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CRIMSON WINE GROUP, LTD - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Interim Operations.

May 9, 2014

Statements included in this Report may contain forward-looking statements. See "Cautionary Statement for Forward-Looking Information" below. The following should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2013 Report.

Seasonality



As discussed in the 2013 Report, the wine industry in general historically experiences seasonal fluctuations in revenues and net income. The Company typically has lower sales and net income during the first quarter and higher sales and net income during the fourth quarter. The Company anticipates similar trends in 2014.

Liquidity and Capital Resources

General

Crimson's principal sources of liquidity are its available cash, funds generated from operations and its revolving credit facility. In March 2013, Crimson entered into a $60,000,000 revolving credit facility with American AgCredit, FLCA, as agent for the lenders identified in the revolving credit facility, comprised of a revolving loan facility and a term revolving loan facility, which together is secured by substantially all of Crimson's assets. The revolving credit facility is for up to $10,000,000 of availability in the aggregate for a five year term, and the term revolving credit facility is for up to $50,000,000 in the aggregate. All obligations of Crimson under the revolving credit facility are collateralized by certain real property, including vineyards and certain winery facilities of Crimson, accounts receivable, inventory and intangible assets. Covenants include the maintenance of specified debt and equity ratios, limitations on the incurrence of additional indebtedness, limitations on dividends and other distributions to shareholders and restrictions on certain mergers, consolidations and sales of assets. In addition to unused line fees ranging from 0.25% to 0.375%, rates for the borrowings are priced based on a performance grid tied to certain financial ratios and the London Interbank Offered Rate, and would have been 1.652% to 1.954% at March 31, 2014. The facility can be used to fund acquisitions, capital projects and other general corporate purposes. No amounts have been borrowed under the facility to date.

Prior to the Distribution, Crimson relied upon Leucadia for debt financing and equity contributions for all of its liquidity needs. As of February 25, 2013, the aggregate amount payable by Crimson to Leucadia and its affiliates was $151,043,000, all of which was contributed to Crimson as capital prior to the Distribution. As a result, in the quarters subsequent to the first quarter of 2013, Crimson did not record interest expense relating to this Leucadia financing.

In March 2013, pursuant to the separation agreement entered into with Leucadia, Leucadia paid $14,175,000 to Crimson as a capital contribution. No additional capital contributions from Leucadia are required or anticipated to be made.

As of March 31, 2014, Crimson's commitments for capital expenditures were not material. Crimson expects to spend approximately $5,400,000 for capital expenditures during 2014, of which $1,100,000 is for technology enhancements related to growth, including infrastructure expansion and to enhance capabilities now expected by consumers, including mobile commerce. As such, these expenditures do not relate to required maintenance or similar costs to sustain our existing operations. The remaining $4,300,000 is for vineyard development, barrel purchases and other winery and facility improvements. Crimson expects to use its available cash and cash flows generated from operating activities to fund its capital expenditures.

In March, 2014, the board of directors of Crimson authorized a stock repurchase program pursuant to which the Company may repurchase up to $2 million of the Company's common stock. The repurchases will be funded by available cash. How much common stock, if any, will be repurchased will depend on market conditions, including the price of the common stock.

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Consolidated Statements of Cash Flows

Net cash provided by operating activities was $1,591,000 and $1,301,000 for the three months ended March 31, 2014 and 2013, respectively. Cash flows from operating activities improved during 2014 as compared to 2013, principally due to increased operating income, certain prior year payments for new standalone costs, offset slightly by increased grape payments in 2014 as compared to 2013, which pertain to the prior year harvest.

Net cash provided by operating activities also reflects less interest paid to Leucadia. Interest paid to Leucadia was zero and $122,000 during the three months ended March 31, 2014 and 2013, respectively.

Net cash provided by (used for) investing activities was $(1,238,000) and $327,000 for the three months ended March 31, 2014 and 2013, respectively. Acquisition of property, equipment and leasehold improvements decreased in the first three months of 2014 as compared to the first three months of 2013, principally due to the 2013 capacity expansion at Seghesio Family Vineyards. 2013 proceeds from disposals of property and equipment include $1,754,000 from the sale of a non-strategic vineyard. In addition, $750,000 was used during the three months ended March 31, 2014 for investing in FDIC insured U.S. Certificates of Deposit.

