Farmer Bros Co (FARM) 2017 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to Farmer Brothers first quarter fiscal 2017 earnings conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Tom Mattei. Go ahead, sir.

Good afternoon, everyone. Thank you for joining Farmer Brothers' First Quarter Fiscal Year 2017 Earnings Conference Call. I'm the Company's General Counsel. With me today, are Mike Keown, President and Chief Executive Officer, and Isaac Johnston, 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 24 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 that 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, 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, our President and Chief Executive Officer. Mike?

Thank you, Tom. Hello everyone, and thank you for joining us this afternoon. Here is our plan for the call today. I will start by highlighting our financial results for the quarter, then I'll provide an update on our key initiatives before turning the call over to Isaac, who will discuss our financial results in greater detail.

Overall, having ended fiscal 2016 on a strong note, we carried over that momentum as we entered the new fiscal year across many areas of the business. The ongoing successful execution of our turnaround strategy is continuing to show up at our financial results. And our balance sheet remains strong, providing us with the financial flexibility to continue to grow our business. We remain confident that we are well-positioned to continue creating value for all of our stockholders.

Turning to a few of our highlights from the quarter, coffee pound volume was again strong, gross margin improved and net income increased on a GAAP basis, as well as on a non-GAAP basis when taking into consideration a few factors which Isaac and I will both discuss. More specifically, coffee volume was up 8.1% driven by improvements in our direct ship channel.

As you know, we saw volume trends start to pick up in the second quarter of fiscal 2016 and this is the third consecutive quarter that we have achieved volume growth in the high single or low double-digits. For the quarter, we processed and sold around 23.3 million pounds of green coffee compared to 21.6 million pounds during the prior year period. We are pleased to see our volume growth being driven by both existing and new customers.

Next on to gross margin, where we again saw year-over-year improvement. Gross profit for the quarter increased 1.2% to $51.2 million from $50.6 million in the prior year period, with the increase driven by lower hedged cost of green coffee while maintaining and improving our efficiencies in our supply chain primarily from the consolidation of coffee production in our Houston facility.

Gross margin increased 130 basis points to 39.2% in the quarter, up from 37.9% in the same period last year. First quarter net income of $1.6 million was an improvement and reversal from a net loss of $1.1 million for the first quarter of fiscal 2016. Restructuring and transition expenses related to the corporate relocation plan in the first quarter were down $2.4 million compared to the first quarter of last year, as we've continued to make progress on our relocation activities.

Non-GAAP net income was $3.4 million or $0.21 per diluted common share in the first quarter of this fiscal year as compared to $4.2 million or $0.25 per diluted common share in fiscal 2016. Non-GAAP net income of $3.4 million includes $2.2 million of higher accrued taxes for the first quarter while we had $100,000 tax benefit in the prior year. And this impacted non-GAAP EPS by $0.13 per diluted common share. Isaac will discuss this in more detail, momentarily.

Next, I'd like to touch upon continued execution of our key strategic initiatives including our sales initiatives, the China Mist acquisition, and our corporate relocation plan. So let's look first at our continued progress in the modernization of our DSD operations, new customer wins, as well as growth with existing customers that collectively are driving volume increases.

In our DSD organization, we are close to completion in rolling out our GPS initiative that is designed to improve delivery route efficiency. We also believe there are significant other benefits to those scenarios, like safety. As to customer wins, our team signed up Allsup's Convenience Stores during the quarter. Allsup's has 300 store locations across Texas and New Mexico and a terrific reputation for quality, innovation and customer service.

Our new customers brought on recently or in the process of coming onboard, include DSD customers like a Big Biscuit, Jackson C Store and SSP that we mentioned on our last call. SSP placements in the major airports are making very good progress. Orders and shipments to 14 airports started in October, equipment installations are ahead of schedule and overall, we feel good about our progress.

Stumptown and Caribou in the specialty coffee category and major retail customers in the club and mass merchant space are up and running smoothly. We are pleased with the growth we experienced in the first quarter from existing customers in our direct channel.

We are continuing to see growth in our existing customer base which combined with additional prospects in our active pipeline positions us for strong activity through the remainder of the fiscal year.

