Earnings Call Transcript - FDP Q2 2022

Operator, Operator

Good day, everyone, and welcome to Fresh Del Monte Produce's Second Quarter 2022 Earnings Conference Call. Today's conference call is being broadcast live over the Internet and is also being recorded for playback purposes. For opening remarks and introductions, I would like to turn today's call over to the Vice President, Global FP&A and Investor Relations with Fresh Del Monte Produce, Ana Miranda. Please go ahead, Ms. Miranda.

Ana Miranda, Vice President, Global FP&A and Investor Relations

Thank you, Rob. Good morning, everyone, and thank you for joining our second quarter 2022 conference call. As Rob mentioned, I am Ana Miranda, Vice President, Global FP&A and Investor Relations with Fresh Del Monte Produce. Joining me in today's discussion are Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer; and Monica Vicente, Senior Vice President and Chief Financial Officer. I hope you've had a chance to review the press release that was issued earlier this morning via Business Wire. You may also visit the company's IR website at investorrelations.freshdelmonte.com to access today's earnings materials and to register for future distribution. This conference call is being webcast live on our website and will be available for replay after this call. Please note that our press release and our call today include non-GAAP measures. Reconciliations of these non-GAAP financial measures are set forth in the press release and earnings presentation, which is available on our website. I would like to remind you that much of the information we'll be speaking to today, including the answers we give in response to your questions, may include forward-looking statements within the provisions of the federal securities laws safe harbor. In today's press release and in our SEC filings, we detail material risks that may cause our future results to differ from these forward-looking statements. Our statements are as of today, August 3, and we have no obligation to update any forward-looking statements we may make. During the call, we will provide a business update along with an overview of our second quarter 2022 financial results followed by a question-and-answer session. With that, I'm pleased to turn today's call over to Mohammad.

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

Thank you, Ana, and good morning, everyone. As you have seen today, we delivered an excellent robust second quarter. Our net sales increased by $70 million compared with the prior year period. And we saw a continuation of our robust top line trend comprised of five consecutive quarters of growth versus the prior year period, demonstrating the resilience of our iconic brands. During the quarter, we continued to operate in one of the most volatile and uncertain operating environments in recent history. As a result, the cost of products sold increased by $100 million, driven by broad-based inflationary supply chain and logistical headwinds. Despite these headwinds, we generated positive earnings, all while maintaining our debt balance in line with last year, generating strong cash flow from operations and continuing our dividend payout. During the quarter, our adjusted EBITDA margin was 4.6%. We lowered our debt by $91 million, generated $95 million in cash flow from operations, and invested $12 million in capital expenditures. Our results are representative of our commitment to grow our brand by revisiting everything we do, highlighting our dedication to outperform in an environment where many are not. On the product innovation front, I'm pleased about our pipeline and the team's focus on the development of our products aligned with consumer trends. We recently launched pre-trade organic bananas and Goodvocado featuring avocados that naturally range from small to large. The Goodvocado pack allows consumers to customize their use of avocados. We recently announced a collaboration with a leading cloud supply chain provider. Their services include warehousing, freight, and fulfillment. Store will leverage 22 of our best-in-class cold storage facilities across the U.S. We also expanded our logistics services in the U.S. with Happy Egg, whereby we provide egg producers access to our temperature-controlled warehouses and fleet of trucks. These collaborations are part of our efforts to look for additional ways to improve the productivity of our assets. In keeping with our asset optimization focus, we announced our row crop expansion project with white corn in Guatemala grown in our resting lands between crop seasons, a strategy we are looking to expand into other areas with other crops. This is an excellent way to leverage our idle lands and is a win-win proposition; we play a bigger part of the global food shortage solution while also improving our grounds for upcoming seasons. Along the same lines, we are also continuing with the expansion of our commercial cargo services via our 13 vessels, offering tailored shipping solutions to a broader customer base amid continuous logistical pressures. This is reflected in our robust Other Products & Services segment net sales, which are up $36 million year-to-date compared with the prior year period with strong double-digit gross margins. On ESG, the team is actively working on our '21 report due to be released soon. We are excited to share the great progress we have made in reducing greenhouse gas emissions and how we are on track to achieve our science-based targets ahead of 2030. In the wake of record-breaking temperatures this summer, climate action is more urgent than ever. We strongly believe our business success depends on the meaningful and effective management of our ESG work and understanding we have held for years. As we move to the back half of the year, fluctuations in exchange rates are expected to go against us in key selling markets due to a forecasted stronger U.S. dollar. We are partially hedged against movements in the euro and Japanese yen through the end of the year, helping us mitigate a portion of the impact. Long-term, we continue to focus on efficiencies in our operations and are confident in our product offering and vertical integration, which uniquely positions us to drive international profits. Despite a softening consumer outlook, demand for our products remains strong, which we believe puts us in a distinctive recession-resistant category. I'm confident in our team's dedication to drive profitable sales by concentrating on all aspects of our business. We plan to do that by focusing on our sustainable growth strategy and delivering against its key elements: organic expansion, product innovation, investments in technology, best-in-class customer relationships, and sustainability. Now I will turn the call to Monica to talk about the second quarter financials. Monica, please.

