Item 1. Business
Truett-Hurst Inc. is a holding company incorporated in 2012 as a Delaware corporation and our 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 noncontrolling interest for the economic interest in the LLC it does not own. Our 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, 2018, 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, “FY18” and “fiscal year 2018” each refer to the fiscal year ended June 30, 2018. 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 October 8, 2017 and for several days thereafter, significant wildfires broke out in Napa, Sonoma, and surrounding counties in Northern California. Certain of our inventory, primarily juice pressed from grapes picked during the 2017 harvest and maintained at outside production and storage facilities, was damaged due to smoke taint during the barrel aging process. We filed a claim with our insurance carrier, who performed testing on samples sent to its labs in June 2018. The results indicated positive for exposure, and as a result we received $1.9 million in insurance proceeds in June of 2018.
On August 13, 2018, we entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Precept Brands LLC, a Washington limited liability company (“Precept”) pursuant to which we have sold certain assets comprising our wholesale wine business (the “Wholesale Business”) to Precept (the “Precept Transaction”). See Note 3 “Discontinued Operations”, and Note 12 “
Subsequent Events
”.
General
Following the sale of the Wholesale Business to Precept on August 13, 2018, we are now only operating our Direct to Consumer (“DTC”) business based at our estate property in Healdsburg, California
as well as the sale of
our
three brands to certain national retailers.
We produce super ultra-premium and luxury tier Pinot Noir, Chardonnay, Sauvignon Blanc, Zinfandel, Petite Sirah, and Syrah for our three brands Truett Hurst, VML and Svengali. We maintain a wine club for Truett Hurst and VML and we provide a premier experience leveraging our creekside property, our hospitality, customer service and award winning wine quality. We continue to be headquartered in Sonoma County, California and lease space for wine production within a custom crush facility located in Santa Rosa, California. The DTC channel consists of sales of products produced by us through our tasting rooms, wine clubs and our winery websites.
Strategic Objectives
We sell our wine into two primary categories: Super Ultra-Premium ($25-49 per bottle retail price) and Luxury ($50+ per bottle retail price). With our focus on the DTC business, we plan to focus on the following sales channels:
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Walk In Visitors:
Dry Creek Valley is home to over 75 wineries and tasting rooms and draws from a large population base in and around the San Francisco Bay Area. These sales make up approximately 25% of our total sales and we work to convert these customers to longer term customers via our Wine Clubs.
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Wine Club:
Truett Hurst and VML
Wine Clubs have over 6,000 member from which we generate
approximately 75% of our annual sales. Wine Club members can choose from a variety of membership options and can also customize their membership to include specific wines or shipping timing. The most common memberships ship four times per year.
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E-Commerce:
With a database of over 20,000 customers we regularly develop offerings of special lots, one time buys and end of vintage opportunities.
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Retail:
We currently sell the Truett Hurst brand directly to several retailers including Total Wine and More and sell the VML brand to a select group of retailers via a traditional three tier distribution.
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Wine Operations
Brands
We operate two tasting rooms and one winery where wine is produced from many varieties of grapes principally grown or purchased in Sonoma County’s Dry Creek Valley and Russian River Valley appellations. Established in 2007, Truett-Hurst was the first winery operation and brand that focuses on producing limited lots of super-premium wine from a range of varietals, including Zinfandel, Chardonnay, Sauvignon Blanc, Pinot Noir, Petite Sirah and other unique red blends from grapes sourced from local growers in the Dry Creek Valley. Established in 2011, VML was the second winery operation and brand that focuses on producing limited lots of super-premium and ultra-premium wines from grapes purchased from local growers in the Russian River Valley. The primary varietals include Pinot Noir, Chardonnay, Sauvignon Blanc, and Gewurztraminer. The Svengali brand was established most recently to focus entirely on a single Dry Creek Valley Syrah.
Property
We own a 25-acre property located at 5610 Dry Creek Road, Healdsburg, California, of which approximately 15 acres is used for growing grapes. The remainder of the property is used for the Truett-Hurst and VML tasting rooms, retail sales space, and office space for support staff. Although we have maintained the proper permits to build a winery at this location and there is infrastructure, such as electricity and access to water, necessary to operate a winery on the property, we have not made the requisite capital expenditures to construct a building to house grape-crushing equipment and wine storage tanks. We believe that the property can be used to expand our wine-making operations in the future and provide better control over wine quality.
We lease wine production space within a custom crush facility located in Santa Rosa, California. The lease commenced on April 15, 2017 and ended on June 15, 2018. The initial 14-month term has been renewed for an additional 12 month period as agreed to by both parties. Previously, we leased a winery located at 4035 Westside Road, Healdsburg, California, but vacated those premises prior to May 31, 2017.
