Farmer Bros Co (FARM) 2018 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Farmer Bros.

Second Quarter Fiscal Year 2018 Earnings Conference Call.

(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 Bros.

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 2 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 our long-term growth strategy.

We'll then open the call up for questions.

We are pleased with our performance in the second quarter with 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 have 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 sold 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 a corresponding 7.7% adjusted EBITDA margin.

The addition of Boyd's 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 the 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's, 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 have 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 3 months into a 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 have successfully transitioned Boyd's top customers without any disruption.

The Boyd's business performed in line with expectations in the second quarter.

Over the next 3 to 6 months, our integration milestones include ongoing physical consolidation of Boyd's branches into Farmer Bros.

branch locations; shifting of production to Farmer Bros.

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 planned movement of a portion of the volumes related to the Boyd's business to this facility.

We expect operating margins to continue improving as we increase utilization of the Northlake production capacity, with a significant increase in production volumes currently expected in fiscal 2019 once we have fully integrated the Boyd's 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 run rate at our state-of-the-art facility.

Farmer Bros.

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 0 to waste landfill targets in our Northlake, Portland and Houston roasting plants and our 2 distribution centers.

We have completed our LEED 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 we're 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 in executing our channel-based selling strategy in DSD.

As you might remember, we completed team member training under our new model in June.

We believe this channel-based 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 the Smart Touch selling tool to half of our routes, with the full deployment expected to be completed by the fourth quarter.

The Smart Touch selling tool automates and streamlines the ordering process, allowing our sales organization to drive incremental sales.

Our modernization initiative demonstrates Farmer Bros.' commitment to providing best-in-class service, a pivotal part 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 6 months or more from lead generation to contract signing and then a 3- to 6-month product transition window as the customer works through previous supplier inventory.

Our sales wins in recent quarters have been transitioning to full service as they work through their previous suppliers' inventory and are expected to contribute to sales in late Q3 and Q4.

We are working diligently at developing this pipeline and bringing on new customers.

We believe the execution of our strategy has created a strong pipeline of opportunities.

In conclusion, high-quality coffees and teas that consumers enjoy are at the center of our success, and we are committed to delivering the best-tasting products.

To that end, I am pleased to share that our tea submissions won 3 silver medals and 2 bronze medals at the recent Global Tea Championship held in January.

These awards are a testament to our efforts to deliver quality in all that we do and add to our differentiation in the marketplace.

Now I'd like to 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 in the quarter increased 18.7% year-over-year with the inclusion of Boyd's volume.

As Mike mentioned, this is a record quarter for us, with coffee volumes increasing by 4.6 million pounds over last year.

Volumes from our base business were 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 you a better sense of mix of volume across our distribution network during the quarter, approximately 9.9 million coffee pounds or 34% of total volume were processed and sold through our DSD network; while direct ship customers represented approximately 18.7 million pounds or 64.3% of total volume; and sales through distributors, including through new distributor relationships we acquired through Boyd's, represent approximately 500,000 pounds or 1.7% of total volume.

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% compared to the prior year quarter.

This increase was driven primarily by a $26.3 million net sales contribution from the acquisition of Boyd's.

Excluding Boyd's, net sales increased $2 million or 1.5%, slightly better than our expectations.

Excluding Boyd's, 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 through our new Northlake facility, and we expect to realize top line benefits of our new DSD sales channel model in 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 are 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 point margin decline were: 48 basis point increase in costs 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 has a slightly lower gross margin rate; and 50 basis points from the absence of a beneficial effect of the liquidation of LIFO inventory, which benefited gross margin during the second quarter last year.

We were able to mitigate these year-over-year cost changes by 70 basis points through improved production efficiencies at our Houston and Portland plants as well as reducing the operating costs 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 a gain of $37.4 million from our Torrance facility sale.

In addition, operating expenses reflect an $8 million increase in selling expenses resulting from the addition of the Boyd's business this year, a $1.1 million increase in operating expenses from the acquisition of West Coast Coffee, and higher depreciation and amortization expense on our base business of $600,000.

These items were partially offset by a $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 last year, increasing $2.6 million from the addition of the Boyd's business and $1 million from onetime acquisition and integration costs in comparison to last year's second quarter, which included $3.7 million in proxy contest costs.

We expect our go-forward operating expense leverage, excluding onetime integration expenses, to improve over time as we realize additional synergies related to the acquisition of Boyd's 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's, 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 in our estimated annual effective tax rate and a recalculation of our deferred tax assets.

Going forward, beginning in Q3, we expect our go-forward tax rate to 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 of $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 million 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's 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 our revolving credit facility.

Our debt net of cash at the quarter end was $79 million compared to $22.4 million at the end of 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 costs 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 in 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 have spent $11.8 million in maintenance CapEx, which is currently in line with our expectations of $20 million to $22 million of 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 at our new 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 quarters.

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 an 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 onetime costs to complete the integration.

