Item
1. Business
The
Company is a holding company incorporated as a Delaware corporation and its sole asset is a controlling equity interest in H.D.D.
LLC (the “LLC”). Unless the context suggests otherwise, references in this report to “Truett-Hurst,” the
“Company,” “we,” “us” and “our” refer to Truett-Hurst, Inc. and its consolidated
subsidiary. Truett-Hurst consolidates the financial results of the LLC and records a non-controlling interest for the economic
interest in the LLC it does not own. The Company’s amended and restated certificate of incorporation authorizes two classes
of common stock, Class A common stock and Class B common stock.
Quantities or results
referred to as “to date” or “as of this date” mean as of or to June 30, 2016, unless otherwise specifically
noted. References to “FY” or “fiscal year” refer to the fiscal year ending on June 30th of the designated
year. For example, “FY16” and “fiscal year 2016” each refer to the fiscal year ended June 30, 2016. This
Annual Report on Form 10-K references certain trademarks and registered trademarks which may be trademarks or registered trademarks
of their respective owners.
On January
25, 2016, the LLC sold its fifty percent interest in The Wine Spies, LLC (“Wine Spies”) with an effective date of December 31,
2015. The results from Wine Spies, which were previously consolidated, have been deconsolidated in the
Company’s audited consolidated financial statements. The gain on the sale along with the current year results have been
recorded in the consolidated statements of operations on the discontinued operations line. Prior periods have been accounted
for on a consistent basis.
General
The Company produces
and sells premium, super-premium, and ultra-premium wines made generally from grapes purchased from California-based growers. In
addition, the Company purchases semi-finished bulk wine under contract and opportunistically on the spot market. On a more limited
basis, the Company also purchases finished goods from both foreign and domestic producers. The Company is headquartered in Sonoma
County, California with tasting rooms in the Dry Creek and Russian River valleys. The Company owns its tasting room and winery
in the Dry Creek Valley and leases the tasting room and winery located in the Russian River Valley. The wines include Pinot Noir,
Chardonnay, Sauvignon Blanc, Zinfandel, Petite Sirah, Merlot, and Cabernet Sauvignon and are sold across a number of price points
via two distinct distribution channels: three-tier and direct to consumer. The business model is a combination of direct to consumer
sales, traditional three-tier brand sales and retail exclusive brand sales. The Company owns, designs and develops its brands,
including those developed and sold on a retailer exclusive basis. The brands are differentiated and marketed through innovative
packaging and label designs.
Wines in the three-tier
channel are sold to distributors with programs available to the broad market or to specific retailers on an exclusive basis. The
traditional three-tier distribution business consists of sales of VML, Healdsburg Ranches, Colby Red and Bradford Mountain branded
wines. Through the retail exclusive brand model, the Company works with retail partners to develop innovative brands which resonate
with their customers and are intended to increase store traffic and expand exclusive brand sales. The retail exclusive model allows
the Company to own the brands it creates, which the Company believes differentiates it from the traditional private label model,
and allows it the option of expanding the brands into national and international markets, thereby increasing sales and building
the brand equity. The direct to consumer channel consists of sales of products produced by the Company through its tasting
rooms, wine clubs and its winery websites.
Strategic Objectives
There are three primary
categories into which the Company sells its wine: premium ($12 - $14 per bottle retail price), super-premium ($15 - $24 per bottle
retail price), and ultra-premium ($25 - $49 per bottle retail price). The Company believes it can benefit from growth at the premium
and above price points and continue to grow the business relying on its competitive strengths: its experienced and knowledgeable
team; its relationships with the world’s top wine distributors and retailers; and its innovative approach to distribution
and brand development. The Company intends to continue growing by:
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Developing innovative retail exclusive products that meet the needs of wine retailers.
The
Company has a reputation for developing innovative retail exclusive brands and working with retailer partners on unique programs
to support sales of those products. With branding expertise the Company intends to continue innovation and build its market share
with global wine retailers who are focused on increasing their profitability through retail exclusive offerings.
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Growing the customer base to include additional major U.S. retail chains.
The Company is
actively pursuing relationships with the largest retail chains in the United States.
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Expanding the direct to consumer business.
The wine clubs continue to grow due to growing
consumer awareness of the brands from targeted public relations, exciting wine club events and advertising. The direct to consumer
business generally generates higher gross margins and the Company intends to continue building this distribution channel in order
to further growth.
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Marketing to key international markets.
During FY14, the Company completed an agreement
with the Trialto Wine Group, LTD, based in Vancouver Canada, creating a national partnership to distribute the Truett-Hurst family
of brands throughout Canada. The Company also continues to review selective brand development and distribution opportunities in
other international markets.
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Developing new ways to engage customers and to distribute products.
The Company continues
to be discovery-oriented in its approach and is always looking for new innovations in and approaches to the global wine market.
The Company believes that traditional wine marketing, to some degree, has stymied creativity and believes the innovative branding
expertise allows it to rapidly capitalize on evolving customer demands.
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The Wineries
Established in 2007,
Truett-Hurst was the first winery operation and brand. The Truett-Hurst winery is owned by the Company and is located in the Dry
Creek Valley appellation of Sonoma County and focuses on producing super-premium wine from a range of varietals, including Zinfandel,
Chardonnay, Sauvignon Blanc, Pinot Noir, Petite Sirah and other unique red blends.
Established in 2011,
VML was the second winery operation and brand. The VML winery, which is leased through May 2017, is located in the Russian River
Valley appellation of Sonoma County and focuses on producing super-premium and ultra-premium wines from grapes purchased from local
growers. The primary varietals include Pinot Noir, Chardonnay, Sauvignon Blanc, and Gewurztraminer.
Wine Supply and Production
Wine Production
The Company operates
two wineries where wine is produced from many varieties of grapes principally grown or purchased in Sonoma County’s Russian
River Valley and Dry Creek Valley appellations. The VML winery, which is leased through May 2017, can crush, ferment and oak barrel
age approximately 500 tons (35,000 cases) of ultra-premium grapes annually, with capacity to increase to 2,000 tons with additional
capital improvements. For increased production capacity, the Company outsources to a variety of specialist wineries and bottling
facilities. The Company has been able to satisfy the production requirements to date and considers its sources to be adequate at
this time. However, the inability of any of the suppliers to satisfy the Company’s requirements could adversely affect operations.
Grape and Wine Contracts
The majority of annual
grape requirements are satisfied by purchases from each year’s harvest which normally begins in August and runs through October.
In addition to purchasing grapes, the Company supplements its needs with bulk wine purchase contracts based on sales and production
requirements. Depending upon overall demand and availability of bulk wine, the Company could experience shortages and/or increased
prices.
