SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended December 31, 1998 Commission file number 0-1375 FARMER BROS. CO. California 95-0725980 State of Incorporation Federal ID Number 20333 S. Normandie Avenue, Torrance, California 90502 Registrant's Address Zip (310) 787-5200 Registrant's telephone number Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Number of shares of Common Stock outstanding: 1,926,414 as of December 31, 1998. PAGE 1 OF 11 PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Dollars in thousands, except per share data) FARMER BROS. CO. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) For the three months For the six months ended December 31, ended December 31, 1998 1997 1998 1997 Net sales $58,408 $64,062 $112,443 $123,559 Cost of goods sold 26,313 27,901 49,233 58,072 32,095 36,161 63,210 65,487 Selling expense 19,836 20,628 39,750 40,383 General and administrative expenses 1,914 2,156 3,794 4,075 21,750 22,784 43,544 44,458 Income from operations 10,345 13,377 19,666 21,029 Other income (expense): Dividend income 582 664 1,187 1,322 Interest income 2,290 1,971 4,529 3,813 Other, net (42) 206 358 519 2,830 2,841 6,074 5,654 Income before taxes 13,175 16,218 25,740 26,683 Income taxes 5,270 6,436 10,296 10,673 Net income $ 7,905 $ 9,782 $ 15,444 $ 16,010 Net income per common share $4.10 $5.08 $8.02 $8.31 Weighted average shares outstanding 1,926,414 1,926,414 The accompanying notes are an integral part of these financial statements. 2 FARMER BROS. CO. CONSOLIDATED BALANCE SHEETS (Unaudited) December 31, June 30, 1998 1998 ASSETS Current assets: Cash and cash equivalents $ 8,823 $ 6,800 Short term investments 149,116 128,004 Accounts and notes receivable, net 20,320 18,006 Inventories 35,619 38,067 Income tax receivable 196 649 Deferred income taxes 2,776 2,776 Prepaid expenses and other 580 526 Total current assets 217,430 194,828 Property, plant and equipment, net 30,344 30,551 Notes receivable 3,988 3,988 Long term investments, net 45,401 55,801 Other assets 20,385 19,527 Deferred taxes 3,354 2,317 Total assets $320,902 $307,012 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 9,318 $ 5,605 Accrued payroll expenses 3,631 4,876 Other 5,107 5,678 Total current liabilities 18,056 16,159 Accrued postretirement benefits 16,828 15,941 Commitments and contingencies - - Shareholders' equity: Common stock, $1.00 par value, authorized 3,000,000 shares; issued and outstanding 1,926,414 shares 1,926 1,926 Additional paid-in capital 568 568 Retained earnings 284,142 271,395 Accumulated other comprehensive income (loss) (618) 1,023 Total shareholders' equity 286,018 274,912 Total liabilities and shareholders' equity $320,902 $307,012 The accompanying notes are an integral part of these financial statements. 3 FARMER BROS. CO. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the six months ended December 31, 1998 1997 Cash flows from operating activities: Net Income $ 15,444 $ 16,010 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 2,770 2,679 Other (55) (35) Net loss on investments (158) (279) Change in assets and liabilities: Accounts and notes receivable (2,349) (2,592) Inventories 2,448 (531) Income tax receivable 453 2,119 Prepaid expenses and other assets (952) (1,346) Accounts payable 3,712 (69) Accrued payroll expenses and other liabilities (1,816) 2,938 Other long term liabilities 887 718 Total adjustments $ 4,940 $ 3,602 Net cash provided by operating activities $ 20,384 $ 19,612 The accompanying notes are an integral part of these financial statements. 4 FARMER BROS. CO CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (Unaudited) For the six months ended December 31, 1998 1997 Net cash provided by operating activities: $ 20,384 $ 19,612 Cash flows from investing activities: Purchases of property, plant and equipment (2,528) (1,026) Proceeds from sales of property, plant and equipment 62 88 Purchases of investments (325,859) (187,662) Proceeds from sales of investments 312,627 155,436 Notes issued (54) (1,052) Notes repaid 88 21 Net cash used in investing activities (15,664) (34,195) Cash flows from financing activities: Dividends paid (2,697) (2,408) Net cash used in financing activities (2,697) (2,408) Net increase (decrease) in cash and cash equivalents 2,023 (16,991) Cash and cash equivalents at beginning of year 6,800 34,174 Cash and cash equivalents at end of quarter $8,823 $17,183 Supplemental disclosure of cash flow information: Income tax payments $ 10,504 $ 5,830 The accompanying notes are an integral part of these financial statements. