Share-based Compensation

Farmer Bros. Co. 2017 Long-Term Incentive Plan

On June 20, 2017 (the “Effective Date“), the Company’s stockholders approved the Farmer Bros. Co. 2017 Long-Term Incentive Plan (the “2017 Plan”). The 2017 Plan succeeded the Company's prior long-term incentive plans, the Farmer Bros. Co. Amended and Restated 2007 Long-Term Incentive Plan (the “Amended Equity Plan“) and the Farmer Bros. Co. 2007 Omnibus Plan (collectively, the “Prior Plans“). On the Effective Date, the Company ceased granting awards under the Prior Plans; however, awards outstanding under the Prior Plans will remain subject to the terms of the applicable Prior Plan.

The 2017 Plan provides for the grant of stock options (including incentive stock options and non-qualified stock options), stock appreciation rights, restricted stock, restricted stock units, dividend equivalents, performance shares and other stock- or cash-based awards to eligible participants. The 2017 Plan also authorizes the grant of awards that are intended to qualify as “qualified performance-based compensation” within the meaning of Section 162(m) of the Internal Revenue Code (the “Code”). Non-employee directors of the Company and employees of the Company or any of its subsidiaries are eligible to receive awards under the 2017 Plan. The 2017 Plan authorizes the issuance of (i) 900,000 shares of common stock plus (ii) the number of shares of common stock subject to awards under the Company’s Prior Plans that are outstanding as of the Effective Date and that expire or are forfeited, cancelled or similarly lapse following the Effective Date. Subject to certain limitations, shares of common stock covered by awards granted under the 2017 Plan that are forfeited, expire or lapse, or are repurchased for or paid in cash, may be used again for new grants under the 2017 Plan. Shares of common stock granted under the 2017 Plan may be authorized but unissued shares, shares purchased on the open market or treasury shares. In no event will more than 900,000 shares of common stock be issuable pursuant to the exercise of incentive stock options under the 2017 Plan.

The 2017 Plan is administered by the Board or another Board committee or subcommittee, as may be determined by the Board from time to time (subject to limitations that may be imposed under Section 162(m) of the Code, Section 16 of the Securities Exchange Act of 1934, as amended, and/or stock exchange rules, as applicable). The administrator of the 2017 Plan (the “Administrator”) or its delegatee will have the authority to determine which eligible persons receive awards and to set the terms and conditions applicable to awards within the confines of the 2017 Plan’s terms. The Administrator will have the authority to make all determinations and interpretations under, and adopt rules and guidelines for the administration of, the 2017 Plan. In addition, the Administrator (which, for purposes of any such awards will be a Board committee comprised solely of two or more directors, each of whom is intended to be an “outside director” within the meaning of Section 162(m) of the Code) will determine whether specific awards are intended to constitute “qualified performance-based compensation,” within the meaning of Section 162(m) of the Code.

The 2017 Plan includes annual limits on certain awards that may be granted to any individual participant. The maximum aggregate number of shares of common stock with respect to all stock options and stock appreciation rights that may be granted to any one person during any calendar year is 250,000 shares. The maximum number of shares of common stock with respect to all awards of restricted stock, restricted stock units, performance shares and other stock- or cash-based awards that are intended to qualify as “qualified performance-based compensation” within the meaning of Section 162(m) of the Code that may be granted to any one person during any calendar year is 250,000 shares. The 2017 Plan also includes limits on the maximum aggregate amount that may become payable pursuant to all performance bonus awards that may be granted to any one person during any calendar year and the maximum amount that may become payable pursuant to all cash-based awards granted under the 2017 Plan and the aggregate grant date fair value of all equity-based awards granted under the 2017 Plan to any non-employee director during any calendar year for services as a member of the Board.

The 2017 Plan contains a minimum vesting requirement, subject to limited exceptions, that awards made under the 2017 Plan may not vest earlier than the date that is one year following the grant date of the award. The 2017 Plan also contains provisions with respect to payment of exercise or purchase prices, vesting and expiration of awards, adjustments and treatment of awards upon certain corporate transactions, including stock splits, recapitalizations and mergers, transferability of awards and tax withholding requirements.

The 2017 Plan may be amended or terminated by the Board at any time, subject to certain limitations requiring stockholder consent or the consent of the applicable participant. In addition, the Administrator may not, without the approval of the Company’s stockholders, authorize certain re-pricings of any outstanding stock options or stock appreciation rights granted under the 2017 Plan. The 2017 Plan will expire on June 20, 2027.

As of June 30, 2017, no awards have been granted under the 2017 Plan.

