Farmer Brothers Company

Welcome to the Farmer Brothers Company Q3 Fiscal 2020 Earnings Conference Call. My name is Annette and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. During the Q&A session, if you have a question, please press star then 1 on your touchtone phone. I will now turn the call over to Jennifer Milan.

Thank you, and good afternoon, everyone. Thank you for joining Farmer Brothers' third quarter fiscal 2021 earnings conference call. Joining me today is Devorah Massarang, President and Chief Executive Officer, and Scott Drake, Chief Financial Officer. Earlier today, the company issued its earnings press release, which is available on the investor relations section of Farmer Brothers' website at www.farmerbrothers.com. The press release is also included as an exhibit to the company's Form 8K and is available on the company's website and on the Security and Exchange Commission's website at www.sec.gov. A replay of this audio-only webcast will be available approximately two hours after the conclusion of this call. The link to the audio replay will also be available on the company's website. Before we begin the call, please note that all of the financial information presented is unaudited and that various remarks made by management during this call about the company's future expectations, plans, and prospects may constitute forward-looking statements for purposes of the safe harbor provision under the federal securities laws and regulations. These forward-looking statements represent the company's views only as of today and should not be relied upon as representing the company's views as of any subsequent date. Results could differ materially from those forward-looking statements. Additional information on factors that could cause actual results and other events to differ materially from those forward-looking statements is available on the company's press release and public filing. On today's call, management will also use certain non-GAAP financial measures, including adjusted EBITDA and adjusted EBITDA margin, in assessing the company's operating performance. Reconciliation of these non-GAAP financial measures to their most directly comparable GAAP measures is also included in the company's press release. I will now turn the call over to DeBorl. DeBorl, please go ahead.