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) A. Unaudited Financial Statements The accompanying unaudited financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. It is Management's opinion that all adjustments of a normal recurring nature necessary for a fair statement of the results of operations for the interim periods have been made. B. Investments The Company hedges interest rate risk in its portfolio of preferred stock. Deferred losses associated with the hedge are $2,639,000 and $1,081,000 at December 31, 1998 and June 30, 1998, respectively. (In thousands) Gross Gross Unrealized Unrealized Fair December 31, 1998 Cost Loss Gain Value Current Assets Commercial Paper $ 61,926 (9) - $ 61,917 U.S. Government Obligations 87,214 ( 32) 17 87,199 $149,140 ( 41) 17 $149,116 Non-Current Assets Municipal debt 1,695 (11) - 1,684 Preferred stocks 36,713 (524) 2,917 39,106 Liquid asset fund and other 4,821 (273) 63 4,611 $ 43,229 (808) 2,980 $ 45,401 (In thousands) Gross Gross Unrealized Unrealized Fair June 30, 1998 Cost Loss Gain Value Current Assets Commercial Paper $ 95,838 - 594 $ 96,432 U.S. Government Obligations 31,608 (36) - 31,572 $127,446 (36) 594 $128,004 Non-Current Assets U.S. Government Obligations $ 9,725 (151) - $ 9,574 Municipal debt 1,695 (11) - 1,684 Preferred stocks 36,504 (52) 3,978 40,430 Liquid asset fund and other 4,067 - 46 4,113 $ 51,991 (214) 4,024 $ 55,801 6 B. Investments, CONTINUED The contractual maturities of debt securities classified as current and non- current available for sale are as follows: (In thousands) Fair Value Maturities 12/31/98 06/30/98 Within 1 year $149,116 $128,004 After 1 year through 5 years 1,684 11,258 $150,800 $139,262 Gross realized gains from available for sale securities were $979,000 and $535,000 at December 31, 1998 and 1997, respectively. C. Inventories (In thousands) Processed Unprocessed Total December 31, 1998 Coffee $ 3,672 $10,281 $13,953 Allied products 11,480 3,927 15,407 Coffee brewing equipment 1,998 4,261 6,259 $17,150 $18,469 $35,619 June 30, 1998 Coffee $ 4,119 $10,406 $14,525 Allied products 12,025 5,079 17,104 Coffee brewing equipment 2,191 4,247 6,438 $18,335 $19,732 $38,067 D. Comprehensive Income Effective July 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS 130) "Reporting Comprehensive Income". SFAS 130 requires disclosure of total non-stockholder changes in equity in interim periods and additional disclosures of the components of non-stockholder changes in equity on an annual basis. Total non-stockholder changes in equity includes all changes in equity during a period except those resulting from investments by and distributions to shareholders. For the three months For the six months (In thousands) ended December 31, ended December 31, 1998 1997 1998 1997 Net income $7,905 $9,782 $15,444 $16,010 Unrealized investment gains (losses), net (736) (112) (1,641) ( 45) Total comprehensive income $7,169 $9,670 $13,803 $16,055 7 <paga> Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Fluctuating green coffee costs continue to effect Registrant's operating results. Competitive roast coffee prices have pressured profit margins, even with lower green coffee costs. The Company makes every effort to provide competitive product pricing, and it is not known whether such operating margins can be maintained. Net sales for the second quarter of fiscal 1999 decreased 9% to $58,408,000 from $64,062,000 in the same quarter of the prior fiscal year. Net sales for the first half of fiscal 1999 decreased 9% to $112,443,000 from $123,559,000 in the first half of fiscal 1998. Gross profit in the second quarter decreased 11% to $32,095,000 or 55% of sales, as compared to $36,161,000, or 56% of sales, in the same quarter of fiscal 1998. Gross profit for the first half of fiscal 1999 decreased 3% to $63,210,000 from $65,487,000 during the same period of the prior fiscal year. Operating expenses decreased 5% to $21,750,000 in the second quarter of fiscal 1999 as compared to $22,784,000 in the second quarter of fiscal 1998. Operating expenses for the first half of fiscal 1999 decreased 2% to $43,544,000 from $44,458,000 during the same period of fiscal 1998. Income after taxes for the three months ended December 31, 1998, reached $7,905,000, or $4.10 per share, as compared to $7,539,000, or $3.91 per share, in the first quarter of fiscal 1999 and $9,782,000, or $5.08 per share, in the same quarter of fiscal 1998. Net income for the first half of fiscal 1999 reached $15,444,000, or $8.02 per share, as compared to $16,010,000, or $8.31 per share, in the first six months of fiscal 1998. Quarterly Summary of Results (In thousands) 12/31/97 03/31/98 06/30/98 09/30/98 12/31/98 Net sales 64,062 58,951 57,582 54,035 58,408 Gross profit 36,161 32,249 34,388 31,115 32,095 Operating income 13,377 10,067 9,859 9,321 10,345 Net income 9,782 8,020 9,370 7,539 7,905 (As a percentage of sales) 12/31/97 03/31/98 06/30/98 09/30/98 12/31/98 Net sales 100.00 100.00 100.00 100.00 100.00 Gross profit 56.45 54.70 59.72 57.58 54.95 Operating income 20.88 17.08 17.12 17.25 17.71 Net income 10.05 13.60 16.27 13.95 13.53 (In dollars) 12/31/97 03/31/98 06/30/98 09/30/98 12/31/98 EPS 5.08 4.16 4.86 3.91 4.10 Year 2000 Issues There have been no material changes from the fiscal year end. 8 Item 3. Quantitative and Qualitative Disclosures about Market Risk Financial Markets Securities are recorded at fair value and unrealized gains or losses have been recorded as a separate component of shareholders equity. The Company maintains two distinct portfolios of securities, both portfolios are classified as available for sale. The Company's portfolio of investment grade money market instruments includes bankers acceptances, discount commercial paper, federal agency issues and treasury securities. As of December 31, 