Earnings Labs

Farmer Bros. Co. (FARM)

Q2 2015 Earnings Call· Thu, Feb 5, 2015

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Transcript

Operator

Operator

Good afternoon ladies and gentlemen and welcome to Farmer Brothers Corporate Relocation and Second Quarter Fiscal 2015 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a brief question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder this conference call is being recorded. I would now like to turn the conference over your host, Tom Mattei. You may begin.

Tom Mattei

Analyst

Good afternoon everyone. Thank you for joining Farmer Brothers corporate relocation and second quarter fiscal year 2015 earnings conference call. I'm the company's General Counsel. With me today are Mike Keown, President and Chief Executive Officer and Mark Nelson, Treasurer and Chief Financial Officer. Earlier today we issued an earnings press release which is available on the Investor Relations section of our website at www.farmerbros.com. The earnings press release is also included as an exhibit to our Form 8-K available on our website and on the Securities and Exchange Commission’s website at www.sec.gov. Please note that all of the financial information presented on this conference call today is unaudited. A replay of this audio only webcast will be available approximately four hours after the conclusion of this call. The link to the audio replay will also be available on our website at www.farmerbros.com. Before we begin the call please note various remarks that we make 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 Laws and regulations. The company’s actual results and other future events could differ materially from what are described in those statements. Additional information on factors that could cause actual results and other events to differ materially from those forward-looking statements is available in the company’s earnings press release and in our public filing which are available on the investor relations section of our website. In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. While we may elect to update these forward-looking statements at some point in the future we specifically disclaim any obligation to do so, even if our views change. Therefore you should not rely on these forward-looking statements as representing our views as of any date subsequent to today. Additionally, please note that the company uses certain non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, net income excluding restructuring and other transition expenses and net income, excluding restructuring and other transition expenses for common share diluted in assessing its operating performance. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is included in our earnings press release, which is available on the Investor Relations section of our website. I will now turn the call over to Mike Keown our President and Chief Executive Officer. Mike?

Michael H. Keown

Analyst

Thank you, Tom. Hello everyone and thank you for joining us this afternoon. This is the third earnings conference call for Farmer Brothers and I'm pleased you have joined us today. I will start with some very important news that we announced today and then move into a top-line review of our second quarter of fiscal 2015 results, update you on a few key corporate strategic initiatives and conclude with some commentary on the overall business. I will then turn it over to Mark Nelson, our Treasure and CFO, who will discuss our financial results for the quarter in greater detail. Over the past 18 months, the company has conducted a thorough review of our operations to determine how we can become more competitive, grow the business, invest in our current and future customers. Through our thorough analysis of our needs it became clear that the best option for the future was a more extensive overhaul to our infrastructure. As a result, today we announce the corporate relocation plan as approved by our Board of Directors which we will begin to implement immediately. The changes associated with this corporate relocation plan are as follows. First, our Torrance facility will close and we will relocate to a new state-of-the-art manufacturing, distribution and corporate headquarters facility expected to be located in either the Dallas/Fort Worth area or Oklahoma City. The final decision on the location is pending the outcome of state and local incentive negotiations and final site selection, which is expected within the next 90 days. We expect to begin closing the company’s Torrance facility in phases starting in the summer of 2015 and concluding by the summer of 2016. Second, construction of the new facility and relocation are expected to be completed by the end of the summer 2016. Lastly…

