UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended December 31, 2016

 

¨Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                      to                      

 

Commission File Number: 333-187164

 

 

 

TRUETT-HURST, INC.

 

(Exact name of registrant as specified in its charter)

 

DELAWARE 46-1561499

(State or other jurisdiction of

incorporation or organization)

(I.R.S. employer

identification number)

   
125 Foss Creek Circle, Healdsburg, California 95448
(Address of principal executive offices) (zip code)

 

(707) 431-4423

(Registrant’s telephone number, including area code)    

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes   x     No   ¨

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).

 

Yes   x     No   ¨

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer        ¨   Accelerated filer                         ¨
Non-accelerated filer          ¨   Smaller reporting company       x
(Do not check if a smaller reporting company)    

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes   ¨     No   x

 

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock, as of the latest practicable date.

 

Class A   Number of Shares Outstanding
Common stock, $0.001 par value per share   4,351,789

 

 

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

FORM 10-Q

  

Part I.   Financial Information 3
  Item 1. Condensed Consolidated Financial Statements 3
    Condensed Consolidated Balance Sheets as of December 31, 2016 (unaudited) and June 30, 2016 3
    Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended December 31, 2016 and 2015 4
    Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2016 and 2015 5
    Notes to the Unaudited Condensed Consolidated Financial Statements 6
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 15
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
  Item 4. Controls and Procedures 23
Part II.   Other Information 24
  Item 1. Legal Proceedings 24
  Item 1A. Risk Factors 24
  Item 2. Unregistered Sales of Securities and Use of Proceeds 24
  Item 3. Defaults Upon Senior Securities 24
  Item 4. Mine Safety Disclosures 24
  Item 5. Other Information 24
  Item 6. Exhibits 25
  Signatures 25

 

2

 

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

TRUETT-HURST, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data/per share data)

 

   December 31, 2016   June 30, 2016 
   (unaudited)     
Assets          
Current assets:          
Cash and cash equivalents  $26   $4,043 
Accounts receivable   2,011    2,678 
Inventories, net   19,755    19,918 
Bulk wine deposits   -    271 
Other current assets   111    125 
Total current assets   21,903    27,035 
Property and equipment, net   5,437    5,583 
Intangible assets, net   501    496 
Other assets, net   334    391 
Total assets  $28,175   $33,505 
           
Liabilities and Equity          
Current liabilities:          
Lines of credit  $4,881   $10,311 
Accounts payable   1,492    1,351 
Accrued expenses   667    1,348 
Depletion allowance   500    610 
Due to related parties   32    - 
Current maturities of long term debt   516    475 
Total current liabilities   8,088    14,095 
           
Long term debt, net of current maturities   3,233    3,189 
Total liabilities   11,321    17,284 
           
Commitments and contingencies (Note 5)           
Equity:          
Stockholders’ equity          
Preferred stock, par value of $0.001 per share, 5,000,000 shares authorized,          
none issued and outstanding at December 31, 2016 and June 30, 2016   -    - 
Class A common stock, par value of $0.001 per share, 15,000,000 authorized,          
4,351,789 and 4,306,609 issued and outstanding at December 31, 2016 and June 30, 2016   4    4 
Class B common stock, par value of $0.001 per share, 1,000 authorized, 7          
issued and outstanding at December 31, 2016 and June 30, 2016   -    - 
Additional paid-in capital   15,945    15,794 
Accumulated deficit   (5,330)   (5,600)
Total Truett-Hurst, Inc. equity   10,619    10,198 
Noncontrolling interest   6,235    6,023 
Total equity   16,854    16,221 
Total liabilities and equity  $28,175   $33,505 

 

See accompanying notes to condensed consolidated financial statements.

 

3

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share data/per share data)

(unaudited)

 

    Three Months Ended     Six Months Ended  
    December 31,     December 31,  
    2016     2015     2016     2015  
Sales   $ 5,958     $ 8,748     $ 12,060     $ 15,280  
Less excise tax     (221 )     (242 )     (438 )     (405 )
Net sales     5,737       8,506       11,622       14,875  
                                 
Cost of sales     3,700       5,866       7,756       10,086  
                                 
Gross profit     2,037       2,640       3,866       4,789  
                                 
Operating expenses:                                
Sales and marketing     1,380       1,384       2,604       2,822  
General and administrative     706       719       1,518       1,609  
Loss (gain) on disposal of assets     26       -       43       (1 )
Total operating expenses     2,112       2,103       4,165       4,430  
                                 
(Loss) income  from operations     (75 )     537       (299 )     359  
                                 
Other income (expense):                                
Interest expense, net     (96 )     (86 )     (176 )     (169 )
Other     101       25       959       (69 )
Total other income (expense), net     5       (61 )     783       (238 )
Net (loss) income before income taxes     (70 )     476       484       121  
Income tax expense     (1 )     (1 )     (2 )     (1 )
Net (loss) income from continuing operations     (71 )     475       482       120  
Income from discontinued operations, net of tax     -       30       -       45  
Net (loss) income attributable to Truett-Hurst, Inc. and H.D.D. LLC     (71 )     505       482       165  
Net (loss) income attributable to noncontrolling interest: H.D.D. LLC     (25 )     270       212       (144 )
Net (loss) income attributable to Truett-Hurst, Inc.   $ (46 )   $ 235     $ 270     $ 21  
                                 
Net (loss) income per share:                                
Basic per share   $ (0.01 )   $ 0.06     $ 0.06     $ 0.01  
Diluted per share   $ (0.01 )   $ 0.03     $ 0.04     $ 0.00  
                                 
Weighted average shares used in computing net (loss) income per share:                                
                                 
Basic weighted average shares     4,314,553       4,062,341       4,310,559       4,045,634  
Diluted weighted average shares     4,314,553       7,239,918       7,510,936       7,200,405  

 

See accompanying notes to condensed consolidated financial statements.

 

4

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

 

   Six Months Ended 
   December 31, 
   2016   2015 
Cash flows from operating activities:          
Net income  $482   $165 
Income from discontinued operations, net of tax   -    (45)
Net income from continuing operations   482    120 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   410    295 
Reserve for assets to be abandoned   127    - 
Stock-based compensation   151    172 
(Gain) loss on fair value of interest rate swap   (130)   37 
Loss (gain) on disposal of assets   43    (1)
           
Changes in operating assets and liabilities, net          
Accounts receivable   667    (836)
Inventories   163    1,930 
Bulk wine deposits   271    320 
Other current assets   22    104 
Accounts payable   141    (248)
Accrued expenses   (557)   228 
Depletion allowance   (110)   120 
Due to related parties   32    104 
Cash provided by discontinued operations   -    55 
Net cash provided by operating activities   1,712    2,400 
           
Cash flows from investing activities:          
Acquisition of property and equipment   (371)   (368)
Acquisition of intangible and other assets   (18)   (53)
Proceeds from sale of assets   5    2 
Net cash used in investing activities   (384)   (419)
           
Cash flows from financing activities:          
Net (payments on) proceeds from line of credit   (5,430)   1,229 
Proceeds from long term debt   387    443 
Payments on long term debt   (302)   (214)
Net cash (used in) provided by financing activities   (5,345)   1,458 
           
Net change in cash and cash equivalents   (4,017)   3,439 
Cash and cash equivalents at beginning of period   4,043    1,578 
Cash and cash equivalents at end of period  $26   $5,017 
           
Supplemental disclosure of cash flow information:          
Cash paid for interest  $174   $169 
Cash paid for income taxes  $2   $- 
           
Non-cash financing activity:          
Conversion of equipment line of credit to term loan   387    500 

 

See accompanying notes to condensed consolidated financial statements.

