CVGW - NASDAQ

Good afternoon, and welcome to the Second Quarter 2022 Calavo Growers Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] 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 cover 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 a $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. Labors 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 push fresh avocados to historically high prices has had an adverse impact on our process avocado and guacamole operations. The price of fruit used for processing nearly doubled versus the same time last year. While our team raise 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 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 process fruit and acquired some volume from new sources that it 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 great quality fruit to our Fresh segment and other grades to our Food business. They're 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 the capital unless we are satisfied that the returns right and projects can be executed crisply and clean. 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 at 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 are 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 are 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 come back 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 sequential improvements in our operating results. I'm happy that our team has embraced change and is driving our performance improvement with an everyday relentless. 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 were 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.

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

So, my first question is we don't have -- I don't have the Q yet, maybe I just, I would, I haven't seen it, but when you look at your avocado -- when you look at your Fresh margins in the quarter, were they below your $3 to $4 number 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 by -- combined with actually a lot less available product to sell. And I think our organization did a really nice job, a really nice job in 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 -- then our range, our gross margin in the second quarter was higher. Now, I think we were priced right in the market with -- 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 initiative 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, 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 is 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 kind of move along with it very quickly. I mean, 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, 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 margin -- gross profit margin, I'm assuming you are not giving full pricing benefits yet.

It's a great question, Eric. But let me also put some context to that. First and foremost, we're kind of getting improvement. If you look at the P&L, we're getting improvement from top to bottom in the P&L. Now, we've talked about it's going to be gradual. We cannot hit a 10-run homerun, right. So, it's going to be gradual. But if you look at our overall price increase, I think we were a 6% price increase year-over-year, 3% quarter-over-quarter. Now some of that is price increases that went into effect during the quarter. So, we don't have a full impact of that. But it's not just price increase. We were able to experience really only 4% -- I'm talking sequentially, quarter-over-quarter material cost improvement but we offset half of that with yield improvement on our manufacturing processes, on our fresh-cut processes. Our labor productivity increased 9% from the first quarter alone. So, we've got the roles filled. When you have the roles filled, you can train, you can work on efficiency initiatives, and that's starting to pay off too. So, I think the very positive thing for me to think about in RFG is, remember, we've kind of talked about a two-year plan with RFG getting to those target market margins of sort of 10% to 12%, but each month we're making progress. I mentioned during the first quarter earnings release that January was the best month out of the quarter. Well, guess what? February was better than January, March was better than February, April was better than March. So, we're even in during the quarter. During the quarter, where overall, we saw 2% gross margin, April was the best month of that quarter.

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. So, just staying on Eric's question, his last question, RFG. Could you talk about or maybe -- to some detail, like within your cost of goods in RFG, what's the percentage of labor, fixed cost, and materials? Or, and where has that gone? Is everything up directionally?

So, let's -- I want to protect our competitive information but let me give you a general feedback. First, and then these are all comparisons to the first quarter because remember RFG is really a story about sequential improvement quarter-over-quarter, not versus last year. So much has changed, so I'm really talking to you about change from the first quarter. From the first quarter, labor productivity is up 9%, so labor as a percentage of overall sales is down.

Material cost is up only 2%. So, we put in some e-sourcing initiatives, we put in some RFP initiatives that helped temper overall cost inflation on the buy side, but then an important part of that was the processes, we were able to drive in on the actual shop floor, and we offset 4% cost inflation with a yield improvement. We had actually 1.1% material yield during the quarter. So, we were able to offset a lot of that cost. So, really only 2%. So, materials as a percentage of overall sales, I'd say we're about same. Even in a period where transportation costs have been increasing, we mentioned during our last call that we put in a nationwide RFP and we're going to yield some cost benefits out of that, that went into effect in the second quarter. We actually saw transportation as a percentage of revenue decline in RFG segment. And then pricing went up. So, again, I want to be complete and robust in our answer. RFG will not hit a 10-run homerun. We're going to need time, but we are getting gradual sequential improvement, and it's coming throughout the entire P&L. It's not just pricing.