Mark J. Nelson

Analyst

Thanks Mike and hello everyone. I'll spend a few minutes discussing our financial performance for the second quarter of our fiscal year 2015. As Mike mentioned we had some challenging headwinds in the quarter but continue to make progress towards our objectives of driving improved operational and financial performance. I'll get right into those details now. Net sales in the second quarter of fiscal 2015 were $144.8 million, representing a 1.2% increase from net sales recorded in the second quarter of fiscal 2014. This increase was primarily due to increases in sales of our coffee, tea and other beverage products. The increase of $1.7 million over the prior year period included approximately $750,000 in price increases to customers, utilizing our commodity-based pricing arrangements where the changes in the green coffee commodity costs are passed on to the customer. Many of our cost plus customers were covered under coffee hedging contracts which insulated them from much of the increase in green coffee commodity prices that were experienced over the past three quarters. The duration of their hedging contracts creates a lag in how quickly commodity price changes are ultimately reflected in our top line revenues. In cost of goods sold for the second quarter of fiscal 2015 they increased by $2.9 million versus the second quarter of 2014. As a percentage of net sales cost of goods sold increased a 130 basis points to 63.3% in the second quarter of fiscal 2015 versus 62% in the prior year period, primarily due to the increase in average cost of green coffee purchased. As a result, gross margin for the second quarter of fiscal 2015 was 36.7% or 130 basis points below that of the second quarter of fiscal 2014. Operating expenses in the second quarter of 2015 increased by $913,000 as compared…

Michael H. Keown

Analyst

Thanks, Mark. I would also like to thank those on the call for their continued interest in Farmer Brothers. We realize that the release in the earnings call schedule is not standard and not as we have done in the past but it was very important to us that our employees hear this message directly from us first. We had a series of meetings that started with the first early morning shift and continue with different groups throughout the day. As we begin to implement the relocation of our Torrance facility during this transition period we remain steadfast in our commitment to ensuring continued and uninterrupted service to our thousands of customers nationwide. We are excited at the tremendous opportunities ahead as we prepare Farmer Brothers for the next 100 years. And with that I’d like to open the call up to a few questions.

Operator

Operator

Thank you. [Operator Instructions]. Our first question comes from the line of Tony Brenner of ROTH Capital Partners. Your line is now open.

Tony Brenner

Analyst

Thank you. I’ve got a couple of questions. First of all can we get a little more granular on your volume change? I understand you had a loss of one of your largest accounts impact and poor [ph] traffic trends at two of your large accounts. However you’ve also signed on some new chain accounts over the 12 months, which should be at least partly offsetting and in addition to that some of those new accounts are in your street business. So first of all I wonder if you could break out the volume change from your -- how would you want to classify as your chain business versus the street business?

Mark J. Nelson

Analyst

So Tony we’ve this is Mark and hi how are you. We do not discretely describe our pounds, coffee pounds by segment. What we can say generally our DSP delivered volume was essentially flat and we did see erosion year-over-year decline in our national account volume to the tune of a percent or two. So the net of that drove a volume of pounds decline for 1% as Mike described.

Tony Brenner

Analyst

Okay, can we talk a little about gross profits? Your chain account gross profit per pound is constant, for each account anyway, because it’s cost plus. On your street or DSP business my understanding is that you increased prices during the fourth and first quarters to reflect higher prices. So that given the case I'm wondering why there was so much margin pressure on the gross profit line or cost of goods line.

Michael H. Keown

Analyst

Hi, Tony. It’s Mike I think I can answer that. We did take pricing pretty aggressively to offset that commodity increase. However we did have some customers that have timing lags or grace periods that didn’t allow us to take the full potential price in the quarter. That being said those pricing opportunities are becoming available now and we are seeing that be into occur but there were some timing issue based on contracts and those types of arrangements.

Mark J. Nelson

Analyst

Tony I’ll add, the mention of the cost plus customers, as we’ve moved through those customers hedging contracts we saw only $750,000 of commodity based -- of revenue increase and that essentially as you described is a dollar for dollar increase in cost and revenue. So the truly the margin pressure is typically seen on those non-cost plus customers and to the extent that we are efficient in increasing prices across that customer base we protect our margin and in some instances some of that price protection prevented us from doing that.

Tony Brenner

Analyst

Okay, and one of those 10 accounts that’s been weak, I believe you're lapping the main problem that's been causing that. So going forward, I wonder Mark if you could talk a little about the trend you're seeing in the third quarter in terms of sequential improvement.

