Summary of Significant Accounting Policies

Organization

Farmer Bros. Co., a Delaware corporation (including its consolidated subsidiaries unless the context otherwise requires, the “Company,” 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, offices, quick service restaurants ("QSR's"), convenience stores, healthcare facilities and other foodservice providers, as well as private brand retailers in the QSR, grocery, drugstore, restaurant, convenience store and independent coffeehouse channels. 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, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2014. Events occurring subsequent to March 31, 2014 have been evaluated for potential recognition or disclosure in the unaudited consolidated financial statements for the three and nine months ended March 31, 2014.

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, 2013, filed with the Securities and Exchange Commission (the “SEC”) on October 9, 2013.

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.

Corrections to Previously Issued Financial Statements

Subsequent to the issuance of the Company’s consolidated financial statements for the year ended June 30, 2013 the Company identified certain errors in the consolidated statements of operations and consolidated statement of cash flows. Accordingly, the Company has corrected the accompanying consolidated statements of operations for the three and nine months ended March 31, 2013 and the accompanying consolidated statement of cash flows for the nine months ended March 31, 2013.

Within the presentation of the consolidated statements of operations for the three and nine months ended March 31, 2013, the Company previously presented certain overhead expenses in "General and administrative expenses" that should have been recorded in "Cost of goods sold." In addition, the Company previously presented net gains from sales of assets within "Other, net" that should have been presented as a separate line item within "(Loss) income from operations" in order to comply with GAAP.

Within the presentation of cash flows from operating activities, the Company previously presented purchases of and proceeds from sales of trading securities held for investment on a net basis that should have been presented on a gross basis to comply with GAAP. In addition, the Company previously presented a $9.4 million increase in the Company's derivative liabilities as a reduction in the net activity in "Short-term investments" that should have been included in the change in "Accrued payroll expenses and other current liabilities."

The errors had no impact on the amounts previously reported in the Company’s consolidated balance sheets. Management has evaluated the materiality of these errors quantitatively and qualitatively and has concluded that the corrections of these errors are immaterial to the consolidated financial statements as a whole.

The accompanying consolidated statements of operations and consolidated statement of cash flows have been corrected for the errors described above. The impact of the adjustments is shown below:



	Three Months Ended March 31, 2013
(In thousands)	As Previously Reported			Adjustments			As Corrected
Net sales	$	126,343		$	—		$	126,343
Cost of goods sold	77,668			1,093			78,761
Gross profit	48,675			(1,093		)	47,582
Selling expenses	39,135			—			39,135
General and administrative expenses	10,034			(1,093		)	8,941
Net gains from sales of assets	—			(1,185		)	(1,185		)
Operating expenses	49,169			(2,278		)	46,891
(Loss) income from operations	(494		)	1,185			691
Other income (expense):
Dividend income	286			—			286
Interest income	92			—			92
Interest expense	(466		)	—			(466		)
Other, net	(764		)	(1,185		)	(1,949		)
Total other (expense) income	(852		)	(1,185		)	(2,037		)
Loss before taxes	(1,346		)	—			(1,346		)
Income tax benefit	(40		)	—			(40		)
Net loss	$	(1,306	)	$	—		$	(1,306	)



	Nine Months Ended March 31, 2013
(In thousands)	As Previously Reported			Adjustments			As Corrected
Net sales	$	381,201		$	—		$	381,201
Cost of goods sold	237,552			3,315			240,867
Gross profit	143,649			(3,315		)	140,334
Selling expenses	117,171			—			117,171
General and administrative expenses	27,844			(3,315		)	24,529
Net gains from sales of assets	—			(4,388		)	(4,388		)
Operating expenses	145,015			(7,703		)	137,312
(Loss) income from operations	(1,366		)	4,388			3,022
Other (expense) income:
Dividend income	829			—			829
Interest income	283			—			283
Interest expense	(1,386		)	—			(1,386		)
Other, net	(3,475		)	(4,388		)	(7,863		)
Total other (expense) income	(3,749		)	(4,388		)	(8,137		)
Loss before taxes	(5,115		)	—			(5,115		)
Income tax expense	369			—			369
Net loss	$	(5,484	)	$	—		$	(5,484	)



	Nine Months Ended March 31, 2013
(In thousands)	As Previously Reported			Adjustments			As Corrected
Cash flows from operating activities:
Net loss	$	(5,484	)	$	—		$	(5,484	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	24,778			—			24,778
Recovery of doubtful accounts	(890		)	—			(890		)
Deferred income taxes	111			—			111
Net gains on sales of assets	(4,388		)	—			(4,388		)
ESOP and share-based compensation expense	2,639			—			2,639
Net losses on derivatives and investments	9,315			—			9,315
Change in operating assets and liabilities:
Restricted cash	(2,140		)	—			(2,140		)
Purchases of trading securities held for investment	—			(6,408		)	(6,408		)
Proceeds from sales of trading securities held for investment	—			5,452			5,452
Short-term investments	(10,347		)	10,347			—
Accounts and notes receivable	(1,167		)	—			(1,167		)
Inventories	(1,291		)	—			(1,291		)
Income tax receivable	645			—			645
Prepaid expenses and other assets	522			—			522
Accounts payable	3,737			—			3,737
Accrued payroll expenses and other current liabilities	2,734			(9,391		)	(6,657		)
Accrued postretirement benefits	462			—			462
Other long-term liabilities	(1,416		)	—			(1,416		)
Net cash provided by operating activities	$	17,820		$	—		$	17,820