Shifting gears, at the end of September we released our latest annual sustainability report which outlined the significant progress we've made in our social, economic and environmental development, or we call it SEED, objectives. Our commitment to sustainability positively impacts all aspects of our business including our grower partners, roasting facilities, distribution centers and offices. Further, we believe it strengths the value propositions we offer to our customers and in turn, strengthens our industry position.

We initiated our sustainability program four years ago and working towards achieving our SEED goals has been a key strategic focus for our team. We are proud of the steps our team is constantly and consistently taking towards achieving our long-term targets.

In addition to organic growth of the business, we're very pleased to have completed our acquisition of China Mist in October and we are now focused on working with the China Mist management team to grow the business.

The China Mist business is a great strategic fit for Farmer Brothers. It is an excellent brand in the premium tea category with a well-established national distribution basin over 20,000 food service locations across the country. We believe that the China Mist business is complementary to ours with different customers and distinct offerings of products and services, allowing us to expand our brand portfolio and contributing to the continuing growth of our fresh brewed tea business.

Importantly, we believe that their strong distribution network provides a new capability and hybrid model that'll work in harmony with our DSD and direct ship capabilities. The China Mist management team, along with representatives from Farmer Brothers, has met with virtually all of the China Mist distributors and received positive feedback about the acquisition.

We are excited about expanding the relationship with each of our China Mist distributors. In addition, China Mist has a growing international business that is very attractive to us as we look forward to additional growth opportunities for the Company. We continue to be enthusiastic about the opportunity to expand our business and better serve our customers through this transaction.

Ahead of the China Mist acquisition, our Board and Management team completed an analysis of our market and competitive landscape. As a result, we believe there may likely be opportunities to pursue additional inorganic growth in the future with operational and financial criteria that would generate stockholder value.

Turning to our operational efficiencies and corporate relocation initiatives, on last quarter's call, I noted our plans have been running very effectively and have been very dialed-in. As we begun this new fiscal year, our organization across the board is continuing to run on all cylinders. We remain intently focused on enhancing the products and service we provide to our customers, as well as creating and leveraging supply chain efficiencies to further reduce costs.

As to our corporate relocation plan, we continue to make progress. As you know, we closed the sale of our Torrance property in the first quarter of 2017 and our spice assets in the second quarter fiscal 2016, both of which are providing funding for the new facility in Texas. We continue to expect to begin to move into the new facility in the second quarter of fiscal 2017 and to be operational in the third quarter.

In other news, we fully converted to 3PL by the end of March and began seeing some of the savings from the transition in this quarter. We expect the savings will increase after bringing on the new Northlake Texas facility. We remain on track to achieve the expected $18 million to $20 million in annualized cost savings from our corporate relocation plan.

We look forward to realizing the expected operational and financial benefits of the new facility as we position Farmer Brothers to better serve existing customers and offer potential customers high quality products from our new state-of-the-art facility. Let me reiterate a few points before I turn the call over to Isaac.

First, execution of our turnaround strategy continues to generate both operational and financial improvements. Second, our efforts to strengthen our DSD group, our ability to win new customers and increase volume with existing customers coupled with the efficiencies we are creating in our supply chain which are continuing to collectively drive volume growth gross margin expansion, cost reductions and ultimately improve profitability.

The improvements we've made across our business in recent months combined with our ongoing focus on the Company's key strategic initiatives, including our corporate relocation, are establishing a strong foundation that we can continue to build upon to achieve long-term sustainable growth and value creation for all stockholders.

Let me now turn the call over to Isaac, who will provide you with additional detail on our quarterly results. Isaac?

Thanks, Mike and hello. I'll spend the first few minutes discussing our financial performance for the first quarter of fiscal 2017. We are pleased with our strong start to the fiscal year. We continue to successfully execute against our objectives of driving improved volume growth and creating efficiencies in supply chain management.

Now, let me go to some of the details of our results. On the income statement, net sales in the first quarter of fiscal 2017 were $130.5 million, representing a 2.2% decrease compared to net sales in the first quarter of fiscal 2016, driven by a decrease in net sales of spice products and coffee sales dollars partially offset by an increase in net sales of tea, culinary and other beverages. Spice sales in particular were down $2.3 million or 2% of sales from the sale of our institutional spice business to Harris that occurred at the late part of last year.

