your host Julie Kegley, Investor Relations for Calavo. You may begin.

Good afternoon, and thank you for joining us today to discuss Calavo Growers' financial results for the second quarter of 2022. 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 is Brian Kocher, President and Chief Executive Officer of Calavo. We will begin with his 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 Federal Securities Laws. Forward-looking statements are identified by words such as will, be, intend, 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. Discussions of the factors that could cause a material difference in our results compared to these forward-looking statements are contained in our SEC filings, including reports on Form 10-K and 10-Q. With that, I will now turn the call over to Brian Kocher.

Thank you, Julie, and good afternoon everyone. We appreciate you joining us today. Let me start off right away with how proud I am of the progress we made in the sequential quarter-over-quarter improvement we delivered in Q2. We are focused on the right initiatives and making the necessary changes in our organization to deliver results. In fact, the quarter has been very busy in terms of improving our business and our future. I'd like to highlight four of the most significant accomplishments. In April, we announced plans to reorganize our leadership and business segments to clarify roles, authorities, and accountabilities. As a result, we believe we have strengthened our ability to execute Project Uno and to realize resulting customer service and efficiency improvements. We streamlined the organization into two reporting segments, ground and prepared. The ground segment will consist of fresh avocados, tomatoes, and papayas. The prepared segment is a combination of our previously disclosed RFG segment and Food segment aggregated together. We expect to report under the new segment structure beginning with our third quarter results. Secondly, we launched a brand refresh of the company logo, tagline, brand personality, and website to support Calavo's one Company vision. The new branding reinforces our core values which can be found on our Careers page at calavo.com, and allows us to consistently present our broad portfolio to the market under one name. Now and into the future, we will have connected the dots for our customers and the trade. So, they can clearly see the power our consolidated business brings to the produce side. Thirdly, we continue to advance Project Uno with initiatives such as product and ingredient optimization, procurement and labor effectiveness, freight consolidation, and administrative synergies across the business. We made progress up and down the P&L by driving efficiencies, improving controls, managing inflation, and importantly, raising prices at a continuously increasing pace. Finally, and the most important accomplishment in the height of our team, we translated the initiatives and projects to the P&L and our reporting tangible visible progress in our financial results. We've delivered continued sequential improvement for the third quarter in a row. As a highlight, from the first quarter to the second quarter of this year, gross profit improved by $8.5 million, net loss improved by $3.7 million or $0.21 per diluted share, and adjusted EBITDA improved by $7.9 million. Let's dig a little bit deeper into our segment results. In the Fresh segment, for almost the entire quarter supply was constrained and the cost of fruit was historically high. We serviced accounts and kept our customers supplied by leveraging our sourcing expertise, and our inventory management processes to meet the needs of our market. Though fruit costs were high given extremely constrained supply coming out of Mexico, our price increase covers these higher fruit costs, inflation of other input costs, and modest negative currency effects, leading to a higher gross profit per case compared to both Q1 of this year, and Q2 of last year. For context, even considering the headwinds in supply cost and currency, we improved our average gross profit per case of avocados compared to Q1 '22 and Q2 of last year by $1.50 per case and $1.30 per case respectively. As a result, total gross margin dollars more than offset the 13% volume decrease caused by lower available export volume from Mexico. As a note, our market share was flat year-over-year, and versus Q1 '22, and our decrease in volumes sold was consistent with the decrease in total exports from Mexico. Turning to our RFG business, I'm proud of our team's daily focus on execution. We have seen improvement in nearly every one of our key performance indicators. We increased pricing by 3% compared to Q1 of this year and by 6% compared to Q2 of last year. Our customer fill rate continued its upward trend reaching an industry-leading 99% by the end of the quarter, up from a very solid 96% in the first quarter of 2022. Simultaneously with improving order fill rate, we decreased customer and consumer complaints by over 17% compared to Q2 last year and by 8% versus Q1 this year. On materials cost, we managed to temper inflation through e-sourcing strategies and production yield programs as part of Project Uno. Labor also improved through employee engagement plans we improved production staffing levels to 96% of required positions. Now that our facilities are fully staffed, our training and efficiency initiatives resulted in labor productivity gains of 9% sequentially from Q1. In terms of resource allocation, we eliminated more than 30 inefficient new product development projects and repurpose those resources to our product and ingredient optimization teams. Some of our accomplishments and initiatives positively impact RFG's performance in the quarter. Our segment gross profit percentage improved sequentially from negative 1% to positive 2%, and our margins have continued to improve as we progress through the third quarter. Transitioning to our Foods business, we are experiencing some challenges. The same constrained supply situation that pushed fresh avocados to historically high prices has had an adverse impact on our processed avocado and guacamole operations. The price of fruit used for processing nearly doubled versus the same time last year. While our team raised prices with contract customers on three separate occasions during the quarter, we couldn't keep up with the increasing cost of fruit. As a result, gross margins for our Foods segment, even after our series of price increases, decreased sequentially from Q1 to Q2 of 2022 from $2.2 million to $1.3 million. We do see some light at the end of the tunnel for our guacamole and processed avocado products. During the quarter, we expanded our sourcing operations for processed fruit and acquired some volume from new