Farmer Bros. Co. (FARM) Q2 2018 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the Farmer Brothers Second Quarter Fiscal Year 2018 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. [Operator Instructions] And as a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Jean Young. Please go ahead.

Thank you. Good afternoon everyone. Thank you for joining Farmer Brothers second quarter fiscal year 2018 Earnings Conference Call. Participating on today's call are Mike Keown, President and Chief Executive Officer; and David Robson, Treasurer and Chief Financial Officer. Earlier today, we issued a press release, which is available on the Investor Relations section of our website at www.farmerbros.com. The 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 two hours after the conclusion of this call. The link to the audio replay will also be available on our website. Before we begin the call, please note, various remarks that we make during this call about our future expectations, plans and prospects may constitute forward-looking statements for purposes of the Safe Harbor provisions under the federal securities laws and regulations. These 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. 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 in the Company's press release and in our public filings, which are available on the Investor Relations section of our website. On today's call, we use certain non-GAAP financial measures, including non-GAAP net income, non-GAAP net income per common share diluted, EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin, in assessing our operating performance. Reconciliation of these non-GAAP financial measures to their 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, President and Chief Executive Officer. Mike, please go ahead.

Thank you, Jean. Hello everyone. Thank you for joining us. On today's call, we will cover the strategic, operational and financial highlights of the quarter and provide an update on our key initiatives and how we continue to execute on long-term growth strategy. We'll then open the call up for questions. We're pleased with our performance in the second quarter which results that reflect the completion of the Boyd's acquisition as well as the continued execution of our strategy, which we believe is creating a solid platform for growth. We continue to see both organic and inorganic growth opportunities and remain focused on leveraging the investments we've made in our roasting facilities, expanding our distribution network, adding new customers and increasing business with existing customers. Touching briefly on the financials, sales in the second quarter increased 20.4% year-over-year, which includes sales related to the newly acquired Boyd's business. Excluding Boyd's sales increased slightly year-over-year in Q2. We processed 29 million pounds of green coffee volume in the second quarter, our highest volume in a single quarter, with Boyd's included volume of green coffee processed and solid increased 18.7% year-over-year in the quarter. Adjusted EBITDA in Q2 increased 15.7% to $12.9 million over the prior year period with the corresponding 7.7% adjusted EBITDA margin. The addition of Boyd helped drive the increase in adjusted EBITDA in the quarter, and we currently expect further contributions to adjusted EBITDA expansion from Boyd's as we integrate businesses and realize additional synergies. As I mentioned, these results were in line with our expectations and we continue to expect fiscal 2018 adjusted EBITDA of $54 million to $58 million, as we deliver synergies related to Boyd, capture benefits from the transformation of our DSD organization to a channel based selling organization, and work to achieve operational cost savings in the back half of the year. Let me take a moment to discuss our key initiatives specifically the execution of our Boyd's integration plan, making progress towards safe quality food certification of our Northlake facility, and the continued ramp up of sales under the channel based selling strategy we've been implementing in our DSD network. First, the integration of the Boyd's business is on track and I am pleased with what has proven to be an excellent effort to date. While we are only three months into 12 to 18 month integration, I have been consistently pleased with our progress and the contributions from the integration team. Our integration plan is disciplined and thorough and our integration goals remain the same to retain our customers and strengthen our revenue channels by providing exceptional customer service while working to capture potential business synergies. We are pleased to report we've successfully transitioned Boyd staff customers without any disruption. The Boyd's business performed in line with expectations in the second quarter. Over the next three to six months our integration milestones include ongoing physical consolidation of Boyd's branches into Farmer Brothers branch locations, shifting up production to Farmer Brothers facilities including our Northlake facility and identifying additional synergies as our teams are combined. Another key initiative of our growth is the continued ramp up of production in our Northlake, Texas facility including the plan movement of the portion of the volumes related to the voyage business to this facility. We expect operating margins to continue improving as we increase utilization of the Northlake production capacity with the significant increase in production volumes currently expected in fiscal 2019 once we are fully integrated to voyage business. Further, we have completed many of the steps required under the Safe Quality Food or SQF program in Northlake and we believe that we are on track to receive SQF certification in our third fiscal quarter required by many large accounts this certification is an important step that will help to enable us to ramp meaningful volumes which can bring associated margin improvement we remain on target by the end of this fiscal year for a 6 million pound at our state-of-the-art facility. Farmer Brothers is also focused on further elevating our sustainability leadership in the coffee industry and we continue to make significant progress on the following. First, conserving resources and encourage biodiversity; second, promoting social economic, environmental and product compliance standards in our supply chain; third, improving energy efficiency within our roasting plants and fourth reducing waste to landfill. In fact, I'm pleased to report we recently achieved our zero to waste landfill targets in our Northlake, Portland and Houston roasting plans and our two distribution centers. We have completed our lead certification audit and expect to announce our certification for our corporate headquarters in calendar year 2018. The combination of productivity and sustainability is proving to be attractive to current and potential customers many of whom have their own sustainability mandate. Lastly, we were pleased to host our first investor open house at our new cutting edge Northlake facility this past November. For those of you who were able to join us, I think you understand why were so proud of the great new facility and why we think it is a tremendous selling tool to attract great customers. Finally, we made continued progress on executing our channel base selling strategy in DSD as you might remember we completed team member training under our new model in June we believe this channel base selling strategy will better serve customers and increase sales while maintaining the value-add from the DSD delivery and service model. As a part of this model, we have completed the deployment of this smart touch selling tool to half of our routes with the full deployment and expect it to be completed by the fourth quarter. The smart touch selling tools automates and streamlines the ordering process allowing our sales organization to drive incremental sales. Our modernization initiatives demonstrates Farmer Brothers commitment to providing best-in-class service a pivotal product of our long-term growth strategy. When it comes to new business, our sales teams have initially focused on larger customer opportunities. These customers typically have a gestation period that can take six months or more from regeneration to contract signing and then as three to six months product transition window as the customer works through pervious supplier inventory. Our sales wins in recent quarters have been transitioning to full service as they work through their previous suppliers' inventory and/or expected to contribute to sales in late Q3 and Q4. We are working diligently and developing this pipeline and bringing on new customers the execution of our strategy has created the strong pipeline of opportunities. In conclusion, high quality coffee's and tea's that consumers enjoy are at the center of our success and we are committed to delivering the best tasting products. To that end, I'm pleased to share that our tea submissions won three silver medals and two bronze medals at the recent Global Tea Championship held in January. These rewards are testaments to our efforts to deliver quality and all that we do and add tour differentiation in the market place. Now, I would turn it over to David to walk you through some of the drivers behind our financial performance in the quarter.

