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 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.

Non-Qualified Stock Options with Time-Based Vesting (“NQOs”)

In the nine months ended March 31, 2016, the Company granted 18,589 shares issuable upon the exercise of NQOs with a weighted average exercise price of $29.17 per share to eligible employees under the Amended Equity Plan which vest ratably over a three-year period. In the nine months ended March 31, 2015, the Company granted 13,123 shares issuable upon the exercise of NQOs with a weighted average exercise price of $23.44 per share to eligible employees under the Amended Equity Plan 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 nine months ended March 31, 2016.



	Nine Months Ended March 31, 2016
Weighted average fair value of NQOs	$	12.74
Risk-free interest rate	1.71		%
Dividend yield	—		%
Average expected term	5.1 years
Expected stock price volatility	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 nine months ended March 31, 2016:



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, 2015	329,300		12.30	5.54	3.9	3,700
Granted	18,589		29.17	12.74	6.6	—
Exercised	(100,895	)	12.99	5.59	—	1,574
Cancelled/Forfeited	(18,371	)	13.45	6.17	—	—
Outstanding at March 31, 2016	228,623		13.28	6.05	3.8	3,336
Vested and exercisable, March 31, 2016	188,705		10.50	4.90	3.3	3,278
Vested and expected to vest, March 31, 2016	225,974		13.12	5.99	3.8	3,333

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 $27.87 at March 31, 2016 and $23.50 at June 30, 2015, 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 NQO exercises in the nine months ended March 31, 2016 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.

A total of 43,225 shares issuable under NQOs vested during the nine months ended March 31, 2016. During each of the nine months ended March 31, 2016 and 2015, the Company received $1.3 million in proceeds from exercises of vested NQOs.

As of March 31, 2016 and June 30, 2015, there was $0.4 million of unrecognized compensation cost related to NQOs. The unrecognized compensation cost related to NQOs at March 31, 2016 is expected to be recognized over the weighted average period of 2.3 years. Total compensation expense for NQOs in the three months ended March 31, 2016 and 2015 was $45,000 and $0.1 million, respectively. Total compensation expense for NQOs in the nine months ended March 31, 2016 and 2015 was $0.2 million and $0.3 million, respectively.

Non-Qualified Stock Options with Performance-Based and Time-Based Vesting (“PNQs”)

In the nine months ended March 31, 2016, the Company granted 143,466 shares issuable upon the exercise of PNQs with a weighted average exercise price of $29.48 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 a modified net income target for fiscal 2016 ("FY16 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 dates 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 FY16 Target, then 20% of the total shares issuable under such grant will be forfeited.

Following are the weighted average assumptions used in the Black-Scholes valuation model for PNQs granted during the nine months ended March 31, 2016.



	Nine Months Ended March 31, 2016
Weighted average fair value of PNQs	$	11.46
Risk-free interest rate	1.71		%
Dividend yield	—		%
Average expected term	4.9 years
Expected stock price volatility	42.5		%

The following table summarizes PNQ activity for the nine months ended March 31, 2016:



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, 2015	224,067		22.44	10.31	6.0	237
Granted	143,466		29.48	11.46	6.5	—
Exercised	(14,144	)	21.20	10.45	—	107
Cancelled/Forfeited	(64,790	)	23.20	10.37	—	—
Outstanding at March 31, 2016	288,599		25.83	10.86	6.0	588
Vested and exercisable, March 31, 2016	48,132		22.52	10.31	5.4	257
Vested and expected to vest, March 31, 2016	272,503		25.74	10.85	6.0	579

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 $27.87 at March 31, 2016 and $23.50 at June 30, 2015, representing the last trading day of the applicable fiscal period, which would have been received by PNQ holders had all award holders exercised their PNQs that were in-the-money as of that date. The aggregate intrinsic value of PNQ exercises in the nine months ended March 31, 2016 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.

As of March 31, 2016, the Company met the performance target for the first year of the fiscal 2014 and fiscal 2015 awards and expects that it will achieve the cumulative performance targets set forth in the PNQ agreements for the fiscal 2014, fiscal 2015 and fiscal 2016 awards. During the nine months ended March 31, 2016, 27,317 shares of PNQs vested. During the nine months ended March 31, 2016 and 2015, respectively, the Company received $0.3 million and $0 in proceeds from exercises of vested PNQs.

As of March 31, 2016 and June 30, 2015, there was $2.1 million and $1.5 million, respectively, in unrecognized compensation cost related to PNQs. The unrecognized compensation cost related to PNQs at March 31, 2016 is expected to be recognized over the weighted average period of 1.6 years. Total compensation expense for PNQs in the three months ended March 31, 2016 and 2015 was $0.2 million and $0.1 million, respectively. Total compensation expense for PNQs in the nine months ended March 31, 2016 and 2015 was $0.3 million and $0.4 million, respectively.

Restricted Stock

In the nine months ended March 31, 2016, the Company granted 9,638 shares of restricted stock under the Amended Equity Plan with a weighted average grant date fair value of $29.91 per share to eligible employees and non-employee directors.

Shares of restricted stock generally vest at the end of three years for eligible employees and ratably over a period of three years for non-employee directors. During the nine months ended March 31, 2016, 24,841 shares of restricted stock vested, of which 5,177 shares were withheld to meet the employees' minimum statutory tax withholding and retired.

The following table summarizes restricted stock activity for the nine months ended March 31, 2016:



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, 2015	47,082		16.48	1.2	1,106
Granted	9,638		29.91	3.0	288
Vested/Released(1)	(24,841	)	14.08	—	747
Cancelled/Forfeited	(8,619	)	13.06	—	—
Outstanding at March 31, 2016	23,260		25.88	2.1	648
Expected to vest, March 31, 2016	21,569		25.79	2.1	601

_____________

(1) 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 period in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $27.87 at March 31, 2016 and $23.50 at June 30, 2015, representing the last trading day of the applicable fiscal period. Restricted stock that is expected to vest is net of estimated forfeitures.

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 the each of the three months ended March 31, 2016 and 2015 was $0.1 million. Compensation expense recognized in the nine months ended March 31, 2016 and 2015 was $0.1 million and $0.2 million, respectively. As of March 31, 2016 and June 30, 2015, there was approximately $0.5 million of unrecognized compensation cost related to restricted stock. The unrecognized compensation cost related to the restricted stock at March 31, 2016 is expected to be recognized over the weighted average period of 2.2 years.