 

5

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

NOTE 1 – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The unaudited interim condensed consolidated financial statements include the results of Truett-Hurst, Inc. (“THI”) and its subsidiary H.D.D. LLC (“LLC”). They have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with general instructions for quarterly reports filed on Form 10-Q and Article 8 of Regulation S-X. THI consolidates the financial results of the LLC and records a noncontrolling interest representing the portion of equity ownership in the LLC that is not attributable to THI.

 

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 unaudited interim condensed consolidated financial statements. The gain on the sale along with the current year results have been recorded in the condensed consolidated statements of operations as part of discontinued operations.

 

The accompanying unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for audited financial statements. The accompanying unaudited condensed consolidated financial statements were prepared on the same basis as the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016, and, in the opinion of management, these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. The operating results for the interim period presented are not necessarily indicative of the results expected for the full fiscal year. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Annual Report on Form 10-K for the fiscal year ended June 30, 2016 filed with the SEC on September 28, 2016.

 

Quantities or results referred to as “to date” or “as of this date” mean as of or to December 31, 2016, unless otherwise specifically noted. References to “FY” or “fiscal year” refer to the fiscal year ending on June 30th of the designated year.

 

Critical Accounting Policies and Estimates

 

There have been no material changes to the critical accounting policies and estimates previously disclosed in the Annual Report on Form 10-K for the fiscal year ended June 30, 2016.

 

Reclassifications

 

Certain prior period amounts in the condensed consolidated financial statements and notes thereto have been reclassified to conform to the current year presentation. These reclassifications had no effect on the reported consolidated results of continuing operations.

 

Accounting Pronouncements

 

In November 2015, the FASB issued ASU No. 2015-17: Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. The update sets forth a requirement for companies to classify deferred tax assets and liabilities as non-current amounts on the balance sheet. It is effective for financial statements issued for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect the adoption of this standard to have a material impact on its condensed consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02: Leases (Topic 842). The standard includes a lessee accounting model that recognizes two types of leases – finance and operating leases. It requires that a lessee recognize on the balance sheet assets and liabilities for leases with lease terms of more than 12 months. The amendment is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU.

 

6

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

In March 2016, the FASB issued ASU No. 2016-09: Improvements to Employee Share-Based Payment Accounting which amends ASU 718, Compensation – Stock Compensation. The update sets forth an initiative to identify, evaluate, and improve areas of GAAP for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to users of financial statements. The amendment is effective for annual reporting periods beginning after December 15, 2016 and interim periods within those annual periods. The Company is currently evaluating the impact of this ASU.

 

In August 2016, the FASB issued ASU No. 2016-15: Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments. The update sets forth guidance on eight specific cash flow issues. The amendment is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU.

 

In January 2017, the FASB issued ASU No. 2017-01: Business Combinations (Topic 805) – Clarifying the Definition of a Business. The update sets forth guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The amendment is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU.

  

NOTE 2 – INVENTORIES

 

Inventories comprise:

 

   December 31, 2016   June 30, 2016 
   (in thousands) 
Grapes and bulk wine  $7,757   $8,413 
Bottled wine   11,779    11,262 
Bottling materials and other   242    322 
    19,778    19,997 
Less:  inventory reserves   (23)   (79)
Total inventories  $19,755   $19,918 

 

NOTE 3 – PROPERTY AND EQUIPMENT, net

 

Property and equipment, net comprise:

 

   December  31, 2016   June 30, 2016 
   (in thousands) 
Land and  land improvements  $3,260   $3,231 
Building and improvements   1,402    1,380 
Machinery and equipment   1,985    1,935 
Vineyard development   554    554 
Vineyard  equipment   88    88 
Furniture and fixtures   286    262 
Leasehold improvements   24    190 
Vehicles   85    85 
    7,684    7,725 
Less: accumulated depreciation and amortization   (2,247)   (2,142)
Total property and equipment, net  $5,437   $5,583 

 

Total depreciation and amortization expense for the three and six months ended December 31, 2016 were $0.2 million and $0.4 million, respectively, compared to $0.1 million and $0.3 million for the same periods in FY16.

 

NOTE 4 – BORROWINGS

 

The Company’s indebtedness is comprised primarily of bank loans including lines of credit and long term debt.

 

Lines of Credit

 

7

 

  

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

The credit facilities, which mature on July 31, 2017, include (a) a revolving line of credit with a maximum commitment of $10.0 million which accrues interest at 2.25% above the London Interbank Offered Rate (“LIBOR”), (b) a capital equipment line with a maximum commitment of $0.5 million which carries an interest rate of 2.25% above floating One-Month LIBOR, and (c) a foreign exchange facility with a maximum commitment of $0.1 million which allows our bank to enter into any spot or forward transaction to purchase or sell a foreign currency. The Company did not use the foreign exchange facility during the six months ended December 31, 2016.

 

The credit facilities are secured by a pledge of substantially all of the Company’s assets with guarantees from the LLC members. The bank borrowings contain usual and customary covenants, including, among others, limitations on incurrence of senior indebtedness, the making of loans and advances, investments, acquisitions, and capital expenditures, the incurrence of liens, and the consummation of mergers and asset sales. The loan maintains the minimum current assets to current liabilities ratio covenant (measured quarterly) and the maximum debt to effective tangible net worth ratio covenant (measured quarterly).

 

Long Term Debt

 

Long term debt comprises:

 

      December 31, 2016   June 30, 2016 
      (in thousands except payment information) 
Long term debt:             
Note 1  (1)  $2,784   $2,851 
Note 2  (2)   83    120 
Note 3  (3)   201    244 
Note 4  (4)   -    57 
Note 5  (5)   332    392 
Note 6  (6)   349    - 
       3,749    3,664 
Less: current maturities      (516)   (475)
Total long term debt     $3,233   $3,189 

 

(1)Note payable to a bank, secured by a deed of trust on property, payable monthly with principal payments of $11,270 plus interest, matures May 31, 2022, variable interest of 2.25% above LIBOR.

 

(2)Note payable to a bank, secured by equipment, payable monthly with principal and interest payments of $6,535, matures January 15, 2018 at 3.75% interest.