Thank you, Jennifer, and good afternoon, everyone. Thanks for joining us today. Our third quarter was highlighted by continued execution of our business optimization, including the doubling of capacity at our Dallas-Fort Worth, Texas facility. The formal shutdown of our Houston, Texas facility and the opening and full ramp up of our new West Coast distribution facility in Rialto, California. Despite the seasonality impact we've historically had in our fiscal third quarter, we've experienced encouraging trends in our DSD business in recent weeks, with sales beginning to stabilize down into the mid to high 20s on average compared to pre-COVID levels. In fact, the week of March 29th was the best week we've had since the onset of COVID. with sales down only 25% compared to pre-COVID levels. Further, the month of March was the best month we've had in terms of sales performance since the pandemic took effect, which drove the strongest gross and operating profit we've had this fiscal year. Despite the anticipated choppy rebound from the pandemic across both markets and customer sets, we're pleased to see the business responding well now that we're consistently under the down 30% mark. It's a good sign as our country continues to recover. Geographically speaking, we're still feeling the impacts in some of our eastern markets. But we see encouraging data in our southern and midwestern regions. And despite lagging reopenings in California and recent outbreaks in Oregon, our most concentrated western markets have positively contributed to our recovery. And according to the governor of California and the mayor of New York City, We can expect to see reopenings in those key areas as early as June 1st. Overall, the fact that our DSD sales are down only around 25% compared to pre-COVID levels is reassuring. With respect to our end markets, recovery trajectory varies from customer set. We're beginning to see consistent weekly improvements in our C-store markets and to even a greater extent within our restaurant segments. However, as you might expect, we will still see headwinds in healthcare, as waiting rooms and cafeterias are still largely shut down. The lodging and casino markets are also slower to ramp up, and hotels and casinos have yet to resume serving breakfast or coffee. While the recovery in these markets may take time, given the behavioral component of these activities, they entail We expect these segments to help drive sales in upcoming quarters as businesses reopen. As we follow the path to sales recovery, it's important to remind everyone that with many of our optimization initiatives now complete, we believe that we don't have to generate the same top-line numbers as we did pre-COVID to deliver comparable EBITDA. That's due to the considerable and scalable efficiencies we've put in place that will benefit us tremendously as sales improve. Let's turn to an update on our footprint optimization efforts. As you will recall, when COVID hit, our initial objective was to stabilize the business, which was accomplished pretty quickly. Next, we turn to accelerating the execution of our turnaround through restructuring certain parts of the business, which is also now essentially complete. Now, with the most significant initiatives within our optimization plan in place, We're zeroing in on smaller but important items that will better position us as volumes return. Our West Coast distribution facility in Rialto is now fully operational. We're pleased with the speed at which we opened and fully ramped up production, which was completed ahead of plan. Rialto is currently exceeding our expectations in terms of total transactions per day and now shipping 6,000 cases per day versus the 2,000 cases it was shipping per day when we first opened. This facility is also now servicing 33 of our branches. With Rialto now fully ramped, we have turned to our production optimization as we continue to modernize our facilities and work through some COVID-related challenges, such as workforce shortages and supply chain management. While we experienced some one-time cost this quarter associated with the process, we're now beginning to see the benefits of these efficiencies we designed into our plans, which will become more apparent as businesses rebound in the coming quarters. It's also worth noting that we're currently undergoing consolidation of some regional facilities assets in Rialto. Our Santa Fe Springs, Santa Ana, and Rialto branch facilities have been moved to held for sale and will be consolidated throughout the next quarter. Ultimately, the sale of these assets will provide additional cash liquidity and further strengthen our balance sheet. Turning to our now shuttered Houston facility. The facility itself and the related land were sold in 2019 and we have now successfully auctioned off any of its remaining assets. The auction exceeded our initial expectations and will officially turn the building over to the landlord this month. Additionally, while any equipment or items from the facility that we don't need have been sold, anything we do need from the facility has been transitioned into Northlake and is now fully installed. The challenges we're currently facing are ramping up our skilled workforce and increasing our scale at DFW as we work to balance production as efficiently as possible across our manufacturing network. As you probably know, the nation is facing workforce shortages in some sectors due to the lingering disruption from COVID, and we are certainly not immune. Further, while we've avoided mass outbreaks at our facilities throughout the pandemic, unfortunately, we've recently experienced some smaller COVID spikes internally, which we'll continue to manage and balance going forward. There are also some other micro challenges we're working through. While we're managing our product lead times as best as we can and got ahead of most of the commodity pricing issues we've seen creeping up, we're still experiencing some supply chain delays. With the COVID-related manufacturing shutdown in China and the Suez Canal delay, the shipping industry is putting a strain on our supply chain. As such, some of our coffee brewing equipment has been delayed and thus some installations. We believe these issues will dissipate in the midterm, but expect to continue to feel the effects for the next 12 months or so. We're pleased with how far we've come with our optimization plan and have now primarily reached our foundational near-term objectives. However, we're still working to optimize our production and modernize our other facilities. We've had our head down on staffing and getting people back to work. which have proved to be a challenging endeavor. We take pride in having some of the most skilled technicians and sales representatives in the business, and there is a training curve for new folks. So it takes time to bring them fully on board. However, that time is well spent, and our efforts will ultimately pay back later. Further, we've strategically reviewed compensation to ensure we are competitive in attracting top talent. Before turning the call over to Scott to run through our financials, I want to quickly touch on our e-commerce initiatives. During the quarter, we launched our third e-commerce site for our China Mist brand. With e-commerce sites already up and running for public domain and boards, we're now beginning to ramp up our marketing efforts to target retail customers directly. Again, this channel still makes up only a fraction of ourselves, but we have plans to integrate e-commerce capabilities across the whole business. So testing and learning all we can from these launches will be critical to the long-term success of our e-commerce business. Lastly, we believe that the changes we've made over the past 12 months have significantly improved the underlying fundamentals of our business and are increasingly doing so. However, at present, there is still too much uncertainty in the trajectory of recovery to provide meaningful guidance. As vaccinations are increasingly made available, the country becomes safer. We are optimistic that we'll see increasing stabilization ultimately leading to recovery. Once we begin to move toward a new normal, we'll be in a much better position to provide color on what the new Farmer Brothers looks like from both a margin and performance perspective. In the interim, we are focusing on completing the full optimization of our network. especially at a Rialto and Northlake facilities to drive incremental efficiencies that will benefit us as a business recovers. With that, I'd like to turn the call over to Scott.

