[letterhead]
LUTIN & COMPANY
575 Madison Avenue
New York, New York 10022
Telephone (212) 605-0335
Facsimile (212) 605-0325
May 18, 2004
By telecopier: 310/320-2436
Messrs. Guenter W. Berger,
Lewis A. Coffman,
Roy E. Farmer,
Thomas Maloof,
John H. Merrell, and
John Samore, Jr.
c/o Farmer Bros. Co.
20333 South Normandie Avenue
Torrance, California 90502
To the members of the board of directors of Farmer Bros. Co.:
The company’s May 13th report of quarterly results
raised serious concerns among Farmer Bros. shareholders, as you must know
from observing the immediate 20% drop in the stock’s market price.
The report suggests that the company’s coffee business is
shrinking rather than growing, and that management is either unable or
unwilling to present a recovery strategy. There was no mention of any plans
for expanding the geographic service area or product lines. Instead, the
only reported project for the company’s future was a four year information
system “update” which is expected to cost $11 million, or about $10,000 per
employee. This information does not justify commitments of capital.
Assuming the board does in fact have information that justifies
your commitments of shareholder capital, investors need to know what it is.
This applies not only to public investors but also, and especially, to the
company employees whose pensions are concentrated in Farmer Bros. stock with
a $63 million debt burden – about $23 for each share securing the debt, or
85% of the stock’s market value after its recent price drop. Their
retirement plans as well as their careers depend on your responsible
management of Farmer Bros.
Following are some of the issues that should be addressed:
1.
Declining coffee sales:
In the May 13th press release, management stated that the
company’s declining coffee business revenue “continues to reflect general
economic conditions.” This appears to be inconsistent with the experience
of other small coffee companies such as Green Mountain and Peet’s Coffee,
which reported 18% and 19% increases in sales, respectively, with 10% and
41% increases in net income, or with food distributors such as Sysco which
reported a 10% increase in sales a 16% increase in net income. Eliminating
the variable of geographic expansion, both Kraft and Sara Lee also reported
increases in coffee revenue for their US markets.
►
Please explain what competitive factors are believed to be causing
Farmer Bros. to lose market share in the coffee business, and what
management plans to do about it.
2.
Shrinking service area:
Although there has been no mention of it in management’s statements,
comparisons of the lists of coffee sales branches in exhibits to recent Form
10K filings shows that Farmer Bros. has closed four locations in the past
two years, including two that supported the Eastern boundaries of the
company’s service area in Shreveport, Louisiana, and Nashville, Tennessee.
Only one new branch was opened during this period, in a California location
that would not expand the service area.
►
Please report the reasons for this reduction of geographic service
area, and correlate the lost sales volume from the abandoned locations with
the company’s reported revenue.
3.
Information systems project:
It has been reported that the company has spent over $4 million on an
information systems “update” project since its initiation in 2002, and
expects to spend another $7 million to complete it by June 2005. Management
also stated at the annual meeting that important strategic initiatives
should be deferred until the information systems project is completed.
►
Please explain how this administrative project will contribute to the
company’s competitive success in either its coffee business or investments,
and why it requires the devotion of senior executive attention and the
preemption of strategic actions.
4.
Management of
derivatives investing: In Item 3 of the recent Form 10-Q, titled
“Quantitative and Qualitative Disclosure About Market Risk,” the company
reports extensive investments in hedging and derivatives transactions, but
does not disclose the amounts involved.
►
Please report specific details of the company’s total capital
commitments and risk exposure, as well as the identity and qualifications of
the people who are responsible for these transactions.
5.
Employee pension security:
Management has issued several statements promoting the positive effects of
an ESOP plan on employee morale, but the publicly filed documents do not
appear to include any provisions for protecting employee pension interests
in the event that the value of “unallocated” ESOP stock falls to a level
that cannot support the ESOP debt. As noted earlier in this letter, this is
a very real concern with the current debt level at 85% of stock value, far
above what would be permitted for a margin loan.
►
Please report any provisions which have been approved by the board to
protect the security of company employees, and to assure the continued
employee morale that is critical to competitive viability.
Your responses to these issues should be presented publicly, for
the benefit of all investors. Anything you present will of course be
distributed to participants in the Forum for Farmer Bros. shareholders and
posted on the program’s web site.
Sincerely yours,
Gary Lutin
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