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THST > SEC Filings for THST > Form 10-K on 27-Sep-2013All Recent SEC Filings

Show all filings for TRUETT-HURST, INC.

Form 10-K for TRUETT-HURST, INC.


27-Sep-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the related notes included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following


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discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions as described under the "Forward-Looking Statements" section that appears earlier in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under Item 1A, "Risk Factors," and elsewhere in this Annual Report on Form 10-K.

The fiscal 2013 results referred to in these consolidated financial statements represent results on a consolidated basis that includes both the results of the Truett-Hurst, Inc. with those of the H.D.D. LLC ("LLC") and provide a full-year presentation for comparability purposes. The LLC's period is from July 1, 2012 to June 25, 2013 and Truett-Hurst, Inc.'s period is from June 26, 2013 to June 30, 2013. However, the following discussion represents the LLC for fiscal periods ended June 30, 2013 and 2012 due to our IPO closing on June 25, 2013 and the five-day period deemed immaterial because the only activities undertaken by Truett-Hurst, Inc. were limited to its formation, granting of restricted stock to a key employee and a key non-employee and the IPO.

Overview

Truett-Hurst, Inc. is a holding company and our sole asset is the controlling member equity interest in the LLC. Unless the context suggests otherwise, references in this report to "Truett-Hurst," the "Company," "we," "us" and "our" refer (1) prior to the June 2013 initial public offering ("IPO") of Truett-Hurst Inc. and related transactions, to the LLC and (2) after our IPO and related transactions, to Truett-Hurst Inc. We refer to The Wine Spies, LLC as "Wine Spies."

Formation Transactions

On June 19, 2013, the limited liability company agreement of the LLC was amended and restated to, among other things, modify its capital structure by replacing the different classes of interests previously held by our then-existing owners with a single new class of units that we refer to as "LLC Units." We and our then-existing owners also entered into an exchange agreement under which (subject to the terms of the exchange agreement) they have the right to exchange their LLC Units for shares of our Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications. As of June 30, 2013 there were 4,102,644 LLC Units held by parties other than Truett-Hurst Inc. which upon exercise of the right to exchange would exchange for 4,102,644 shares of Class A common stock.

In connection with the IPO, one share of Class B common stock was distributed to each existing holder of LLC Units, each of which provides its owner with no economic rights but entitles the holder, without regard to the number of shares of Class B common stock held by such holder, to one vote on matters presented to our stockholders for each LLC Unit held by such holder. Holders of our Class A common stock and Class B common stock vote together as a single class on all matters presented to our stockholders for their vote or approval, except as otherwise required by applicable law.

Subsequent to the IPO, our LLC existing owners control approximately 61% of the voting power of our outstanding Class A common stock and 100% of the voting power of our outstanding Class B common stock. Accordingly, our LLC existing owners have the ability to elect all of the members of our board of directors, and thereby control our management and affairs.

The LLC Agreement provides that substantially all expenses incurred by or attributable to us (such as expenses incurred in connection with the IPO), but not including obligations incurred under the Tax Receivable Agreement (see below), our income tax expenses and payments on indebtedness incurred by us, are be borne by the LLC.

Tax Receivable Agreement

On June 19, 2013, we entered into a tax receivable agreement. The agreement provides for the payment from time to time by us, 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 us entering into the agreement, including tax benefits attributable to payments under the agreement. These payment obligations are


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obligations of the corporate taxpayer and not of the LLC. For purposes of the agreement, the benefit deemed realized by the corporate taxpayer will be computed by comparing the actual income tax liability of the corporate taxpayer (calculated with certain assumptions) to the amount of such taxes that the corporate taxpayer would have been required to pay had there been no increase to the tax basis of the assets of the LLC as a result of the exchanges, and had the corporate taxpayer not entered into the agreement. 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.

There were no exchanges of LLC units by holders of LLC units for the fiscal year ended June 30, 2013.

Initial Public Offering

Our IPO closed on June 25, 2013 and pursuant to the IPO, we offered and sold
2,700,000 shares of Class A common stock and acquired an equivalent number of
LLC Units of the LLC.

The following table summarizes the proceeds and use of proceeds from the IPO as
of June 30, 2013:

[[Image Removed]]                                               [[Image Removed]]
(in thousands, except share data)
Truett-Hurst, Inc.
Gross proceeds from 2,700,000 Class A common shares             $        16,200
Use of Proceeds:
Purchase of H.D.D. LLC, newly issued LLC Units from existing            (15,143 )
owners and management
Placement agent fee                                                      (1,057 )
Truett-Hurst Inc. proceeds                                      $             -
H.D.D. LLC
Proceeds from sale of LLC units to Truett-Hurst, Inc.           $        15,143
Use of Proceeds:
Debt repayment                                                           (1,648 )
H.D.D. LLC proceeds                                             $        13,495

As of June 25, 2013, we received gross IPO proceeds of approximately $16.2 million and used approximately $15.1 million of the IPO proceeds to purchase 2,700,000 newly-issued LLC Units from the LLC. We caused the LLC to use approximately $1.6 million of the $15.1 million IPO net proceeds from the sale of such newly-issued LLC Units to repay outstanding indebtedness and related IPO expenses. In addition, we paid approximately $1.1 million to the Placement Agent.

