Thank you. And good afternoon, everyone.

Thank you for joining Farmer Brothers Fiscal Second Quarter 2022 earnings conference call. Joining me today are Deverl Maserang, President and Chief Executive Officer and Scott Drake, Chief Financial Officer.

Earlier today, the company issued its earnings press release, which is available on the Investor Relations section of Farmer Brothers Best site at www.farmerbrothers.com. The press release 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 this audio-only webcast will be available approximately two hours after the conclusion of the 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 the financial information presented is unaudited and that various remarks made by management during this call about the company's future expectations, plans, and prospects may constitute forward-looking statements for purposes of the safe harbor provisions under the Federal Securities Laws and Regulations. These forward-looking statements represent the company's views only as of today and should not be relied upon as representing the company's views as of any subsequent date.

Results could differ materially from those forward-looking statements. Additional information on factors that could cause actual results and other events that differ materially from those forward-looking statements is available on the company's press release and public filings.

On today's call, management will also use certain non-GAAP financial measures, including adjusted EBITDA and adjusted EBITDA margin, and assess taking the company's operating performance. Reconciliation of these non-GAAP financial measures to their most directly comparable GAAP measures is also included in the company's press release.

I will now turn the call over to Deverl. Deverl, please go ahead.

Thank you, Jen. Good afternoon, everyone.

Thanks for joining us today. Our second fiscal quarter was highlighted by another period of meaningful sequential improvement amid the continued recovery of the business, with both gross margin and DSD sales volumes improving sequentially for the sixth consecutive quarter.

Of course, I should also note that the accelerated impact of the Omicron variant experienced in the last two weeks of the calendar year and entering the new year have presented some fresh challenges, which I'll address shortly. Overall, however, we're excited that our strategies and execution have significantly and positively impacted the business over the past several quarters.

We know that when the impact of COVID abates, we will be able to forecast the business better and provide long-term guidance going forward. In terms of the topline for the second fiscal quarter, net sales were up about $10 million sequentially and grew nearly $14 million from the prior year period, representing a 13% increase year-over-year.

Improvements in our DSD volumes were the primary driver as we processed and sold more green coffee during the period in that channel. We continue to produce improved gross margin, which is our key metric and evidence that our strategies are working.

Our current quarterly gross margin is the strongest we've posted since fiscal Q2 of 2019, nearly three years ago before the onset of COVID, and what was the beginning of the turnaround. As Scott will discuss in more detail, gross margin expanded by 50 basis points sequentially to 29.5% during the second fiscal quarter, and by 440 basis points compared to the prior year period.

Demonstrating the structural operating leverage and the incremental improvements we've implemented in the business. The improvement in gross margin also led to stronger adjusted EBITDA performance, excluding the one-time amortization benefit in the prior year period from the curtailment of the post-retirement medical plan, which Scott will provide more detail on as well, based on these improvements are top and bottom-line numbers are the best we've posted since the onset of the pandemic.

Despite some headwinds late in the quarter presented by the Omicron variant and the associated economic impacts, including labor shortages, logistical challenges, and inflationary pressures on coffee process, and throughout the supply chain. We've been working diligently to offset and to minimize these impacts where possible.

These elements make it's still very challenging to provide guidance in the short-term. It's worth noting that the bottom line also reflects a lag in recognizing the benefit of our recent price increases and contractual cost plus directorship agreements that pass along inflationary costs to our direct ship customers after a short period of time.

We expect more of these benefits to flow through our P&L in the fiscal third and fourth quarters. We ended the quarter with average DSD sales volumes down 17% from pre-COVID levels, compared to down 40% in the prior year period, demonstrating that these businesses and consumers are learning to live with COVID.

I also want to note the strength of sales in individual weeks we experienced in November and early December before the Omicron variant was prevalent. We believe these weeks align more with the true potential of the recovery in our DSD business, where sales were down only single-digits nationally compared to pre-COVID levels.

Ultimately, the key takeaway from our second fiscal quarter is that our business is structurally and meaningfully stronger than before the onset of the pandemic. We have a high degree of confidence in the overall health of our business, our market position, and our ability to navigate the near-term headwind and subsequently, a return of the business to a higher level of sales and profitability.

Our confidence is born out of better sales and margin trends, and importantly, our operational execution. At DFW, production output continues to operate at the highest level in company history.

While we still have room to increase volume further, the facility is fully operational, including our new packaging launch. Unfortunately we continue to see supply chain headwinds as mentioned, especially in the western COVID impacts have been more pronounced.

