| FARMER BROTHERS CO Item 1A Risk Factors Certain statements contained in this Annual Report on Form 10-K regarding the risks, circumstances and financial trends that may affect our future operating results, financial position and cash flows may be forward-looking statements within the meaning of federal securities laws |
| These statements are based on management’s current expectations, assumptions, estimates and observations about our business and are subject to risks and uncertainties |
| As a result, actual results could materially differ from the forward-looking statements contained herein |
| These forward-looking statements can be identified by the use of words like “expects,” “plans,” “believes,” “intends,” “will,” “assumes” and other words of similar meaning |
| While we believe our assumptions are reasonable, we caution that it is impossible to predict the impact of such factors which could cause actual results to differ materially from predicted results |
| We intend these forward-looking statements to speak only at the time of this report and do not undertake to update or revise these statements as more information becomes available |
| For these statements, we claim the protection of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995 |
| The Company’s business, its future performance and forward-looking statements are affected by general industry and market conditions and growth rates, general US and non-US economic and political conditions (including the global economy), competition, interest rate and currency exchange rate fluctuations, and other events |
| The following items are representative of the risks, uncertainties and other conditions that may impact the Company’s business, future performance and the forward-looking statements that it makes in this Annual Report on Form 10-K or that it may make in the future |
| Our actual results could differ materially from anticipated results due to some or all of the factors discussed below |
| To help ensure future supplies, we may purchase our coffee on forward contracts for delivery as long as six months in the future |
| In the event of non-performance by the suppliers, the Company could be exposed to credit and supply risk |
| Entering into such future commitments also leaves the Company subject to purchase price risk |
| Various techniques are used to hedge these purchases against untoward price movement |
| Competitive factors make it difficult for the Company to “pass through” such price fluctuation to its customers |
| Therefore, unpredictable price changes can have an immediate effect on operating results that cannot be corrected in the short run |
| To reduce its exposure to the volatile fluctuation of green coffee costs, Farmer Bros |
| has, from time to time, entered into futures contracts to hedge coffee purchase commitments |
| Open contracts associated with these hedging activities are described in Item 7A “Quantitative and Qualitative Disclosures About Market Risk |
| ” 3 ______________________________________________________________________ INCREASES IN THE COST OF GREEN COFFEE COULD REDUCE OUR GROSS MARGIN AND PROFIT Our primary raw material is green coffee, an agricultural commodity |
| Green coffee is mainly grown outside the US and can be subject to volatile price fluctuations |
| Weather, real or perceived shortages, labor actions, political unrest and armed conflict in coffee producing nations, and government actions, including treaties and trade controls between the US and coffee producing nations, can affect the price of green coffee |
| Green coffee prices can also be affected by the actions of producer organizations |
| The most prominent of these are the Colombian Coffee Federation (CCF), the International Coffee Organization (ICO) and the Association of Coffee Producing Countries (ACPC) |
| These organizations seek to increase coffee prices largely be attempting to restrict supplies, thereby limiting the availability of green coffee to coffee consuming nations |
| In the past, we generally have been able to pass increases in green coffee costs to our customers |
| However, there can be no assurance that we will be successful in passing such fluctuations on to our customers without losses in sales volume or gross margin in the future |
| Similarly, rapid sharp decreases in the cost of green coffee could also force us to lower sales prices before realizing cost reductions in our green coffee inventory |
| OUR INDUSTRY IS HIGHLY COMPETITIVE AND WE MAY NOT HAVE THE RESOURCES TO COMPETE EFFECTIVELY We primarily compete with other coffee companies, including multi-national firms with substantially greater financial, marketing and operating resources than the Company |
| We face competition from many sources including the food service divisions of multi-national manufacturers of retail products such as Proctor and Gamble (Folgers Coffee), Kraft Foods (Maxwell House Coffee) and Sara Lee Foods (Superior Coffee), wholesale grocery distributors such as Sysco and US Food Service, and regional coffee roasters such as Boyd Coffee Company |
| Some of our competitors outsource their product distribution, while others conduct their own distribution |