The Company enters
into grape contracts with terms generally of one to four years, which requires payment of an agreed upon price per ton that varies
according to the type of grape, its appellation and in certain cases, the vineyard block in which the grapes are grown. Contracts
are typically terminable after a specified term, unless earlier mutually agreed by the parties.
Vineyards Owned
by Founders
Certain of the Founders
operate or farm vineyards. The grapes produced from these vineyards are sold to the Company at market prices, with the balances
sold to other wineries. See Part II, Item 8, Note 8, “Commitments and Contingencies,” to the Consolidated Financial
Statements included in this Annual Report on Form 10-K for additional details regarding related party commitments.
Sources and Availability of Production
Materials
The Company utilizes
glass and other materials such as corks, capsules, labels and cardboard cartons in the bottling and packaging of its products.
After grape purchases and associated production overhead, glass bottle costs are the next most significant component of the cost
of sales. The glass bottle industry is highly concentrated with only a small number of quality producers. The Company obtains glass
requirements from a limited number of producers under supply arrangements. The Company has been able to satisfy production requirements
with respect to the foregoing and consider the sources of supply to be adequate at this time. However, the inability of any of
the glass bottle suppliers to satisfy the Company’s requirements could adversely affect the Company’s operations.
Seasonality
There is seasonality
in the growing, procurement and transportation of grapes. The wine industry typically experiences increased sales in
October, November and December. Sales are typically higher upon the launch of a new product into the marketplace and when retailers
promote brands through in-store displays and advertisements. The Company expects these trends to continue.
Company Team and Culture
The Company’s
team consists of seasoned professionals who have worked their way up through the industry often achieving senior level positions
in noted wine companies such as the Brown-Forman Corporation, Gallo, Domaine Chandon, Kendall-Jackson, and Fetzer Vineyards.
In addition to building
a seasoned team of professionals and shaping the entrepreneurial culture, an important part of the ongoing strategy is to create
partnerships with the best organizations and professionals in order to leverage core competencies in the most efficient, cost effective
and profitable manner. The Company is proud of the corporate partnerships that have been created throughout the sales
channels and the Company believes it can build a business that can change the way consumers purchase and enjoy wine.
Sales and Marketing
The Company employs
a relatively small full-time, in-house marketing, sales and customer service organization. The sales and marketing team uses a
range of marketing strategies designed to build brand equity and increase sales. Strategies include, but are not limited to, market
research, consumer and trade advertising, price promotions, point-of-sale materials, event sponsorship, on premise promotions,
social media and public relations.
Competitive Environment
All the segments the
Company participates in are highly competitive. The Company competes on the basis of quality, price, brand recognition and distribution
strength against domestic and multinational producers and distributors, some of which have greater resources than the Company,
for consumer purchases, as well as shelf space in retail stores, restaurant presence and wholesaler attention. Further, wine competes
with other alcoholic and nonalcoholic beverages.
In the retail exclusive
label market, the Company believes the chief competitors are Constellation Brands, Inc., E.&J. Gallo Winery, Bronco Wines,
Winery Exchange Inc., Vintage Wine Estates, Delicato Family Vineyards, and other California and international wine producers.
There are relatively
few publicly traded beverage companies with significant wine operations and most also have beer and spirits divisions.
Demand for wine in
the premium, super-premium, ultra-premium and luxury market segments can rise and fall with general economic conditions. The
Company’s ability to respond to market demand, deliver a variety of wine styles, create and design innovative packaging combined
with an effective distribution system will allow the Company to continue to penetrate the mainstream wine markets.
Intellectual Property
The Company protects proprietary
rights through a variety of means and measures, including patents, trade secrets, copyrights, trademarks, contractual restrictions
and technical measures. A number of brands are under registered trademarks. International trademark registrations are also maintained
where it is appropriate to do so. Each of the U.S. trademark registrations is renewable indefinitely so long as the
Company is making a bona fide usage of the trademark. As of September 1, 2016, the Company had 40 registered material
trademarks, 7 published and 2 pending.
Regulatory Environment
The wine industry is
part of the highly regulated U.S. liquor industry. While there have been significant relaxations over time, such as
those arising following the Granholm v. Heald U.S. Supreme Court decision in 2005, the U.S. wine industry is still highly regulated.
For example, the Company is able to ship wine directly now to consumers and businesses in 42 states, but must only work through
traditional “three-tier” distributors in the remaining 8 states.
The production and
sale of wine is subject to extensive regulation by the United States Department of the Treasury, Alcohol and Tobacco Tax and Trade
Bureau and the California Liquor Control Commission. The Company is licensed by and meets the bonding requirements of
each of these governmental agencies. Sales of wine are subject to federal alcohol tax, payable at the time wine is removed
from the bonded area of the winery for shipment to customers or for sale in the Company’s tasting rooms. The current
federal alcohol tax rate is $1.07 per gallon for wines with alcohol content at or below 14.0% and $1.57 per gallon for wines with
alcohol content above 14.0% but less than 21%; however, wineries that produce not more than 250,000 gallons during the calendar
year are allowed a graduated tax credit of up to $0.90 per gallon on the first 100,000 gallons of wine (other than sparkling wines)
removed from the bonded area during that year.
The Company also pays
the state of California an excise tax of $0.20 per gallon for all wine sold in California. In addition, all states in
which wines are sold impose varying excise taxes on the sale of alcoholic beverages. Payments of these taxes are the
responsibility of the supplier or distributor depending upon the channel in which the wine is sold.
Consumer direct sales
are also subject to state regulation which governs the quantity and manner in which products can be shipped, delivered and excise
taxes collected.
As an agricultural
processor, the Company is also regulated by Sonoma County and, as a producer of wastewater, by the state of California. The
Company maintains all necessary permits.
Prompted by growing
government budget shortfalls and public reaction against alcohol abuse, Congress and many state legislatures are considering various
proposals to impose additional excise taxes on the production and sale of alcoholic beverages, including table wines. Some
of the excise tax rate increases being considered are substantial. The ultimate effects of such legislation, if passed,
cannot be assessed accurately since the proposals are still in the discussion stage. Any increase in the taxes imposed
on table wines can be expected to have a potentially adverse impact on overall sales of such products. However, the
impact may not be proportionate to that experienced by producers of other alcoholic beverages and may not be the same in every
state.
Management is strongly
focused on environmental stewardship and maintains a variety of policies and processes designed to protect the environment, the
public and the consumers of its wine. Many of the expenses for protecting the environment are voluntary, however the
Company is regulated by various local, state and federal agencies regarding environmental laws where the costs of these laws and
requirements of these agencies are effectively integrated into regular operations and do not cause significant negative impacts
or costs.
The Company believes
they are in compliance in all material respects with all applicable governmental laws and regulations in the countries in which
it operates. The Company also believes that the cost of administration and compliance with, and liability under, such laws and
regulations have not had a material adverse impact on the Company’s financial condition, results of operations or cash flows
for the fiscal year ended June 30, 2016.