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

In fiscal 2017, the Company granted no shares issuable upon the exercise of NQOs. In fiscal 2016 and 2015, the Company granted 21,595 and 25,703 shares, respectively, issuable upon the exercise of NQOs with a weighted average exercise price of $29.48 and $23.91 per share, respectively, to eligible employees under the Amended Equity Plan which vest ratably over a three-year period. Following are the assumptions used in the Black-Scholes valuation model for NQOs granted during the fiscal years ended June 30, 2016 and 2015:



	Year Ended June 30,
	2016			2015
Weighted average fair value of NQOs	$	12.63		$	10.38
Risk-free interest rate	1.6		%	1.5		%
Dividend yield	—			—
Average expected term (years)	5.1			5.1
Expected stock price volatility	47.1		%	47.9		%

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 historical weighted time outstanding and the expected weighted time outstanding calculated by assuming the settlement of outstanding awards at 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.

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, 2014	412,454		12.44	5.30	4.4	3,782
Granted	25,703		23.91	10.38	6.8	—
Exercised	(95,723	)	16.17	5.86	—	747
Cancelled/Forfeited	(13,134	)	11.26	5.00	—	—
Outstanding at June 30, 2015	329,300		12.30	5.54	3.9	3,700
Granted	21,595		29.48	12.63	6.4	—
Exercised	(112,895	)	12.35	5.37	—	1,853
Cancelled/Forfeited	(18,371	)	13.45	6.17	—	—
Outstanding at June 30, 2016	219,629		13.87	6.28	3.7	3,995
Granted	—		—	—	—	—
Exercised(1)	(67,482	)	12.38	5.57	—	1,407
Cancelled/Forfeited	(18,683	)	25.13	10.90	—	—
Outstanding at June 30, 2017	133,464		13.05	5.99	2.6	2,299
Vested and exercisable at June 30, 2017	125,376		12.13	5.64	2.5	2,274
Vested and expected to vest at June 30, 2017	133,073		13.00	5.97	2.6	2,298

___________

(1) Includes 11,147 shares that were withheld to cover option cost and meet the employees' minimum statutory tax withholding and retired.

The aggregate intrinsic values outstanding at the end of each fiscal period in the table above represent the total pretax intrinsic value, based on the Company’s closing stock price of $30.25 at June 30, 2017, $32.06 at June 30, 2016 and $23.50 at June 30, 2015, representing the last trading day of the respective fiscal years, which would have been received by NQO holders had all award holders exercised their NQOs that were in-the-money as of those dates. The aggregate intrinsic value of NQO exercises in each fiscal period above 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 fiscal 2017, 2016, and 2015 was $0.2 million, $0.3 million and $0.5 million, respectively. The Company received $0.5 million, $1.4 million and $1.5 million in proceeds from exercises of vested NQOs in fiscal 2017, 2016 and 2015, respectively.

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



Nonvested NQOs:	Number of NQOs		Weighted Average Exercise Price ($)	Weighted Average Grant Date Fair Value ($)	Weighted Average Remaining Life (Years)
Outstanding at June 30, 2014	167,798		10.65	5.06	5.3
Granted	25,703		23.91	10.38	6.8
Vested	(101,172	)	9.87	4.72	—
Forfeited	(12,134	)	10.31	4.91	—
Outstanding at June 30, 2015	80,195		15.94	7.21	5.2
Granted	21,595		29.48	12.63	6.4
Vested	(47,418	)	14.05	6.44	—
Forfeited	(15,641	)	12.95	6.09	—
Outstanding at June 30, 2016	38,731		27.02	11.63	6.1
Vested	(15,765	)	26.45	11.41	—
Forfeited	(14,878	)	27.44	11.96	—
Outstanding at June 30, 2017	8,088		27.33	11.47	5.3

As of June 30, 2017 and 2016, respectively, there was $80,000 and $0.4 million of unrecognized compensation cost related to NQOs. The unrecognized compensation cost related to NQOs at June 30, 2017 is expected to be recognized over the weighted average period of 1.3 years. Total compensation expense for NQOs was $0.1 million, $0.2 million and $0.4 million in fiscal 2017, 2016 and 2015, respectively.

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

In the fiscal year ended June 30, 2017, the Company granted 149,223 shares issuable upon the exercise of PNQs to eligible employees under the Amended Equity Plan, with 20% of each such grant subject to forfeiture if a target modified net income goal for fiscal 2017 (“Fiscal 2017 Target”) is not attained. For this purpose, “Modified Net Income” is defined as net income (GAAP) before taxes and excluding any gains or losses from sales of assets, and excluding the effect of restructuring and other transition expenses related to the relocation of the Company’s corporate headquarters to Northlake, Texas. These PNQs have an exercise price of $32.85 per share which was the closing price of the Company’s common stock as reported on the NASDAQ Global Select Market on the date of grant. One-third of the total number of shares subject to each such stock option vest ratably on each of the first three anniversaries of the grant date, contingent on continued employment, and subject to accelerated vesting in certain circumstances.

