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Farmer Brothers Company 10-Q 2013

Documents found in this filing:

  1. 10-Q
  2. Ex-10.8
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
FARM-2013.03.31-10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2013
OR 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number: 001-34249
 
FARMER BROS. CO.
(exact name of registrant as specified in its charter)
 
 
Delaware
 
95-0725980
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
 
 
20333 South Normandie Avenue, Torrance, California 90502
(address of principal executive offices, Zip code)
 
Registrant’s telephone number, including area code: 310-787-5200

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ý    NO  £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ý    NO  £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one): 
Large accelerated filer
 
£
  
Accelerated filer
 
ý
Non-accelerated filer
 
£  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
£

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  £    NO  ý
On May 3, 2013, the registrant had 16,449,456 shares outstanding of its common stock, par value $1.00 per share, which is the registrant’s only class of common stock.



TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 







PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
FARMER BROS. CO.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
 
March 31, 2013
 
June 30, 2012
ASSETS
(Unaudited)
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
5,525

 
$
3,906

Restricted cash
3,751

 

Short-term investments
20,769

 
21,021

Accounts and notes receivable, net
42,793

 
40,736

Inventories
67,273

 
65,981

Income tax receivable
139

 
762

Prepaid expenses
2,800

 
3,445

Total current assets
143,050

 
135,851

Property, plant and equipment, net
93,837

 
108,135

Intangible assets, net
6,586

 
7,615

Other assets
3,026

 
2,904

Deferred income taxes
854

 
854

Total assets
$
247,353

 
$
255,359

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
30,909

 
$
27,676

Accrued payroll expenses
16,735

 
20,494

Short-term borrowings under revolving credit facility
9,912

 
29,126

Short-term obligations under capital leases
3,435

 
3,737

Deferred income taxes
1,480

 
1,480

Other current liabilities
16,492

 
10,176

Total current liabilities
78,963

 
92,689

Long-term borrowings under revolving credit facility
10,000

 

Accrued postretirement benefits
35,393

 
34,557

Other long-term liabilities—capital leases
9,552

 
12,130

Accrued pension liabilities
41,973

 
42,513

Accrued workers’ compensation liabilities
4,022

 
4,131

Deferred income taxes
718

 
607

Total liabilities
$
180,621

 
$
186,627

Commitments and contingencies

 

Stockholders’ equity:
 
 
 
Preferred stock, $1.00 par value, 500,000 shares authorized and none issued
$

 
$

Common stock, $1.00 par value, 25,000,000 shares authorized; 16,449,456 and 16,308,859 issued and outstanding at March 31, 2013 and June 30, 2012, respectively
16,449

 
16,309

Additional paid-in capital
33,728

 
34,834

Retained earnings
94,620

 
100,455

Unearned ESOP shares
(20,836
)
 
(25,637
)
Less accumulated other comprehensive loss
(57,229
)
 
(57,229
)
Total stockholders’ equity
$
66,732

 
$
68,732

Total liabilities and stockholders’ equity
$
247,353

 
$
255,359

The accompanying notes are an integral part of these financial statements.

3



FARMER BROS. CO.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
 
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
2013
 
2012
 
2013
 
2012
Net sales
$
126,343

 
$
121,527

 
$
381,201

 
$
374,494

Cost of goods sold
77,668

 
78,380

 
237,552

 
247,121

Gross profit
48,675

 
43,147

 
143,649

 
127,373

Selling expenses
39,135

 
37,909

 
117,171

 
110,361

General and administrative expenses
10,159

 
9,345

 
28,217

 
27,050

Pension withdrawal expense

 

 

 
4,348

Operating expenses
49,294

 
47,254

 
145,388

 
141,759

Loss from operations
(619
)
 
(4,107
)
 
(1,739
)
 
(14,386
)
Other (expense) income:
 
 
 
 
 
 
 
Dividend income
286

 
295

 
829

 
958

Interest income
92

 
63

 
283

 
99

Interest expense
(466
)
 
(498
)
 
(1,386
)
 
(1,579
)
Other, net
(764
)
 
(1,831
)
 
(3,475
)
 
(2,458
)
Total other expense, net
(852
)
 
(1,971
)
 
(3,749
)
 
(2,980
)
Loss before taxes
(1,471
)
 
(6,078
)
 
(5,488
)
 
(17,366
)
Income tax (benefit) expense
(56
)
 
(577
)
 
347

 
(171
)
Net loss
$
(1,415
)
 
$
(5,501
)
 
$
(5,835
)
 
$
(17,195
)
Net loss per common share—basic and diluted
$
(0.09
)
 
$
(0.35
)
 
$
(0.38
)
 
$
(1.11
)
Weighted average common shares outstanding—basic and diluted
15,600,040

 
15,592,291

 
15,540,697

 
15,448,622

 
 
 
 
 
 
 
 

The accompanying notes are an integral part of these financial statements.


4



FARMER BROS. CO.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
 
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
 
2013
 
2012
 
2013
 
2012
Net income (loss)
 
$
(1,415
)
 
$
(5,501
)
 
$
(5,835
)
 
$
(17,195
)
Other comprehensive income (loss)
 

 

 

 

Total comprehensive income (loss)
 
$
(1,415
)
 
$
(5,501
)
 
$
(5,835
)
 
$
(17,195
)

The accompanying notes are an integral part of these financial statements.


5



FARMER BROS. CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
 
Nine Months Ended March 31,
 
 
2013
 
2012
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(5,835
)
 
$
(17,195
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
24,778

 
23,831

(Recovery of) provision for doubtful accounts
 
(890
)
 
880

Deferred income taxes
 
111

 

Net gains on sales of assets
 
(4,388
)
 
(1,161
)
ESOP and share-based compensation expense
 
2,639

 
2,519

Net losses on derivatives and investments
 
9,315

 
5,131

Change in operating assets and liabilities:
 
 
 
 
Short-term investments
 
(9,063
)
 
1,027

Accounts and notes receivable
 
(1,167
)
 
936

Inventories
 
(1,291
)
 
3,533

Income tax receivable
 
622

 
(377
)
Prepaid expenses and other assets
 
522

 
81

Accounts payable
 
4,359

 
(9,342
)
Accrued payroll expenses and other liabilities
 
(1,312
)
 
1,102

Accrued postretirement benefits
 
836

 
1,130

Other long-term liabilities
 
(1,416
)
 
(1,083
)
Net cash provided by operating activities
 
$
17,820

 
$
11,012

Cash flows from investing activities:
 
 
 
 
Purchases of property, plant and equipment
 
(10,118
)
 
(10,533
)
Proceeds from sales of property, plant and equipment
 
5,556

 
2,112

Net cash used in investing activities
 
$
(4,562
)
 
$
(8,421
)
Cash flows from financing activities:
 
 
 
 
Proceeds from revolving credit facility
 
22,550

 
13,700

Repayments on revolving credit facility
 
(32,771
)
 
(17,700
)
Payments of capital lease obligations
 
(2,613
)
 
(1,209
)
       Proceeds from stock option exercises
 
1,195

 

Net cash used in financing activities
 
$
(11,639
)
 
$
(5,209
)
Net increase (decrease) in cash and cash equivalents
 
$
1,619

 
$
(2,618
)
Cash and cash equivalents at beginning of period
 
3,906

 
6,081

Cash and cash equivalents at end of period
 
$
5,525

 
$
3,463


The accompanying notes are an integral part of these financial statements.


6




FARMER BROS. CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Farmer Bros. Co. and Summary of Significant Accounting Policies
The Company
Farmer Bros. Co., a Delaware corporation (including its consolidated subsidiaries, unless the context otherwise requires, herein referred to as the “Company,” “we,” “our” or “Farmer Bros.”), is a manufacturer, wholesaler and distributor of coffee, tea and culinary products. The Company is a direct distributor of coffee to restaurants, hotels, casinos, hospitals and other foodservice providers, and is a provider of private brand coffee programs to quick service restaurants, grocery retailers, national drugstore chains, restaurant chains, convenience stores, and independent coffee houses, nationwide. The Company was founded in 1912, was incorporated in California in 1923, and reincorporated in Delaware in 2004. The Company operates in one business segment.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States (“GAAP”) for complete consolidated financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals, unless otherwise indicated) considered necessary for a fair presentation of the interim financial data have been included. Operating results for the three and nine months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2013. Events occurring subsequent to March 31, 2013 have been evaluated for potential recognition or disclosure in the unaudited consolidated financial statements for the three and nine months ended March 31, 2013.
The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2012, filed with the Securities and Exchange Commission (the “SEC”) on September 10, 2012.
Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company reviews its estimates on an ongoing basis using currently available information. Changes in facts and circumstances may result in revised estimates and actual results may differ from those estimates.
Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability, in an orderly transaction between market participants. The Company maximizes the use of observable market inputs, minimizes the use of unobservable market inputs and discloses in the form of an outlined hierarchy the details of such fair value measurements. See Note 2 for additional information.

7

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Coffee Brewing Equipment and Service
The Company classifies certain expenses related to coffee brewing equipment provided to customers as cost of goods sold. These costs include the cost of equipment as well as the cost of servicing that equipment (including service employees' salaries, cost of transportation and the cost of supplies and parts) and are considered directly attributable to the generation of revenues from the Company's customers. Accordingly, such costs included in cost of goods sold in the accompanying unaudited consolidated financial statements for the three months ended March 31, 2013 and 2012 are $7.0 million and $6.7 million, respectively. Coffee brewing equipment costs included in cost of goods sold for each of the nine months ended March 31, 2013 and 2012 are $19.1 million. The Company capitalized coffee brewing equipment in the amounts of $7.1 million and $9.9 million in the nine months ended March 31, 2013 and 2012, respectively. Depreciation expense related to capitalized coffee brewing equipment reported as cost of goods sold was $3.2 million and $2.9 million in the three months ended March 31, 2013 and 2012, respectively. Depreciation expense related to capitalized coffee brewing equipment reported as cost of goods sold was $9.8 million and $8.7 million in the nine months ended March 31, 2013 and 2012, respectively.
Revenue Recognition
Most product sales are made “off-truck” to the Company's customers at their places of business by the Company's sales representatives. Revenue is recognized at the time the Company's sales representatives physically deliver products to customers and title passes or upon acceptance by the customer when shipped by third party delivery.
The Company sells roast and ground coffee and tea to The J.M. Smucker Company ("J.M. Smucker") pursuant to a co-packing agreement. The Company recognizes revenue from the co-packing arrangement for the sale of tea on a net basis, net of direct costs of revenue, since the Company acts as an agent of J.M. Smucker in such transactions. As of March 31, 2013 and June 30, 2012, the Company had $0.3 million and $0.8 million, respectively, of receivables related to this arrangement, which are included in “Other receivables” in the consolidated balance sheets (see Note 4).
Earnings (Loss) Per Common Share
Basic earnings (loss) per share ("EPS") represents net earnings attributable to common stockholders divided by the weighted average number of common shares outstanding for the period, excluding unallocated shares held by the Company's Employee Stock Ownership Plan ("ESOP"). Diluted EPS represents net earnings attributable to common stockholders divided by the weighted average number of common shares outstanding, inclusive of the dilutive impact of common equivalent shares outstanding during the period. However, nonvested restricted stock awards (referred to as participating securities) are excluded from the dilutive impact of common equivalent shares outstanding in accordance with authoritative guidance under the two-class method. The nonvested restricted stockholders are entitled to participate in dividends declared on common stock as if the shares were fully vested and hence are deemed to be participating securities. Under the two-class method, earnings (loss) attributable to nonvested restricted stockholders are excluded from net earnings (loss) attributable to common stockholders for purposes of calculating basic and diluted EPS.
Computation of EPS for the three and nine months ended March 31, 2013 does not include the dilutive effect of 567,088 shares issuable under stock options since their inclusion would be anti-dilutive. Computation of EPS for the three and nine months ended March 31, 2012 does not include the dilutive effect of 662,810 shares issuable under stock options since their inclusion would be anti-dilutive. Accordingly, the unaudited consolidated financial statements present only basic net loss per common share for all periods presented (see Note 10).
Dividends Declared
Although historically the Company has paid a dividend to stockholders, in light of the Company's current financial position, the Company's Board of Directors has omitted the payment of a quarterly dividend since the third quarter of fiscal 2011. The amount, if any, of dividends to be paid in the future will depend upon the Company's then available cash, anticipated cash needs, overall financial condition, loan agreement restrictions, future prospects for earnings and cash flows, as well as other relevant factors.

