Farmer Brothers Q3 2024 Earnings Call Transcript

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May 9, 2024

Key Takeaways

  • Q3 saw a 660 bps gross margin improvement to 40.1% and adjusted EBITDA turn positive at $0.3 million versus a $0.6 million loss a year ago.
  • The company has consolidated roasting, packaging, and production at its Portland facility and is rationalizing SKUs into a three-tiered coffee offering, expected to finish by Q1 FY 2025 to drive cost and inventory efficiencies.
  • Management reported an inflection in customer retention, with churn stabilizing to neutral levels as in-stock positions, delivery capabilities, and route technology improvements take effect.
  • Farmer Brothers ended Q3 with $5.5 million in unrestricted cash, $30.5 million of revolver availability, and remains on track to be free cash flow positive in early FY 2025.
  • Ongoing technology upgrades—including a handheld device refresh, CRM Phase 1 rollout, and ERP enhancements—aim to strengthen inventory management and customer service.
AI Generated. May Contain Errors.
Earnings Conference Call
Farmer Brothers Q3 2024
00:00 / 00:00

There are 5 speakers on the call.

Operator

Good afternoon, and welcome to the Farmer Brothers Fiscal Third Quarter 20 24 Earnings Conference Call. At this time, all participants are in a listen only mode. As a reminder, this call is being recorded. Earlier today, the company issued its quarterly shareholder letter available on the Investor Relations section of Farmer Brothers' website at farmerbros.com. The shareholder letter is also included as an exhibit on the company's Form 10 Q and is available on its website and the Securities and Exchange Commission's website atsec.gov.

Operator

A replay of this audio only webcast will also be available on the company's website approximately 2 hours after the conclusion of this call. Before we begin the call, please note all of the financial information presented and unaudited and 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 provisions under the federal security laws and regulations. These forward looking statements represent the company's views 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 which could cause actual results and other events to differ materially from those forward looking statements is available in the company's shareholders' letter and public filings.

Operator

On today's call, management will also reference 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 shareholder letter. I will now turn the call over to Farmer Brothers' President and Chief Executive Officer, John Moore. Mr. Moore, please go ahead.

Speaker 1

Good afternoon, everyone, and thank you for joining us. Over the course of the Q3, we continued to see positive momentum as we made year over year gains versus many of our key metrics. We see ongoing progress in our transformation to becoming a direct store delivery based organization and in our efforts to optimize utilization of newly rightsized operations. We executed a new corporate headquarters lease in Fort Worth, Texas, which better aligns with our current business needs. We also continue to consolidate roasting, packaging and production at our Portland, Oregon facility.

Speaker 1

In addition, we made significant strides in our brand pyramid and SKU rationalization initiatives. Designed to create clearly defines traditional, premium and specialty coffee lines within our product catalog, this change to our brand pyramid will remove SKU redundancies and simplify our offerings for customers. It will also provide additional operational and cost efficiencies for the organization as well as streamline our inventory and overall sales approach. We achieved a milestone in relation to this project during the Q3 as we now have more SKUs related to our new tiered coffee offerings in inventory than those of our previous catalog. We are encouraged to already be seeing scheduling and production improvements leading to increases in our in stock and delivery capabilities.

Speaker 1

We expect to complete this initiative by the end of the Q1 of fiscal 2025. We are also continuing to improve our field operations through investment in technology upgrades and enhancements. We recently completed an upgrade of handheld devices for our route sales representatives, which will simplify device management, enhance support and improve our inventory management invoicing and overall customer service efforts. The common theme in these initiatives is that we remain focused on customer growth, retention and improving key elements of our value proposition to ensure profitable growth. This process will take time, but our efforts and initiatives are beginning to bear fruit.

Speaker 1

We reached an inflection point during the quarter as retention trends stabilized and our rate of customer decline improved compared to the prior year. Overall, we are proud of the strides we have made so far this year and the early wins we have achieved related to our DSD transformation, but there is still much work to be done. As we have said before, we do not expect our results to be linear quarter to quarter. Change of this magnitude takes time and patience as we continue to implement the deliberate foundational changes necessary for long term success. Our focus continues to be on the following: driving customer retention and growth, improving our cost structure, delivering incremental margin improvement, increasing market penetration for new on trend products and completing the transitional services associated with our direct ship sale.

