Laurie Little - IR, The Piacente Group, Inc. Michael H. Keown - President, CEO and Director David G. Robson - Treasurer and CFO

Francesco Pellegrino - Sidoti & Company Chris Krueger - Lake Street Capital Markets

Good afternoon, ladies and gentlemen, and welcome to the Farmer Bros. First Quarter Fiscal Year 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Laurie Little. Please go ahead.

Thank you. Good afternoon everyone. Thank you for joining Farmer Bros. First 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 Web-site at www.farmerbros.com. The press release is also included as an exhibit to our Form 8-K available on our Web-site and on the Securities and Exchange Commission's Web-site at www.sec.gov. Please note that all of the financial information presented on this conference call today is unaudited. A replay of this audio-only Webcast will be available approximately two hours after the conclusion of this call. The link to the audio replay will also be available on our Web-site. Before we begin, 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 Web-site. 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 Web-site. I will now turn the call over to Mike Keown, President and Chief Executive Officer. Mike, go ahead. Michael H. Keown: Thank you, Laurie. Hello everyone and thank you for joining us. On today's call, we will cover the operational and financial highlights of the quarter and provide an update on our key initiatives before opening the call up for questions. We are off to a solid start in 2018, highlighted by the acquisition of the business of Boyd's Coffee Company and continued progress on our growth and our growth initiatives. Although we faced certain hurdles during the quarter, such as hurricanes Harvey and Irma, followed by the fires in California, in our second quarter, I am so proud of the way our teams remained focused on getting our affected operations up and running quickly and assisting affected employees as well as the communities that were hard hit. Although these events caused some disruptions to both our customers and Farmer Bros. in the short term, we believe that our ongoing investments in our operations, employees, and communities will help to drive future growth and profitability. Although David will walk you through the financials later in the call, I'd like to briefly touch on the highlights of the quarter. As we mentioned on our last call, we expected for the first quarter that green coffee volume and revenue would be relatively flat as compared to the prior year, based on what we were seeing at that time, including the negative impact hurricanes Harvey and Irma was expected to have on our operations and financial performance. And that is how the first quarter played out. For the first quarter, we currently estimate that the disruption from hurricanes Harvey and Irma led to a decrease in net sales of approximately 1% to 2% compared to the prior year. We expect the lingering effects from the hurricanes and California fires will likely continue to dampen our volume growth over the next quarter or so, as many of our customers continue to experience operational disruptions and sluggish sales. Adjusted EBITDA in Q1 decreased 15% to $9.3 million over the prior year period, with a corresponding 7.1% EBITDA margin, our profitability being impacted by overall slower growth. David will walk you through some of the drivers behind this performance in a few minutes. Next, I'd like to touch upon our key events of the quarter. We are pleased to report that our new DSD sales team continues to build momentum with customers. Following our reorganization earlier this year, which included a hiring cycle that just ended in June, we have now completed and trained the new team and have begun to execute on our new channel-based selling approach. We have implemented key growth planning processes to identify same-store sales growth opportunities, in addition to working on building a strong pipeline of new customer opportunities. Furthermore, we made good progress in rolling out our new selling technology platform, Smart Touch, to our field. It is important to note that although we are beginning to see some success from our efforts out in the field, a typical selling cycle takes six months or more from generation of the lead to a signed contract. Due to the long lead time as well as the fundamental changes that we've been implementing with the initial startup of the new channel-based sales model and new talent, through the first quarter we were not adding new business at the same pace as we have historically. We do expect that to improve over time. We currently forecast growth to pick up by the end of fiscal 2018. As to customer wins, we continue to sign new customers and have recently secured a large contract management customer for corporate dining work at multiple locations. We are currently working on installation in these locations, which typically takes a minimum of three months to transition, and expect to see the benefit from this new customer realized later in fiscal 2018. We are especially pleased with this progress, albeit small for now, as we believe that it shows that our new channel-based sales strategy is working. This is exactly the type of customer that we are targeting, and while our advancement may be uneven from quarter to quarter, from an external perspective we believe that our pipeline of opportunities has never been stronger. Lastly, I mentioned we picked up two larger customers of note in the last call and we would begin the transition process in the second quarter. We are working through the normal transition currently and expect to be fully up and running by the third quarter, as they transition out of the previous supplier's inventory. Finally, our new Northlake facility is on track towards expanding production volume and has become a great asset in more ways than one. Customers are excited to tour our facility and it has become a fantastic selling tool. We are on track to achieve SQF certification