Executive Summary / Key Takeaways

• Farmer Brothers is undergoing a significant transformation, pivoting from a broader coffee business to a focused Direct-Store-Delivery (DSD) model after divesting its direct ship and private label assets, aiming for enhanced profitability and operational efficiency.
• Recent financial results, particularly in the nine months ended March 31, 2025, show progress with improved gross margins (43.0% year-to-date) and positive Adjusted EBITDA ($9.1 million year-to-date), driven by strategic pricing, cost controls, and operational streamlining despite a decline in coffee volumes.
• The completion of the brand pyramid and SKU rationalization initiatives, alongside improvements in fulfillment rates and the upcoming B2B ordering platform, are expected to drive further operational efficiencies and unlock growth opportunities through increased product penetration and route density.
• While macroeconomic headwinds, volatile commodity prices, and competitive pressures (including the rise of bean-to-cup technology) pose ongoing risks, management is focused on leveraging its DSD network and cost structure improvements to maintain margins and drive targeted growth.
• The company is making progress towards its goal of positive free cash flow, supported by improved cash flow from operations, and anticipates capital expenditures of $9 million to $11 million in fiscal 2025 to support ongoing initiatives.

A Century of Coffee, Refocused

Farmer Brothers Co., a name steeped in over a century of coffee tradition since its founding in 1912, is currently in the midst of a profound strategic pivot. Historically a diversified player in the coffee, tea, and allied products space, serving a broad spectrum of customers from independent cafes to large institutions, the company has strategically narrowed its focus. A pivotal moment arrived on June 30, 2023, with the divestiture of its direct ship and private label business, including key manufacturing and office assets, to TreeHouse Foods (THS). This move signaled a clear intent: to concentrate on the Direct-Store-Delivery (DSD) model, which management identified as the more profitable core of the business.

This strategic shift is not merely a divestiture but a comprehensive transformation. Post-sale, Farmer Brothers centralized its roasting operations to its Portland, Oregon facility and embarked on optimizing its physical footprint and distribution network. The goal is to leverage the existing nationwide DSD network, comprising 234 delivery routes and 97 branch warehouses as of March 31, 2025, to deliver a differentiated "white glove service" value proposition to its diverse customer base. This network, supported by a fleet of trucks and 3PL providers, is the backbone of the refocused strategy, aiming to enhance customer service, drive operational efficiency, and ultimately improve profitability.

In the competitive landscape, Farmer Brothers operates against a backdrop of formidable players like Starbucks (SBUX), Keurig Dr Pepper (KDP), and J.M. Smucker (SJM), each with distinct strengths. While Starbucks dominates the premium retail space with strong branding and global scale, and KDP leads in the single-serve and ready-to-drink segments with technological innovation, Farmer Brothers carves out its niche primarily within the wholesale and institutional markets through its DSD model. This model, while potentially offering greater efficiency in specific foodservice settings and enabling stronger customer relationships, faces challenges from competitors' scale and technological advancements, such as the increasing adoption of bean-to-cup technology in channels like convenience stores, which can impact coffee volumes per customer. Farmer Brothers' strategic response involves leveraging its cost structure and distribution efficiency to compete effectively in price-sensitive segments while simultaneously enhancing its product offerings and service to increase value per customer stop.

The DSD Advantage and Operational Transformation

The DSD model is central to Farmer Brothers' value proposition, offering direct delivery, equipment servicing, and personalized customer interaction. Recognizing the need to optimize this core asset, the company has undertaken several key initiatives. A major focus has been on improving fulfillment rates and inventory management, addressing past out-of-stock issues that impacted customer retention. Management reports significant progress, reaching an "almost completely resolved state" for finished goods and equipment availability, achieved through better demand planning, inventory management (including decreasing days-on-hand for finished goods), and leveraging equipment refurbishment capabilities without increasing related capital expenditures.

A transformative initiative nearing completion is the brand pyramid and SKU rationalization project. This involves simplifying the product portfolio, removing redundancies, and consolidating brands into clearly defined traditional, premium (led by the refreshed Boyd's Coffee brand, now offered nationwide), and specialty tiers (culminating in the launch of Sum>One Coffee Roasters in Q3 FY25). This rationalization has resulted in a significant reduction in SKUs (upward of 50% for finished goods and over 66% including raw materials), which is expected to drive operational efficiencies in sourcing, manufacturing, and distribution, simplifying the go-to-market strategy and enhancing the customer experience.

Beyond product and inventory, Farmer Brothers is also enhancing its technological capabilities to support the DSD network. While not focused on revolutionary product technology like competitor single-serve systems, the company is upgrading its operational technology. A key development is the planned launch of a B2B web-based ordering platform in Q4 FY25. This platform is designed to offer customers the convenience of placing orders online while still receiving DSD fulfillment. Management anticipates this will facilitate increased product penetration within existing accounts and enable loyalty and promotional programming, thereby enhancing revenue per customer stop.

