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FARM > SEC Filings for FARM > Form 10-Q on 6-May-2013All Recent SEC Filings

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Form 10-Q for FARMER BROTHERS CO


6-May-2013

Quarterly Report


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

Forward-Looking Statements
The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. The results of operations for the three and nine months ended March 31, 2013 are not necessarily indicative of the results that may be expected for any future period. The following discussion should be read in combination with the consolidated financial statements and the notes thereto included in Part I, Item 1 of this report and with the "Risk Factors" described in Part II, Item 1A of this report.
Liquidity and Capital Resources
Credit Facility
On September 12, 2011, we entered into an Amended and Restated Loan and Security Agreement (the "Loan Agreement") among the Company and CBI, as Borrowers, certain of the Company's other subsidiaries, as Guarantors, the Lenders party thereto, and Wells Fargo Bank, National Association ("Wells Fargo"), as Agent for the Lenders.
On January 9, 2012, the Loan Agreement was amended in connection with JPMorgan Chase Bank, N.A. ("JPMorgan Chase"), becoming an additional Lender thereunder. On March 18, 2013, the Loan Agreement was amended further ("Amendment No. 2") to amend the definition of "Maximum Credit" available thereunder to $75.0 million from $85.0 million. Pursuant to Amendment No. 2, Wells Fargo will provide a commitment of $53.0 million and JPMorgan Chase will provide a commitment of $22.0 million.
The Loan Agreement provides for a senior secured revolving credit facility of up to $75.0 million, with a letter of credit sublimit of $20.0 million. The revolving credit facility provides for advances of 85% of eligible accounts receivable and 75% of eligible inventory (subject to a $60.0 million inventory loan limit), as defined. The Loan Agreement provides for interest rates based on modified Monthly Average Excess Availability levels with a range of PRIME + 0.25% to PRIME + 0.75% or Adjusted Eurodollar Rate + 2.0% to Adjusted Eurodollar Rate + 2.5%. The Loan Agreement has an amendment fee of 0.375% and an unused line fee of 0.25%. Outstanding obligations under the Loan Agreement are collateralized by all of the Borrowers' assets, including the Company's preferred stock portfolio. The term of the Loan Agreement expires on March 2, 2015.
The Loan Agreement contains a variety of affirmative and negative covenants of types customary in an asset-based lending facility, including those relating to reporting requirements, maintenance of records, properties and corporate existence, compliance with laws, incurrence of other indebtedness and liens, limitations on certain payments, including the payment of dividends and capital expenditures, and transactions and extraordinary corporate events. The Loan Agreement allows us to pay dividends, subject to certain liquidity requirements. The Loan Agreement also contains financial covenants requiring the Borrowers to maintain minimum Excess Availability and Total Liquidity levels. The Loan Agreement allows the Lender to establish reserve requirements, which may reduce the amount of credit otherwise available to us, to reflect events, conditions, or risks that would have a reasonable likelihood of adversely affecting the Lender's collateral or our assets, including our green coffee inventory. The Loan Agreement provides that an event of default includes, among other things, subject to certain grace periods: (i) payment defaults; (ii) failure by any guarantor to perform any guarantee in favor of Lender; (iii) failure to abide by loan covenants; (iv) default with respect to other material indebtedness; (v) final judgment in a material amount not discharged or stayed;
(vi) any change of control; (vii) bankruptcy or insolvency; and (viii) the failure of the Farmer Bros. Co. Employee Stock Ownership Benefit Trust, created by the Company to implement the Farmer Bros. Co. Employee Stock Ownership Plan ("ESOP"), to be duly qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended, or exempt from federal income taxation, or if the ESOP engages in a material non-exempt prohibited transaction. Effective December 1, 2012, we entered into an interest rate swap transaction utilizing a notional amount of $10.0 million and a maturity date of March 1, 2015. We entered into the swap transaction to effectively fix the future interest rate during the applicable period on a portion of our borrowings under the revolving credit facility. The swap transaction is intended to manage our interest rate risk related to the revolving credit facility and requires us to pay a fixed rate of 0.48% per annum in exchange for a variable interest rate based on 1-month USD LIBOR-BBA. As of April 30, 2013, the variable interest rate based on 1-month USD LIBOR-BBA was 0.20% We have not designated our interest rate swap as an accounting hedge. We record the interest rate swap on our consolidated balance sheet at fair market value with the changes in fair value recorded as gain or loss in "Other, net" in our


