SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[ ] 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: 0-13406
The Chalone Wine Group, Ltd.
(Exact Name of Registrant as Specified in Its Charter)
California 94-1696731
(State or Other Jurisdiction of
Incorporation or Organization) (I.R.S. Employer Identification No.)
621 Airpark Road
Napa, California 94558
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 707-254-4200
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
--- ---
The number of shares outstanding of Registrant's Common Stock on August 9, 1999
was 9,363,658.
The Chalone Wine Group, Ltd.
PART I. - FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1999, and March 31, 1999. 3
Consolidated Statements of Income for the three months ended June
30, 1999 and 1998. 4
Consolidated Statements of Cash Flows for the three months ended
June 30, 1999 and 1998. 5
Notes to Consolidated Financial Statements. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8
Item 3. Disclosures about market risk 12
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 16
The Chalone Wine Group, Ltd.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
June, March 31,
1999 1999
--------- ---------
Current assets:
Cash and cash equivalents $ 2,163 $ 1,670
Accounts receivable, less allowance for doubtful
accounts of $106 and $86, respectively 7,597 8,086
Notes receivable 109 109
Income tax receivable 1,252 616
Inventory 45,011 40,926
Prepaid expenses 535 492
Deferred income taxes 899 158
--------- ---------
Total current assets 57,566 52,057
Investment in Chateau Duhart-Milon 9,545 10,409
Notes receivable, long-term portion 119 119
Property, plant and equipment - net 37,595 33,591
Goodwill and trademarks - net 6,612 6,196
Other assets 1,171 1,099
--------- ---------
Total assets $ 112,608 $ 103,471
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 5,854 $ 2,494
Current maturities of long-term obligations 309 371
--------- ---------
Total current liabilities 6,163 2,865
Bank line of credit 11,218 3,938
Long-term obligations, less current maturities 22,560 22,835
Convertible subordinated debentures -- 8,500
Deferred income taxes 3,108 2,765
--------- ---------
Total liabilities 43,049 40,903
--------- ---------
Minority interest 4,282 4,277
Shareholders' equity:
Common stock - authorized 15,000,000 shares no par value;
issued and outstanding: 9,363,658 and 8,720,771 shares,
respectively 54,518 48,965
Stock subscription receivable (38) (1,007)
Retained earnings 13,555 12,629
Cumulative foreign currency translation adjustment (2,758) (2,296)
--------- ---------
Total shareholders' equity 65,277 58,291
--------- ---------
Total liabilities and shareholders' equity $ 112,608 $ 103,471
========= =========
<FN>
The accompanying notes are an integral part
of the consolidated financial statements
</FN>
3
The Chalone Wine Group, Ltd.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited, in thousands, except per-share data)
Three months
ended June 30,
-----------------------
1999 1998
-------- --------
Gross revenues $ 10,828 $ 9,015
Excise taxes (259) (203)
-------- --------
Net revenues 10,569 8,812
Cost of wines sold (5,538) (4,720)
-------- --------
Gross profit 5,031 4,092
Other revenues from operations 40 --
Selling, general and administrative expenses (3,086) (2,534)
-------- --------
Operating income 1,985 1,558
Interest expense (493) (419)
Equity in Chateau Duhart-Milon 337 316
Minority interests (304) (243)
Other, net 43 8
-------- --------
Income before income taxes 1,568 1,220
Income taxes (642) (500)
-------- --------
Net income $ 926 $ 720
======== ========
Net income per common share
Basic $ 0.10 $ 0.08
Diluted $ 0.10 $ 0.08
Average number of shares used
in income per share computation
Basic 9,221 8,580
Diluted 9,341 8,873
The accompanying notes are an integral part
of the consolidated financial statements
4
The Chalone Wine Group, Ltd.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
Three months
ended June 30,
------------------
1999 1998
------- -------
Cash flows from operating activities:
Net income $ 926 $ 720
Non-cash transactions included in earnings:
Depreciation 560 464
Amortization 114 85
Equity in net income of Chateau Duhart-Milon (337) (316)
Increase in minority interest 304 243
Loss on sale of equipment 4 --
Changes in:
Settlement advance -- 4,500
Accounts and other receivable (6) 602
Inventory (925) (908)
Prepaid expenses and other assets (171) (273)
Accounts payable and accrued liabilities 2,812 (875)
------- -------
Net cash provided by operating activities 3,281 4,242
------- -------
Cash flows from investing activities:
Capital expenditures (2,069) (2,200)
Purchase of Staton Hills Winery, net of cash acquired (6,127)
Proceeds from disposal of property and equipment 5 --
Distributions from Duhart-Milon 738 --
------- -------
Net cash used in investing activities (7,453) (2,200)
------- -------
Cash flows from financing activities:
Borrowings on line of credit - net 7,280 (3,661)
Repayment of short-term debt -- (952)
Distributions to minority interests (300) (71)
Repayment of long-term debt (2,337) (457)
Proceeds from issuance of common stock 22 1,044
------- -------
Net cash provided by financing activities 4,665 (4,097)
------- -------
Net increase (decrease) in cash 493 (2,055)
Cash at beginning of period 1,670 2,232
------- -------
Cash at end of period $ 2,163 $ 177
======= =======
The accompanying notes are an integral part
of the consolidated financial statements
5
The Chalone Wine Group, Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Consolidated Financial Statements
The consolidated balance sheet as of June 30, 1999, the consolidated statements
of Income for the three months ended June 30, 1999, and 1998, and the
consolidated statements of cash flows for the three months then ended have been
prepared by the Company, without audit. In the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the Company's financial position, results of operations and cash
flow at June 30, 1999, and for all periods presented have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. For further information, reference should be
made to the consolidated financial statements and notes included in the
Company's Form 10-K for the year ended March 31, 1999, on file with the
Securities and Exchange Commission.