Monica Vicente, Senior Vice President and Chief Financial Officer

Thank you, Mohammad. Let's turn to our second quarter of 2022 financial results. As noted by Mohammad, net sales for the second quarter of 2022 increased by $70 million or 6% compared with the prior year. Net sales benefited from inflation-justified price increases. Partially offsetting the increase was the negative impact of fluctuations in exchange rates mainly versus the Japanese yen and, to a lesser extent, the euro. The negative impact of fluctuations in exchange rates was partially mitigated by our foreign currency hedges. Adjusted gross profit for the second quarter of 2022 was $81 million compared with $112 million in the prior year period. Despite higher net sales, gross profit continued to be negatively impacted by broad-based inflationary pressures and logistics constraints. Higher costs across the board resulted in an increase in the cost of sales of $100 million, including costs of packaging materials, fertilizer, ocean and inland freight, fuel, and labor. Adjusted operating income was $33 million compared with $61 million in the prior year period. The decrease in operating income was primarily due to lower gross profit, partially offset by lower administrative and advertising expenses. Adjusted net income was $21 million compared with $47 million in the prior year. Our diluted earnings per share were $0.44 compared with diluted earnings per share of $0.99 in the prior year. Adjusted diluted earnings per share were relatively in line with our GAAP performance as both periods had minimal nonoperational and nonrecurring items. Adjusted EBITDA for the second quarter was $56 million compared with $84 million in the prior year, and the corresponding adjusted EBITDA margin was 4.6% compared with 7.3% in the prior year period. Let's now turn to the segment results, beginning with our Fresh and Value-Added product segments. Net sales for the second quarter of 2022 increased by $58 million or approximately 9% compared with the prior year period, as a result of higher pricing in most product categories. Sales volumes remained in line with the prior year. Fresh and value-added product segment adjusted gross profit for the second quarter of 2022 was $49 million compared with $60 million in the prior year. The decrease in gross profit was primarily driven by our non-tropical fruit category, which was negatively impacted by lack of availability of third-party shipping capacity on certain shipping routes as well as our avocado category due to market volatility. Despite higher pricing, gross profit continued to be negatively impacted by higher per-unit production and distribution costs, including ocean and inland freight. As a result, adjusted gross margin decreased to 6.7% compared to 8.9% in the prior year period. The Fresh and Value-Added product segment included a $1.6 million one-time charge in the second quarter of 2021, primarily in the Middle East. There were no one-time charges to gross profit in the second quarter of 2022. Moving to our banana segment. Net sales for the second quarter of 2022 decreased by $5 million compared with the prior year period. The decrease was mainly due to slightly lower sales volume and unfavorable fluctuations in exchange rates in Asia. Banana segment adjusted gross profit for the second quarter of 2022 was $22 million compared with $49 million in the prior year period, mainly driven by higher per-unit production and distribution costs, including ocean and inland freight. As a result of these factors, gross margin decreased to 5.3% compared with 11.3% in the prior year period. Lastly, net sales of our Other Products and Services segment increased by $17 million or 42%, mainly due to higher net sales of third-party freight services in North America. As noted by Mohammad, our fleet of vessels has enabled us to expand our commercial cargo services, which are benefiting from elevated shipping rates and demand due to market constraints. Gross profit increased by 5% as a result of higher net sales of third-party freight services. Moving to selected financial data. Selling, general, and administrative expenses were $47 million compared with $51 million in the prior year period. The decrease was primarily due to lower administrative and advertising expenses. Net interest expense was approximately $6 million, $0.5 million higher compared with the prior year, mainly due to higher interest rates. Income tax expense was similar in both periods at approximately $5 million despite lower income before taxes. Taxes last year reflected the impact of return to provision adjustments, including a $1 million benefit relating to the Coronavirus, CARES Act. Year-to-date, we generated net cash from operating activities of $95 million compared with $140 million in the prior year period. The decrease was primarily attributable to lower net income compared to the first quarter of 2022. Our cash flow from operations is $95 million higher, mainly driven by working capital improvements. Long-term debt decreased to $463 million at the end of the second quarter of 2022 from $473 million at the end of the second quarter of 2021 despite unprecedented pressures to working capital related to increases in cost of goods sold as well as increases in accounts receivable. Long-term debt decreased $91 million compared with the first quarter of this year. We continue to make progress on our optimization program announced in the second half of 2020. At that time, we performed a comprehensive review of our asset portfolio aimed at identifying non-strategic and underutilized assets to dispose of while reducing costs and driving further efficiencies in our operations. Since the program was announced, we have generated $63 million of cash proceeds, out of which $5 million were realized in the second quarter. We expect progress towards achieving our target of $100 million in cash proceeds to continue in the back half of the year. As it relates to capital spending, we invested $23 million in the first six months of 2022 compared with $70 million in the prior year period. The $70 million last year included the final payments on the purchase of two of our refrigerated container ships. The spending this year has focused on improvements in our banana and pineapple operations and production and distribution facilities in the U.S., mainly comprised of investments in automation and technology. As announced this morning in our financial results press release, our Board of Directors declared a quarterly cash dividend of $0.15 per share payable on September 9, 2022, to shareholders of record on August 17, 2022. This concludes our financial review. We can now turn the call over to Q&A. Rob?