Scott? Thanks, DeVril. During the three months ended March 31st, 2021, we continued to make progress against pandemic headwinds. While we reported declines in our DSD and direct ship sales channels compared to the prior year period, The results show encouraging sequential sales improvements in our DSD business compared to pre COVID levels. Most recently in April, average weekly DSD sales were down 27% compared to pre COVID levels, which are the most robust sustained DSD sales levels we've seen since the start of the pandemic. For the third quarter, average weekly DSD sales were down 36% compared to pre COVID levels. As expected, The most significant DSD revenue declines in terms of dollar impact were from restaurants, hotels, and casino channels, which have been slower to recover. Overall, the trends have been heading in the right direction over the past 12 months, even with the seasonality we've historically felt during this period. We are now seeing significant improvements over the trough in April 2020, when DSD sales were down by approximately 65% to 70%. Our direct ship sales declined 23% in the quarter compared to the prior year period due to lower coffee volume related to COVID-19 and the impact of coffee prices for our Cost Plus customers. This was partially offset by improved volume from our retail business, key grocery stores under their private labels, and third-party e-commerce platforms. We also experienced a bit of a sales shift into the month of April with limited customers. Our net sales in the third quarter of fiscal 2021 were $93.2 million, representing a decline of $36 million, or 28%, from the prior year period. As a result of the continuation of reduced volumes from our DSD business, our gross margin decreased to 25.6% from 29.4% year over year. The fiscal third quarter gross margin continued the trend of sequential improvement in each quarter of this fiscal year, which we expect will continue throughout the remainder of the fiscal year. Net loss was $13.7 million in the third quarter of fiscal 2021 compared to a net loss of $39.8 million in the prior year period. Adjusted EBITDA in the third quarter was negative $800,000 compared to adjusted EBITDA of $6.6 million in the prior year period. Note that the curtailment of the gain related to our post-retirement medical plan is now complete. With the plan sunsetting as of December 31st, 2020, the amortization and gain has now ended. As a result, we no longer benefit from the $7.2 million quarterly benefit that we have experienced in each of the previous COVID impacted quarters. As a reminder, EBITDA. EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin are non-GAAP financial measures. You can find a reconciliation to the comparable GAAP measures at the end of the Q3 financial results press release that we issued earlier today. Our total operating expenses decreased by $48.8 million to $34.3 million in the third quarter. compared to $83.1 million in the same period of the prior year. These declines were attributable to a $9.2 million decrease in selling expenses and the absence of $42 million of goodwill and intangible asset impairments. This was partially offset by a $2.2 million increase in general and administrative expenses due to bonus reversals in the prior year's third quarter and a $200,000 increase in net losses realized from the sale of assets. As DeVerle noted earlier, we also experienced some additional costs this quarter related to the new Rialto Distribution Center and the exit of our Houston facility that will not recur. We have made considerable efficiency improvements in our operations, as DeVerle has detailed, and we expect those to materialize in our financial results as sales volumes continue their recovery. It's worth noting that the most significant go-forward cost savings will flow through our cost of goods sold and not our SG&A. which is one reason that we're confident that we'll see margin expansion over the next few quarters. Notably, as volumes do come back, we also expect some expenses to return as we bring back people to operate our routes and facilities. However, the net impact will be margin accretive, and we are looking forward to seeing what a fully optimized Farmer Brothers can do once the country as a whole reaches its new normal and fully open status. Our capital expenditures for the nine months ended March 31st, 2021 declined 45.6% from the prior year period to $12.8 million, which includes lower maintenance capital spend of $5.8 million, partially offset by other capital spending of $7 million that was primarily dedicated to key initiatives completed during the fiscal year. The spending reductions were driven by several key initiatives. including a focus on refurbished CBE equipment to drive cost savings and reductions across some capital categories due to additional cost controls implemented during the pandemic. This is the second consecutive quarter with reductions of roughly 50% in our year-over-year maintenance spend, which were driven by the recent refurbishing trends. Over 80% of our equipment was refurbished during the quarter versus less than 20% that was bought new. In past years, This ratio was around 70% new equipment and 30% refurbished equipment. However, we do expect a continued recovery in the U.S., and that will begin to limit our supply of refurbishable equipment, and we think that we'll settle into a normal mix of around 70% refurbished equipment and 30% new in the longer term. Regarding our third-party CBE initiative to begin developing revenues from our service capabilities, we've also made strong headway. And with our new CBE back office infrastructure now built, we've now started pilot testing in more markets. The next steps of this test include setting up detailed third-party contracts with key relationships and building a dedicated website to help drive demand. Turning now to our balance sheet. We successfully completed a new financing agreement during the quarter, which includes an $80 million asset-backed revolving credit facility and a $47.5 million term loan. The completion of this new arrangement will provide us with greater flexibility in leveraging our assets at a lower cost of borrowing, further solidifying our capital structure, and allowing us to return our focus to our customers, operations, and other strategic growth initiatives. Our revolver's outstanding balance was $88 million at quarter end, representing a decline of $34 million since June 30th of 2020. Our cash balance decreased to $8.5 million as of March 31st, 2021, compared to $60 million as of June 30th, 2020. These changes resulted from the repayments on our revolver completed under the terms of our amended credit facility in July of 2020. As of April 26th, 2021, our total debt was $93 million and we had unrestricted cash of $8.2 million and $23 million of availability under our new credit facilities. We also had restricted cash on hand of $4.5 million used to collateralize our letters of credit on the old facility until we issue the letters of credit on the new credit facility. Overall, we're pleased with the progress we've made, and we're looking forward to finishing our fiscal year in a stronger position. We also look forward to providing you with better insights into the business, hopefully in the near future. once we gain better insights into how our now optimized business operates in a stabilized post-COVID environment. Thank you, and I'll now turn the call over to DeVerl for closing remarks. DeVerl?