Organizational changes have also supported this operational focus. The sales organization has been restructured, with Brian Miller appointed VP of Sales to focus specifically on business development and customer acquisition, while Tom Bauer transitioned to VP and Chief Field Operations Officer (and subsequently departed, with Travis Young taking over Field Operations) to concentrate on DSD team leadership, route optimization, and operational processes. This separation aims to provide dedicated focus on both retaining and growing the customer base and maximizing the efficiency of the delivery network.

Financial Performance: Signs of Progress Amidst Headwinds

The strategic pivot and operational initiatives are beginning to show in Farmer Brothers' financial performance, albeit within a challenging market. For the three months ended March 31, 2025 (Q3 FY25), net sales decreased 3.9% year-over-year to $82.1 million, primarily due to lower coffee volumes, partially offset by higher pricing. However, for the nine months ended March 31, 2025 (9M FY25), net sales saw a slight increase of 0.2% to $257.1 million compared to the prior year period, driven by pricing actions offsetting volume declines. Coffee pounds sold decreased 9.4% in Q3 FY25 and 11.6% in 9M FY25 compared to the respective prior year periods, reflecting ongoing pressure on customer counts and lower consumption per customer.

Despite the top-line volume pressure, gross profit and gross margin have shown notable improvement. Gross profit increased to $34.5 million in Q3 FY25 (from $34.2 million) and significantly to $110.7 million in 9M FY25 (from $101.1 million). Gross margin expanded to 42.1% in Q3 FY25 (from 40.1%) and 43.0% in 9M FY25 (from 39.4%). These improvements are primarily attributed to proactive pricing actions taken in response to rising coffee commodity markets and ongoing price optimization efforts. Management expects rising coffee prices to continue impacting cost of goods sold in coming quarters but remains confident in maintaining margins above the 40% target through active inventory and pricing management.

Operating expenses increased in Q3 FY25 ($38.1 million vs. $34.7 million) and 9M FY25 ($116.0 million vs. $99.2 million), primarily due to lower net gains on disposal of assets compared to the prior year periods, which included proceeds from branch sales. Excluding these gains/losses, operating expenses decreased both in dollars and as a percentage of sales, reflecting the impact of cost structure rightsizing, including lower compensation, severance, and insurance costs.

Adjusted EBITDA, a key metric for the company's operational performance, has turned positive and shown sequential improvement. It was $1.7 million in Q3 FY25, marking the third consecutive positive quarter. For 9M FY25, Adjusted EBITDA was $9.1 million, a significant improvement from $2.1 million in the prior year period. This progress is a direct result of the expanded gross margins and reduced operating expenses (excluding asset sale impacts).

Liquidity remains a focus. As of March 31, 2025, the company had $4.1 million in unrestricted cash and $23.3 million outstanding on its $75 million Revolver Credit Facility, with $22.1 million available. Cash flow from operating activities has improved markedly, turning positive for three consecutive quarters ($1.3 million in Q3 FY25, $2.6 million in Q2 FY25), resulting in $6.4 million provided by operations in 9M FY25 compared to $13.2 million used in the prior year period. This improvement is driven by better gross profit and inventory management. While free cash flow was slightly negative in Q3 FY25 (-$0.7 million), it was positive in Q2 FY25 ($0.5 million), indicating progress towards this key goal. Capital expenditures for fiscal 2025 are projected to be between $9 million and $11 million, expected to be funded by operating cash flow and the credit facility. The company was in compliance with its credit facility covenants as of March 31, 2025, and expects to remain so for the next 12 months.

Competitive Dynamics and Market Positioning

Farmer Brothers operates in a highly competitive environment characterized by diverse players and evolving market trends. Its DSD model, while a core strength, positions it differently than national retail giants like Starbucks or single-serve innovators like Keurig Dr Pepper. Farmer Brothers' competitive edge lies in its established DSD network, which facilitates direct customer relationships and efficient delivery of a broad product portfolio, including coffee, tea, and allied culinary items. This allows for a level of service and product mix flexibility that larger, less direct competitors may not offer in certain institutional or independent foodservice segments.

However, Farmer Brothers faces challenges from the scale and financial power of larger competitors, who can invest more heavily in branding, technology, and supply chain optimization. While Farmer Brothers has demonstrated improved operational efficiency, as seen in its expanding gross margins (43.0% in 9M FY25), competitors like KDP often exhibit higher operating margins (e.g., KDP's TTM operating margin of 17%) due to scale and product mix. Farmer Brothers' smaller scale can lead to higher per-unit operating costs compared to mass-market players.