sources that helps slow the inflationary pressures. Immediately, we have incorporated these new options into our everyday supply chain. Additionally, customers and consumers have been receptive to price increases, and we are seeing retail prices on the shelf continuing to increase with little impact on sales velocities at present. Proactively, we eliminated products that either no longer made sense for us to produce or for the customer to sell. And even looking internally, we continue to evaluate our own processes to improve labor and throughput efficiencies at our Foods facilities. Finally, and potentially the biggest impact to the cost of our fruit and margin headwinds in our Foods business, the summer avocado crop in Mexico should arrive in mid-July. We expect the new supply will provide some relief to overall prices. We should also focus through to our margins in the Foods segment. Our Foods segment remains an important piece of our overall business and strategy. Although pressure this segment is still gross profit positive. We continue to see strong demand for both processed avocado and prepared guacamole at retail and in foodservice, due to the ongoing consumer trends for healthy, flavorful foods. Additionally, the business provides a strategic advantage to our avocado portfolio as it allows us to buy the full crop from growers. For example, when we take an acre of fruit, we allocate retail-grade quality fruit to our Fresh segment and other grades to our Food business, thereby providing an outlet for the entire harvest. In summary, regarding the Foods business, we will continue working every line in this segment's P&L to drive a fair return on sales. That wraps up our segment discussion. Now let's move on to the balance sheet. We continue to maintain a healthy balance sheet. We paid down over $22 million in debt in the quarter and ended April with $48.1 million of total debt, which included $41.9 million of borrowings under our line of credit and $6.2 million of long-term obligations and finance leases. Unrestricted cash and cash equivalents totaled $2.3 million as of April 30, 2022. Total available liquidity at quarter-end was $15.9 million, including unrestricted cash investments and available borrowings under the facility. We believe our existing liquidity position is sufficient for our working capital needs and investment plans as we continue to implement Project Uno and drive performance improvements across the business. Capital expenditures for the year are projected to total approximately $15 million, which is consistent with fiscal '21. However, we are being judicious in our capital allocation. We are prioritizing those projects which have an extremely quick payback or provide a significant structural advantage in the future. We will not spend capital unless we are satisfied that the returns are right and projects can be executed clearly. For a moment, I would like to look ahead to the next several quarters. We expect to see continued sequential improvement in our operating results while generating positive cash flow from operations. In modeling our business, our investors should remember several things. With respect to Project Uno, we announced Project Uno in the third quarter of 2021 and targeted approximately $70 million of annualized EBITDA improvement within two years. As of the end of Q2, we achieved approximately $13 million in positive impact. Last quarter, we further indicated that investors should think about Project Uno benefits in terms of sequential, gradual improvement over the next seven or so fiscal quarters. While inflation headwinds have been more significant than we originally anticipated, we expect steady progress will continue. Subject to seasonality and the Project Uno benefits will be predominantly recognized in our RFG business. As it relates to RFG and we start thinking about the next fiscal year, our RFG business is progressing toward our target gross margin range of 10% to 12% by the end of 2023. However, also remember RFG has some seasonality, and profits in the back half of the year usually outperform the front half of the fiscal year. In relation to avocados, demand continues and the cost of avocados from Mexico is historically high. As supply normalizes, we fully expect avocado prices in the market to decrease even as we anticipate supply and prices to return to normalized levels, we expect our sourcing initiatives and the breadth of our customers across all distribution channels and all product sizes will allow us to maintain gross margin per case within the historical range of $3 to $4. Specifically for our Foods business, we're still seeing cost pressure for fruit used as ingredients in our guacamole and other prepared foods. We will continue to increase prices across our customer portfolio in our Foods segment. However, we believe the high prices of raw materials will continue well into the third quarter and therefore Foods segment margins will remain compressed. And lastly, as an overall outlook on our business, we expect inflation to continue, and we plan to counteract higher costs with all the tools at our disposal including pricing actions across the portfolio, throughput and labor productivity initiatives, and sourcing programs to leverage our scale. Now, finally, as one more update item before I conclude my prepared remarks, Calavo is conducting a search for a new Chief Financial Officer, and we're working with an outside search firm as well as within our own professional networks to identify candidates. Interviews are already underway. While not one single initiative, project, or program has been postponed, slowed, or halted, while the CFO chair is open, we are moving with great speed to place a successor. However, finding the right person, not speed is our primary goal, and I'm confident we'll do that given the strong slate of candidates we're interviewing. In summary, I'm proud that we are controlling what we can control and our initiatives and efforts are showing up as sequential improvements in our operating results. I'm happy that our team has embraced change and is driving our performance improvement every day with relentlessness. However, while happy and proud, I am not, and our team is not yet satisfied with our progress. We expect and hold each other accountable for continuous sequential improvement and will not rest. We strive to be better today than we were yesterday and better tomorrow than we are today. We also know that while we have several metrics that are important to the health of our business, progress in our minds is measured by what shows up in the financial statements and how fast we are driving cash flow in our business. That concludes my prepared remarks. Now, I'd like to turn the call back to the operator for questions.

