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. 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. As of June 30, 2018, there were 956,830 shares available under the 2017 Plan including shares that were forfeited under the Prior Plans. 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 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 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, 2018, awards covering 174,802 shares of common stock have been granted under the 2017 Plan.

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

In fiscal 2018, the Company granted 124,278 shares issuable upon the exercise of NQOs to eligible employees under the 2017 Plan. These NQOs have an exercise price of $31.70 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 fiscal 2017, the Company granted no shares issuable upon the exercise of NQOs. In fiscal 2016, the Company granted 21,595 shares issuable upon the exercise of NQOs with a weighted average exercise price of $29.48 per share to eligible employees under the Amended Equity Plan which vest ratably over a 3-year period.

Following are the assumptions used in the Black-Scholes valuation model for NQOs granted during the fiscal years ended June 30, 2018 and 2016:



	Year Ended June 30,
	2018			2016
Weighted average fair value of NQOs	$	10.41		$	12.63
Risk-free interest rate	2.0		%	1.6		%
Dividend yield	—		%	—		%
Average expected term	4.6 years			5.1 years
Expected stock price volatility	35.4		%	47.1		%

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, 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
Granted	124,278		31.70	10.41	6.1	—
Exercised	(86,160	)	12.32	5.71	—	1,654
Cancelled/Forfeited	(10,258	)	28.52	10.72	—	—
Outstanding at June 30, 2018	161,324		26.82	9.24	5.1	741
Vested and exercisable at June 30, 2018	41,163		12.59	5.79	1.5	741
Vested and expected to vest at June 30, 2018	153,562		26.58	9.18	5.1	741

___________

(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 $30.55 at June 29, 2018, $30.25 at June 30, 2017 and $32.06 at June 30, 2016 , 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 2018, 2017, and 2016 was $24,000, $0.2 million and $0.3 million, respectively. The Company received $1.1 million, $0.5 million and $1.4 million in proceeds from exercises of vested NQOs in fiscal 2018, 2017 and 2016, 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, 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
Granted	124,278		31.70	10.41	6.1
Vested	(1,947	)	31.70	10.41	—
Forfeited	(10,258	)	30.47	12.40	—
Outstanding at June 30, 2018	120,161		31.70	10.43	6.4

As of June 30, 2018 and 2017, respectively, there was $1.0 million and $80,000 of unrecognized compensation cost related to NQOs. The unrecognized compensation cost related to NQOs at June 30, 2018 is expected to be recognized over the weighted average period of 2.4 years. Total compensation expense for NQOs was $0.3 million, $0.1 million and $0.2 million in fiscal 2018, 2017 and 2016, respectively.

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

In fiscal 2018, the Company granted no shares issuable upon the exercise of PNQs.

In fiscal 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 fiscal 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.

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



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

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, 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
Exercised	(10,342	)	27.13	11.02	—	61
Cancelled/Forfeited	(47,736	)	32.06	11.43	—	—
Outstanding at June 30, 2018	300,708		27.08	10.89	4.0	1,207
Vested and exercisable at June 30, 2018	223,318		25.54	10.72	3.7	1,174
Vested and expected to vest at June 30, 2018	298,120		27.04	10.88	4.0	1,206

___________

(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 $30.55 at June 29, 2018, $30.25 at June 30, 2017 and $32.06 at June 30, 2016, 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, 2018, 2017 and 2016 was $0.9 million, $1.3 million and $0.3 million, respectively. The Company received $0.3 million, $0.2 million and $0.3 million in proceeds from exercises of vested PNQs in fiscal 2018, 2017 and 2016, respectively.

As of June 30, 2018, the Company met the performance targets for the fiscal 2016 PNQ awards and the fiscal 2015 PNQ awards. In fiscal 2018, based on the Company's failure to achieve certain financial objectives over the applicable performance period, a total of 18,708 shares subject to fiscal 2017 PNQ awards were forfeited, representing 20% of the shares subject to each such award. Subject to certain continued employment conditions and subject to accelerated vesting in certain circumstances, one half of the remaining PNQs subject to the fiscal 2017 PNQ awards are scheduled to vest on each of the second and third anniversaries of the grant date. The Company expects to meet the performance targets for the remainder of the fiscal 2017 PNQ 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, 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
Vested	(82,899	)	29	10.99	—
Forfeited	(47,736	)	32	11.43	—
Outstanding at June 30, 2018	77,390		31.53	11.39	5.0

As of June 30, 2018 and 2017, there was $0.5 million and $1.8 million, respectively, of unrecognized compensation cost related to PNQs. The unrecognized compensation cost related to PNQs at June 30, 2018 is expected to be recognized over the weighted average period of 0.9 years. Total compensation expense related to PNQs in fiscal 2018, 2017 and 2016 was $0.8 million, $1.1 million and $0.5 million, respectively.