Subsequent to the IPO and the formation transactions described above, we consolidated the financial results of the LLC and its subsidiaries and reflected the ownership interest of the other members of the LLC as a non-controlling interest in our consolidated financial statements beginning June 30, 2013.

The unaudited pro forma condensed consolidated financial information is included for informational purposes only and does not purport to reflect the results of operations or financial position of Truett-Hurst Inc. that would have occurred had we operated as a public company during the periods presented and should be read together with Truett-Hurst, Inc. and Subsidiaries audited consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included below. The unaudited pro forma consolidated statement of operations for the fiscal year ended June 30, 2013 present our consolidated results of operations giving pro forma effect to the IPO and formation transactions and the use of the net proceeds from the IPO and formation transactions described in Note 1 of Truett-Hurst, Inc. and Subsidiaries audited consolidated financial statements within this Annual Report on Form 10-K as if such transactions occurred on July 1, 2012. The pro forma adjustments are based on available information and upon assumptions that our management believes are reasonable in order to reflect, on a


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pro forma basis, the impact of these transactions on the historical financial information of the LLC and does not project our results of operations or financial position for any future period or date.

Prior to the IPO, the LLC's fiscal year end was December 31, while Truett-Hurst, Inc.'s fiscal year end is June 30. We have presented audited financial statements of the LLC as of June 30, 2012 so that it will be comparable with our audited consolidated financial statements. Concurrent with the IPO, the LLC amended its operating agreement to change its fiscal year end to June 30.

The following table reconciles our Adjusted Pro Forma results with our results presented in accordance with GAAP for the year ended June 30, 2013:

                       Truett-Hurst, Inc and Subsidiaries
            Unaudited Pro Forma Consolidated Statement of Operations
                        For the Year Ended June 30, 2013
                       (in thousands, except share data)

[[Image Removed]]         [[Image Removed]]      [[Image Removed]]      [[Image Removed]]
                               H.D.D. LLC             Pro Forma          Truett-Hurst, Inc.
                                 Actual              Adjustments             Pro Forma
Sales                     $        17,587        $        -             $          17,587
Less excise taxes                    (425 )               -                          (425 )
Net sales                          17,162                 -                        17,162
Cost of sales                      11,496                 -                        11,496
Gross profit                        5,666                 -                         5,666
Operating expenses:
Sales and marketing                 3,435                 -                         3,435
General and                         2,098                 -                         2,098
administrative
Non-recurring                         284                 -                           284
Stock-based                           174                 -                           174
compensation
Bulk wine sales, net                   30                 -                            30
loss
Sale of assets, net                    18                 -                            18
loss (gain)
Total operating                     6,039                 -                         6,039
expenses
Income (loss) from                   (373 )               -                          (373 )
operations
Other income (expense):
Interest expense                     (356 )               -                          (356 )
Changes in fair value
of warrant and interest               120                 -                           120
rate
swap
Gain (loss) foreign                   (10 )               -                           (10 )
currency
Total other income                   (246 )               -                          (246 )
(expense)
Income (loss) before                 (619 )               -                          (619 )
income taxes
Income tax expense                      2               (87 )(1)                      (85 )
(benefit)
Net income (loss)
attributable to the
controlling and                      (621 )              87                          (534 )
non-controlling
interest
Less: Net loss (income)
attributable to
noncontrolling                        (25 )            (375 )(2)                     (400 )
interest - The Wine
Spies, LLC
Net income (loss)
attributable to           $          (596 )      $      462             $            (134 )
Truett-Hurst, Inc.
Weighted average shares
of Class A common stock
outstanding(3)(4)
Basic                                                                           2,700,000
Diluted                                                                         2,700,000
Net loss available to
Class A common stock
per share(3)(4)
Basic                                                                   $           (0.05 )
Diluted                                                                 $           (0.05 )
Pro forma net income
available to Class A
common stock per share
Basic                                                                   $           (0.05 )
Diluted                                                                 $           (0.05 )


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(1) Due to the IPO and formation transactions, we are subject to U.S. federal income taxes, in addition to state taxes, with respect to our allocable share of any net taxable income of the LLC, which will result in higher income taxes. As a result, the pro forma statements of operations reflect an adjustment to our provision for corporate income taxes to reflect a statutory rate of 39.8%, which includes provision for U.S. federal income taxes and California statutory rates.