As Mike mentioned, we had an 8.1% increase in coffee pounds sold in the first quarter which was offset by $4.2 million in price decreases to customers utilizing commodity-based pricing arrangements. This compares to $1.3 million in price increases to customers utilizing such arrangements in the first quarter of fiscal 2016.

Total unit sales increased 7.4% in the quarter, as compared to fiscal 2016, but average unit price decreased by 8.9%. The increase in unit sales was partially due to the 8.1% increase in net sales of roast and ground coffee products which accounted for approximately 62% of our total net sales. The decrease in average unit price was primarily due to the lower average unit price of roast and ground coffee products, mostly driven by the pass-through mechanisms of more green coffee commodity purchases, costs that have been passed on to our customers.

Gross margin for the first quarter of fiscal 2017 was 39.2%, compared to the 37.9% we reported in the first quarter of fiscal year 2016, a 130 basis point improvement versus the prior year. The improvement in gross margin was primarily driven by lower green coffee costs, as well as maintaining improvements in conversion of leverage as we move production from our Torrance California manufacturing site to our and other supply chain improvements.

Gross margin includes a benefit from expected LIFO layer reductions in the first quarter fiscal 2017 of 800,000 compared to no benefit in Q1 of fiscal year 2016. The LIFO layer benefit in 2017 is primarily from the reduction of spice inventory materials and finished product from the sale of our spice business to Harris. Overall, we experienced a strong quarter in gross margin improvement.

Operating expenses in the first quarter was $48.7 million, representing a decrease of $2.4 million as compared to the $51.1 million recorded in the prior year period. The decrease was primarily due to restructuring and other transaction expenses in connection with our corporate relocation plan, being $2.4 million lower than the prior year period because the majority of the plant expenses related to the relocation have already been recognized in prior periods.

In addition, we recorded a $1.7 million net gain on sales of real estate and earn-out from last year's sale of spice assets and had lower general and administrative expenses partially offset by increases in selling expenses. Included in operating expenses were 400,000 related to M&A activity which included the China Mist due diligence completed in the first quarter and subsequently closed in the second quarter along with some landscape work.

Additionally, during the first quarter of fiscal 2016, we incurred $1.3 million in legal and professional service expenses from the 2016 proxy contest that were in excess of the level of expenses normally incurred for an annual meeting of stockholders. As a result, income from operations in the first quarter was $2.5 million, compared to a loss from operations of $600,000 in the prior year period, an improvement of $3.1 million.

Total other income was $200,000 in the first quarter of fiscal 2017 as compared to total other expense of $600,000 in the first quarter of fiscal 2016 which included a net loss on derivative instruments and investments of $900,000 in the prior year. We had an effective tax rate of 39.9% in the first quarter as compared to a tax rate of 7.6% in the first quarter of the prior fiscal year. The Company's effective tax rate for the first quarter of 2017 was higher than the US statutory rate of 35%, primarily due to state income tax expense and higher as compared to the first quarter of fiscal 2016.

This change in our tax rate is due to the action we took in the fourth quarter of fiscal 2016, releasing our valuation allowance against our prior deferred tax asset. As a reminder, we made the determination to release the valuation allowance based on the fact that it is more likely than not, the Company will be able to utilize the deferred tax assets.

This was based on our solid financial performance with 36 months of net income, the sale of the Torrance Facility that is expected to result in a significant gain in fiscal 2017, and a strong outlook of future earnings. As a result of all the factors above I mentioned, that income was $1.6 million in the first quarter of fiscal 2017 as compared to a net loss of $1.1 million in the first quarter of the prior fiscal year. Net income per diluted common share in the first quarter was $0.10 versus net loss per diluted common share of $0.07 in the prior year quarter.

For non-GAAP, as Mike mentioned, our non-GAAP net income was $3.4 million in the first quarter of fiscal 2017 versus $4.2 million in the prior year period. Our non-GAAP net income per diluted common share was $0.21 in the first quarter of fiscal 2017 versus $0.25 in the first quarter of the prior year. Our 2017 non-GAAP net income includes a total of $2.2 million in taxes.

This consists of $1.1 million in taxes from GAAP income and $1.1 million for the tax effect of non-GAAP adjustments and this compares to a $100,000 tax benefit for the first quarter of fiscal 2016. This decrease in non-GAAP net income was primarily driven by the book tax rate and was lower by $2.2 million or $0.13 per diluted share impact from taxes. For liquidity purposes, for those who are using a cash model, our cash tax rate is expected to be 0.5% for 2017 as we utilize our large deferred tax assets.

