Mission Produce, Inc.

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 Sonick, Investor Relations at ICR. Sir, please go ahead.

Thank you. Today's presentation will be hosted by Steve Barnard, Chief Executive Officer, and Brian 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, 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.

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 own 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 disruption, 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 and that we will drive through the region as well as filling 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 was very productive, and we continue to expect solid yields from our own production, which remains on track to produce the planned 95 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, Brian Giles, for his financial commentary.

Thank you, Steve, and good afternoon to everyone on the call. I'll start with a brief review of our fiscal third quarter 2021 performance, ended July 31st, 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 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 irregular 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 and 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 31st, 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 and distribution segment net sales increased 4% to $239.6 million for the quarter. The drivers for the marketing and 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 and distribution segment. While we are more exposed to price in this segment compared to marketing and 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 and 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 online 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 sale 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 31st, 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 costs 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 nine months ended July 31st, 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're 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 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 own farms remains unchanged in the range of 95 million to 105 million pounds. Full year fiscal 2021 adjusted EBITDA is expected in the range of 88 million to 94 million dollars, 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.

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Brian Spillane of Bank of America. Please proceed with your question.

Hi, thank you, Operator, and good afternoon, guys. So just a couple of questions, I guess, related to first on the Mexican crop and supply. I guess by the comments, it sort of sounded like it's still a pressure early in the quarter, but I guess by saying early in the quarter, do you expect that that should begin to alleviate as you exit the fourth quarter? So just trying to get an understanding of Timing-wise, is the worst of this past you or would you expect the supply constraints to continue all the way through and as you're exiting 4Q?

Well, I think, Brian, if we look at history, it goes in cycles and they tend to alternate every other year. So 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 flower and they tend to alternate And if it stays the way it is today, it's going to be a tough road, but it never does.

Yeah, Brian, I'll elaborate on that a little bit. Yeah, we're still selling through kind of 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 kind of right at that transition point. Typically, there tends to be a lot of volume that comes into the market at that point in time, and we're expecting that that will be the case again this year, and that at that point, the supply dynamics will ease up a bit. So certainly, we got off, I think, some of the challenges we saw at the end of Q2, or I'm sorry, Q3, continued through August, but we do expect improvement as we move through the latter half of the quarter.

Okay, that's helpful. And then the second is just on terms of cost pressures. So beyond supply, just thinking about things like freight costs, availability of shipping containers, port congestion, just the moving of stuff, for lack of a better way to put it, which has really been a challenge for a lot of companies or most companies. Can you just give us a little bit more color on just the dynamic there? And again, same idea, is it kind of fully baked into the base? Is it getting worse? Just trying to get an understanding of that as well.

Well, let's just take one at a time. The freight deal is still an issue. You know, you read all these journals and a lot of these containers are stuck in China or somewhere in Asia, trying to get out of there. Fortunately, starting Mexico, we have a lot less freight compared to, say, out of Peru, which is pretty much mostly freight or ocean freight. So That'll ease up the pressure on us a little bit. I don't think it's going to change the shipping side of it, but that will help here because most of it will be by truck into the U.S. or Canada through our Laredo facility, which should help too. So that side of it. But yes, you're going to see inflation on everything from materials to labor. I mean, this labor thing, not necessarily in Mexico, but here. And I just read today in Chile, they've got the same problem due to the fact they're getting paid to stay home and no one wants to work. So that and get back to work as a country, not just us.

Yeah, I'll elaborate even a little further on those overhead costs. I think certainly the largest component of our cost of goods sold, Brian, is the purchase of third-party fruit. I think we kind of understand the dynamics that are at play there aren't really inflationary in nature. They're more of a supply-demand issue. The second largest item is our transportation costs. And I think to Steve's point, We came through the preseason with a heavy slant towards ocean cargo. I think we negotiated terms early on, and with our scale that we have, they were actually fairly favorable this year. So we didn't really experience big increases in ocean cargo cost year over year. And just with our volume itself ramping up as well, it gave us more leverage with the carriers. I think on the land transport, which to Steve's point is significant when we transition to the Mexico season, We were operating a level this year that is quite a bit higher than a year ago at this time, but it seems to be pretty stable right now. We have not seen big increases over the last two to three months. So I certainly I can't predict what's going to happen next, but it feels as if that market has stabilized a bit. If you go behind that labor would be the next one. And certainly with the majority of our labor located in Mexico and in Peru, We don't have the same dynamics at play, maybe to the same extent that somebody who's operating in the US does. But that being said, there's been changes in the laws down in Peru that have increased wages that we've dealt with over the course of this year. And we've kind of managed that. That's kind of part of some of the higher costs that we've experienced in our farming operations. but I don't think we haven't really had an issue yet where it's impacted our ability to deliver product to our customers.

