Participants

John Moore; President, Chief Executive Officer, Director; Farmer Bros Co

Brad Bollner; Interim Chief Financial Officer; Farmer Bros Co

Gerry Sweeney; Analyst; Roth Capital Partners, LLC

Eric Des Lauriers; Analyst; Craig-Hallum Capital Group

Presentation

Operator

Good afternoon, and welcome to the Farmer Brothers fiscal third quarter 2024 earnings conference call. (Operator Instructions) As a reminder, this call is being recorded.
Earlier today, the company issued its quarterly shareholder letter available on the Investor Relations section of Farmer Brothers' website at farmerbrothers.com. The shareholder letter is also included as an exhibit on the company's Form 10-Q and is available on its website and the Securities Exchange Commission's website at SEC.gov. A replay of this audio-only webcast will be available on the company's website approximately two hours after the conclusion of this call.
Before we begin the call, please note all the financial information presented is unaudited and 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 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, which could cause actual results and other events to differ materially from those forward-looking statements is available on 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 the most directly comparable GAAP measures is also included in the company's shareholder letter.
I will now turn the call over to Farmer Brothers' President and Chief Executive Officer, John Moore. Mr. Moore, please go ahead.

John Moore

Good afternoon, everyone, and thank you for joining us. Over the course of the third quarter, we continued to see positive momentum has made year over year gains versus many of our key metrics. We see ongoing progress in our transformation to becoming a direct store delivery based organization and in our efforts to optimize utilization of newly right-sized operations.
We've executed a new corporate headquarters lease in Fort Worth, Texas, which better aligns our current business needs. We also continue to consolidate roasting packaging and production at our Portland, Oregon facility. In addition, we made significant strides in our brand pyramid and SKU rationalization initiatives, designs to create clearly defines traditional premium and specialty property lines within our products catalog.
This change to our brand pyramid to remove skewed redundancies and simplify our offerings for customers. It will also provide additional operational and cost efficiencies for the organization as well as streamline our inventory and overall sales approach. We achieved a milestone in relation to this project during the third quarter as we now have more SKUs related to our new tiered coffee offerings in inventory than those of our previous catalog.
We are encouraged to already hitting scheduling and production improvements leading to increases in our in-stock and delivery capabilities. We expect to complete this initiative by the end of the first quarter of fiscal 2025. They are also continuing to improve our field operations through investment in technology upgrades and enhancements. We recently completed an upgrade of handheld devices for our route sales representatives, which will simplify device management, enhanced support, and improve our inventory management, invoicing and overall customer service efforts.
The common theme in these initiatives is that we remain focused on customer growth, retention, and improving key elements of our value proposition to ensure profitable growth. This progress will take time for our efforts and initiatives are beginning to bear fruit. We reached an inflection point during the quarter as retention trends stabilized and our rate of customer decline improved compared to the prior year.
Overall, we are proud of the strides we've made so far this year and the early wins we have achieved related to our DSD transformation, but there's still much work to be done. As we have said before, we do not expect our results to be linear quarter to quarter. Change of this magnitude takes time and patience as we continue to implement the deliberate foundational changes necessary for long-term success.
Our focus continues to be on the fall. Driving customer retention and growth, improve our cost structure, delivering incremental margin improvement, increasing market penetration for new on-trend products, and completing the transitional services associated with our direct ship sale.
With that, I'll turn it over to Brad to discuss our financials in more detail. Brad?