And our first question comes from the line of Eric Larson with Seaport Research. Please proceed with your question.

My first question is about your Fresh margins for the quarter. Were they below your $3 to $4 target or within that range?

So, it's a great question. Eric, you've been around this long enough and you know when you're in a commodity business almost every quarter is unique, and this was a unique quarter. We had very strong demand combined with actually a lot less available product to sell. I think our organization did a really nice job managing our gross margin per case. In fact, if you compare it to our historical range, it would be much higher than our gross margin per case. Now, we were priced right in the market. The market may have moved up; we were priced right in the market, we satisfied our customers, we serviced our customers, but it was really some of our sourcing initiatives that allowed us to generate that gross margin improvement, but it was above the historic norm. And again, I would expect that it would normalize back to that historic norm. But I think it was a really unique quarter in that our gross margin increase and expansion for the quarter was able to offset a 13% volume decline and still show improvement quarter-over-quarter.

Okay. Yes. Got it. So, are we starting to see better supplies coming out of Mexico? How long would you expect to see sort of these really elevated we're talking $70 to $80 a case, a carton really high costs, really high prices, when might that start circling back down?

Well, we kind of are seeing the summer bloom in the initial estimates on the summer bloom say that there'll be some relief and available product and that would usually start in mid-July. But we're just trying to manage our category as it's presented with high prices. We're trying to keep our inventory really tight. I think one of the advantages of being a marketer of fruit is that we're buying and selling at daily pricing each and every day, and we're carrying a week, a week and a half inventory. So, as the market moves up and down, we are able to move along with it very quickly. It doesn't mean that we'll never get caught in a situation. But I think over the long term, having that ability to move up and down with the market to buy and sell every day at a quoted price really is an advantage as you see some of these high market prices.

Got it. Then my final question before I go back in the queue. The pricing at RFG that there had been an issue for some time. It looks like it's starting to get better. Do you need more pricing? Did your costs continue to increase again this quarter like we're seeing at other companies? And where do you think you are on sort of price recognition benefits? I would assume it's going to continue to improve over the next few quarters, but my sense is with a 2% gross profit margin, I'm assuming you are not giving full pricing benefits yet.

That's a great question, Eric. Let me provide some context. First off, we are seeing improvement across the board in our profit and loss statement. As we've mentioned, this progress will be gradual, and we won't achieve instant success. Looking at our overall price increase, we've seen a 6% increase year-over-year and a 3% increase quarter-over-quarter. Some of this is due to price increases implemented during the quarter, so we haven't fully realized the impact yet. However, it's not solely about price increases. We have experienced a 4% improvement in material costs sequentially quarter-over-quarter, but we offset half of that with yield improvements in our manufacturing and fresh-cut processes. Our labor productivity has increased by 9% since the first quarter. With our roles filled, we can focus on training and efficiency initiatives, which are beginning to show results. A positive aspect for me regarding RFG is that we have outlined a two-year plan to reach target market margins of 10% to 12%. We are making progress each month. I previously mentioned that January was the best month of the quarter, but February surpassed January, March exceeded February, and April outperformed March. Overall, we experienced a 2% gross margin during the quarter, with April being the strongest month.