Employees
As
of June 30, 2016, the Company had a full time equivalent of 43 employees. The Company hires part time and seasonal help as needed.
All employees were located in the United States. The Company believes that future success will depend in large part on the ability
to attract and retain highly skilled technical, managerial, and sales and marketing personnel. None of the employees are subject
to collective bargaining agreements. The Company believes relations with their employees are good.
Information About the Company’s
Executive Officers
The information required under this Item
is incorporated by reference from the Company’s definitive proxy statement to be filed relating to the Company’s 2016
annual meeting of shareholders.
Available Information
Principal executive
offices are located at 125 Foss Creek Circle, Healdsburg, California 95448, and the telephone number is (707) 431-4423. The Company
files Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and proxy statements with the
SEC. The public may read and copy any materials that are filed with the SEC at the SEC’s Public Reference Room at 100 F
Street, NE, Washington, D.C. 20549, on official business days during the hours of 10 a.m. to 3 p.m. The public may obtain information
on the operation of the Public Reference Room by calling the SEC at (800) SEC-0330. The SEC maintains an internet site that contains
reports, proxy and information statements, and other information regarding issues, including what the Company files electronically
with the SEC at www.sec.gov. You may learn more about the Company by visiting the website at
www.truetthurstinc.com
, the
information on the website is not part of this Form 10-K. The foregoing information regarding the website and its content
is for your convenience only. The content of the website is not deemed to be incorporated by reference in this report or filed
with the SEC.
Emerging Growth Company Status
The Company is an
“emerging growth company,” as defined in the Jumpstart Our Business Startups Act, enacted on April 5, 2012 (“JOBS
Act”). For as long as the Company is an “emerging growth company,” the Company may take advantage
of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging
growth companies,” including, but not limited to, not being required to comply with the auditor attestation requirements
of Section 404(b) of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in the Company’s
periodic reports and proxy statements, and exemptions from the requirements of holding shareholder advisory “say-on-pay”
votes on executive compensation and shareholder advisory votes on golden parachute compensation.
Under the JOBS Act,
the Company will remain an “emerging growth company” until the earliest of:
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the last day of the fiscal year during which the Company has total annual gross revenues of $1
billion or more;
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the last day of the fiscal year following the fifth anniversary of the Company’s IPO;
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the date on which the Company has, during the previous three-year period, issued more than $1 billion
in non-convertible debt; and
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the date on which the Company is deemed to be a “large accelerated filer” under the
Exchange Act (the Company will qualify as a large accelerated filer as of the first day of the first fiscal year after the
Company has (i) more than $700 million in outstanding common equity held by the Company’s non-affiliates and (ii) been public
for at least 12 months; the value of the Company’s outstanding common equity will be measured each year on the last day of
the second fiscal quarter).
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The JOBS Act also provides
that an “emerging growth company” can utilize the extended transition period provided in Section 7(a)(2)(B) of the
Securities Act of 1933, as amended (the “Securities Act”) for complying with new or revised accounting standards.
However, the Company chose to “opt out” of such extended transition period, and, as a result, the Company will comply
with new or revised accounting standards on the relevant dates on which adoption of such standards is required for companies that
are not “emerging growth companies.”
Smaller Reporting Company
The Company became
subject to the reporting requirements of Section 15(d) of the Exchange Act, subject to the disclosure requirements of Regulation
S-K of the SEC, as a “smaller reporting company,” on the effective date of the Registration Statement. The designation
of being a “smaller reporting company” relieves the Company of some of the more detailed informational requirements
of Regulation S-K.
Item 1A. Risk Factors
Risks Related to the Company’s
Business
A reduction in the supply of grapes
and bulk wine available to us from the independent grape growers and bulk wine suppliers could reduce the Company’s annual
production of wine.
The Company relies
on annual contracts with independent growers to purchase substantially all of the grapes used in wine production. The
business would be harmed if the Company is unable to contract for the purchase of grapes at acceptable prices from these or other
suppliers in the future. The terms of many of the Company’s purchase agreements also constrain the ability to discontinue
purchasing grapes in circumstances where the Company might want to do so.
Some of these agreements
provide that either party may terminate the agreement prior to the beginning of each harvest year.
The Company depends
on a single bulk wine supplier for the production of several wines, particularly the direct to retailer designated labels. This
contract currently covers only the 2016 harvest. Extension of this contract is not guaranteed and thus may have exposure to the
availability and pricing of bulk wine for production needs which could increase the cost or reduce the amount of wine the Company
is able to produce for sale. This could reduce sales and profits.
The Company faces inventory risk, and if it fails to predict
accurately demand for products, the Company may face write-downs or other charges.
The Company is exposed to inventory risks
that may adversely affect operating results as a result of new product launches, changes in product cycles and pricing, limited
shelf-life of certain of the Company’s products, changes in consumer demand, and other factors. The Company endeavors to
predict accurately, based on information from distributors and reasonable assumptions, the expected demand for their products in
order to avoid overproduction. Demand for products, however, can change significantly between the time of production and the date
of sale. It may be more difficult to make accurate predictions regarding new products. In part, the Company depends
on the marketing initiatives and efforts of distributors in promoting products and creating consumer demand and the Company has
limited or no control regarding its promotional initiatives or the success of their efforts.
The Company has a history of losses,
and may not achieve or maintain profitability in the future.
The Company has had
a limited number of quarters or years of profitability and historically raised additional capital to meet its growth needs.
The Company expects to make significant future investments in order to develop and expand its business, which, it believes, will
result in additional sales, marketing and general and administrative expenses that will require increased sales to recover these
additional costs. As a public company the Company expects to continue to incur legal, accounting, and other administrative
expenses that are material. While revenue has grown in recent periods, this growth may not be sustainable or sufficient to cover
the costs required to successfully compete.
The Company may not
generate sufficient revenue to achieve profitability. The Company may incur significant losses in the future for a number of reasons,
including slowing demand for its products and increasing competition, as well as the other risks described in this Annual Report
on Form 10-K, and may encounter unforeseen expenses, difficulties, complications and delays, and other unknown factors in the expansion
of the business. Accordingly, the Company may not be able to achieve or maintain profitability and, may incur significant losses
in the future, and this could cause the price of the Class A common stock to decline further.
The Company faces significant competition
which could adversely affect profitability.