Brad Bollner

But thanks, John. And hello, everyone. As a reminder, results for fiscal 2024 and the prior year third quarter are reported on a continuing operations basis, reflecting the performance of our DSD business in the respective periods. Please refer to our Form 10-Q, which was filed with the SEC today, further explanation of our expected performance of our discontinued and continuing operations. Overall, we're pleased to have maintained the positive year-over-year gains we have made in gross margin and adjusted EBITDA profitability.
Net sales for the third quarter of fiscal 2024 were relatively flat on a year-over-year basis by $85.4 million compared to $85.7 million in the prior year period. Overall, net sales were impacted by a reduction in total unit sales, which were offset by higher pricing. During the quarter, gross margins increased 660 basis points compared to the third quarter of fiscal 2023 moving from 33.5% to 40.1% respectively.
Gross profit during the quarter increased $5.5 million from $34.2 million or 19% on a year-over-year basis. This increase in gross margin was primarily driven by improvements in pricing and a decrease in underlying commodities costs.
Operating expenses increased slightly from $35.6 million in the prior year period to $34.7 million during the third quarter fiscal 2024. This improvement was a result of a $2.3 million increase in net gains associated with property sales and other assets was offset by the $1.3 million increase in selling expenses and a $200,000 increase in general and administrative expenses.
The selling expense increase was primarily a result of additional costs related to health care benefits and vehicle rental expense, both partially offset by a decrease in advertising related expenses. Net income from continuing operations moved to a loss of $682,000 during the quarter compared to a loss of $6.9 million during the prior year period, an improvement of more than $6.2 million.
Our capital expenditures for the quarter were flat on a year-over-year basis at $3.4 million. In fiscal 2024, we anticipate between $12 million and $15 million in total capital expense. We expect to finance these expenditures through cash flow from operations and borrowings under our credit facility. Adjusted EBITDA for the third quarter remained positive for the second consecutive quarter at $271,000. This compares to a loss of $579,000 in the prior year period.
Looking at the balance sheet, as of March 31, 2024, Farmer Brothers had $5.5 million of unrestricted cash and cash equivalents and $200,000 in restricted cash. We had outstanding borrowings of $23.3 million utilized $4.6 million of letters of credit supplement at $30.5 million of availability under our revolver credit facility.
We believe we are adequately capitalized to finance our operations and expect to achieve our goal to be free cash flow positive in early fiscal '25. Although we do not expect results to be linear quarter to quarter, we are pleased with the progress we've made so far in fiscal 2024 and are confident we are building a foundation to support long-term profitable growth and value creation.
With that, I'll turn it back to John. John?

John Moore

Thanks, Brad. As you've heard, we're making market progress in our DSD transformation, but are nowhere near the finish line. It is our view that there is a significant amount of upside still to be realized in the operational and cost efficiencies as well as top line growth. We firmly believe in the potential of our revenues to generate significant and sustainable shareholder value.
Thank you to all for joining us on the call today. Operator, we will now open it up for Q&A.

Question and Answer Session

Operator

(Operator Instructions) Gerry Sweeney, Roth Capital.

Gerry Sweeney

Good afternoon, guys. Thanks for taking my call.

Brad Bollner

Hey, Gerry. How are you?

Gerry Sweeney

Doing well, thanks. I wanted to start on customer retention. It sounded like two different things falling out from quarter, one, revenues were down and it sounded as though revenue was down because you had some customers have not secondarily, in your script, you talked about customer retention stabilizing. We sort of was that an inflection point during the quarter that retention has sort of flipped from a negative to a positive just once again on that a little bit further?

John Moore

Yeah. Hi, Gerry, this is John. In terms of the customer attention and what we're seeing is the numbers are decrease in customers that we were facing last year, a change that was happening. It's much, much better than it was. And if anything, it's stabilized and comes to neutral. So that in and of itself is a huge positive relative to the performance last year.
And I think as we continue to refine how we're going to market and focusing on execution at the field level, we're seeing that it's starting to bear fruit. So in the past, we've talked about operational excellence when it comes to showing up at the right place at the right time with the right product at the right price and basically fulfilling on the service proposition.
We're starting to see that as we invest in our manufacturing capability, our plan planning and procurement capability we're building in better systems and infrastructure, allowing us to fulfill on the value proposition to the customers. That's beginning to bear fruit. And again, we're starting to see that customer accounts are approaching neutral or at neutral, even turning a little bit positive from week to week. And that's an extremely positive situation for us.