8

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Impairment of Indefinite-lived Intangible Assets
The Company performs its annual indefinite-lived intangible assets impairment test as of June 30 of each fiscal year. Indefinite-lived intangible assets are not amortized but instead are reviewed for impairment annually by comparing their fair values to their carrying values.
In addition to an annual test, indefinite-lived intangible assets must also be tested on an interim basis if events or circumstances indicate that the estimated fair value of such assets has decreased below their carrying value. There were no such events or circumstances during the nine months ended March 31, 2013.
Long-lived Assets, Excluding Indefinite-lived Intangible Assets
The Company reviews the recoverability of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Long-lived assets evaluated for impairment are grouped with other assets to the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. The estimated future cash flows are based upon, among other things, assumptions about expected future operating performance, and may differ from actual cash flows. If the sum of the projected undiscounted cash flows (excluding interest) is less than the carrying value of the assets, the assets will be written down to the estimated fair value in the period in which the determination is made. There were no such events or circumstances during the nine months ended March 31, 2013.
Recently Adopted Accounting Standards
In September 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2011-08, “Goodwill and Other (Topic 350), Testing Goodwill for Impairment” (“ASU 2011-08”). Pursuant to ASU 2011-08 companies have the option to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. If, after considering the totality of events and circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, performing the two-step impairment test is unnecessary. The amendments include examples of events and circumstances that an entity should consider. ASU 2011-08 is effective for annual and interim impairment tests performed for fiscal years beginning after June 15, 2012 and is effective for the Company for fiscal 2013 beginning July 1, 2012. Adoption of ASU 2011-08 did not have a material effect on the results of operations, financial position or cash flows of the Company.
On July 1, 2012, the Company adopted ASU No. 2011-05, "Comprehensive Income (Topic 220): Presentation of Comprehensive Income" ("ASU 2011-05"), except for the provisions of ASU 2011-05 which were deferred by ASU No. 2011-12, "Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income" ("ASU 2011-12"). The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, the Company presents other comprehensive income in a separate statement following the consolidated statements of operations. The new guidance also requires entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the consolidated statement of operations and the consolidated statement of comprehensive income. ASU 2011-12 indefinitely defers the guidance related to the presentation of reclassification adjustments. ASU 2011-05 only relates to disclosure requirements and its adoption did not have a material effect on the results of operations, financial position or cash flows of the Company.
In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”). ASU 2011-04 amends the fair value measurement and disclosure guidance in Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures” (“ASC 820”), of the FASB for financial assets and liabilities to converge GAAP and International Financial Reporting Standards requirements for measuring amounts at fair value as well as disclosures about these measurements. Many of the amendments clarify existing concepts and are generally not expected to result in significant changes to how many companies currently apply the fair value principles. In certain instances, however, the FASB changed a principle to achieve convergence, and while limited, these amendments have the potential to significantly change practice for some companies. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The Company adopted the amendments beginning July 1, 2012. The adoption of ASU 2011-04 did not have a material effect on the results of operations, financial position or cash flows of the Company.

9

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


New Accounting Pronouncements
As of March 31, 2013, there were no new accounting pronouncements anticipated to be adopted by the Company.
Note 2. Investments and Derivative Instruments
The Company purchases various derivative instruments as investments or to create economic hedges of its interest rate risk and commodity price risk. At March 31, 2013 and 2012, derivative instruments were not designated as accounting hedges as defined by ASC 815, “Derivatives and Hedging.” The fair value of derivative instruments is based upon broker quotes. The Company records unrealized gains and losses on trading securities and changes in the market value of certain coffee contracts meeting the definition of derivatives in "Other, net" in the consolidated statements of operations.
The Company groups its assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2—Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3—Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
Assets and liabilities measured and recorded at fair value on a recurring basis were as follows (in thousands): 
As of March 31, 2013 (Unaudited)
 
Total
 
Level 1
 
Level 2
 
Level 3
Preferred stock(1)
 
$
20,769

 
$
16,454

 
$
4,315

 
$

Derivative liabilities(2)
 
$
5,930

 
$

 
$
5,930

 
$

Derivative liabilities—interest rate swap(2)
 
$
35

 
$

 
$
35

 
$

 
 
 
 
 
 
 
 
 
As of June 30, 2012
 
Total
 
Level 1
 
Level 2
 
Level 3
Preferred stock(1)
 
$
19,395

 
$
14,078

 
$
5,317

 
$

Futures, options and other derivative assets(1)
 
$
1,626

 
$

 
$
1,626

 
$

Derivative liabilities(3)
 
$
410

 
$

 
$
410

 
$

____________________
(1) Included in "Short-term investments" on the consolidated balance sheets.
(2) Included in "Other current liabilities" on the consolidated balance sheet.
(3) Included in "Accounts Payable" on the consolidated balance sheet.
There were no significant transfers of securities between Level 1 and Level 2 in each of the periods presented.
Effective December 1, 2012, the Company entered into an interest rate swap transaction utilizing a notional amount of $10.0 million and a maturity date of March 1, 2015. The Company entered into the swap transaction to effectively fix the future interest rate during the applicable period on a portion of its borrowings under the revolving credit facility. The swap transaction is intended to manage the Company's interest rate risk related to its revolving credit facility and requires the Company to pay a fixed rate of 0.48% per annum in exchange for a variable interest rate based on 1-month USD LIBOR-BBA.
The Company values its interest rate swap using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of the interest rate swap. This analysis reflects the contractual terms of the interest rate swap, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.
Valuation of the interest rate swap transaction is based on proprietary curves that take into account both Level 1 and Level 2 inputs. The fair value of the interest rate swap is determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves). These forward curves are market-based, utilizing observable market data. Discount curves for present value purposes are constructed using rates representing estimated costs of funding swap positions for early terminations based on an appropriate observable discount rate.

10

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Gains and losses, both realized and unrealized, on derivatives and investments, are included in "Other, net" in the consolidated statements of operations and in "Net losses on derivatives and investments" in the consolidated statements of cash flows. Net realized and unrealized gains and losses on derivatives and investments are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 31,
 
March 31,

 
2013
 
2012
 
2013
 
2012
(In thousands)
 
(Unaudited)
 
(Unaudited)
Coffee-related derivatives:
 
 
 
 
 
 
 
 
Unrealized gains (losses), net
 
$
5

 
$
(1,532
)
 
$
(5,507
)
 
$
(2,551
)
Realized losses, net
 
(2,923
)
 
(1,786
)
 
(4,567
)
 
(4,925
)
Net realized and unrealized coffee-related derivative losses
 
(2,918
)
 
(3,318
)
 
(10,074
)
 
(7,476
)
Net realized and unrealized gains from investments
 
636

 
436

 
794

 
2,345

Net unrealized gains (losses) from interest rate swap
 
4

 

 
(35
)
 

Net losses on derivatives and investments
 
(2,278
)
 
(2,882
)
 
(9,315
)
 
(5,131
)
Net gains on sales of assets
 
1,185

 
499

 
4,388

 
1,161

Other gains, net
 
329

 
552

 
1,452

 
1,512

Other, net
 
$
(764
)
 
$
(1,831
)
 
$
(3,475
)
 
$
(2,458
)
Preferred stock investments as of March 31, 2013 consisted of securities with a fair value of $18.2 million in an unrealized gain position and securities with a fair value of $2.6 million in an unrealized loss position. Preferred stock investments as of June 30, 2012 consisted of securities with a fair value of $16.5 million in an unrealized gain position and securities with a fair value of $2.9 million in an unrealized loss position.
The following tables show gross unrealized losses (although such losses have been recognized in the consolidated statements of operations) and fair values for those investments that were in an unrealized loss position as of March 31, 2013 and June 30, 2012, aggregated by the length of time those investments have been in a continuous loss position: 
 
 
March 31, 2013 (Unaudited)
 
 
Less than 12 Months
 
12 Months and Greater
 
Total
(In thousands)
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Preferred stock
 
$
1,100

 
$
(10
)
 
$
1,463

 
$
(53
)
 
$
2,563

 
$
(63
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2012
 
 
Less than 12 Months
 
12 Months and Greater
 
Total
(In thousands)
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Preferred stock
 
$
1,750

 
$
(16
)
 
$
1,141

 
$
(24
)
 
$
2,891

 
$
(40
)

Note 3. Restricted Cash
At March 31, 2013, the Company had $3.8 million in restricted cash which is classified as a current asset. The restricted cash represents the total amount held as collateral in the Company's coffee derivatives trading account. There was no such collateral in the Company's coffee derivatives trading account at June 30, 2012.



11

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Note 4. Accounts and Notes Receivable, Net
 

 
As of
(In thousands)
 
March 31, 2013
 
June 30, 2012
 
 
(Unaudited)
 
 
Trade receivables
 
$
42,771

 
$
40,687

Other receivables
 
1,004

 
1,921

Allowance for doubtful accounts
 
(982
)
 
(1,872
)
Accounts and notes receivable, net
 
$
42,793

 
$
40,736

Allowance for doubtful accounts decreased in the nine months ended March 31, 2013, primarily due to $0.8 million in recovery of an account previously deemed uncollectible.