 

(3)Note payable to a bank, secured by equipment, payable monthly with principal and interest payments of $7,783, matures March 1, 2019; at 3.75% interest.

 

(4)On November 30, 2014, the Company acquired the unrestricted use of the Stonegate trademark in exchange for a trademark release payment which is to be made over time and is accounted for as a note payable. The note payable has three equal installments: a) within five days of November 30, 2014, b) on October 31, 2015, and c) on July 31, 2016. The note does not accrue interest outstanding on the principal. An imputed interest rate of 5.5% was assessed under GAAP and the impact was considered immaterial.

 

(5)Note payable to a bank, secured by equipment, payable monthly with principal and interest payments of $11,267, matures July 1, 2019; at 3.90% interest.

 

(6)Note payable to a bank, secured by equipment, payable monthly with principal and interest payments of $8,729, matures July 1, 2020; at 3.95% interest.

 

8

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

Future principal and interest payments for the long term debt as of December 31, 2016 are as follows:

  

Years ending June 30,
(in thousands)
2017 (remaining six months)  $256 
2018   491 
2019   434 
2020   249 
2021   144 
Thereafter   2,175 
    3,749 
Add: estimated interest payments   579 
Total future principal and interest payments  $4,328 

 

NOTE 5 – COMMITMENTS AND CONTINGENCIES

 

Leases

 

The Company leases one of its tasting rooms and a winery production facility. The lease for both of these facilities was modified in July 2016. The modification calls for the Company to vacate the tasting room portion of the property no later than December 31, 2016, and the balance of the space no later than May 31, 2017. The tasting room located on Westside Rd. was vacated as of December 31, 2016.

 

The Company has two lease agreements for administrative office space. Both are three-year leases with an end date of October 31, 2019. One of these leases contains three one-year renewal options with adjustment to market rates.

 

Lease payments for these facilities were $0.09 million and $0.2 million for the three and six months ended December 31, 2016, respectively, compared to $0.1 million and $0.2 million for the same periods in FY16.

 

Future lease commitments are:

 

Years ending June 30,
(in thousands)
2017 (remaining six months)  $96 
2018   84 
2019   90 
2020   31 
Thereafter   - 
Total future lease payments  $301 

 

9

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

Supply Contracts

 

The Company enters into short and long term contracts with third-parties and related party growers to supply a portion of its future grape and bulk wine inventory requirements. The grape commitments for the fiscal year 2017 were received in the first quarter of FY17. The Company did not extend a large contract for the purchase of bulk wine to future years. Future minimum grape and bulk wine inventory purchase commitments are as follows:

 

Years ending June 30,  Third-Parties   Related Parties   Total 
   (in thousands) 
2017  $1,652   $-   $1,652 
2018   531    57    588 
2019   310    -    310 
Thereafter   -    -    - 
Total grape and bulk purchase commitments  $2,493   $57   $2,550 

 

At December 31, 2016, total future purchase commitments for finished goods were approximately $1.8 million and are expected to be fulfilled during fiscal 2018. Moreover, at December 31, 2016, a $0.03 million liability was outstanding to a related party for grapes from the 2016 harvest.

 

Production & Storage

 

The Company enters into various contracts with third-party service providers for grape crushing, wine storage, and bottling. The costs are recorded in the period for which the service is provided. The actual costs related to custom crush services are based on volume. The Company’s current contracts for custom crush services cover the 2016 harvest. The current bottling contract requires a minimum of 200,000 cases at $2.40 per case to be bottled in a one year period. During FY16, the Company transferred bulk wine to a storage facility owed by a related party. At December 31, 2016, approximately 57% of its bulk wine inventory was stored at the related party location.

 

Litigation

 

From time to time, the Company may be subject to various litigation matters arising in the ordinary course of business. Other than discussed below, the Company is not aware of any current pending legal matters or claims, individually or in the aggregate, that are expected to have a material adverse impact on the Company’s consolidated financial position, results of operations, or cash flows.

 

On January 29, 2016, Mendocino Wine Group (“MWG”) filed a complaint against Phil Hurst (“Hurst”) and H.D.D., LLC (“LLC”). The complaint alleges that, prior to January 2012, Hurst and LLC aided and abetted Paul Dolan in his alleged breach of fiduciary duties to MWG and that they interfered with Dolan's contract with Thornhill Management Company (the manager of MWG), and aided and abetted Dolan's interference with MWG's economic advantage. LLC denies the claims, denies all wrongdoing, and denies that they caused any harm to MWG. On November 10, 2016, the Court granted MWG’s Motion to Consolidate the Hurst/LLC case with a second complaint MWG filed against a law firm for legal malpractice and breach of fiduciary duty. The Court ruled the cases were sufficiently related and should be tried together. A new trial date has been set for November 3, 2017. No amount has been recorded in the condensed consolidated financial statements related to this suit.

 

The Company settled outstanding litigation related to the lease of one of its tasting rooms and a winery production facility, in exchange for payment of $1.0 million to LLC, quitclaimed certain rights, and modified its lease such that the Company will vacate the tasting room portion of the property no later than December 31, 2016, and the balance of the space no later than May 31, 2017. The Company received a payment of $0.7 million during the first quarter of FY17. The balance of $0.3 million is held in an escrow account with amounts payable upon vacating the tasting room by December 31, 2016 and the winery production facility by May 31, 2017. The $0.3 million receivable is recorded in accounts receivable on the condensed consolidated balance sheet. The entire $1.0 million was recorded as a gain in other income on the condensed consolidated statement of operations. The gain was offset by a reserve for abandoned assets in the amount of $0.1 million. The $0.1 million represents the book value of assets that were left at the property when the Company vacated the tasting room premises prior to December 31, 2016.

 

10

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

Exchange and Tax Receivable Agreement

 

The Company has an exchange agreement with the existing owners of the LLC, several of whom are directors and/or officers.  Under the exchange agreement, each LLC member (and certain permitted transferees thereof) may (subject to the terms of the exchange agreement), exchange their LLC Units for shares of Class A common stock of the Company on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications, or for cash, at the Company’s election. In connection with the exchange agreement, the Company has a tax receivable agreement (“TRA”) with the LLC members. The agreement provides for the payment from time to time, as “corporate taxpayer,” to holders of LLC Units of 90% of the amount of the benefits, if any, that the corporate taxpayer is deemed to realize as a result of (i) increases in tax basis resulting from the exchange of LLC Units and (ii) certain other tax benefits related to the Company entering into the agreement, including tax benefits attributable to payments under the agreement. These payment obligations are obligations of the corporate taxpayer and not of the LLC. The term of the agreement will continue until all such tax benefits have been utilized or expired, unless the corporate taxpayer exercises its right to terminate the agreement for an amount based on the agreed payments remaining to be made under the agreement or the corporate taxpayer breaches any of its material obligations under the agreement in which case all obligations will generally be accelerated and due as if the corporate taxpayer had exercised its right to terminate the agreement.