Production
The wine production space within the custom crush facility allows us to crush, ferment and oak barrel age approximately 700 tons (50,000 cases) of ultra-premium grapes annually, with capacity to increase to 1,000 tons with additional capital improvements. For increased production capacity, we outsource to a variety of specialist wineries and bottling facilities. We have been able to satisfy the production requirements to date and considers our sources to be adequate at this time. However, the inability of any of the suppliers to satisfy our requirements could adversely affect operations.
We entered into a Transition Services Agreement with Precept to harvest and produce wine for Precept from the 2018 vintage and oversee blending and bottling of the bulk wine sold to Precept in the Precept Transaction. See Note 12 “Subsequent Events” for further information.
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Grape and Wine Contracts
The majority of annual grape requirements are satisfied by purchases from each year’s harvest and from fruit harvested from our estate vineyards which normally begins in August and runs through October. In addition to purchasing grapes, we supplement our needs with bulk wine purchase contracts based on sales and production requirements. Depending upon overall demand and availability of bulk wine, we could experience shortages and/or increased prices.
We enter 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 us 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
We utilize glass and other materials such as corks, capsules, labels and cardboard cartons in the bottling and packaging of our 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. We obtain glass requirements from a limited number of producers under supply arrangements. We have 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 our requirements could adversely affect our 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. We expect these trends to continue.
Company Team and Culture
Our 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. We are proud of the corporate partnerships that have been created throughout the sales channels and believe we can build a business that can change the way consumers purchase and enjoy wine.
Sales and Marketing
We employ 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.
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As a part of the sale of our Wholesale Business to Precept in August 2018, we sold
our wholesale brands and, as a result our future sales will be comprised of sales through
our
DTC busines
s.
On a combined basis, t
he DTC segment represented approximately 27% of our net sales and 51% of our gross profit for the year ended June 30, 2018.
DT
C sales have high margins, typically include more expensive wines, and create a “halo effect” for ou
r
national brands. The remaining national brand segment is comprised of brands we have developed and own (VML, Truett Hurst and Svengali). We
also
sell
these brands to on and off-premise regional and national
retail
chains, as well as independent restaurants, liquors stores, and grocery stores.
Competitive Environment
All the segments we participate in are highly competitive. We compete 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 us, 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.
There are relatively few publicly traded beverage companies with significant wine operations and most also have beer and spirits divisions.
Demand for wine in our market segments can rise and fall with general economic conditions. Our 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 us to continue to penetrate the mainstream wine markets.
Intellectual Property
We protect 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 we are making a bona fide usage of the trademark. Subsequent to the sale of the Wholesale Business on August 13, 2018, we have 3 registered material trademarks.
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, we are 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. We are licensed by and meet 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 our tasting rooms.
In conjunction with the signing of the 2018 Tax Reform Bill, the federal alcohol tax rate changed effective January 1, 2108. The previous rates of $1.07 per gallon for wines with alcohol content at or below 14% and $1.57 per gallon for wines above 14% but less than 21% has been modified to reflect the following tiered structure:
For wines with alcohol content of 16% and under – ($.07 per gallon on first 30,000 gallons, $.17 per gallon from 30,001 – 130,000, $.535 per gallon from 130,001 – 750,000, $1.07 over 750,000)
For wines with alcohol content between 16% - 21% - ($.57 per gallon on first 30,000 gallons, $.67 per gallon from 30,001 – 130,000, $1.035 per gallon from 130,001 – 750,000, $1.57 over 750,000)
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For
w
ines with alcohol content between 21% - 24% ($2.15 per gallon on first 30,000 gallons, $2.25 per gallon from 30,001 – 130,000, $2.62 per gallon from 130,001 – 750,000, $3.15 over 750,000)
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, we are also regulated by Sonoma County and, as a producer of wastewater, by the state of California. We maintain 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 our wine. Many of the expenses for protecting the environment are voluntary, however we are 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.
We believe we are in compliance in all material respects with all applicable governmental laws and regulations in the countries in which we operate. We also believe that the cost of administration and compliance with, and liability under, such laws and regulations have not had a material adverse impact on our financial condition, results of operations or cash flows for the fiscal year ended June 30, 2018.
Employees
As of June 30, 2018, we had 35 full time, 15 part time, and 4 seasonal employees. We hire part time and seasonal help as needed. All employees are located in the United States. We believe 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. We believe relations with our employees are good.
Information About Our Executive Officers
The information required under this Item is incorporated by reference from our definitive proxy statement to be filed relating to our 2018 annual meeting of stockholders.
Available Information
Principal executive offices are located at 125 Foss Creek Circle, Healdsburg, California 95448, and the telephone number is (707) 431-4423. We file 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 we file electronically with the SEC at www.sec.gov. You may learn more about us 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.