Note 5. Inventories
The Company's inventories consisted of the following:
 
 
Processed
 
Unprocessed
 
Total
March 31, 2013 (Unaudited)
 
(In thousands)
Coffee
 
$
13,875

 
$
14,245

 
$
28,120

Tea and culinary products
 
22,880

 
5,599

 
28,479

Coffee brewing equipment
 
5,869

 
4,805

 
10,674

 
 
$
42,624

 
$
24,649

 
$
67,273

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Processed
 
Unprocessed
 
Total
June 30, 2012
 
(In thousands)
Coffee
 
$
15,485

 
$
11,836

 
$
27,321

Tea and culinary products
 
24,502

 
4,817

 
29,319

Coffee brewing equipment
 
3,977

 
5,364

 
9,341

 
 
$
43,964

 
$
22,017

 
$
65,981

Inventories are valued at the lower of cost or market. The Company accounts for coffee, tea and culinary products on the last in, first out ("LIFO") basis and coffee brewing equipment manufactured on the first in, first out ("FIFO") basis. The Company regularly evaluates these inventories to determine whether market conditions are correctly reflected in the recorded carrying value. At the end of each quarter, the Company records the expected beneficial effect of the liquidation of LIFO inventory quantities, if any, and records the actual impact at fiscal year-end. An actual valuation of inventory under the LIFO method is made only at the end of each fiscal year based on the inventory levels and costs at that time. If inventory quantities decline at the end of the fiscal year compared to the beginning of the fiscal year, the reduction results in the liquidation of LIFO inventory quantities carried at the cost prevailing in prior years. This LIFO inventory liquidation may result in a decrease or increase in cost of goods sold depending on whether the cost prevailing in prior years was lower or higher, respectively, than the current year cost. Accordingly, interim LIFO calculations must necessarily be based on management's estimates of expected fiscal year-end inventory levels and costs. Because these estimates are subject to many forces beyond management's control, interim results are subject to the final fiscal year-end LIFO inventory valuation. The Company anticipates its inventory levels at June 30, 2013 will decrease from June 30, 2012 levels, and, therefore, recorded $0.2 million and $0.7 million, respectively, in expected beneficial effect of LIFO inventory liquidation in cost of goods sold in the three and nine months ended March 31, 2013 which reduced net loss for the three and nine months ended March 31, 2013 by $0.2 million and $0.7 million, respectively. In the three and nine months ended March 31, 2012, the Company recorded $2.2 million and $7.8 million, respectively, in expected beneficial effect of LIFO inventory liquidation in cost of goods sold which reduced net loss for the three and nine months ended March 31, 2012 by $2.2 million and $7.8 million, respectively.
The Company routinely enters into specialized hedging transactions to purchase future coffee contracts to enable it to lock in green coffee prices within a pre-established range, and holds a mix of futures contracts and options to help hedge against volatility in green coffee prices. None of these hedging transactions, futures contracts or options is designated as an accounting hedge. The Company values its futures contracts by marking them to market price and recognizes the unrealized and realized gains or losses immediately in “Other, net” in the consolidated statements of operations. The unrealized and realized gains or

12

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


losses are based on whether the market price is higher or lower than the price that was locked-in. During the three and nine months ended March 31, 2013, green coffee commodity prices declined below the Company's locked-in price, and the Company recognized the resulting losses in its results. Such losses are expected to either be offset by future derivative gains as the coffee market changes, recovered through operating income as a result of the lower cost of goods assigned to the related coffee or recovered from customers for whom contracts were purchased for their accounts.
For the three and nine months ended March 31, 2013, the Company recorded $2.9 million and $10.1 million, respectively, in net realized and unrealized coffee-related derivative losses. For the three and nine months ended March 31, 2012, the Company recorded $3.3 million and $7.5 million, respectively, in net realized and unrealized coffee-related derivative losses (see Note 2).

Note 6. Employee Benefit Plans
The Company provides pension plans for most full time employees. Generally the plans provide benefits based on years of service and/or a combination of years of service and earnings. Certain retirees are also eligible for medical, dental and vision benefits.
The Company is required to recognize the funded status of a benefit plan in its consolidated balance sheet. The Company is also required to recognize in other comprehensive income certain gains and losses that arise during the period but are deferred under pension accounting rules. The Company measures its plan assets and benefit obligations annually as of June 30.
Single Employer Pension Plans
The Company has a defined benefit pension plan, the Farmer Bros. Salaried Employees Pension Plan (the “Farmer Bros. Plan”), for the majority of its employees who are not covered under a collective bargaining agreement. The Company amended the Farmer Bros. Plan, freezing the benefit for all participants effective June 30, 2011. After the plan freeze, participants do not accrue any benefits under the plan, and new hires are not eligible to participate in the plan. As all plan participants became inactive following this curtailment, net gain or loss is now amortized based on the remaining life expectancy of these participants instead of the remaining service period of these participants.
The Company also has two defined benefit pension plans for certain hourly employees covered under a collective bargaining agreement (the “Brewmatic Plan” and the “Hourly Employees’ Plan”).
The net periodic benefit cost for the defined benefit pension plans is as follows:
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2013
 
2012
 
2013
 
2012
(In thousands)
(Unaudited)
 
(Unaudited)
Service cost
$
119

 
$
124

 
$
357

 
$
371

Interest cost
1,449

 
1,525

 
4,347

 
4,575

Expected return on plan assets
(1,660
)
 
(1,703
)
 
(4,980
)
 
(5,108
)
Amortization of net loss(1)
387

 
342

 
1,161

 
1,027

Amortization of net prior service cost(1)
5

 
5

 
15

 
14

Net periodic benefit cost
$
300

 
$
293

 
$
900

 
$
879

_____________
(1)
These amounts represent the estimated portion of the net loss and net prior service cost remaining in accumulated other comprehensive income that is expected to be recognized as a component of net periodic benefit cost over the current fiscal year.


13

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Weighted average assumptions used to determine net periodic benefit cost
 
Fiscal
 
2013
 
2012
Discount rate
4.55%
 
5.60%
Expected long-term rate of return
8.00%
 
8.25%
Rate of compensation increase(1)
—%
 
3.00%
 
_____________
(1) For Hourly Employees' Plan only.
Basis used to determine expected long-term rate of return on plan assets
Historical and future projected returns of multiple asset classes were analyzed to develop a risk-free real rate of return and risk premiums for each asset class. The overall rate for each asset class was developed by combining a long-term inflation component, the risk-free real rate of return, and the associated risk premium. A weighted average rate of return was developed based on those overall rates and the target asset allocation of the plans.
Multiemployer Pension Plans
The Company participates in the Western Conference of Teamsters Pension Plan (“WCTPP”), a defined benefit pension plan that is union sponsored and collectively bargained, for the benefit of certain employees subject to collective bargaining agreements. The Company makes contributions to WCTPP generally based on the number of hours worked by the participants in accordance with the provisions of negotiated labor contracts.

Effective October 2011, the Company withdrew from the United Teamsters Pension Fund, a defined benefit pension plan, and replaced it with the United Teamsters Annuity Fund (the “Annuity Fund”), a defined contribution pension plan, for certain employees covered by a collective bargaining agreement expiring in 2014. The Company incurred no withdrawal liability related to the withdrawal from the United Teamsters Pension Fund. The Company's contributions to the Annuity Fund are based on the number of compensable hours worked by the Company's employees who participate in the Annuity Fund.
In the second quarter of fiscal 2012, the Company withdrew from the Labor Management Pension Fund, a defined benefit pension plan, and recorded a charge of $4.3 million associated with withdrawal from this plan, representing the present value of the estimated withdrawal liability expected to be paid in quarterly installments of $0.1 million over 80 quarters. Installment payments will commence once the final determination of the amount of withdrawal liability is established, which determination may take up to 24 months from the date of withdrawal from the pension plan. Upon withdrawal, the employees covered under this multiemployer pension plan were included in the Company's 401(k) plan (the “401(k) Plan”).
Future collective bargaining negotiations may result in the Company withdrawing from the remaining multiemployer pension plans in which it participates and, if successful, the Company may incur a withdrawal liability, the amount of which could be material to the Company's results of operations and cash flows.
Multiemployer Plans Other Than Pension Plans
The Company participates in five multiemployer defined contribution plans other than pension plans that provide medical, vision, dental and disability benefits to certain retirees subject to collective bargaining agreements who meet the eligibility rules in effect when they retire and/or qualified members of their families.
401(k) Plan
The Company's 401(k) Plan is available to all eligible employees who have worked more than 1,000 hours during a calendar year and were employed at the end of the calendar year. Participants in the 401(k) Plan may choose to contribute 1% to 100% of their annual pay subject to the maximum contribution allowed by the Internal Revenue Service. The Company's matching contribution is discretionary based on approval by the Company's Board of Directors. For the calendar year 2013, the Company's Board of Directors approved a Company matching contribution of 50.0% of an employee's annual contribution to the 401(k) Plan, up to 6.0% of the employee's eligible income. The matching contributions (and any earnings thereon) vest at the rate of 20.0% for each of the participant's first 5 years of vesting service, so that a participant is fully vested in his or her matching contribution account after 5 years of vesting service. A participant is automatically vested in the event of death,

14

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


disability or attainment of age 65 while employed by the Company. Employees are 100% vested in their contributions. For employees subject to a collective bargaining agreement, the match is only available if so provided in the labor agreement.
The Company recorded matching contributions of $0.8 million and $0.9 million in operating expenses for the nine months ended March 31, 2013 and 2012, respectively.
Postretirement Benefits
The Company sponsors an unfunded postretirement medical, dental and vision plan that covers qualified non-union retirees and certain qualified union retirees. Under this postretirement plan, the Company’s contributions toward premiums for retiree medical, dental and vision coverage for participants and dependents are scaled based on length of service, with greater Company contributions for retirees with greater length of service, but subject to a maximum monthly Company contribution.
 
The net periodic postretirement benefit cost is as follows:
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,

 
2013
 
2012
 
2013
 
2012
(In thousands)
 
(Unaudited)
 
(Unaudited)
Service cost
 
$
634

 
$
409

 
$
1,903

 
$
1,227

Interest cost
 
178

 
330

 
534

 
990

Amortization of net gain
 
(218
)
 
(199
)
 
(653
)
 
(597
)
Amortization of prior service credit
 
(240
)
 
(58
)
 
(720
)
 
(174
)
Net periodic postretirement benefit cost
 
$
354

 
$
482

 
$
1,064

 
$
1,446

Weighted average assumptions used to determine net periodic postretirement benefit cost 
 
Fiscal
 
2013
 
2012
Discount rate
4.40%
 
5.46%
The fiscal 2013 estimate of net periodic postretirement benefit cost is based on July 1, 2012 census data.