 

Indemnification

 

From time to time the Company enters into certain types of contracts that contingently require it to indemnify various parties against claims from third-parties. Historically, the Company has not been required to make payments under these obligations, and no liabilities have been recorded at December 31, 2016 and June 30, 2016 for these obligations on the consolidated balance sheets.

 

NOTE 6 – DISCONTINUED OPERATIONS

 

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 condensed consolidated financial statements. The gain on the sale along with the prior year results have been recorded in the consolidated statement of operations as part of discontinued operations. The Company has no continuing relationship with Wine Spies. For the six months ended December 31, 2015, net income from discontinued operations was $0.05 million. Earnings per share from discontinued operations was less than one cent.

 

NOTE 7 – STOCK-BASED COMPENSATION

 

Equity Incentive Plan

 

The Company has granted restricted stock awards, stock options and restricted stock units to employees, directors and non-employees under its 2012 Stock Incentive Plan. As of December 31, 2016, the 2012 Plan has 1.0 million shares reserved for issuance and a total of 0.1 million shares available to be issued.

 

A summary of the activity for restricted stock awards is presented below:

 

   Number
 of Shares
   Weighted Avg Grant
Date Fair Value per
Share
   Weighted Avg
Contractual
Term in Years
   Aggregate Intrinsic
Value (in thousands)
 
Outstanding at June 30, 2016   5,263   $3.80    -   $9 
Granted   -    -    -    - 
Released   -    -    -    - 
Forfeited, cancelled or expired   -    -    -    - 
Outstanding at December 31, 2016   5,263   $3.80    1.00   $9 
RSAs vested   2,632    3.80    -    5 
Expected to vest at December 31, 2016   2,631   $3.80    1.00   $9 

 

11

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

A summary of the activity for restricted stock units is presented below:

 

   Number
 of Shares
   Weighted Avg Grant
Date Fair Value per
Share
   Weighted Avg
Contractual
Term in Years
   Aggregate Intrinsic
Value (in thousands)
 
Outstanding at June 30, 2016   88,930   $3.30    -   $158 
Granted   -    -    -    - 
Released   (45,180)   1.66    -    80 
Vested   -    -    -    - 
Forfeited, cancelled or expired   (43,750)   5.00    -    78 
Outstanding at December 31, 2016   -   $-    -   $- 
Expected to vest at December 31, 2016   -   $-    -   $- 

 

A summary of the activity for stock options is presented below:

 

   Number
 of Shares
   Weighted Avg Grant
Date Fair Value per
Share
   Weighted Avg
Contractual
Term in Years
   Aggregate Intrinsic
Value (in thousands)
 
Outstanding at June 30, 2016   465,000   $2.95    -   $(542)
Granted   70,000    1.64    -    10 
Forfeited, cancelled or expired   (175,000)   3.58    -    (314)
Outstanding at December 31, 2016   360,000   $2.39    8.90   $(218)
Options Vested   147,500   $3.50         (253)
Options Non-Vested   212,500   $1.61    -   $36 
Options Exercisable   147,500   $3.50    -    (253)

 

The following table summarizes stock-based compensation included in the condensed consolidated statements of operations for the three and six months ended December 31, 2016 and December 31, 2015:

 

   Three Months Ended   Six Months Ended 
   December 31,   December 31, 
   (in thousands) 
   2016   2015   2016   2015 
Sales and marketing  $10  $7   $20   $19 
General and administrative   46    78    131    153 
Total stock-based compensation  $56   $85   $151   $172 

 

NOTE 8 – FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The carrying amount reflected in the condensed consolidated balance sheets of financial assets and liabilities are all categorized as Level 1. They include cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, which approximated their fair values due to the short-term nature of these financial assets and liabilities. The carrying amount of the Company’s debt approximates its fair value based on prevailing interest rates and time to maturity.

 

In October 2012, the Company executed an interest rate swap obligation that was measured using observable inputs such as the LIBOR and Ten-year Treasury interest rates, and therefore has been categorized as Level 2. This derivative is not designated as a hedging instrument and has been recorded at fair value in the condensed consolidated balance sheets. Changes in the fair value of this instrument have been recognized in the condensed consolidated statements of operations in other expense. The maturity date of the swap is May 31, 2022. At December 31, 2016 and June 30, 2016, the interest rate swap balance was $0.008 million and ($0.1) million for both the fair value and the Level 2 value. The balance for the interest rate swap is included in other current assets in the consolidated balance sheets.

  

NOTE 9 – INCOME TAXES

 

For the six months ended December 31, 2016, the Company recorded income tax expense of $.002 million and had an effective tax rate of less than 1%. The Company's effective tax rate is a function of:

  

12

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

·A rate benefit attributable to the fact that HDD operates as a limited liability company which is not subject to federal or state income tax. Accordingly, a portion of the earnings are not subject to corporate level taxes.
·Operating losses for the periods or utilization of net operating loss carryforwards.
·Recording a full valuation allowance against net deferred tax assets as the Company has determined that it is more likely than not that the future tax benefits would not be realized. The Company did not record a deferred tax asset as of December 31, 2016.

 

There were no unrecognized tax benefits at December 31, 2016 and the Company did not incur any income tax related interest expense or penalties related to uncertain tax positions.

 

NOTE 10 – SIGNIFICANT CUSTOMER INFORMATION, SEGMENT REPORTING AND GEOGRAPHIC INFORMATION

 

The Company’s primary reporting segments are identified as wholesale and direct to consumer.

 

Wholesale sales include the retail exclusive brand label model and other brands sold through the three-tier distribution system. Direct to consumer sales occur through the Company’s tasting rooms and wine clubs. Operating and other expenses are not allocated between operating segments; therefore, operating and net income (loss) information for the respective segments is not available. In addition, discrete financial information related to segment specific assets is not available. Sales and cost of sales are reported by segment.