Net cash provided by financing activities reflects $1,700,000 of principal payments on debt to Leucadia and the Leucadia capital contribution of $14,175,000, discussed above, for the three months ended March 31, 2013.

Results of Operations

Overview

The Company generates revenues from sales of wine to wholesalers and direct to consumers, sales of bulk wine and grapes, special event fees, tasting fees and retail sales. Revenues, gross profit and income from operations for the three months ended March 31, 2014 and 2013 are as follows (in thousands):

2014 2013 Revenues: Wholesalers $ 8,125$ 7,477 Direct to consumers 4,588 4,226

Bulk wine and grape sales, event fees and retail sales 559 303

$ 13,272$ 12,006 Gross profit: Wholesalers $ 3,907$ 3,135 Direct to consumers 3,071 2,408

Bulk wine and grape sales, event fees and retail sales 24 76

$ 7,002$ 5,619 Operating expenses: Sales and marketing $ 3,048$ 2,632 General and administrative 2,207 2,007 Administrative service fees paid to Leucadia National Corporation 9 15 Income from operations $ 1,738$ 965



Crimson's wines are primarily sold to distributors, who then sell to retailers and restaurants. As permitted under federal and local regulations, Crimson has also been placing increased emphasis on generating revenue from direct sales to consumers which occur through wine clubs, at the wineries' tasting rooms and through the internet.

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Direct sales to consumers are more profitable for Crimson as it is able to sell its products at a price closer to retail prices rather than the wholesale price received from distributors. From time to time Crimson may sell grapes or bulk wine, because the wine does not meet the quality standards for Crimson's products, market conditions have changed resulting in reduced demand for certain products, or because Crimson may have produced more of a particular varietal than it can use. When these sales occur they may result in a loss.

Cost of sales includes grape and bulk wine costs, whether purchased or produced from Crimson's controlled vineyards, crush costs, winemaking and processing costs, bottling, packaging, warehousing and shipping and handling costs. For vineyard produced grapes, grape costs include annual farming costs and amortization of vineyard development expenditures. For wines that age longer than one year, winemaking and processing costs continue to be incurred and capitalized to the cost of wine, which can range from 3 to 36 months. Reductions to the carrying value of inventories to estimated net realizable value are also included in costs of sales.

At March 31, 2014, wine inventory includes approximately 660,000 cases of bottled and bulk wine in various stages of the aging process. Case wine is expected to be sold over the next 12 to 36 months and generally before the release date of the next vintage.

Income Statement

Consolidated Operations - Three months ended March 31, 2014 and 2013

Revenues increased for the three months ended March 31, 2014 as compared to 2013 as a result of a 8.9% increase in case sales, resulting in a $648,000 increase in wholesale revenue and a $362,000 increase in direct to consumer revenue, accompanied by a $265,000 increase in bulk wine and grape sales. Direct to consumer revenue increase is the result of $375,000 in Wine Club revenue, $20,000 in Tasting Room revenue and $13,000 in Special Events revenue, offset slightly by a $46,000 decrease in E-Commerce revenue, primarily attributable to timing of sales initiatives. Gross profit increased $1,383,000 in the three months ended March 31, 2014 as compared to 2013 reflecting an increase in case wine sales, a decrease in cost of goods sold per case predominately attributable to lower costs specific to newly released vintages for certain wines, and lower costs for direct to consumer freight. In addition to change in revenues, gross profit also reflects net losses on sales of bulk wine and grapes of $123,000 and $21,000 for the three months ended March 31, 2014 and 2013, respectively.