Note 7. Bank Loan
On September 12, 2011, the Company entered into an Amended and Restated Loan and Security Agreement (the “Loan Agreement”) among the Company and Coffee Bean International, Inc. (“CBI”), as Borrowers, certain of the Company’s other subsidiaries, as Guarantors, the Lenders party thereto, and Wells Fargo Bank, National Association (“Wells Fargo”), as Agent.
On January 9, 2012, the Loan Agreement was amended in connection with JPMorgan Chase Bank, N.A. (“JPMorgan Chase”), becoming an additional Lender thereunder. On March 18, 2013, the Loan Agreement was amended further ("Amendment No. 2") to amend the definition of "Maximum Credit" available thereunder to $75.0 million from $85.0 million. Pursuant to Amendment No. 2, Wells Fargo will provide a commitment of $53.0 million and JPMorgan Chase will provide a commitment of $22.0 million.
The Loan Agreement provides for a senior secured revolving credit facility of up to $75.0 million, with a letter of credit sublimit of $20.0 million. The revolving credit facility provides for advances of 85% of eligible accounts receivable and 75% of eligible inventory (subject to a $60.0 million inventory loan limit), as defined. The Loan Agreement provides for interest rates based on modified Monthly Average Excess Availability levels with a range of PRIME + 0.25% to PRIME + 0.75% or Adjusted Eurodollar Rate + 2.0% to Adjusted Eurodollar Rate + 2.5%. The Loan Agreement has an amendment fee of 0.375% and an unused line fee of 0.25%. Outstanding obligations under the Loan Agreement are collateralized by all of the Borrowers’ assets, including the Company’s preferred stock portfolio. The Loan Agreement expires on March 2, 2015.
The Loan Agreement contains a variety of affirmative and negative covenants of types customary in an asset-based lending facility, including those relating to reporting requirements, maintenance of records, properties and corporate existence, compliance with laws, incurrence of other indebtedness and liens, limitations on certain payments, including the payment of dividends and capital expenditures, and transactions and extraordinary corporate events. The Loan Agreement allows the

15

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Company to pay dividends, subject to certain liquidity requirements. The Loan Agreement also contains financial covenants requiring the Borrowers to maintain minimum Excess Availability and Total Liquidity levels. The Loan Agreement allows the Lender to establish reserve requirements, which may reduce the amount of credit otherwise available to the Company, to reflect events, conditions, or risks that would have a reasonable likelihood of adversely affecting the Lender’s collateral or the Company’s assets, including the Company’s green coffee inventory.    
Effective December 1, 2012, the Company entered into an interest rate swap transaction utilizing a notional amount of $10.0 million and a maturity date of March 1, 2015. The Company entered into the swap transaction to effectively fix the future interest rate during the applicable period on a portion of its borrowings under the revolving credit facility. The swap transaction is intended to manage the Company's interest rate risk related to its revolving credit facility and requires the Company to pay a fixed rate of 0.48% per annum in exchange for a variable interest rate based on 1-month USD LIBOR-BBA. As of March 31, 2013, the variable interest rate based on 1-month USD LIBOR-BBA was 0.20%.

The Company has not designated its interest rate swap as an accounting hedge. The Company records the interest rate swap on its consolidated balance sheet at fair market value with the changes in fair value recorded as gain or loss in "Other, net" in its consolidated statements of operations. In the three and nine months ended March 31, 2013, respectively, the Company recorded a gain of $4,000 and a loss of $35,000 for the change in fair value of its interest rate swap. No such gains or losses were recorded in the three and nine months ended March 31, 2012 (see Note 2).

On March 31, 2013, the Company was eligible to borrow up to a total of $65.2 million under the credit facility. As of March 31, 2013, the Company had outstanding borrowings of $20.2 million, including loan extension fees of $0.2 million, utilized $10.2 million of its letters of credit sublimit, and had excess availability under the credit facility of $34.8 million. In connection with entering into the interest rate swap agreement, the Company reclassified $10.0 million of its borrowings under the revolving credit facility as long-term because the Company intends to repay the borrowings in accordance with the termination date of the swap agreement which extends beyond one year. At March 31, 2013, the weighted average interest rate on the Company’s outstanding borrowings under the credit facility was 1.35%. As of March 31, 2013, the Company was in compliance with all restrictive covenants under the credit facility. There can be no assurance that the Lender will issue a waiver or grant an amendment to the covenants in future periods, if the Company required one.

Note 8. Share-based Compensation
On August 23, 2007, the Company’s Board of Directors approved the Farmer Bros. Co. 2007 Omnibus Plan (the “Omnibus Plan”), which was approved by stockholders on December 6, 2007. On December 6, 2012, the stockholders approved an amendment to increase the maximum number of shares of common stock available for issuance under the Omnibus Plan to 1,125,000 from 1,000,000, subject to adjustment as provided in the Omnibus Plan.
The Company measures and recognizes compensation expense for all share-based payment awards made under the Omnibus Plan based on estimated fair values. 
Stock Options
During the nine months ended March 31, 2013, the Company granted a total of 163,446 shares issuable upon the exercise of non-qualified stock options with a weighted average exercise price of $11.85 per share to eligible employees and officers under the Omnibus Plan. Shares issuable under the options vest ratably over a three-year period. Following are the weighted average assumptions used in the Black-Scholes valuation model for the grants issued during the nine months ended March 31, 2013 and 2012:  
 
Nine Months Ended March 31,  
 
2013
 
2012
Weighted average fair value of options
$5.56
 
$4.74
Risk-free interest rate
0.8%
 
1.1%
Dividend yield
 
Average expected life
6 years
 
6 years
Expected stock price volatility
49.5%
 
52.5%


16

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


The Company estimates the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period in the Company’s consolidated statements of operations. Compensation expense recognized for all stock option awards is recognized using the straight-line method over the vesting period. The options generally vest ratably over a three-year period, however, fiscal 2012 grants included nonqualified stock option awards to executive officers with different vesting periods, in each case, subject to certain events of acceleration as provided in the applicable employment agreement or award agreement with the executive officer.
The share-based compensation expense recognized in the Company’s consolidated statements of operations for the three and nine months ended March 31, 2013 and 2012 is based on awards ultimately expected to vest. Currently, management estimates an annual forfeiture rate of 6.5% based on actual forfeiture experience from the inception of the Omnibus Plan. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
The Company uses the Black-Scholes option valuation model, which requires management to make certain assumptions for estimating the fair value of stock options at the date of grant. The Company’s assumption regarding expected stock price volatility is based on the historical volatility of the Company’s stock price. The risk-free interest rate is based on U.S. Treasury zero-coupon issues at the date of grant with a remaining term equal to the expected life of the stock options. The average expected life is based on the midpoint between the vesting date and the end of the contractual term of the award. 
The following table summarizes stock option activity for the nine months ended March 31, 2013 (unaudited):
Outstanding Stock Options
 
Number
of
Stock
Options
 
Weighted
Average
Exercise
Price ($)
 
Weighted
Average
Grant Date
Fair Value ($)
 
Weighted
Average
Remaining
Life
(Years)
 
Aggregate
Intrinsic
Value
($ in 
thousands)
Outstanding at June 30, 2012
 
667,235

 
12.84
 
4.78
 
4.8
 
143

Granted
 
163,446

 
11.85
 
5.56
 
6.7
 
465

Exercised
 
(116,471
)
 
10.27
 
5.24
 
 

Cancelled/forfeited
 
(147,122
)
 
13.21
 
5.75
 
 

Outstanding at March 31, 2013
 
567,088

 
12.99
 
5.46
 
5.1
 
1,875

 
 
 
 
 
 
 
 
 
 
 
Vested and exercisable, March 31, 2013
 
244,851

 
16.66
 
6.26
 
3.5
 
356

Vested and expected to vest, March 31, 2013
 
537,471

 
13.13
 
5.49
 
5.0
 
1,745

The aggregate intrinsic values in the table above represent the total pretax intrinsic value, based on the Company’s closing stock price of $14.70 at March 28, 2013, representing the last trading day of the fiscal quarter ended March 31, 2013, which would have been received by award holders had all award holders exercised their awards that were in-the-money as of that date. Total fair value of options vested during the nine months ended March 31, 2013 was $0.9 million. During the three and nine months ended March 31, 2013, the Company received $1.2 million in proceeds from exercises of vested options.

As of March 31, 2013 and 2012, there was approximately $1.3 million and $1.9 million, respectively, of unrecognized compensation cost related to stock options. Compensation expense recognized in general and administrative expenses in the three and nine months ended March 31, 2013 was $0.2 million and $0.7 million, respectively. Compensation expense recognized in general and administrative expenses for the three and nine months ended March 31, 2012 was $0.4 million and $1.0 million, respectively.
Restricted Stock
During the nine months ended March 31, 2013, the Company granted a total of 45,230 shares of restricted stock with a weighted average grant date fair value of $11.42 per share. Shares of restricted stock generally vest on the third anniversary of the date of grant for employees, including officers. Shares of restricted stock generally vest ratably over a three-year period for directors and officers who are not employees. Fiscal 2012 grants included certain awards to executive officers with different vesting periods, in each case, subject to accelerated vesting as provided in the applicable employment agreement or award agreement with the executive officer.

17

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Compensation expense is recognized on a straight-line basis over the service period based on the estimated fair value of the restricted stock. Compensation expense recognized in general and administrative expenses was $0.1 million and $0.2 million, for the three months ended March 31, 2013 and 2012, respectively. Compensation expense recognized in general and administrative expenses was $0.6 million and $0.4 million, for the nine months ended March 31, 2013 and 2012, respectively. As of March 31, 2013 and 2012, there was approximately $1.0 million and $1.3 million, respectively, of unrecognized compensation cost related to restricted stock.
The following table summarizes restricted stock activity for the nine months ended March 31, 2013 (unaudited):
Outstanding and Nonvested Restricted Stock Awards
 
Shares
Awarded
 
Weighted
Average
Grant Date
Fair Value
($)
 
Weighted
Average
Remaining
Life
(Years)
 
Aggregate
Intrinsic
Value
($ in 
thousands)
Outstanding June 30, 2012
 
175,947

 
10.16

 
1.9
 
1,401

Granted
 
45,230

 
11.42

 
2.6
 
516

Vested
 
(50,085
)
 
12.52

 
 
638

Cancelled/forfeited
 
(21,104
)
 
12.34

 
 

Outstanding at March 31, 2013
 
149,988

 
9.45

 
2.0
 
2,205

 
 
 
 
 
 
 
 
 
Expected to vest, March 31, 2013
 
127,128

 
9.41

 
1.9
 
1,869



18

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Note 9. Income Taxes
The Company adjusts its effective tax rate each quarter based on its current estimated annual effective tax rate. The Company also records the tax impact of certain discrete items, unusual or infrequently occurring tax events and the effects of changes in tax laws or rates, in the interim period in which they occur. In addition, the Company evaluates its deferred tax assets quarterly to determine if a valuation allowance is required.
The Company considered whether a valuation allowance should be recorded against deferred tax assets based on the likelihood that the benefits of the deferred tax assets would or would not ultimately be realized in future periods. In making this assessment, significant weight was given to evidence that could be objectively verified such as recent operating results and less consideration was given to less objective indicators such as future earnings projections.
After consideration of positive and negative evidence, including the recent history of losses, the Company cannot conclude that it is more likely than not to generate future earnings sufficient to realize the Company's deferred tax assets. Accordingly, the Company increased its valuation allowance by $0.6 million in the three months ended March 31, 2013 to $87.2 million. The valuation allowance at June 30, 2012 was $85.0 million.
     A summary of the income tax expense recorded for the three and nine months ended March 31, 2013 and 2012 is as follows:

 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
 
 
2013
 
2012
 
2013
 
2012
 
(In thousands)
 
(Unaudited)
 
(Unaudited)
 
Loss before taxes
 
$
(1,471
)
 
$
(6,078
)
 
$
(5,488
)
 
$
(17,366
)
 
Income tax benefit at statutory rate
 
(500
)
 
(2,066
)
 
(1,866
)
 
(5,904
)
 
State income tax (benefit) expense (net of federal tax benefit)
 
(161
)
 
(238
)
 
(52
)
 
(687
)
 
Dividend income exclusion
 

 
(79
)
 

 
(137
)
 
Valuation allowance
 
597

 
2,794

 
2,214

 
7,478

 
ESOP dividend
 

 
(464
)
 

 
(464
)
 
Changes in FIN48 reserves
 

 
(673
)
 

 
(673
)
 
Other permanent items
 
8

 
149

 
51

 
216

 
Income tax (benefit) expense
 
$
(56
)
 
$
(577
)
 
$
347

 
$
(171
)
 

As of March 31, 2013 and June 30, 2012, the Company had not recognized the following tax benefits in its consolidated financial statements: 
 
 
As of  
 
 
March 31,
2013
 
June 30,
2012 
(In thousands)
 
(Unaudited)
 
 
Total unrecognized tax benefits(1)
 
$
3,211

 
$
3,211

Unrecognized tax benefits that, if recognized, would affect the Company's effective tax rate, subject to the valuation allowance(1)
 
$
3,064

 
$
3,064

_____________ 
(1) Excluding interest and penalties.
The Company believes it is reasonably possible that none of its total unrecognized tax benefits will be released in the next 12 months.
The Company is currently appealing a decision reached by the Internal Revenue Service regarding its June 30, 2003 through June 30, 2008 tax returns. In January 2012, the appeals officer gave a preliminary indication that the audit results will be upheld.

