Farmer Bros. Co. (FARM) Q3 2023 Earnings Call Transcript
Good day, and welcome to the Farmer Brothers Fiscal Third Quarter 2023 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.
Joining me today are Deverl Maserang, President and Chief Executive Officer; and Scott Drake, Chief Financial Officer.
Earlier today, the company issued its quarterly shareholder letter, which is available on the Investor Relations section of Farmer Brothers website at www.farmerbros.com. The shareholder letter is also included as an exhibit to the company’s Form 8-K and is available on the company’s website and on the Securities and Exchange Commission’s website at www.sec.gov.
A replay of its 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 the call, 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 regulation. 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 shareholder letter and public filings.
On today’s call, management will also reference 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 shareholder letter.
Now, I’ll turn the call over to Deverl. Deverl, please go ahead.
Good afternoon, and thank you for joining us.
I’d like to take this opportunity to discuss some highlights from our third quarter, before Scott discusses financials, and we will take questions.
While we did make some slight progress this quarter, our results are not what we or our investors should expect. Progress in restoring sales growth and rebuilding gross margins back toward our targeted 30% level has been challenging. This has been due in part to issues outside of our control in terms of coffee pricing volatility and inflationary impacts on costs in a tough macro environment.
But frankly, we know we need to execute better. To that end, we pivoted in the third quarter, implementing critical long-term pricing optimization and production process enhancements, which we believe will put us on a stronger foundation. These efforts are beginning to drive efficiencies and position us to better capture pricing opportunities as we head into the 2024 fiscal year.
However, there are near-term costs to implementing these changes, including some short-term disruptions in inventory planning, which impacted our third quarter. As part of these efforts, we launched our new AI-based pricing engine, which is already providing improved, actionable data, enabling us to optimize pricing structures with customers and facilitate our goals toward margin expansion. In fact, we have already implemented a coffee price increasing using the data from this tool early in our fiscal fourth quarter.
Production wise, we also implemented strategic changes to our customer ordering process, including adopting a longer lead time ordering approach. This effort involves holding more finished goods to better plan for and meet fluctuating customer demand for key items while creating manufacture efficiencies that will benefit our cost structure.
The targeted improvements include realizing lower cost per pound, delivering better margins and generating additional cash flow, all while better serving our customers through improved product availability and quality. The benefits of this new ordering processes are already beginning to appear with record-setting production at our facilities in recent weeks and lower price per pound.
While focusing in on efficiencies in the third quarter, we are also executing on future growth initiatives. During the quarter, we saw tremendous growth from our REVIVE services business unit, securing several new national accounts and successfully launched SHOTT, an innovative line of premium shelf-stable, real fruit syrup concentrates, which we’re very excited about. We are already experiencing solid demand from our limited releases on the West Coast and are working to expand its availability.
To close, we remain firmly committed to improving execution and achieving our financial, operational and strategic goals. At the same time, our Board Committee on strategic alternatives and capital allocation is working expeditiously on potential enhancement to our capital and operating structure. Together, both the Board and management are very focused on delivering results for our shareholders, and we will have more to share in the near future.
I will now turn it to Scott. Scott?
Net sales in the fiscal third quarter of 2023 were $124.2 million, an increase of $4.8 million or 4% compared to the prior-year period. The revenue growth reflected pricing increases to date.
Gross profit was $28.7 million for the quarter. This results in a slight improvement in gross margin on a quarter-over-quarter basis for the second consecutive quarter.
The fiscal third quarter marked the first recent three month period where the average coffee product cost per pound did not increase compared to the prior period, a trend we expect to continue to benefit from.
Farmer Brothers reported an adjusted EBITDA loss of $800,000 in the third quarter of fiscal 2023, a significant improvement over the previous quarter’s $3.1 million loss.
Our unrestricted cash balance decreased by $2.5 million from $9.8 million as of June 30, 2022 to $7.3 million as of March 31, 2023.
We had an increase in DSD revenues, reflecting increased realization of recent pricing increases. Additionally, we had lower coffee costs, better pound volumes for DSD customers, several new customer wins and a lower customer churn rate.