Industry trends, such as the increasing adoption of bean-to-cup technology, particularly in convenience stores, also pose a competitive threat by potentially reducing the volume of traditional brewed coffee needed per location, impacting Farmer Brothers' core coffee pound sales. To counter this, Farmer Brothers is focusing on increasing product penetration with its allied products, which make up roughly half of its sales, to increase the value of each customer stop regardless of coffee volume trends. The completion of the tiered brand pyramid allows Farmer Brothers to offer customers options across different price points and quality levels, potentially retaining customers who might otherwise seek alternative suppliers due to price sensitivity or a desire for more premium/specialty offerings. The B2B ordering platform is another strategic move to enhance customer stickiness and facilitate cross-selling within the existing base.

Farmer Brothers' competitive positioning is thus one of leveraging its DSD infrastructure and improving operational efficiency to defend and grow share in its target markets, while strategically enhancing its product and service offerings to adapt to changing customer needs and competitive pressures. Its ability to source globally (accessing 90% of the global coffee market) and its improved sourcing protocols are also competitive factors, allowing for greater flexibility in managing commodity price volatility compared to less agile competitors.

Outlook and Growth Levers

Management acknowledges that market conditions, particularly volatile coffee prices and uncertain consumer spending, are expected to remain challenging in the near term. Rising coffee costs are anticipated to continue flowing through the cost of goods sold, potentially pressuring margins, although the company is committed to maintaining margins above 40% through active management. No immediate impact from potential tariffs on COGS is expected in the current fiscal year.

Despite these headwinds, Farmer Brothers is focused on driving top-line growth, which management recognizes is crucial for long-term success. The primary growth levers are centered on maximizing the potential of the DSD network and existing customer base:

1. Increasing Product Penetration: Selling more allied products and different coffee tiers into the existing base of approximately 30,000 customers. Management views this as a "tremendous opportunity" with high return on investment, as it leverages existing routes and equipment placement.
2. Adding Route Density: Focusing business development efforts on areas served by existing routes to increase the number of stops per route and improve utilization.
3. Acquiring New Profitable Customers: The restructured sales team, with a dedicated focus on business development, is tasked with bringing in new accounts, with an emphasis on customer profitability.

The completion of the brand pyramid provides a clearer tiered offering to support these growth efforts, allowing customers to find products that fit their needs and price points. The upcoming B2B ordering platform is also expected to be a key enabler for product penetration and customer loyalty.

Capital expenditures for fiscal 2025 are projected between $9 million and $11 million, supporting ongoing operational improvements and potentially equipment for new customer acquisitions. Management is confident that the operational efficiencies achieved and the strategic focus on the DSD business position Farmer Brothers for significant positive gains and long-term growth when market conditions become more stable.

Risks to the Thesis

While Farmer Brothers has made significant strides in its transformation, several risks could impact the investment thesis:

• Commodity Price Volatility: Historically high and volatile Arabica and Robusta coffee prices pose a significant risk, potentially increasing COGS and pressuring margins if price increases cannot be fully passed on to customers.
• Macroeconomic Headwinds: Low consumer confidence, inflation, and reduced spending frequency can continue to impact coffee volumes and customer demand across the industry.
• Customer Attrition: Despite improved retention rates, ongoing pricing fatigue and economic pressures could lead to accelerated customer churn.
• Competition: Intense competition from larger, more technologically advanced players and evolving industry trends like bean-to-cup technology could erode market share.
• Execution Risk: The success of the strategic pivot hinges on the effective execution of operational improvements, sales initiatives, and the adoption of new platforms like the B2B ordering system.
• Liquidity and Debt: While currently in compliance with covenants, continued operating losses or unexpected capital needs could strain liquidity and borrowing capacity under the credit facility.
• Pension Liabilities: The company still has accrued pension liabilities and is subject to multiemployer pension plan contributions, which could represent future obligations.

Conclusion

Farmer Brothers is navigating a critical period of transformation, shedding non-core assets to focus on its DSD strengths. The past year has seen meaningful progress in operational efficiency, cost structure rightsizing, and gross margin expansion, leading to positive Adjusted EBITDA despite challenging market conditions and declining coffee volumes. The completion of the brand pyramid and initiatives to improve fulfillment and leverage technology like the upcoming B2B platform lay the groundwork for future growth.

The investment thesis rests on the company's ability to translate these operational improvements into sustainable top-line growth by effectively increasing product penetration within its existing customer base and strategically acquiring new, profitable accounts. While macroeconomic headwinds, commodity volatility, and intense competition present ongoing challenges, Farmer Brothers' focused DSD model and commitment to efficiency provide a differentiated position. Investors should monitor the execution of growth initiatives, the impact of rising coffee prices on margins, and the company's continued progress towards consistent positive free cash flow as key indicators of the success of this strategic pivot.