Share-based Compensation

On December 5, 2013, the Company’s stockholders approved the Farmer Bros. Co. Amended and Restated 2007 Long-Term Incentive Plan (the “Amended Equity Plan”). The Amended Equity Plan is an amendment and restatement of, and successor to, the Farmer Bros. Co. 2007 Omnibus Plan (the "Omnibus Plan"), and, among other things, increases the number of shares of the Company’s common stock, par value $1.00 per share, authorized for issuance under the plan by 250,000 from 1,125,000 from 1,375,000. In addition, the Amended Equity Plan provides for the following material changes: limits the types of equity awards available to be granted under the Amended Equity Plan to options, performance-based options and restricted stock; limits participants in the Amended Equity Plan to directors, officers and other employees of the Company; limits the performance criteria that will be used to establish performance goals under the plan to (i) net sales or revenue; (ii) net income before tax and excluding gain or loss on sale of property, plant and equipment; and/or (iii) cash flow (including, but not limited to, operating cash flow and free cash flow); reduces the maximum number of shares of stock with respect to one or more awards that may be granted to any one participant during any calendar year from 250,000 to 75,000; requires that all options issued to employees include performance criteria or performance goals, unless issued in connection with the commencement of employment as an executive of the Company; provides for forfeiture of unvested awards upon termination of employment or termination of directorship, except as otherwise determined by the plan administrator; prohibits awards of restricted stock to employees except in connection with the commencement of employment as an executive of the Company; limits the value of restricted stock awards granted to any non-employee director to an amount not more than $30,000 annually; and prohibits delegation of administration of the plan to another committee or subcommittee of the Board, or authority to grant or amend awards to participants to a committee of one or more members of the Board or one or more officers of the Company.

Stock Options

The share-based compensation expense recognized in the Company’s consolidated statements of operations for the fiscal years ended June 30, 2014, 2013 and 2012 is based on awards ultimately expected to vest. Compensation expense is recognized on a straight-line basis over the service period based on the estimated fair value of the stock options. The Company estimates the fair value of option awards using 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 Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimates, in management’s opinion the existing models may not necessarily provide a reliable single measure of the fair value of the Company’s stock options. Although the fair value of stock options is determined using an option valuation model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Non-qualified stock options with time-based vesting ("NQOs")

In fiscal 2014, the Company granted 1,927 shares issuable upon the exercise of NQOs with an exercise price of $18.68 per share to an eligible employee under the Omnibus Plan prior to its amendment and restatement which vest ratably over a three-year period.

Following are the weighted average assumptions used in the Black-Scholes valuation model for NQOs granted during the fiscal years ended June 30, 2014, 2013 and 2012:



	Year Ended June 30,
	2014			2013			2012
Weighted average fair value of NQOs	$	9.17		$	5.69		$	4.42
Risk-free interest rate	1.7		%	0.9		%	1.1		%
Dividend yield	—		%	—		%	—		%
Average expected term	6 years			6 years			6 years
Expected stock price volatility	50.4		%	49.5		%	52.5		%

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 term is based on the midpoint between the vesting date and the end of the contractual term of the award. Currently, management estimates an annual forfeiture rate of 6.5% based on actual forfeiture experience. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

The following table summarizes NQO activity for the three most recent fiscal years:



Outstanding NQOs:	Number of NQOs		Weighted Average Exercise Price ($)	Weighted Average Grant Date Fair Value ($)	Weighted Average Remaining Life (Years)	Aggregate Intrinsic Value ($ in thousands)
Outstanding at June 30, 2011	497,810		17.19	6.44	5.7	61
Granted	356,834		8.90	4.42	—	—
Cancelled/Forfeited	(187,409	)	16.89	5.06	—	—
Outstanding at June 30, 2012	667,235		12.84	4.78	4.8	143
Granted	192,892		12.12	5.69	6.5	374
Exercised	(117,482	)	10.24	5.23	—	336
Cancelled/Forfeited	(185,218	)	13.83	5.92	—	—
Outstanding at June 30, 2013	557,427		12.81	5.44	5.1	1,620
Granted	1,927		18.68	9.17	6.4	—
Exercised	(112,964	)	13.10	5.81	—	895
Cancelled/Forfeited	(33,936	)	16.63	6.13	—	—
Outstanding at June 30, 2014	412,454		12.44	5.30	4.4	3,782
Vested and exercisable, June 30, 2014	244,656		13.67	5.46	3.7	1,967
Vested and expected to vest, June 30, 2014	402,440		12.48	5.30	4.3	3,700

The aggregate intrinsic values outstanding at the end of each period in the table above represent the total pretax intrinsic value, based on the Company’s closing stock price of $21.61 at June 30, 2014, $14.06 at June 28, 2013 and $7.96 at June 29, 2012, representing the last trading day of the respective fiscal years, which would have been received by NQO holders had all NQO holders exercised their awards that were in-the-money as of those dates.

Total fair value of NQOs vested during fiscal 2014, 2013 and 2012 was $0.7 million, $1.0 million and $1.2 million, respectively. The Company received $1.5 million and $1.2 million in proceeds from exercises of vested NQOs in fiscal 2014 and 2013, respectively.