Derivative Instruments

The Company purchases various derivative instruments to create economic hedges of its commodity price risk and interest rate risk. These derivative instruments consist primarily of futures and swaps. The Company reports the fair value of derivative instruments on its consolidated balance sheets in "Short-term investments," "Short-term derivative assets," "Other assets," "Short-term derivative liabilities," or "Long-term derivative liabilities." The Company determines the current and noncurrent classification based on the timing of expected future cash flows of individual trades and reports these amounts on a gross basis. Additionally, the Company reports cash held on deposit in margin accounts for coffee-related derivative instruments on a gross basis on its consolidated balance sheet in "Restricted cash."

The accounting for the changes in fair value of the Company's derivative instruments can be summarized as follows:



Derivative Treatment		Accounting Method
Normal purchases and normal sales exception		Accrual accounting
Designated in a qualifying hedging relationship		Hedge accounting
All other derivatives		Mark-to-market accounting

The Company enters into green coffee purchase commitments at a fixed price or at a price to be fixed (“PTF”). PTF contracts are purchase commitments whereby the quality, quantity, delivery period, price differential to the coffee "C" market price and other negotiated terms are agreed upon, but the price at which the base “C” market price will be fixed has not yet been established. The coffee "C" market price is fixed at some point after the purchase contract date and before the futures market closes for the delivery month and may be fixed either at the direction of the Company to the vendor, or by the application of a derivative that was separately purchased as a hedge. For both fixed-price and PTF contracts, the Company expects to take delivery of and to utilize the coffee in a reasonable period of time and in the conduct of normal business. Accordingly, these purchase commitments qualify as normal purchases and are not recorded at fair value on the Company's consolidated balance sheets.

Prior to April 1, 2013, the Company had no derivative instruments that were designated as accounting hedges. Beginning April 1, 2013, the Company implemented procedures following the guidelines of Accounting Standards Codification ("ASC") 815, "Derivatives and Hedging" ("ASC 815"), to enable it to account for certain coffee-related derivatives as accounting hedges in order to minimize the volatility created in the Company's quarterly results from utilizing these derivative contracts and to improve comparability between reporting periods. For a derivative to qualify for designation in a hedging relationship, it must meet specific criteria and the Company must maintain appropriate documentation. The Company establishes hedging relationships pursuant to its risk management policies. The hedging relationships are evaluated at inception and on an ongoing basis to determine whether the hedging relationship is, and is expected to remain, highly effective in achieving offsetting changes in fair value or cash flows attributable to the underlying risk being hedged. The Company also regularly assesses whether the hedged forecasted transaction is probable of occurring. If a derivative ceases to be or is no longer expected to be highly effective, or if the Company believes the likelihood of occurrence of the hedged forecasted transaction is no longer probable, hedge accounting is discontinued for that derivative, and future changes in the fair value of that derivative are recognized in “Other, net.”

For commodity derivatives designated as cash flow hedges, the effective portion of the change in fair value of the derivative is reported as accumulated other comprehensive income (“AOCI”) and subsequently reclassified into cost of goods sold in the period or periods when the hedged transaction affects earnings. Any ineffective portion of the derivative's change in fair value is recognized currently in “Other, net.” Gains or losses deferred in AOCI associated with terminated derivatives, derivatives that cease to be highly effective hedges, derivatives for which the forecasted transaction is reasonably possible but no longer probable of occurring, and cash flow hedges that have been otherwise discontinued remain in AOCI until the hedged item affects earnings. If it becomes probable that the forecasted transaction designated as the hedged item in a cash flow hedge will not occur, any gain or loss deferred in AOCI is recognized in “Other, net” at that time. For derivative instruments that are not designated in a hedging relationship, and for which the normal purchases and normal sales exception has not been elected, the changes in fair value are reported in “Other, net.”

The following gains and losses on derivative instruments are netted together and reported in “Other, net” in the Company's consolidated statements of operations:


•	Gains and losses on all derivatives that are not designated as cash flow hedges and for which the normal purchases and normal sales exception has not been elected; and


•	The ineffective portion of gains and losses on derivatives that are designated as cash flow hedges.

The fair value of derivative instruments is based upon broker quotes. At March 31, 2014, approximately 86% of the Company's outstanding coffee-related derivative instruments were designated as cash flow hedges (see Note 2). At March 31, 2013, no derivative instruments were designated as accounting hedges.