Thanks Mike. Turning now to some more detail on our results, as all of you had a chance to review the press release, I will only touch on a few key areas, beginning with coffee volumes. Volume of green coffee processed and sold increase 18.7% year-over-year with the inclusion of Boyd's volumes. As Mike mentioned, this is a record quarter for us with coffee volumes increasing by 4.6 million pound over last year. Volume for our base business relatively flat to a year ago driven by a few large customers in line with the expectations we discussed on our last call. To give a better sense of mix to volume across our distribution network during the quarter, approximately 9.9 million coffee founds or 34% of total volume were processed and sold through our DSD network, while direct ship customers represented approximately 18.7 million pound or 64.3% of total volume, and sales through distributors including through new distributor relationship we acquired for Boyd represent approximately 500,000 pounds or 1.7% of total volumes. Now, turning to the income statement; net sales for the quarter were $167.4 million, representing an increase of $28.3 million or 20.4% as compared to the prior year quarter. This increase was driven primarily by a $26.3 million increase in net sales contribution from the acquisition of Boyd. Excluding Boyd, net sales increase $2 million or 1.5% slightly better than our expectations. Excluding Boyd, we expect volume to remain relatively flat in the third quarter but we anticipate stronger growth in both volume and net sales in the fourth quarter of this year with further acceleration in fiscal '19. We believe that the completion of our SQF certification will allow us to increase volume produced for large national customers throughout new facility and we expect to realize top line benefits of our new DSD sales channel model and late fiscal '18 and into fiscal '19. Gross margin in the second quarter was 39.1% of sales, compared to 39.6% of sales in the prior year quarter. We're pleased with our gross margin performance which is a 190 basis point, improvement over Q1 and only 50 basis points lower than a year ago. The major drivers of the 50 basis points margin decline were 48 basis points increase in cost from our new Northlake facility which was not part of our cost structure a year ago. 20 basis points from the inclusion of Boyd's which had a slightly lower gross margin rates and 50 basis points from the absence of the beneficial effect of the liquidation of LIFO inventory, which benefited gross margin during the second quarter of last year. We were able to mitigate these year-over-year cost changes by 70 basis points to improve production efficiencies at our Huston important plans as well as reducing the operating cost associated with our coffee brewing equipment. Now, turning to operating expenses; operating expenses in the quarter were $63.1 million or 37.7% of sales, as compared to $19.2 million or 13.8% of sales recorded in the prior year quarter, an increase of $43.9 million recall that in last year's second quarter we recognized the gain of 37.4 million from our Torrance facility sale. In addition, operating expenses reflected $8 million increase in selling expenses, resulting from the additional Boyd business this year, a $1.1 million increase in operating expense from the acquisition West Coast Coffee and higher depreciation and amortization expense on our base business of $600,000. These items were partially offset by $3.8 million decrease in restructuring and other transition expenses associated with the corporate relocation plan last year. Total G&A expenses increased by $121,000 over the last year, increasing 2.6 million from the addition of Boyd business and 1 million from one-time acquisition and integration costs, in comparison the last year's second quarter which included 3.7 million in proxy contest cost. We expect our go forward operating expense leverage excluding one-time integration expense to improve over time as we realize additional synergies related to the acquisition of Boyd as integration progresses. Turning to interest expense, interest expense was $861,000 in the second quarter up from $524,000 last year due to higher borrowings compared to the prior-year period. We expect interest expense to continue to remain at higher levels compared to last year given the borrowings made associated with the acquisition of Boyd which closed in early October. Turning to income taxes, we recorded $20.9 million in tax expense in the quarter compared to 13.4 million in the prior-year period. The increase was driven by the tax cuts and jobs act of 2017 