consolidated statements of operations. In the three and nine months ended March 31, 2013, we recorded a gain of $4,000 and a loss of $35,000, respectively, for the change in fair value of our interest rate swap. No such gains or losses were recorded in the three and nine months ended March 31, 2012 (see Note 2 to the consolidated financial statements).
On March 31, 2013, we were eligible to borrow up to a total of $65.2 million under the credit facility. As of March 31, 2013, we had outstanding borrowings of $20.2 million, including loan extension fees of $0.2 million, utilized $10.2 million of the letters of credit sublimit, and had excess availability under the credit facility of $34.8 million. In connection with entering into the interest rate swap agreement, we reclassified $10.0 million of our borrowings under the revolving credit facility as long-term because we intend to repay the borrowings in accordance with the termination date of the swap agreement which extends beyond one year. The weighted average interest rate on our outstanding borrowings under the credit facility was 1.35% at March 31, 2013. We believe that the carrying value of our outstanding borrowings under the revolving credit facility approximates fair value at March 31, 2013 as the revolving credit facility bears interest at a variable interest rate based on prevailing market conditions.
As of March 31, 2013, we were in compliance with all restrictive covenants under the Loan Agreement. There can be no assurance that the Lender will issue a waiver or grant an amendment to the covenants in future periods, if we required one. As of April 30, 2013, we were eligible to borrow $65.7 million, had outstanding borrowings of $17.7 million, including loan extension fees of $0.2 million, utilized $11.6 million of the letters of credit sublimit, and had excess availability under the credit facility of $36.4 million. As of April 30, 2013, the weighted average interest rate on our outstanding borrowings under the credit facility was 1.33%.
Liquidity
We generally finance our operations through cash flow from operations and borrowings under our revolving credit facility described above. As of March 31, 2013, we had $5.5 million in cash and cash equivalents, $3.8 million held in our derivatives trading account as collateral for our coffee-related derivatives activity and $20.8 million in short-term investments. We believe our revolving credit facility, to the extent available, in addition to our cash flows from operations and other liquid assets, are sufficient to fund our working capital and capital expenditure requirements for the next 12 months.
We generate cash from operating activities primarily from cash collections related to the sale of our products. Net cash provided by operating activities was $17.8 million in the nine months ended March 31, 2013, compared with $11.0 million in the nine months ended March 31, 2012. Net cash provided by operating activities in the nine months ended March 31, 2013 was primarily due to lower net loss and increase in accounts payable, offset, in part, by increase in accounts receivable and inventories. Net cash provided by operating activities in the nine months ended March 31, 2012 was primarily due to decrease in inventory levels and collection of outstanding receivables.
Net cash used in investing activities was $4.6 million in the nine months ended March 31, 2013, compared to $8.4 million in the nine months ended March 31, 2012. In the nine months ended March 31, 2013, cash inflow from the sale of fixed assets, primarily real estate, was $5.6 million and cash outflow for capital expenditures was $10.1 million. In the nine months ended March 31, 2012, cash inflow from the sale of fixed assets, primarily real estate, was $2.1 million and cash outflow for capital expenditures was $10.5 million. Net cash used in financing activities was $11.6 million in the nine months ended March 31, 2013, compared to $5.2 million in the nine months ended March 31, 2012. Cash flows related to financing activities included net repayments on our revolving credit facility of $10.2 million in the nine months ended March 31, 2013, partially offset by $1.2 million in proceeds from stock option exercises, compared to $4.0 million in net repayments on our revolving credit facility in the nine months ended March 31, 2012.
In the nine months ended March 31, 2013, we capitalized $10.1 million in property, plant and equipment purchases which included $7.1 million in expenditures to replace normal wear and tear of coffee brewing equipment, and $2.3 million in expenditures for vehicles and machinery and equipment. Our total expected capital expenditures for fiscal 2013 include expenditures to replace normal wear and tear of coffee brewing equipment, vehicles, and machinery and equipment and are expected not to deviate significantly from fiscal 2012 levels.