Still we're diligently working to mitigate the effects and have several levers at our disposal. Both inbound ocean supply and truck freight have been particularly challenging with many routes on the West Coast experiencing significant delays and logistical bottlenecks that are driving higher cost.

While this has resulted in some problems around moving products, we made some changes during the quarter that are helping to mitigate some of this. We crowded volume from the West Coast into the Gulf and East Coast during the quarter and relied more heavily on rail and truck transportation.

Additionally, we continue to move more manufacturing into our Portland facility as part of our ongoing plans for the region, which is expected to help further mitigate some of these challenges moving forward. We also continue to make progress on our IT and digital infrastructure optimization plans and consolidate our green coffee supply and in commerce capabilities within the region.

We believe this work will better enable our operations and translate into savings into future periods, and we look forward to providing further updates against these initiatives in the coming quarters. As we continue to focus on cost savings opportunities, we're prioritizing cost avoidance while finding new ways to help mitigate the impact of some of the macro challenges.

Our efforts in this regard are focus on three key areas. The first and most important and significant area is procurement.

The second is streamlining the flow of goods throughout our network, which includes optimizing our fleets and rationalizing the number of trucks sent to our various distribution routes. We've also accelerated direct shipments to our branches and distribution centers during the quarter, instead of first moving products through our DFW facility.

Lastly, we continue our efforts to rationalize and optimize our products SKU count to improve the productivity of our overall product portfolio. Last quarter, we mentioned the official roll-out and rebranding of our CBE or coffee brewing equipment business to revive.

We continue to make notable progress during the second fiscal quarter and added several new branded trucks to our fleet with newly uniformed drivers and technicians. Additionally, we've launched a new website.

While we're still in the pilot phases and operating solely in our five initial markets, we're ensuring that the technological infrastructure is in place for an eventual and successful full roll out into new markets. We're currently having meaningful discussions around service contract agreements with various parties and are optimistic about the future potential of this business.

Ultimately, we've been proud of our ability to weather COVID over the past two years and have achieved consistent progress and improved performance, including significant improvements made in the second fiscal quarter. It should be noted, however, that in recent weeks, we have seen some softening in our sales trends and other pressures streaming from Omicron, which absent a rapid turnaround, will slow our progress in the current quarter as the slowdowns that started in late December continued through the holidays and into January.

The most meaningful challenges we're currently facing include labor, as I mentioned earlier, which is likely impacting our customers more than us, and shortages of certain allied products from our suppliers and coffee bean suppliers due to shipping disruptions and inflationary pressures. We're working aggressively to mitigate these disruptions and have the flexibility to manage proactively in the near-term, while not [Indiscernible] from our execution against our overall strategic goals.

Overall, we remain confident in our ability to operate through these challenges and deliver on the considerable promise the business has shown in recent quarters. I'll wrap up there, and turn the call over to Scott.

Thanks, Deverl. Our Fiscal second quarter marked another period of meaningful progress and improvements, highlighted by significantly higher gross margins driven by product margins expansion in both our DSD and direct ship channels.

While past recovery trends have been on track to continue earlier in the year and during the first fiscal quarter, the uptick of the recent omicron variant presented challenges across many channels due to labor, traffic, and local policy changes that constricted some of our customers’ ability to operate as they had been. However, due to the significant recovery in our DSD channel throughout fiscal 2021 and in the past two quarters, our average weekly DSD sales compared to pre-COVID levels, improved from down 40% a year ago to down 17% during our Fiscal Second Quarter.

This also represents a sequential improvement from down 25% in the first fiscal quarter. All-in, we are pleased with the ongoing recovery of the DSD channel, especially given the strong weeks we experienced in this business from November to early December that Deverl noted earlier.

During the second fiscal quarter, we implemented another price increase, including delivery surcharges across our DSD network to mitigate the impact of higher supply chain and product costs. However, these changes will be more fully realized in January and thereafter.

We will remain proactive regarding any future needs to protect margin or reduce any delivery or fuel surcharges for our customers if conditions improve in those areas. Turning to the direct ship channel, we ended the quarter with direct ship sales down 6.8% and pounds down 15.6% compared to the prior year period.

However, these declines were predominantly due to the exit of less profitable direct ship accounts in fiscal 2021 that we've discussed on prior calls, partially offset by the continued recovery of several larger accounts. Approximately half of the volume decline is attributable to customers that were benefiting significantly from last year's COVID conditions, while the remaining decline is due to the exited customers.