Thanks, Scott, and thanks to all of you who tuned in for our call today. We're pleased with the recent trends in our business and excited to see greater benefits from all we've accomplished as the country continues to rebound in the coming months. With government representatives announcing plans to fully reopen soon in certain markets, we look forward to updating you shortly on the substantial and fundamental efficiencies that will become increasingly evident as our volumes continue to recover and our efficiencies scale. We also look forward to reflecting on all the hard work our team has put into effecting our turnaround plan and demonstrating the underlying strength of our business. Thank you again. And I now will turn the call back over to the operator to field any questions. Operator?

Thank you. We will now begin the question and answer session. If you have a question, please press star then 1 on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then 1 on your touch-tone phone. There will be a slight pause before the first question. Okay, and our first question is from Kara Anderson with B. Reilly Securities. Go ahead.

Hi, guys.

Hello, Kara.

Thanks for taking my questions. I guess to just start off, is it possible to quantify the revenue impact from severe weather or differences in selling days or seasonality versus the fourth quarter that it had on the the, sorry, not fourth quarter, your second quarter, add on your third quarter.

Yeah, actually, it's quantified as the numbers that we put as the unusual item in there, but really it was more of a You know, the Dallas area, you know, since our plants are based here, it was about a week-long disruption of one kind or another. And then we had, obviously, a little period of recovery after that. But I think it was more a timing issue than it was really direct impact to revenues. It just caused us to have to move things around and do a little bit of catch-up, but it did impact us a little more on the cost side.

Got it. I guess I missed that in the release. On the DSD business, down 36%, I think, from pre-pandemic levels in the quarter as a whole. Can you or did you discuss how March is kind of comparing to April, given that you've stated March is kind of like your best in the quarter?