Mark J. Nelson

Analyst

Okay, so the customer’s ultimate revenue in the quarter was about -- in the second fiscal quarter of 2014 was about $1.7 million. That is the 130 basis points Mike referred to. We have lapped that now in this quarter, there was the last of it. As we move forward into the third quarter we don't expect to see that headwind against us. We do have a natural seasonal trend in our business and the second quarter or the second quarter which we just came off typically represents a stronger quarter for us and that is obviously not fully related to national account volume that we add two times. So I'm gone stop short of giving you a concrete number for what I expect as far as volume guidance into our third quarter, although I can tell you the seasonality does show typically trends to show decline from our fiscal second quarter into our fiscal third quarter.

Tony Brenner

Analyst

Right, now I understand the seasonal aspect. My last question would you explain that $2.2 million cost of goods benefit from [indiscernible] liquidation in the quarter.

Mark J. Nelson

Analyst

Certainly we are in a LIFO inventory accounting system and as we reduce our inventory and this is a byproduct of the operational drive to consolidate the manufacturing capacity from Torrance into Houston and Poland and also as a result of the compression of our distribution out of Houston and into our Oklahoma City facilities. We are anticipating pretty good drop in our inventory levels. As a result we begin to estimate what that impact is going to be as we eat into the lower price levels of our inventory. And so that lower cost coffee is essentially trapped an inventory and as we reduced our inventory we released some of that LIFO benefit. So that might…

Tony Brenner

Analyst

So there’s more to go in terms of liquidating some of these inventories?

Mark J. Nelson

Analyst

That would be correct. Through the six month period we estimated about half of that benefit through were six month financial period.

Tony Brenner

Analyst

Okay. Thank you very much.

Mark J. Nelson

Analyst

Sure.

Operator

Operator

Thank you. Our next question comes from line of Kara Anderson of B. Riley and Company. Your line is now open.

Kara Anderson

Analyst

Hi guys. I'm just wondering if you could update us on coffee pricing, what you're seeing in the market for pricing and if your views have -- towards hedging has changed given the current market?

Mark J. Nelson

Analyst

I think and I'll start with the first part, we are seeing some support in that 1.60, 1.65 that's $1.60 to $1.65 in the [indiscernible] market. As you know in the third quarter of -- our fiscal third quarter of last year coffee prices jumped pretty aggressively. They got as high as $2.25, since have come down and kind of bouncing around a pretty reasonable level compared to that $2.25. It's hard to say what the future of the coffee prices may hold. What we are seeing now is a period of rain and the country that we hear about the most is Brazil which is experiencing good rain conditions which has I think lessened the pressure on that tendency to make coffee prices go up. With that being said I think our perspective on coffee prices has got more favorable. When coffee was up around $2 to $2.25 we were not buyers of coffee futures. So we effectively waited out what I think was a peak in the market. And we continuing to evaluate when and how much we start to layer back in our hedging contracts and you can see that just naturally as those hedging positions have come down year-over-year. So I hope that answers your question.

Kara Anderson

Analyst

Yeah, it does, thank you. And then with regards to the relocation in selecting a final location what kind of incentives might you receive from the local and state governments?

Michael H. Keown

Analyst

I think it’s a little early to speculate on that. This is Mike. We are in the middle of negotiations now across multiple fronts. So you are going to have to give us a little time to let that process take place before we share anything it’s premature at this point.

Kara Anderson

Analyst

Okay. And then also wondering if you might be able to comment now on some further detail on ways that you achieve to $12 million to $15 million in annual savings once this is fully implemented?

Michael H. Keown

Analyst

Just at a high level you know those savings are in aggregation some of the things we are doing to compress manufacturing some of the elements of the benefit of moving into a low cost state whether it be Oklahoma or Texas. I think the distribution savings that we annualized are pretty significant as we evaluate that across our nationwide network. And ultimately the construction of our new state-of-the-art facility we believe will have certain benefits as we I mean fracture and move towards some manufacture on that side. So it comes from a number of different areas which we believe are well evaluated and concrete at this point.

