Farmer Brothers Company

Good afternoon, ladies and gentlemen, and welcome to the Farmers Brothers Financial Third Quarter's 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require operator assistance during the conference call, please press star then zero on your touchtone telephone. As a reminder, this call is being recorded. Joining us today are Deval Mazaring, 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 the Farmer Brothers website at www.farmerbros.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 Securities 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 reply 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 the management during this call about the company's future expectations, plans, and prospects may constitute forward-looking statements for purposes of the safe harbor provisions under the federal securities law and regulations. The forward-looking statements represent the company's views only as of today and should not be relied upon as representing the company's views on any other subsequent date. Results could vary materially from those forward-looking statements Additional information on factors that could cause actual results and other events to differ materially from these forward-looking statements is available in the company's press release and public findings. On today's call, management will also use certain non-GAAP financial measures, including adjusting 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 Deverell. Deverell, please go ahead.

Thank you, and good afternoon, everyone. Thanks for joining us today. Our 2022 fiscal third quarter represents another period of meaningful performance improvement across the business, highlighted by our seventh consecutive quarter of gross margin expansion and higher net sales. As volumes in both our DSD and direct ship businesses continue to recover. Further, we posted meaningful progress in our adjusted EBITDA performance by attaining a 20 million annual run rate this quarter. Operationally, we saw incremental improvements and continued recovery across our business throughout the fiscal third quarter. These improvements were aided by the efficiencies we've implemented across the businesses over the past couple of years. which have reinforced the strength of our distribution network and positioned us for further improvement as the industry continues to recover. While our fiscal fourth quarter is subject to typical seasonality, we expect to finish out the fiscal year on a strong note, and we're excited to see the full potential of our improved business as the recovery continues and consumer behavior normalizes. We posted net sales of $119 million in the third fiscal quarter. representing a 28% increase from the prior year, which was again driven by continued recovery in our DSD and direct SIP channels. Within DSD, we experienced our highest average weekly sales since early 2020 and have more routes running over 1 million of annualized sales than we've had in many years. We are seeing net new customer sales growth and increased drop sizes at our long-term customer locations. Additionally, our direct shift channel saw year-over-year growth of 23.7%, primarily due to higher volumes among critical customers and the increasing impact of our cost plus price increases, which are now flowing through our P&L. Turning to our gross margin, which, as we mentioned, has continued to expand over the past seven consecutive quarters. We reported a 29.8% margin in the third quarter. representing a 4.2% or 420 basis point increase from the prior year period and an expansion of 30 basis points from the previous quarter. As noted earlier, our adjusted EBITDA improved meaningfully to $5 million, compared to a loss of $0.8 million in the prior year period, representing the most robust operational performance we've seen since the onset of the pandemic. While we recorded higher adjusted EBITDA in our fiscal first and second quarters of 2021, those quarters benefited from one-time gains from our retired medical plan that were not a direct result of our field operational performance. Turning now to an update on our operations. With respect to specific markets, we saw a substantial recovery in our eastern and northeastern markets, both of which were more significantly impacted by COVID. Additionally, during the quarter, a major competitor closed over 60 plus branches, and we are seeing others scale back, which is presenting us with opportunities to expand our current offerings in these markets. While our highest customer concentrated western region, in addition to our northwest and southern regions, saw better sales compared to pre-COVID levels, they were not as heavily impacted in the prior year and did not have quite the same year-over-year growth opportunity. Nonetheless, All regions trended positively throughout the quarter and continue to show improvements year-to-date. In the Pacific Northwest, we continue to make progress in Portland, which will ultimately allow us to offset some of the higher costs we've been seeing and is also part of our proactive strategy for the region. On that front, our consolidation efforts remain ongoing, and due to our recent announcement that we'll be consolidating our West Coast coffee operations nationwide, into our existing facilities in the area, we expect more branch consolidation in the coming quarters. Further, we continue to make progress with our IT infrastructure in Portland and across the organization in key areas. Our consolidation efforts remain a key strategic initiative for us across the board as we continue to increase the efficiency of our footprint throughout the nation. More specifically, we We're considering the exit or sale of excess properties that will provide both lower operating expenses and potentially