Farmer Brothers - 10-Q quarterly report FY

PART I  FINANCIAL INFORMATION

Item 1.   Financial Statements

FARMER BROS. CO.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share and per share data)

The accompanying notes are an integral part of these financial statements

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FARMER BROS. CO.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except share and per share data)

(Unaudited)

The accompanying notes are an integral part of these financial statements

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FARMER BROS. CO.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

The accompanying notes are an integral part of these financial statements

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Notes to Consolidated Financial Statements

Note 1. Unaudited Financial Statements

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 six month periods ended December 31, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2007.

The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Farmer Bros. Co. annual report on Form 10-K for the fiscal year ended June 30, 2006.

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.  Actual results may differ from those estimates.

Note 2. Investments and Derivative Instruments

The Company purchases various derivative instruments as investments or to create economic hedges of its interest rate risk and commodity price risk. At December 31, 2006 and June 30, 2006, derivative instruments are not designated as accounting hedges as defined by Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The fair value of derivative instruments is based upon broker quotes. The Company records unrealized gains and losses on trading securities and changes in the market value of certain coffee contracts meeting the definition of derivatives in Other, net income (expense).

Investments, consisting of marketable debt and equity securities and money market instruments, are held for trading purposes and are stated at fair value.

Investments are as follows:

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Note 3. Inventories 

Inventories are valued at the lower of cost or market.  Costs of coffee and allied products are determined on the last in, first out (LIFO) basis.  Costs of coffee brewing equipment manufactured are accounted for on the first in, first out (FIFO) basis.  An actual valuation of inventory under the LIFO method is made only at the end of each fiscal year based on the inventory levels and costs at that time.  Accordingly, interim LIFO calculations must necessarily be based on management’s estimates of expected year-end inventory levels and costs.  Because these estimates are subject to many forces beyond management’s control, interim results are subject to the final year-end LIFO inventory valuation.

Note 4. Employee Benefit Plans

The Company provides pension plans for most full time employees. Generally the plans provide benefits based on years of service and/or a combination of years of service and earnings. Retirees are also eligible for medical and life insurance benefits.

Company Pension Plans

The Company has a contributory defined benefit plan for all employees not covered under a collective bargaining agreement (Farmer Bros. Co. Plan) and non-contributory defined benefit pension plan (Brewmatic Co. Plan) for certain hourly employees covered under a collective bargaining agreement.  The net periodic benefit costs for the defined benefit plans were as follows:

Components of net periodic benefit cost

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Weighted-average assumptions used to determine net periodic benefit cost

Basis used to determine expected long-term rate of return on plan assets

Historical and future expected rates of return of multiple asset classes were analyzed to develop a risk-free real rate of return and risk premiums for each asset class.  The overall rate of return for each asset class was developed by combining a long-term inflation component, the risk-free real rate of return, and the associated risk premium.  A weighted average rate of return was developed based on those overall rates of return and the target asset allocation of the plans.

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Certain statements contained in this quarterly report on Form 10-Q regarding the risks, circumstances and financial trends that may affect our future operating results, financial position and cash flows are not based on historical fact and are forward-looking statements within the meaning of federal securities laws and regulations.  These statements are based on management’s current expectations, assumptions, estimates and observations of future events and include any statements that do not directly relate to any historical or current fact.  These forward-looking statements can be identified by the use of words like “anticipates,” “feels,” “estimates,” “projects,” “expects,” “plans,” “believes,” “intends,” “will,” “assumes” and other words of similar meaning.  Owing to the uncertainties inherent in forward-looking statements, actual results could differ materially from those set forth in forward-looking statements.  A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur.  Users should not place undue reliance on the forward-looking statements, which speak only as of the date of this report.  The Company undertakes no obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by the federal securities laws. Factors that could cause actual results to differ materially from those in forward-looking statements include, but are not limited to, fluctuations in availability and cost of green coffee, competition, organizational changes, the impact of a weaker economy, business conditions in the coffee industry and food industry in general, the Company’s continued success in attracting new customers, variances from budgeted sales mix and growth rates, and weather and special or unusual events, as well as other risks described in this report and other factors described from time to time in the Company’s filings with the SEC.