 

The following tables reflect net sales, cost of sales and gross profit by segment for continuing operations for each of the three and six months ended December 31, 2016 and 2015, respectively:

  

   Three Months Ended December 31, 
   (in thousands) 
   Wholesale   Direct to Consumer   Total 
   2016   2015   2016   2015   2016   2015 
Net Sales  $3,951   $6,852   $1,786   $1,654   $5,737   $8,506 
Cost of Sales   3,064    5,272    636    594    3,700    5,866 
Gross Profit  $887   $1,580   $1,150   $1,060   $2,037   $2,640 
Gross Profit %   22.4%   23.1%   64.4%   64.1%   35.5%   31.0%

 

   Six Months Ended December 31, 
   (in thousands) 
   Wholesale   Direct to Consumer   Total 
   2016   2015   2016   2015   2016   2015 
Net Sales  $8,461   $11,960   $3,161   $2,915   $11,622   $14,875 
Cost of Sales   6,603    9,072    1,153    1,014    7,756    10,086 
Gross Profit  $1,858   $2,888   $2,008   $1,901   $3,866   $4,789 
Gross Profit %   22.0%   24.1%   63.5%   65.2%   33.3%   32.2%

 

Significant Customer Information:

 

The following tables set forth concentrations of wholesale sales and accounts receivable as a percent of each total:

 

                   Percentage of Total 
   Percentage of Wholesale Sales   Accounts Receivable 
   Three Months Ended   Six Months Ended         
   December 31,   December 31,   December 31, 
   2016   2015   2016   2015   2016   2015 
Customer A   28%   44%   21%   41%   35%   53%
Customer B   26%   14%   32%   19%   9%   18%

   

International sales were $0.2 million and $0.5 million for the three and six months ended December 31, 2016, respectively, compared to $0.2 million and $0.5 million for the same periods of FY16.

 

13

 

 

TRUETT-HURST, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

(Unaudited)

 

NOTE 11 – SUBSEQUENT EVENTS

 

The Company has evaluated all subsequent event activity through the issue date of these condensed consolidated financial statements and concluded that no additional subsequent events have occurred that would require recognition in the condensed consolidated financial statements or disclosure in the notes to the condensed consolidated financial statements.

 

14

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements, other than statements of historical fact, regarding strategy, future operations, financial position, prospects, plans, opportunities, and objectives constitute “forward-looking statements.” The words “may,” “will,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “potential,” or “continue” and similar types of expressions identify such statements, although not all forward-looking statements contain these identifying words. These statements are based upon information that is currently available to the Company and or management’s current expectations, speak only as of the date hereof, and are subject to risks and uncertainties. The Company expressly disclaims any obligation, except as required by federal securities laws, or undertaking to update or revise any forward-looking statements contained herein to reflect any change or expectations with regard thereto or to reflect any change in events, conditions, or circumstances on which any such forward-looking statement is based, in whole or in part. The Company’s actual results may differ materially from the results discussed in or implied by such forward-looking statements. Important factors that could cause such differences include, but are not limited to, a reduction in the supply of grapes and bulk wine available to the Company; significant competition; any change in our relationships with retailers which could harm the Company’s business; the Company may not achieve or maintain profitability in the future; the loss of key employees; a reduction in our access to, or an increase in the cost of, the third-party services the Company uses to produce its wine; credit facility restrictions on the Company’s current and future operations; failure to protect, or infringement of, trademarks and proprietary rights; these factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report. The Company undertakes no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. Risks that may affect the Company’s operating results include, but are not limited to, those discussed in the “Risk Factors” section of its Annual Report on Form 10-K for fiscal 2016 filed with the Securities Exchange Commission (“SEC”) on September 28, 2016. Readers should carefully review the risk factors described in the Annual Report on Form 10-K for fiscal 2016 and in other documents that the Company files from time to time with the SEC.

 

The unaudited interim condensed consolidated financial statements include the results of Truett-Hurst, Inc. and its subsidiary: H.D.D. LLC (“LLC”) (collectively, “we,” “Truett-Hurst” “our,” “us,” or “the Company”) and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the general instructions for quarterly reports filed on Form 10-Q and Article 8 of Regulation S-X. The disclosures do not include all the information necessary for audited financial statements in accordance with GAAP.  These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in the Annual Report on Form 10-K for the fiscal year ended June 30, 2016 filed with the SEC on September 28, 2016. In the opinion of our management, all adjustments, which include normal recurring adjustments, considered necessary for a fair presentation have been included.  All intercompany transactions and balances have been eliminated. Unless otherwise indicated, the Notes to the unaudited condensed consolidated financial statements relate to the discussion of our continuing operations. The Company’s condensed consolidated financial statements reflect all of the Company’s accounts, including those of our controlled subsidiary and the portion of equity in a consolidated subsidiary that is not attributable to us, directly or indirectly, is presented as noncontrolling interests.

 

15

 

 

OVERVIEW OF BUSINESS

 

General

 

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 noncontrolling 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 December 31, 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, “FY17” and “fiscal year 2017” each refer to the fiscal year ending June 30, 2017. This Quarterly Report on Form 10-Q 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 condensed consolidated financial statements. The gain on the sale along with the current year results have been recorded in the condensed consolidated statements of operations on the discontinued operations line. Prior periods have been accounted for on a consistent basis.

 

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 Company vacated its tasting room in the Russian River Valley just prior to December 31, 2016. 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 its 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:

 

·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.

 

16

 

  

·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.

 

·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.

 

·Marketing to key international markets. Since FY14, the Company has had an agreement in place with the Trialto Wine Group, LTD, based in Vancouver Canada, that created 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.

 

·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 the Company to rapidly capitalize on evolving customer demands.

 

RESULTS OF OPERATIONS

 

Factors Affecting Operating Results

 

Net sales are affected by advertising, discounts and promotions, merchandising, packaging and in the wholesale segment, the availability of display space at retailers, all of which have a significant impact on consumers’ buying decisions. Continued growth of net sales and profits will depend, substantially, on the continued popularity of the Company’s new and existing brands, its ability to effectively manage sales channels, and its ability to maintain sufficient product supply to meet expected growth in demand.

 

Cost of sales for the wholesale and direct to consumer segments includes wine-related inputs, such as grapes and semi-finished bulk wine, bottling materials, such as bottles, capsules, corks and labeling materials, labor and overhead expenses including inbound and outbound freight, storage and barrel depreciation.  

 

Comparison of the Three and Six Months Ended December 31, 2016 and 2015

 

The following table compares the financial results by reporting segment:

 

   Three Months Ended December 31, 
   (in thousands, except percentages) 
   Wholesale   Direct to Consumer   Total 
   2016   2015   2016   2015   2016   2015 
Net Sales  $3,951   $6,852   $1,786   $1,654   $5,737   $8,506 
Cost of Sales   3,064    5,272    636    594    3,700    5,866 
Gross Profit  $887   $1,580   $1,150   $1,060   $2,037   $2,640 
Gross Profit %   22.4%   23.1%   64.4%   64.1%   35.5%   31.0%

 

   Six Months Ended December 31, 
   (in thousands, except percentages) 
   Wholesale   Direct to Consumer   Total 
   2016   2015   2016   2015   2016   2015 
Net Sales  $8,461   $11,960   $3,162   $2,915   $11,622   $14,875 
Cost of Sales   6,603    9,072    1,154    1,014    7,756    10,086 
Gross Profit  $1,858   $2,888   $2,008   $1,901   $3,866   $4,789 
Gross Profit %   22.0%   24.1%   63.5%   65.2%   33.3%   32.2%

 

17

 

 

For the three and six months ended December 31, 2016, net sales decreased $2.8 million (32.6%) and $3.3 million (21.9%), respectively. A significant portion of these decreases relate to a single retailer that did not anniversary a promotional rollout from the prior year. The consolidated gross profit margin increased for the three and six months ended December 31, 2016 from 31.0% to 35.5% and from 32.2% to 33.3%, respectively. The gross profit improvement was due to a greater mix of direct to consumer vs. wholesale sales.