The wine industry
is intensely competitive. The Company’s wines compete in several super-premium and ultra-premium wine market segments
with many other super-premium and ultra-premium domestic and foreign wines, with imported wines coming from the Burgundy and
Bordeaux regions of France, as well as Italy, Chile, Argentina, South Africa and Australia. The Company’s wines also
compete with other alcoholic and, to a lesser degree, non-alcoholic beverages, for shelf space in retail stores and for
marketing focus by independent distributors, many of which carry extensive brand portfolios. As a result of this intense
competition there has been and may continue to be upward pressure on selling and promotional expenses. In addition, the wine
industry has experienced significant consolidation. Many competitors have greater financial, technical, marketing and public
relations resources. The Company’s sales may be harmed to the extent it is not able to compete successfully against
such wine or alternative beverage producers’ costs. There can be no assurance that in the future the Company will be
able to successfully compete with current competitors or that it will not face greater competition from other wineries and
beverage manufacturers.
Because a significant amount of the
Company’s business is made through retail exclusive model any change in relationships with the retail partners
could harm the business.
The Company’s
agreements with direct retail partners are informal and therefore subject to change. If one or more of the direct retail
partners chose to purchase fewer products, or the Company is forced to reduce the prices, the Company’s sales and profits
would be reduced and the business would be harmed.
The loss of key employees or personnel
could damage the Company’s reputation and business.
The Company believes
that success largely depends on the employment of experienced professionals in a number of key positions. Examples include Phil
Hurst, Chief Executive Officer, Paul Forgue, Chief Financial Officer and Chief Operations Officer, Virginia Lambrix, Winemaker, and
Kevin Shaw, an independent contractor who serves as the Creative Director. Any inability or unwillingness of these or
other key management team members to continue in their present capacities could harm the business and its reputation.
A reduction in the Company’s access
to or an increase in the cost of the third-party services used to produce its wine could harm its business.
The Company utilizes
capacity at several third-party facilities for the production of a significant portion of its wines. The inability
to use these or alternative facilities, at reasonable prices or at all, could increase the cost or reduce the amount of production,
which could reduce the Company’s sales and profits. The Company does not have long-term agreements with any of
these facilities, and they may provide services to competitors at a price above what the Company is willing to pay. The activities
conducted at outside facilities include crushing, fermentation, storage, blending, and bottling. The reliance on these
third-parties varies according to the type of production activity. As production increases, the Company must increasingly
rely upon these third-party production facilities. Reliance on third-parties will also vary with annual harvest volumes.
In addition, the Company
has limited direct impact over the quality control and quality assurance of these third-party manufacturers. If
its suppliers are not able to deliver products that satisfy the Company’s requirements, the Company may be forced to seek
alternative providers, which may not be available at the same price, or at all. Moving production to a new third-party service
provider could negatively impact the Company’s financial results.
The terms of the Company’s
current bank loans may restrict current and future operations, which could adversely affect the Company’s ability to respond
to changes in its business and to manage its operations.
The Company’s
bank loans include a number of customary restrictive covenants that could impair the Company’s financing and operational
flexibility and make it difficult to react to market conditions and satisfy ongoing capital needs and unanticipated cash requirements.
The bank loans contain usual and customary covenants, including, without limitation:
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limitation on incurring senior indebtedness;
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limitation on making loans and advances;
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limitation on investments, acquisitions and capital expenditures;
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limitation on liens, mergers and sales of assets;
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minimum current assets to current liabilities ratio;
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maximum debt to effective tangible net worth ratio; and
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minimum debt service coverage ratio.
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The Company’s
ability to comply with the covenants and other terms of its bank loans will depend on future operating performance and, in addition,
may be affected by events beyond the Company’s control, and the Company may not meet them. If the Company fails to comply
with such covenants and terms, it would be required to obtain waivers from its lenders or agree with the lenders to an amendment
of the facility's terms to maintain compliance under such facility. If the Company is unable to obtain any necessary waivers and
the debt is accelerated, it would have a material adverse effect on the financial condition and future operating performance, and the
Company may be required to limit activities.
Because the Founders retain significant
control over Truett-Hurst, Inc. current shareholders and new investors will not have as much influence on corporate decisions as
they would if control were less concentrated.
As of June 30, 2016,
the Founders and current officers and directors of the Company (together, “Founders and Affiliates”) control 43% of
the combined voting power of the Company through ownership of outstanding Class A common stock and/or Class B common stock. Prior
to conversion of their LLC Units, each holder of LLC Units holds a single share of Class B common stock. Although these shares
have no economic rights, they allow the existing owners to exercise voting power over Truett-Hurst, Inc., the managing member of
the LLC, at a level that is consistent with their overall equity ownership of the business. As a result, Founders and Affiliates
have significant influence in the election of directors and the approval of corporate actions that must be submitted for a vote
of shareholders.
In addition, certain
of the Founders, as well as certain trusts and other entities under their control, have entered into guarantee agreements in connection
with its bank loans. For additional information related to bank guaranties, see Part II, Item 8, Note 6, “Borrowings,”
to the Consolidated Financial Statements included in this Annual Report on Form 10-K.
The interests of these
affiliates may conflict with the interests of other shareholders, and the actions they take or approve may be contrary to those
desired by the other shareholders. This concentration of ownership may also have the effect of delaying, preventing
or deterring an acquisition of Truett-Hurst, Inc. by a third-party.
The Company has certain transactions
with related parties, including Founders, which may present a conflict of interest.
The Company routinely
sources grapes for its products from vineyards owned by Founders and principal shareholders. The interests of these
affiliates in such transactions may be contrary to those desired by shareholders. The policies in place designed to
mitigate the risk associated with such transactions; however, shareholders may be harmed by self-dealing with affiliates and loss
of corporate opportunity.
In addition, from time
to time the Company enters into transactions for goods and services with entities in which its executive officers, directors and/or
affiliates have interests, as further described under Part II, Item 8, Note 8, “Commitments and Contingencies,” to
the Consolidated Financial Statements included in this Annual Report on Form 10-K.
The Company also enters
into grape and bulk wine purchase agreements from time to time with entities in which Founders have financial interests. During
FY15 and FY16, the Company has entered into such arrangements with:
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Ghianda Rose Vineyard, which is owned by Diana Fetzer, wife of Paul E. Dolan;
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Gobbi Street Vineyards, which is partly owned by Diana Fetzer, and Paul E. Dolan, III’s daughter,
Nya Kusakabe; and
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Dark Horse Farming Company, which is owned Paul E. Dolan III (75%)
and Heath E. Dolan (25%).
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Premium Wine Storage, which is owned Paul E. Dolan
III (33%) and Heath E. Dolan (33%).
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Paul E. Dolan and Heath
E. Dolan are each directors of the Company and each control approximately 6% of the combined voting power of the Company.
The Company believes
these arrangements reflect substantially the same market terms that would be received in transactions with unaffiliated third-parties.
However, if the Company fails to receive market terms for these transactions or other similar transactions in the future, expenses
could increase.
A failure of one or more of the Company’s
key information technology systems, networks, processes, associated sites or service providers could have a material adverse impact
on the business.
