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Los Angeles Business Journal
Farmer Brothers Finally Perks Up
By RICHARD CLOUGH - 5/14/2007
Los Angeles Business Journal Staff


After years of prodding by disgruntled shareholders, Farmer Bros. Co. has finally made a move to accelerate its growth with the $22 million purchase of a high-end Portland, Ore. coffee roaster.

The acquisition of Coffee Bean International will give the 95-year-old Torrance coffee roaster and distributor access to the fast-growing specialty coffee market pioneered by Starbucks Corp. and exploited by competitors such as Peet’s Coffee & Tea Inc.

The question remains: Is Farmer Bros. too late to the game? Company critics fear they are; the company thinks otherwise.

“The strategy behind the acquisition was to rapidly get Farmer Bros. into the specialty side of coffee,” said Rocky Laverty, the company’s president and chief operating officer, who was hired less than a year ago. “We’re trying to keep up with changing customer tastes.”

Farmer Bros. has built a roughly $200 million a year business supplying lower grade coffee to restaurants and institutional clients such as hospitals and hotels, but that segment of the coffee market is stagnant at best as Americans acquire a taste for richer specialty brews.

Indeed, the company’s revenues have essentially been flat over the past five years, hitting about $207 million in the fiscal year ending June 30, 2006, barely up from $206 million in the 2002 fiscal year. At the same time, annual profits have fallen to $5 million from $31 million, along with the stock, which is off about a third to around $22 a share.

Meanwhile, companies selling specialty coffee at supermarkets and other retail sites or operating cafes offering the richer brew have seen their revenues explode. Market leader Starbucks reported $7.8 billion in revenue in 2006, up from $3.3 billion in 2002. That growth has helped create a demand at all levels for higher quality coffee.

However, there are fears among some shareholders that Farmer Bros. may have missed the best opportunity for growth in the specialty market, even as Starbucks last year said it has plans to double the number of North American stores and competitors such as Peet’s are still adding scores of stores.

“Farmer Bros. missed the entire upswing of Starbucks. The company has not kept up with the industry,” said Noble Trenham, an investment banker who has owned shares of Farmer Bros. for 38 years. “They missed the market and now they’re trying to catch up.”

Expanding distribution


Under the deal, announced April 30, Coffee Bean International will operate as a separate company and will remain headquartered in Portland. Farmer Bros. plans to build a new roasting plant in Portland and will increase the distribution capabilities of Coffee Bean International.

The small roaster recorded sales of $30 million in 2006, largely distributing its product wholesale to restaurants, cafes and other retail outlets both regionally and nationally. However, its growth has been strong, hitting 20 percent annually over the past three years.

“We’ve grown tremendously over the past few years,” said Patrick Criteser, president and chief executive of Coffee Bean International. “I think (this sale) will give us an opportunity to continue down the growth path we’ve been on.”

Specialty coffee sales in the United States are growing by about 11 percent each year, compared to just a 2 percent growth rate for traditional coffee, which still makes up about 90 percent of total coffee sales. It’s that kind of growth that has caused discontent among Farmer Bros. shareholders.

After several years of declining sales, a number of shareholders drafted a letter to management in 2004, demanding that it explain why Farmer Bros. seemed unable to keep up with the coffee market.

Around the same time, there were several major shakeups in company management. Roy F. Farmer, the chairman of the company for more than 50 years, died of cancer at age 87 in early 2004. Eight months later, his son, Roy E. Farmer, who had taken over as chairman, committed suicide, leaving a void at the top.

Then in 2005 several shareholders launched a futile but symbolic attempt to sell the company without the sanction of Farmer Bros. management. (The Farmer family still retains a 40 percent stake in the company.)

The company tried to relieve some of the friction by bringing in new management. Last June, the company hired Laverty away from Irvine-based Diedrich Coffee Inc. to serve as president and chief operating officer.

Gary Lutin, a New York investment banker who runs an online forum for Farmer Bros. shareholders, said despite the changes in management, the business has so far not improved.

“Other coffee businesses are growing and making profits, which means that Farmer Bros. is losing the industry competition,” he said. “If something isn’t done to change that, investors will lose their money and employees will lose their jobs.”

However, Lutin said the acquisition of Coffee Bean International does indicate a willingness on the part of management to pursue new markets, but it is too early to tell if it will amount to anything.

“Shareholders are hopeful that that means a redirection not only of the business operations, but of management’s respect for shareholders,” he said.

Cash horde?


Farmer Bros. executives said they had been interested in buying Coffee Bean International for about three years, but they could not complete the deal until this year. However, both sides would not disclose details about the talks.

Another point of contention among some shareholders is the company’s conservative business strategies. The company reported about $180 million in short-term investments, according to its financial statement for the quarter ending March 31.

As a result, the company generated $1.5 million in interest income, which helped offset an operating loss of $2.2 million. The interest income, as well as an income tax benefit and other non-operating income, helped the company report a profit of $1.5 million, or 11 cents per share.

Dissident shareholders say the company has simply failed to take advantage of the cash reserve, which has been similarly sized for years, with Trenham referring to Farmer Bros. as “a cash holding company masquerading as a coffee company.

“I’m excited about American capitalism,” he said. “I get very upset when I see management that’s not equally excited about their opportunities.”

Los Angeles Business Journal, Copyright © 2007, All Rights Reserved.


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