19

Farmer Bros. Co.
Notes to Consolidated Financial Statements (Unaudited) (continued)


Note 10. Earnings (Loss) Per Common Share 
The following table sets forth the calculation of basic and diluted net loss per common share:

 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
2013
 
2012
 
2013
 
2012
(In thousands, except share and per share amounts)
 
(Unaudited)
 
(Unaudited)
Net loss attributable to common stockholders—basic
 
(1,403
)
 
(5,445
)
 
(5,786
)
 
(17,019
)
Net loss attributable to nonvested restricted stockholders
 
(12
)
 
(56
)
 
(49
)
 
(176
)
Total net loss
 
$
(1,415
)
 
$
(5,501
)
 
(5,835
)
 
(17,195
)
Weighted average shares outstanding—basic
 
15,600,040

 
15,592,291

 
15,540,697

 
15,448,622

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Shares issuable under stock options
 

 

 

 

Weighted average shares outstanding—diluted
 
15,600,040

 
15,592,291

 
15,540,697

 
15,448,622

Net loss per common share—basic and diluted
 
$
(0.09
)
 
$
(0.35
)
 
$
(0.38
)
 
$
(1.11
)

20



Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. The results of operations for the three and nine months ended March 31, 2013 are not necessarily indicative of the results that may be expected for any future period. The following discussion should be read in combination with the consolidated financial statements and the notes thereto included in Part I, Item 1 of this report and with the “Risk Factors” described in Part II, Item 1A of this report.
Liquidity and Capital Resources
Credit Facility
On September 12, 2011, we entered into an Amended and Restated Loan and Security Agreement (the “Loan Agreement”) among the Company and CBI, as Borrowers, certain of the Company’s other subsidiaries, as Guarantors, the Lenders party thereto, and Wells Fargo Bank, National Association ("Wells Fargo"), as Agent for the Lenders.
On January 9, 2012, the Loan Agreement was amended in connection with JPMorgan Chase Bank, N.A. (“JPMorgan Chase”), becoming an additional Lender thereunder. On March 18, 2013, the Loan Agreement was amended further (“Amendment No. 2") to amend the definition of "Maximum Credit" available thereunder to $75.0 million from $85.0 million. Pursuant to Amendment No. 2, Wells Fargo will provide a commitment of $53.0 million and JPMorgan Chase will provide a commitment of $22.0 million.
The Loan Agreement provides for a senior secured revolving credit facility of up to $75.0 million, with a letter of credit sublimit of $20.0 million. The revolving credit facility provides for advances of 85% of eligible accounts receivable and 75% of eligible inventory (subject to a $60.0 million inventory loan limit), as defined. The Loan Agreement provides for interest rates based on modified Monthly Average Excess Availability levels with a range of PRIME + 0.25% to PRIME + 0.75% or Adjusted Eurodollar Rate + 2.0% to Adjusted Eurodollar Rate + 2.5%. The Loan Agreement has an amendment fee of 0.375% and an unused line fee of 0.25%. Outstanding obligations under the Loan Agreement are collateralized by all of the Borrowers’ assets, including the Company’s preferred stock portfolio. The term of the Loan Agreement expires on March 2, 2015.
The Loan Agreement contains a variety of affirmative and negative covenants of types customary in an asset-based lending facility, including those relating to reporting requirements, maintenance of records, properties and corporate existence, compliance with laws, incurrence of other indebtedness and liens, limitations on certain payments, including the payment of dividends and capital expenditures, and transactions and extraordinary corporate events. The Loan Agreement allows us to pay dividends, subject to certain liquidity requirements. The Loan Agreement also contains financial covenants requiring the Borrowers to maintain minimum Excess Availability and Total Liquidity levels. The Loan Agreement allows the Lender to establish reserve requirements, which may reduce the amount of credit otherwise available to us, to reflect events, conditions, or risks that would have a reasonable likelihood of adversely affecting the Lender’s collateral or our assets, including our green coffee inventory.
The Loan Agreement provides that an event of default includes, among other things, subject to certain grace periods: (i) payment defaults; (ii) failure by any guarantor to perform any guarantee in favor of Lender; (iii) failure to abide by loan covenants; (iv) default with respect to other material indebtedness; (v) final judgment in a material amount not discharged or stayed; (vi) any change of control; (vii) bankruptcy or insolvency; and (viii) the failure of the Farmer Bros. Co. Employee Stock Ownership Benefit Trust, created by the Company to implement the Farmer Bros. Co. Employee Stock Ownership Plan ("ESOP"), to be duly qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended, or exempt from federal income taxation, or if the ESOP engages in a material non-exempt prohibited transaction.
Effective December 1, 2012, we entered into an interest rate swap transaction utilizing a notional amount of $10.0 million and a maturity date of March 1, 2015. We entered into the swap transaction to effectively fix the future interest rate during the applicable period on a portion of our borrowings under the revolving credit facility. The swap transaction is intended to manage our interest rate risk related to the revolving credit facility and requires us to pay a fixed rate of 0.48% per annum in exchange for a variable interest rate based on 1-month USD LIBOR-BBA. As of April 30, 2013, the variable interest rate based on 1-month USD LIBOR-BBA was 0.20%
We have not designated our interest rate swap as an accounting hedge. We record the interest rate swap on our consolidated balance sheet at fair market value with the changes in fair value recorded as gain or loss in "Other, net" in our

21



consolidated statements of operations. In the three and nine months ended March 31, 2013,  we recorded a gain of $4,000 and a loss of $35,000, respectively, for the change in fair value of our interest rate swap. No such gains or losses were recorded in the three and nine months ended March 31, 2012 (see Note 2 to the consolidated financial statements).
On March 31, 2013, we were eligible to borrow up to a total of $65.2 million under the credit facility. As of March 31, 2013, we had outstanding borrowings of $20.2 million, including loan extension fees of $0.2 million, utilized $10.2 million of the letters of credit sublimit, and had excess availability under the credit facility of $34.8 million. In connection with entering into the interest rate swap agreement, we reclassified $10.0 million of our borrowings under the revolving credit facility as long-term because we intend to repay the borrowings in accordance with the termination date of the swap agreement which extends beyond one year. The weighted average interest rate on our outstanding borrowings under the credit facility was 1.35% at March 31, 2013. We believe that the carrying value of our outstanding borrowings under the revolving credit facility approximates fair value at March 31, 2013 as the revolving credit facility bears interest at a variable interest rate based on prevailing market conditions.
As of March 31, 2013, we were in compliance with all restrictive covenants under the Loan Agreement. There can be no assurance that the Lender will issue a waiver or grant an amendment to the covenants in future periods, if we required one. As of April 30, 2013, we were eligible to borrow $65.7 million, had outstanding borrowings of $17.7 million, including loan extension fees of $0.2 million, utilized $11.6 million of the letters of credit sublimit, and had excess availability under the credit facility of $36.4 million. As of April 30, 2013, the weighted average interest rate on our outstanding borrowings under the credit facility was 1.33%.
Liquidity
We generally finance our operations through cash flow from operations and borrowings under our revolving credit facility described above. As of March 31, 2013, we had $5.5 million in cash and cash equivalents, $3.8 million held in our derivatives trading account as collateral for our coffee-related derivatives activity and $20.8 million in short-term investments. We believe our revolving credit facility, to the extent available, in addition to our cash flows from operations and other liquid assets, are sufficient to fund our working capital and capital expenditure requirements for the next 12 months.
We generate cash from operating activities primarily from cash collections related to the sale of our products. Net cash provided by operating activities was $17.8 million in the nine months ended March 31, 2013, compared with $11.0 million in the nine months ended March 31, 2012. Net cash provided by operating activities in the nine months ended March 31, 2013 was primarily due to lower net loss and increase in accounts payable, offset, in part, by increase in accounts receivable and inventories. Net cash provided by operating activities in the nine months ended March 31, 2012 was primarily due to decrease in inventory levels and collection of outstanding receivables.
Net cash used in investing activities was $4.6 million in the nine months ended March 31, 2013, compared to $8.4 million in the nine months ended March 31, 2012. In the nine months ended March 31, 2013, cash inflow from the sale of fixed assets, primarily real estate, was $5.6 million and cash outflow for capital expenditures was $10.1 million. In the nine months ended March 31, 2012, cash inflow from the sale of fixed assets, primarily real estate, was $2.1 million and cash outflow for capital expenditures was $10.5 million.
Net cash used in financing activities was $11.6 million in the nine months ended March 31, 2013, compared to $5.2 million in the nine months ended March 31, 2012. Cash flows related to financing activities included net repayments on our revolving credit facility of $10.2 million in the nine months ended March 31, 2013, partially offset by $1.2 million in proceeds from stock option exercises, compared to $4.0 million in net repayments on our revolving credit facility in the nine months ended March 31, 2012.
In the nine months ended March 31, 2013, we capitalized $10.1 million in property, plant and equipment purchases which included $7.1 million in expenditures to replace normal wear and tear of coffee brewing equipment, and $2.3 million in expenditures for vehicles and machinery and equipment.
Our total expected capital expenditures for fiscal 2013 include expenditures to replace normal wear and tear of coffee brewing equipment, vehicles, and machinery and equipment and are expected not to deviate significantly from fiscal 2012 levels.