I guess, to then -- that was very helpful, Brian. Thank you for that answer. But I guess there was an important thing is ultimately have to grow volume, need revenue growth, and particularly volume growth. Where -- how do you see that coming? Is this -- I know you've cut back on SKUs and underperforming SKUs certainly, but is this coming from new products are you going to -- are there new customers that you know about that are coming. Where just -- is it going to be taking market share from other vendors, can you talk about how you see the components of the revenue?

Yes, I can. And I'm going to describe that in broad terms. Mitch, I think it's really important to remember that during this quarter, we improved pricing, we improved our cost of goods sold efficiency but the fact of the matter is we improve two really critical cold customer service metrics. Fill rate, which is in the last month of the quarter was almost over 99%. So, over 99% of what a customer ordered, we delivered on time. That is really special produce in fresh-cut operation. And then secondly, we decreased customer and consumer complaints during the quarter. So, simultaneously with increasing fill rate, we decreased customer complaints. That is one of the ways that we win service, that we win customers as we demonstrate our service level. So, if I would -- I just didn't want to lose that in the context of the script, it's a really important sales strategy, where is the growth going to come from? First and foremost, the category is still growing. Grab and go fresh cut produce is still growing. It's growing on a dollars basis because obviously there is some price increases, but it's growing on a unit basis, too. So, we see some growth from the category altogether. We also have certain customers that we're looking to expand with. Either, we currently do their business and are looking to grow in terms of another distribution center to cover or another region to cover or potentially another segment, maybe we do fruit with them only, but now we can do fruit and veg. So, there is a block of cost -- a block of existing customers that we want to grow with, and then lastly there are new customers that we want to grow with. And you can say that okay, that might be share that is just trading between competitors. And I would agree with you there, but we're not interested in gaining share by buying customers. We were working too hard on price increases, we're working too hard on efficiencies, that's not what we're interested in. We're working -- We're interested in winning customers on service, on availability, on the completeness of our offerings, and just be relentless in that every day. So, I think those are some of the areas that you will see growth on the customer side with us.

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 base. Okay. So, even though the price is higher, it's growing on a volume basis. And 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 people have less time to prepare products, and the idea at home, and meals at home, and idea that they can grab something quickly is still strong. So, the growth in grab and go convenience is still strong, and I think, 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 is a lot of tailwinds that are, let's say, covering or exceeding that downward pressure by price. At least 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 that 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 avocados 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, constraints 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, by the way, do that while at least temporarily, I would say, doing a hell of a job expanding our gross margin per case.

[Operator Instructions] 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 in the fiscal '24, we'd like to be at that run rate.

Got it, got it. That's what I thought, I just wanted to make sure I heard that right. And then one of the --

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, was stopped, or deferred, because of that resignation. We have now have people in place, and infrastructure in place to keep that going. And in fact, I even 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 in 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, we are -- headcount our resources beneath the C-suite have been relatively stable.

Okay, great. That's good to know and helpful context. And yes, I think, last couple of years made everybody rethink how they operate on 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 flown 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.

Okay. Well, thanks again for joining us for listening in on the prepared remarks and then the Q&A as well. There is a couple of things before I close that I'd really like everyone to remember. First and foremost, we're really proud of this quarter, we're proud of the quarter, but not satisfied. We know we have more work to do across our business and we've got the projects and plans in place to do it. I've been really excited about our Fresh business this quarter, not only in the avocados but our tomato program did really well and I think we took advantage of some unique market circumstances, and eventually those will normalize and our returns will normalize to regular levels but we were able to take advantage of that. I'm excited about the RFG progress, again, we're going to do this kind of one base it at a time and slow and gradual but going from minus 1% to 2% positive gross margin and then having the third month of the quarter be your best month out of the quarter is a really positive sign for our organization. And I'm really excited that in the grand scheme of all of this, we've worked our balance sheet too. We've worked receivables, we've worked collections, we've worked our accounts payable, and we managed to pay down $22 million of debt in the quarter, which is really good for the EBITDA we were generating. So, a lot of good things are happening. We continue to press forward, we continue to work for sequential improvement, sequential month over month, and quarter-over-quarter improvement and we're going to do that every single day. So, again, thanks for your time. I want to -- I'd also be remiss if I didn't thank the employees and supporters of Calavo who are out there trying to do something better today than they were yesterday, and we appreciate everybody tuning in. Hope you have a great summer and look forward to talking to you when we can. Thank you.