Mark J. Nelson

Analyst

And in addition to the savings I think it’s important to note that we believe that this facility and if you think of it as manufacturing, distribution at headquarters of course but also from research and development to training standpoint we believe this facility can offer us a better chance to compete for new business, better interaction with our customer base and so forth and we haven’t built that in to the economics but I think it’s really important to note that this facility we think can be a better engine for new business growth that remains to be seen.

Kara Anderson

Analyst

Thank you.

Operator

Operator

Thank you. Our next question comes from the line of Chris Krueger of Lake Street Capital. Your line is open.

Chris Krueger

Analyst

Hi, good afternoon.

Michael H. Keown

Analyst

Hi, Chris.

Mark J. Nelson

Analyst

Hi, Chris.

Chris Krueger

Analyst

Another question on the new facility, more of a kind of long-term vision type of question. With I assume a large capacity, do you foresee yourselves like potentially making acquisitions of smaller competitors but then consolidation that into that facility or making moves with other existing facilities at your own into that one down the road.

Michael H. Keown

Analyst

Let me break that up into pieces. In terms of a more aggressive acquisition profile, I think we have commented in the past that as the company turnaround continues, as our financial strength grows there is a clearly an opportunity to do with what we did with Gourmet Cup and we are pleased that was a good test for us to successfully integrate them albeit a relatively small organization but it went very well. So yes, I would see us attempting to do that more in the future, should the right conditions exist for an acquisition and so forth. On the second piece, I think at this point we are not in any position to say anything or make any comment on that. Frankly we have our hands full right now closing this facility, pushing volume into Houston and Portland maintaining our high quality position in customer service and so forth and it’s frankly been a huge focus of management, my team here to get us to this place. So anything beyond that is not a place we're ready to at all right now. We're focused on executing what's in front of us.

Chris Krueger

Analyst

Okay. Then over to the e-commerce, I know it's very early, but can you tell us how you making people aware that service is there that they can buy coffee?

Michael H. Keown

Analyst

We're just in our infancy of marketing it. So we went online as we committed at the end of last year. And I think you'll see a presence on Facebook and Twitter. I think you'll see us try to connect, given our experiences and expertise in local growing areas and so forth. We've got a very good presence and a great team in green coffee, that I think can bring a lot of the magic of the coffee industry and our grower and industry experience directly to the customer. So again we're only a month into it, so there is no real results but I'm excited for this for the future. I think it could have all sorts of benefits for us.

Chris Krueger

Analyst

Okay, last question. I think I know the answer but on your national accounts, as you stated that you have the three of the top 100 restaurants, two of the top 20 convenience store chains and five of the top grocery store chains. Are those numbers the same still?

Michael H. Keown

Analyst

Yes.

Chris Krueger

Analyst

Okay, that's all I got. Thanks.

Operator

Operator

Thank you. [Operator Instructions]. Our next question comes from the line of Keith Rosenbloom of Cruiser Capital Group. Your line is now open.

Keith Rosenbloom

Analyst

Thanks. Thank you guys. It sounds like you've been making a lot of tough decisions. Want to ask about the two clients that you called out on the call, Big Watts and Cozy. When did those companies become customers and were they reflected in your last quarter's results?

Michael H. Keown

Analyst

No, neither were reflected. I believe one comes on board at the very end of the quarter with the second one quickly thereafter, at the beginning of our fourth quarter.

Keith Rosenbloom

Analyst

Okay, and the relative size of these clients are they -- you've called them out. Are they material?

Michael H. Keown

Analyst

We're still getting the volume estimates and the plans pulled together. So it's probably premature to give you a number but I do think that there will be meaningful for us, both of them, both from a size standpoint but also a strategic standpoint. We're very pleased to have this emerging partnership with both. But I'm afraid at this point we're still pulling it together. So I don't have a good number. But I'm personally excited for both of them coming on board.

Keith Rosenbloom

Analyst

Perfect. And then just the last question, so I think everyone is aware that Torrance has been operating at sub-optimal level, like 25% of capacity or something. What is actually going on now at Torrance with these layoffs today. Are they're actually producing much products there now or you have pretty much moved everything to Texas and Oregon.