 

Wholesale net sales decreased 42.3% and 29.3% for the three and six months ended December 31, 2016, from $12.0 million to $8.5 million. The decrease for the six months was due to the mix of product sold during the quarter.

 

Direct to consumer net sales increased 8.0% and 8.5% for the three and six months ended December 31, 2016 from $2.9 million to $3.2 million. The increase in direct to consumer net sales was primarily due to continued efforts to grow the channel through wine club and tasting room sales, as well as special offers presented via email to wine club members and others.

 

International sales were $0.2 million and $0.5 million for the three and six months ended December 31, 2016 which was flat compared to the same period in FY16.

 

Sales discounts and depletion allowances are recorded as a reduction of sales at the time of sale. Sales discounts and depletion allowances were $1.3 million and $2.2 million for the three and six months ended December 31, 2016, respectively, compared to $1.6 million and $2.7 million for the same periods in FY16.

 

Sales and Marketing

 

Sales and marketing expenses consist primarily of personnel costs, advertising and other costs for marketing and promoting the Company’s products. Advertising costs are expensed as incurred and were $0.1 million and $0.2 million for the three and six months ended December 31, 2016, respectively, compared to $0.08 million and $0.3 million for the same periods in FY16.

 

Sales and marketing expenses consist of the following:

 

 

   Three Months Ended December 31,   Six Months Ended December 31, 
   (in thousands, except for percentages) 
           Increase               Increase     
   2016   2015   Decrease   % Change   2016   2015   Decrease   % Change 
Sales and marketing  $1,380   $1,384   $(4)   -   $2,604   $2,822   $(218)   7.7%
                                         
Percentage of net sales   24.1%   16.3%   7.8%        22.4%   19.0%   3.4%     

 

Sales and marketing expenses were flat to the prior period for the three months ended December 31, 2016 and decreased 7.7% for the six months ended December 31, 2016 compared to the same prior period. The decrease is largely due to a reduction in point of sale expenses and storage fees, offset by increases in freight and outside services.

 

The amounts billed to customers for shipping and handling are recorded as sales and reported as the costs are incurred for shipping and handling as a sales and marketing expense. For the three and six months ended December 31, 2016 shipping costs were $0.3 million and $0.5 million, respectively, flat to when compared to the same periods of FY16.

 

General and Administrative

 

General and administrative expenses include the costs associated with personnel, professional fees, insurance and other expenses related to administrative and compliance functions. General and administrative expenses consist of the following:

 

   Three Months Ended December 31,   Six Months Ended December 31, 
   (in thousands, except for percentages) 
           Increase               Increase     
   2016   2015   Decrease   % Change   2016   2015   Decrease   % Change 
General and administrative  $706   $719   $(13)   1.8%  $1,518   $1,609   $(91)   5.7%
                                         
Percentage of net sales   12.3%   8.5%   3.8%        13.1%   10.8%   2.3%     

 

18

 

  

General and administrative expense for the three and six months ended December 31, 2016 decreased compared to the same period in FY16. The decrease was largely due to decreases in personnel related costs and outside services offset by increases in legal and consulting expenses.

 

Interest Expense

 

Interest and loan fee amortization was $0.09 million and $0.2 million for the three and six months ended December 31, 2016, respectively, flat to the prior period.

 

LIQUIDITY AND CAPITAL RESOURCES

 

General

 

The primary sources of available cash are from operations, bank borrowings and equity offerings. The Company’s primary cash needs are to fund working capital requirements (primarily inventory), capital expenditures for barrels and other equipment to facilitate production, repay indebtedness (interest and principal payments) and for other operating expenses. The Company is able to borrow against working capital assets (accounts receivable and inventory) via an asset based bank loan.

 

   December 31, 2016   June 30, 2016   Increase
(Decrease)
   % Change 
   (in thousands, except percentages) 
Working capital  $13,815   $12,940   $875    6.8%
Cash and cash equivalents  $26   $4,043   $(4,017)   (99.4%)

 

The Company paid down its line of credit during the quarter in the amount of $5.4 million and as of December 31, 2016, had approximately $5.1 million of availability under its revolving line of credit facility.

 

The weighted average interest rate on the line of credit was 2.85% and 2.80% for the three and six month periods ended December 31, 2016, respectively. Both rates increased 0.35% from prior year.

 

In July 2016, the capital equipment line of credit from the prior fiscal year was converted to a term loan. The interest rate on the loan is 3.95% with a maturity date of July 1, 2020 and monthly payments of $0.09 million.

 

The lines of credit, which were refinanced on July 29, 2016, include (a) a revolving line of credit with a maximum commitment of $10.0 million which accrues interest at 2.25% above the LIBOR, (b) a capital equipment line of credit with a maximum commitment of $0.5 million which carries an interest rate of 2.25% above floating One-Month LIBOR, and (c) a foreign exchange facility with a maximum commitment of $0.1 million which allows the Company to enter into any spot or forward transaction to purchase from or sell to the bank a foreign currency. The Company did not use the foreign exchange facility during the first quarter of FY17. These lines of credit mature on July 31, 2017.

 

The outstanding balances on the lines of credit are:

 

   December 31, 2016   June 30, 2016 
   (in thousands) 
Lines of Credit        
Revolving line of credit  $4,583   $9,924 
Equipment line of credit   298    387 
Total lines of credit  $4,881   $10,311 

 

Bank borrowings are collateralized by substantially all of the Company’s assets and are supported by guaranties from certain LLC members with significant ownership positions. Availability on the revolving line of credit is subject to a monthly borrowing base and compliance with certain covenants, including, without limitation, a minimum current assets to current liabilities ratio (measured quarterly), and a debt to effective tangible net worth ratio (measured quarterly). When the lines of credit were renewed on July 29, 2016, the previous minimum EBITDA covenant was replaced with a debt service coverage ratio (measured quarterly on a trailing twelve-month basis). The Company was in compliance in all material aspects with the covenants at December 31, 2016.

 

19

 

 

The Company believes that its cash position, net cash provided by operating activities in coming periods, and the current lines of credit will be adequate to finance working capital and operations needs for at least the next twelve months. The Company may, however, require additional liquidity as it continues to execute its business strategy. The Company anticipates that to the extent that it requires additional liquidity, it will be funded through the incurrence of indebtedness, additional equity financings or a combination of these potential sources of liquidity, although no assurance can be given that such forms of capital will be available at all, or if available, on terms acceptable to the Company.