Speaker 1

With that, I'll turn it over to Brad to discuss our financials in more detail. Brad?

Speaker 2

Thanks, John, and hello, everyone. As a reminder, results for fiscal 2024 and the prior year Q3 are reported on a continuing operations basis, reflecting the performance of our DSD business in the respective periods. Please refer to our Form 10 Q, which was filed with the SEC today further information regarding the respective performance of our discontinued and continuing operations. Overall, we're pleased to have maintained the positive year over year gains we have made in gross margin and adjusted EBITDA profitability. Net sales for the Q3 of fiscal 2024 were relatively flat on a year over year basis at $85,400,000 compared to $85,700,000 in the prior year period.

Speaker 2

Overall, net sales were impacted by a reduction in total unit sales, which were offset by higher pricing. During the quarter, gross margins increased 660 basis points compared to the Q3 of fiscal 2023 moving from 33.5 percent to 40.1% respectively. Gross profit during the quarter increased $5,500,000 to $34,200,000 or 19% on a year over year basis. This increase in gross margin was primarily driven by improvements in pricing and a decrease in underlying commodities costs. Operating expenses decreased slightly from $35,600,000 in the prior year period to $34,700,000 during the Q3 of fiscal 2024.

Speaker 2

This improvement was a result of a $2,300,000 increase in net gains associated with property sales and other assets and was offset by a $1,300,000 increase in selling expenses and a $200,000 increase in general and administrative expenses. The selling expense increase was primarily a result of additional costs related to healthcare benefits and vehicle rental expense, both partially offset by a decrease in advertising related expenses. Net income from continuing operations moved to a loss of $682,000 during the quarter compared to a loss of $6,900,000 during the prior year period, an improvement of more than $6,200,000 Our capital expenditures for the quarter were flat on a year over year basis at $3,400,000 In fiscal 2024, we anticipate between $12,000,000 and $15,000,000 in total capital expense. We expect to finance these expenditures through cash flow from operations and borrowings under our credit facility. Adjusted EBITDA for the 3rd quarter remained positive for the 2nd consecutive quarter at $271,000 This compares to a loss of $579,000 in the prior year period.

Speaker 2

Looking at the balance sheet, as of March 31, 2024, Farmer Brothers had $5,500,000 of unrestricted cash and cash equivalents and $200,000 in restricted cash. We had outstanding borrowings of $23,300,000 utilized $4,600,000 of the letters of credit sublimit and had 30,500,000 dollars of availability under our revolver credit facility. We believe we are adequately capitalized to finance our operations and expect to achieve our goal to be free cash flow positive in early fiscal 2025. Although we do not expect results to be linear quarter to quarter, we are pleased with the gains we have made so far in fiscal 2024 and are confident we are building a foundation to support long term profitable growth and value creation. With that, I'll turn it back to John.

Speaker 2

John?

Speaker 1

Thanks, Brad. As you have heard, we are making market progress in our DST transformation, but are nowhere near the finish line. It is our view that there is a significant amount of upside still to be realized in operational and cost efficiencies as well as top line growth. We firmly believe in the potential of Farmer Brothers to generate significant and sustainable shareholder value. Thank you to all for joining us on the call today.

Speaker 1

Operator, we will now open it up for questions.

Operator

We will now begin the question and answer Our first question will come from Gerry Sweeney with ROTH Capital. You may now go ahead.

Speaker 3

Good afternoon, guys. Thanks for taking my call.

Speaker 4

Hi, Jerry. Hey, Jerry. How are you?

Speaker 3

Doing well. Thanks. I wanted to start on customer retention. It sounded like 2 different things that was pulling out from the quarter. 1, revenues were down and it sounded as though revenue was down because you some customers had left.

Speaker 3

But secondarily, in your script, you talked about customer retention stabilizing. Are we sort of was that an inflection point during the quarter that retention has sort of flipped from a negative to a positive? Just want to dig in on that a little bit further.

Speaker 1

Yes. Hi, Jerry. This is John. In terms of the customer retention, what we're seeing is the numbers are the decrease in customers that we were facing last year, the cadence at which that was happening, it's much, much better than it was. And if anything, it's stabilized and come to neutral.