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Emerging Growth Company Status
We were initially an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act, enacted on April 5, 2012 (“JOBS Act”). For as long as we remained an “emerging growth company,” we could 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 our 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. We reached our fifth anniversary of our IPO as of June 30, 2018, and no longer qualify as an “emerging growth company’ under the JOBS Act.
Smaller Reporting Company
Although we no longer qualify as an “emerging growth company” we are still able to take advantage of certain exemptions from various reporting obligations as a “smaller reporting company”. We 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 IPO. The designation of being a “smaller reporting company” relieves us from some of the more detailed informational requirements of Regulation S-K.
Item 1A. Risk Factors
Risks Related to the Company’s Business
We recently consummated the sale of assets constituting our wholesale wine business, one of our two primary business segments. This divestiture and related contingent liabilities from the sale could adversely affect our results of operations and financial condition.
On August 13, 2018 we completed the sale of certain assets comprising our wholesale wine business (the “Wholesale Business”) to Precept Brands LLC, a Washington limited liability company (“Precept”) for a cash purchase price (subject to certain post-closing adjustments), assumed liabilities and future royalty payments (the “Precept Transaction”). As a result of the Precept Transaction, our revenues will be materially reduced as compared to prior periods.
We expect to restructure our operations to focus on our direct to consumer business (the “DTC Business”). Our success in realizing benefits from such restructuring, and the timing of this realization, depends on many factors, some of which are not within our control. For example, risks in realizing these benefits include failure to retain key customers, employees and suppliers; difficulties under contracts (particularly those that covered both businesses); changes in our senior leadership; diversion of resources to address transition services obligations; inherent risks in operating the business; and unanticipated issues, expenses and liabilities. Even if we are able to restructure our business and operations successfully, restructuring may not result in the realization of the full benefits of the Precept Transaction that we currently expect within the anticipated time frame, or at all.
The Precept Transaction could result in a financial loss which could have a material adverse effect on our results.
In addition, in connection with such divestiture, we have retained responsibility for some of the known and unknown contingent liabilities related to the Precept Transaction such as indemnification, lawsuits, tax liabilities, product liability claims, and other matters. The realization of any of these potential liabilities could have a material adverse effect on our business or results of operations.
We also entered into a Transition Services Agreement in connection with the sale of the Wholesale Business, under which we will provide winemaking and other services to Precept over the nine month period following closing. Such services may divert human and financial resources from focus on the remaining business, and may expose us to additional risks and liabilities.
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Finally, a portion of the purchase price is based on Precept’s sales of
the
Wholesale Business brands and is paid over tim
e pursuant to a Royalty Payment Agreement. If Precept fails to sell sufficient amounts of such brands or the market for the Wholesale Business brands deteriorates, such royalty amounts may not be realized in full or at all.
Following the sale of the Wholesale Business, we have chosen to refocus the strategic direction of our business on our DTC Business. There can be no guarantee that this strategy will be successful or that we will experience consistent and sustainable profitability in the future as a result of our new strategy.
The sale of the Wholesale Business enables us to concentrate exclusively on our DTC Business. We cannot guarantee that our strategy is the right one or that we will be effective in executing our strategy. Our strategy may not succeed for a number of reasons, including, but not limited to: general economic risks; execution risks; risks associated with sales not materializing based on a change in circumstances; disruption to sales; increasing competitiveness in our markets; our ability to retain key personnel; the dynamic nature of the markets in which we operate; specific economic risks in different geographies and among different customer segments; uncertainty regarding increased business and renewals from existing customers; uncertain growth prospects and market share; risks of new product development and introductions and innovation; product defects; unexpected costs, assumption of unknown liabilities and increased costs for any reason; potential litigation and disputes and the potential costs related thereto; distraction and damage to sales and reputation caused thereby; market acceptance of new products and services; the ability to attract and retain personnel; risks associated with management of growth; competition and pricing pressure.
If one or more of the foregoing risks were to materialize, our business, results of operations and ability to achieve sustained profitability could be adversely affected.
We may not be able to maintain the profitability or operating efficiencies that we and the DTC Business had achieved or might achieve with the Wholesale Business. We may be less able to offset such risks in the DTC Business by operating with a single line of business. The markets in which the DTC Business operates may not experience the growth rates expected and any economic downturn affecting those markets could negatively impact the DTC Business. These markets may experience more volatility than expected or face more operating risks than in the markets in which we have historically operated with the Wholesale Business. If the DTC Business or the markets in which it operates deteriorate, the potential cost savings, efficiencies, growth opportunities and other benefits of the Precept Transaction may not be realized fully, or at all, or may take longer to realize than expected. In such case, our business, financial condition, results of operations and cash flows may be negatively impacted.
We may require additional debt and/or equity financing for our DTC Business, and such financing may not be available to us on favorable terms, or at all.