In the fiscal year ended June 30, 2016, the Company granted 143,466 shares issuable upon the exercise of PNQs with an exercise price of $29.48 per share to eligible employees under the Amended Equity Plan. With the exception of a portion of the award to the Company’s President and Chief Executive Officer as described below, 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, based on the Company’s achievement of modified net income targets for fiscal 2016 (“Fiscal 2016 Target“) as approved by the Compensation Committee, 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. But if actual modified net income for fiscal 2016 is less than the Fiscal 2016 Target, then only 80% of the total shares issuable under such grant will vest subject to continued employment with the Company on the relevant vesting dates.

On June 3, 2016, the Compensation Committee of the Board of Directors of the Company determined that a portion of the performance non-qualified stock option granted to Michael H. Keown, the Company's President and Chief Executive Officer, on December 3, 2015 (the “Original Option”) was invalid because such portion caused the total number of option shares granted to Mr. Keown in calendar year 2015 to exceed the limit of 75,000 shares that may be granted to a participant in a single calendar year under the Amended Equity Plan by 22,862 shares. Therefore, the Compensation Committee reduced the total number of shares of common stock issuable under the Original Option by 22,862 shares. The reduction of the 22,862 excess option shares brought the total number of option shares granted to Mr. Keown in calendar 2015 within the limitation of the Amended Equity Plan.

In addition, on June 3, 2016, the Compensation Committee, in accordance with the provisions of the Amended Equity Plan, granted Mr. Keown a performance non-qualified stock option to purchase 22,862 shares of the Company's common stock (the “New Option”) with an exercise price of $29.48 per share, which was the greater of the exercise price of the Original Option and the closing price of the Company's common stock as reported on the NASDAQ Global Select Market on June 3, 2016, the date of grant. The New Option is subject to the same terms and conditions of the Original Option including an expiration date of December 3, 2022, and the three-year vesting schedule, except that to comply with the Amended Equity Plan's minimum vesting schedule of one year from the grant date, one-third of shares issuable under the New Option will vest on June 3, 2017, and the remainder of the New Option shares will vest one-third each on the second and third anniversaries of the grant date of the Original Option, based on the Company’s achievement of the same performance goals as the Original Option, subject to Mr. Keown’s continued employment on the applicable vesting date.

In the fiscal year ended June 30, 2015, the Company granted 121,024 shares issuable upon the exercise of PNQs with an exercise price of $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, 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.

Following are the assumptions used in the Black-Scholes valuation model for PNQs granted during the fiscal years ended June 30, 2017, 2016 and 2015:



	Year Ended June 30,
	2017			2016			2015
Weighted average fair value of PNQs	$	11.42		$	11.38		$	10.16
Risk-free interest rate	1.5		%	1.6		%	1.5		%
Dividend yield	—			—			—
Average expected term (years)	4.9			4.9			5.0
Expected stock price volatility	37.7		%	42.5		%	47.9		%

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



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	6.6	—
Cancelled/Forfeited	(9,399	)	21.33	10.52	—	—
Outstanding at June 30, 2015	224,067		22.44	10.31	6.0	237
Granted	143,466		29.48	11.38	6.2	—
Exercised	(14,144	)	21.20	10.45	—	107
Cancelled/Forfeited	(64,790	)	23.20	10.37	—	—
Outstanding at June 30, 2016	288,599		25.83	10.82	5.7	1,798
Granted	149,223		32.85	11.42	4.6	—
Exercised(1)	(15,321	)	26.26	10.98	—	109
Cancelled/Forfeited	(63,715	)	31.39	11.39	—	—
Outstanding at June 30, 2017	358,786		27.75	10.96	5.2	1,181
Vested and exercisable at June 30, 2017	150,761		23.97	10.58	4.3	947
Vested and expected to vest at June 30, 2017	347,766		27.64	10.95	5.2	1,173

___________

(1) Includes 6,326 shares that were withheld to cover option cost and meet the employees' minimum statutory tax withholding and retired.

The aggregate intrinsic values outstanding at the end of each fiscal period in the table above represent the total pretax intrinsic values, based on the Company’s closing stock price of $30.25 at June 30, 2017, $32.06 at June 30, 2016 and $23.50 at June 30, 2015 representing the last trading day of the respective fiscal years, which would have been received by PNQ holders had all award holders exercised their PNQs that were in-the-money as of those dates. The aggregate intrinsic value of PNQ exercises in each fiscal period represents the difference between the exercise price and the value of the Company’s common stock at the time of exercise. PNQs outstanding that are expected to vest are net of estimated forfeitures.