Okay, great. Thanks. I'll pass it on.

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

Hey, good afternoon, and thanks for the questions. I wanted to ask just first on the realized pricing side, it seems like you exited last quarter and, you know, the update you gave for May was that pricing had really strengthened. It seems like for the quarter, a little bit more stagnant relative to the last quarter, despite calling out some supply constraints that I thought would have showed better flow through plus, you know, the cost environment that you're facing. So just kind of wondering what, what limited that pricing. And as we look at the, the fourth quarter, how you're thinking about that?

Well, again, it goes back to the supply. I think we have to keep in mind, too, at the same time, consumption continues to grow in this category globally, not just here in the U.S., but everywhere. The high single digits to low double digits, I know both here and in the European Union. So on top of that... You know, these avocados are alternate bearing, and in Mexico there's three or four different flowers you deal with, and they tend to sometimes overlap when you have an abundance, and then sometimes they're delayed like the situation we're in right now. So I guess what I like to tell people around here when you have this thing figured out is when you're in real trouble because you don't. You just keep playing the game with your head up, be vertically integrated like we are around the world where we have other options other than just one source such as Mexico or California, and it tends to mitigate the situation. We're not quite where we want to be yet on the supply side of it timing-wise, but we've got, as we know, operations in Guatemala, Colombia, South Africa is coming. So we're working hard to mitigate that issue and take the risk out of it.

Tom, I'll kind of give a few more details on the numbers as well. When we ran in Q2, our average per pound price for the quarter was $1.42. I think that was a period where we were building up to where we kind of peaked in pricing at the end of the quarter, which led to that $1.42 average, coming off having an average of $1.04 during the first quarter of the year. What we saw leading to Q3 is for the first month, we maintained pricing during the month of May at fairly close to those levels. And then we saw it come off a bit during June and July to where we ran an average of $1.43 again for the quarter as a whole. I think that the size curve that came out of Mexico does come into play here. When we're getting a lot of smaller fruit, out of the field, it does tend to sell for a lower per pound price than larger fruit does. And we did see kind of that kind of shift in the mix towards smaller fruit during the quarter. So that does kind of put a cap on where pricing can go. As we look to Q4, I think the way we've modeled internally, I think we're seeing pricing for the quarter as a whole remaining relatively stable with where we ran in Q3, probably somewhere around $1.40 to $1.42 a pound. I would say that we came into August with pricing a little bit higher than what we were running as we came out of July. It feels like we're going to peak in September. And then the expectation is that when the new crop comes on board and has a meaningful impact in October, that prices will start to come back off again. Oh, great. Thank you for all that detail.

And to follow up, I guess on the Peru harvest, just any split on how we should think about volumes in the third quarter relative to the fourth quarter?

I think what we can say is, you know, we're still holding to the number that we're projecting for the year as a whole. We are expecting a heavier portion of the fruit in the fourth quarter this year. On a percentage basis, heavier than what we've seen in prior periods. So, yeah, I think that, you know, somewhere in the neighborhood of 60% plus of the fruit will be sold through during Q4 this year. Thank you.

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for additional questions. Our next question is from Ben Bienvenue of Stevens. Please state your question.

Hey, thanks. Good afternoon. I want to follow up on the comments that you provided on 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, the ramp to maturity, and should we be thinking of that as a net positive to margins in the next fiscal year, or is it going to take longer than that? Just give us some sense, if you can, of the ramp of that facility.