In connection with the restructuring of the DTC Business, we may require funds in excess of our existing cash resources and debt to fund operations, develop new products, fulfill SEC reporting and compliance obligations and finance general and administrative activities.
Due to market conditions at the time we may need additional funding, or due to our financial condition at that time, it is possible that we will be unable to obtain additional debt or equity financing as and when we need it. If we are unable to obtain additional funding, we may not be able to repay debts when they are due and payable. If we are able to obtain capital it may be on unfavorable terms or terms which excessively dilute our stockholders. If we are unable to obtain additional funding as and when needed, we could be forced to delay our business growth efforts and, if we continue to experience losses, potentially cease operations.
Management changes in connection with the Precept Transaction, particularly relating to Phil Hurst, our President and Chief Executive Officer, may have an adverse impact on our operations and reputation.
In connection with the Precept Transaction, we made changes in certain management positions, including the resignation of Phil Hurst, our President and Chief Executive Officer, effective November 1, 2018. We may experience further changes in key leadership or key positions in the future. The departure of key leadership personnel, especially a long-serving Chief Executive Officer, can take from us significant knowledge and experience. There can be no assurance that we will be successful in such efforts.
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A reduction in the supply of grapes and bulk wine available to us from the independent grape growers and bulk wine suppliers could reduce
our
annual production of wine.
We rely on annual contracts with independent growers to purchase substantially all the grapes used in wine production. The business would be harmed if we are unable to contract for the purchase of grapes at acceptable prices from these or other suppliers in the future. The terms of many of our purchase agreements also constrain the ability to discontinue purchasing grapes in circumstances where we 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.
We depend on various bulk wine suppliers for the production of several wines, including those being produced for Precept under the Transition Services Agreement. These contracts currently cover the 2017-2019 harvests. Extension of these contracts is not guaranteed and thus we may have exposure to the availability and pricing of bulk wine for our production needs which could increase the cost or reduce the amount of wine we are able to produce for sale in the future. This could reduce sales and profits.
We face inventory risk, and if we fail to predict accurately demand for products, we may face write-downs or other charges.
We are 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 our products, changes in consumer demand, and other factors. We endeavor 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, we depend on the marketing initiatives and efforts of distributors in promoting products and creating consumer demand and we have limited or no control regarding their promotional initiatives or the success of their efforts.
We have a history of losses, and may not achieve or maintain profitability in the future.
We have had a limited number of quarters or years of profitability and historically raised additional capital to meet our growth needs. Further, the sale of the Wholesale Business removed certain costs but also removed revenue streams associated with that line of business. We expect to make significant investments in order to develop and expand our restructured business, which, we believe, 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, we expect to continue to incur legal, accounting, and other administrative expenses that are material. Our revenues have been subject to volatility in recent periods and this volatility may cause us to not cover our costs and successfully compete in the highly competitive wine market.
We may not generate sufficient revenue to achieve profitability. We may incur significant losses in the future for a number of reasons, including slowing demand for our 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, we 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.
We face significant competition which could adversely affect profitability.
The wine industry is intensely competitive. Our 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. Our 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. Our sales may be harmed to the extent we
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are
not able to compete successfully against such wine or alternative beverage producers’ costs. There can be no a
ssurance that in the future
we
will be able to successfully compete with current competitors or that
we
will not face greater competition from other wineries and beverage manufacturers.
The loss of key employees or personnel could damage our reputation and business.
We believe that success largely depends on the employment of experienced professionals in a number of key positions. The Company has experienced turnover in such key positions in fiscal year 2018, including changes in our Chief Financial Officer, Phil Hurst’s transition to Precept as described above, and the recent departure of Ginny Lambrix, our chief winemaker. Any inability or unwillingness of key management team members to continue in their present capacities could harm the business and our reputation.
Attracting, retaining, and developing individuals in key roles is a component of our strategy for addressing our business opportunities. Attracting and retaining qualified leadership may be more challenging under certain business conditions, especially in times of transition such as those now facing us. Failure to attract and retain the right talent, or to smoothly manage the transition of responsibilities resulting from such turnover, would affect our ability to meet our challenges and may cause us to miss performance objectives or financial targets.
A reduction in our access to or an increase in the cost of the third-party services used to produce our wine could harm our business.
We utilize capacity at several third-party facilities for the production of a significant portion of our 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 our sales and profits. Certain of these facilities may have been impacted by the Northern California wildfires in October 2017. We do not have long-term agreements with any of these facilities, and they may provide services to competitors at a price above what we are 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, we must increasingly rely upon these third-party production facilities. Reliance on third-parties will also vary with annual harvest volumes.
In addition, we have limited direct impact over the quality control and quality assurance of these third-party manufacturers. If our suppliers are not able to deliver products that satisfy our requirements, we 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 our financial results.