that resulted in a reduction of our estimated annual effective tax rate and the recalculation of our deferred tax assets. Going forward beginning in Q3, we expect our go forward tax rate be approximately 28% and our expected cash tax rate will remain unchanged at between 3% to 4%. Net loss in the second quarter was $18.8 million or a loss of $1.13 per diluted common share compared to net income of 20.1 million or $1.20 per diluted common share in the prior-year period. Net loss this quarter includes the incremental tax expense to $20.3 million due to the reduction in our deferred tax assets as a result of the new tax laws. Adjusted EBITDA was $12.9 for the quarter compared to 11.2 million in the prior-year period and adjusted EBITDA margin was 7.7% compared to 8% in the prior-year period. We were pleased with the increase in adjusted EBITDA performance in the quarter compared to the prior year resulting primarily from the incremental volume and we expect further improvement in future adjusted EBITDA as we realize the synergies from Boyd and expansion of operating margins from our base business through cost efficiencies and incremental volume from our DSD sales channel. Now let's turn to the balance sheet, at the end of the quarter we had 5.4 million in cash, we had 84.4 million borrowed on a revolving credit facility. Our debt net to cash at the quarter end was 79 million compared to 22.4 million at September 30, 2017. The increase in debt net of cash and short-term investments of 56.6 million was primarily used to fund the Boyd's acquisition including making incremental investments in Boyd's working capital and onetime cost related to the transaction and integration in addition to cash consideration paid at closing. At the end of the quarter our availability under our credit facility was 24.5 million, we expect our borrowing base and associated availability under our credit line to increase further once we complete the process next quarter, to include our assets related to the Boyd's business within our borrowing base. Now turning to capital expenditures, for the current quarter our capital expenditures and cash were 8.5 million with 1.3 million of spend for our new facility and 7.2 million of spend for maintenance CapEx, year-to-date we've spent 11.8 million in maintenance CapEx, which is currently in line with our expectations of 20 million to 22 million in maintenance CapEx annually. Depreciation and amortization expense was 8.1 million this quarter versus 5.1 million in the prior year quarter. The increase in depreciation and amortization expense resulted primarily from investments made in our Northlake facility, the deployment of the new smart touch devices used by our DSD organization and the depreciation and amortization from the acquisition of Boyd's coffee. The acquisition of Boyd's coffee added 1.1 million in depreciation and amortization expense in the quarter. Based on our existing fixed asset commitments and the useful life of our intangible assets including the addition of Boyd's we currently expect depreciation and amortization expense to run at approximately 8 million to 8.5 million per quarter for the next several quarter. Now turning to the Boyd's acquisition, we continue to estimate post integration the Boyd's business will contribute approximately 13 million to 16 million in incremental adjusted EBITDA on annual basis. To-date, we have incurred approximately 5.2 million in acquisition and integration costs and we currently expect to incur an additional 3.8 million to 5.8 million of one-time costs to complete the integration. We've yet to spend CapEx costs associated with the Boyd's acquisition and we still expect to spend between 8 million to 11 million in CapEx, over the next 12 to 15 months to complete the integration. As Mike mentioned earlier, we continue to believe that our full year adjusted EBITDA will be between 54 million to 58 million for the consolidated business in fiscal '18, based on our expectations of delivering additional synergies from the Boyd's acquisition, realizing incremental sales and operating margin expansion from our DSD channel sales strategy and achieving cost savings. Looking out to fiscal '19 we also believe we'll realize further operating profit expansion on top of our performance in fiscal '18 as additional synergies from Boyd's materialize as we progress for its full integration. The DSD channel sales team matures and drives incremental top line and SQF certification attracts meaningful volume growth for our new Northlake facility from large new Direct Ship customers. Now, I'll turn the call back to Mike for closing remarks.