Speaker 1

So that in and of itself is a huge positive relative to the performance last year. And I think as we continue to refine how we're going to market and focusing on execution at the field level, we're seeing that it's starting to bear fruit. So in the past, we've talked about operational excellence when it comes to showing up at the right place at the right time with the right product at the right price and basically fulfilling on the service proposition. We're starting to see that as we invest in our manufacturing capability, our planning and procurement capability, we're building in better systems and infrastructure allowing us to fulfill on the value proposition of the customers, that's beginning to bear fruit. And again, we're starting to see that the customer accounts are approaching neutral or at neutral, even turning a little bit positive from week to week.

Speaker 1

And that's an extremely positive situation for us.

Speaker 3

Got it. So we're getting there is sort of I'll put it as a summation. We're getting there. It's improving. We're looking at it week to week and we're getting to neutral, if not positive.

Speaker 3

Got it. And then secondarily, on the operational side, see here, reduced SKUs, scheduled planning, roasting, consolidating everything in Portland. Where what inning would you say you're in on that process? And how much opportunity remains? It sounds like we're still in the early, early section of that to be honest with you.

Speaker 1

Yes. I would say we're in the early to mid innings. We haven't brought in our 1st reliever yet.

Speaker 3

2nd time for the lineup.

Speaker 1

The other piece to that puzzle is that when we initiate a change in the planning and production, it takes weeks for that to be realized at the field level. I can tell you that there has been exponential improvement. We're tracking this on a weekly cadence and of course we're planning production daily. There has been a market improvement. If I look from February to today, there's significant improvement in our fulfillment rates.

Speaker 1

Not only in the fulfillment rates, but then also in our line of sites and ability to track from the manufacturing level all the way through to the branch level. And I know you've been following us for a while and you may have heard in the past we talked about difficulty in establishing line of sight to the branch even beyond to the route level where it really matters to the customer. And I think we've made substantive changes in our infrastructure, redeploying assets, building new systems of communication from the branch level operatives back through to the planning and procurement even into the manufacturing piece, integrating all of those in a meaningful way so that we get manufacturing cadence that matches to the need of the customer. And I would say that that is a somewhat new capability that we've developed in the last couple of months. We are beginning to see meaningful fulfillment at the branch level, but we're in that regard we're in the early innings.

Speaker 3

Does that mean you're having the right products on the trucks to satisfy customers?

Speaker 1

That's correct. So in the past, we felt as though we had the right products in the system in general, they just happened to be in the wrong place. Today, I would say that we're getting much better about manufacturing the right products and getting them to the right place at the right time. And in that regard, we're in the early inningsmiddle innings, but we are beginning to see the impact. And that's one of the things we see with this Q3 inflection in the customer rates.

Speaker 1

We feel as though that's having an immediate impact. And that's by the way, that same level of line of sight on the finished goods inventory side, we're also making substantive changes on the other piece of this, which our field representatives and the customers told us, again reinforced by the artificial intelligence engine. The other piece of that equation was the equipment placement and getting speed to market with the equipment, so that customers could actually brew the coffee and service their customers further downstream. And there again, we've made substantive changes making sure that at the branch level, there's an adequate inventory of the equipment that is most often used in the field so that they can get speed to market with their equipment placement and allocation. So on both sides of that, the pieces that the customers were telling us through their purchasing cadence, there were issues around retention and purchasing.

Speaker 1

Now we feel as though we've made substantive changes and we're beginning to get traction with

Speaker 2

those. Jerry, one thing I'd add is, as you're looking at this, you're reading the P and L and trying to see what inning we're in. We call that I think in the shareholder letter that we are now our inventory level on the new SKUs for example is higher than the inventory level on the old SKUs. As that flows to the P and L though that's still to come because that product has to get sold through. We get through the old inventory, we start selling the new inventory.

Speaker 2

At that point you see it on the top line. Then you start to see the efficiencies on the bottom line. We're less and doing less with more inventory other way around. We're doing more with less inventory. So all of these things are we have a line of sight to this progress being made and then it trickles through the supply chain and then trickles through the business.

Speaker 2

So you'll see those things as we go along. As we talk about these inflection points, just keep that in mind.

Speaker 3

Got you. And I should have asked this question earlier, but when you talked about the AI pricing engine, there were several models. 1 was the pricing and the other 2, I think, were market basket and customer retention. And they were going to, I think, be for lack of better term, turned on, I think, this year. Just curious if they're in play and if they're part of the solution not only driving sales but customer retention?