The terms of future bank loans may restrict current and future operations, which could adversely affect our ability to respond to changes in our business and to manage our operations.
As discussed above, the Company may require funds in excess of our existing cash resources and debt to fund operations, develop new products, fulfill SEC reporting and compliance obligations and finance general and administrative activities. We have in the past used bank loans as a method of obtaining funds for such matters, and expect to do so in the future.
Bank loans may include restrictive covenants that could impair our financing and operational flexibility and make it difficult to react to market conditions and satisfy ongoing capital needs and unanticipated cash requirements.
Our ability to comply with any such covenants and other terms of our bank loans will depend on future operating performance and, in addition, may be affected by events beyond our control, and we may not meet them.
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, 2018, our Founders and current officers and directors (together, “Founders and Affiliates”) control approximately 40.11% 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
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holds a single share of Class B common stock. Although these shares have no economic rights, they allo
w 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 th
e election of directors and the approval of corporate actions that must be submitted for a vote of shareholders.
The interests of these Founders and Affiliate 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.
We have certain transactions with related parties, including Founders, which may present a conflict of interest.
We routinely source grapes for our 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 we enter into transactions for goods and services with entities in which our 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.
We also enter into grape and bulk wine purchase agreements and bulk wine storage contracts from time to time with entities in which Founders have financial interests. During FY18, we entered into such arrangements with:
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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 each control approximately 5.4% of the combined voting power of the Company. Paul E. Dolan is a director of the Company and has been appointed the President and Chief Executive Officer effective November 1, 2018, while Heath E. Dolan resigned as a director in May 2017.
We believe these arrangements reflect substantially the same market terms that would be received in transactions with unaffiliated third-parties. However, if we fail to receive market terms for these transactions or other similar transactions in the future, expenses could increase.
A failure of one or more of our key information technology systems, networks, processes, associated sites or service providers could have a material adverse impact on the business.
We rely 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 our 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 our 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 our IT systems, networks, and services, as well as the confidentiality, availability, and integrity of our data. If the IT systems, networks, or service providers fail to function properly, or if we suffer 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 our business continuity plans do not effectively address these failures on a timely basis, we may suffer interruptions in our ability to manage operations and reputational, competitive and/or business harm, which may adversely affect business operations and/or financial condition. In addition, such events could result in unauthorized disclosure of material confidential information, and we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us or to our partners, our employees, customers, suppliers or consumers. In any of these events, we 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.
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If
we are
unable
to maintain effective internal control over financial reporting in the future, the accuracy, and timeliness of
our
financial reporting may be adversely affected.
Companies that file reports with the SEC, including us, are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”). The Sarbanes-Oxley Act requires management to establish and maintain a system of internal control over financial reporting and annual reports on Form 10-K filed under the Exchange Act to contain a report from management assessing the effectiveness of a company’s 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”). Our management is responsible for establishing and maintaining adequate internal control over financial reporting, and a report of our management is included under Item 9A.“Controls and Procedures” of this report. We are a smaller reporting company and, consequently, are not required to include an attestation report of our auditor in this annual report. However, if and when we become subject to the auditor attestation requirements under SOX 404, we can provide no assurance that we will receive an unqualified report from our independent auditors.
If we identify material weaknesses in our internal controls over financial reporting or fail to meet the demands placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act, we may be unable to accurately report our financial results or report them within the timeframes required by law or stock exchange regulations. Failure to comply with Section 404 of the Sarbanes-Oxley Act could also potentially subject us to sanctions or investigations by the SEC or other regulatory authorities. If material weaknesses exist or are discovered in the future, and we are unable to remediate any such material weakness, our reputation, financial condition and operating results could suffer.
The success of our business relies heavily on brand image, reputation, and product quality.
It is important that we maintain and increase the image and reputation of our existing brands and products. Concerns about product quality, even when unsubstantiated, could be harmful to our image and reputation of our brands and products. While we have quality control programs in place, in the event we experienced an issue with product quality, we may experience recalls or liability in addition to business disruption which could further negatively impact brand image and reputation and negatively affect our sales. Our brand image and reputation may also be more difficult to protect due to less oversight and control as a result of the outsourcing of some of our operations. We also could be exposed to lawsuits relating to product liability or marketing or sales practices. Deterioration to our brand equity may be difficult to combat or reverse and could have a material effect on our business and financial results. In addition, because our brands carry family names, personal activities by certain members of the Truett or Hurst families that harm their public image or reputation could have an adverse effect on our brands.
We depend 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 our competitive position and brand equity.