The Company relies
on information technology (“IT”) systems, networks, and services, including internet sites, data hosting and processing
facilities and tools, hardware (including laptops and mobile devices), software and technical applications and platforms, some
of which are managed, hosted, provided and/or used by third-parties or their vendors, to assist in the management of the Company’s
business. The various uses of these IT systems, networks, and services include, but are not limited to: hosting the internal network
and communication systems; ordering and managing materials from suppliers; supply/demand planning; production; shipping product
to customers; hosting the Company’s branded websites and marketing products to consumers; collecting and storing customer,
consumer, employee, investor, and other data; processing transactions; summarizing and reporting results of operations; hosting,
processing, and sharing confidential and proprietary research, business plans, and financial information; complying with regulatory,
legal or tax requirements; providing data security; and handling other processes necessary to manage the business.
Increased IT security
threats and more sophisticated cyber-crime pose a potential risk to the security of the Company’s IT systems, networks, and
services, as well as the confidentiality, availability, and integrity of its data. If the IT systems, networks, or service providers
fail to function properly, or if the Company suffers a loss or disclosure of business or other sensitive information, due to any
number of causes, ranging from catastrophic events to power outages to security breaches, and the Company’s business continuity
plans do not effectively address these failures on a timely basis, the Company may suffer interruptions in its ability to manage
operations and reputational, competitive and/or business harm, which may adversely effect business operations and/or financial
condition. In addition, such events could result in unauthorized disclosure of material confidential information, and the Company
may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to the Company
or to its partners, its employees, customers, suppliers or consumers. In any of these events, the Company could also be required
to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks
and IT systems.
If the Company is unable to maintain
effective internal control over financial reporting in the future, the accuracy, and timeliness of its financial reporting may
be adversely affected.
The Company’s
management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control
over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements in accordance with generally accepted accounting principles in the United States of
America (“U.S. GAAP” or “GAAP”).
The Company is an
“emerging growth company” as defined in the JOBS Act, and as such may elect to avail itself of the certain exemptions
from various reporting requirements of public companies that are not “emerging growth companies,” including, but not
limited to, an exemption from complying with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002,
as amended, which is referred to as the “Sarbanes-Oxley Act.”
The Company depends upon trademarks
and proprietary rights, and any failure to protect intellectual property rights or any claims that are infringing upon the rights
of others may adversely affect the competitive position and brand equity.
The Company’s
future success depends significantly on the ability to protect its current and future brands and products, and to defend intellectual
property rights. The Company has staked out a reputation for innovation and has introduced new product innovations, including,
for example, the evocative “wine wraps” and its proprietary square bottle. The Company has been granted numerous trademark
registrations covering its brands and products and has filed, and expects to continue to file, trademark applications seeking
to protect newly-developed brands and products. The Company cannot be sure that trademark registrations will be issued with respect
to any of the trademark applications. There is also a risk that, by the Company’s omission, failure to timely renew or protect
a trademark, the trademark could be lost. Additionally, competitors could challenge, invalidate or circumvent existing or future
trademarks issued to, or licensed by, the Company.
A reduction in consumer demand for
wines could harm the Company’s business.
There have been periods
in the past in which there were substantial declines in the overall per capita consumption of alcoholic beverages in the United
States and other markets in which the Company participates. A limited or general decline in consumption in one or more of the product
categories could occur in the future due to a variety of factors, including a general decline in economic conditions, increased
concern about the health consequences of consuming beverage alcohol products and about drinking and driving, a trend toward a healthier
diet including lighter, lower calorie beverages such as diet soft drinks, juices and water products, the increased activity of
anti-alcohol consumer groups and increased federal, state or foreign excise and other taxes on alcoholic beverage products. The
competitive position of the Company’s products could also be affected adversely by any failure to achieve consistent, reliable
quality in the product or service levels to customers.
Changes in consumer spending could
have a negative impact on the financial condition and business results.
Wine sales depend upon
a number of factors related to the level of consumer spending, including the general state of the economy, federal and state income
tax rates, deductibility of business entertainment expenses under federal and state tax laws, and consumer confidence in future
economic conditions. Changes in consumer spending in these and other areas can affect both the quantity and the price of
wines that customers are willing to purchase at restaurants or through retail outlets. Reduced consumer confidence and spending
may result in reduced demand for products, limitations on the ability to increase prices and increased levels of selling and promotional
expenses. This, in turn, may have a considerable negative impact upon sales and profit margins.
The market price of the Company’s
stock may fluctuate due to seasonal fluctuations in wine sales, operating expenses and net income.
The Company experiences
seasonal and quarterly fluctuations in sales, operating expenses and net income. The Company has managed, and will continue to
manage, the business to achieve long-term objectives. In doing so, the Company may make decisions that it believes will
enhance long-term profitability, even if these decisions may reduce quarterly earnings. These decisions include the
timing of the release of wines for sale, the Company’s wines’ competitive positioning and the grape and bulk wine sources
used to produce wines.
Bad weather, drought, plant diseases
and other factors could reduce the amount or quality of the grapes available to produce the Company’s wines.
A shortage in the supply
of quality grapes may result from the occurrence of any number of factors which determine the quality and quantity of grape supply,
such as weather conditions and natural disasters, such as floods, droughts, frosts, earthquakes, pruning methods, the existence
of diseases and pests, and the number of vines producing grapes, as well as the level of consumer demand for wine. Any
shortage could cause an increase in the price of some or all of the grape varieties required for wine production and/or a reduction
in the amount of wine the Company is able to produce, which could harm the business and reduce sales and profits.
Recent examples of
events affecting supply include the frost in 2008 that significantly impacted the amount of grapes harvested in Mendocino County,
the frost of 2011 that had a significant impact on the crop size in Paso Robles and the widespread drought which impacted parts
of the United States from 2011 to 2016. Currently 100% of the state of California is now classified as being in one of the three
worst levels of drought which range from abnormally dry, moderate drought, severe drought, extreme drought and exceptional drought.
Factors that reduce
the quantity of grapes may also reduce their quality, which in turn could reduce the quality or amount of wine the Company produces. Deterioration
in the quality of the wine produced could harm the brand name and a decrease in production could reduce sales and increase expenses.
Adverse public opinion about alcohol may harm the Company’s
business.
While a number of research
studies suggest that moderate alcohol consumption may provide various health benefits, other studies conclude or suggest that alcohol
consumption has no health benefits and may increase the risk of stroke, cancer and other illnesses. An unfavorable report
on the health effects of alcohol consumption could significantly reduce the demand for wine, which could harm the business and
reduce sales and increase expenses.
In recent years, activist
groups have used advertising and other methods to inform the public about the societal harms associated with the consumption of
alcoholic beverages. These groups have also sought, and continue to seek, legislation to reduce the availability of
alcoholic beverages, to increase the penalties associated with the misuse of alcoholic beverages, or to increase the costs associated
with the production of alcoholic beverages. Over time, these efforts could cause a reduction in the consumption of alcoholic
beverages generally, which could harm the Company’s business and reduce sales and increase expenses.