In our direct ship customers, we delivered a mid-single digit year-over-year sales decrease, primarily due to previously mentioned near-term disruptions as we shifted our production planning process from a make-to-order to a make-to-stock focus. We are now operating at full capacity and anticipate recovering most of the resulting paused sales before the end of this fiscal year.
Overall, we have exited the third quarter a healthier business than we entered it, though, as Deverl noted, we have a lot of work to do to deliver the results we are committed to delivering. We remain focused on our near-term objectives, which are to continue expanding our margins, improve our capital structure, and position the company for sustainable long-term growth.
We will now open up for questions. Operator?
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Thank you. Our first question comes from Brandon Rogers with ROTH MKM. Please go ahead.
Hey, good morning, Deverl and Scott. It’s actually Gerry Sweeney. Brandon registered for me, so it came up under his name, so my apologies. But…
Good morning, Gerry.
I have a — I want to start with margins, right? So, obviously that’s a lot of focus, it’s still down in the low 20%-s, and you’re targeting high 20%-s and eventually into the low 30% range. As we were progressing through this year, we knew we had some contractual headwinds that were — are supposed to roll off Q3, Q4. I believe you made some investments that maybe impact the margins in the short term, but then you also have pricing structure changes, and then make-for-stock.
So, there’s a lot of moving parts under here that we’re looking at margins. And I was hoping maybe you could peel back the onion a little bit and just work through this, how the contractual aspects of pricing, how that’s going to work through the system? And then, look at investments and pricing structure changes and make versus stock, how that’s going to impact it over the next couple of quarters? I know that it’s a lot to unpack there and it’s a little bit of a messy question, but if you could maybe take a shot at it, I would appreciate it.
You bet. Good morning, Gerry. I think that if you look at it, you’re right, it’s not where we want it to be, it’s not where it needs to be, to start, obviously. And there’s a lot in there. But I think the highest level way to look at it just to try to make it digestible components is that you’re right, there’s — we talked about price increases contractual changes, and I would say that obviously for the most part, those are having minimal impact to this point.
So then you have to flip over to the cost side and that’s where we have seen our coffee costs peak out for both the DSD and direct ship business, a little bit different timing on those because of the way some of our customers handle their pricing on coffee. But we’ve seen both of those peak and they’re starting to decline now. So, it’s really just us selling through this higher priced coffee that is on the balance sheet, so that we can get to lower price coffee and better margins.
Another response to that, two other primary drivers that are really you’ll see as we go forward, we wanted to be sure that we still absolutely see the margin recovery coming, it’s just a timing issue at this point. So, we expect for the rest of the calendar year here to continue to gain on the margin equation.
The efficiencies and the changes in the investments we’ve made to both our production and how we’re going about the production of coffee and handling of coffee, it was almost kind of a investment for the longer term to really, really get efficient and really have efficiencies that we could rely on for a longer period of time versus a short-term fix. So that did pause a little bit the cost equation, but we absolutely are setting up for a better long-term pricing and cost per pound in the operations.
And then finally, we did note that we’re taking more pricing action as well. That’s the other thing. With coffee having not really fallen much, we’re still in the $1.80s, $1.90s, it’s just appropriate to go in and adjust pricing. And the good news is we have much better insights and much better analytics due to the tools and the outside parties we’re looking at and working with now. So it’s another one where we think we can have near-term benefits from pricing as the actions that we’re taking now as well as get really, really better refinement going forward as well that will really help us with long-term margins again.
Got it. And just to follow-up on the DSD pricing that you mentioned, it also sounded as though volumes were up and you want some customers. So, those price increases have not only been passed through to customers or successfully being passed through to customers, you’re still — you’re winning customers as well. So, am I reading that correctly?
Yes, we’ve definitely seen the margins — sorry, the pounds year-over-year in DSD improved. Now, I would say if you look at the quarter and kind of unpack it a little bit, we did have January with a little softer again because those manufacturers changes, we call that a primarily impacted direct ship, but there was some impact to DSD in January. But in March, February and going into April, we’re seeing much better pound volume increases and again, yes, customer wins. So, definitely momentum within DSD.