Thanks, David. As always I thank those on the call for your continued interest in Farmer Brothers. It's a midpoint of our fiscal year we are pleased with all that our team has accomplished, but we recognize that we have ways to go to achieve our goals. As we look forward to fiscal '19, we remain focused on executing our differentiating strategies and unlocking Farmer Brothers full potential. We remain optimistic about the opportunities presented in the back half of fiscal 2018 and more importantly in fiscal 2019. We believe that we're well positioned to realize efficiencies and to reap the benefits of the acquisitions we've completed, the new national accounts we've added and the changes we've been implemented in our GST model. And with that, I'd like to open the call up for questions. Operator?

[Operator Instructions] And our first question comes from the line of Kara Anderson with B. Riley. Your line is now open.

So couple of calls ago, you mentioned that you won I think it was a 1.5 million pound to 2.5 million pound of new business from some notable customers, but you didn’t name. And then another bigger corporate win last call. Can you talk about where you are in on-boarding those new accounts? And then maybe just overall recap and new business won in the last year that you've announced?

Sure. So, we -- the two we mentioned on the last call, one is started up, we're in the ramp up process though very early on in it. The other customer quite frankly most of that volume begin to come on this quarter. So we're still where we've said we've been maybe a step or two behind in the customer transition, but nothing out of the norm. So generally we feel good about it. What I'm most excited about is obviously getting the new facility up in running. We have cleared the desktop portion of the SQF and they are going through the second step of the process and that's where I think we can really begin to leverage this facility moving forward. Regarding your question around customers won in the last 12 months, how could I best get it that if just there is a lot of ground to cover there.

Alright, we can take that on off line at another time. Just one other question from me, with respect to your EBITDA guidance to 54 million to 58 million kind of laid out three ways. You think you get there. I think the third way you said it was additional cost savings. I'm wondering if you can elaborate on that and it sounds like that is in addition to synergies with Boyd, if I am understanding it properly?

That’s right Kara. I think it was probably back in May when we kind of gave a view of what we thought the year was going to be look like and we said 5 million to 7 million of cost savings some of those we've realized through our DSD restructuring but others which were operational efficiencies or more of back ended toward the back half of this year, so you are going to start to see that primarily through SG&A leverage.

[Operator Instructions] And our next question comes from the line of Francesco Pellegrino with Sidoti. Your line is now open.