Our adjusted EBITDA margin increased to 8.9% during the quarter versus 8% in Q1 of 2016, a 90 basis point improvement. Now, let's turn to the balance sheet. As of September 30, 2016 we had $16.5 million in cash and cash equivalents. Additionally, we had $26 million in short-term investments. As of September 30, 2016 we had $200,000 borrowed and outstanding on our revolver credit facility. Our credit facility with JP Morgan, Chase and SunTrust has a $75 million borrowing capacity and a $50 million accordion expansion feature.

As of September 30, 2016 we utilized $11.9 million in letters of credit and had $45.4 million of excess availability of the credit facility based on our borrowing base capacity. For the first quarter of fiscal 2017, our capital expenditures were $24.6 million as compared to $3.8 million in the first quarter of fiscal year of 2016. $21.3 million is related to our new facility and $3.3 million for our routine capital expenditures, primarily, coffee brewing equipment.

On the balance sheet, for those of you looking through the press release on the balance sheet, you'll notice a few items related to the Torrance sale leaseback transaction. Because the sales leaseback arrangement for the Torrance Facility includes zero base rent, the sale leaseback transaction is treated as a financing transaction and will effectively defer the gain on the sale of the Torrance Facility until we vacate the Torrance building which we expect to by the end of December, 2016. As a result, we have deferred the gain on sale of the Torrance Facility and instead, recorded the net sales proceeds of $42.5 million accrued interest on the financing transaction of $300,000 in sale-leaseback financing obligation, you'll see that on the balance sheet.

And then have accrued interest in a non-cash charge and along with $900,000 of accrued rent expense recorded in other current liabilities will increase -- both of these will increase the gain on the sale of the Torrance Facility when we transition out of the facility. In addition, we exercised the lease to purchase the partially constructed new headquarters, manufacturing and warehousing facility in Northlake, Texas for $42 million.

If you follow the lines of the balance sheet, in cash we received $42.5 million of cash from the sale of Torrance. We then spent $42 million exercising the purchase option of the facility in Northlake, so $42.5 million in, $42 million out. The Torrance Facility remains on our balance sheet at a $7.1 million current asset held-for-sale and we have a $42.8 million current liability under the sale leaseback financing obligation on the balance sheet.

Upon closing of the option to purchase the new Northlake Texas Facility, other long-term liabilities decreased by $28 million and PP&E increased by $22.3 million. Total capitalized assets for the Northlake Facility as of September 30, 2016 were $42 million. So we put the new facility asset on the books. Depreciation and amortization expense for the first quarter of fiscal year 2017 was $5 million versus $5.3 million in the prior year period.

As of September 30, 2016 we held coffee-related derivative instruments covering 15 million notational pounds of green coffee as compared to 34 million pounds covered as of June 30, 2016. In addition, we had green coffee fixed price contract commitments of $65 million, which is a $28.1 million higher dollars than September 30, 2015. As of September 30, 2016 we have $32.1 million in coffee inventory processed and unprocessed.

The combination of increased coffee-related derivative instruments and the increase in fixed price green coffee contract commitments, has increased the price certainty of our green coffee costs. I would now like to discuss some of the details relating to our corporate relocation plan.

Since the project started in 2015, the Company has recognized a total of $28 million including employee retention and separation benefits of $16.6 million, facility-related cost of $4.5 million related to the temporary office space and $6.8 million associated with the move of our headquarters, relocation of the Torrance operations and other related costs.

We have estimated that we will incur approximately $31 million in aggregate cash cost in connection with these restructuring and other transition expenses associated with the corporate relocation plan. The remainder is expected to be recognized in the second and third quarters of fiscal 2017. The Company also recognized $2 million in non-cash depreciation expense associated with the Torrance production facility and has reported $900,000 of non-cash rent for the Torrance Facility as part of the Torrance sale leaseback transaction.

In addition, we may incur certain pension related costs. As you know, in June 2016, the Company exercised its purchase option to purchase the new facility under construction in Northlake, Texas. On September 15, 2016 the Company closed the purchase option and acquired the land and the partially constructed new facility located there on aggregate purchase price of $42.5 million, consisting of the purchase option price of $42 million based on the actual construction cost incurred as of the purchase option closing date.