NOTE 2 - Reclassifications
Certain prior period amounts have been reclassified in order to conform with the
current period presentation.
NOTE 3 - Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No.130 ("SFAS 130") - Reporting Comprehensive
Income. SFAS 130 requires the reporting of a new measure of income which takes
into account certain elements otherwise recorded directly in equity. The
following is a reconciliation of net income and comprehensive income (in
thousands):
Three months ended
June 30,
----------------
1999 1998
------ ------
Net income $ 926 $ 720
Change in cumulative foreign currency translation adjustment (462) 280
------ ------
Comprehensive income $ 464 $1,000
====== ======
NOTE 4 - Earnings per Share
Basic EPS represents the income available to common shareholders divided by the
weighted average number of common shares outstanding for the period. Diluted EPS
represents the income available to common shareholders divided by the weighted
average of common shares outstanding while also giving effect to the potential
dilution that could occur if securities or other contracts to issue common stock
(e.g. stock options) were exercised and converted into stock. For all periods
presented, the difference between basic and diluted earnings per share for the
Company is the inclusion of dilutive stock options and stock warrants, the
effect of which is calculated using the treasury stock method as shown below.
The Company's convertible debentures are excluded from the computation, as these
have had an antidilutive effect. In April 1999, debentures with a face value of
$6.5 million were converted into 738,014 shares of the Company's common stock.
At such time, holders of the remaining $2.0 million in debentures elected not to
exercise their conversion rights and the Company repaid the $2.0 million using
available borrowings under its line of credit.
6
The Chalone Wine Group, Ltd.
NOTE 4 - Earnings per Share (Continued)
The following is a reconciliation of share information used to compute basic EPS
and diluted EPS:
(in thousands, except per-share data)
Basic EPS Diluted EPS
--------------- ---------------
Effect of dilutive
securities Income
--------------------------- available to
Income common
available to shareholders
common Stock and assumed
shareholders Warrants options conversion
--------------- ------------- ------------ ---------------
Three months ended June 30, 1999:
Income $ 926 -- -- $ 926
Shares 9,221 120 -- 9,341
--------------- ---------------
EPS $ 0.10 $ 0.10
=============== ===============
Three months ended June 30, 1998:
Income $ 720 -- -- $ 720
Shares 8,580 227 66 8,873
--------------- ---------------
EPS $ 0.08 $ 0.08
=============== ===============
NOTE 5 - Acquisition of Staton Hills Winery
On June 15, 1999, the Company purchased 100% of the outstanding shares of SHW
Equity Company, a holding company which, in turn, owns 100% of Staton Hills
Winery ("SHW") and its adjacent vineyards in Yakima County, Washington. The cost
of the acquisition, which included $3.3 million of SHW's notes payable that were
repaid by the Company at the date of the acquisition, was approximately $6.0
million and was financed with the Company's long-term bank line of credit.
The acquisition was recorded using the purchase method of accounting and the
acquisition price was allocated to the assets acquired and liabilities assumed
based on their estimated fair values. The excess of the acquisition price over
the fair value of net assets acquired was recorded as goodwill, which is being
amortized over 20 years. A breakdown of the allocation of the acquisition price
is as follows (in thousands):
Cash $ 62
Accounts receivable 140
Inventory 3,160
Property, plant and equipment 2,504
Deferred tax asset 741
Goodwill 473
Accounts payable and accrued liabilities (548)
Deferred tax liabilities (343)
-------
Total $ 6,189
=======
The accompanying condensed consolidated financial statements include the
operations of SHW for the period from June 15, 1999 through June 30, 1999. The
pro-forma effect of including the operations of SHW in the accompanying
condensed consolidated financial statements as if it had been acquired at the
beginning of the quarter would not be significant.