Gerry Sweeney

Got it. So, we're getting there's sort of putting summation -- we're getting there. It's improving. Looking at a week to week and we're getting to neutral, it's not positive.
Got it. And then secondarily, on the operational side, reduce skews, scheduling planning, roasting, consolidating everything in Portland. Where -- what inning would you say you are in on that process and how much opportunity from means. It sounds like we're still in the early section of that, to be honest with you.

John Moore

Yeah. I would say we're in the early to mid-innings. We haven't brought in our first lever yet (technical difficulty) .
The other piece to that puzzle is that when we initiated a change in planning and production, it takes weeks for that to be realized at the field level. I can tell you that there's been an exponential improvement, we're tracking this on a weekly cadence. And of course, we're planning production daily. There has been a market improvement. If I look from February to today, there is significant improvement in our fulfilment rates, not only in the fulfilment rates, but then also in our line of sight and ability to track from the manufacturing level all the way through to the branch level.
And I know you've been following us for a while and you may have heard in the past, we talked about difficulty in establishing line of sight to the branch even beyond the route level where it really matters to the customer. And I think we've made substantive changes in our infrastructure, redeploying assets, building new systems of communication from the branch level or goes back through to the planning and procurement even into the manufacturing piece, integrating all of those in a meaningful way. So that we get manufacturing cadence that matches to the need of the customer.
And I would say that is a somewhat new capability that we've developed in the last couple of months. We are beginning to see meaningful fulfilment at the branch level, but we're in that regard are in the early innings.

Gerry Sweeney

Does that mean you are having the right products on the trucks? Satisfying (multiple speakers)

John Moore

That's correct. So in the past, we felt as though we had the right products in the system in general, they just happen to be in the wrong place. Today, I would say that we're getting much better about manufacturing the right products and getting them to the right place at the right time. And in that regard, we're in the early innings/middle innings, but we are beginning to see the impact. And that's one of the things we see with this Q3 inflection in the customer rates. We feel as though that's having an immediate impact.
And that's -- by the way that same level of line of sight on the finished goods inventory side. We're also making substantive changes on the other piece of this, which our field representatives and the customers told us, again reinforced by the artificial intelligence. And the other piece of that equation was the equipment placement and getting speed to market with the equipment so that customers could actually brew the coffee and service their customers further downstream.
And there, again, we've made substantive changes, making sure that at the branch level, there is an adequate inventory of the equipment that is most often used in the field, so that they can get speed to market with an equipment placement and allocation. So on both sides of that, the pieces that the customers are telling us through their purchasing cadence, there were issues around retention and purchasing. Now we feel as though we made substantive changes and we're beginning to get traction with those.

Brad Bollner

Gerry, one thing I'd add is, as you're looking at there soon to reading the P&L. And I'm trying to say what inning we're in because I think in the shareholder letter that we are now our inventory level and the new skews, for example, is higher than the inventory level on the book, both skews as that flows through the P&L, though, that's still to come because that product has to get sorted through.
We get through the old inventory, we start selling the new inventory that focusing on the top line. Then you start to see that business coming out of my world less and doing less with more inventory or their outlook. For doing more with less inventory. So all of these things that we have a line of sight to this progress being made by then it trickled through the supply chain and that trickles through the business. So I guess you'll see those things as we as we go along. But we talk about these inflection points just keep that in mind.

Gerry Sweeney

Got, it. And I should have asked this question earlier, but when you talk about the AI pricing engine, there were several models. One was the pricing and the other two, I think we’re market basket and customer retention, and they were going to -- I think for like a term turned on this year. Just curious if they are in play and if they're part of the solution, not only driving sales but customer retention.

Brad Bollner

So that was developed by our initial understanding of what we could do with that tool. I would not say that we're driving market basket with the AI tool at this point. It's certainly in the capability. What I would call out is that we used that a key part of the pricing engine is too anticipate when we think we might lose the customer because that is the most critical thing to pricing.
So applying the fact that we have the pricing engine built moves, we've done more than just optimize pricing. It's also given us really good feedback on how to retain customers in general, not just related to the price we're giving up. But I would say that intelligence has driven us towards our focus on in-stock position and our focus on equipment service levels. So we found those to be good predictors of customer turnover. So we're leveraging that for more than just, hey, what's the price of this have a copy. For that we haven't gotten to -- just the basket value. I would say, even found lower hanging fruits, but that's pretty valuable on the way there.