Operator, Operator

At this time, I would like to remind everyone. Your first question comes from the line of Jonathan Feeney from Consumer Edge.

Jonathan Feeney, Analyst

I'm particularly interested in the developments within the banana business. While we recognize that everyone is facing unprecedented costs, I'm curious about what is hindering pricing from increasing despite a significant reduction in margin year-over-year. You specifically mentioned the Asian market, but I would like to know more about U.S. contract pricing, European markets, and the overall market dynamics. Why isn't pricing stronger if all companies are dealing with similar costs?

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

The main reason for the price is not going up is because of the retailers' resistance to increase the pricing on the shelf. And hopefully, they will understand that this cannot go on forever because we will not be able to supply bananas in any material form going forward unless the prices start going up and really compensating for all the efforts and investments that we put on the farm. It's crucial. The prices on the shelf have to go up.

Jonathan Feeney, Analyst

Absolutely. There need to be some cooperative suppliers at this time. I recognize that this has been the situation and we've been in this together for a long time. I have experienced many similar scenarios over the past 20 years and more. However, what is different this time is the extent of this inflation; it seems to be on everyone's mind. Are you losing or gaining market share in certain areas because there are businesses you choose not to engage with, while other companies that operate more on a commodity basis are willing to sell at lower prices? How is that situation unfolding?

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

Not necessarily, Jonathan. It seems like we lose on one side and gain on the other. In my opinion, the price of bananas hasn't changed over the last 15 years, while everything else has increased by almost 100%. If you go to a supermarket today, you can't find an apple for even $1 or $2 in some cases, and even a single lemon can cost you $1. Everything is skyrocketing. When a pound of bananas is still $0.50 or $0.60, it just doesn’t make sense. We are caught in a difficult situation. Our producers can't keep up, shipping costs have risen, fuel prices have surged—everything has really increased. We are at a point now where action needs to be taken.

Jonathan Feeney, Analyst

I guess that's helpful context. Can you comment specifically about the effect of the Asian exchange rates you mentioned, but I was surprised not to see a mention of the roughly 15% decline in the euro in the press release. Historically, this business has been extraordinarily euro-driven. Was that a significant challenge this quarter?

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

No. To be honest, we were hedged against the euro at the beginning of the year, but not completely. Additionally, European prices have remained strong over the last few months, which has greatly benefited banana returns. The market is experiencing logistical challenges, such as a shortage of containers and high freight costs. In some areas, we are even seeing banana shortages. This situation is also related to rising input costs, as many growers can no longer afford fertilizers as they did previously, leading to reduced production rates. If this trend continues, we may experience even more significant impacts in the future.

Jonathan Feeney, Analyst

It seems there is more discipline in the European market and possibly in other regions as well. My final question is how do you view the pricing dynamics for bananas in relation to the stronger performance of some of your other products? Is it easier to implement price increases in those other areas? Are you confident that in the second half of the year, despite elevated costs, you will be able to recover pricing and achieve the margin goals you set at the beginning of the year?