Contamination of the Company’s wines would harm
business.
Because the Company’s
products are designed for human consumption, the Company’s business is subject to hazards and liabilities related to food
products, such as contamination. A discovery of contamination in any of the Company’s wines, through tampering
or otherwise, could result in a recall of products. Any recall would significantly damage the Company’s reputation
for product quality, which the Company believes is one of its principal competitive assets, and could seriously harm the Company’s
business and sales. Although the Company maintains insurance to protect against these risks, the Company may not be able
to maintain insurance on acceptable terms, and this insurance may not be adequate to cover any resulting liability.
A decrease in wine score ratings by important rating organizations
could have a negative impact on the Company’s ability to create greater demand and pricing.
Many of the Company’s
brands are issued ratings or scores by local and national wine rating organizations, and higher scores usually translate into greater
demand and higher pricing. Although some of the Company’s brands have been highly rated in the past, and the Company
believes its farming and winemaking activities are of a quality to generate good ratings in the future, the Company has no control
over ratings issued by third-parties which may not be favorable in the future.
Increased regulatory costs or taxes would harm the Company’s
financial performance.
The wine industry is
regulated extensively by the Federal Tax and Trade Bureau and state and local liquor authorities and State of California environmental
agencies. These regulations and laws dictate various matters, including:
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Licensing requirements;
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Trade and pricing practices;
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Permitted distribution channels;
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Permitted and required labeling;
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Relationships with distributors and retailers; and
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Air quality, storm water and irrigation use.
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Recent and future zoning
ordinances, environmental restrictions and other legal requirements may limit the Company’s plans to expand production capacity,
as well as any future development of new vineyards and wineries. In addition, federal legislation has been proposed
that could significantly increase excise taxes on wine. Other federal legislation has been proposed which would prevent
the Company from selling wine directly through the mail. This proposed legislation, or other new regulations, requirements
or taxes, could harm business and operating results. Future legal or regulatory challenges to the wine industry could
also harm business and impact the Company’s operating results.
Prompted by growing
government budget shortfalls and public reaction against alcohol abuse, Congress and many state legislatures are considering various
proposals to impose additional excise taxes on the production and sale of alcoholic beverages, including table wines. Some
of the excise tax rates being considered are substantial. The ultimate effects of such legislation, if passed, cannot
be assessed accurately since the proposals are still in the discussion stage. Any increase in the taxes imposed on table
wines can be expected to have a potentially adverse impact on overall sales of such products. However, the impact may
not be proportionate to that experienced by producers of other alcoholic beverages and may not be the same in every state.
An increase in the cost of energy
or the cost of environmental regulatory compliance could affect the Company’s profitability.
The Company has experienced
increases in energy costs, and energy costs could continue to rise, which would result in higher transportation, freight and other
operating costs. The Company may experience significant future increases in the costs associated with environmental regulatory
compliance, including fees, licenses and the cost of capital improvements to the Company’s operating facilities in order
to meet environmental regulatory requirements. Future operating expenses and margins will be dependent on the ability to manage
the impact of cost increases. The Company cannot guarantee that it will be
able to pass along increased energy costs or
increased costs associated with environmental regulatory compliance to its customers through increased prices.
In addition, the Company
may be party to various environmental remediation obligations arising in the normal course of business or in connection with historical
activities of businesses that may be acquired. Due to regulatory complexities, uncertainties inherent in litigation and the risk
of unidentified
contaminants at current and former properties, the potential exists for remediation, liability and
indemnification costs to differ materially from the
costs that have been estimated. The Company cannot guarantee that the
cost in relation to these matters will not exceed projections or otherwise have an adverse effect upon the Company’s business
reputation, financial condition or results of operations.
Climate change, or legal, regulatory
or market measures to address climate change, may negatively affect the Company’s business, operations or financial performance,
and water scarcity or poor water quality could negatively impact production costs and capacity.
The Company’s
business depends upon agricultural activity and natural resources. There has been much public discussion related to concerns that
carbon dioxide and other greenhouse gases in the atmosphere may have an adverse impact on global temperatures, weather patterns
and the frequency and severity of extreme weather and natural disasters. Severe weather events and climate change may negatively
affect agricultural productivity in the regions from which the Company presently sources agricultural raw materials such as grapes.
Decreased availability of raw materials may increase the cost of goods for the Company’s products. Severe weather events
or changes in the frequency or intensity of weather events can also disrupt the supply chain, which may affect production operations,
insurance cost and coverage, as well as delivery of products to wholesalers, retailers and consumers.
Water is essential
in the production of the Company’s products. The quality and quantity of water available for use is important to the supply
of grapes and the Company’s ability to operate its business. Water is a limited resource in many parts of the world and if
climate patterns change and droughts become more severe, there may be a scarcity of water or poor water quality that may affect
production costs or impose capacity constraints. Such events could adversely affect results of operations and financial condition.
Natural disasters, including earthquakes
or fires, could destroy the Company’s facilities or the Company’s inventory.
The Company must store
its wine in a limited number of locations for a period of time prior to its sale or distribution. Any intervening catastrophes,
such as an earthquake or fire, that result in the destruction of all or a portion of its wine would result in a loss of investment
in, and anticipated profits and cash flows from, that wine. Such a loss would seriously harm business and reduce sales and profits.
From time to time the Company may become subject to litigation
arising in the ordinary course of business. Uninsured judgments or a rise in insurance premiums may adversely impact business,
financial condition and results of operations.
In the ordinary course of business, the
Company may become subject to legal and regulatory proceedings. Any claims raised in such proceedings, whether with or without
merit, could be time consuming and expensive to defend and could divert management’s attention and resources. Additionally,
the outcome of such proceedings may differ from expectations because outcomes are often difficult to predict reliably. Various
factors can lead to changes in estimates of liabilities and other costs and may require the Company to make new or additional estimates.
A future adverse ruling, settlement or unfavorable development could result in charges that could have a material adverse effect
on results of operations in any particular period.
In accordance with customary practice, the
Company maintains insurance against some, but not all, of these potential claims. In the future, the Company may not be able to
maintain insurance at commercially acceptable premium levels. In addition, the levels of insurance the Company maintains may not
be adequate to fully cover any and all losses or liabilities. If any significant judgment or claim is not fully insured or indemnified
against, it could have a material adverse impact on the business, financial condition and results of operations.
Risks Related to the Company’s
Organizational Structure
Truett-Hurst, Inc.’s only
material asset is its interest in the LLC, and it is accordingly dependent upon distributions from the LLC to pay taxes, make payments
under the tax receivable agreement or pay dividends.