Well, I'll have Brian give you the numbers, but again, it's all volume-based. We aren't anywhere close to the volume that we will see in, say, January going through Laredo, and it will continue to start going up probably in the next couple of weeks and peak in January and then pretty much maintain until it starts slowing down in late spring. So You know, that whole thing is based off of volume, and with these prices, you can tell the volume isn't there today. But it's out there. It's just delayed in harvest. It's a different flower this year, so to speak.

Yeah, Ben, I think as we went through Q3, we know that Q3 tends to be our low point for importing fruit from Mexico. But even when Mexico is at its low point, it still makes up more than 50%. of the product that we sell into the U.S. And for most other marketers, it's more than that. So we knew that volumes running through Laredo would be lower in Q3, but we also knew that that would give us a chance to kind of work out any operational kinks that were required when things weren't quite as stressful. I think as we move into times of the year where volume is higher through those facilities, it absolutely will have – less of an impact on margin. That being said, you know, we're running at volumes that were relatively flat in the North American market as we introduced a substantial amount of new capacity in Laredo during the third quarter. I think what's going to need to happen over time is that we, you know, continue to see this year over year growth to absorb that capacity that we've introduced. It's tough for me to know exactly when it will be profitable on a standalone basis, only looking at kind of operational dynamics. But I think what we can say in the short term is that we're not running significantly more volume through today than we were before Laredo opened. We've kind of redistributed where fruit's coming out today, and there's likely some ability to optimize margin as a result of that. But I think to truly get the throughput we need from that facility, we're going to need to continue to see growth over time. And again, it's just an example of the investments that Mission's willing to make because to position ourselves well for the future. This wasn't going to maximize short-term profits by bringing a facility of this size up and running, but we certainly feel very strongly that it's going to keep us in the driver's seat for the long haul.

Yeah. Okay. Makes perfect sense. Thanks. And then if I could ask a question on SG&A expense. I know in the short term, the gross margins can be variable based on price swings in the market. The SG&A was up a lot year over year. I know there's some strange comparisons because of the IPO, but Could you help us think about what sort of a baseline SG&A is and what a reasonable rate of growth is going forward just so that we can try to calibrate our margins relative to reality?

Yeah, so if we look at Q3 standalone, we saw a $3.7 million increase in SG&A of which more than 50% of that we believe is attributed to public company costs. While it's tough to estimate how much of that It's difficult for me to say that all of it is going to continue at that $1.8 million level over time. I think we do know that there's certain items like, you know, putting a SOX, an internal audit program in place is going to be more expensive in year one than it's going to be in year two and year three. We know that D&O insurance, while we're inside the 1933 Act, is going to be more in year one, two, and three than it's going to be in year four. So we know that there's certain things out there that are going to come off over time. We just don't know the exact amount or the exact timing that they will. But if I had to estimate, you know, of that 1.8 million, I would say at least probably a million of it is ongoing public company costs that are not going to go away in the future. That's probably a new baseline that we're measuring against. And of the other 800, I would say that it would probably come off over a multi-year period. Difficult to estimate how much per year. I'd say if you look separate from the public company costs at our SG&A, you know, there are components to SG&A like selling that are investments into the business in the long haul. And those things are, they're going to grow at a rate that's likely a little higher than inflation over time because we are continuing to invest in our strategy. whether it be something like mangoes, you know, as we moved into and staffing that up over the course of this year, or as we continue to move forward with our plans, you know, we've said that we have plans to grow internationally, whether that be in Europe and Asia, and we're going to add resources over time in those areas to support it. So I don't think we're going to be your typical stagnant SG&A where it's just a fixed cost that's growing at an inflationary rate. I think that there's going to be growth in that that's geared around investment in the business for the long haul.

Okay. Thanks for all the detail. Appreciate it.

Ladies and gentlemen, 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.

Well, we see a great opportunity ahead, as we always do. The consumption of avocados continues to grow globally. We continue to invest in our business and the industry's business, not only in the sourcing side of it to diversify there so we don't get into supply issues, but at the overall consumption around the world, there's a huge opportunity ahead. And we plan on being a major player pretty much everywhere. Stay tuned.

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