Nonvested NQOs:	Number of NQOs		Weighted Average Exercise Price ($)	Weighted Average Grant Date Fair Value ($)	Weighted Average Remaining Life (Years)
Outstanding at June 30, 2011	322,869		15.02	6.50	1.7
Granted	356,834		8.90	4.42	6.6
Vested	(243,518	)	13.00	5.85	—
Forfeited	(92,946	)	12.54	5.80	—
Outstanding at June 30, 2012	343,239		10.76	4.20	6.3
Granted	192,892		12.12	5.69	6.5
Vested	(188,909	)	11.56	5.33	—
Forfeited	(31,561	)	13.82	5.92	—
Outstanding at June 30, 2013	315,661		10.80	5.12	6.1
Granted	1,927		18.68	9.17	6.4
Vested	(133,957	)	11.02	5.21	—
Forfeited	(15,833	)	11.48	5.49	—
Outstanding at June 30, 2014	167,798		10.65	5.06	5.3

As of June 30, 2014, 2013 and 2012, there was $0.7 million, $1.3 million and $1.3 million, respectively, of unrecognized compensation cost related to NQOs. Total compensation expense for NQOs was $0.6 million, $0.9 million and $1.2 million in fiscal 2014, 2013 and 2012, respectively.

Non-qualified stock options with performance-based and time-based vesting ("PNQs")

In the fiscal year ended June 30, 2014, the Company granted a total of 112,442 shares issuable upon the exercise of PNQs with a weighted average exercise price of $21.27 per share to eligible employees under the Amended Equity Plan. These PNQs vest over a three-year period with one-third of the total number of shares subject to each such PNQ vesting on the first anniversary of the grant date based on the Company’s achievement of a modified net income target for the first fiscal year of the performance period as approved by the Compensation Committee, and the remaining two-thirds of the total number of shares subject to each PNQ vesting on the third anniversary of the grant date based on the Company’s achievement of a cumulative modified net income target for all three years during the performance period as approved by the Compensation Committee, in each case, subject to the participant’s employment by the Company or service on the Board of Directors of the Company on the applicable vesting date. No PNQs were granted prior to fiscal 2014.

Following are the assumptions used in the Black-Scholes valuation model for PNQs granted during the fiscal year ended June 30, 2014:



	Year Ended June 30,
	2014
Weighted average fair value of PNQs	$	10.49
Risk-free interest rate	1.8		%
Dividend yield	—		%
Average expected term	6 years
Expected stock price volatility	50.5		%

The following table summarizes PNQ activity in fiscal 2014:



Outstanding PNQs:	Number of PNQs	Weighted Average Exercise Price ($)	Weighted Average Grant Date Fair Value ($)	Weighted Average Remaining Life (Years)	Aggregate Intrinsic Value ($ in thousands)
Outstanding at June 30, 2013	—	—	—	—	—
Granted	112,442	21.27	10.49	6.5	—
Cancelled/Forfeited	—	—	—	—	—
Outstanding at June 30, 2014	112,442	21.27	10.49	6.5	38
Vested and exercisable, June 30, 2014	—	—	—	—	—
Vested and expected to vest, June 30, 2014	99,727	21.28	10.49	6.5	33

The aggregate intrinsic values outstanding at the end of fiscal 2014 in the table above represent the total pretax intrinsic values, based on the Company’s closing stock price of $21.61 at June 30, 2014 representing the last trading day of fiscal 2014, which would have been received by award holders had all award holders exercised their awards that were in-the-money as of that date.

In the fiscal year ended June 30, 2014, the Company recognized $0.3 million in compensation expense for PNQs and as of June 30, 2014, there was approximately $0.9 million of unrecognized compensation cost related to PNQs.

As of June 30, 2014, the Company expects that it will achieve the performance targets set forth in the PNQ agreements.

Restricted Stock

During each of fiscal 2014, 2013 and 2012 the Company granted a total of 9,200 shares, 51,177 shares and 142,070 shares of restricted stock, respectively, with a weighted average grant date fair value of $20.48, $11.67 and $7.70 per share, respectively, to eligible employees, officers and directors. Shares of restricted stock generally vest at the end of three years for eligible employees and officers who are employees. No restricted stock was granted to executive officers in fiscal 2014. Shares of restricted stock generally vest ratably over a period of three years for directors.

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 $0.5 million, $0.6 million and $0.6 million, for the fiscal years ended June 30, 2014, 2013 and 2012, respectively. As of June 30, 2014, 2013 and 2012, there was approximately $0.6 million, $1.0 million and $1.3 million, respectively, of unrecognized compensation cost related to restricted stock.

The following table summarizes restricted stock activity:



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 at June 30, 2011	80,687		17.31	2.6	818
Granted	142,070		7.70	2.1	1,094
Exercised/Released	(27,227	)	15.80	—	202
Cancelled/Forfeited	(19,583	)	13.92	—	—
Outstanding June 30, 2012	175,947		10.16	1.9	1,401
Granted	51,177		11.67	—	597
Exercised/Released	(64,668	)	11.27	—	832
Cancelled/Forfeited	(23,096	)	12.21	—	—
Outstanding at June 30, 2013	139,360		9.87	1.9	1,959
Granted	9,200		20.48	—	188
Exercised/Released	(38,212	)	11.59	—	820
Cancelled/Forfeited	(14,136	)	9.38	—	—
Outstanding at June 30, 2014	96,212		10.27	1.5	2,079
Expected to vest, June 30, 2014	90,359		12.61	1.5	1,953

Aggregate intrinsic values outstanding at the end of fiscal 2014 in the table above represent the total pretax intrinsic values, based on the Company’s closing stock price of $21.61 at June 30, 2014 representing the last trading day of fiscal 2014.