in our third quarter, with production levels forecasted at a 6 million pound run rate by the year end. Next, a quick acquisition update. Both of the acquisitions from fiscal 2017, China Mist and West Coast Coffee, continue to be productive. We have now implemented an ERP system substitution at China Mist to enable product offerings and other business channels, and West Coast Coffee continues to perform in line with or better than our expectations. We have also been hard at work with the integration of Boyd's following the closing on October 2. We have spent quite a lot of time in Portland with the Boyd's team and remain bullish about the opportunities the combined operations can bring. Through these meetings we are refining our integration plan and we'll provide updates on progress and timing as we get deeper into that process. Part of that integration plan will be the eventual transfer of coffee production to our plants as well as other production-related functions, but expect these processes to proceed carefully with the aim to cause no disruptions to customers. Our integration goals remain the same, to retain our customers and protect our revenue channels by providing exceptional customer service, while capturing potential business synergies between Boyd's and Farmer Bros. Finally, a brief overview on the impact from the hurricanes. We noted on our last call that we would expect some short-term operational and financial impact from both the hurricanes in the first fiscal quarter. While Farmer Bros. operations [indiscernible] all up and running, thanks to our dedicated employees, many of our customers are still struggling to get back on their feet. Not only did our immediate customers feel the disruption from these weather disasters, their customers were impacted as well. We saw sales volume slow in the affected areas as the focus became getting these communities stabilized. [Indiscernible] that as these communities rebuild and recover, our sales in these areas are expected to return to historical levels in the back half of fiscal 2018. Now, I will turn the call to David for a more detailed review of our first quarter results. David G. Robson: 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 declined 0.4% for the quarter. Our newly acquired West Coast Coffee division added an incremental 0.8% to this total volume. Over the past two quarters, we have experienced less than expected demand from several of our larger Direct Ship customers. In addition, we have seen some impact to coffee pounds sold through our Direct Store Delivery sales network related to the restructuring of our sales force we announced in February. As Mike previously mentioned, the new sales channel organization is focusing more of their current efforts on larger customer wins, which have a longer conversion cycle, as compared to the prior year quarter where we had a mix of sales focus on smaller customer wins, which have a shorter conversion cycle. The weather-related disasters have had some impact on coffee pound volume during the quarter. We estimate that Hurricane Harvey and Irma impacted total coffee volume by approximately 2% compared to the prior year quarter. To give you a better sense for the mix of volume across our distribution network during the quarter, coffee pounds processed and sold through our DSD network was approximately 8.3 million pounds or 36% of total volume, while Direct Ship customers represented approximately 14.9 million pounds or 64% of total volume. Now, turning to the income statement; net sales for the quarter were $131.7 million, representing an increase of $1.2 million or 0.9% as compared to the prior year quarter. This increase compared to the prior year period was driven primarily by a $1.5 million increase in net sales of roast and ground coffee products and a $1.3 million increase in net sales of tea products, offset by a decline in net sales from products sold primarily through our DSD network other than roast and ground coffee. The $1.5 million increase in roast and ground coffee sales benefited from higher prices to our cost plus customers, resulting from higher hedged cost of green coffee in the current quarter as compared to the first quarter last year. West Coast Coffee and China Mist contributed $4.1 million of the increase in net sales during the first quarter. Net of the benefit of West Coast Coffee, China Mist, and the offset of the sales we generated last year related to our institutional spice business we divested, net sales declined 1.8%. As Mike mentioned, we estimated the net sales were affected by hurricanes Harvey and Irma by approximately 1% to 2% compared to the prior year period. We continue to expect that our base business will grow in the range of market rates or faster over the longer term. However, we anticipate sluggishness in the near term, with our second quarter revenue growth expected to be relatively flat with the prior year quarter. Gross margin in the first quarter was 37.2% of sales, compared to 39.2% of sales in the prior year quarter. Gross margin declined 200 basis points, primarily due to higher manufacturing costs for our new Northlake, Texas production facility, the impact of higher hedged cost of green coffee for our cost plus customers; and the absence of the beneficial effect of the liquidation of LIFO inventory we realized last year, as well as the effect of sales mix from higher net sales growth from our Direct Ship customers which carry a lower gross margin. Although our new Northlake facility was a drag on margins in the first quarter, once we begin to drive meaningful incremental volume through this state-of-the-art facility, we expect further economies of scale, which should allow us to realize margin improvement. The drag to gross margin in the first quarter from the higher Northlake manufacturing costs was 91 basis points. The impact of higher C market prices on margin rate was 57 basis points, with 20 basis points related to LIFO inventory adjustments and the remaining offset of 32 basis