Gerry Sweeney

Got it. And then just new growth -- new products growth opportunities, obviously, I think you guys are getting to on it were operational efficiencies are coming into play. We're seeing in the margins, we're seeing in EBIDTA results center or target for free cash flow. The natural step is that I know you had done with that side. Next step is maybe new products and adding that to the system against growth, maybe some thoughts on that.

John Moore

Yeah, you bring up a great point, Gerry. I mean, as you know, we've been emphasizing both the shots, the innovative syrup line extension that we have in our portfolio and also the Boyd's lipid Ambien coffee and both of which are beginning to get traction. There's no question when we talk about driving top line growth, one of the bigger opportunities for us is really the idea of product penetration in the customers that we have, and that's where offering products like shot, like the voids that they have in coffee throughout the rest of this fiscal year as they begin to gain traction probably into the next fiscal year as they continue to grow and come to maturity because we'll continue to gain points of focus for us. But we do see some positive signs of growth in both right now.
And then obviously, we also have an eye to the future. So a future state beyond that, what will the next innovation look like. We're constantly looking toward the future state where we'll be shifting emphasis in months ahead toward new products and new introductions.

Gerry Sweeney

And staying with this theme on growth, what about adding more routes or routes optimized? Or is there an opportunity there?

John Moore

There may very well be an opportunity there longer term. I think, right now what we're looking to as opposed to adding routes, it's adding density to the routes that we have. And I think one of the things we're looking at, how do we get more value out of the existing infrastructure that we have. There's still a lot to be gained through that exercise. And I think we're really looking to leverage the assets we have -- where we have and looked channel-by-channel for opportunity.
So rather than adding routes, I think you would see us optimizing routes and adding value to the routes that exist at the moment. But we are also keep in mind we've completely transformed the sales team and fulfilment capability. We've added with Tom Bauer's leadership as the Chief Commercial Officer. We've completely restructured that side of the business.
And an established new KPI's, what we refer to internally as power rankings. And we've created somewhat of a performance driven culture on that side of the equation. And that's another piece that we look to in order to grow through new customer acquisition, but at the same time, have an eye to establishing density in areas where we already exist.

Brad Bollner

Got it. Density is key to growth. I guess --

Gerry Sweeney

That is it for me. I appreciate it. Thanks.

John Moore

Thanks, Gerry.

Brad Bollner

Thanks, Gerry.

Operator

(Operator Instructions) Eric Des Lauriers, Craig-Hallum Capital Group.

Eric Des Lauriers

Great. Thank you for taking my questions and congrats on the steel rationalization progress here.

John Moore

Thanks, Eric.

Eric Des Lauriers

My first question is kind of diving a bit more deeply into that's the rationalization and the progress there. So I understand that you're expecting to have all the legacy skews sort of fully up by the end of Q1 of fiscal '25. Have you finalized, which SKUs and brands will be included in the new tiered offerings. I mean, I'm just sort of fully built out what those tiers will look like.

John Moore

We have in terms of the first two tiers where most of the volume is. So essentially in the traditional tier, we've established the Farmer Brothers brand as our traditional Tier offering. And then what we're referring to as the premium tier we have avoid spread positions take that space. We're still working on the brand expression in the specialty space, but those will be essentially the three defined tiers, the value propositions presented by those are pretty much for all define. And essentially now we're in the brand building effort on the specialty side, but the Farmer Brothers and the Boyd’s brands are established and will be the brands of choice for those other two tiers.

Eric Des Lauriers

And I understand that we're at sort of more than half of your inventory now. Is these new skews. You mentioned the obvious sort of delay of getting this news in the inventory and then out into the market. I'm just wondering if any of these were peers have gone out into the market and if there's been any sort of early feedback from customers or any sort of early insights to ascertain from that.