Ultimately, our healthier customer mix is showing favorable results as evidenced by the product margin expansion we achieved within the direct ship channel during the second fiscal quarter. Additionally, the higher prices for coffee and transportation that we saw since the prior year period also inflated sales prices compared to pounds on a year-over-year basis.

Overall, net sales in the second fiscal quarter increased by $13.9 million year-over-year or 13.3% to $118.4 million compared to $104.6 million in the year-ago period. This increase was primarily due to continued recovery from the impact of the pandemic on our DSD network, where we had more green coffee volume processed and sold in addition to improved volumes of other beverages, culinary, spice, and tea products that are sold on those routes.

Gross profit in the second fiscal quarter increased by $8.7 million or 33.3% to $35 million from $26.3 million in the prior year period. Primarily driven by higher net sales and partially offset by higher cost of goods sold, as well as higher freight, and coffee brewing equipment costs, due to higher DSD sales volumes.

Our gross margin in the second fiscal quarter was 29.5% compared to 25.1% during the prior year period, representing the highest quarterly gross margins since our December 31, 2018 reported quarter, which was well before any impact of the COVID virus. We will closely monitor the challenges and uncertainties noted on the horizon that will pressure our cost of goods sold via higher inventory costs.

Still, despite the slowing sales trends that we began seeing towards the end of December and into January, we're particularly pleased to see our product margins expand given all the hard work we've done to optimize the business. The price increase previously implemented within our DSD channel, and the subsequent sales benefit have not yet fully flowed through our gross margin.

Additionally, 2/3 of our green bean coffee pounds flow-through our national accounts within our direct ship channels. While the cost plus nature of this business does fully protect us from inflationary increases there's still a 30-90 day contractual lag before we can fully pass those costs through to our customers.

As we enter the new calendar year, we're beginning to see an uptick in partial and temporary restaurant closures, which is a primary driver of the recent weakness in our DSD business. Similarly, the challenges we're facing around labor, both for our customers and ourselves, add complexity and impact performance.

Finally, supply chain challenges resulting in specific products running out of stock have decreased our fill rates in recent weeks. As demand continues to outpace supply in these instances, we're doing everything we can to get our hands on more of the most impacted products.

Until these challenges are resolved, we will continue to struggle to provide meaningful direction on key financial measures such as sales and margins. Our net loss improved year-over-year from a loss of $17.7 million to $5.4 million loss in the second fiscal quarter.

We posted an adjusted EBITDA of $4.5 million compared to $8.3 million in the prior-year period. Of note, the prior year period included a $7.2 million benefit from higher amortized gains related to the curtailment of the post-retirement medical plan last year, as mentioned in prior quarters.

Excluding this impact, adjusted EBITDA improved by $3.4 million or quadrupled year-over-year, driven in large part by a recovery in gross margin that was partially offset by higher operating expenses. Adjusted EBITDA margin was 3.8% in the second quarter of fiscal 2022, compared to 7.9% in the prior-year period.

During the second fiscal quarter, our operating expenses increased by $3.2 million compared to the prior year period, which was mainly due to a $3.3 million increase in selling expense and a reduction of $1.3 million in net gains from the sale of a branch, both of which were partially offset by a $1.2 million lower fixed debt set impairment and a $200,000 decrease in general and administrative expenses. The decrease in general and administrative expenses was primarily due to the absence of one-time severance costs in the prior year period.

While the increase in selling expenses was primarily due to variable costs, including payroll associated with the higher sales rates volumes, as well as operating expenses associated with our new distribution center in Rialto, California. Of note, operating expenses as a percent of sales were more efficient than in the prior year period at 33.4%, compared to 34.8% last year.

Increasing the efficiency of our cost structure as we drive sales increases remains a focus for the company. As mentioned, the inflationary and supply chain challenges present increasing headwinds.

Coffee prices remain among the highest we've seen in decades and inbound ocean supply remains stressed and delayed, which is significantly impacting our inventory and more specifically, our cost of goods line item. Again, the increased cost of green coffee, freight, and labor need to be accounted for upfront.

So we do experience some delays in passing along these costs to our direct ship customers. And we start to carry more of these costs in our finished goods inventory balances over time.

While our hedged positions on coffee has been reduced due to the higher prices we see in the market, we feel we're still in good position with our hedge protection through this fiscal year, and due to our ability to execute any needed price or surcharge updates over time. We continue to invest in our optimization efforts to ensure continued operational efficiencies in future quarters.

Our capital expenditures for the six months ended December 31, 2021 were $5.9 million, a decline of $3.8 million compared to the prior year period. This is due to lower investment capital of $4.9 million for several strategic initiatives completed during fiscal 2021, partially offset by higher maintenance capital spend of $1.2 million compared to the prior year period.