additional capital that would be used to reduce our debt levels. We are currently reviewing these branches along our vast asset base for opportunities to optimize our capital structure and expect to share more details on our plans for improvements that would include lower debt levels in the coming months. Despite the ongoing challenges with international shipping, we're pleased to see domestic shipping starting to normalize again, and we continue to find new ways to offset many of the higher costs we're facing due to the macroeconomic challenges. One such way we're doing so is by proactively managing more components of our DSD business. For example, we're able to offset some of the product and labor inefficiencies during the quarter by targeting our Tier 5 customers. or less profitable customers, and picking up older equipment for refurbishment and reinstallation at a higher volume and in new customer locations. Additionally, within our DSD businesses, we'll continue to implement surcharges, which we're now breaking down into individual delivery and fuel costs. I'll let Scott discuss all the nuances in more detail, but I'll quickly note that we continue to manage our pricing against inflation in an efficient manner. The price hack we implemented in November has now mostly flowed through our P&L and contributed meaningful to our DSD margin in the quarter. During March and April, we implemented additional price changes that essentially protect our margins for the current cost environment that we are seeing. In closing, We continue to manage through the inflationary environment during the third quarter and are encouraged by trends we see in the business as the initiatives we've been working on continue to take hold and translate into continued improvements in our financial performance. We're pleased with how quickly the business has responded to post-COVID world, which in large part is being driven by operational changes we executed throughout the pandemic. As we enter the fiscal Q4, we continue to focus on forecasting and managing inflation directly and indirectly. And despite the normal seasonality we tend to experience in our fiscal fourth quarter, we are confident in our ability to close out our fiscal year on a strong note. Before turning the call over to Scott, I want to quickly mention two things. As the 2020 calendar year marks two significant anniversaries for Farmer Brothers. First, The company turned 110 years old this year. While we're proud of all the progress we've made and are happy to say that we've been providing the U.S. with delicious coffee for over a century, we by no means plan on slowing down. In fact, we plan on being even more ambitious in the next 110 years. Second, we recently released our 10th Annual Sustainability Report, which can be found on our website. We are among only a handful of companies that have set and met specific scientific-based criteria in this realm. As a result, we're proud to say that for the second consecutive year, we were listed on the Carbon Disclosure Report CDP Supplier Engagement Leaderboard and recognized as one of the best companies for supplier engagement rating, SER, indicating our commitment to collaborate with our suppliers on climate action. Sustainability remains a priority for us. as it has for 10 years now, and we're incredibly proud of the work we've done there. With that, I'll turn the call over to Scott to walk you through our financials.

Thanks, DeVerell. Since DeVerell hit on the high-level numbers, I'll focus my commentary on the performance drivers and the strategic initiatives that enable us to achieve them. As DeVerell mentioned, our total sales were up 28.2% from the prior year period, which was driven by continued recovery across our channel. Further, our continued gross margin expansion was driven by higher contribution from DSD given the channel's higher product margins. Our DSD sales continued to recover in Q3 and we saw volume improvements on a year-over-year and quarterly sequential basis. During the quarter, we experienced our highest average weekly DSD sales since the onset of the pandemic and now have more routes running over $1 million on an annual sales run rate basis than we've had in many years. Within the channel, we also saw increased drop sizes at our long-term customer sites, and we continue to see new customer sales growth year-to-date. Please note, our DSD year-over-year comparisons reflect better production variances and inventory scrap write-downs from the closure of our aged Houston, Texas plant that happened last year. And while this quarter and our fiscal fourth quarter will have some negative production variances due to the Omicron slowdown, we do not expect these impacts to carry into our 2023 fiscal year in any meaningful way. Additionally, the price increases and delivery surcharges implemented across our DSD network in the previous quarter and flowing through our results in Q3 helped to mitigate that impact and will continue to offset some of the higher supply chain and product costs. We continue to keep our heads down on inflationary forecasting and do what we can to stay ahead of the pressures. As such, the price hike we implemented in November was by design and was needed to offset the higher inflation we experienced throughout the current quarter. We feel that our more recent price increases have positioned us well for the current environment we are operating in. We've also started analyzing our price increases by individual components, such as delivery and fuel surcharges instead of just product types, which provides us with more data and helps us forecast and manage the pressures more effectively. Additionally, it will also help us provide relief to our customers should the needed surcharge costs dissipate. If you recall, we