And our next question comes from the line of Mitch Pinheiro with Sturdivant and Company. Please proceed with your question.

I think good avocado last night. So, that was good.

Keep on eating them.

I'm trying to address Eric's last question about RFG. Could you discuss in more detail the percentage breakdown of labor, fixed costs, and materials within your cost of goods for RFG? Also, how have those figures changed? Are all costs moving upward?

I want to protect our competitive information, but I can provide some general feedback. First, I will compare to the first quarter since RFG is focused on sequential improvement from quarter to quarter rather than year-over-year. A lot has changed, so I am discussing changes from the first quarter. Labor productivity is up 9%, and as a result, labor as a percentage of overall sales has decreased. Materials cost has only increased by 2%. We implemented some e-sourcing and RFP initiatives that helped manage cost inflation on the purchasing side, and importantly, we drove processes on the shop floor, which allowed us to offset 4% cost inflation with a yield improvement. We achieved a 1.1% material yield during the quarter, allowing us to offset much of that cost, so the increase was really only 2%. As for materials as a percentage of overall sales, it remains about the same. Even amid rising transportation costs, we previously mentioned implementing a nationwide RFP, which will yield cost benefits, and it took effect in the second quarter. We actually observed transportation costs as a percentage of revenue decline in the RFG segment. Pricing has also increased. RFG will not achieve a major breakthrough immediately; it will take time, but we are seeing gradual sequential improvement throughout the entire P&L, not just in pricing.

That was very helpful, Brian. Thank you for that answer. An important aspect is that we ultimately need to grow volume and revenue, particularly in terms of volume. How do you see that happening? I know you've reduced SKUs and eliminated underperforming ones, but will growth come from new products or new customers? Will it involve taking market share from competitors? Can you discuss the components of the revenue?

Yes, I can explain that broadly. It's important to note that in this quarter, we improved our pricing and enhanced the efficiency of our cost of goods sold. More importantly, we significantly improved two key customer service metrics. Our fill rate in the last month of the quarter exceeded 99%, meaning we delivered over 99% of what customers ordered on time, which is remarkable for our fresh-cut operation. Additionally, we reduced the number of customer and consumer complaints during the quarter. This simultaneous increase in fill rate and decrease in complaints reflects our commitment to service excellence and customer satisfaction. Regarding growth, the category of grab-and-go fresh-cut produce continues to expand, both in dollar and unit terms, thanks in part to some price adjustments. We’re actively looking to grow with certain existing customers, either by expanding into new distribution centers or regions, or by diversifying our offerings to include more products like fruit and vegetables. Additionally, we aim to attract new customers. While some market share might shift between competitors, we are not focused on simply buying customers; rather, our goal is to earn their business through exceptional service, product availability, comprehensive offerings, and unwavering commitment each day. These are the areas where we anticipate customer side growth.

And then you mentioned grab and go still growing, just in light of the inflationary pressure on the average consumers' spending budget for food, do you think the fresh-cut fruit, even fresh-cut vegetables would be at risk at all of some trade-down effect? Should inflation remain stubbornly high?

It's a great question. And here's a perspective on that. Even though the price of these products at retail are increasing, the Fresh Cut category continues to grow on a volume basis. So, even though the price is higher, it's growing on a volume basis. I think that's for two reasons. One is the lower of convenience and grab-and-go right now is still very strong. People have less time, and the idea that they can grab something quickly is still strong. So, the growth in grab-and-go convenience is still strong, and I think is helping the overall fresh-cut produce category. Consumer trends in health and wellness are still strong. So, again, there is support there. And then lastly, and this is probably another area of growth. We also see grab-and-go and fresh produce items coming more and more prevalent in the convenience channel. So, we're a category five or seven years ago might only be a traditional retail. Now you see it at traditional retail, now you see it at convenience, now you see it at airports, now you see it at other non-traditional retail outlets. And I think that all continues to help the category growth. So, while higher prices, I would say are putting some pressure on the category, overall, there are a lot of tailwinds that are, let's say, covering or exceeding that downward pressure by price. At least, that's what we've seen today.

Okay. Just one last question if I can get it in here is just on the avocado business. Can you talk about any differences in gross revenue volume between your retail and foodservice channels?