The higher maintenance capital was mainly due to the purchase of coffee brewing equipment for our DSD customers as volumes have improved, along with smaller DFW plant and IT projects. Several key initiatives in fiscal 2021, including a focus on refurbished coffee brewing equipment to drive cost savings, have helped reduce our purchases as DSD sales volumes continue to recover.

Turning now to the balance sheet. In November, we refreshed our shelf as a matter of good corporate hygiene.

We used to have a shelf registration that expired, and due to COVID and the related costs, we waited to restore it and registered any securities. While the shelf provides us with a flexible and efficient channel to issue shares, we currently have no near-term plans to issue any shares under the new agreement.

Our focus remains on generating improved cash flow and paying down debt. At the end of fiscal Q2, our total outstanding borrowings were $91 million compared to $91 million as well at our June 30th, 2021 fiscal year end.

Our cash balance was $3.6 million at quarter-end compared to $10.3 million as of the June 30th, 2021, representing a decrease of $6.7 million. The change in our cash position was primarily due to higher cost of goods, increased purchases for our peak season during our second fiscal quarter, and funding of incentive payments during the first fiscal quarter, all of which were slightly offset by cash proceeds from the sale of three branch properties during the six months ended December 31st, 2021, and realized hedging gains.

Our net debt, which we define as total outstanding borrowings, less cash and cash equivalents, was $87.4 million at the end of our second fiscal quarter, compared to $80.7 million at fiscal year-end 2021, primarily due to investments made in inventory and incentive plan payments. With that, I'll now turn the call back over to the operator for any questions.

Operator?

Good afternoon. Deverl and Scott, thanks for taking my call.

You bet Gerry.

Wanted to start on the sales side. Obviously, there's a lot going on there.

You have COVID rebounding to a degree. But you've also reduced some activity with certain customers, both on type of things on the direct ship side and maybe even on the DSP side by tiering of customers.

But what about new customer additions? Are you seeing either some growth with new -- straight out new customers, as well as maybe expanding your average order size within the DSD, and how is that coming along and being positioned as you go through all this?

Thanks Gerard for the question. First of all, we haven't reduced any customers in the quarter relative to prior year that hadn't already been taken out.

So the good thing is all those are now fully out on direct ship. We're actually seeing some rebound of new customers and increase in customers, but you can get a clean picture of direct ship as it stands today.

Okay. Cleaned up now to turning to DSD, lot of customer opportunity, I think the story is mixed they're predominantly for a couple of points.

One, we are adding lots of new customers and winning new business. But at the same time, as we talked in the prepared remarks, we're seeing this impact of closures multiple days a week with many of these accounts.

And then other impacts of labor shortages impacting multiple channels that we operate in. So that net is still that COVID effect.

But when you look at overall, I think the positive thing for volume in general, if we can truly get behind COVID and not have another Omicron or Delta,

Yeah.

Or any of those. You're going to see the true increase that we're seeing in new accounts that we're bringing on.

As you know, we don't specifically call out any accounts, be at direct ship or DSD. I can tell you we are adding at a good clip, and it's covering up the other components that are still result of COVID, and the impacts of labor, and so forth.

I think I'm very, very energized with what the sales team is doing and we're extremely excited that we can post the results that we posted this last quarter, and we just need to get beyond these impacts of COVID. I think it shows again, we've had now six quarters of progressive movement, we had a very substantial top-line compared to prior year, 70% down.

All that's as a result of 17% in DSD. But we had peaks when COVID was really starting to bate in the early part of the quarter where it was less than 17.

So the average for the quarter was 17 down over 40 last year. So as this improves consistently, I think what we'll see coming up in coming quarters as we get behind, and you tell me when that happens, we're all going to see it in our numbers.

And I'm really excited about the work the sells team is doing. We could talk more specific about that, but that's the general feel.

We are winning new customers and much of that's coming up. The loss volume, it's occurring as a result of these pandemic hangover issues.

Scott, you want to comment any further?

[Indiscernible] I'm sorry. Go ahead.

Okay.

What is driving some of that sales growth as you said, even some sales initiatives or opportunities?

While lots of different things. We are up on a per drop basis.

I think we've reported specific dropped size improvements but we're seeing substantial uptick in drop size improvement which is obviously driving that continued margin improvement. Two, we've added in each of our markets, especially in our strongest markets, what we call sales ambassadors and business development managers.