The Company is a holding
company and has no material assets other than its controlling member equity interest in the LLC. It has no independent means
of generating revenue. The Company will cause the LLC to make distributions to its unit holders in an amount sufficient to cover
all applicable taxes at assumed tax rates, payments under the tax receivable agreement (which the Company expects to be substantial)
and dividends, if any, declared by the Company. To the extent that the Company needs funds, and the LLC is restricted from making
such distributions under applicable law or regulation or under the terms of its financing arrangements, or is otherwise unable
to provide such funds, it could materially adversely affect the liquidity and financial condition of the Company.
The Founders have significant influence
on Truett-Hurst, Inc. and their interests may differ from those of the public shareholders.
As of June 30, 2016,
the Founders and Affiliates control 43% of the combined voting power through their ownership of the outstanding Class A common
stock and/or Class B common stock. Because the Founders and Affiliates hold a majority of their ownership interest in the business
through the LLC (approximately 92% of their ownership), rather than through the public company, the Founders and Affiliates may
have conflicting interests with holders of shares of the Class A common stock. For example, the Founders and Affiliates may have
different tax positions from the Company which could influence their decisions regarding whether and when to dispose of assets,
whether and when to incur new or refinance existing indebtedness, especially in light of the existence of the tax receivable agreement
that the Company entered in to, and whether and when the Company should terminate the tax receivable agreement and accelerate the
obligations thereunder. In addition, the structuring of future transactions may take into consideration the Founders’ and
Affiliates’ tax or other considerations even where no similar benefit would accrue to the Company.
The Company will be required to pay
the counterparties to the tax receivable agreement for certain tax benefits the Company may claim arising in connection with current
exchanges, future purchases or exchanges of LLC Units and related transactions, and the amounts the Company may pay could be significant.
The Company entered
into a tax receivable agreement with the pre-IPO owners that provides for the payment by Truett-Hurst, Inc. to these parties of
90% of the benefits, if any, that Truett-Hurst, Inc. is deemed to realize as a result of the increases in tax basis resulting from
its purchases or exchanges of LLC Units and certain other tax benefits related to it entering into the tax receivable agreement,
including tax benefits attributable to payments under the tax receivable agreement.
The Company expects
the payments that it may make under the tax receivable agreement will be substantial. There may be a material negative effect on
the Company’s liquidity if, as a result of timing discrepancies or otherwise, the payments under the tax receivable agreement
exceed the actual benefits realized in respect of the tax attributes subject to the tax receivable agreement and/or distributions
to Truett-Hurst, Inc. by LLC. LLC are not sufficient to permit Truett-Hurst, Inc. to make payments under the tax receivable agreement
after it has paid taxes. The payments under the tax receivable agreement are not conditioned upon the continued ownership of us
by the counterparties to the tax receivable agreement.
The Company is required
to make a good faith effort to ensure that it has sufficient cash available to make any required payments under the tax receivable
agreement. The operating agreement of the LLC requires the LLC to make “tax distributions” which, in the ordinary course,
will be sufficient to pay the actual tax liability and to fund required payments under the tax receivable agreement. If for any
reason the LLC is not able to make a tax distribution in an amount that is sufficient to make any required payment under the tax
receivable agreement or the Company otherwise lacks sufficient funds, interest would accrue on any unpaid amounts at LIBOR plus
500 basis points until they are paid.
In the event that the
Company and an exchanging LLC Unit holder are unable to resolve a disagreement with respect to the tax receivable agreement, the
Company is required to appoint either an expert in the relevant field or an arbitrator to make a determination, depending on the
matter in dispute.
In certain cases,
payments under the tax receivable agreement to the existing owners may be accelerated and/or significantly exceed the actual benefits
realized in respect of the tax attributes subject to the tax receivable agreement.
The
tax receivable agreement provides that upon certain mergers, asset sales, other forms of business combinations or other
changes of control, or if, at any time, Truett-Hurst, Inc. elects an early termination of the tax receivable
agreement, Truett-Hurst, Inc’s (or its successor's) obligations with respect to exchanged or acquired LLC Units (whether
exchanged or acquired before or after such transaction) would be based on certain assumptions, including that the corporate
taxpayer would have sufficient taxable income to fully utilize the deductions arising from the increased tax deductions and
tax basis and other benefits related to entering into the tax receivable agreement. As a result, (i) the Company could be
required to make payments under the tax receivable agreement that are greater than or less than the specified percentage of
the actual benefits realized in respect of the tax attributes subject to the tax receivable agreement and (ii) if the Company
elects to terminate the tax receivable agreement early, the Company would be required to make an immediate payment equal to
the present value of the anticipated future tax benefits, and this upfront payment may be made years in advance of the actual
realization of such future benefits. Upon a subsequent actual exchange, any additional increase in tax deductions, tax basis
and other benefits in excess of the amounts assumed at the change in control will also result in payments under the tax
receivable agreement. In these situations, the Company’s obligations under the tax receivable agreement could have a
substantial negative impact on its liquidity. There can be no assurance that the Company will be able to finance its
obligations under the tax receivable agreement.
Payments under
the tax receivable agreement are based on the tax reporting positions that the Company determines. Although the Company is
not aware of any issue that would cause the IRS to challenge a tax basis increase, Truett-Hurst, Inc. will not be reimbursed
for any payments previously made under the tax receivable agreement. As a result, in certain circumstances, payments could be
made under the tax receivable agreement in excess of the benefits that Truett-Hurst, Inc. actually realizes in respect of
(i) the increases in tax basis resulting from exchanges of LLC Units and (ii) certain other tax benefits related to
entering in to the tax receivable agreement, including tax benefits attributable to payments under the tax receivable
agreement.
Risks Related to the Company’s
Class A Common Stock
The Company’s failure to meet the continued listing
requirements of The NASDAQ Capital Market could result in a delisting of the Class A common stock.
If the Company fails to satisfy the continued
listing requirements of The NASDAQ Capital Market, such as the requirement that it maintain a share price of at least $1.00 per
share, NASDAQ may take steps to de-list the Class A common stock. Such a delisting would likely have a negative effect on the price
of the Class A common stock and would impair your ability to sell or purchase the Company’s Class A common stock when you
wish to do so. In the event of a delisting, the Company would expect to seek to take actions to restore compliance with NASDAQ’s
listing requirements, but the Company can provide no assurance that any such action taken would allow the Class A common stock
to become listed again, stabilize the market price or improve the liquidity of the Class A common stock or prevent the Class A
common stock from dropping below the NASDAQ minimum bid price requirement in the future.
The Company does not intend to pay
any cash dividends in the foreseeable future.