Our working capital is composed of the following:

                          March 31, 2013      June 30, 2012
(In thousands)              (Unaudited)
Current assets           $        143,050    $       135,851
Current liabilities(1)             78,963             92,689
Working capital          $         64,087    $        43,162


______________


(1) Includes $10.0 million in borrowings under revolving credit facility as of June 30, 2012, which has been reclassified into long-term liabilities as of March 31, 2013.
Liquidity information:
                             Nine Months Ended March 31,
                                  2013                2012
(In thousands)                      (Unaudited)
Capital expenditures   $       10,118               $ 10,533

Results of Operations
Net sales in the fiscal quarter ended March 31, 2013 increased $4.8 million, or 4%, to $126.3 million as compared to $121.5 million in the fiscal quarter ended March 31, 2012. The increase was primarily due to increases in sales of our coffee and tea products. Net sales in the nine months ended March 31, 2013 increased $6.7 million, or 2%, to $381.2 million as compared to $374.5 million in the nine months ended March 31, 2012, primarily due to increases in sales of our coffee and tea products.
Gross profit in the three months ended March 31, 2013 increased $5.6 million, or 13%, to $48.7 million, as compared to $43.1 million in the three months ended March 31, 2012. Gross margin increased to 39% in the three months ended March 31, 2013 from 36% in the comparable period in the prior fiscal year. Gross profit during the nine months ended March 31, 2013 increased $16.2 million, or 13%, to $143.6 million, as compared to $127.4 million in the nine months ended March 31, 2012. Gross margin increased to 38% in the nine months ended March 31, 2013 from 34% in the comparable period of the prior fiscal year. Gross profit in each of the three and nine months ended March 31, 2013 included the expected beneficial effect of the liquidation of LIFO inventory quantities in the amount of $0.2 million and $0.7 million, respectively. Gross profit in the three and nine months ended March 31, 2012 included the expected beneficial effect of the liquidation of LIFO inventory quantities in the amount of $2.2 million and $7.8 million, respectively (see Note 5 to the consolidated financial statements). The increase in gross margin during the three and nine months ended March 31, 2013 is primarily due to a 29% and 31% decline, respectively, in the average cost of green coffee beans purchased compared to the same periods in the prior fiscal year.
Operating expenses in the three months ended March 31, 2013 increased $2.0 million, or 4.3%, to $49.3 million, or 39% of sales, from $47.3 million, or 39% of sales, in the three months ended March 31, 2012. Operating expenses in the nine months ended March 31, 2013 increased $3.6 million, or 3%, to $145.4 million, or 38% of sales, from $141.8 million, or 38% of sales, in the nine months ended March 31, 2012. Operating expenses in the three months ended March 31, 2013 included higher expenses resulting from our investments in additional sales and marketing training, expenses related to the launch of the Artisan Collection by Farmer Brothers™and the new Farmer Brothers teas, and higher expenses related to severance. Operating expenses in the nine months ended March 31, 2013 benefited from the absence of pension withdrawal expense but included higher expenses resulting from our investments in additional sales and marketing training, expenses related to the launch of the Artisan Collection by Farmer Brothers™and the new Farmer Brothers teas, higher startup costs associated with the increase in national customers, higher expenses related to severance and losses in one of our distribution centers affected by hurricane Sandy. Operating expenses in the nine months ended March 31, 2012 included $4.3 million in pension withdrawal expense related to a multiemployer pension plan. Total other expense in the three months ended March 31, 2013 was $0.9 million compared to $2.0 million in the three months ended March 31, 2012. Total other expense in the nine months ended March 31, 2013 was $3.7 million compared to $3.0 million in the nine months ended March 31, 2012.
Total other expense in the three and nine months ended March 31, 2013 included $2.9 million and $10.1 million, respectively, in net realized and unrealized coffee-related derivative losses, compared to $3.3 million and $7.5 million, respectively, in the three and nine months ended March 31, 2012. The increase in net realized and unrealized coffee-related derivative losses in the three and nine months ended March 31, 2013 compared to the same periods in the prior fiscal year is due in large part to the increase in the number of futures contracts combined with a decline of approximately 5% per pound and