 

Cash Flows

 

   Six Months Ended
December 31, 2016
   Six Months Ended
December 31, 2015
     
   (in thousands)   (Dec) 
Net cash provided by operating activities  $1,712   $2,400   $(688)
Net cash (used in) investing activities  $(384)  $(419)  $(35)

Net cash (used in) provided by financing activities

  $(5,345)  $1,458   $(6,803)

 

Operating Activities

 

For the six months ended December 31, 2016, net cash provided by operating activities was $1.7 million which was a decrease of $0.7 million compared to the same period last fiscal year. The changes in cash flows provided by operating activities in the first six months of FY17 are attributable to a net improvement in working capital investment with decreases in accounts receivable, bulk wine deposits, and inventories, coupled with an increase in accounts payable. Those improvements were partially offset by decreases in various accrued expense categories.

 

Investing Activities

 

Cash used in investing activities was flat year over year with no significant changes to investment in property and equipment or intangible assets.

 

Financing Activities

 

The Company paid down its line of credit in the amount of $5.4 million and entered into a new $0.4 million term loan. Payments on the Company’s term loans were $0.3 million.

 

Contractual Obligations and Commitments

 

Financing Agreements

 

The Company’s indebtedness is comprised primarily of bank loans including lines of credit and long term debt.

 

Lines of Credit 

 

See discussion under ”Liquidity and Capital Resources” above.

 

Long Term Debt

 

Long term debt consists of various notes payable to a bank secured by specific property and/or equipment. The total outstanding principal balance on all the notes as of December 31, 2016 was $3.7 million. The interest rates and maturity dates of the notes are described in Note 4 - “Borrowings” of the condensed consolidated financial statements of this Quarterly Report on Form 10-Q.

 

Concentration of Credit Risk and Off-Balance Sheet Arrangements

 

The Company’s cash is held in highly rated credit institutions. Although the Company tries to limit the amount of credit exposure with any one financial institution, the Company does in the normal course of business maintain cash balances in excess of federally insured limits.

 

Accounts receivable consists primarily of trade receivables from customers. The Company reviews accounts receivable regularly and makes estimates for an allowance when there is doubt as to the collectability of individual balances. The Company’s accounts receivable credit risk is not concentrated within any one geographic area. The Company has national distribution agreements with multi-state distributors and these distributors make up a significant amount of the accounts receivable; however, the Company believes the accounts receivable credit risk is limited. The Company has not experienced any material charge offs.

 

20

 

 

Off-Balance Sheet Arrangements

 

The Company does not have off-balance sheet risks related to foreign exchange contracts, option contracts or other foreign hedging arrangements.

 

The Company enters into short and long term contracts with third-parties and related party growers to supply a portion of its future grape and bulk wine inventory requirements. The grape commitments for the FY17 were received during the first quarter. The Company did not extend a large contract for the purchase of bulk wine to future years. Future minimum grape and bulk wine inventory purchase commitments are as follows:

 

Years ending June 30,  Third-Parties   Related Parties   Total 
   (in thousands) 
2017  $1,652   $-   $1,652 
2018   531    57    588 
2019   310    -    310 
Thereafter   -    -    - 
Total grape and bulk purchase commitments  $2,493   $57   $2,550 

 

At December 31, 2016, total future purchase commitments for finished goods total approximately $1.8 million and are expected to be fulfilled during fiscal 2018. Moreover, at December 31, 2016, a $0.03 million liability was outstanding to a related party for grapes from the 2016 harvest.

 

Production & Storage

 

The Company enters into various contracts with third-party service providers for grape crushing, wine storage and bottling. The costs are recorded in the period for which the service is provided. The actual costs related to custom crush services are based on volume. The Company’s current contracts for custom crush services cover the 2016 harvest. The current bottling contract requires a minimum of 200,000 cases at $2.40 per case to be bottled in a one year period. During FY16, the Company transferred bulk wine to a storage facility owned by a related party. At December 31, 2016, approximately 57% of its bulk wine inventory was stored at the related party location.

 

Leases

 

During the first quarter of FY17, the Company modified a tasting room and winery production facility lease agreement as described in Part II, Item 1. Legal Proceedings. The future lease commitments as presented below give effect to the modified lease terms.

 

The Company has two lease agreements for administrative office space. Both are three leases with an end date of October 31, 2019. One of these leases contains three one-year renewal options with adjustment to market rates.

 

Lease payments for these facilities were $0.09 million and $0.2 million for the three and six months ended December 31, 2016, respectively, compared to $0.1 million and $0.2 million for the same periods in FY16.

 

Future lease commitments are:

 

Years ending June 30,
(in thousands)
2017 (remaining six months)  $96 
2018   84 
2019   90 
2020   31 
Thereafter   - 
Total future lease payments  $301 

 

The Company settled outstanding litigation related to the lease of one of its tasting rooms and a winery production facility, in exchange for payment of $1.0 million to LLC, quitclaimed certain rights, and modified its lease such that the Company will vacate the tasting room portion of the property no later than December 31, 2016, and the balance of the space no later than May 31, 2017. The Company received a payment of $0.7 million during the first quarter of FY17. The balance of $0.3 million is held in an escrow account with payments due on December 31, 2016 with the vacancy of the tasting room and on May 31, 2017 with the vacancy of the winery production facility. The $0.3 million receivable is recorded in accounts receivable on the condensed consolidated balance sheets. The entire $1.0 million was recorded as a gain in other income on the condensed consolidated statements of operations. The gain was offset by a reserve for abandoned assets in the amount of $0.1 million. The $0.1 million represents the book value of assets that will be left at the property when the Company vacates on December 31, 2016.

 

21

 

  

Effects of Inflation and Changing Prices

 

The results of operations and financial condition have not been materially affected by inflation and changing prices; however, as agricultural commodities, grape and bulk wine prices experience certain levels of variability. The Company intends to pass along rising costs through increased selling prices, subject to normal competitive conditions. There can be no assurances, however, that the Company will be able to pass along rising costs through increased selling prices effectively. In addition, the Company continues to identify on-going cost savings initiatives.

 

Critical Accounting Policies and Estimates

 

There have been no material changes to the critical accounting policies and estimates previously disclosed in the Annual Report on Form 10-K for the fiscal year ended June 30, 2016.

 

22

 

  

Accounting Pronouncements

 

See Note 1 of the condensed consolidated financial statements of this Quarterly Report on Form 10-Q for the summary of accounting pronouncements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Truett Hurst is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information required under this Item.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Management's Report on Internal Controls over Financial Reporting

 

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as of the end of the period covered by this report.  Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective and provide reasonable assurance, as of the end of the period covered by this report, that information required to be disclosed by the Company in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and were effective to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate, to allow timely discussions regarding required disclosure.