| Large roasters have volumes far in excess of ours, with a business model that is substantially different from ours |
| We compete with those firms and others for a wide variety of customers, from small restaurants and donut shops, to large institutional buyers like restaurant chains, hospitals, hotels, contract food services and convalescent hospitals |
| If we do not succeed in differentiating ourselves from our competitors or our competitors adopt our strategies, then our competitive position may be weakened |
| we differentiate ourselves from our competitors by the quality of our products, our distribution network and our customer service |
| Some of our customers are “price” buyers, seeking the low cost provider with little concern about service; others find great value in the service programs we provide |
| We compete well when service and distribution are valued by our customers, and are less effective when only price matters |
| Our customer base is price sensitive and we are often faced with price competition |
| CHANGES IN CONSUMER PREFERENCES COULD ADVERSELY AFFECT OUR BUSINESS Our continued success depends, in part, upon the demand for coffee |
| Shifts in consumer preferences away from a “standard” cup of coffee could adversely affect our profitability |
| Our primary market is restaurants and other food service establishments |
| We also provide coffee and related products to offices |
| We believe the success of our market segment is dependent upon personal and business expenditures in restaurants and other food service businesses |
| There are many beverages, hot and cold, competing for the same restaurant dollar |
| Our restaurant customers report that competition from such beverages continues to dilute the demand for coffee |
| Consumers who choose soft drinks, bottled water, and flavored coffees and teas are all reducing the restaurant dollar formerly spent on a “standard” cup of coffee |
| While restaurants and coffee houses that sell “specialty” coffee and flavored coffee products may have increased 4 ______________________________________________________________________ the demand for coffee beverages, many of these establishments have taken market share from existing Farmer Bros |
| We have a line of products that compares favorably with products sold in such “specialty coffee” stores, but most of our restaurant customers do not specialize in coffee drinks |
| As a result, a further shift toward “specialty” coffee houses may adversely impact the demand for the Company’s products |
| REDUCTIONS IN DISCRETIONARY SPENDING COULD ADVERSELY AFFECT OUR BUSINESS Our success depends to a significant extent on a number of factors that affect discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence |
| In a slow economy, businesses and individuals scale back their discretionary spending on travel and entertainment, including “dining out |
| ” Economic conditions may also cause businesses to reduce travel and entertainment expenses, and even cause office coffee benefits to be eliminated |
| These factors could reduce demand for our products or impose practical limits on pricing, either of which could adversely affect our business, financial condition, operating results and cash flows |
| OUR SALES AND DISTRIBUTION NETWORK IS COSTLY TO MAINTAIN Our sales and distribution network requires a large investment to maintain and operate |
| Costs include the fluctuating cost of gasoline, diesel and oil, the costs associated with managing, purchasing, maintaining and insuring a fleet of delivery vehicles, the costs of maintaining distribution warehouses throughout the country, and the costs of hiring, training and managing our route sales professionals |
| Some competitors use alternate methods of distribution that eliminate some of the costs associated with our method of distribution |
| WE ARE SELF-INSURED OUR RESERVES MAY NOT BE SUFFICIENT TO COVER FUTURE CLAIMS We are self-insured for many risks up to significant deductible amounts |
| The premiums associated with our insurance have recently increased substantially |
| General liability, fire, workers’ compensation, directors and officers liability, life, employee medical, dental and vision and automobile risks present a large potential liability |
| While we accrue for this liability based on historical experience, future claims may exceed claims we have incurred in the past |
| Should a different amount of claims occur compared to what was estimated or the cost of the claims increase or decrease beyond what was anticipated, reserves recorded may not be sufficient and the accruals may need to be adjusted accordingly in future periods |
| EMPLOYEE STRIKES AND OTHER LABOR-RELATED DISRUPTIONS MAY ADVERSELY AFFECT OUR OPERATIONS We have union contracts relating to the majority of our workforce in California, Oregon, Washington and Nevada |
| Although we believe union relations have been amicable in the past, there is no assurance that this will continue in the future |
| There are potential adverse effects of labor disputes with our own employees or by others who provide transportation (shipping lines, truck drivers) or cargo handling (longshoremen), both domestic and foreign, of our raw materials or other products |
