Good afternoon ladies and gentlemen and welcome to the Farmer Brothers' Second Quarter Fiscal 2020 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] As a reminder, this call is being recorded. I would now like to turn the call over to your host, Rachel Goldman. Please go ahead.

Thank you. Good afternoon everyone. Thank you for joining Farmer Brothers second quarter fiscal 2020 earnings conference call. Participating on today's call are Deverl Maserang, President and CEO; and Scott Lyon, Interim Principal Financial and Accounting Officer. Earlier today, the company issued its earnings press release, which is available on the Investor Relations section of Farmer Brothers' website at www.farmerbros.com. The press release is also included as an exhibit to the company's Form 8-K 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 replay will also be available on the company's website. Before we begin please note that all of the financial information presented is unaudited and that various remarks made by management during this call about the company's future expectations, plans and prospects may constitute forward-looking statements for purposes of the Safe Harbor provisions under the federal securities laws and regulations. These forward-looking statements represent the company's views only as of today and should not be relied upon as representing the company's views as of any subsequent date. Results could differ materially from those forward-looking statements. Additional information on factors that could cause actual results and other events to differ materially from those forward-looking statements is available in the company's press release and public filings. On today's call, management will also use certain non-GAAP financial measures, including adjusted EBITDA and adjusted EBITDA margin in assessing the company's operating performance. Reconciliation of these non-GAAP financial measures to their most directly comparable GAAP measures is also included in the company's press release. I'll now turn the call over to Deverl. Deverl, please go ahead.

Thank you, Rachel. Good afternoon everyone and thanks for joining us. I'm pleased to be with you today to provide an update on the progress against our turnaround strategy and five key initiatives. Since I spoke to all of you on last quarter's earnings call, I have continued to meet with a significant number of our customers, strategic vendors and our Farmer Brothers' team members. The knowledge gained from each of these meetings has further reinforced that the critical initiatives we have identified are the correct initiatives on which we should focus. Specifically, we need to reverse the sales to call trend in our DSD business, address the significant inefficiencies in our supply chain that creates substantial and unnecessary expense, and improve the processes and our execution throughout the various functional areas of the company. While these challenges will take both time and capital, we do not see any fundamental reasons that we cannot execute on them as part of our previously discussed 5E turnaround plan. As a reminder, our five key initiatives are: executing our supply chain optimization, owing our execution, enhancing our service capability and building upon our competitive advantage with our coffee brewing equipment program and evolving our product portfolio through innovation, and engaging our talent and refocusing our culture. And of course, while we focus on these improvements to our operation, prudent cash and liquidity management will continue to be important financial objectives. I'd like to start with a more specific status update on our progress with these initiatives. First, optimizing our supply chain. With Ruben Inofuentes on Board in the role of Chief Supply Chain Officer, we have conducted a thorough analysis of our manufacturing and distribution footprint to identify the right steps to optimize across both direct ship and DSD networks. We are continuing…

Thanks Deverl. Now, let me walk through our second quarter results. Beginning with coffee volumes. Green coffee processed and sold in the quarter increased by 2 million to 29.4 million pounds, a 7.2% increase over the prior year period. The mix of coffee volumes processed and sold during the quarter was approximately 9.0 million pounds or 31% of the total volume through our DSD network while direct ship customers represented approximately 19.9 million pounds of green coffee processed and sold or 68% of total volume. Approximately 500,000 pounds or 1% of the total volume was through distributors. The improvement in coffee volumes reflects higher sales to several direct ship customers partially offset by declining volume within our DSD network and the sale of our office coffee business in July of this year. The increase in volume did not translate to higher revenues due to customer mix, which I will discuss shortly. Turning to the income statement, net revenues for the quarter were $152.5 million, which is a decrease of $7.3 million or 4.6% from $159.8 million reported in the same period a year ago. The decline in net revenues was driven primarily by lower sales of coffee, beverage, and allied products through our DSD network due to net customer attrition as well as the sale of our office coffee business in July 2019. Our direct ship sales were comparable to the prior year period because the increase in direct ship volume was offset by the impact of coffee prices for our cost-plus customers and unfavorable customer mix. Gross profit in the second quarter of fiscal 2020 was $44.0 million, a decrease of $9.3 million from the prior year period. Gross margin also declined from 33.3% to 28.8%. The decrease in gross profit was primarily driven by lower net sales of…

Thank you. [Operator Instructions] And our first question is from Gerry Sweeney with ROTH Capital. Please go ahead, your line is open.

Good afternoon Deverl and Scott. Thanks for taking my call.

Good afternoon Gerry.

I apologize, I got dropped for a little bit, so maybe I missed some of this, and I had to dial back in. But I wanted to just talk about some of the initiatives that you're looking at, and in particular, maybe some of the items in terms of supply chain. And they appear, at least from an outsider looking in, that there may be some of the low-hanging fruit. I want to see where they are? And when -- if we're seeing any impact on margins or improvements? Or when we can expect it? And those two, I guess, areas would be the Houston rebalance and maybe the SKU counts.

Hey Gerry thanks for the question. Yes, from a supply chain perspective, we're starting to see the early signs of improvement in those areas. I would just add that on the rebalancing Houston, that is front and center right now. And the first component part of that, and we'll see that come online by April. And then we'll be executing more activity around the network from both. One, manufacturing. Two, the DC. You heard us mention the West Coast distribution network that we need to put in play to help drive supply chain savings. And then third, it's going to come out in transportation, which will have an impact in regards to the network there. So, from an executional perspective on those areas, I'm very confident that as this year continues to unfold, we will see results within this year on those areas. Speaking of SKU, as you know, when Chris Mottern was in as the interim CEO, he really was pressing on the SKU optimization. We've continued that work, and we're dead center in the middle of executing many of those SKU reductions, and I would expect that's probably some of the earlier work that we'll see bear some fruit here in the coming months and quarters.