Our future success depends significantly on the ability to protect our current and future brands and products, and to defend intellectual property rights. We have staked out a reputation for innovation and has introduced new product innovations, including, for example, our brand names, evocative “wine wraps” and our proprietary square bottle (which was transferred to Precept in the sale of the Wholesale Business). The intellectual property relating to these innovations includes copyright, trademark, patent and trade secrets, some of which are developed in-house and some of which is developed by third party consultants. Although most of our intellectual property is owned by the Company, third party intellectual property is sometimes co-owned with the developers or licensed for use. Any failure to obtain, maintain and defend sufficient rights to this intellectual property could harm our reputation, results and financial condition.
We have 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. We cannot be sure that trademark registrations will be issued with respect to any of the trademark applications. There is also a risk that, by our omission, failure to timely renew or protect a trademark, the trademark could be lost.
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Additionally, competitors could challenge, invalidate or circumvent existing or future
intellectual property
developed by,
issued to, or licensed by, the Company.
Should
we co
me into conflict with third parties over intellectual property rights,
it
could result in disruptive and expensive litigation. Any of the foregoing could harm our business.
A reduction in consumer demand for wines could harm our 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 we participate. 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 our 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 our 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 our stock may fluctuate due to seasonal fluctuations in wine sales, operating expenses and net income.
We experience seasonal and quarterly fluctuations in sales, operating expenses and net income. We have managed, and will continue to manage, the business to achieve long-term objectives. In doing so, we may make decisions that we believe 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, our 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 our 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 we are 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.
Factors that reduce the quantity of grapes may also reduce their quality, which in turn could reduce the quality or amount of wine we produce. Deterioration in the quality of the wine produced could harm our brand name and a decrease in production could reduce sales and increase expenses.
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Adverse public opinion about alcohol may harm
our
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 our business and reduce sales and increase expenses.
Contamination of our wines would harm business.
Because our products are designed for human consumption, our business is subject to hazards and liabilities related to food products, such as contamination. A discovery of contamination in any of our wines, through tampering or otherwise, could result in a recall of products. Any recall would significantly damage our reputation for product quality, which we believe is one of our principal competitive assets, and could seriously harm our business and sales. Although we maintain insurance to protect against these risks, we 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 our ability to create greater demand and pricing.
Many of our 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 our brands have been highly rated in the past, and we believe our farming and winemaking activities are of a quality to generate good ratings in the future, we have no control over ratings issued by third-parties which may not be favorable in the future.
Increased regulatory costs or taxes would harm our 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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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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Recent and future zoning ordinances, environmental restrictions and other legal requirements may limit our 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 us 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 our 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
16
ult
imate 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 suc
h 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 our profitability.
We have experienced increases in energy costs, and energy costs could continue to rise, which would result in higher transportation, freight and other operating costs. We may experience significant future increases in the costs associated with environmental regulatory compliance, including fees, licenses and the cost of capital improvements to our 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. We cannot guarantee that it will be able to pass along increased energy costs or increased costs associated with environmental regulatory compliance to our customers through increased prices.
In addition, we 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. We cannot guarantee that the cost in relation to these matters will not exceed projections or otherwise have an adverse effect upon our business reputation, financial condition or results of operations.
Climate change, or legal, regulatory or market measures to address climate change, may negatively affect our business, operations or financial performance, and water scarcity or poor water quality could negatively impact production costs and capacity.
Our 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 we presently source agricultural raw materials such as grapes. Decreased availability of raw materials may increase the cost of goods for our 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 retailers and consumers.
Water is essential in the production of our products. The quality and quantity of water available for use is important to the supply of grapes and our ability to operate our 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 our facilities or our inventory, and/or negatively impact contracted third-party production and storage capacity and availability.
We must store our 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 our 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 we 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, we 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
17
could divert
our
attention and resources. Additionally, the outcome of such p
roceedings 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
us
to make new or additional estimates. A future adverse rulin
g, 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, we maintain insurance against some, but not all, potential claims. In the future, we may not be able to maintain insurance at commercially acceptable premium levels. In addition, the levels of insurance we maintain 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 Our 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.
Truett-Hurst, Inc. 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. We will cause the LLC to make distributions to our unit holders in an amount sufficient to cover all applicable taxes at assumed tax rates, payments under the tax receivable agreement (which we expect to be substantial) and declared dividends, if any. To the extent that we need funds, and the LLC is restricted from making such distributions under applicable law or regulation or under the terms of the financing arrangements, or is otherwise unable to provide such funds, it could materially adversely affect our liquidity and financial condition.
The Founders have significant influence on Truett-Hurst, Inc. and their interests may differ from those of the public shareholders.
As of June 30, 2018, the Founders and Affiliates control 40.1% 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 94% 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 us 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 we entered in to, and whether and when we 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 us. The tax receivable agreement also provides that upon certain mergers, asset sales, or other forms of business combinations, substantial payment obligations to the Founders and Affiliates will accelerate.