Operator

So

Speaker 2

that was part of our initial understanding of what we could do with that tool. I would not say that we're driving market basket with the AI tool at this point. It's certainly in the capability. What I would call out is that we've used it a key part of the pricing engine is to anticipate when we think we might lose a customer because that is the most critical thing to pricing. So applying the fact that we have the pricing engine built means we've done more than just optimized pricing.

Speaker 2

It's also given us really good feedback on how to retain customers in general, not just related to the price we're giving them, but I would say that intelligence has driven us towards our focus on in stock position and our focus on equipment service levels. So we found those to be good predictors of customer turnover. So we're leveraging that tool for more than just, hey, what's the price of this pound of coffee? But that said, we haven't gotten to the basket driver yet. I would say we've found lower hanging fruits that's pretty valuable on the way there.

Speaker 3

Got it. And then just new products growth opportunities. Obviously, I think you guys are getting to a point where operational efficiencies are coming into play we're seeing in the margins we're seeing in EBITDA results, etcetera, and your target for free cash flow. The next real step is and I know you're not done with that side, but next step is maybe new products and adding that to the system and getting some growth, maybe some thoughts on that?

Speaker 1

Yes. You bring up a great point, Jerry. I mean, as you know, we've been emphasizing both the shots, the innovative syrup line extension that we have in our portfolio and also the Boyd's liquid Ambient coffee, both of which are beginning to get traction. There's no question when we talk about driving top line growth, one of the bigger opportunities for us is really the idea of product penetration in the customers that we have. And that's where offering products like Schott, like the Boyd's liquid Ambient coffee throughout the rest of this fiscal year as they begin to gain traction probably into the next fiscal year as they continue to grow and come to maturity.

Speaker 1

Those will continue to be points of focus for us. We do see some positive signs of growth in both right now. And then obviously we also have an eye to the future. So a future state beyond that what will the next innovation look like. We're constantly looking toward a future state where we'll be shifting emphasis in months ahead toward new products and new introductions.

Speaker 3

Got it. And staying with this theme on growth, what about adding more routes? Or are your routes optimized? Or is there an opportunity there?

Speaker 1

There may very well be opportunity there longer term. I think right now what we're looking to as opposed to adding routes, it's adding density to the routes that we have. And I think one of the things we're looking at how do we more value out of the existing infrastructure that we have. There's still a lot to be gained through that exercise. And I think we are really looking to leverage the assets we have where we have them and look channel by channel for opportunity.

Speaker 1

So rather than adding routes, I think you would see us optimizing routes and adding value to the routes that exist at the moment. But we are also keep in mind, we've completely transformed the sales team and fulfillment capability. We've added with Tom Bower's leadership as the Chief Commercial Officer, we've completely restructured that side of the business and established new KPI sets, what we refer to internally as power rankings. And we've created somewhat of a performance driven culture on that side of the equation. And that's another piece that we look to in order to grow through new customer acquisition, but at the same time with an eye to establishing density in areas where we already exist.

Speaker 3

Got it. Density is key to route based businesses. So I get that. That is it for me. I appreciate it.

Speaker 3

Thanks.

Speaker 1

Thanks, Jerry. Thanks, Jerry.

Operator

Our next question will come from Eric De Lloris with Craig Hallum Capital Group. You may now go ahead.

Speaker 4

Great. Thank you for taking my questions and congrats on the SKU rationalization progress here. Thanks, Eric. My first question is kind of diving a bit more deeply into that SKU rationalization and the progress there. So I understand that you're expecting to have all the legacy SKUs sort of fully out by the end of Q1 of fiscal 2025.

Speaker 4

Have you finalized which SKUs and brands will be included in the new tiered offerings? Have you fully built out what those tiers will look like?

Speaker 1

We have in terms of the first two tiers where most of the volume is. So essentially in the traditional tier, we've established the Farmer Brothers brand as our traditional tier offering. And then what we're referring to as the premium tier, we have the Boyd's brand positioned to take that space. We're still working on the brand expression in the specialty space. But those will be essentially the 3 defined tiers.

Speaker 1

The value propositions presented by those are pretty much well defined. And essentially now we're in the brand building effort in the specialty side. But the Farmer Brothers and the Boyd's brands are established and will be the brands of choice for those other 2 tiered.