22



Our working capital is composed of the following: 
 
 
March 31, 2013
 
June 30, 2012
(In thousands)
 
(Unaudited)
 
 
Current assets
 
$
143,050

 
$
135,851

Current liabilities(1)
 
78,963

 
92,689

Working capital
 
$
64,087

 
$
43,162

______________
(1) Includes $10.0 million in borrowings under revolving credit facility as of June 30, 2012, which has been reclassified into long-term liabilities as of March 31, 2013.
Liquidity information:
 
 
Nine Months Ended March 31,

 
2013
 
2012
 
(In thousands)
 
(Unaudited)
 
Capital expenditures
 
$
10,118

 
$
10,533

 
Results of Operations
Net sales in the fiscal quarter ended March 31, 2013 increased $4.8 million, or 4%, to $126.3 million as compared to $121.5 million in the fiscal quarter ended March 31, 2012. The increase was primarily due to increases in sales of our coffee and tea products. Net sales in the nine months ended March 31, 2013 increased $6.7 million, or 2%, to $381.2 million as compared to $374.5 million in the nine months ended March 31, 2012, primarily due to increases in sales of our coffee and tea products.
Gross profit in the three months ended March 31, 2013 increased $5.6 million, or 13%, to $48.7 million, as compared to $43.1 million in the three months ended March 31, 2012. Gross margin increased to 39% in the three months ended March 31, 2013 from 36% in the comparable period in the prior fiscal year. Gross profit during the nine months ended March 31, 2013 increased $16.2 million, or 13%, to $143.6 million, as compared to $127.4 million in the nine months ended March 31, 2012. Gross margin increased to 38% in the nine months ended March 31, 2013 from 34% in the comparable period of the prior fiscal year. Gross profit in each of the three and nine months ended March 31, 2013 included the expected beneficial effect of the liquidation of LIFO inventory quantities in the amount of $0.2 million and $0.7 million, respectively. Gross profit in the three and nine months ended March 31, 2012 included the expected beneficial effect of the liquidation of LIFO inventory quantities in the amount of $2.2 million and $7.8 million, respectively (see Note 5 to the consolidated financial statements). The increase in gross margin during the three and nine months ended March 31, 2013 is primarily due to a 29% and 31% decline, respectively, in the average cost of green coffee beans purchased compared to the same periods in the prior fiscal year.
Operating expenses in the three months ended March 31, 2013 increased $2.0 million, or 4.3%, to $49.3 million, or 39% of sales, from $47.3 million, or 39% of sales, in the three months ended March 31, 2012. Operating expenses in the nine months ended March 31, 2013 increased $3.6 million, or 3%, to $145.4 million, or 38% of sales, from $141.8 million, or 38% of sales, in the nine months ended March 31, 2012. Operating expenses in the three months ended March 31, 2013 included higher expenses resulting from our investments in additional sales and marketing training, expenses related to the launch of the Artisan Collection by Farmer Brothersand the new Farmer Brothers teas, and higher expenses related to severance. Operating expenses in the nine months ended March 31, 2013 benefited from the absence of pension withdrawal expense but included higher expenses resulting from our investments in additional sales and marketing training, expenses related to the launch of the Artisan Collection by Farmer Brothersand the new Farmer Brothers teas, higher startup costs associated with the increase in national customers, higher expenses related to severance and losses in one of our distribution centers affected by hurricane Sandy. Operating expenses in the nine months ended March 31, 2012 included $4.3 million in pension withdrawal expense related to a multiemployer pension plan.
Total other expense in the three months ended March 31, 2013 was $0.9 million compared to $2.0 million in the three months ended March 31, 2012. Total other expense in the nine months ended March 31, 2013 was $3.7 million compared to $3.0 million in the nine months ended March 31, 2012.
Total other expense in the three and nine months ended March 31, 2013 included $2.9 million and $10.1 million, respectively, in net realized and unrealized coffee-related derivative losses, compared to $3.3 million and $7.5 million, respectively, in the three and nine months ended March 31, 2012. The increase in net realized and unrealized coffee-related derivative losses in the three and nine months ended March 31, 2013 compared to the same periods in the prior fiscal year is due in large part to the increase in the number of futures contracts combined with a decline of approximately 5% per pound and

23



19% per pound, respectively, in coffee commodity costs during the three and nine months ended March 31, 2013. There was a four-fold increase in the number of our coffee-related derivative contracts as of March 31, 2013 covering 34.8 million pounds of green coffee compared to 9.4 million pounds of green coffee covered as of March 31, 2012. The increase in the number of such contracts is primarily due to the increase in the number of our national customers since a majority of the contracts are purchased for their accounts.
We have adopted a hedging strategy intended to establish predictable prices for future supply of green coffee with futures contracts that we purchase for certain of our national customer accounts and for our own account for longer periods of time than was done previously because the cost of coffee significantly declined during the last 12 to 18 months, making these long-term futures contracts relatively less expensive than they had been previously. Since the coffee-related derivatives are not designated as accounting hedges, in accordance with GAAP, we recognized the net unrealized and realized losses immediately in our consolidated statements of operations as the derivative contracts were re-valued to their market prices. These losses are expected to be offset by future derivative gains as the coffee market changes, recovered through operating income as a result of the lower cost of goods assigned to the related coffee or recovered from customers for whom contracts were purchased for their accounts. Beginning April 1, 2013, we implemented procedures following the guidelines of ASC 815, “Derivatives and Hedging” (“ASC 815”), to enable us to account for certain coffee-related derivatives as accounting hedges in order to minimize the volatility created in our quarterly results from utilizing these derivative contracts and to improve comparability between reporting periods. As a result, beginning in the fourth quarter of fiscal 2013, we anticipate a portion of the gains and losses from re-valuing the coffee-related derivative contracts to their market prices will be recorded in accumulated other comprehensive income on our consolidated balance sheet and recognized in cost of goods sold when the related coffee is received.
Total other expense in the three months ended March 31, 2013 and 2012 included $1.2 million in net gains on sales of assets, primarily real estate, and $0.5 million in net gains on sales of assets, respectively. Total other expense in the nine months ended March 31, 2013 included $4.4 million in net gains on sales of assets, primarily real estate, and $0.8 million in recovery of an account previously deemed uncollectible. Total other expense in the nine months ended March 31, 2012 included $2.3 million in net gains on sales of investments and $1.2 million in net gains on sales of assets, primarily real estate.
Income tax benefit in the three months ended March 31, 2013 was $56,000 compared to $0.6 million in the three months ended March 31, 2012. Income tax expense in the nine months ended March 31, 2013 was $0.3 million compared to income tax benefit of $0.2 million in the nine months ended March 31, 2012.
As a result of the forgoing factors, net loss in the fiscal quarter ended March 31, 2013 was $(1.4) million, or $(0.09) per common share, as compared to net loss of $(5.5) million, or $(0.35) per common share, during the same period in the prior fiscal year. Net loss in the nine months ended March 31, 2013 was $(5.8) million, or $(0.38) per common share, as compared to net loss of $(17.2) million, or $(1.11) per common share, during the same period in the prior fiscal year.
Non-GAAP Financial Measures
In addition to net income (loss) determined in accordance with GAAP, we use certain non-GAAP financial measures, such as “EBITDAE” in assessing our operating performance. We believe that this non-GAAP financial measure serves as an appropriate measure to be used in evaluating the performance of our business.
We define EBITDAE as net income (loss) excluding the impact of income taxes, interest expense, depreciation and amortization expense, ESOP and share-based compensation expense, non-cash impairment losses and pension withdrawal expense, if any, and net gains and losses from derivatives and investments. EBITDAE as defined by us may not be comparable to similarly titled measures reported by other companies. We do not intend for non-GAAP financial measures to be considered in isolation or as a substitute for other measures prepared in accordance with GAAP.

24



Set forth below is a reconciliation of reported net loss to EBITDAE: 
 
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
(In thousands)
 
2013
 
2012
 
2013
 
2012
 
 
(Unaudited)
 
(Unaudited)
Net loss, as reported(1)(2)
 
$
(1,415
)
 
$
(5,501
)
 
$
(5,835
)
 
$
(17,195
)
Income tax (benefit) expense
 
(56
)
 
(577
)
 
347

 
(171
)
Interest expense
 
466

 
498

 
1,386

 
1,579

Depreciation and amortization expense
 
8,138

 
8,010

 
24,778

 
23,831

ESOP and share-based compensation expense
 
733

 
1,043

 
2,639

 
2,519

Pension withdrawal expense
 

 

 

 
4,348

Net losses on derivatives and investments
 
2,278

 
2,882

 
9,315

 
5,131

EBITDAE(1)(2)
 
$
10,144

 
$
6,355

 
$
32,630

 
$
20,042

_____________
(1) Three months ended March 31, 2013 and 2012, respectively, include $1.2 million and $0.5 million in net gains on sales of assets. Nine months ended March 31, 2013 and 2012, respectively, include $4.4 million and $1.2 million in net gains on sales of assets, primarily real estate.
(2) Three months ended March 31, 2013 and 2012, respectively, include the expected beneficial effect of LIFO inventory liquidation in the amount of $0.2 million and $2.2 million. Nine months ended March 31, 2013 and 2012, respectively, include the expected beneficial effect of LIFO inventory liquidation in the amount of $0.7 million and $7.8 million.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are exposed to market value risk arising from changes in interest rates on our securities portfolio. Our portfolio of preferred securities has sometimes included investments in derivatives that provide a natural economic hedge of interest rate risk. We review the interest rate sensitivity of these securities and may enter into “short positions” in futures contracts on U.S. Treasury securities or hold put options on such futures contracts to reduce the impact of certain interest rate changes. Specifically, we attempt to manage the risk arising from changes in the general level of interest rates. We do not transact in futures contracts or put options for speculative purposes. The number and type of futures and options contracts entered into depends on, among other items, the specific maturity and issuer redemption provisions for each preferred stock held, the slope of the Treasury yield curve, the expected volatility of U.S. Treasury yields, and the costs of using futures and/or options.
The following table demonstrates the impact of varying interest rate changes based on our preferred securities holdings and market yield and price relationships at March 31, 2013. This table is predicated on an “instantaneous” change in the general level of interest rates and assumes predictable relationships between the prices of our preferred securities holdings and the yields on U.S. Treasury securities. At March 31, 2013, we had no futures contracts or put options with respect to our preferred securities portfolio designated as interest rate risk hedges.
(Unaudited)
 
Market Value of
Preferred
Securities at 
March 31, 2013
 
Change in  Market
Value
Interest Rate Changes
 
(In thousands)
 –150 basis points
 
$
21,398

 
$
629

 –100 basis points
 
$
21,221

 
$
452

 Unchanged
 
$
20,769

 
$

 +100 basis points
 
$
20,159

 
$
(610
)
 +150 basis points
 
$
19,862

 
$
(907
)

Our revolving credit facility with Wells Fargo is at a variable rate. The interest rate varies based upon line usage, borrowing base availability and market conditions. As of March 31, 2013, we had outstanding borrowings of $20.2 million, including loan extension fees of $0.2 million, utilized $10.2 million of the letters of credit sublimit, and had excess availability under the credit facility of $34.8 million.


25



Effective December 1, 2012, we entered into an interest rate swap transaction utilizing a notional amount of $10.0 million and a maturity date of March 1, 2015. We entered into the swap transaction to effectively fix the future interest rate during the applicable period on a portion of our borrowings under our revolving credit facility. In connection with entering into the interest rate swap agreement, we reclassified $10.0 million of our borrowings under the revolving credit facility as long-term because we intend to repay the borrowings in accordance with the termination date of the swap agreement which extends beyond one year. The swap transaction is intended to manage our interest rate risk related to our borrowings under our revolving credit facility and requires us to pay a fixed rate of 0.48% per annum in exchange for a variable interest rate based on 1-month USD LIBOR-BBA. As of April 30, 2013, the variable interest rate based on 1-month USD LIBOR-BBA was 0.20%.

We have not designated our interest rate swap as an accounting hedge. We record the interest rate swap on our consolidated balance sheet at fair market value with the changes in fair value recorded as gain or loss in "Other, net" in our consolidated statements of operations. In the three and nine months ended March 31, 2013, we recorded a gain of $4,000 and a loss of $35,000, respectively, for the change in fair value of our interest rate swap. No such gain or loss was recorded in the three and nine months ended March 31, 2012 (see Note 2 to the consolidated financial statements).