Michael H. Keown

Analyst

We have not yet moved everything. So the departure from Torrance will begin with production. We're targeting for that in May and then we have a phased sequence through each function that largely carries through the end of the year. So it will take a little time. Frankly we wanted to give employees the best chance to transition. So we felt it was important to announce a little earlier than perhaps we had every detail sorted out. We're very proud of this employee base and confident that they'll do everything into the way the company always has to move us through the next transition period.

Keith Rosenbloom

Analyst

Okay, thanks a lot, Mike.

Operator

Operator

Thank you. [Operator Instructions]. Our next question comes from the line of Matt [indiscernible] Partners. Your line is now open.

Unidentified Analyst

Analyst

Hi guys.

Michael H. Keown

Analyst

Hi.

Unidentified Analyst

Analyst

So it's sounds like the -- some of your other facilities are going to be able to handle the volume that was coming out of the Torrance plan. And so maybe you can just help me better understand the benefits that are going to be generated from spending $85 million to build a new headquarters and facility, because that's an awful lot of money for a company of your size.

Mark J. Nelson

Analyst

Let me take that. One of the things that we -- as we evaluated this, struggled with is the where to invest across our existing infrastructure base and it became pretty clear that it was a tough decision to put capital and facility infrastructure into the Torrance facility. As a result the decision was made to essentially utilize the value that was in the asset here primarily, the land, to incorporate that into the construction of new facility. And if you look at it on the high end of land or in the low end of the new facility those two kind of are pretty close equivalents which led to some discussion around the benefits of being in a new facility, new state-of-the-art facility with new production capacity headquarters and design. As Mike mentioned the facility here is 65 years old, this year and it’s definitely ramping in its capital expenditure that we need to put into it, to maintain it and certainly to meet [indiscernible] and SQF certification requirement, it was going to be an incredible challenge to get this facility up to that level of standard. That being said the investments in this decision associated with the exit cost and associated with the additional CapEx related for the machinery and the equipment facility and fixtures these are the things I think were warranted when you look at the potential benefit that we see going into the future. The $12 million to $15 million savings range, as we start to compress some of the production, as we start to realize what some of the benefits more fully we fully expected that and will be readily achievable and so I think that’s kind of the story behind the math, that we went through as a leadership team and through the board of directors.

Michael H. Keown

Analyst

Let me comment it just a little bit differently. When I think you mentioned that other plants can handle the volume. If you were to look at our second quarter, which is our highest volume season, they probably couldn’t have. So we needed to do something to get capacity for the future to last us all year. As we began to push volume albeit very slowly to Houston and to Portland both of those facilities were certainly working at a very large pace. So ultimately if we continue to put volume on the way we have over the last couple of years which has been pretty sizeable we do need to plan for additional capacity.

Unidentified Analyst

Analyst

Okay I mean I guess I understand the exit from the Torrance facility given what you said and certainly considering where those capacity levels were but I guess I'm just curious if the Board considered any other alternatives then spending that amount of capital on the new facility and a new corporate headquarters?

Michael H. Keown

Analyst

Yes, I think it’s important to note this has been a large initiative that we’ve been working on for 12 to 18 months in various stages. As we’ve gone down that path the board has been extensively involved and we did flush out other options and different scenarios, this one, I believe and they ultimately believe was clearly the best one for the long-term.

Unidentified Analyst

Analyst

Okay, yeah I just only asked because it seems like potentially exploring a sale of the company the strategic buyer might be a possible alternative considering theoretically could have the capacity to handle the volume already in place and we’ve seen a lot of consolidation in the coffee space at pretty high multiples over the last few years. So I just, I'm curious the Board has thought of that and considered it?

Michael H. Keown

Analyst

I can’t comment on any of the options we looked at.

Unidentified Analyst

Analyst

Okay, thank you.

Operator

Operator

Thank you [Operator Instructions] Our next question comes from the line of Carter Dunlap of DEM. Your line is now open.