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Liquidity and Capital Resources

There have been no material changes in the Company’s liquidity or capital resources since the fiscal year ended June 30, 2006. We continue to maintain a strong working capital position, and believe that our short and long term cash requirements will be provided by internal sources. We do not expect to rely on banks or other third parties for our working capital needs.

Our working capital is composed of the following:

At December 31, 2006 we had no material commitments for capital expenditures.

Results of Operations

Overview

Management’s initiatives to strengthen the Company’s sales and distribution network and improve sales, as described in the Company’s annual report on Form 10-K for the fiscal year ended June 30, 2006, continued during the second quarter of the fiscal year ending June 30, 2007 (“fiscal 2007”), and are updated as follows:

·                  Promotion of our BRAND.

·                  Our new product packaging and point of sale marketing materials are expected to further establish brand awareness and enhance the image of our product line.

·                  The roll-out of new packaging began in October 2006, and will continue through the remainder of fiscal 2007. We believe that our new packaging will help stimulate sales of our allied products.

·                  Introduction of New Products.

·                  We believe the regular introduction of new products will engage our customers, both existing and potential, and further brand awareness.

·                  During the second quarter of fiscal 2007, we continued our introduction of new products. In particular, we expanded our line of canned coffees to include Premium, Premium Decaf, 100% Colombian, Dark-Roast and a seasonal Holiday Blend. Additionally, we introduced a new bag coffee, Arabica Rush. These items have been favorably received and we believe are helping our sales force reintroduce our entire product line.

·                  Expansion and Cost Control.

·                  In an effort to expand our geographic presence, we opened a new branch in Cincinnati, Ohio during the most recent fiscal quarter and expect to open a branch in Shreveport, Louisiana by the end of fiscal 2007.

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·                  We continue to implement changes to our information systems, which we expect over time will lead to lower operating costs. A major upgrade to our ERP system will be installed during the third quarter of fiscal 2007, with testing of the sales system expected during the fourth quarter of fiscal 2007.

Comparative Information

Net sales in the second quarter of fiscal 2007 increased $526,000 or 1% to $55,476,000 as compared to $54,950,000 in the second quarter of fiscal 2006. Sales for the first half of fiscal 2007 increased $366,000 to $103,740,000 as compared to $103,374,000 in the same period of fiscal 2006. A decline in coffee sales during the first half of fiscal 2007 was offset by an increase in sales of allied products during the period.

Cost of goods sold in the second quarter of fiscal 2007 increased to $22,995,000, or 41% of sales, as compared to $21,796,000, or 40% of sales, in the second quarter of fiscal 2006. Cost of good sold for the first half of fiscal 2007 increased to $43,176,000 or 42% of sales as compared to $41,335,000 or 40% of sales in the same period of fiscal 2006. Gross profit in the second quarter of fiscal 2007 decreased $673,000 to $32,481,000 as compared to $33,154,000 in the same quarter of fiscal 2006. Gross profit in the first half of fiscal 2007 decreased $1,475,000 to $60,564,000 from $62,039,000 in the same period of fiscal 2006. Although profit margins on allied products improved in the first half of fiscal 2007 as compared to fiscal 2006, the average cost of green coffee during this period of fiscal 2007 exceeded that of the same period of fiscal 2006 by approximately 10% as reported by the New York Board of Trade.

Selling, general and administrative expenses in the second quarter of fiscal 2007 increased $1,336,000, or 4%, to $31,341,000 from $30,005,000 in the same quarter of fiscal 2006. For the first half of fiscal 2007 selling, general and administrative expenses increased $2,147,000 or 4% to $62,161,000 from $60,014,000 in the same period of fiscal 2006, primarily due to increased costs of coffee brewing equipment associated with the new sales programs.

Total other income, net in the second quarter of fiscal 2007 increased to $2,830,000 from $2,138,000 in the same period of fiscal 2006. Higher interest rates during the second quarter of fiscal 2007 compared favorably with interest rates in the same quarter of the prior fiscal year. Total other income, net in the first half of fiscal 2007 increased to $6,550,000 from $2,207,000 in the same period of fiscal 2006. This increase is largely the result of higher interest rates in the first half of fiscal 2007 and unrealized gains on interest sensitive investments, primarily preferred stock, futures and options.