We have 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 will realize further operating profit expansion on top of our performance in fiscal '18 as additional synergies from Boyd's materialize as we progress towards full integration, the DSD channel sales team matures and drives incremental top line, and SQF certification attracts meaningful volume growth through 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 Bros.

At the midpoint of our fiscal year, we are pleased with all that our team has accomplished, but we recognize that we have a ways to go to achieve our goals.

As we look forward to fiscal 2019, we remain focused on executing our differentiating strategies and unlocking Farmer Bros.' 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 are well positioned to realize efficiencies and to reap the benefits of the acquisitions we have completed, the new national accounts we have added and the changes we've implemented in our DSD 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.

So a couple of calls ago, you mentioned that you won -- I think it was 1.5 million to 2.5 million pounds of new business from some notable customers that you didn't name and then another bigger corporate win last call.

Can you talk about where you are in onboarding those new accounts?

And then maybe just overall, recap the new business won in the last year that you've announced.

Sure.

So we -- of the 2 we mentioned on the last call, 1 has started up.

We're in the ramp-up process, though very early on in it.

The other customer, quite frankly, most of that volume looks to come -- begin to come on this quarter.

So we're still where we said we'd be, maybe a step or 2 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 and running.

We have cleared the desktop portion of the SQF, and they're 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 can I -- how could I best get at that?

There's a lot of ground to cover there.

All right.

We can take that one off-line at another time.

Just one other question for me with respect to your EBITDA guidance of $54 million to $58 million.

You kind of laid out 3 ways you think you'll get there.

I think the third way you said was additional cost savings.

I'm wondering if you can elaborate on that.

It sounds like that is in addition to synergies with Boyd's if I'm understanding it properly.

Yes.

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 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, are more back ended towards the back half of this year.

So you're 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.

So I just want 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 of new business.

And I'm just wondering if at any point during the quarter, were you potentially maybe, like, turning business away as we're not fully SQF certified, 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, it's sort of like the floodgates open?

Because I'm just sort of thinking that you're having a lot of sales guys right now just potentially sitting on their hands, waiting for the certification to come through to really be able to market the business a little bit better.

So what I can tell you is we certainly have had a lot of interest from larger customers over the last 6 months, on-site visits, those types of things.

I think the SQF certifications are an important step and then [on lot].

Then there's typically the certification or the process with a specific customer.

But to answer your -- first parts of your question, we're not turning any business away at all.

Maybe we'll be much better poised to bring on that business once we get that -- get this fully certified.

And we remain really excited 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 customers grow.

And Francesco, one thing we said over the last couple of quarters that some -- a big part of our growth has just been flat where a few large customers were softer than we expected.

A lot of that is, of course, outside of our control.

We don't think that's an ongoing thing, but it certainly happened 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 past certification that we have a bigger opportunity to win some big business.

I guess just keeping with that comment of winning new business.

So recently, a large food retailer just divested their convenience stores.

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're going to continue to be with the existing coffee manufacturers or roasters that currently supply those businesses?

Well, I think we're really pleased with the growth that we've had in convenience stores over the last 5 or 6 years.

We're thrilled with some of the awards we've 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'd like to go after it.

And again, if you look at our track record over the last 5, 6 years, we've won some considerable business in that channel as well as others in foodservice.

Okay.

And this question is for David and it's on everyone's favorite topic, the new tax law.

I -- your guidance for your cash tax rate remains unchanged at 3% to 4%.

It -- I thought there were sort of some implications for limitations regarding the amount of the trailing or 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's an 80 -- there's a 20% limitation on the amount you can write off.

And yes, we took that math into account with respect to our NOLs and what we thought our go-forward cash tax rate was, and it's still 3% to 4%.

And our next question comes from the line of Chris Krueger with Lake Street Capital Markets.

Just a couple of quick ones.

First, was there any lingering hurricane impact in the quarter on your business?

Yes.

What I -- if you lump the hurricane with the fires in California, we have had a small -- but it's not really a critical part of the story.

We've 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 there may be a lingering effect just as those cities and towns, which have been through so much, continue to rebuild.

Yes, and we've had individual employees and branches affected, but the impact was much bigger for us in Q1, which is why we called it out.

We certainly measure the effect and we're filing insurance claims, but it wasn't material enough to bring out in the second quarter.

Okay.

My other question is now that you've moved from Torrance to Texas, I know some people didn't make the move and you've 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 is yes and yes.

We're really pleased with our ability to attract talent, and the relocation has gone well.

The key people are in place.

As you know, we have a pretty diverse set of needs since this facility has a headquarter component in areas like finance and marketing and distribution and so forth and then a roasting and a distribution center, and we've been able to meet our needs in all 3 areas very well.

I think having a state-of-the-art headquarters and a really forward-thinking point of view on sustainability and the way we take care of the environment really helped us recruit some great young talent.

(Operator Instructions) And we have no additional questions at this time.

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 Bros., 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.