Crimson's sales and marketing expenses have a variable component that tends to correspond to changes in sales volume. Sales and marketing expenses increased $416,000 for the three months ended March 31, 2014 as compared to 2013, which includes an increase of $75,000 in variable cost components and $341,000 in fixed cost components. Increase in variable sales and marketing expenses were primarily due to increases in broker commissions due to timing, and include final expense related to a terminated broker relationship which concluded March 31, 2014, and event expenses, offset slightly by a decrease in distributor initiatives as a result of timing of current year planned initiatives. Increases in fixed sales and marketing expenses were primarily due to increased compensation related expense of $226,000, to accommodate growth and replace a significant broker in a top 5 U.S. market, internet redesign costs of $49,000, increased contract services of $20,000 for certain technology related to the wholesale channel, and increased promotional materials costs of $23,000 pertinent to new labels and marketing strategies.

General and administrative expenses increased $200,000 in the three months ended March 31, 2014 as compared to 2013, principally due to $59,000 increase in costs for services over three months in 2014 as compared to one month in 2013 to satisfy standalone public company requirements, $79,000 increase in employee compensation as a result of strategic hires to manage growth, $47,000 increase in travel as a result of strategic planning and sales initiatives, and $42,000 increase in other taxes related to standalone franchise tax requirements.

Income tax increased $687,000 for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 as a result of the reversal of the valuation allowance in the fourth quarter of 2013. The 2014 expense reflects the recognition of statutory income taxes, which was reflected as a component of the valuation allowance in 2013. The Company's effective tax rate, calculated by dividing the income tax provision by net income before income tax expense, is affected by recurring items such as the relative amount of income earned in jurisdictions, which we expect to be fairly consistent in the near term. It is also affected by discrete

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items that may occur in any given year, but are not consistent from year to year. The Company's effective income tax rate is higher than the federal statutory rate primarily due to state income taxes.

Cautionary Statement for Forward-Looking Information

Statements included in this Report may contain forward-looking statements. Such statements may relate, but are not limited, to projections of revenues, income or loss, case sales, development expenditures and expected sources of funds related thereto, plans for growth and future operations, competition and regulation, as well as assumptions relating to the foregoing. Such forward-looking statements are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted or quantified. When used in this Report, the words "estimates," "expects," "anticipates," "believes," "plans," "intends" and variations of such words and similar expressions are intended to identify forward-looking statements that involve risks and uncertainties. Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements.

Factors that could cause actual results to differ materially from any results projected, forecasted, estimated or budgeted or that may materially and adversely affect the Company's actual results include but are not limited to the following: worsening economic conditions causing a decline in estimated future cash flows; our dependence on certain key personnel; significant increases in operating costs and reduced profitability due to competition for skilled management and staff employees; various diseases, pests and weather conditions affecting the quality and quantity of grapes; our inability to grow or acquire enough fruit for our wines; significant competition adversely affecting our profitability; competition for shelf space in retail stores and for marketing focus by our independent distributors; the contamination of our wines; a reduction in consumer demand for our wines; a decrease in wine score rating by important rating organizations; climate change, or legal, regulatory or market measures to address climate change, negatively affecting our business, operations or financial performance, and water scarcity or poor quality negatively impacting our production costs and capacity; environmental issues or hazardous substances on our properties resulting in us incurring significant liabilities; our indebtedness materially affecting our financial health; changes in laws and government regulations or in the implementation and/or enforcement of government rules and regulations increasing our costs or restricting our ability to sell our products into certain markets; our inability to insure certain risks economically; being subject to litigation which may have a significant adverse effect on our consolidated financial condition or results of operations; not paying dividends currently or in the future; impairment of our intangible assets; the limited market for our common stock because our stock is not listed on any securities exchange; volatility in our common stock price; future sales of our common stock depressing the market price of our stock; public company compliance costs; loss of our status as an emerging growth company; restrictions on our ability to enter into certain transactions that could jeopardize our tax free spin-off from Leucadia; and the significant influence of certain principal stockholders. For additional information see Part I, Item 1A. Risk Factors in the 2013 Report.

Undue reliance should not be placed on forward-looking statements, which are applicable only as of the date hereof. The Company undertakes no obligation to revise or update its forward-looking statements to reflect events or circumstances that arise after the date of this Report or to reflect the occurrence of unanticipated events.


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Source: Edgar Glimpses


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