Plus amounts paid in respect of real estate commission, title insurance and recording fees.

The Company continues to estimate that the total construction cost, including land, will be approximately $55 million to $60 million for facility and cost of IT, furniture fixtures and other costs in the $35 million to $39 million range. As of September 30, 2016 the Company has spent $42.5 million on the construction of the building. Construction of and relocation to the new facility are expected to be completed by the third quarter of fiscal 2017.

We continue to make progress in our corporate relocation activities which remain on track to produce cost savings of approximately $18 million to $20 million annually.

With that, I'll turn the call back over to Mike.

Thanks, Isaac. As always, I would like to thank those on the call for your continued interest in Farmer Brothers. We are very excited about the continuing improvements in our operations and in our financial performance and we remain confident in our ability to continue creating value for our stockholders as we execute our turnaround strategy, including our corporate relocation and sales initiatives.

And with that, I'd like to open the call up for a few questions. Operator?

(Operator Instructions) Tony Brenner with ROTH Capital Partners.

A couple of questions, green coffee prices are up about 40% since the beginning of the calendar year. At what point do you estimate your sales will reflect higher prices rather than lower prices?

There's two parts to that answer. As you know, we have a number of customers that are on a cost plus basis and we also have some hedging arrangements with them, as well.

When will you know? That's what I'm asking.

Those will tend to flow over some period of time in the relative mid-term, I would say but I'm giving you a balance of what all of those look like. In our DSD business, probably begin to see that happen again over what I'll call the mid-term being -- would be kind of the middle of the bell curve.

One of the things over the last kind of 12, 14 months, we instituted a program where we can go farther out in hedging programs. So when the coffee prices are low, then many of the customers and then also Farmer Brothers and you can see that on our purchase commitments, went farther out.

So when the prices were in the $1.30 range, we were going longer and we communicated that on the call a couple of times. So you'll see that translate, so you'll see a lag impact a little farther from us than you probably will see from some of the others as far as the impact on prices and also, within some of our larger customers, you'll probably see something similar.

The gains on sale of assets, on spice assets, are in the line item, they are net gains. Does that mean net of tax, the net gains after the tax provision?

Those are shown as a gross number for both of those items and then the tax provision is shown as a separate line.

And then, we've covered this a couple of times. When we reengineer the facilities and the infrastructure, if we're moving to other facilities, we attempt to qualify for a 1031 exchange in those facilities that could potentially qualify. But those are items that occurred longer term. But for what's shown on the income statement, it is shown without the tax impact.

One more for you Isaac; the ongoing tax rate?

Yes. I would say the best estimate including the state income tax rate, Federal up 35 and then combined up to 39% is probably the best rate, 39% to utilize.

One more, Mike; your direct sales are just about all private label, I believe. And most of your DSD sales of coffee are sold by your customers as generic coffee. Yet, you've got a number of brands that I know you're proud of, at least some of them you are. Are there any plans to expand the use of those brands either in other sales channels or some other way to take advantage of whatever value they contain?

The answer is yes, we do have several brands that we're proud of. I would say in answer to your question, it's on the list of things we're working through right now, as we look at how do we better leverage brands. China Mist will give us tremendous opportunity to do that.

They've built a terrific brand and I think we've got the capabilities inside to grow that business, as well as others whether it's a regional brand like Cain's and McGarvey or other brands in this stable. So I would say more to come on that and that's something we're actively working on as we go through our next rounds of strategic planning and execution.

(Operator Instructions) Chris Krueger with Lake Street Capital.

First, I did not catch the name of the chain of 300 stores in Texas and New Mexico that you're doing business with now, can you repeat that?

Sure, it's Allsup's.

How do you spell that?

A-L-L-S-U-P-'S. Very significant down in this part of the country and like I said, a tremendous reputation across many areas of their business, so we're thrilled to bring them on.

And is your pipeline of potential accounts like that starting to build and potentially, you can see kind of a momentum as you get into new your facility, is that still the way that we should look at that?

Well, it's very difficult to predict potential customer behavior on a quarter-on-quarter basis. But I feel good that we're past some of the issues we had at this time last year, when we were managing at different times the exit of Torrance moving the volume into the other facilities. So a lot of that complexity is gone and as we've talked before, we were hopeful that we could bring on new business.