| These actions could restrict our ability to obtain, process and/or distribute our products |
| WE MAY ENTER INTO NEW BUSINESS VENTURES THAT COULD HAVE A NEGATIVE IMPACT ON OPERATING RESULTS From time to time, we evaluate potential business ventures and acquisitions |
| Entering into any such transaction entails many risks, any of which could materially harm our business |
| There is no assurance that any such venture, should we decide to enter into one, will accrue the projected returns |
| It is possible that such ventures could result in losses or returns that would have a negative impact on operating results |
| 5 ______________________________________________________________________ OUR ROASTING AND BLENDING METHODS ARE NOT PROPRIETARY, SO COMPETITORS MAY BE ABLE TO DUPLICATE THEM, WHICH COULD HARM OUR COMPETITIVE POSITION We consider our roasting and blending methods essential to the flavor and richness of our coffee and, therefore, essential to our brand |
| Because the Company’s roasting methods cannot be patented, we would be unable to prevent competitors from copying these methods if such methods became known |
| If our competitors copy our roasts or blends, the value of our brand may be diminished, and we may lose customers to our competitors |
| In addition, competitors may be able to develop roasting or blending methods that are more advanced than our production methods, which may also harm our competitive position |
| We expect that these operations will continue to generate a substantial portion of our revenue |
| A significant interruption in operations at our facilities in these markets, whether as a result of an earthquake, natural disaster, terrorism or other causes, could significantly impair our ability to operate our business |
| Our major manufacturing facility and distribution hub is in Los Angeles County |
| The majority of our green coffee comes through the Port of Los Angeles or the Port of Long Beach |
| Any interruption to port operations, highway arteries, gas mains or electrical service in this area could restrict our ability to supply our branches with product and would adversely impact our business |
| OUR OPERATING RESULTS MAY HAVE SIGNIFICANT FLUCTUATIONS FROM QUARTER TO QUARTER WHICH COULD HAVE A NEGATIVE EFFECT ON OUR STOCK PRICE From time to time, our operating results likely will fall below investor expectations |
| These results are influenced by a number of factors, including fluctuations in the price of green coffee, competition from existing or new competitors in our industry and changes in consumer preferences |
| Quarterly fluctuations in our operating results as the result of these factors or for any other reason, could cause our stock price to decline |
| Accordingly, we believe that period-to-period comparisons of our historical or future operating results are not necessarily meaningful, and such comparisons should not be relied upon as indicators of future performance |
| We could suffer additional losses in future years and as a result our stock price could decline |
| FUTURE FUNDING DEMANDS UNDER PENSION PLANS FOR CERTAIN UNION EMPLOYEES ARE UNKNOWN We participate in two multi-employer defined benefit plans for certain union employees |
| The management, funding status and future viability of these plans is not known at this time |
| The nature of the contract with these plans allows for future funding demands that are outside our control or ability to estimate |
| 6 ______________________________________________________________________ WE RELY ON A SINGLE THIRD PARTY SUPPLIER TO MANAGE OUR INTEGRATED ORACLE SYSTEM THAT IS INTEGRAL TO THE SUCCESS AND OPERATION OF OUR BUSINESS We rely on WTS, a company affiliated with Oracle, and its employees, in connection with the hosting of our integrated Management Information System |
| This System is essential to our operations and currently includes all accounting and production software applications |
| By the end of fiscal 2007, WTS is also expected to host our Route Sales application software |
| If WTS were to experience financial, operational, or quality assurance difficulties, or if there were any other disruption in our relationship with WTS, we might be unable to produce financial statements, fill replenishment orders for our branch warehouses, issue payroll checks, process payments to our vendors or bill customers |
| Any of these items could have a material adverse effect on the Company |
| WE ARE DEPENDENT ON ENTERPRISE RESOURCE MANAGEMENT (“ERP”) SOFTWARE TO OPERATE OUR BUSINESS SHOULD WE FAIL TO OPERATE EFFECTIVELY OR IF WE ENCOUNTER DIFFICULTIES INTEGRATING SYSTEMS OR SUFFER ILL-TIMED POWER OR COMMUNICATIONS FAILURES, THE RESULT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS We rely on complex software and hardware to invoice our customers, produce customer statements, account for our inventory and manufacturing costs, fill branch inventory replenishment orders, pay our bills, pay our employees and produce our financial statements |