(2) Truett-Hurst, Inc. is the sole managing member of the LLC with a 39.7% interest in the LLC. Net income (loss) attributable to Truett-Hurst Inc.'s non-controlling interest represents approximately 60.3% or $0.4 million of net income (loss) before income taxes $0.6 million.

(3) The shares of Class B common stock do not share in our earnings and are therefore not included in the weighted-average shares outstanding or net income (loss) available per share.

(4) Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted net loss per share is computed by giving effect to all potential dilutive common shares, including convertible LLC units and restricted stock. The assumed exchange of 4,102,644 LLC units for Class A common stock and the vesting of 252,000 shares of restricted stock is expected to have an anti-dilutive effect. Accordingly, the effect of the LLC exchange and restricted stock have been excluded from pro forma net income available to Class A common stock per share. Giving the effect to the exchange of all LLC Units for shares of Class A common stock and vesting of restricted stock, adjusted pro forma net income available to Class A common stock per share would be computed as follows:

[[Image Removed]]                                               [[Image Removed]]
(in thousands, except share data)
Pro forma income before income taxes, less beginning            $         (594 )
noncontrolling interest
Adjusted pro forma income tax benefit                                      236 (a)
Adjusted pro forma net income                                             (358 )(b)
Weighted average shares                                              7,054,644
Adjusted pro forma net income (loss) available to Class A       $        (0.05 )
common stock per share

[[Image Removed]]

a) Represents the implied provision for income taxes assuming full exchange using the same methodology applied in calculating pro forma provision.

b) Assumes elimination of the non-controlling interest.

Recent Trends

According to the 2012 Gomberg-Fredrikson & Associates Annual Wine Industry Review for the twelve months ended December 2012, wine shipments advanced by 50% since 2001, making the U.S. the largest wine consumer. Our strategy has been to utilize our knowledge, expertise and competitive positioning to deliver innovative products to the wine market. We face evolving trends in the wine industry that can provide opportunities as well as potential risks, including:

• Market ripe for disruption: Food retailers account for roughly 65% of wine sales, with a high concentration of market share among only a handful of major wine producers and distributors. The top four wine producers in California control approximately 65% of unit shipments of California wine. In order to compete with powerful producers and suppliers for this growing profit pool, food and grocery retailers have turned to retail exclusive brand label programs as a way of gaining margin, customer loyalty, category growth and differentiation.

• Retailer focus on innovation: Increased market competition has heightened for retailers the emphasis on increasing consumer traffic to grow same store sales year over year. In order to create excitement in their stores, major global retail chains and top wine retailers in the United States have made wine and packaging innovations, including "earth-friendly" elements, a key strategic initiative for 2013 and beyond. Our core values are aligned with our retail alliance initiatives and consumer consciousness as we strive to make our products in a way that minimizes waste and fossil fuel usage and increases recyclability.


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• Retail exclusive brand label model remains in its infancy: Nielsen estimates that, in the United States, only 3.7% of wines, by dollar value, were sold through retail exclusive brand labels in the year to date, as of August 2010, which was a 20% increase compared to the prior year. Other mature wine markets have experienced considerably higher penetration; for example, retail exclusive brand label wine sales make up 19% and 16% of total wine sales in the U.K. and Australia, respectively. The U.S. market appears poised for growth in this segment.

• Declining brand loyalty: Along with robust growth, the U.S. wine market has also witnessed a proliferation of new brands. In 2010 alone, the United States approved 120,000 new wine labels. Consumers have shown an increasing appetite to sample new labels and varietals, which can be promoted cost-effectively on an in-store basis. For example, relatively new brands like Cupcake, Ménage à Trois and E.&J. Gallo Winery's Apothic grew by 55%, 18% and 258%, respectively, in 2011. Food retailers are well-positioned to manage this promotion as they control the shelf space and brand positioning in their stores. In an ever more crowded market, this advantage has become increasingly valuable.

• Rapid growth of internet retailing: Small but rapidly growing, we expect the internet segment to continue to outpace brick and mortar retailer sales, and we believe it is poised to surpass winery direct sales.

• "Premiumization" of the market: Following years of explosive growth in the late 1980s and early 1990s, the U.S. market experienced a supply glut which resulted in severe pricing pressure from so-called "value brands." Due to significant consumption growth of California wines and the reduction of imported wines, as well as changes in exchange rates and taste preferences, this trend has reversed in the current cycle, with the super-premium and ultra-premium segments among those experiencing the highest growth.

• Significant direct to consumer sales growth: Tasting room and wine club sales are typically the highest gross margin sales for a winery. From fiscal 2012 to fiscal 2013 our direct to consumer net sales grew at a compound annual growth rate of 45%. Direct to consumer sales represented 19% and 17% of our total net sales for the fiscal years ended June 30, 2013 and 2012, respectively.