And that we've been pleased over the last three quarters that we've had growth rates, as I mentioned, in the high single or low double-digits. So I would hope that continues but very difficult to in any way forecast, it's basically impossible to forecast but we'll continue to do our best.

And when we bring the new facility up and running, we will bring between 24 million to 28 million pounds of incremental capacity which will bring that capacity online one shipped at a time.

So the team and I think we've mentioned this about two or three conference calls in a row, the team has been selling for that incremental capacity for at least three quarters of the time. So we're working very aggressively to try to gain as much incremental volume as we can.

Next question; your December quarter typically is your seasonally strongest quarter. Can you talk a little bit about how maybe the month-to-month trends in the third quarter -- your September quarter went? Is the typical momentum building heading into the fourth quarter as far as that seasonality?

The phenomenon of coffee increasing in that quarter, the October, November, December quarter, has been with us and been with the category for many years. I would suspect that would continue and we feel very good right now. As I mentioned, the plants are running very well.

The supply chain's doing a terrific job. So too early to comment on the volume trends in any specific quarter, but we're hopeful that that category trends [occurs] this year and that our customers and by linkage, ourselves, benefit from that.

Francesco Pellegrino with Sidoti & Company.

So quick question for you, just looking at how to get to the adjusted number, the $1.3 million in the proxy for the elevated proxy spending that rolls up into G&A, right?

In the G&A line, that is correct.

And then the $400,000 that you talked about, Mike, for I guess due diligence fees to acquire China Mist, was that a G&A expense or does that fall below the operating income line?

No, that fell into the G&A line also within the quarter, a portion of it, I think fell into G&A and a portion of it into selling, if I recall correctly.

So the $8.9 million in G&A expenses could really be closer do like $7.5 million like normalized, you're saying, roughly?

Roughly, I think we also had a lower bonus accrual in the quarter within the G&A relative to some of the accruals we've had within the same quarter prior year. So I think that gave us a little bit of benefit within the quarter.

So Mike, your opening comments were that there was a way to view the quarter that maybe some adjustments you didn't necessarily take for your non-GAAP net income, could allow us to sort of view adjusted EPS as actually being up year-over-year.

If I look at the China Mist due diligence fee of 400k, I think that comes out to about maybe $0.03 per share. Could you just maybe walk us through that math?

If you look at last year's adjusted -- last year's non-GAAP, it was in the $0.25 range.

Right.

For liquidity purposes, if you look at the difference in the tax rates between year-to-year, the impact on that alone is $0.13 a share. So a very significant impact between year-to-year. So that would take you -- if you were looking at it from a cash basis standpoint, would take you above the prior year because we're utilizing our deferred tax asset.

So those are not necessarily cash taxes paid, they're deferred tax assets. So if you're using a cash flow model, a liquidity model, that's the way you would want to look at. The other item we did incur and we didn't put it on as a non-GAAP adjustment. We spent about $400 million in the M&A activity. We bought China Mist, but we didn't close the transaction until Q2. We did the due diligence in Q1.

So we had to -- we would recorded cost associated with the due diligence but we didn't get the -- we haven't started getting the revenue in the upside score. So there was a timing issue, but because we completed the due diligence within the quarter, we had to record the costs. And then we spent a couple hundred grand in the landscape activity also, to try to get a better understanding of what potentials are out there from a strategic standpoint, so combined in the $400,000 range.

And then I know also the year ago period included business from the spice assets that you sold off. Is there a way to quantify that in the year ago period just sort of make it an apples-to-apples comparison?

Yes that's a very good question. If you look at the real estate gains and losses, there's just under $200,000 that moved from gross margin down to real estate gains and losses because as you're selling off the business, the volume flowed out, the gross margin flowed out. And as we're selling the business, the majority of the earn-out is flowing through real estate gains and losses, and I believe that's a separate line.

We broke that line item out in the income statement. So you can see that as the reader, the difference between the sale of assets and in the sale of the spice business, the earn-out associated with the spice business. That's a little bit less than $200,000, I believe on that item.