We will be required to pay the counterparties to the tax receivable agreement for certain tax benefits we may claim arising in connection with current exchanges, future purchases or exchanges of LLC Units and related transactions, and the amounts we may pay could be significant.
We 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.
18
We
expect the payments that
we
may make under the tax receivable agreement will be substantial. There may be a material negative effect on
our
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 the LLC, or if LLC funds are not sufficient to permi
t 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 tax receivable agreement also provides that upon certain mergers, asset sales, or other forms of business combinations, substantial payment obligations to the Founders and Affiliates will accelerate.
We are required to make a good faith effort to ensure that we 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 we otherwise lack sufficient funds, interest would accrue on any unpaid amounts at LIBOR plus 500 basis points until they are paid. If we breach any of our material obligations under the tax receivable agreement, substantial payment obligations will generally be accelerated and due as if we had exercised our right to terminate the agreement
In the event that we and an exchanging LLC Unit holder are unable to resolve a disagreement with respect to the tax receivable agreement, we are 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) we 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 we elect to terminate the tax receivable agreement early, we 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, our obligations under the tax receivable agreement could have a substantial negative impact on our liquidity. There can be no assurance that we will be able to finance our obligations under the tax receivable agreement.
Payments under the tax receivable agreement are based on the tax reporting positions that we determine. Although we are 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 we actually realize 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.
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Risks Related to
our
Class A Common Stock
Our failure to meet the continued listing requirements of The NASDAQ Capital Market could result in a delisting of the Class A common stock.
If we fail 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 could have a significant negative effect on the value and liquidity of our Class A common stock, may preclude us from using exemptions from certain state and federal securities regulations, and could adversely affect our ability to raise capital on terms acceptable to us or at all. In the event of a delisting, we would expect to seek to take actions to restore compliance with NASDAQ’s listing requirements, but we 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.
We could choose to delist and deregister the Class A common stock, which would result in more limited access to information and decreased liquidity.
The Company incurs direct and indirect costs and burdens associated with the filing and reporting requirements imposed on SEC reporting companies by the Exchange Act and complying with the Sarbanes-Oxley Act. In light of such costs and burdens and the sale of the Wholesale Business, the Company has considered and will continue to consider cost-saving alternatives to remaining a NASDAQ listed reporting company. We would be eligible to delist from
The NASDAQ Capital Market
and deregister our Class A common stock under Sections 12(b), 12(g) and 15(d) of the Exchange Act if we have less than 300 shareholders of record (as defined in the Exchange Act), do not file a registration statement (of which we have no current plans to file) in the current fiscal year and meet certain other requirements. D
elisting would likely have a negative effect on the price of the Class A common stock and would impair our ability to sell or purchase our Class A common stock when we wished to do so, and deregistration would suspend our obligations to provide periodic reporting under the Exchange Act and to comply with proxy rules, beneficial ownership reporting and other similar SEC requirements, resulting in limited access to financial and other information.
As of the June 30, 2018, we believe we meet the requirements to delist and deregister, after which your access to our business information would be more restricted and the liquidity of your Class A common stock would significantly decrease.
We do not intend to pay any cash dividends in the foreseeable future.
We do 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 our 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 we decide 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 the LLC and its affiliates for cash to pay its obligations and make dividend payments. Deterioration in the financial condition, earnings or cash flow of the LLC and its affiliates for any reason could limit or impair its ability to pay cash distributions or other distributions to us. In addition, our ability to pay dividends in the future is dependent upon receipt of cash from the LLC and its affiliates. The LLC and its affiliates may be restricted from sending cash to us by, among other things, law or provisions of the documents governing our existing or future indebtedness.
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If securities or industry analysts stop publishing research or reports about
our
business, or if they downgrade their recommendations regarding
our
Class A common stock, the stock price and trading volume could decline
further
.
As a small-cap company, our common stock has limited liquidity. The market price and trading volume of shares of the common stock are volatile and are likely to continue to fluctuate substantially in response to various factors, many of which are beyond our control and may not be related to operating performance. The trading market for our Class A common stock is influenced by the research and reports that industry or securities analysts publish about us or our business. We have limited research coverage for our stock and it is difficult to attract research coverage for small-cap companies like ours. If any of the analysts who cover us downgrade our Class A common stock or publishes inaccurate or unfavorable research about our business, our Class A common stock price may decline further. If analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause the Class A common stock price or trading volume to decline further and the Class A common stock to be less liquid.
The market price and trading volume of our common stock are volatile and may be affected by market conditions beyond our control.
As a small-cap company, our common stock has limited liquidity. The market price and trading volume of shares of the common stock are volatile and are likely to continue to fluctuate substantially in response to various factors, many of which are beyond our 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 our 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 our business, adverse market reaction to any indebtedness we may incur or securities we may issue in the future, and other factors. You may be unable to resell our shares of Class A common stock at or above the price you originally paid. In addition, as a result of our market capitalization, among other factors, there is limited liquidity in the market for our 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 us, could result in substantial costs and a diversion of our management's attention and resources.