points primarily due to a higher sales mix from our Direct Ship customer business. Now, turning to operating expenses; operating expenses in the quarter were $50.3 million or 38.2% of sales, as compared to $48.7 million or 37.3% of sales recorded in the prior year quarter, an increase of $1.6 million or 80 basis points. The increase in operating expenses during the quarter was primarily due to a $2.4 million increase in G&A expenses, a $1.6 million reduction in net gains from the sale of other assets, and a $500,000 increase in selling expenses. The increase in operating expenses was partially offset by a $2.9 million decrease in restructuring and other transition expenses associated with the corporate relocation plan. The increase in G&A expenses and selling expenses during the quarter were partially driven by the addition of West Coast Coffee and China Mist, which added approximately $1.6 million to operating expenses, exclusive of the related depreciation and amortization. In summary, the addition of West Coast Coffee and China Mist, along with the increase in depreciation and amortization expense, played a large part in operating expenses increases during the quarter, and we realized positive offsets from savings initiatives including savings realized from the DSD reorganization. There were one-time expenses in both this quarter and the prior year quarter, as shown in the reconciliation of adjusted EBITDA, and these were nearly offset each other period-to-period. Turning to interest expense, interest expense was $523,000 in the first quarter, up from $389,000 last year, due to higher borrowings compared to the prior year period. We expect interest expense decline in fiscal 2018 from fiscal 2017, given our higher existing debt levels, including additional borrowings that we anticipated under our credit facility for the acquisition of Boyd's, which closed in early October. Net loss was $978,000 this quarter or a loss of $0.06 per diluted share, as compared to net income of $1.6 million or $0.10 per diluted share in the prior year period. Excluding one-time and non-recurring items, non-GAAP net income for the first quarter was $0.5 million or $0.03 per diluted common share, compared to $3.4 million or $0.21 per diluted common share in the first quarter last year. The $2.9 million or $0.18 decline in non-GAAP net income per diluted common share was primarily due to higher year-over-year depreciation expense of $1.3 million or $0.08, a decrease in investment income of $0.3 million or $0.02, and the balance of $1.3 million or $0.08 per diluted common share primarily resulting from a decline in gross profits. Adjusted EBITDA was $9.3 million for the quarter, as compared to $11.6 million in the prior year period, and adjusted EBITDA margin was 7.1% as compared to 8.4% in the prior year period. Now, let's turn to the balance sheet. At the end of the quarter, we had $7.7 million in cash and short-term investments. We had $30.1 million borrowed on our revolving credit facility. Our debt, net of cash and short-term investments, at the quarter end was $22.4 million compared to $21 million at June 30, 2017. The increase in debt, net of cash and short-term investments, over the quarter was $1.4 million, which was used to fund a portion of our CapEx spending during the quarter, with the balance of the CapEx funding coming from operating cash flows. Subsequent to year end, as we previously announced, we closed on the acquisition of Boyd's Coffee Company business and we amended our credit facility, increasing our maximum credit line to $125 million from $75 million, some of which has been used to fund the Boyd's acquisition. After closing the transaction, our debt net of cash was approximately $62 million and availability under our credit facility was approximately $29 million. Now, turning to capital expenditures, for the current quarter our capital expenditures in cash were $7.8 million, with $3.3 million of spend for our new facility and $4.5 million in spend for maintenance CapEx. We currently estimate that we still have $1 million to $2 million in CapEx spend left to complete the initial equipment installation of our Northlake facility, which was planned as part of the corporate relocation plan, which we expect to spend during the second quarter. Depreciation and amortization expense was $7.3 million this quarter versus $5 million in the prior year quarter. Depreciation expense increased as a result of our investments made in our new Northlake facility, the rollout of our new Smart Touch devices used by our DSD organization, and amortization of intangibles added from the China Mist and West Coast Coffee acquisitions. Based on our existing fixed asset commitments and the useful lives of our intangible assets, we forecast depreciation and amortization expense to run at approximately $7.5 million to $8 million per quarter for the next several quarters. We have not yet factored the impact of the Boyd's acquisition into this forecast. Finally, last Friday, we filed a Form S-3 shelf registration with the SEC, allowing us to sell up to $250 million in equity securities [indiscernible]. We believe having a shelf registration in place will give us the added flexibility we may need to react swiftly to the future capital requirements of the business. Now, I'll turn the call back to Mike for closing remarks. Michael H. Keown: Thanks David. As always, I thank those on the call for your continued interest in Farmer Bros. The first quarter of 2018 has begun what should be another significant year for Farmer Bros. We are excited about the growth opportunities that lie ahead as we begin to realize success from the reorganization of our DSD operations, continue to broaden our relationships with our existing customer base, and integrate the Boyd's business into Farmer Bros. operations. While it is all about execution now, we believe we are on the right track to drive strong operational and financial performance in the coming years. And with that, we'll take some questions.