And you guys have been doing pretty impressively since the third quarter. As you've been having this nice gross margin above 39%, is there any concern I guess maybe as you take some volume out and start transitioning it into Northlake, that just maybe over the short-term, we can get some processing deleverage that sort of drives down your margins until you're all in with the new Northlake Facility?

Where you're going to see as the depreciation load will come onboard so you're going to probably want to look at more of an EBITDA number versus just the gross margin number. So that depreciation load will come in, and that'll be a non-cash expense.

So looking at it from an EBITDA standpoint, it's probably the best way to analyze the effectiveness of the business. As we brought the new facility up and running, we went through a pathway to try to scale the cost and somewhat mitigate the cost of bringing the new line on board. Instead of bringing that entire 24 million to 28 million pounds up and running, we de-risked it and are bringing basically one shift up at a time.

What that does, is it allows your organization to go through a learning curve at a lower cost structure, than trying to bring up three shifts at a time. It also allows you to make sure you're getting very good quality product, you're servicing, you're --

But you have a lot of overhead I would think, like overhead stays the same.

Yes, but its overhead off of one shift, you're not bringing on overhead of three shifts. We're bringing a third of the number of bodies on board that you are bringing incremental overhead. And then as part of the corporate relocation plan as Mike mentioned earlier, we've moved over to 3PL by bringing the new facility up and running, and the warehouse up and running, it allows us to then start working on the efficiencies, the movement from the plant warehouse to our branches and to our distribution centers from a supply chain management standpoint.

So we can start focusing in that area as we grow the business and then start driving leverage out of that site through incremental growth. And so that's kind of the pathway that we went down towards. We're trying to somewhat mitigate the incremental costs associated with bringing the new production line up and running.

To give you just a little deeper sense of that, so the distribution center is very close to starting up on that process which requires a considerable amount of training and we're going through that I think with some pace, but also ensuring that we check the boxes in terms of quality and so forth. We have a number of teams, I think 21 teams working on the corporate piece of that to ensure that we get over there and we can continue to perform our jobs.

And then to Isaac's point on the roasting, we think the fastest path would be to get those lines in, get an experienced group out there, take care of our Food Safety Modernization requirements and take quality food requirements. And so forth, and then as we bring in volume, move additional capacity in there. So it's quite an undertaking, but overall we feel like we're well poised to achieve what we told you we would in the last call.

When I think about just the on boarding and the way you're going to be bringing shifts online over the next year, maybe year and a half. Is there a thought of maybe like what trainee expenses will be that will sort of be like one time in nature on a quarterly basis? Like $300,000 can sort of like add up to your -- the difference between them, your adjusted number and your GAAP number?

Yes. Any time you bring up those incremental shifts online, there will be some training associated with it. The way most manufacturing companies operate is to try to bring one shipped up at a time. And then you start moving people from the first ship to the second ship, you don't bring all the people but you take a few of the individuals.

So let's say you take two of the individuals off the ship, you move them into the second ship, and then you bring somebody new and so you have the new employees working with experienced employees. And then you -- what that does is, it helps mitigate the overall toll, training costs and also the costs associated with getting your conversion efficiencies to the state that you would like to get them to.

So yes, there will be some cost associated with it, but the pathway we've gone down is to try to mitigate it versus trying to bring it all up in one very large slug.

And last question; could you give us insight into maybe what the depreciation load will be over the next three quarters?

We haven't given that exact number. What we will give in the queue that's coming out, we will give you the updated useful lives of each category. And then you can apply the spend that we had within what's in the building, what's in machinery equipment furniture and fixtures, against the useful lives.

We're handling -- we've gone through more normalized industry useful life categories and we'll handle that on a prospective basis when those assets come on board. So it'll be fairly easy to take our capital expense and then apply against those cost categories. In most instances, machinery and equipment is in the 10 year life if it's new. Most instances, buildings are in a 30 year useful life. Furniture and fixtures, and IT software in the five to seven year range.

So I know you want an exact number, but we haven't provided the guidance on an exact number on the depreciation at this time.

At this time, I'm showing no further questions. I would like to turn the call back over to Mike Keown, for closing remarks.

Well, once again, thank you everybody for your time, for your questions. We look forward to seeing those who will be coming to our Annual Stockholder Meeting and thanks once again. We'll be talking to you in a quarter. Thanks so much, bye-bye.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect, everyone have a great day.