Carter Dunlap

Analyst

Hi, guys. A couple questions I realized you’re not in a position to discuss whatever incentives may or may not be offer to you but in terms of thinking what kind they could be it sounds like from your budget forecast of this spend, you’re talking about owning land, owning your building and owning all your capital equipment, so as opposed to other alternatives that might be available to you. So is it safe to say that the incentives we’re talking about are just sort of taxes?

Michael H. Keown

Analyst

Well, so there are couple of different forms of incentives. Some come in the form of tax abatement. Others come in the form of job creation credits. There are other payroll type benefit tax advantages that -- or incentives that some of the states do, but generally speaking it’s in those new jobs or tax abatement type buckets.

Carter Dunlap

Analyst

Okay. And maybe to go that sort of one more long-term and then a short-term. To go back to the gentlemen’s questions about -- sorry, if you could handle the volume temporarily and I realize you can’t at peak with the other two roasting facilities. But the forward question is once you get whatever the new place in production up to, what will be the purpose of the Houston and Portland rousing facilities? I realize they were put there due to historical acquisition, but if this is a white board start over what’s they will going to be?

Michael H. Keown

Analyst

Well in the near-term, which is really all I can comment on right now, we’ve got, we will have our hand more than full to keep Portland and Houston running at a very high capacity level invest need the customer needs. If you step back and look at where we were three years ago, you can see that we put a very significant volume on in a relative short period of time. And that’s created the need for this facility. In the long-term, who knows, I think at this point, we can’t comment on what that might be. It would be a hypothetical question at best. So like I said, we’re really focused right now on ensuring the Houston and Portland can handle the significant volume if they’re coming their way and has begun to go their way.

Mark J. Nelson

Analyst

One of the things that we struggled with as we are in this quarter is the prospect of additional volume coming on. And without saying it was tough decisions. We had to measure our growth through this period to make sure we can execute in this transition. Which we believe in the pursuit of high customer service levels and making sure we maintain high quality levels is the right thing to do. We certainly hope to have that excess capacity and build this excess or build in the additional capacity to grow and to find additional growth opportunities. And so I think that factored a little bit into our decision making as well.

Carter Dunlap

Analyst

One and one more last, excuse me, short-term question. You’ve made great strides in reducing your working capital and you’ve spoken even on this call about bringing inventory down. But as you envision this migration do you see needing to bring those numbers backup just to ensure there is no delivery kinks in the process i.e. reducing inventories and flex backup here?

Mark J. Nelson

Analyst

We think, we will be able to plan adequately through a transition. And if our targeting is correct to have that completed by the -- I think the May timeframe, which would allow us to have our inventories back to a kind of a more operating level by the end of our fiscal year, which is really the measuring point, when we take a snapshot of that LIFO inventory calculation. I think part of the planning, we’re doing is really to optimize where the inventory is coming into which port Houston or LA and that has also factored into our decision making as we encounter some difficulty and bring things into the Los Angeles port. But we’ve really modeled this so that we will make inventory available and our output of production of our facilities continuous as we move through this transition.

Michael H. Keown

Analyst

It’s Mike, let me just add another layer to that. So if you recall, we went live with JD Edwards across the system, which was important for us to see the system. Now we’re beginning to build capabilities of understanding that tool. You might also recall, we mentioned that we were putting things like barcode scanners on the product. So we can see in manage inventory that process is continuing on now. We’re in the process of rolling out scanner-based technology to all of our branches. We’re also looking at improving our SNLP process. And the point is when you ladder -- link all those up together we should be able to do a significantly better job managing our inventory at lower levels then we’ve done in the past. Now, we still have to prove that, but I do think you begin to see the wave of initiatives we’ve talked about over the last two years or so begin to come together.

Carter Dunlap

Analyst

Thank you. I appreciate the help.

Operator

Operator

Thank you. That’s all the time we have for questions today. Mike?

Michael H. Keown

Analyst

Thank you for being part of Farmer Brothers second quarter fiscal 2015 earnings call. We appreciate your interest in our story and are excited about the future. And we look forward to continuing the progress we’ve made in the past few years and updating you as we embark on the next chapter in our evolution of Farmer Brothers. Thanks and have a great day.