Yeah, actually, we... We put the numbers in there. The best way to think of it really, we don't talk a lot about months, but if you were to break the Q3 months apart, really January and February, they look exactly like November, December timeframe did. The impact of COVID was really the same as once we had the resurgence in early to mid-November all the way through February. It was March where we really had the recovery and, you know, had much better performance within the business, and then it's continued in April. So we talk about how in April we're running it, you know, down 27% to pre-COVID levels, and it wasn't quite that good in March, obviously. It was still in the, you know, the 30s or so.

Okay.

But much better than it turned before. It was clearly, you know, 40, you know, the low 40s the other months before that.

Understood. And then on the direct ship business, there was a pretty big sequential change in the green pounds sold, more than what I would expect for seasonality. Can you talk about that?

Yeah, absolutely. That was another one that we probably should have maybe called out a little more plainly because in our discussions internally, we realized that was something maybe we didn't address fully. But you're right. There is some seasonality impact in there. But on top of that, we're also starting to cycle the exit of some of those customers that we've talked about. You know, as Deverell came on, looked at the business, and he and Chris spent time together looking at the business, this is that timeframe where some of those customers were in last year's results as direct ship or national account customers, and they weren't in this year's results. But in the script, we also talked a little bit about how we had a little bit of a shift of some of those sales just straight timing between March and April. So, again, it kind of got overstated in this third quarter here a little bit because of that timing, a little bit of which was due to the weather that we just spoke of. And then I think cost plus customers was another one where year over year, there was a little bit of a price deflation on some of those as well.

Just so I understand, the customers that are cycling out, like, were those customers also in the second quarter then, and they're just, like, rolling off because of large programs?

Yes, yes, some of them were. And there were a couple that were decent size that were in the second quarter, yes. Okay. So we're literally kind of hitting that anniversary of when they exited the business, you know, just out a year ago or just under a year ago.

Got it. And then, I know you're not giving guidance, but is there a threshold for when we think you get back to the 30% gross margin range that we can think about from a revenue perspective?

Yeah, it's really dependent on the pace of the recovery. We're obviously hopeful that we'll get there sooner than later, and we're very confident we'll get there. It's really a matter of a couple of key events that are coming up soon will give us some good information. One of those is obviously the opening that's planned for California at the start of June. Then out east, I think they're starting to look at dates around the start of July. And kind of as DeVille noted in his script, the other parts of the country are really outperforming. It's the east and the west that are still better than they were, certainly performing better, but they're still lagging behind the other parts of the country. So we're looking to those two key dates. Obviously, unfortunately, we won't get a lot of great information by the end of Q4, but we'll start to see some of that in June. And then, you know, obviously, once we get – that's kind of why we speak to the next few quarters. We think there will be this kind of downhill run with both sales and margins.

Got it. And then just last, a housekeeping question, the breakout for coffee revenue in the quarter?

Yeah. So roasted coffee as a percent of total sales was 65.2% for the quarter.

Great. That's it for me. Thank you.

You got it. Thanks, Karen. Thank you, Karen.

Okay. And we have a question from Sam Namiri of Ridgewood Investment.

Hello. I just wanted to follow up on the last part of the question that Kara asked was, can you break out the places that have been fully open, what sales in the DSD business have been comparatively to pre-COVID? Okay.

Sam, I appreciate the question, but we haven't historically broken it out by region or branch publicly. And don't plan to provide that level of information other than what we do at the level that we've been providing.

OK.

We just haven't historically done it. And yeah, competitive reasons, since we're the only public company talking.

Got it. Okay. But you mentioned like it's outperformed. Maybe can you give a little more color on what you mean by outperformed?

Yeah, just the recovery rates are stronger in, you know, I would say the South, the Midwest, you know, those kind of core areas of the country. If you look at, you know, the total decline they had during COVID, not only are they performing better as a percentage of that, but the percentage of recovery, you know, they're just further back to where they were originally than the East and the West areas. And obviously it's primarily due to, you know, just the reopening trajectory of the states and areas and geographies. that have opened either more fully or fully as compared to the far east and west coast or you know specifically new york and california okay okay um i think that's good for me appreciate it okay and with that we are concluding today's conference we thank you ladies and gentlemen for participating

You may now disconnect.