The weighted average interest rate on our outstanding borrowings under the credit facility at March 31, 2013 was 1.35%. The Loan Agreement provides for interest rates based on modified Monthly Average Excess Availability levels with a range of PRIME + 0.25% to PRIME + 0.75% or Adjusted Eurodollar Rate + 2.0% to Adjusted Eurodollar Rate + 2.5%.
The following table demonstrates the impact of interest rate changes on our annual interest expense under the revolving credit facility based on the outstanding balance and interest rate as of March 31, 2013: 
(Unaudited)
 
Interest Rate
 
Annual Interest 
Expense
Interest Rate Changes
 
 
 
(In thousands)
 –100 basis points
 
0.35%
 
$
71

 –50 basis points
 
0.85%
 
$
171

 Unchanged
 
1.35%
 
$
271

 +50 basis points
 
1.85%
 
$
372

 +100 basis points
 
2.35%
 
$
472

Commodity Price Risk
We are exposed to commodity price risk arising from changes in the market price of green coffee. We value green coffee inventory on the LIFO basis. In the normal course of business we hold a large green coffee inventory and enter into forward commodity purchase agreements with suppliers. We are subject to price risk resulting from the volatility of green coffee prices. Due to competition and market conditions, volatile price increases cannot always be passed on to our customers.
We routinely enter into specialized hedging transactions to purchase future coffee contracts to enable us to lock in green coffee prices within a pre-established range, and hold a mix of futures contracts and options to help hedge against volatility in green coffee prices. None of these hedging transactions, futures contracts or options is designated as an accounting hedge. We value our futures contracts by marking them to market price and recognize immediately in “Other, net” in the consolidated statements of operations the unrealized and realized gains or losses based on whether the market price is higher or lower than the price that was locked-in.
Beginning April 1, 2013, we implemented procedures following the guidelines of ASC 815 to enable us to account for certain coffee-related derivatives as accounting hedges in order to minimize the volatility created in our quarterly results from utilizing these derivative contracts and to improve comparability between reporting periods. As a result, beginning in the fourth quarter of fiscal 2013, we anticipate a portion of the gains and losses from re-valuing the coffee-related derivative contracts to their market prices will be recorded in accumulated other comprehensive income on our consolidated balance sheet and recognized in cost of goods sold when the related coffee is received.
For the three months ended March 31, 2013 and 2012, we recorded $2.9 million and $3.3 million, respectively, in coffee-related net realized and unrealized derivative losses. For the nine months ended March 31, 2013 and 2012, we recorded $10.1 million and $7.5 million, respectively, in coffee-related net realized and unrealized derivative losses (see Note 2 to the consolidated financial statements).

26



The following table demonstrates the impact of changes in the market value of coffee cost on the market value of coffee inventory and futures contracts: 
(Unaudited)
 
Market Value
 
(Decrease) Increase in Market Value
 
 
Coffee
Inventory
 
Futures &
Options
 
Total
 
Derivatives
 
Inventory
Coffee Cost (Decrease) Increase
 
 
 
 
(In thousands)
– 10%
 
$
25,308

 
$
30

 
$
25,338

 
$
30

 
$
(2,812
)
Unchanged
 
$
28,120

 
$

 
$
28,120

 
$

 
$

+10%
 
$
30,932

 
$
(30
)
 
$
30,902

 
$
(30
)
 
$
2,812


Item 4.
Controls and Procedures
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”), is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosures. In January 2010, we adopted Disclosure Controls and Procedures that included the organization of a Disclosure Committee designed to enhance our process of documenting our compliance with Rule 13a-15(e) promulgated under the Exchange Act. The Disclosure Committee performed its duties as prescribed by our Disclosure Controls and Procedures in preparing this Quarterly Report on Form 10-Q for the fiscal period ended March 31, 2013.
As of March 31, 2013, our management, with the participation of our principal executive and principal financial officers, or persons performing similar functions, carried out an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15(e) promulgated under the Exchange Act. Based upon this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of March 31, 2013, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
Management has determined that there has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) during our fiscal quarter ended March 31, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.
Legal Proceedings

On August 31, 2012, the Council for Education and Research on Toxics (“CERT”) filed an amendment to a private enforcement action adding a number of companies as defendants, including CBI, which sell coffee in California. The suit alleges that the defendants have failed to issue clear and reasonable warnings in accordance with Proposition 65 that the coffee they produce, distribute and sell contains acrylamide. This lawsuit was filed in Los Angeles Superior Court (the “Court”). CERT has requested that the alleged violators remove acrylamide from their coffee or provide Proposition 65 warnings on their products and pay $2,500 per day for each and every violation while they are in violation of Proposition 65. The Company has joined a Joint Defense Group and filed with the Court requesting a Motion to Stay. At its November 2012 hearing on the Motion to Stay, the Court made certain inquiries to which the Joint Defense Group responded in January 2013. Discovery is currently stayed pending the resolution of a related case. At this time, the Company is not able to predict the probability of the outcome or estimate of loss, if any, related to these matters. 

Item 1A.
Risk Factors
Certain statements contained in this quarterly report on Form 10-Q are not based on historical fact and are forward-looking statements within the meaning of federal securities laws and regulations. These statements are based on management's current expectations, assumptions, estimates and observations of future events and include any statements that do not directly

27



relate to any historical or current fact. These forward-looking statements can be identified by the use of words like “anticipates,” “estimates,” “projects,” “expects,” “plans,” “believes,” “intends,” “will,” “assumes” and other words of similar meaning. Owing to the uncertainties inherent in forward-looking statements, actual results could differ materially from those set forth in forward-looking statements. We intend these forward-looking statements to speak only at the time of this report and do not undertake to update or revise these statements as more information becomes available except as required under federal securities laws and the rules and regulations of the SEC. Factors that could cause actual results to differ materially from those in forward-looking statements include, but are not limited to, fluctuations in availability and cost of green coffee, competition, organizational changes, the impact of a weaker economy, business conditions in the coffee industry and food industry in general, our continued success in attracting new customers, variances from budgeted sales mix and growth rates, weather and special or unusual events, changes in the quality or dividend stream of third parties' securities and other investment vehicles in which we have invested our assets, as well as other risks described in this report and other factors described from time to time in our filings with the SEC.
You should consider each of the following factors as well as the other information in this report, including our consolidated financial statements and the related notes, in evaluating our business and our prospects. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also negatively affect our business operations. If any of the following risks actually occurs, our business and financial results could be harmed. In that case, the trading price of our common stock could decline.
INCREASES IN THE COST OF GREEN COFFEE COULD REDUCE OUR GROSS MARGIN AND PROFIT.
Our primary raw material is green coffee, an agricultural commodity. The bulk of the world's green coffee supply is mainly grown outside the United States and can be subject to volatile price fluctuations. Weather, real or perceived supply shortages, speculation in the commodity markets, political unrest, labor actions, currency fluctuations, armed conflict in coffee producing nations, and government actions, including treaties and trade controls between the U.S. and coffee producing nations, can affect the price of green coffee. In fiscal 2011, the market for green Arabica coffee increased approximately 80% per pound compared to the prior fiscal year. Additionally, green specialty coffees sell at a premium to other green coffees due to the inability of producers to increase supply in the short run to meet rising demand. As a result, the price spread between specialty coffee and non-specialty coffee is likely to widen as demand for specialty coffee continues to increase.
Green coffee prices can also be affected by the actions of producer organizations. The most prominent of these are the Colombian Coffee Federation, Inc. (CCF) and the International Coffee Organization (ICO). These organizations seek to increase green coffee prices largely by attempting to restrict supplies, thereby limiting the availability of green coffee to coffee consuming nations. As a result, these organizations or others may succeed in raising green coffee prices.
There can be no assurance that we will be successful in passing commodity price increases on to our customers without losses in sales volume or gross margin in the future. Additionally, if green coffee beans from a region become unavailable or prohibitively expensive, we could be forced to use alternative (and potentially inferior or unpopular) coffee beans or discontinue certain blends, which could adversely impact our sales.
OUR EFFORTS TO SECURE AN ADEQUATE SUPPLY OF QUALITY COFFEES MAY BE UNSUCCESSFUL AND IMPACT OUR ABILITY TO SUPPLY OUR CUSTOMERS OR EXPOSE US TO COMMODITY PRICE RISK.
Some of the Arabica coffee beans of the quality we purchase do not trade directly on the commodity markets. Rather, we purchase these coffee beans on a negotiated basis from coffee brokers, exporters and growers. If any of these supply relationships with coffee brokers, exporters or growers deteriorate, we may be unable to procure a sufficient quantity of high quality coffee beans at prices acceptable to us or at all. In such case, we may not be able to fulfill the demand of our existing customers, supply new customers or expand other channels of distribution.
Maintaining a steady supply of green coffee is essential to allow us to keep inventory levels low and, at the same time, secure sufficient stock to meet customer needs. To help ensure future supplies, we may purchase coffee for delivery, in some instances, up to 18 months in the future. Non-performance by suppliers could expose us to credit and supply risk. Additionally, entering into such future commitments exposes us to purchase price risk. Because we are not always able to pass price changes through to our customers due to competitive pressures, unpredictable price changes can have an immediate effect on operating results that cannot be corrected in the short run. To reduce our potential price risk exposure we have, from time to time, entered into futures contracts to hedge coffee purchase commitments. Open contracts associated with these hedging activities are described in Part I, Item 3, "Quantitative and Qualitative Disclosures About Market Risk" of this report.

