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”), which is an amendment and restatement of, and successor to, the Farmer Bros. Co. 2007 Omnibus Plan (the "Omnibus Plan"). The principal change to the Amended Equity Plan was to limit awards under the plan to performance-based stock options and to restricted stock under limited circumstances.

Stock Options

The share-based compensation expense recognized in the Company’s consolidated statements of operations 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.

Following are the weighted average assumptions used in the Black-Scholes valuation model for non-qualified stock options with time-based vesting ("NQOs") and non-qualified stock options with performance-based and time-based vesting ("PNQs") granted during the nine months ended March 31, 2015 and 2014:



	Nine Months Ended March 31,
	2015			2014
Weighted average fair value of NQOs and PNQs	$	10.16		$	9.17
Risk-free interest rate	1.50		%	1.74		%
Dividend yield	—		%	—		%
Average expected term	5.1 years			6.0 years
Expected stock price volatility	47.9		%	50.4		%

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 4.8% 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.

NQOs

In the three and nine months ended March 31, 2015, the Company granted 13,123 shares issuable upon the exercise of NQOs with an exercise price of $23.44 per share to an eligible employee under the Amended Equity Plan which vest ratably over a three-year period.

The following table summarizes NQO activity for the nine months ended March 31, 2015:



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, 2014	412,454		12.44	5.30	4.4	3,782
Granted	13,123		23.44	10.16	6.9	—
Exercised	(78,692	)	16.10	5.81	—	612
Cancelled/Forfeited	(13,134	)	11.26	5.00	—	—
Outstanding at March 31, 2015	333,751		12.06	5.38	4.1	4,236
Vested and exercisable, March 31, 2015	226,320		11.98	5.23	3.7	2,891
Vested and expected to vest, March 31, 2015	330,353		12.02	5.36	4.1	4,206

The aggregate intrinsic value outstanding at the end of each period in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $24.75 at March 31, 2015 and $21.61 at June 30, 2014, representing the last trading day of the applicable fiscal period, which would have been received by NQO holders had all award holders exercised their NQOs that were in-the-money as of that date. The aggregate intrinsic value of stock option exercises in the nine months ended March 31, 2015 represents the difference between the exercise price and the value of the Company’s common stock at the time of exercise. NQOs outstanding that are expected to vest are net of estimated forfeitures.

Total fair value of NQOs vested during the nine months ended March 31, 2015 was $0.3 million. During the nine months ended March 31, 2015 and 2014, the Company received $1.3 million and $1.4 million, respectively, in proceeds from exercises of vested NQOs.

As of March 31, 2015 and June 30, 2014, there was $0.4 million and $0.7 million, respectively, of unrecognized compensation cost related to NQOs. Total compensation expense for NQOs in each of the three and nine months ended March 31, 2015 was $0.1 million and $0.3 million, respectively. Total compensation expense for NQOs in the three and nine months ended March 31, 2014 was $0.1 million and $0.5 million, respectively.

PNQs

In the three and nine months ended March 31, 2015, the Company granted 121,024 shares issuable upon the exercise of PNQs with an exercise price equal to $23.44 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 becoming exercisable each year on the anniversary of the grant date, commencing on February 9, 2016, based on the Company’s achievement of modified net income targets for fiscal years within the performance period as approved by the Compensation Committee, subject to catch-up vesting of previously unvested shares in a subsequent year within the three year period in which a cumulative modified net income target as approved by the Compensation Committee is achieved, 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 and the acceleration provisions contained in the Amended Equity Plan and the applicable award agreement.

The following table summarizes PNQ activity for the nine months ended March 31, 2015:



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, 2014	112,442		21.27	10.49	6.5	38
Granted	121,024		23.44	10.16	6.9	—
Cancelled/Forfeited	(9,399	)	21.33	10.52	—	—
Outstanding at March 31, 2015	224,067		22.44	10.31	6.3	517
Vested and exercisable, March 31, 2015	33,971		21.32	10.51	5.6	116
Vested and expected to vest, March 31, 2015	202,544		22.40	10.32	6.3	477

Total fair value of PNQs vested during the nine months ended March 31, 2015 was $0.4 million. No PNQs were exercised during the nine months ended March 31, 2015.

As of March 31, 2015, the Company met the performance target for the first year of the fiscal 2014 awards and expects that it will achieve the cumulative performance targets set forth in the PNQ agreements for the fiscal 2014 awards and the performance targets set forth in the PNQ agreements for the fiscal 2015 awards.

As of March 31, 2015 and June 30, 2014, there was $1.6 million and $0.9 million, respectively, in unrecognized compensation cost related to PNQs. Total compensation expense for PNQs in the three and nine months ended March 31, 2015 was $0.1 million and $0.4 million, respectively. Total compensation expense for PNQs recognized in the three and nine months ended March 31, 2014 was $0.1 million and $0.2 million, respectively.

Restricted Stock

In the three and nine months ended March 31, 2015, the Company granted 10,524 shares of restricted stock under the Amended Equity Plan with a grant date fair value of $23.44 per share to eligible employees and directors.

The following table summarizes restricted stock activity for the nine months ended March 31, 2015:



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, 2014	96,212		10.27	1.5	2,079
Granted	10,524		23.44	2.9	247
Exercised/Released(1)	(28,402	)	9.22	—	772
Cancelled/Forfeited	(8,984	)	8.36	—	—
Outstanding at March 31, 2015	69,350		12.94	1.9	1,716
Expected to vest, March 31, 2015	66,960		12.77	1.9	1,657

______________

(1) Includes 4,297 shares that were withheld to meet the employees' minimum statutory tax withholding and retired.

The aggregate intrinsic value of shares outstanding at the end of each period in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $24.75 at March 31, 2015 and $21.61 at June 30, 2014, representing the last trading day of the applicable fiscal period. Restricted stock that is expected to vest is net of estimated forfeitures.

Shares of restricted stock generally vest at the end of three years for eligible employees. Shares of restricted stock generally vest ratably over a period of three years for directors. During the nine months ended March 31, 2015, 28,402 shares of restricted stock vested, of which 4,297 shares were withheld to meet the employees' minimum statutory tax withholding and retired.

Compensation expense is recognized on a straight-line basis over the service period based on the estimated fair value of the restricted stock. As of March 31, 2015 and June 30, 2014, there was approximately $0.5 million and $0.6 million, respectively, of unrecognized compensation cost related to restricted stock. Total compensation expense recognized in the three and nine months ended March 31, 2015 was $0.1 million and $0.2 million, respectively. Total compensation expense recognized in the three and nine months ended 2014 was $0.1 million and $0.4 million, respectively.