The Company does not
expect to pay any dividends in the foreseeable future. Payments of future dividends, if any, will be at the discretion of the board
of directors after taking into account various factors, including the business, operating results and financial condition, current
and anticipated cash needs, plans for expansion and any legal or contractual limitations on the Company’s ability to pay
dividends. As a result, capital appreciation in the price of the Class A common stock, if any, may be the only source of gain
on an investment in the Class A common stock.
Even if the Company
decides in the future to pay any dividends, Truett-Hurst, Inc. is a holding company with no independent operations of its
own except its controlling member equity interest in the LLC. As a result, Truett-Hurst, Inc. depends on LLC and its affiliates
for cash to pay its obligations and make dividend payments. Deterioration in the financial condition, earnings or cash flow of LLC and its affiliates for any reason could limit or impair its ability to pay cash distributions or other distributions
to us. In addition, the Company’s ability to pay dividends in the future is dependent upon receipt of cash from LLC
and its affiliates. LLC and its affiliates may be restricted from sending cash to the Company by, among other things, law
or provisions of the documents governing the Company’s existing or future indebtedness.
If securities or industry analysts
stop publishing research or reports about the Company’s business, or if they downgrade their recommendations regarding the
Company’s Class A common stock, the stock price and trading volume could decline.
The trading market
for the Company’s Class A common stock is influenced by the research and reports that industry or securities analysts
publish about the Company or its business. The Company has limited research coverage for its stock and it is difficult to attract
research coverage for small-cap companies like ours. If any of the analysts who cover the Company downgrades the Company’s
Class A common stock or publishes inaccurate or unfavorable research about the Company’s business, its Class A
common stock price may decline. If analysts cease coverage of the Company or fail to regularly publish reports on the Company,
the Company could lose visibility in the financial markets, which in turn could cause the Class A common stock price or trading
volume to decline and the Class A common stock to be less liquid.
The market price and trading volume
of the Company’s common stock may be volatile and may be affected by market conditions beyond the Company’s control.
The trading price of
shares of the common stock may fluctuate substantially. The trading price for many micro-cap and small-cap stocks tends to be volatile.
As a result, the prevailing trading price of the shares of the Company’s common stock lower than prices paid by investors,
depending on many factors, some of which are beyond the Company’s control and may not be related to operating performance.
These fluctuations could cause investors to lose part or all of their investment in shares of the Company’s common stock.
In addition, operating results could be below the expectations of the public market analysts and investors due to a number of potential
factors, including variations in quarterly operating results, departures of key management personnel, failure to meet analysts'
earnings estimates, publication of research reports about the industry, litigation and government investigations, changes or proposed
changes in laws or regulations or differing interpretations or enforcement thereof affecting the Company’s business, adverse
market reaction to any indebtedness the Company may incur or securities the Company may issue in the future, and other factors.
You may be unable to resell your shares of Class A common stock at or above the price you originally paid. In addition as
a result of the Company’s market capitalization, among other factors, there is limited liquidity in the market for the Company’s
common stock. As a result, even if you choose to sell your shares of Class A common stock, you may find it difficult to do so.
In past years, stock
markets have experienced extreme price and volume fluctuations. In the past, following periods of volatility in the overall market
and the market price of a company's securities, securities class action litigation has often been instituted against these companies.
This litigation, if instituted against the Company, could result in substantial costs and a diversion of its management's attention
and resources.
You may be diluted by the future
issuance of additional Class A common stock in connection with the Company’s incentive plans, acquisitions or otherwise.
As of June 30, 2016,
the Company had an aggregate of 11.0 million shares of Class A common stock authorized but unissued, including approximately 2.8
million shares of Class A common stock issuable upon exchange of outstanding LLC Units and 0.1 million shares reserved for issuance
under its 2012 Incentive Plan. See Part II, Item 8, Note 10, “Stock-based Compensation” to the Consolidated Financial
Statements included in this Annual Report on Form 10-K. The certificate of incorporation authorizes the Company to issue these
shares of Class A common stock and restricted stock rights relating to Class A common stock for the consideration and on the terms
and conditions established by the board of directors in its sole discretion. Any Class A common stock that is issued, including
under the 2012 Incentive Plan or other equity incentive plans that the Company may adopt in the future, would dilute the percentage
ownership held by then existing holders of Class A common stock.
The Company
incurs increased costs and demands upon management as a result of complying with the laws and regulations that affect public companies,
which could materially adversely affect results of operations, financial condition, business and prospects.
As a public company,
the Company incurs significant legal, accounting and other expenses that it did not incur as a private company, including costs
associated with public company reporting and corporate governance requirements. These requirements include compliance with Section
404 and other provisions of the Sarbanes-Oxley Act, as well as rules implemented by the SEC and NASDAQ. In addition, the management
team will also have to adapt to the requirements of being a public company. The Company expects compliance with these rules and
regulations will substantially increase its legal and financial compliance costs and will make some activities more time-consuming
and costly.
The increased costs
associated with operating as a public company will decrease the Company’s net income or increase its net loss, and may require
the Company to reduce costs in other areas of its business or increase the prices of its products or services. Additionally, if
these requirements divert management’s attention from other business concerns, they could have a material adverse effect
on the Company’s results of operations, financial condition, business and prospects.
However, for as long
as the Company remains an “emerging growth company” as defined in the JOBS Act, the Company may take advantage of certain
exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth
companies” including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley
Act, reduced disclosure obligations regarding executive compensation in the Company’s periodic reports and proxy statements
and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of
any golden parachute payments not previously approved. The Company may take advantage of these reporting exemptions until it is
no longer an “emerging growth company.”
The Company
will not be required to comply with certain provisions of the Sarbanes-Oxley Act for as long as it remains an “emerging growth
company.”
For as long as the
Company remains an emerging growth company, it may take advantage of certain exemptions from various reporting requirements that
are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required
to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations
regarding executive compensation in its periodic reports and proxy statements, and exemptions from the requirements of holding
a non-binding advisory vote on executive compensation. The Company may take advantage of these reporting exemptions until it is
no longer an emerging growth company. The Company will remain an emerging growth company for up to five years unless it no longer
qualifies for such status prior to that time. After the Company is no longer an emerging growth company, it expects to incur additional
expenses and devote substantial management effort toward ensuring compliance with those requirements applicable to companies that
are not emerging growth companies.
Reduced disclosure
requirements applicable to emerging growth companies may make the Company’s common stock less attractive to investors.
As an “emerging
growth company,” the Company takes advantage of certain exemptions from various reporting requirements that are applicable
to other public companies that are not “emerging growth companies” including not being required to comply with the
auditor attestation requirements of section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation
in its periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive
compensation and shareholder approval of any golden parachute payments not previously approved. The Company cannot predict if investors
will find its common stock less attractive as it relies on these exemptions. If some investors find the common stock less attractive
as a result, there may be a less active trading market for the Company’s common stock and its stock price may be more volatile.