Well, unfortunately, it's tough to talk about growth in a quarter where supply is constrained. So, overall, our volume was down 13%, and that's down a little less than the imports from Mexico, and we are able to soften some of that impact with sourcing from other regions. So, I'd say the supply constraints make that comparison really difficult. Overall, our foodservice volume is down versus the year before, versus Q2 of '21, not unlike our overall volume is down versus Q2 of '21. So, it's really hard to kind of say one segment was more effective than the other when both were dealing with supply constraints. I am excited that overall, market share has stayed about the same. So, again, we're dealing with a very unique market, extremely high prices, constrained fruit, and yet somehow we managed to service our customers find enough fruit in the market that we could manage to keep our market share the same, doing a great job expanding our gross margin per case.

And our next question comes from the line of Ben Klieve with Lake Street Capital Markets. Please proceed with your question.

Hi, thanks for taking my questions. Just a couple from me here. First of all, just a point of clarification, you talked about the targeted gross margin structure that RFG business coming out of next year at 10%, but noted the seasonality of that business, so as your target kind of full-year 10% plus gross margins for fiscal '24 out of that business? Is that correct?

We'd like to be at that run rate, yes, going into fiscal '24. We'd like to be at that run rate.

Got it, I just wanted to confirm I understood that correctly.

Ben, I'm sorry, I'm almost obligated to say this too. Look, our entire process and our entire culture is based on continuous improvement. So, when we reach the goal, we just got to drive for something better.

Got it.

That's aspirational, okay.

Got it, got it. Fair enough. And then one other just kind of big picture question from me. I mean with the turnover in the C-suite over the last couple of years, I'm wondering if you can talk about any ripple effects seen throughout the rest of the organization? And the extent what you've seen, turnover at lower levels perhaps attributable to lots of folks in the C-suite over the last few years. Has it been pretty stable below that level? Or have you guys had to deal with challenges and turnover, maybe that we don't see be at press releases?

Yes, I think overall I would say it's stable. Now that doesn't mean we haven't had a loss or two here or there, but what's been really important is over the course of the last couple of years and particularly over the course of the last six months, we've added both talent and structure to help our operation be more sustainable. So, and I'll use the example of our recent departure of our CFO there isn't one project, not one, not one initiative, not one program that slowed down, was canceled, stopped, or deferred, because of that resignation. We have now have people in place and infrastructure in place to keep that going. In fact, I would like at some point do not even ever talk about Project Uno again. Ideally, I'd like that, every one of those projects to be embedded in our everyday life. So, for instance, now I'm 100% confident that our employees and our sales employees have pricing and pricing for inflationary cost pressure embedded every day in their life. We don't go a day without thinking about pricing. I'd like to think that labor productivity is embedded in our operations every single day. We measure it every day, we measure it every hour of every shift, and we can compare that. So, again, I think part of what we've been able to do over the course of the last six months but even the last couple of years is put infrastructure and talent in place. So that our operational improvements are sustainable and our processes are sustainable. And that's really critical to help manage when you do have some turnover. But to specifically answer your question, our headcount and our resources beneath the C-suite have been relatively stable.

Okay, great. That's good to know and helpful context. And yes, I think the last couple of years made everybody rethink how they operate on a daily basis. So, good to hear that you guys are spreading out throughout the organization well. That's it from me. Congratulations on a really good quarter getting some progress here flowing into the P&L, it's great to see you looking forward to continued progress here in coming quarters. So, thanks for taking my questions.

And we have reached the end of the question-and-answer session, I'll now turn the call back over to Brian Kocher for closing remarks.

Thank you for joining us today for the prepared remarks and the Q&A session. Before I wrap up, I want to highlight a couple of key points. First, we take pride in our performance this quarter, yet we recognize there's still work to be done. We have projects and plans in place to address that. I'm particularly excited about our Fresh division this quarter, where not only did avocados perform well, but our tomato program thrived as well. We capitalized on specific market conditions, and while we expect those to stabilize, we benefited from them in the short term. I'm also pleased with the progress in our RFG segment; we are taking a steady approach, and moving from a negative gross margin to a positive one with our best month happening in the third month of the quarter shows promising signs for our organization. Additionally, we've made strides with our balance sheet by managing receivables, collections, and accounts payable, leading to a $22 million reduction in debt this quarter, which positively impacts our EBITDA. There are many positive developments taking place, and we are committed to continuous improvement on a monthly and quarterly basis. Thank you again for your time, and I want to express my gratitude to the employees and supporters of Calavo for their efforts to improve daily. We appreciate your attention and wish you a wonderful summer. We look forward to our next communication. Thank you.

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