Total fair value of PNQs vested during the fiscal years ended June 30, 2017, 2016 and 2015 was $1.3 million, $0.3 million and $0.4 million, respectively. The Company received $0.2 million and $0.3 million in proceeds from exercises of vested PNQs in fiscal 2017 and 2016, respectively. No PNQs were exercised during the fiscal year ended June 30, 2015.

As of June 30, 2017, the Company met the performance targets for the fiscal 2016 PNQ awards and the first two tranches of the fiscal 2015 PNQ awards. The Company expects to meet the performance targets for the remainder of the fiscal 2015 and fiscal 2016 awards, and for the fiscal 2017 awards.

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



Nonvested PNQs:	Number of PNQs		Weighted Average Exercise Price ($)	Weighted Average Grant Date Fair Value ($)	Weighted Average Remaining Life (Years)
Outstanding at June 30, 2014	112,442		21.27	10.49	6.5
Granted	121,024		23.44	10.16	6.6
Vested	(34,959	)	21.27	10.49	—
Forfeited	(9,399	)	21.33	10.52	—
Outstanding at June 30, 2015	189,108		22.66	10.28	6.2
Granted	143,466		29.48	11.38	6.2
Vested	(27,317	)	10.16	23.44	—
Forfeited	(64,790	)	23.20	10.37	—
Outstanding at June 30, 2016	240,467		26.49	10.92	5.9
Granted	149,223		32.85	11.42	4.6
Vested	(119,403	)	24.91	10.75	—
Forfeited	(62,262	)	31.39	11.39	—
Outstanding at June 30, 2017	208,025		30.48	11.24	5.8

As of June 30, 2017 and 2016, there was $1.8 million and $1.9 million , respectively, of unrecognized compensation cost related to PNQs. The unrecognized compensation cost related to PNQs at June 30, 2017 is expected to be recognized over the weighted average period of 1.3 years. Total compensation expense related to PNQs in fiscal 2017, 2016 and 2015 was $1.1 million, $0.5 million and $0.5 million, respectively.

Restricted Stock

During fiscal 2017, 2016 and 2015 the Company granted 5,106 shares, 10,170 shares and 13,256 shares of restricted stock under the Amended Equity Plan, respectively, with a weighted average grant date fair value of $35.25, $29.99 and $23.64 per share, respectively, to eligible employees and directors. Shares of restricted stock generally vest at the end of three years for eligible employees. Unlike prior-year awards to non-employee directors, which vest ratably over a period of three years, the fiscal 2017 restricted stock awards cliff vest on the first anniversary of the date of grant subject to continued service to the Company through the vesting date and the acceleration provisions of the LTIP and restricted stock agreement. During the fiscal year ended June 30, 2017, 7,458 shares of restricted stock vested and were released.

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



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	13,256		23.64	—	313
Exercised/Released(1)	(53,402	)	8.43	—	1,377
Cancelled/Forfeited	(8,984	)	8.36	—	—
Outstanding at June 30, 2015	47,082		16.48	1.2	1,106
Granted	10,170		29.99	—	305
Exercised/Released(2)	(24,841	)	14.08	—	747
Cancelled/Forfeited	(8,619	)	13.06	—	—
Outstanding at June 30, 2016	23,792		26.00	1.8	763
Granted	5,106		35.25	—	180
Exercised/Released	(7,458	)	24.16	—	253
Cancelled/Forfeited	(5,995	)	26.41	—	—
Outstanding at June 30, 2017	15,445		29.79	0.9	467
Expected to vest at June 30, 2017	14,989		29.79	0.9	453

__________

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

(2) Includes 5,177 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 fiscal period in the table above represent the total pretax intrinsic values, based on the Company’s closing stock price of $30.25 at June 30, 2017, $32.06 at June 30, 2016 and $23.50 at June 30, 2015, representing the last trading day of the respective fiscal years. Restricted stock that is expected to vest is net of estimated forfeitures.

As of June 30, 2017 and 2016, there was $0.3 million and $0.5 million of unrecognized compensation cost related to restricted stock. The unrecognized compensation cost related to restricted stock at June 30, 2017 is expected to be recognized over the weighted average period of 1.0 year. Total compensation expense for restricted stock was $0.2 million, $0.2 million, and $0.3 million, for the fiscal years ended June 30, 2017, 2016 and 2015, respectively.