We anticipate net sales will increase as our existing brands and concepts continue to gain acceptance in the marketplace and through our scheduled introduction of new brands and packaging. We expect cost of goods sold to continue to increase as sales increase. Operating expenses will increase as we generate and sustain increased revenue to achieve and maintain future profitability. In addition, we will continue to incur additional expenses related to various financial reporting, legal, corporate governance and other expenses as a result of being a publicly-traded company.

Seasonal Trends

Our sales have historically followed a cyclical trend, with sales being typically higher after a product launch and higher during holidays.

Reporting Segments

Our primary reporting segments are identified by each distribution channel:
wholesale, direct to consumer and internet. Wholesale sales include our retail exclusive label model and four fully-owned brands through the three-tier distribution system. Direct to consumer sales of our own brands occur through our tasting rooms and wine clubs. Internet sales occur through Wine Spies and are principally comprised of brands not owned by us.

In fiscal year 2013, we sold approximately 209,000 cases of wine, generating $17.2 million in net sales as compared to 187,000 cases of wine, generating $12.7 million net sales, in fiscal 2012. For details, see "Net Sales" and Note 17, "Significant Customer Information, Segment Reporting and Geographic Information," to the Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K.


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Results of Operations
Factors Affecting Our Operating Results

Our net sales are affected by advertising, discounts and promotions, merchandising, packaging and in the wholesale segment, the availability of wall display space at our retailer customers, all of which have a significant impact on consumers' buying decisions. Continued growth of our net sales and profits will depend, substantially, on the continued popularity of our new and existing brands, our ability to effectively manage our sales by segment and distribution networks, and our ability to maintain sufficient product supply to meet expected growth in demand.

Our 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, and barrel depreciation. The internet segment cost of sales is comprised of finished cased wine.

Fiscal 2013 compared to Fiscal 2012
Net Sales

Net sales include sales from each distribution channel: wholesale, direct to consumer and internet. Wholesale sales include our retail exclusive brands and four fully-owned brands through the three-tier distribution system. Direct to consumer sales of our own brands occur through our tasting rooms and wine clubs. Internet sales occur through Wine Spies and are principally comprised of brands not owned by us.

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                                                  Fiscal Years Ended June 30,
                                               (in thousands, except percentages)
Segment                     2013                  2012                Increase                  %
                                                                     (Decrease)               Change
Wholesale            $          12,427     $          10,493     $           1,934                18 %
Direct to consumer               3,193                 2,196                   997                45 %
Internet                         1,542                     -                 1,542               100 %
Total net sales      $          17,162     $          12,689     $           4,473                35 %

Net sales increased 35% from fiscal year 2012 to fiscal year 2013. Wholesale sales increased 18% compared to the prior-year period due to increased case sales of existing brands and introduction of new brands including: Bewitched, Candells, Chateau Crisp, Curious Beasts, Eden Ridge, Fuchsia, Schuck's, The Criminal, The Supper Club and Wine with No Name.

These new brands represented approximately 25% of our wholesale case volume and 29% of our wholesale sales for fiscal year 2013. Direct to consumer sales increased 45% compared to the prior-year period and was attributable to increased wine club memberships and increased tasting room traffic. The addition of internet sales compared to the prior-year period was due to the acquisition of the Wine Spies.

During fiscal 2013, international sales were less than 2% of our net sales. There were no international sales in fiscal 2012.

We record sales discounts and depletion allowances as a reduction of sales. For the fiscal years ended June 30, 2013 and 2012, sales discounts and depletion allowances totaled $1.4 million and $1.0 million, respectively. We anticipate an increase in sales discounts and depletion allowances in the upcoming fiscal year due to product positioning and increased wholesale sales and changes in distributors.

Cost of Sales

Costs of sales includes costs associated with grape growing, external grape, bulk wine and finished goods purchases, packaging materials, winemaking and production costs, vineyard and production administrative support and overhead costs, and purchasing, receiving and warehousing costs. No further costs are allocated to inventory once the product is bottled and available for sale.


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                                                  Fiscal Years Ended June 30,
                                               (in thousands, except percentages)
Segment                     2013                  2012                Increase                  %
                                                                     (Decrease)               Change
Wholesale            $           9,280     $           8,780     $             500                 6 %
Direct to consumer               1,356                   838                   518                62 %
Internet                           860                     -                   860               100 %
Cost of sales                   11,496                 9,618                 1,878                20 %

Wholesale cost of sales increased 6% compared to the same prior-year period and was attributable to the brand and volume changes discussed above. The wholesale gross margin increased 9% compared to the same prior-year period due to the introduction of new brands which have higher margins than those in the prior-year period.

Direct to consumer sales cost of sales increased 62% compared to the same . . .

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