 

Changes to Internal Controls over Financial Reporting

 

There have been no changes in the Company’s internal controls over financial reporting during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

Limitations on the Effectiveness of Controls

 

A control system, no matter how well designed and operated, cannot provide absolute assurance due to its inherent limitations: it is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human or other failures. A control system also can be circumvented in various ways, including, without limitation, by collusion or improper management override. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of such limitations, disclosure controls and internal control over financial reporting cannot prevent or detect all misstatements, including, without limitation, unintentional errors or fraud. Because these inherent limitations are known features of the financial reporting process, it is possible to design and implement process safeguards to reduce such risk, however, such risk cannot be completely eliminated. As such, management, including the Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s disclosure controls or internal controls over financial reporting will prevent or detect all misstatements, including without limitation, unintentional errors and fraud.

 

23

 

 

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

The Company may be subject to various litigation matters arising in the ordinary course of business from time to time.  Other than the matters discussed below, the Company is not aware of any current pending legal matters or claims, individually or in the aggregate, that are expected to have a material adverse impact on our consolidated financial position, results of operations, or cash flows.

 

On January 29, 2016, Mendocino Wine Group (“MWG”) filed a complaint against Phil Hurst (“Hurst”) and H.D.D., LLC (“LLC”). The complaint alleges that, prior to January 2012, Hurst and LLC aided and abetted Paul Dolan in his alleged breach of fiduciary duties to MWG and that they interfered with Dolan's contract with Thornhill Management Company (the manager of MWG), and aided and abetted Dolan's interference with MWG's economic advantage. LLC denies the claims, denies all wrongdoing, and denies that they caused any harm to MWG. On November 10, 2016, the Court granted MWG’s Motion to Consolidate the Hurst/LLC case with a second complaint MWG filed against a law firm for legal malpractice and breach of fiduciary duty. The Court ruled the cases were sufficiently related and should be tried together. A new trial date has been set for November 3, 2017. No amount has been recorded in the condensed consolidated financial statements related to this suit.

 

The Company settled outstanding litigation related to the lease of one of its tasting rooms and a winery production facility, in exchange for payment of $1.0 million to the LLC, quitclaimed certain rights, and modified its lease such that the Company will vacate the tasting room portion of the property no later than December 31, 2016, and the balance of the space no later than May 31, 2017. The Company received a payment of $0.7 million during the first quarter of FY17. The balance of $0.3 million is held in an escrow account with amounts payable upon vacating the tasting room by December 31, 2016 and the winery production facility by May 31, 2017. The Company vacated the tasting room premises just prior to December 31, 2016.

 

ITEM 1A. RISK FACTORS  

 

There have been no material changes in information regarding our risk factors as described in Item 1A of our Form 10-K as filed with the SEC on September 28, 2016.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

Not Applicable

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not Applicable

 

ITEM 5. OTHER INFORMATION

 

Not Applicable

 

24

 

 

ITEM 6. EXHIBITS.

 

Exhibit Number   Description
3.1+   Amended and Restated Certificate of Incorporation of Truett-Hurst, Inc. (incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-1/A submitted to the SEC on April 11, 2013 (File No.: 333-187164)).
3.2+   Bylaws of Truett-Hurst, Inc. (incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-1/A submitted to the SEC on March 27, 2013 (File No.: 333-187164)).
3.3+   Third Amended and Restated Operating Agreement of H.D.D. LLC, dated as of June 19, 2013 (incorporated by reference to Exhibit 10.1 to the Report on Form 8-K submitted to the SEC on June 25, 2013 (File No.: 001-35973)).
4.1+   Class A common stock certificate (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-1/A submitted to the SEC on April 11, 2013 (File No.: 333-187164)).
4.2+   Class B common stock certificate (incorporated by reference to Exhibit 4.2 to the Registration Statement on Form S-1/A submitted to the SEC on April 11, 2013 (File No.: 333-187164)).  
10.1+   2012 Stock Incentive Plan (incorporated by reference to Exhibit 10.14 to the Registration Statement on Form S-1 submitted to the SEC on March 11, 2013 (File No.: 333-187164)).
10.2+   Exchange Agreement, dated as of June 19, 2013, by and among Truett-Hurst, Inc. and the members of H.D.D. LLC from time to time party thereto (incorporated by reference to Exhibit 10.2 to the Report on Form 8-K submitted to the SEC on June 25, 2013 (File No.: 001-35973)).
10.3+   Tax Receivable Agreement, dated as of June 19, 2013, by and among Truett-Hurst, Inc., H.D.D. LLC and the members of H.D.D. LLC from time to time party thereto (incorporated by reference to Exhibit 10.3 to the Report on Form 8-K submitted to the SEC on June 25, 2013 (File No.: 001-35973)).
10.4+   Registration Rights Agreement, dated as of June 19, 2013, by and among Truett-Hurst, Inc. and the members of H.D.D. LLC from time to time party thereto (incorporated by reference to Exhibit 10.4 to the Report on Form 8-K submitted to the SEC on June 25, 2013 (File No.: 001-35973)).
10.5+   Loan and Security Agreement dated July 15, 2015 (incorporated by reference to Exhibit 10.1 to the Report on Form 8-K/A submitted to the SEC on September 28, 2015 (File No.: 001-35973)).
10.6+   Accounts Receivable Line of Credit Note dated July 15, 2015 (incorporated by reference to Exhibit 10.2 to the Report on Form 8-K submitted to the SEC on July 16, 2015 (File No.: 001-35973)).
10.7+   Modification Agreement dated as of July 29, 2016, to the Loan and Security Agreement, dated July 15, 2015 (incorporated by reference to Exhibit 10.1 to the Report on Form 8-K submitted to the SEC on August 2, 2016 (File No.: 001-35973)).
10.8+   Amendment dated July 29, 2016, to the Accounts Receivable Line of Credit Note, dated July 15, 2015 (incorporated by reference to Exhibit 10.2 to the Report on Form 8-K submitted to the SEC on August 2, 2016 (File No.: 001-35973)).
14+   Code of Business Conduct and Ethics (incorporated by reference to Exhibit 14 to the Registration Statement on Form S-1/A submitted to the SEC on April 3, 2013 (File No.: 333-187164)).  
21.1+   Subsidiaries of the Registrant
31.1   Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934
31.2   Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934
32.1   Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2   Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

101.INS XBRL Instance Document

101.SCH XBRL Taxonomy Extension Schema Document

101.CAL XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF XBRL Taxonomy Extension Definition Linkbase Document

101.LAB XBRL Taxonomy Extension Label Linkbase Document

101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

 

 

+ Indicates documents previously filed with our registration and prospectus filings with the SEC.  

 

 25 
 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Healdsburg, State of California, on the 14th day of February, 2017.

 

TRUETT-HURST, INC.    
     
/s/ Phillip L. Hurst   February 14, 2017
     

Phillip L. Hurst

President and Chief Executive Officer

(Principal Executive Officer)

   
     
/s/ Evan B. Meyer   February 14, 2017
     

Evan B. Meyer

Chief Financial Officer

(Principal Financial/Accounting Officer)

   

 

26