Share-based Compensation

On August 23, 2007, the Company’s Board of Directors approved the Farmer Bros. Co. 2007 Omnibus Plan (the “Omnibus Plan”), which was approved by stockholders on December 6, 2007. Prior to adoption of the Omnibus Plan the Company had no share-based compensation plan. Awards issued under the Omnibus Plan may take the form of stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalents, performance-based awards, stock payments, cash-based awards or other incentives payable in cash or shares of stock, or any combination thereof. Each award will be set forth in a separate agreement with the person receiving the award and will indicate the type, terms and conditions of the award. The maximum number of shares of common stock as to which awards may be granted under the Omnibus Plan is 1,000,000, subject to adjustment as provided in the Omnibus Plan.

The Company measures and recognizes compensation expense for all share-based payment awards made under the Omnibus Plan based on estimated fair values.

Stock Options

The Company estimates the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period in the Company’s consolidated statements of operations.

Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Compensation expense recognized for all stock option awards granted is recognized using the straight-line method over the vesting period. The options generally vest ratably over a period of 3 years, however, fiscal 2012 grants included nonqualified stock option awards to executive officers with different vesting periods, in each case, subject to certain events of acceleration as provided in the applicable employment agreement or award agreement with the executive officer.

The share-based compensation expense recognized in the Company’s consolidated statement of operations for the fiscal years ended June 30, 2012, 2011 and 2010 is based on awards ultimately expected to vest. Currently, management estimates an annual forfeiture rate of 6.5% based on actual forfeiture experience from the inception of the Omnibus Plan. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

The Company uses 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 the 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.

The following are the weighted average assumptions used in the Black-Scholes valuation model:



	Year Ended June 30,
	2012			2011			2010
Average fair value of options	$	4.42		$	7.05		$	6.09
Forfeiture rate	6.5		%	6.5		%	6.5		%
Risk-free interest rate	1.1		%	2.7		%	2.6		%
Dividend yield	—		%	1.3		%	2.5		%
Average expected life	6 years			6 years			6 years
Expected stock price volatility	52.5		%	54.7		%	41.2		%

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 life is based on the midpoint between the vesting date and the end of the contractual term of the award.

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



Outstanding Stock Options	Number of Stock Options		Weighted Average Exercise Price ($)	Weighted Average Grant Date Fair Value ($)	Weighted Average Remaining Life (Years)	Aggregate Intrinsic Value (Dollars in thousands)
Outstanding at June 30, 2009	239,000		22.22	6.41	6.1	60
Granted	220,789		18.25	6.09	—	—
Cancelled/Forfeited	(54,846	)	21.65	6.87	—	—
Outstanding at June 30, 2010	404,943		20.17	6.25	5.8	—
Granted	327,656		14.95	7.05	—	—
Cancelled/Forfeited	(234,789	)	19.21	6.97	—	—
Outstanding at June 30, 2011	497,810		17.19	6.44	5.7	61
Granted	356,834		8.90	4.42	—	—
Cancelled/Forfeited	(187,409	)	16.89	5.06	—	—
Outstanding at June 30, 2012	667,235		12.84	4.78	4.8	143
Vested and exercisable, June 30, 2012	323,996		15.04	5.39	3.1	—
Vested and expected to vest, June 30, 2012	641,455		12.84	4.80	3.1	128

The aggregate intrinsic values in the table above represent the total pretax intrinsic value, based on the Company’s closing stock price of $7.96 at June 29, 2012, $10.14 at June 30, 2011 and $15.09 at June 30, 2010, representing the last trading day of the respective years, which would have been received by award holders had all award holders exercised their awards that were in-the-money as of those dates. Total fair value of options vested during fiscal 2012, 2011 and 2010 was $1.2 million,

$0.7 million and $0.4 million, respectively.



Nonvested Stock Options	Number of Stock Options		Weighted Average Exercise Price ($)	Weighted Average Grant Date Fair Value ($)	Weighted Average Remaining Life (Years)
Outstanding at June 30, 2009	198,510		22.13	6.46	2.1
Granted	220,789		18.25	6.09	—
Vested	(68,990	)	22.20	6.43	—
Cancelled/Forfeited	(49,515	)	21.21	6.35	—
Outstanding at June 30, 2010	300,794		19.42	6.22	2.1
Granted	327,656		14.95	7.05	—
Vested	(105,458	)	20.29	6.30	—
Cancelled/Forfeited	(200,123	)	18.74	7.09	—
Outstanding at June 30, 2011	322,869		15.02	6.50	1.7
Granted	356,834		8.90	4.42	—
Vested	(243,518	)	13.00	5.85	—
Cancelled/Forfeited	(92,946	)	12.54	5.80	—
Outstanding at June 30, 2012	343,239		10.76	4.20	6.3

As of June 30, 2012, 2011 and 2010, there was approximately $1.3 million, $1.5 million, and $1.4 million, respectively, of unrecognized compensation cost related to stock options. Compensation expense recognized in general and administrative expenses was $1.2 million, $0.7 million and $0.6 million for fiscal 2012, 2011 and 2010, respectively.

Restricted Stock

During each of fiscal 2012, 2011 and 2010 the Company granted a total of 142,070 shares, 63,979 shares and 48,722 shares of restricted stock, respectively, with a weighted average grant date fair value of $7.70, $16.67 and $18.31 per share, respectively, to eligible employees, officers and directors under the Omnibus Plan. Shares of restricted stock generally vest at the end of three years for eligible employees and officers who are employees. The fiscal 2012 grants included awards to executive officers with different vesting periods, in each case, subject to accelerated vesting as provided in the applicable employment agreement or award agreement with the executive officer.

Shares of restricted stock generally vest ratably over a period of three years for directors and officers who are not employees. 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 general and administrative expense was $0.6 million, $0.5 million and $0.4 million, for the fiscal years ended June 30, 2012, 2011 and 2010, respectively. As of June 30, 2012, 2011 and 2010, there was approximately $1.3 million, $0.9 million and $0.9 million, respectively, of unrecognized compensation cost related to restricted stock.

The following tables summarize restricted stock activity:



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, 2009	48,169		22.19	2.1	1,072
Granted	48,722		18.31	—	892
Exercised/Released	(5,860	)	22.18	—	105
Cancelled/Forfeited	(10,823	)	21.79	—	235
Outstanding at June 30, 2010	80,208		19.91	2.0	1,210
Granted	63,979		16.67	—	1,066
Exercised/Released	(20,674	)	21.52	—	332
Cancelled/Forfeited	(42,826	)	19.19	—	497
Outstanding at June 30, 2011	80,687		17.31	2.6	818
Granted	142,070		7.70	—	1,094
Exercised/Released	(27,227	)	15.80	—	202
Cancelled/Forfeited	(19,583	)	13.92	—	—
Outstanding June 30, 2012	175,947		10.16	1.9	1,401
Expected to vest, June 30, 2012	143,819		10.16	1.9	1,401