Speaker 4

Got it. And understand that we're at sort of more than half of your inventory now is these new SKUs. You mentioned the obvious sort of delay of getting these SKUs in the inventory and then out into the market. I'm just wondering if any of these newer tiers have gotten out into the market and if there's been any sort of early feedback from customers or any sort of early insights to ascertain from that?

Speaker 1

No, that's a great question. I mean, I would say market space. Keep in mind that both Farmer Brothers and Boyd's had been out in the market in the past and were essentially distilling down other brands that had been out. But even in those markets, they may have had some exposure to Farmer Brothers and Boyd's. So the resistance has not been significant.

Speaker 1

Having said that, on the manufacturing side and the planning side, the efficiencies are definitely there and being realized. So you can imagine when it comes to procurement, the efforts and attention that you need to source when you've got half of the coffee SKUs that you had in the past is radically reduced and you can really focus on adding value there. But when it comes to the manufacturing and production side, even more so the planning of manufacturing on the lines is much more straightforward. You can realize the efficiencies by not turning over your line changes as often. And so there we've seen a great deal of efficiency gains when it comes to the manufacturing in Portland.

Speaker 1

Also the fact that we've been able to consolidate the vast majority of the manufacturing in the Portland facility has made that facility much more efficient in and of itself. So we're seeing lots of advantages there. Where I think we'll be continue to see efficiencies gained in the future. As that stretches through the chain and it goes into the distribution center and into the branch level and onto the trucks ultimately, we'll see a much more streamlined capability. So as much as producing things and getting to the right branch and to the right truck, we have improved that.

Speaker 1

Part of the ability to improve that has been, yes, communication, additional infrastructure and resources, but it's also the fact that the offering set has been radically reduced. So we're going to see efficiencies when it comes to the amount of space we need, the amount of gas we burn. Every single piece of the puzzle will be more efficient as we continue to roll this out.

Speaker 4

Great color and very great to hear. Last question on the new tiered offerings here. Do you anticipate any meaningful gross margin difference among the tiers? And understood that specialty is still sort of a work in progress here. But just as you see it now, do you anticipate any meaningful gross margin difference among the tiers?

Speaker 1

No. Honestly, keep in mind, we have existing business associated with these tiers. And we are as much collapsing multiple brands into singular brands as anything. So we already have gross margin data around where these brands have been positioned. And as such, I think we're able to maintain consistency in the gross margin across the 3 brand tiers.

Speaker 1

Brad, if you want to speak to that?

Speaker 2

Yes. Well, what I would call out Eric, your question, the answer is definitely I think we're thinking of the same margin profile within each tier. But that said, the simplification of our product offering and on the back end is going to allow us to be very intentional with our pricing in a way that will raise all the boats. So there's opportunity to find inefficiencies in where individual customers are priced and move them into the new system. So there's potential to derive more value, not to the extent we've done over the last year with 600 basis points.

Speaker 2

This isn't going from 0 to full, but it is an opportunity for us to be much more strategic with the pricing on an ongoing maintenance basis.

Speaker 3

All right. That's helpful.

Speaker 4

And then on the technology upgrades, nice to see these handheld device upgrades and the expected improvement there in inventory management and customer service. Can you just give us a high level update on what other technology upgrades you're focusing on? I know last quarter you mentioned the or you touched on the CRM upgrade, maybe just an update there and on any other technology upgrades you're working on? Thanks.

Speaker 1

Sure. We refer to that sort of suite of improvements internally as Project Symphony, Because essentially what we're doing is we're seeing our IT capability as really a partner in the software programming around everything from risk mitigation and software programming around everything from risk mitigation and sourcing when it comes to commodities driven purchasing. We're utilizing it when it comes to the CRM activities and we have rolled that out. What we're referring to as Phase 1 is now complete. We're in Phase 2 of the rollout with the CRM.

Speaker 1

We're utilizing that when it comes to street level operations and the handheld technologies both in terms of hardware, but also software. So improvements there to be expected. And let's not forget, we had significant upgrades to the ERP over the last 6 months. So a great deal of work happening on that side. So again, we're seeing that the IT integration is a key part of what we're doing driving the business forward.

Speaker 4

Very helpful. I appreciate the color. Thanks for taking my questions.

Speaker 2

Sure. Thanks, Eric.

Operator

This concludes our question and answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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