Got it. And then on -- just a follow-up on that. Talking about the West Coast distribution, it sounds like it's still a little bit intermingled with the rebalancing, et cetera. Does that mean some capital outlay in terms of facilities? Or does that mean a sort of restructuring of where facilities are and mapping out some better locations or closing and adding, et cetera? Just any thoughts on that.

Yes. It's definitely not a rebalancing in the context of utilizing existing infrastructure. We've evaluated that. But this would be a lease facility with some capital to bring that facility up based on the size and scale. We're in the midst of determining where we are relative to the network optimization study that will be -- that we're currently performing, which is anywhere from eight to 12-week top study. We've got that underway. And so as we define with good information, and then we -- while we are in that process, we'll also be looking for the site that we want to go into. We sit with 40% of those customers, as we mentioned, being out in the West in the total network. The fact that we bring product off the West Coast, and then go right back to the West Coast from the Northlake, Texas facility. It's just been incurring a lot of additional transportation expense that we should never incur. And so, yes, some amount of the capital over the coming quarters would be placed into that, but it's for basic things. We'll do lease situation on the facility, and then we'll look to further optimize the network from a branch and overall D.C. perspective. But it's clear that we need a West Coast facility.

Got it. And then just switching gears over to maybe the direct ship side. If I heard it right, on the prepared remarks, you've done a customer review of that side of the business. And it sounded as though you may have had some either contracts or customers that maybe you're supplying coffee to on less than advantageous terms. Is that a fair way of looking at it? Is there some opportunity to gain by cuttings on the direct ship side?

I think the best way -- and not -- and I appreciate the question the way you're asking it. I think the way I'd like to talk about it, especially on rationalizing is to focus, first and foremost, on top line growth in that category with a heavy focus toward it being favorable on an EBITDA basis. And I want to continue to reiterate that, that's the way we're going to look at it. And so we're out hunting new customers. We're evaluating existing customers, and we're having good success across that category. As you saw, we grew direct shift on a total volume basis in the Q over prior, which I was happy to see. And we're going to just continue to slog along in that path. And we've got a lot of promise in that category as we're working with our direct ship customers. So, this is where -- if I see choppiness in the future, we're going to focus on free cash flow and EBITDA. And we'll see how that fares out over the coming quarters. And we'll report more as we see more success in that category.

I appreciate those comments and I'll jump back in queue. Thank you very much.

Thank you, Gerry.

Thank you. [Operator Instructions] Our next question is from Kara Anderson with B. Riley FBR. Please go ahead.

Hey, good afternoon guys.

Hello Kara.

I kind of wanted to jump back to that direct ship question. I know you were comping kind of a rather lackluster 2Q last year in terms of volume. But anything particular to call out? Was it really just two customers? Are you seeing strength across the Board? Or just is that kind of around the decision to target small or midsized business. Just if you could provide more color on that, that would be helpful.

Hey Kara, this is Scott. I'm not going to comment right now around specific customers. We delivered volume growth in our direct ship business in the quarter, and are focused on continuing to deliver volume growth long-term through improvements both in our direct ship and DSD businesses, while also remaining committed to increasing our EBITDA. From quarter-to-quarter, we may have puts and takes across customers. But as we mentioned in our prepared remarks, we have completed a customer-by-customer profitability analysis and see opportunities to improve our pricing structure for certain accounts. But where it may be best to discontinue the business.

The last thing I'd say, Kara, on that point is, we definitely see a mix of some customers contributing more growth than we expected based on the segment of the industry that they're covering, which has been positive, and we're continuing to cultivate those relationships. And of course, as our national direct ship sales team is out working. And as I've made many visits here in Northlake along with those customers along with going to visit customers, it's clear that we have lots of opportunity across that piece of business, and we'll continue to focus on that one's again, coming back to the ones that drive the most EBITDA and the topline growth that also impacts free cash flow. So, we're continuing to do that work.

Okay. And just kind of a follow-up on that. Since you have completed your profitability analysis of each, can you just comment on sort of what the pricing environment looks like with respect to direct ship customers or national customers?

Let me make sure, you want it from a pricing environment or from a margin perspective? Or--

Pricing environment. For instance, are you seeing pressure on prices as you're going out there and bidding new business or even as you think about maybe going back in renegotiating terms? What's the environment look like?

Listen, I think the comment that best would surmise that segment or area of the business would be, the industry is becoming more rational, and we're being more disciplined in regards to working with these direct ship customers.

Okay. Just one housekeeping question for me before I jump off. Can you provide the total revenue contribution from roast and ground coffee in the quarter or either as a percentage of sales or just a dollar amount?

Sure. So, for the quarter, our -- it was 63% of total revenue.

Perfect. Thank you.

Thank you, Kara.

Thank you. And I'm not showing any further questions. I would like to turn the call back to Deverl Maserang with his final remarks.

Thank you. As we enter the second half of the fiscal year, the entire team is motivated and focused on achieving our objectives. And I see great potential in Farmer Brothers and I'm confident that the strategic initiatives that we are focused on are the right ones. And I also continue to believe that coffee is a tailwind and not a headwind. And I'm encouraged by what I've seen thus far in my first few months here. I look forward to continue to drive toward returning Farmer Brothers to growth and profitability, and I thank you for joining us today and thank you for your continued interest in Farmer Brothers.

And with that, thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.