| We have in the past encountered, and in the future may encounter, software and hardware errors, system design errors and errors in the operation of our systems |
| This has resulted in and may in the future result in a number of adverse consequences, including: users being disconnected from systems and being unable to perform their job functions, delays in producing financial statements and other key management system information |
| Reliance on such software also leaves us exposed to harmful software programs such as viruses that could disrupt our business and damage our network |
| It is possible that a security breach or inappropriate use of our network could expose us to the possibility of system failure or other disruption |
| A security breach could jeopardize security of confidential information and thereby expose the Company to potential legal liability |
| THE COMPANY DEPENDS ON THE EXPERTISE OF KEY PERSONNEL THE UNEXPECTED LOSS OF ONE OR MORE OF THESE KEY EMPLOYEES COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS OR COMPETITIVE POSITION Our continued success largely depends on the efforts and abilities of our executive officers and other key personnel |
| There is limited management depth in certain key positions throughout the Company |
| The unexpected loss of one or more of these key employees could have a material adverse effect on our operations and competitive position |
| Our former Chairman and Chief Executive Officer and sole coffee buyer, Roy E Farmer, died unexpectedly in January 2005 |
| Guenter W Berger, a long time member of our Board of Directors and Vice President, Production was appointed interim CEO and in August 2005 assumed the title of Chairman, CEO and President |
| A new coffee buyer was hired in June 2005 |
| In July 2006 we hired Roger M Laverty III as President and COO We continue to evaluate and recruit key personnel to enhance the depth of our management |
| Employee Stock Ownership Plan was designed to help us attract and retain employees and to better align the efforts of our employees with the interests of our stockholders |
| It is possible that additional shares could be acquired that might deplete the Company’s cash |
| We expect that the future re-funding liability of the existing shares in the ESOP will increase and require additional investment as the ESOP matures and individual holdings grow |
| When employees vested in the ESOP leave the Company, they have the right to “put” their shares to the Company for cash |
| Assuming all shares currently owned by the ESOP are fully distributed, the Company’s re-funding liability is approximately dlra64cmam700cmam000 based on the June 30, 2006 closing share price |
| CONCENTRATION OF OWNERSHIP AMONG OUR EXISTING PRINCIPAL STOCKHOLDERS MAY PREVENT NEW INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS AND MAY RESULT IN A LOWER TRADING PRICE FOR OUR STOCK THAN IF OWNERSHIP OF OUR STOCK WAS LESS CONCENTRATED As of September 1, 2006, members of the Farmer family or entities controlled by the Farmer family (such as trusts or business entities) as a group beneficially owned approximately 40prca of our outstanding common stock |
| As a result, these stockholders, acting together, may be able to influence the outcome of stockholder votes, including votes concerning the election and removal of directors and approval of significant corporate transactions |
| This level of concentrated ownership, along with the factors described in “Risk Factors—ANTI-TAKEOVER PROVISIONS COULD MAKE IT MORE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US,” may have the effect of delaying or preventing a change in the management or voting control of the Company |
| In addition, this significant concentration of share ownership may adversely affect the trading price for our common stock if investors perceive disadvantages in owning stock in a company with such concentrated ownership |
| ANTI-TAKEOVER PROVISIONS COULD MAKE IT MORE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US We have adopted a stockholder rights plan (the “Rights Plan”) and declared a dividend distribution of one preferred share purchase right (a “Right”) for each outstanding share of our common stock to stockholders of record as of March 28, 2005 |
| Each Right, when exercisable, will entitle the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, dlra1dtta00 par value per share, at a purchase price of dlra112dtta50, subject to adjustment |
| The Rights expire on March 28, 2015, unless they are earlier redeemed, exchanged or terminated as provided in the Rights Plan |
| Because the Rights may substantially dilute the stock ownership of a person or group attempting to take us over without the approval of our Board of Directors, our Rights Plan could make it more difficult for a third party to acquire us (or a significant percentage of our outstanding capital stock) without first negotiating with our Board of Directors regarding such acquisition |
| In addition, our Board of Directors has the authority to issue up to 500cmam000 shares of Preferred Stock (of which 200cmam000 shares have been designated as Series A Junior Participating Preferred Stock) and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders |
| The rights of the holders of our common stock may be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future |
| The issuance of preferred stock may have the effect of delaying, deterring or preventing a change of control of Farmer Bros |
| without further action by the stockholders and may adversely affect the voting and other rights of the holders of our common stock |
| Further, certain provisions of our charter documents, including a classified board of directors, provisions eliminating the ability of stockholders to take action by written consent, and provisions limiting the ability of stockholders to raise matters at a meeting of stockholders without giving advance notice, may have the effect of delaying or preventing changes in control or management of Farmer Bros, which could 8 ______________________________________________________________________ have an adverse effect on the market price of our stock |
| In addition, our charter documents do not permit cumulative voting, which may make it more difficult for a third party to gain control of our Board of Directors |
| Further, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit us from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, even if such combination is favored by a majority of stockholders, unless the business combination is approved in a prescribed manner |
| The application of Section 203 also could have the effect of delaying or preventing a change of control or management |
| FAILURE TO MAINTAIN EFFECTIVE INTERNAL CONTROLS IN ACCORDANCE WITH SECTION 404 OF THE SARBANES-OXLEY ACT OF 2002 COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND STOCK PRICE As directed by Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”), the SEC adopted rules requiring us, as a public company, to include a report of management on our internal controls over financial reporting in our annual report on Form 10-K and quarterly reports on Form 10-Q that contains an assessment by management of the effectiveness of our internal controls over financial reporting |
| In addition, our independent auditors must attest to and report on management’s assessment of the effectiveness of our internal controls over financial reporting as of the end of the fiscal year |
| Compliance with SOX Section 404 has been a challenge for many companies |
| Our ability to continue to comply is uncertain as we expect that our internal controls will continue to evolve as our business activities change |
| If, during any year, our independent auditors are not satisfied with our internal controls over financial reporting or the level at which these controls are documented, designed, operated, tested or assessed, or if the independent auditors interpret the requirements, rules or regulations differently than we do, then they may decline to attest to management’s assessment or may issue a report that is qualified |
| In addition, if we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with SOX Section 404 |
| Failure to maintain an effective internal control environment could have a material adverse effect on our stock price |
| In addition, there can be no assurance that we will be able to remediate material weaknesses, if any, that may be identified in future periods |
| COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC DISCLOSURE MAY RESULT IN ADDITIONAL EXPENSES Changing laws, regulations and standards relating to corporate governance and public disclosure, including SOX, new SEC and Public Accounting Oversight Board regulations and NASDAQ National Market rules, are creating uncertainty for public companies |
| These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices |
| We are committed to maintaining high standards of corporate governance and public disclosure |
| As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and management time related to compliance activities |
| Substantial costs have been incurred in fiscal 2006, and will continue to be incurred to comply with various of these mandates, including the engagement of separate public accounting firms to perform work that is now prohibited to be performed by our regular independent accounting firm, internal costs associated with documenting the adequacy of our internal controls over financial reporting and similar compliance activities, and increased costs of audit by our independent accounting firm |
| If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or 9 ______________________________________________________________________ governing bodies due to ambiguities related to practice, our reputation may be harmed and we might be subject to sanctions or investigation by regulatory authorities, such as the SEC Any such action could adversely affect our financial results and the market price of our common stock |
| believes that it has been at all times in material compliance with laws and regulations pertaining to the proper recording and reporting of our financial results, there can be no assurance that future regulations, implementing SOX and otherwise, will not have a material adverse impact on our reported results as compared with prior reporting periods |