made mention of another price increase last quarter which went into effect in April. So you can expect that to start to materialize in our financials throughout the fiscal fourth quarter. Even with the impacts of Omicron and the inflationary and other challenges we faced and continue to face, we posted our best gross margin in recent history for Q3, which speaks to our ability to manage expenses and implement price hikes strategically and effectively. As noted, we expect Q4 to be the first full quarter of normalized DSD operations with Omicron finally in the rearview mirror, and thus expect the efficiencies we've implemented to be better reflected in our gross margin. Turning now to our direct ship business. As previously discussed, our direct ship business operates under a cost-plus model, which means the pricing pressures flow to our customers instead of us manually increasing prices. As such, the inflationary challenges we faced from September through March in our direct ship business won't be fully realized until the next quarter as our pricing engine captures these increases and passes them along to our customers. While a portion of those price increases are recognized in our P&L, the remainder sits within our inventory line items. This is because two-thirds of our coffee pounds roasted and shipped are for our direct ship customers, which again, by the cost plus model. Because we have the data and control of our supply chain from bean to cup, we've also started to help our customers manage their inventory as the supply chain challenges around getting coffee beans into the US and the continued increases in coffee spot prices have become increasingly burdensome for them. So, to ensure that our customers stay in stock when possible, we've begun ordering our specialty coffee beans further in advance, especially our limited types of Arabica beans which have been significantly impacted by the higher commodity prices. As a result, our net debt is higher in the quarter due to the upfront investments we've made. In fact, the primary investments we've made throughout the quarter were in inventory, which increased by $13 million from the prior year period, $10 million of which were direct investments in coffee. Coffee spot prices from our 2021 fiscal year end, or the period into June 30 of last year, have increased by 42% on a cost per pound basis. At the same time, our coffee inventory balance on a cash basis over that same period has only increased by 27%. So, while our hedging strategy is working and helping mitigate those increases, we are still expecting some inflationary investment in coffee inventory on our balance sheet in the upcoming quarters. In the long run, our focus will be on optimizing the efficiency of our inventory to improve working capital metrics, which will also aid in lowering our debt leverage. Turning now to our operating expenses. In the third quarter of fiscal 2022, our operating expenses increased by $5.2 million, or 15.2%, to $39.5 million, from $34.3 million in the prior year period. As a percentage of net sales, our operating expense decreased by over 260 basis points to 33.1% of sales compared to 36.8% of sales in the prior year period. The increase in operating expenses on a dollar basis were driven by a $4.7 million increase in selling expenses and a $600,000 increase in general and administrative expenses. The increase in selling expenses was primarily due to variable costs. including payroll associated with the return of DSD routes over the past year and the operating costs associated with our new distribution center in Rialto, California. The increase in payroll in both selling and general and administrative expenses was predominantly due to the expiration of the temporary 15% reduction in base salaries and the expiration of the 401k cash match suspension under the Farmer Brother Company 401k plan. which were both cost-saving actions implemented in fiscal 2020 due to the COVID-19 pandemic. Our capital expenditures for the three months ended March 31, 2022, were $3 million, a decrease of $100,000 compared to the prior year period. This was due to lower investment spending of $1.1 million for several strategic initiatives completed during fiscal 2021, partially offset by higher maintenance capital spending of $900,000 compared to the prior year period. The higher maintenance capital was mainly due to coffee brewing equipment refurbished and purchased for our DSD customers as volumes have improved and new customers are being added. Several key initiatives, including a focus on refurbished coffee brewing equipment to drive cost savings on a per unit basis, have helped reduce our purchases as DSD sales volumes return. Turning now to the balance sheet. At the end of fiscal Q3, our total outstanding borrowings were $101.1 million, an increase of $10.1 million from June 30 of 2021, while our cash balance increased by $100,000 from $10.3 million as of June 30, 2021, to $10.4 million as of March 31, 2022. The increases in our total outstanding borrowings were primarily due to higher inventory costs and the investments we've made there, in addition to the payment of our fiscal 2021 employee incentive program. These uses of cash were partially offset by cash proceeds from the sale of three branch properties during the nine months ended March 31, 2022, and realized hedging gains. Our net debt, which we define as total outstanding borrowings, less cash and cash equivalents, was $90.7 million at the end of our third fiscal quarter, compared to $80.7 million at fiscal year end of 2021, primarily due to the noted investments in inventory and incentive plan payments. Going forward, our focus remains on generating improved cash flow and paying down our debt. With that, I'll now turn the call back over to DeVerl.