John Moore

Now, that's a great question. I mean, I would say that the early indications are that -- we've managed thus far to thread the needle when it comes to positioning the new products into the market space. Keep in mind that both Farmer Brothers and Boyd’s had been out in the market in the past, and we're essentially distilling down other brands that have been out. But even in those markets, they may have had some exposure to Farmer Brothers and Boyd’s. So the resistance has not been significant.
Having said that, on the manufacturing side and the planning side, the efficiencies are definitely there and being realized. So you can imagine when it comes to procurement and the efforts and attention that you need to source when you've got half of the coffee SKUs that you've had in the past is radically reduced and you can really focus on adding value there.
When it comes to the manufacturing and production side, even more so the planning of manufacturing on the lines is much more straightforward. You can realize the efficiency as by not turning over your line changes as often. And so there we've seen a great deal of efficiency gain when it comes to the manufacturing in Portland.
Also the fact that we've been able to consolidate the vast majority of the manufacturing in the Portland facility has made that facility much more efficient in and of itself. So we're seeing lots of advantages there. Where I think we'll be continuing to see efficiencies being in the future as that stretches through the chain and it goes into the distribution center and into the branch level and onto the trucks ultimately, we'll see a much more streamlined capability.
So as much as reducing things and getting sort of the right brands, the right truck, we have improved that part of the ability to improve that has been, yes, communication, additional infrastructure and resources, but it's also the fact that the offering set has been radically reduced. So we're going to see efficiencies when it comes to the amount of space we need. The amount of gas we burn on. Every single piece of the puzzle will be more efficient as we continue to roll this out.

Eric Des Lauriers

That's great color and great to hear. Last question on the new tiered offerings here. Do you anticipate any meaningful gross margin difference among the peers? Yeah, I understood that specialty is still sort of a work in progress here, but just a view as you see now, do you anticipate any meaningful gross margin difference among the peers.

John Moore

No, honestly, keep in mind, we have existing business associated with these tiers. And we are we are as much collapsing multiple brands into singular brands as anything. So we already have gross margin data around where these brands have been positioned. And as such, I think we're able to maintain consistency in the gross margin across the three branches.
Brad, if you want to speak to that.

Brad Bollner

Yeah, What I would call out your question, the answer is definitely I think we're thinking of the same margin profile within each tier. But that said, the simplification of our product offering and on the back end is going to allow us to be very intentional with our pricing in a way that (technical difficulty) will raise almost.
So there's opportunity to find inefficiencies and where individual customers are priced to move them into the new system. So there's potential to do the right model. That's certainly better than last year with 600 basis points, this isn't going from zero to full. But it is an opportunity for us to be much more strategic about the pricing online payments business.

Eric Des Lauriers

Yeah, that's helpful. And then on the technology upgrades, nice to see this handheld device upgrades and the expected improvement there in inventory management and customer service. Can you give us a high-level update on what other technology upgrades you're focusing on? I know last quarter you mentioned the or you touched on the CRM upgrade, maybe just an update and any other technology upgrades are working on that?

John Moore

Sure. So we refer to that sort of suite of improvements internally as Project Symphony because essentially what we're doing is we're seeing are a key capability as really a partner in the business, not sort of as an isolated or siloed activity. And as such, I think it's touching every piece.
So we're implementing new software programming around everything from risk mitigation and sourcing when it comes to commodities driven, purchasing from utilizing it when it comes to the CRM activities, that we have rolled that out. What we're referring to as phase one is now complete, we're into phase two of the rollout with the CRM.
We're utilizing that when it comes to street level operations and the handheld technologies, both in terms of hardware but also software. So improvements there to be expected. And let's not forget, we had significant upgrades to the ERP over the last six months. So a great deal of work happening on that side on.
So you know, again, we're seeing that the IT integration is a key part of what we're doing driving the business forward.

Eric Des Lauriers

Very helpful. I appreciate the color. Thanks for taking my questions.

Brad Bollner

Sure. Thank you.

Operator

This concludes our question and answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.