You may be diluted by the future issuance of additional Class A common stock in connection with our incentive plans, acquisitions or otherwise.
As of June 30, 2018, we had an aggregate of 10.5 million shares of Class A common stock authorized but unissued, including approximately 2.73 million shares of Class A common stock issuable upon exchange of outstanding LLC Units and 0.1 million shares reserved for issuance under our 2012 Incentive Plan. See Part II, Item 8, Note 9, “Stock-based Compensation” to the Consolidated Financial Statements included in this Annual Report on Form 10-K. The certificate of incorporation authorizes us 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 our sole discretion. Any Class A common stock that is issued, including under the 2012 Incentive Plan or other equity incentive plans that we may adopt in the future, would dilute the percentage ownership held by then existing holders of Class A common stock.
We incur 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, we incur significant legal, accounting and other expenses that we 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. We expect compliance with these rules and regulations will require significant management time and attention.
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The costs associated with operating as a public company will decrease
our
net income or increase
our
net loss, and may require
us
to reduce costs in other areas of
our
business or increase the prices of
our
products or services. Additionally, if t
hese requirements divert management’s attention from other business concerns, they could have a material adverse effect on
our
results of operations, financial condition, business and prospects.
Our failure to timely file periodic reports we are required to file under the Securities Exchange Act of 1934 could adversely affect the market for our Class A common stock and make it more difficult for us to access the public markets to raise debt or equity capital.
We filed our Annual Report on Form 10-K for the year ended June 30, 2017 approximately two weeks late, and because of the time required to complete and file this report, we also were also unable to timely file our Quarterly Report on Form 10-Q for the quarter ended September 30, 2017 on a timely basis. We are also filing this Annual Report on Form 10-K approximately two weeks late. Failure to timely file periodic reports subjects us to the risk of delisting of our Class A common stock from The NASDAQ Capital Market, may preclude us from using exemptions from certain state and federal securities regulations, limit our ability to access the public markets to raise debt or equity and could adversely affect our ability to raise capital on terms acceptable to us or at all.
As a result of our failure to timely file the Part III information in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017, we are currently ineligible to file new short form registration statements on Form S-3 for sales of securities by us, which may impair our ability to raise capital on terms favorable to us, in a timely manner or at all.
Form S-3 permits eligible issuers to conduct registered offerings using a short form registration statement that allows the issuer to incorporate by reference its past and future filings and reports made under the Securities Exchange Act of 1934, as amended, or the Exchange Act. In addition, Form S-3 enables eligible issuers to conduct primary offerings “off the shelf” under Rule 415 of the Securities Act of 1933, as amended, or the Securities Act. The shelf registration process, combined with the ability to forward incorporate information, allows issuers to avoid delays and interruptions in the offering process and to access the capital markets in a more expeditious and efficient manner than raising capital in a standard registered offering pursuant to a Registration Statement on Form S-1. The ability to register securities for resale may also be limited as a result of the loss of Form S-3 eligibility.
As a result of our failure to timely file the Part III information in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017, we are currently ineligible to file new short form registration statements on Form S-3. If we seek to access the capital markets through a registered offering during the period of time that we are unable to use Form S-3, we may be required to publicly disclose the proposed offering and the material terms thereof before the offering commences, we may experience delays in the offering process due to SEC review of a Form S-1 registration statement and we may incur increased offering and transaction costs and other considerations. Disclosing a public offering prior to the formal commencement of an offering may result in downward pressure on our stock price. In addition, our inability to conduct an offering “off the shelf” may require us to offer terms that may not be advantageous (or may be less advantageous) to us or may generally reduce our ability to raise capital in a registered offering. If we are unable to raise capital through a registered offering, we would be required to conduct our financing transactions on a private placement basis, which may be subject to pricing, size and other limitations imposed under rules of The NASDAQ Capital Market.
Assuming we continue to timely file our required Exchange Act reports, the earliest we would regain the ability to use Form S-3 is April 17, 2019.
22
We
no longer qualif
y
as an “emerging growth company” and will
be required to comply with certain provisions of the Sarbanes-Oxley Act
and can no longer take advantage of reduced disclosure requirements.
For as long as we remained an emerging growth company, we could 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. We no longer qualify for such status, and as we are no longer an emerging growth company, we expect to incur additional expenses and devote substantial management effort toward ensuring compliance with those requirements applicable to companies that are not emerging growth companies. Even though we no longer qualify as an emerging growth company, we currently do, and may continue to, qualify as a “smaller reporting company” which would allow us to take advantage of many of the same exemptions from disclosure requirements. However, we cannot be certain we will continue to so qualify or predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.