Restricted Stock

During fiscal 2018, the Company granted 13,110 shares of restricted stock under the 2017 Plan with a weighted average grant date fair value of $33.88 per share, to eligible employees and directors. The fiscal 2018 restricted stock awards cliff vest on the earlier of the one year anniversary of the grant date or the date of the first annual meeting of the Company’s stockholders immediately following the grant date, in the case of non-employee directors, and the third anniversary of the grant date, in the case of eligible employees, in each case subject to continued service to the Company through the vesting date and the acceleration provisions of the 2017 Plan and restricted stock agreement.

During fiscal 2017 and 2016, the Company granted 5,106 shares and 10,170 shares of restricted stock under the Amended Equity Plan, respectively, with a weighted average grant date fair value of $35.25 and $29.99 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 to non-employee directors 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 Amended Equity Plan and restricted stock agreement.

During fiscal 2018, 9,642 shares of restricted stock vested.

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, 2015	47,082		16.48	1.2	1,106
Granted	10,170		29.99	—	305
Exercised/Released(1)	(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
Granted	13,110		33.88	—	444
Exercised/Released	(9.642	)	31.12	—	323
Cancelled/Forfeited	(3.955	)	26.13	—	—
Outstanding at June 30, 2018	14,958		33.48	1.7	457
Expected to vest at June 30, 2018	14,493		33.50	1.7	443

__________

(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 fiscal period in the table above represent the total pretax intrinsic values, based on the Company’s closing stock price of $30.55 at June 29, 2018, $30.25 at June 30, 2017 and $32.06 at June 30, 2016, representing the last trading day of the respective fiscal years. Restricted stock that is expected to vest is net of estimated forfeitures.

As of each of June 30, 2018 and 2017, there was $0.3 million of unrecognized compensation cost related to restricted stock. The unrecognized compensation cost related to restricted stock at June 30, 2018 is expected to be recognized over the weighted average period of 0.8 years. Total compensation expense for restricted stock was $0.3 million, $0.2 million and $0.2 million, for the fiscal years ended June 30, 2018, 2017 and 2016, respectively.

Performance-Based Restricted Stock Units (“PBRSUs”)

During fiscal 2018, the Company granted 37,414 PBRSUs under the 2017 Plan to eligible employees with a grant date fair value of $31.70 per unit. The fiscal 2018 PBRSU awards cliff vest on the third anniversary of the date of grant based on the Company’s achievement of certain financial performance goals for the performance period July 1, 2017 through June 30, 2020, subject to certain continued employment conditions and subject to acceleration provisions of the 2017 Plan and restricted stock unit agreement. At the end of the three-year performance period, the number of PBRSUs that actually vest will be 0% to 150% of the target amount, depending on the extent to which the Company meets or exceeds the achievement of those financial performance goals measured over the full three-year performance period. No PBRSUs were granted during fiscal 2017 and fiscal 2016.

The following table summarizes PBRSU activity for the most recent fiscal year:



Outstanding and Nonvested PBRSUs:	PBRSUs Awarded		Weighted Average Grant Date Fair Value ($)	Weighted Average Remaining Life (Years)	Aggregate Intrinsic Value ($ in thousands)
Outstanding and nonvested at June 30, 2017	—		—	—	—
Granted(1)	37,414		31.70	—	1,186
Vested/Released	—		—	—	—
Cancelled/Forfeited	(1,682	)	31.70	—	—
Outstanding and nonvested at June 30, 2018	35,732		31.70	3.4	1,092
Expected to vest at June 30, 2018	31,800		31.70	3.4	971

_____________

(1) The target number of PBRSUs is presented in the table. Under the terms of the awards, the recipient may earn between 0% and 150% of the target number of PBRSUs depending on the extent to which the Company meets or exceeds the achievement of the applicable financial performance goals.

The aggregate intrinsic value of PBRSUs outstanding at June 30, 2018 represents the total pretax intrinsic value, based on the Company’s closing stock price of $30.55 at June 29, 2018, representing the last trading day of the fiscal year. PBRSUs that are expected to vest are net of estimated forfeitures.

As of June 30, 2018 and 2017, there was $0.9 million and $0, respectively, of unrecognized compensation cost related to PBRSUs. The unrecognized compensation cost related to PBRSUs at June 30, 2018 is expected to be recognized over the weighted average period of 2.4 years. Total compensation expense for PBRSUs was $0.2 million, $0 and $0 for the fiscal years ended June 30, 2018, 2017 and 2016, respectively.