1998, over 93% of these funds were invested in instruments with maturities shorter than one year. The remaining balance matures during fiscal 2000. This portfolio's interest rate risk is unhedged. Its average maturity is approximately 60 days and a 100 basis point move in the Fed Funds Rate would not have a material effect on Registrant's results of operations. The Company is exposed to market value risk arising from changes in interest rates on its portfolio of preferred securities. The Company reviews the interest rate sensitivity of these securities and (a) enters into "short positions" in futures contracts on U.S. Treasury securities or (b) holds put options on such futures contracts in order to reduce the impact of certain interest rate changes on such preferred stocks. Specifically, the Company attempts to manage the risk arising from changes in the general level of interest rates. The Company does 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, 1998. 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. Interest Rate Changes (In thousands) Market Value of Change in Market Preferred Futures and Total Value of Total Securities Options Portfolio Portfolio - -200 basis points $16,576.7 $(1,480.9) $15,095.8 $2,437.2 ("b.p.") - -100 b.p. 44,414.3 (667.4) 43,746.9 1,088.3 Unchanged 41,775.6 883.0 42,658.6 0.0 +100 b.p. 38,678.5 3,727.9 42,406.4 (252.2) +200 b.p. 35,591.6 6,536.2 42,127.8 (530.8) 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 security held, the slope of the Treasury yield curve, the expected volatility of Treasury yields, and the costs of using futures and/or options. At December 31, 1998 and 1997 the hedge consisted entirely of put options on the U.S. Treasury Bond futures contract. 9 Item 3 Quantitative and Qualitative Disclosures about Market Risk (CONTINUED) Commodity Price Changes The Company is exposed to commodity price risk arising from changes in the market price of green coffee. Registrant prices its inventory on the LIFO basis. In the normal course of business, the Company enters into commodity purchase agreements with suppliers, and futures contracts to hedge exposure to inventory price fluctuations. The Company does not transact in futures contracts or put options for speculative purposes. The following table demonstrates the impact of changes in the price of green coffee on inventory and hedge instruments at December 31, 1998. It assumes an immediate change in the price of green coffee, and the demonstrable relationship between the price of green coffee and the valuations of coffee index futures and put options and relevant commodity purchase agreements at December 31, 1998, and does not take into account fluctuations of inventory levels and futures and options activity. Commodity Risk Disclosure (In thousands) December 31, 1998 Market Value of Change in Coffee Cost Coffee Futures Market Change Inventory & Options Total Value - - 10% $13,953,000 $ 977,000 $14,930,000 $1,423,000 unchanged 13,953,000 (446,000) 13,507,000 - + 10% 13,953,000 (1,869,000) 12,084,000 (1,423,000) At December 31, 1998 the hedge consisted of commodity futures and commodity purchase agreements. PART II OTHER INFORMATION Item 1. Legal proceedings. not applicable. Item 2. Changes in securities. none. Item 3. Defaults upon senior securities. none. Item 4. Submission of matters to a vote of security holders. The Annual Meeting of Shareholders of Farmer Bros. Co. was held on November 30, 1998. Holders of the Company's common stock were entitled to one vote per share of common stock held. Six directors were elected at the meeting, each to serve for the coming year and until any successors are elected and qualify. The following persons were elected as directors: Roy F. Farmer, Roy E. Farmer, Catherine E. Crowe, Lewis A. Coffman, Guenter W. Berger and John M. Anglin. There were 1,750,960 shares for election and 10,150 shares against. 10 PART II OTHER INFORMATION, (CONTINUED) The proposal to appoint Ernst & Young LLP as the independent accountants for the Company for the year ended June 30, 1999 was approved with 1,759,302 shares in favor of the resolution, 401 shares against and 1,415 shares abstaining. Item 5. Other information. none. Item 6. Exhibits and reports on Form 8-K. (a) Exhibits. (2) Plan of acquisition, reorganization, arrangement, liquidation or succession not applicable. (4) Instruments defining the rights of security holders, including indentures. not applicable. (11) Statement re computation of per share earnings. not applicable. (15) Letter re unaudited interim financial information. not applicable. (18) Letter re change in accounting principles. not applicable. (19) Report furnished to security holders not applicable. (22) Published report regarding matters submitted to vote of security holders. not applicable. (23) Consents of experts and counsel. not applicable. (24) Power of attorney. not applicable. (27) Financial Data Schedule See attached Form EX-27. (99) Additional exhibits. not applicable. (b) Reports on Form 8-K none. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: February 12, 1999 FARMER BROS. CO. (Registrant) John E. Simmons John E. Simmons Treasurer and Chief Financial Officer