As a result of the forgoing factors net income for the second quarter of fiscal 2007 was $2,953,000, or $0.21 per share, as compared to net income of $4,164,000, or $0.30 per share, in the same period of fiscal 2006. Net income for the first half of fiscal 2007 reached $3,966,000, or $0.28 per share, as compared to $3,085,000, or $0.22 per share in the first half of fiscal 2006.

Quarterly Financial Data

(In thousands except per share data)

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Item 3. Qualitative and Quantitative Disclosures About Market Risk

Interest Rate Risk

We are exposed to market value risk arising from changes in interest rates on our securities portfolio. Our portfolio of investment grade money market instruments can include at any given time discount commercial paper, medium term notes, federal agency issues and treasury securities. As of December 31, 2006, over 90% of these funds were invested in U.S. Treasury securities and approximately 40% of these issues have maturities shorter than 90 days. This portfolio’s interest rate risk is not hedged and its average maturity is approximately 106 days. A 100 basis point move in the general level of interest rates would result in a change in the market value of the portfolio of approximately $1,149,000.

Our portfolio of preferred securities includes investments in derivatives that provide a natural economic hedge of interest rate risk. We review the interest rate sensitivity of these securities and (a) enter into “short positions” in futures contracts on U.S. Treasury securities or (b) hold put options on such futures contracts in order to reduce the impact of certain interest rate changes on such preferred stocks. Specifically, we attempt to manage the risk arising from changes in the general level of interest rates. We do not transact in futures contracts or put options for speculative purposes.

The following table demonstrates the impact of varying interest rate changes based on the preferred stock holdings, futures and options positions, and market yield and price relationships at December 31, 2006. This table is predicated on an instantaneous change in the general level of interest rates and assumes predictable relationships between the prices of preferred securities holdings, the yields on U.S. Treasury securities and related futures and options.

The number and type of futures and options contracts entered into depends on, among other items, the specific maturity and issuer redemption provisions for each preferred stock held, the slope of the Treasury yield curve, the expected volatility of U.S. Treasury yields, and the costs of using futures and/or options.

Commodity Price Risk

We are exposed to commodity price risk arising from changes in the market price of green coffee. We price our coffee inventory on the LIFO basis. In the normal course of business we hold a large green coffee inventory and enter into forward commodity purchase agreements with suppliers. We are subject to price risk resulting

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from the volatility of green coffee prices. Volatile price increases cannot, because of competition and market conditions, always be passed on to our customers. From time to time the Company will hold a mix of futures contracts and options to help hedge against volatile green coffee price decreases. Gains and losses on these derivative instruments are realized immediately in Other, net income (expense).

On December 31, 2006 we had no open hedge derivative contracts, and our entire exposure to commodity price risk was in the potential change of our coffee inventory value resulting from changes in the market price of green coffee.

Item 4. Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

In designing and evaluating the Company’s disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and in reaching a reasonable level of assurance. Our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As of December 31, 2006, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Rules 13(a)-15(e) and 15(d)-15(e) promulgated under the Exchange Act. Based upon this evaluation, and subject to the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2006, our disclosure controls and procedures were (1) designed to ensure that material information relating to our company is accumulated and made known to our management, including our Chief Executive Officer and Chief Financial Officer, in a timely manner, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in Internal Control over Financial Reporting

Management has determined that there has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) during our fiscal quarter ended December 31, 2006, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders.

(a)           The Company held its Annual Meeting of Stockholders on November 28, 2006.

(b)           Omitted pursuant to Instruction 3 to Item 4 of Form 10-Q.

(c)           The two items voted upon at the meeting were (i) to elect two directors to a three year term of office expiring at the 2009 Annual Meeting of Stockholders (“Item 1”); and (ii) to ratify the selection of Ernst & Young LLP as the Company’s independent registered public accounting firm for the fiscal year ending June 30, 2007 (“Item 2”).

The results of voting at the Annual Meeting of Stockholders follows:

Item 1 - Election of Directors

Item 2 - Ratification of Selection of Ernst & Young LLP as independent registered public accounting firm for the fiscal year ending June 30, 2007.

All nominees to the Board of Directors were declared to have been elected as directors to hold office until the 2009 Annual Meeting of Stockholders. Item 2 was declared to have been approved.

(d) Not applicable.

Item 6. Exhibits

See Exhibit Index.

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EXHIBIT INDEX

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* Management contract or compensatory plan or arrangement.

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