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

I think in the value-added segment and Services segment, we have more, let’s say, flexibility in working with the customers to implement decent pricing. But in the case of bananas, we are always influenced by the price ambitions.

Operator, Operator

Again, your next question comes from the line of Mitch Pinheiro from Sturdivant.

Mitch Pinheiro, Analyst

Following up on John's questions, if we look at the long term, particularly over the past decade, the banana business has remained relatively stagnant due to retailers being hesitant to adjust pricing. However, in the Fresh and Value-Added segment, you've seen an increase of $1 billion in sales over the same period, yet gross profits have remained unchanged. It's worth noting that you've managed to keep SG&A costs flat in absolute terms over the past ten years, demonstrating good cost control. Nevertheless, it appears that the Fresh and Value-Added side has struggled to gain momentum. While I understand that current inflation presents challenges, there will always be global factors acting as headwinds over a decade. Can you explain why the Fresh and Value-Added business is not as profitable as expected? You anticipate it will improve, but what factors have prevented meaningful profit growth over the past ten years?

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

Unfortunately, I need to be very transparent. On the fresh cut and the value-added, we have increased prices over time. Of course, cost of production and product costs have also been going up. Sometimes we even raised the price this quarter. At the end of the quarter, the cost of goods has caught up with us for whatever we have increased in pricing, and we get it back to ground zero again. But another area where we really have suffered during the last couple of years is our acquisition of Mann Packing where we have suffered in the margins, especially during the COVID period in 2021 where the market has almost come to a stop. We suffered quite substantial losses from our products that are in the fields we could not move and less demand and less pricing power. So this probably is the factor seeing lower or no movement in the average pricing. But in reality, yes, we are doing very well, except for this particular case, which is the Mann Packing. Hopefully, by the end of the year, this will be taken care of, and we will see going forward with growth in that area.

Mitch Pinheiro, Analyst

What is it with Mann Packing specifically that you want to see improved? I mean, you're getting pricing, but is it a channel issue? Is it a customer issue?

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

Unfortunately, it's a contract issue. When you sign a contract that doesn't reflect the actual costs or offers a good margin, you end up in a situation where you have to continue supplying while incurring negative returns. We are addressing these issues; contracts that aren't providing sufficient payment have not been renewed or have been cut off. We are also working on various aspects of production and contracting. This is an area that needs improvement to avoid having more production than necessary. Our team is currently managing several fronts, particularly in sales and production, and I am confident that these matters will be resolved going forward.

Mitch Pinheiro, Analyst

Okay. Is that something we can expect to see improvement in over the next year? Or will it be different?

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

I hope within '23, we should see improvements there. Yes, definitely.

Mitch Pinheiro, Analyst

Okay. That was very helpful color there. I guess also on just the banana segment, can you just give us just how the supply-demand outlook looks here in the very near term?

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

It’s been very unpredictable in the past few months, particularly with Ecuador. The country is currently experiencing significant turmoil regarding production consistency. While they have output, the quality and condition of the fruit on the market from Ecuador are not reliable. As I mentioned earlier, the usual application of fertilizers and chemicals to manage diseases and pests is not occurring as it should. This has impacted production in both yield and quality. Additionally, we have encountered disruptions in the supply chain, shipping, and securing sufficient equipment and containers to transport the fruit from source to markets. Smaller and medium-sized growers are facing substantial challenges in obtaining financing for ongoing operations. I believe that these combined factors will lead the banana sector to a point where production will decline significantly in the future. I cannot specify whether this will happen in one or two years, but I am convinced that the banana industry, overall, will struggle to maintain its current state after a decade of easy financing. Interest rates were nearly zero, and the costs of chemicals, fertilizers, inputs, and transportation were all quite competitive and affordable. That situation has changed drastically now. Considering all these factors, it won't be sustainable. I wouldn't be surprised if one day the cost of a box of bananas reaches $20, and this is not mere speculation. I've held this belief for many years, and I think there will come a time when everyone realizes there won't be enough bananas to supply the markets.

Operator, Operator

And there are no further questions at this time. I will turn the call back over to management for some final closing remarks.

Mohammad Abu-Ghazaleh, Chairman and Chief Executive Officer

I would like to thank everybody for attending this call today, and I hope to talk to you on our next quarter and wish you a good day. Thank you.

Operator, Operator

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