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DECLINES IN GREEN COFFEE COMMODITY PRICES MAY NOT BE IMMEDIATELY REFLECTED IN OUR COST OF GOODS SOLD AND MAY INCREASE VOLATILITY IN OUR RESULTS.
We routinely use futures contracts to lock-in green coffee market prices, in some instances, as much as 18 months prior to the actual delivery date. Accounting rules require that we value our open futures contracts by marking them to market price at the end of each reporting period and include in our financial results the unrealized gains or losses based on whether the market price is higher or lower than the price we locked-in. If green coffee commodity prices decline below our locked-in price, we will be required to recognize the resulting losses in our results. Although such losses are expected to be offset by future derivative gains as the coffee market changes, or recovered through operating income as a result of the lower cost of goods assigned to the related coffee, such transactions could potentially cause volatility in our results because the recognition of losses and the offsetting gains may occur in different fiscal periods. Rapid, sharp decreases in the cost of green coffee could also force us to lower sales prices before realizing cost reductions in our green coffee inventory.
WE FACE EXPOSURE TO OTHER COMMODITY COST FLUCTUATIONS, WHICH COULD IMPACT OUR MARGINS AND PROFITABILITY.
We are exposed to cost fluctuations in other commodities, including milk, spices, natural gas and gasoline. In addition, an increase in the cost of fuel could indirectly lead to higher electricity costs, transportation costs and other commodity costs. Much like green coffee costs, the costs of these commodities depend on various factors beyond our control, including economic and political conditions, foreign currency fluctuations, and global weather patterns. To the extent we are unable to pass along such costs to our customers through price increases, our margins and profitability will decrease.
IMPAIRMENT CHARGES RELATED TO OUR DEFINITE-LIVED AND INDEFINITE-LIVED INTANGIBLE ASSETS COULD ADVERSELY AFFECT OUR FUTURE OPERATING RESULTS.
Indefinite-lived intangible assets (other than goodwill) are not amortized but instead are reviewed for impairment annually and on an interim basis if events or changes in circumstances between annual tests indicate that an asset might be impaired. A definite-lived intangible asset is only deemed to have become impaired if the sum of the projected undiscounted future cash flows related to the asset is less than the carrying value of the asset. If the sum of the projected cash flows is less than the carrying value, then we must write down the carrying value to its estimated fair value in the period in which the determination is made. An indefinite-lived intangible asset (other than goodwill) is deemed impaired if its estimated fair value is less than its carrying value.
In the fourth quarter of fiscal 2012, we determined that certain indefinite-lived intangible assets consisting of trademarks acquired in connection with the CBI acquisition were impaired and recorded an impairment charge of $0.5 million in operating expenses. In the fourth quarter of fiscal 2011, we determined that definite-lived intangible assets consisting of the customer relationships acquired, and the distribution agreement and co-pack agreement entered into, in connection with the DSD Coffee Business acquisition were impaired and recorded an impairment charge of $7.8 million in operating expenses. Failure to achieve our forecasted operating results, due to further weakness in the economic environment or other factors, and further declines in our market capitalization, among other things, could result in further impairment of our definite-lived and indefinite-lived intangible assets.
OUR LEVEL OF INDEBTEDNESS COULD ADVERSELY AFFECT OUR ABILITY TO RAISE ADDITIONAL CAPITAL TO FUND OUR OPERATIONS, AND LIMIT OUR ABILITY TO REACT TO CHANGES IN THE ECONOMY OR OUR INDUSTRY.
We have a $75.0 million senior secured revolving credit facility. As of April 30, 2013, we were eligible to borrow $65.7 million, had estimated outstanding borrowings of $17.7 million, including $0.2 million in loan extension fees, utilized $11.6 million of the letters of credit sublimit, and had excess availability under the credit facility of $36.4 million. Maintaining a large loan balance under our credit facility could adversely affect our business and limit our ability to plan for or respond to changes in our business. Additionally, our borrowings under the credit facility are at variable rates of interest, exposing us to the risk of interest rate volatility, which could lead to an increase in our net loss. Our debt obligations could also:
increase our vulnerability to general adverse economic and industry conditions;
require us to dedicate a portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow for other purposes, including funding daily operations, investing in future business opportunities and capital expenditures;

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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate thereby placing us at a competitive disadvantage compared to our competitors that may have less debt or debt with less restrictive debt covenants;
limit, by the financial and other restrictive covenants in our loan agreement, our ability to borrow additional funds; and
have a material adverse effect on us if we fail to comply with the covenants in our loan agreement because such failure could result in an event of default which, if not cured or waived, could result in our indebtedness becoming immediately due and payable.
RESTRICTIVE COVENANTS IN OUR CREDIT FACILITY MAY RESTRICT OUR ABILITY TO PURSUE OUR BUSINESS STRATEGIES.
Our revolving credit facility contains various covenants that limit our ability and/or our subsidiaries’ ability to, among other things:
incur additional indebtedness;
pay dividends on or make distributions in respect of capital stock or make certain other restricted payments or investments;
sell assets;
create liens on certain assets to secure debt; and
consolidate, merge, sell or otherwise dispose of all or substantially all of our assets.
Our credit facility also contains restrictive covenants that require the Company and its subsidiaries to satisfy financial condition and liquidity tests. Our ability to meet those tests may be affected by events beyond our control, and there can be no assurance that we will meet those tests. The breach of any of these covenants or our failure to meet the financial condition or liquidity tests could result in a default under the credit facility, and the lender could elect to declare all amounts borrowed thereunder, together with accrued interest, to be due and payable and could proceed against the collateral securing that indebtedness.
OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH THE CURRENT ECONOMIC CLIMATE.
Our success depends to a significant extent on a number of factors that affect discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence, all of which have deteriorated due to current economic conditions. In a slow economy, businesses and individuals scale back their discretionary spending on travel and entertainment, including “dining out” as well as the purchase of high-end consumables like specialty coffee. Economic conditions may also cause businesses to reduce travel and entertainment expenses, and may even cause office coffee benefits to be eliminated. The current economic downturn and decrease in consumer spending may continue to adversely impact our revenues and may affect our ability to market our products or otherwise implement our business strategy. Additionally, many of the effects and consequences of the global financial crisis and a broader global economic downturn are currently unknown; any one or all of them could potentially have a material adverse effect on our liquidity and capital resources, including our ability to sell third party securities in which we have invested some of our short-term assets or raise additional capital, if needed, or the ability of our lender to honor draws on our credit facility, or otherwise negatively affect our business, financial condition, operating results and cash flows.
WE RELY ON INFORMATION TECHNOLOGY AND ARE DEPENDENT ON ENTERPRISE RESOURCE PLANNING SOFTWARE IN OUR OPERATIONS. ANY MATERIAL FAILURE, INADEQUACY, INTERRUPTION OR SECURITY FAILURE OF THAT TECHNOLOGY COULD AFFECT OUR ABILITY TO EFFECTIVELY OPERATE OUR BUSINESS.
We rely on information technology systems across our operations, including management of our supply chain, point-of-sale processing, and various other processes and transactions. Our ability to effectively manage our business and coordinate the production, distribution and sale of our products depends significantly on the reliability and capacity of these systems. The failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, or a breach in security of these systems could result in delays in processing replenishment orders from our branch warehouses, our inability to record product sales and reduced operational efficiency. Significant capital investments could be required to remediate any potential problems.

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VOLATILITY IN THE EQUITY MARKETS COULD REDUCE THE VALUE OF OUR INVESTMENT PORTFOLIO.
We maintain a portfolio of fixed-income based investments disclosed as cash equivalents and short-term investments on our consolidated balance sheets. The value of our investments may be adversely affected by interest rate fluctuations, downgrades in credit ratings, illiquidity in the capital markets and other factors which may result in other than temporary declines in the value of our investments. Any of these events could cause us to record impairment charges with respect to our investment portfolio or to realize losses on the sale of investments. If our operating losses continue, a portion or this entire investment portfolio may be liquidated to fund those losses.
WE ARE LARGELY RELIANT ON MAJOR FACILITIES IN CALIFORNIA, TEXAS AND OREGON FOR PRODUCTION OF OUR PRODUCT LINE.
A significant interruption in operations at our manufacturing facilities in Torrance, California (our largest facility); Houston, Texas; or Portland, Oregon, whether as a result of a natural disaster, terrorism or other causes, could significantly impair our ability to operate our business. The majority of our green coffee comes through the Ports of Los Angeles, Long Beach, Houston, San Francisco and Portland. Any interruption to port operations, highway arteries, gas mains or electrical service in these areas could restrict our ability to supply our branch warehouses with product and would adversely impact our business.
INCREASED SEVERE WEATHER PATTERNS MAY INCREASE COMMODITY COSTS, DAMAGE OUR FACILITIES, AND IMPACT OR DISRUPT OUR PRODUCTION CAPABILITIES AND SUPPLY CHAIN.
There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere have caused and will continue to cause significant changes in weather patterns around the globe and an increase in the frequency and severity of extreme weather events. Major weather phenomena like El Niño and La Niña are dramatically affecting coffee growing countries. The wet and dry seasons are becoming unpredictable in timing and duration causing improper development of the coffee cherries. Decreased agricultural productivity in certain regions as a result of changing weather patterns may affect the quality, limit availability or increase the cost of key agricultural commodities, such as green coffee, sugar and tea, which are important ingredients for our products. Increased frequency or duration of extreme weather conditions could also damage our facilities, impair production capabilities, disrupt our supply chain or impact demand for our products. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations.
OUR INDUSTRY IS HIGHLY COMPETITIVE AND WE MAY NOT HAVE THE RESOURCES TO COMPETE EFFECTIVELY.
We primarily compete with other coffee companies, including multi-national firms with substantially greater financial, marketing and operating resources than the Company. We face competition from many sources including the institutional foodservice divisions of multi-national manufacturers of retail products such as J.M. Smucker (Folgers Coffee), Dunkin' Donuts and Kraft Foods Inc. (Maxwell House Coffee), wholesale foodservice distributors such as Sysco Corporation and U.S. Foods, regional institutional coffee roasters such as S & D Coffee, Inc. and Boyd Coffee Company, and specialty coffee suppliers such as Green Mountain Coffee Roasters, Inc., Rogers Family Company, Distant Lands Coffee, Mother Parkers Tea & Coffee, Inc., and Peet’s Coffee & Tea, Inc. As many of our customers are small foodservice operators, we also compete with club stores such as Costco and Restaurant Depot. If we do not succeed in differentiating ourselves from our competitors or our competitors adopt our strategies, then our competitive position may be weakened. In addition, from time to time, we may need to reduce our prices in response to competitive and customer pressures and in order to maintain our market share. Competition and customer pressures, however, also may restrict our ability to increase prices in response to commodity and other cost increases. Our results of operations will be adversely affected if our profit margins decrease, as a result of a reduction in prices or an increase in costs, and if we are unable to increase sales volumes to offset those profit margin decreases.
VOLATILITY IN THE EQUITY MARKETS OR INTEREST RATE FLUCTUATIONS COULD SUBSTANTIALLY INCREASE OUR PENSION FUNDING REQUIREMENTS AND NEGATIVELY IMPACT OUR FINANCIAL POSITION.
At June 30, 2012, the projected benefit obligation under our single employer defined benefit pension plans was $130.4 million and the fair value of plan assets was $85.8 million. The difference between plan obligations and assets, or the funded status of the plans, significantly affects the net periodic benefit cost and ongoing funding requirements of those plans. Among other factors, changes in interest rates, mortality rates, early retirement rates, investment returns and the market value of plan assets can affect the level of plan funding, cause volatility in the net periodic benefit cost and increase our future funding

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requirements. As of March 31, 2013, we have made $1.4 million in contributions to these pension plans and have accrued $0.9 million in expense. We expect to make approximately $4.3 million in contributions to our single employer defined benefit pension plans in fiscal 2013 and accrue expense of approximately $1.2 million per year beginning in fiscal 2013. These pension payments are expected to continue at this level for several years, and the current economic environment increases the risk that we may be required to make even larger contributions in the future.
OUR SALES AND DISTRIBUTION NETWORK IS COSTLY TO MAINTAIN.
Our sales and distribution network requires a large investment to maintain and operate. Costs include the fluctuating cost of gasoline, diesel and oil, costs associated with managing, purchasing, leasing, maintaining and insuring a fleet of delivery vehicles, the cost of maintaining distribution centers and branch warehouses throughout the country, and the cost of hiring, training and managing our route sales professionals. Many of these costs are beyond our control, and many are fixed rather than variable. Some competitors use alternate methods of distribution that eliminate many of the costs associated with our method of distribution.
EMPLOYEE STRIKES AND OTHER LABOR-RELATED DISRUPTIONS MAY ADVERSELY AFFECT OUR OPERATIONS.
We have union contracts relating to a significant portion of our workforce. Although we believe union relations have been amicable in the past, there is no assurance that this will continue in the future. There are potential adverse effects of labor disputes with our own employees or by others who provide transportation (shipping lines, truck drivers) or cargo handling (longshoremen), both domestic and foreign, of our raw materials or other products. These actions could restrict our ability to obtain, process and/or distribute our products.