[Operator Instructions] Our first question comes from the line of Francesco Pellegrino with Sidoti.

So, on the fourth quarter call, you were nice enough to give us first quarter sales guidance, and since you did such a great job in forecasting that number, I was wondering if we could maybe think about where the second quarter sales or revenue is going to be, just given some of the headwinds that you're going to be facing with the wildfires that you cited. David G. Robson: Sure. I think what we said on the call just now was that it's going to be relatively flat next quarter.

Okay, flat year-over-year? David G. Robson: Yes. Michael H. Keown: And within that you've got significant moving pieces. We touched on some of the headwinds, and frankly, we're still sorting out, and I don't believe we're the only company as I've listened to some other earnings calls that are. We have the startup of some businesses that I referenced on the last call, and there's usually some unknowns. While we're pleased with the progress, I think that's the best number we have right now, but there are some moving pieces within there.

Only because I missed the sales, did you guys provide your full year outlook, especially your full year EBITDA guidance? David G. Robson: We did that a while ago and we're not changing that guidance. [Indiscernible]

Okay, so you're going to be reconfirming it? David G. Robson: Yes, we're not changing it.

Okay. Is the implied gross margin for the full year still in that 38.7% to 39.5%, or given the reduction in depreciation, should we see some margin lift from your previous implied guidance? David G. Robson: The only thing you have to take in account is the movement of commodity prices that will impact our top line as well as our margin rate, not necessarily the margin dollar. But taking that out of consideration, I think what we said before is, yes, kind of the 38% range is the right one. But if commodity prices move, you'll see that impacted in both the top line and the rate.

Okay. And just talking about commodity prices for a minute now, just given where coffee bean prices are, is your hedging strategy going to I guess continue as it was, or will you guys be a little bit more opportunistic due to the fact that we're seeing relatively low coffee bean prices? Michael H. Keown: Francesco, it's probably not appropriate to comment on that. But what you have seen is the implementation of the hedging process over the last few years that has served us well. We continue to refine it. But this isn't the format for me to speculate how we might move forward. As you could imagine, it's something we take very confidentially as a topic. David G. Robson: In many of these, we move on the direction of our customers. Of course we make recommendations, but they make a lot of those decisions on how far out they'd like to commit.

Okay. And just the last question for me before I jump back in the queue, I know that the SQF certification is for 3Q 2017, could we get a timeframe for I guess when the SQF certification would be for the Boyd's business that you're going to be bringing into Northlake, since those product lines probably aren't even built yet? Michael H. Keown: No, I think it's a little premature, and this is probably not the forum. Maybe offline we can take you through all the nuances of SQF certification. It's a lengthy process. If you look at what we've done over the last few years, our Portland facility and our Houston facility enjoy very high scores. We think we're on track for that here, but beyond that, that's a pretty detailed response for the rest of the group. David G. Robson: And Francesco, just one point, we've always said that we're not going to keep the production facilities from Boyd. So we're moving their volume at some point over to ours. That doesn't impact our existing certification.

Okay. I'll look forward to that conversation off-base, and I'll jump back in the queue. Thanks again, guys.

Our next question comes from the line of Chris Krueger with Lake Street Capital.

First, on that second quarter sales guidance for relatively flat year-over-year run rate, does that include Boyd's? David G. Robson: No. Michael H. Keown: No.

Okay, all right, that makes a lot more sense. And the same question I often come up with on most calls, how is kind of your internal pipeline of potential new business building? Is it improving since you've got the new facility kind of closer to being up and running? Michael H. Keown: I think what we mentioned on the last call that we've got a very strong pipeline, and we do, maybe as a secondary point, I think the pipeline is building in our DSD as the channel structure. It was a little nuanced in my comments, but we did pick up a notable customer, over 40 outlets as part of it in the dining arena in the contract manufacturing world. So, that pipeline is picking up now as that new team comes onboard. David G. Robson: And I would say, this is David, that certainly with our new facility, the opportunity for the improvement in the pipeline is there and exists. So, we're in a lot stronger position than we were say a year ago.

Okay. Then the last question, you indicated on your comments that you're winning a new corporate customer with several locations, is that a new win incremental from your last conference call a month ago or is that something you talked about then? I'm a little fuzzy on that. Michael H. Keown: It is and we're in the process of installing the equipment now. It takes a little while, given the size of it. But I think if you were evaluating it, what David's comments were, probably the place I would start, and then note the two customers we didn't talked about in the last call, we're in the process of ramping up now and that goes through a process of transitioning out of the old roasters inventory and so forth. But I would go back to David's comments on the second quarter. That's reflective of what we know now. David G. Robson: Yes, and what Mike said well earlier in the call was that our fourth quarter we're going to see some good growth because of some of these new contracts we won.

Okay, all right. Looking forward to next week's event. That's all I got. Michael H. Keown: Thanks. We look forward to seeing you.

Thank you. And that concludes our question-and-answer session for today. I'd like to turn the floor back over to the Farmer Bros. for any closing comments. Michael H. Keown: Once again, we thank everybody for your interest in Farmer Bros., and for those who are coming down to Northlake next week for our Investor Day, we look forward to seeing you, and we will be talking to you shortly with continued update on our strategic progress. Thank you.

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