Got it. And then switching gears to direct ship. The stock versus make aspect, is that — I don’t know if — I don’t want to — a standard procedure in the industry or are your customers comfortable with that or is there any risk that customers will bulk at that and reduce volumes? I understand that certainly the benefits longer runs, just more efficiencies et cetera, just curious as to how that customer reaction to that process is?
Gerry, great question. I’ll tell you this. We’ve gone, since my time here for the last four years, in making the order in direct ship. The direct ship peaks trough can vary anywhere from zero growth to 400% deviation. That reality creates a lot of immediate issues when you’re trying to cover those kind of volume fluctuations and forecasting demand for those direct ship customers.
In COVID, and currently post-COVID, the supply chain has dramatically shifted. That shift has resulted in basically the elimination of spot market volume within North America. So, we said with those longer lead time challenges of getting specialty coffees for certain roast profiles for direct ship customers, fluctuation in demand and forecasting for those customers that we couldn’t continue to just service those customers in a make-to-order fashion. So we have changed the way we’re producing those to build more stock for them. And by doing that, it’s provided us better production efficiencies. We are running better production efficiencies in the last couple of months than we’ve ever seen. We’re actually setting records on cost to serve in the last few months.
And secondly, it’s actually improving the overall service to those direct ship customers, because we then have inventory. And if we’re missing some amount of inventory and we have the green beans available, then we’re able to make up that and not have to make it up in such a dramatic way within a week or a month of them ordering. So, we’ve asked them to lengthen, the challenge for those customers is lengthening their order lead time, that’s one ramification. And then, making sure that we have the green beans pull-through and available and close by because of the lack of the spot market on green beans in the U.S., and then we’re building the inventory based on those overruns. And that’s provided us some success. We knew it would be good, but we didn’t know it’d be as good as what we witnessed in the recent weeks and months.
And so that is kind of the outcome of that. And that’s investment that we made in this last quarter that we saw some cost absorbed through that and increases. And now, we’re coming out of it and it’s paying some dividends as we move at the end of that quarter and move into the current quarter.
Got it. Just a couple of more quick questions. In the shareholder letter, you talked a little bit about the debt covenants or a waiver for the June forward covenants. And there was a sense of — not security, but you had a level of confidence that you can obtain that waiver. I mean any — can you comment on what provides that sense of security or higher level of confidence that you’re going to obtain that waiver?
Yes, sure. No details obviously at this time. But the fact that margin is a top priority and that the capital structure is a top priority. So we’ve continued conversations with our banking partners. We have a good relationship. We feel it’s very supportive both directions. We have solutions that we’re working through. They just take a little bit of time. But we have — and worst case scenario, obviously, we have other backup solutions. So, we just — we’re highly confident that we’ll be able to resolve that before we have any type of formal covenant testing later this fall.
Got it. And then, does some of that go hand in hand with the strategic alternatives and — that the Board is exploring? And then, the Part B to that question would be sort of do you sort of have a timeline when you’re going to announce some of those strategic alternatives or moves or however we want to phrase it?
Well, as you know, Gerry, we announced at the end of last year, the formation of the strategic committee. They’ve continued to meet. They’re aggressively reviewing, as we’ve stated. To date, all alternatives have been evaluated and we, as the management committee and team, have continued to provide them lots of alternatives that they’re considering. We’re moving on a very tight timeline given the nature of the business and nature of the global economic pressures that we’re all under, and tied to the question you just asked. So, we will be hopeful that we’ll have news in the short order to come back and start to lay out some of the actions of that committee.
Got it. Okay. That’s it for me. I appreciate taking my questions this morning.
You bet. Thank you, Gerry.
Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Deverl Maserang for any closing remarks. Please go ahead, sir.
Thank you, operator, and thanks again everyone for joining our call today.
We know we have a lot of work to do to achieve our goals, but we’re confident we’re moving in the right direction and the actions we’ve taken, combined with an improving pricing and operating environment, point to future upside. We want to emphasize here that both the Board and management are moving with a strong sense of urgency, and we look forward to keeping you posted on our progress in the coming weeks and months. Thank you.
The conference has now concluded. Thank you for attending today’s presentation. You may disconnect your lines at this time.