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 the 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 its customers. Accordingly, such servicing costs included in cost of goods sold in the accompanying unaudited consolidated financial statements for the three months ended March 31, 2014 and 2013 were $6.6 million and $7.0 million, respectively. Coffee brewing equipment servicing costs included in cost of goods sold for the nine months ended March 31, 2014 and 2013 were $19.6 million and $19.1 million, respectively. In addition, depreciation expense related to capitalized coffee brewing equipment reported as cost of goods sold in the three months ended March 31, 2014 and 2013 was $2.8 million and $3.2 million, respectively. Depreciation expense related to capitalized coffee brewing equipment reported as cost of goods sold in the nine months ended March 31, 2014 and 2013 was $8.6 million and $9.8 million, respectively. The Company capitalized coffee brewing equipment in the amounts of $9.8 million and $7.1 million in the nine months ended March 31, 2014 and 2013, 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, 2014 and June 30, 2013, the Company had $0.2 million and $0.3 million, respectively, of receivables relating to this arrangement which are included in "Other receivables" (see Note 6).

Net Income (Loss) Per Common Share

Net income (loss) per share (“EPS”) represents net income (loss) 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 income (loss) 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, net income (loss) attributable to nonvested restricted stockholders is excluded from net income (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, 2014 includes the dilutive effect of 126,959 and 98,160 shares, respectively, issuable under stock options (see Note 12). 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 because their inclusion would be anti-dilutive.

Dividends

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.

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, 2014.

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, 2014.

Self-Insurance

The Company is self-insured for California workers’ compensation claims subject to specific retention levels, and uses historical analysis to determine and record the estimates of expected future expenses resulting from workers’ compensation claims in California. The estimated outstanding losses are the accrued cost of unpaid claims. The estimated outstanding losses, including allocated loss adjustment expenses (“ALAE”), include case reserves, the development of known claims and incurred but not reported claims. ALAE are the direct expenses for settling specific claims. The amounts reflect per occurrence and annual aggregate limits maintained by the Company. The analysis does not include estimating a provision for unallocated loss adjustment expenses.

The Company accounts for its accrued liability relating to California workers’ compensation claims on an undiscounted basis. The estimated gross undiscounted workers’ compensation liability relating to such claims was $8.0 million and the estimated recovery from reinsurance was $1.9 million as of March 31, 2014. The short-term and long-term accrued liability for workers’ compensation claims are presented on the Company's consolidated balance sheets in "Other current liabilities" and in "Accrued workers' compensation liabilities," respectively.

In May 2011, the Company did not meet certain minimum credit rating criteria for participation in the alternative security program for California self-insurers for workers' compensation liability. As a result, the Company was required to post a $5.9 million letter of credit as a security deposit with the State of California Department of Industrial Relations Self-Insurance Plans. At March 31, 2014, this letter of credit continues to serve as a security deposit but has been reduced to $5.4 million.

The estimated liability related to the Company's self-insured group medical insurance at March 31, 2014 is $0.8 million and is recorded on an incurred but not reported basis, within deductible limits, based on actual claims and the average lag time between the date insurance claims are filed and the date those claims are paid.

General liability, product liability, commercial auto liability and workers' compensation liability (in all states other than California) are insured through a captive insurance program. The Company retains risk within certain aggregate amounts. Cost of the insurance through the captive program is accrued based on estimates of the aggregate liability claims incurred using certain actuarial assumptions and historical claims experience. In the three and nine months ended March 31, 2014, the Company accrued an additional $0.3 million and $1.6 million, respectively, in selling expenses and increased its liability reserves for such claims to $2.4 million at March 31, 2014. In the three and nine months ended March 31, 2013, no additional liability reserves for such claims were recorded.

The estimated liability related to the Company's self-insured group medical insurance, general liability, product liability, commercial auto liability and accrued liability for workers’ compensation claims in all states other than California are included on the Company's consolidated balance sheets in "Other current liabilities" and in "Accrued workers' compensation liabilities," as appropriate. The estimated insurance receivable is included in "Other assets" on the Company's consolidated balance sheets.

Recently Adopted Accounting Standards

In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-10, "Derivatives and Hedging (Topic 815) - Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes" ("ASU 2013-10"). "ASU 2013-10 permits the use of the Fed Funds Effective Swap Rate as a U.S. benchmark interest rate for hedge accounting purposes. ASU 2013-10 also removes the restriction on using different benchmark rates for similar hedges. ASU 2013-10 was effective for qualifying new or re-designated hedging relationships entered into on or after July 17, 2013. The Company adopted the provisions of ASU 2013-10 in July 2013. Adoption of ASU 2013-10 did not have a material impact on the results of operations, financial position, or cash flows of the Company.

New Accounting Pronouncements

In July 2013, the FASB issued ASU No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11"). An entity is required to present unrecognized tax benefits as a decrease in net operating loss, similar tax loss or tax credit carryforward if certain criteria are met. The determination of whether a deferred tax asset is available is based on the unrecognized tax benefit and the deferred tax asset that exists at the reporting date and presumes disallowance of the tax position at the reporting date. The guidance will eliminate the diversity in practice in the presentation of unrecognized tax benefits but will not alter the way in which entities assess deferred tax assets for realizability. This update is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2013 and will be effective for the Company beginning July 1, 2014. Adoption of ASU 2013-11 is not expected to have a material effect on the results of operations, financial position or cash flows of the Company.