So I just wanted to touch on your organic volumes which were flat year-over-year. Sporadically, we'll get a nice uptick as we've seen in the past couple of quarters a new business and I'm just wondering if at any point during the quarter will you potentially maybe like turning business away, as we're not fully as to up certify that maybe you had some big contracts come your way that you just currently aren't able to handle right now? And that when SQF certification does occur sort of like the floodgates opened because I'm just sort of thinking like you're having a lot of sales guys right now just potentially sitting on their hand waiting for the certification to come through really be able to market the business all of a better?

So what I can tell you is, we certainly had a lot of interest from larger customers, over the last six months on site visits, those types of things. I think the SQF certification is an important step. And then there is typically the certification of the process with the specific customer, but to answer your first part of your question, we're not turning any business away at all, maybe we will be much better poised to bring on that business once we get this fully certified and we remain really exciting about it. You've seen the facility, many of the people on the call have seen the facility, and we think it will be a very powerful tool to help recruit new customers along with our sustainability programs and marketing programs, and all those types of things we do to help our customer to grow.

And then just a one thing we said over the last couple of quarters that a big of our growth that just been flat or a few large customers where softer than we expected, a lot of that of course outside of our control. We don’t think that’s an ongoing thing but certainly happen in the last couple of quarters, which is the nature of our business can be choppy when you have a few big customers that can move around. But as Mike said, the outlook for '19 remains unchanged which we’re pretty bullish once we get passed certification that we have a bigger opportunity to win some business.

I guess just keeping with that comment of wining new business. So recently a large food retailer just divested their convenience store. When we see something like that, is competition? Does that get you guys excited to go after that type of business? Or is that business to supply those C stores sort of understood that they are going to continue to be with the existing coffee manufacturers or rosters that currently supply on those businesses?

I think we're really pleased with the growth that we had in convenience stores over the last five or six years. We're thrilled with some of the awards we won from some of those customers. So without knowing who you're referencing directly, we want to always be at the table assuming that it’s a good price structure and good for the business, and we like to go after it and get it you look at our track record over the last five to six years. We won some considerable business in that channel as well as other service.

And this question is for David and it's everyone favorite topic, the new tax law. You were guiding through your cash tax rate, remains unchanged that 3% to 4%. I thought there was some sort of implications for limitations regarding the amount of the trailing of previous NOL position that you had up to a certain point to offset certain pretax income. Was that anything that went into your unchanged cash rate guidance that you have provided us with?

Yes, I think there is a 20% limitation the amount you can write off. Yes, we took that math into account with respect to our NOLs what we thought our go forward cash tax rate was and still 3% to 4%.

Thank you. And our next question comes from the line of Chris Krueger with Lake Street Capital Markets. Your line is now open.

Just a couple of quick ones. First, was there any lingering hurricane impact in the quarter on your business?

Yes, as a few lumps the hurricane with the fires in California, we have had a small but it's not really a critical part of the story. We have got a sizable business in some of those areas and of course we feel the drag as well as the continued impact of the hurricane in certain parts of Texas, but I wouldn't let that distract from the build out of the new facility, the integration of Boyd's and the restructure of our DSD. We all think are pretty compelling. And then there may be a lingering effect just to those cities and towns which have been through so much continue to rebuild.

And we have had individual employees and branches affected, but the impact was much bigger for us in Q1 which is why we call that out. We certainly measured the effect from our fire and insurance claims but it wasn’t material enough to bring out in the second quarter.

My other question is, now that you have moved from Torrance to Texas. I know some people didn’t make the move and you had to hire a lot of new people. Are all the key people in place now and have you had a good ability to attract talent to your new location?

The answer yes and yes. We are really pleased with the ability to attract talent and relocations going well the key people are in place. As you know we have pretty diverse set of needs since this facility has a headquarter component in the areas like finance and marketing and distribution and so forth and roasting in a distribution center we have been able to meet our needs in all three areas very well.

I think I under that our headquarters and really forward thinking point of view on sustainability in the way we think that it admires good health of those recruits and great talent. [Operator Instructions] And we have no additional questions at this time. So, I would like to turn the call back to management for any closing remarks.

Well, thank you very much, as always I would like to thank those on the call for your continued interest in Farmer Brothers. And we look forward to speaking with you again soon. Thank you very much.

Ladies and gentlemen, thank you for participating in today's call. This does conclude the program and you may all disconnect. Everyone have a great day.