We've continued to add those as we see the opportunities occur where they're out hunting and driving new business and penetration especially in those accounts that are predominantly delivered by DSD, delivery drivers in some case, or RSAs and route sales representatives in other cases. That's where we get these kind of regional customers, and we're winning those regional customers whether they'd be at QSR -- small QSR regional player, restaurant regional player, or other types of convenience stores.

We're seeing that be the driver, and that's been really positive.

Got it. Switching gears a little bit to gross margins to couple of things on that front.

Just curious of how the market reacted to price increases. Obviously, a lot of Dunkin Donuts.

That's different. You can, given Starbucks announced to trend in varying price increases.

Just curious as to how well it was accepted.

I'll just wait for Scott there. Okay.

Yeah. We've had really positive reaction from customers on price increases.

And specifically, as I've been out on several of those customer visits, where we've had to sit down with customers, it's well understood. And I think the way we went about structuring our cost increase, in our price increase rather, was that we broke it apart into a base price component, and then we put our surcharges.

So if over time the delivery surcharge or the fuel surcharge was to improve, we can take that out and not be a permanent, lasting effect. I said with several customers and I will just tell you it was very positive.

They said we get it, we understand. It hasn't been pushed back.

I'd tell you what's really exciting is the fact that most customers are looking at this and saying, "Ensuring the supply is really where we want you to focus ". So, on a take price situation in the market today has been, as a result of COVID and other factors inflationary that we talked, we haven't had a problem with instituting.

We just have contracts at some cases, lag as we mentioned in the prepared remarks.

Got it And then just on gross margins, obviously made a lot of improvements, over the last several years and there's still some things still along to talk about IT. I think you talked about improving DFW further, as well as Portland.

What are the top 1, 2, or 3 opportunities there that can drive to move the needle the most? I know probably the bigger items have been done, but what's remaining, what gets you?

We still have -- we still -- we're working on several, so let me just take the Portland Consolidation clearly is an opportunity. And as you know, we put on an additional capacity to free up our ability to move more manufacturing into Portland, and thus relieve them from the distribution side.

Being able to consolidate a green copy, being able to consolidate the operations within the overall Pacific Northwest to better serve those customers. That's been -- I'll put that as active with lots of resources being put against that from the management side.

So that's been very positive, and we haven't seen those fully come through as of yet, but they're there, and coming. Two, as you know, we continue to optimize our new CBE now revive network and we have yet to put the refurbishment into the West Coast.

That remains in Rialto. We like that opportunity, but we've been focusing heavily on getting as many refurbs through Oklahoma City, and leveraging that to the maximum while we see the churn in Tier 5 and Tier 4 can bring more equipment to support a larger refurbishment, specifically into the West.

Optimization of the logistics network, both from suppliers to DCs, DCs to branch, and also branch down to routes, we continue to have opportunities there as we're trying to offset all these increases in costs due to fuel, due to freight, due to ocean, due to rail. What we're seeing mainly, if you heard in our prepared remarks around cost avoidance.

So cost avoidance is really important, but I'd like to have said that that was going to be all our cost savings dollar per dollar. But given these pressures and then the lag and prices.

We're not fully seeing it. But I think as we -- again, COVID abates and we can forecast this business better will be in a much stronger position to see that flow through and get back to those historical gross margin highs.

I think given the quarter, I don't know what word you want me to use, but I can tell you my feeling is we're incredibly pleased to see at 29.5 in a period of the second quarter, the way we did. I would like to see more and I think we would have seen it over 30 if all these other factors that we're working against, but seeing 6 sequential quarters of margin improvement and still have opportunities in the last one is going to be procurement.

We're working feverously on continue to build our procurement organization to really go out for a lot more which other customers and suppliers are doing the same type of thing. We're doing it as well.

I think we'll see more from that as well.

Got it. I will jump back to queue.

Deverl, thank you I really appreciate it and congrats it's a great quarter, especially considering the headwinds.

Thank you, Gerard.

Thank you. In summary, we're excited about our performance throughout one of the most challenging times in our history.

That said, we believe our results would have been significantly better if not for the pandemic's recent resurgence and the reluctance in terms of the stalled recovery. The reality is that until the macro challenges subside, namely those associated with labor and supply chain, we'll continue to navigate these headwinds.

Nonetheless, given our experience managing through previous waves of pandemic, we remain optimistic that the current wave will be on the downturn within the next many weeks or so. Given that we're already demonstrating the potential to operate at a pre -COVID level when conditions permit, and we really highly confident in the ultimate recovery of our business and the return to growth.

So thank you for your time today and your interest in Farmer Brothers.