19% per pound, respectively, in coffee commodity costs during the three and nine months ended March 31, 2013. There was a four-fold increase in the number of our coffee-related derivative contracts as of March 31, 2013 covering 34.8 million pounds of green coffee compared to 9.4 million pounds of green coffee covered as of March 31, 2012. The increase in the number of such contracts is primarily due to the increase in the number of our national customers since a majority of the contracts are purchased for their accounts.
We have adopted a hedging strategy intended to establish predictable prices for future supply of green coffee with futures contracts that we purchase for certain of our national customer accounts and for our own account for longer periods of time than was done previously because the cost of coffee significantly declined during the last 12 to 18 months, making these long-term futures contracts relatively less expensive than they had been previously. Since the coffee-related derivatives are not designated as accounting hedges, in accordance with GAAP, we recognized the net unrealized and realized losses immediately in our consolidated statements of operations as the derivative contracts were re-valued to their market prices. These losses are expected to be offset by future derivative gains as the coffee market changes, recovered through operating income as a result of the lower cost of goods assigned to the related coffee or recovered from customers for whom contracts were purchased for their accounts. Beginning April 1, 2013, we implemented procedures following the guidelines of ASC 815, "Derivatives and Hedging" ("ASC 815"), to enable us to account for certain coffee-related derivatives as accounting hedges in order to minimize the volatility created in our quarterly results from utilizing these derivative contracts and to improve comparability between reporting periods. As a result, beginning in the fourth quarter of fiscal 2013, we anticipate a portion of the gains and losses from re-valuing the coffee-related derivative contracts to their market prices will be recorded in accumulated other comprehensive income on our consolidated balance sheet and recognized in cost of goods sold when the related coffee is received.
Total other expense in the three months ended March 31, 2013 and 2012 included $1.2 million in net gains on sales of assets, primarily real estate, and $0.5 million in net gains on sales of assets, respectively. Total other expense in the nine months ended March 31, 2013 included $4.4 million in net gains on sales of assets, primarily real estate, and $0.8 million in recovery of an account previously deemed uncollectible. Total other expense in the nine months ended March 31, 2012 included $2.3 million in net gains on sales of investments and $1.2 million in net gains on sales of assets, primarily real estate. Income tax benefit in the three months ended March 31, 2013 was $56,000 compared to $0.6 million in the three months ended March 31, 2012. Income tax expense in the nine months ended March 31, 2013 was $0.3 million compared to income tax benefit of $0.2 million in the nine months ended March 31, 2012. As a result of the forgoing factors, net loss in the fiscal quarter ended March 31, 2013 was $(1.4) million, or $(0.09) per common share, as compared to net loss of $(5.5) million, or $(0.35) per common share, during the same period in the prior fiscal year. Net loss in the nine months ended March 31, 2013 was $(5.8) million, or $(0.38) per common share, as compared to net loss of $(17.2) million, or $(1.11) per common share, during the same period in the prior fiscal year.
Non-GAAP Financial Measures
In addition to net income (loss) determined in accordance with GAAP, we use certain non-GAAP financial measures, such as "EBITDAE" in assessing our operating performance. We believe that this non-GAAP financial measure serves as an appropriate measure to be used in evaluating the performance of our business. We define EBITDAE as net income (loss) excluding the impact of income taxes, interest expense, depreciation and amortization expense, ESOP and share-based compensation expense, non-cash impairment losses and pension withdrawal expense, if any, and net gains and losses from derivatives and investments. EBITDAE as defined by us may not be comparable to similarly titled measures reported by other companies. We do not intend for non-GAAP financial measures to be considered in isolation or as a substitute for other measures prepared in accordance with GAAP.


Set forth below is a reconciliation of reported net loss to EBITDAE:

                                      Three Months Ended March 31,           Nine Months Ended March 31,
(In thousands)                           2013               2012              2013                2012
                                               (Unaudited)                           (Unaudited)
Net loss, as reported(1)(2)        $      (1,415 )     $      (5,501 )   $     (5,835 )     $      (17,195 )
Income tax (benefit) expense                 (56 )              (577 )            347                 (171 )
Interest expense                             466                 498            1,386                1,579
Depreciation and amortization
expense                                    8,138               8,010           24,778               23,831
ESOP and share-based
compensation expense                         733               1,043            2,639                2,519
Pension withdrawal expense                     -                   -                -                4,348
Net losses on derivatives and
investments                                2,278               2,882            9,315                5,131
EBITDAE(1)(2)                      $      10,144       $       6,355     $     32,630       $       20,042


_____________


(1) Three months ended March 31, 2013 and 2012, respectively, include $1.2 million and $0.5 million in net gains on sales of assets. Nine months ended March 31, 2013 and 2012, respectively, include $4.4 million and $1.2 million in net gains on sales of assets, primarily real estate.
(2) Three months ended March 31, 2013 and 2012, respectively, include the expected beneficial effect of LIFO inventory liquidation in the amount of $0.2 million and $2.2 million. Nine months ended March 31, 2013 and 2012, respectively, include the expected beneficial effect of LIFO inventory liquidation in the amount of $0.7 million and $7.8 million.

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