7
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
FORWARD LOOKING STATEMENTS
From time to time, information provided by the Company, statements made by its
employees, or information included in its filings with the Securities and
Exchange Commission (including this Form 10-Q) may contain statements which are
not historical facts, so called "forward looking statements" that involve risks
and uncertainties. Forward looking statements are made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. When
used in this Form 10-Q, the terms "anticipates," "expects," "projects," "may,"
"may not," "believes," and other similar terms as they relate to the Company or
its management are intended to identify such forward looking statements. In
particular, statements made in this Item 2, Management's Discussion and Analysis
of Financial Condition and Results of Operations, relating to projections or
predictions about the Company's future investments in vineyards and other
capital projects are forward looking statements. The Company's actual future
results may differ significantly from those stated in any forward looking
statements. Factors that may cause such differences include, but are not limited
to (i) reduced consumer spending or a change in consumer preferences, which
could reduce demand for the Company's wines; (ii) competition from numerous
domestic and foreign wine producers which could affect the Company's ability to
sustain volume and revenue growth; (iii) interest rates and other business and
economic conditions which could increase significantly the cost and risks of
projected capital spending; (iv) the price and availability in the marketplace
of grapes meeting the Company's quality standards and other requirements; (v)
the effect of weather and other natural forces on growing conditions and, in
turn, the quality and quantity of grapes produced by the Company and (vi) the
risks associated with the assimilation of Staton Hills Winery. Each of these
factors, and other risks pertaining to the Company, the premium wine industry
and general business and economic conditions, are more fully discussed herein
and from time to time in other filings with the Securities and Exchange
Commission, including the Company's annual report on Form 10-K for the year
ended March 31, 1999.
DESCRIPTION OF THE BUSINESS
The Company produces, markets and sells super, ultra and super-ultra premium
white and red varietal table wines, primarily Chardonnay, Pinot Noir, Cabernet
Sauvignon, Merlot and Sauvignon Blanc. The Company operates six wineries; four
located in various counties of California, and two located in the State of
Washington. The Company's wines are made principally from grapes grown at the
Chalone Vineyard(R), Carmenet(R) Vineyard, Edna Valley Vineyard(R),
Company-owned vineyards adjacent to the Acacia(TM) Winery in California and the
Canoe Ridge(R) Vineyard in Washington State. These wines are primarily sold
under the labels "Chalone Vineyard," "Edna Valley Vineyard," "Carmenet,"
"Acacia," "Canoe Ridge Vineyard," and "Echelon(TM)".
As a result of a substantial investment in the Company by France-based Les
Domaines Barons de Rothschild (Lafite) ("DBR"), the Company receives an
allocation of DBR wines, including the wines of Chateau Lafite-Rothschild and
Chateau Duhart-Milon, first-growth and fourth-growth Bordeaux region wines,
respectively.
The Chalone Wine Group, Ltd. was incorporated under the laws of the State of
California on June 27, 1969. Unless otherwise indicated, the term "Company" as
used in this report refers to The Chalone Wine Group, Ltd. and its consolidated
subsidiaries. The Company became a publicly held reporting company as the result
of an initial public offering of common stock in 1984. Today, the Company is one
of only nine publicly held U.S. corporations whose principal business is in the
production, marketing and selling of wine.
8
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
RESULTS OF OPERATIONS
The following table represents financial data as a percentage of net revenues
for the indicated periods:
Three months ended Percent
June 30, Change
------------------------- -----------
1999 1998 99 vs 98
------------ ------------ -----------
Net revenues 100.0 % 100.0 % 19.9%
Cost of sales (52.4)% (53.6)% 17.3%
----- -----
Gross profit 47.6 % 46.4 % 22.9%
Other revenues from operations 0.4 % 0.0 % n/a
Selling, general and admin. expenses (29.2)% (28.8)% 21.8%
----- -----
Operating income 18.8 % 17.6 % 27.4%
Interest Expense (4.7)% (4.8)% 17.7%
Equity in Chateau Duhart-Milon 3.2 % 3.6 % 6.6%
Minority interest (2.9)% (2.7)% 25.1%
Other, net 0.4 % 0.1 % 437.5%
----- -----
Income before income taxes 14.8 % 13.8 % 28.5%
Income taxes (6.0)% (5.6)% 28.4%
----- -----
Net income (loss) 8.8 % 8.2 % 28.6%
===== =====
Net Revenues
Net revenues increased approximately 20%, from $8.8 million to $10.6 million,
for the three months ended June 30, 1998 and 1999, respectively, primarily due
to a 15% volume increase and a 4% average price-per-unit increase.
Gross Profit
Gross profit increased approximately 23%, from $4.1 million to $5.0 million, for
the three months ended June 30, 1998 and 1999, respectively, primarily due to
increased net revenues. The corresponding gross profit margin increased from
46.4% to 47.6% during the period due to selected price increases and product-mix
differences.
Other Revenue from Operations
The $40,000 in other revenue from operations for the three months ended June 30,
1999 was attributable to custom bottling activities which had not begun at this
time last year.
Other revenue from operations consists of (i) processing and other revenue from
third-party wineries and (ii) net profit from sales of bulk wine. The Company
cannot predict the effect on future operating results, as this source of revenue
is highly unpredictable and largely contingent on other wineries' demand for
extra production capacity, which can and does vary significantly from year to
year.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 22%, from $2.5 million to
$3.1 million for the three months ended June 30, 1998 and 1999, respectively,
primarily as a result of increased selling efforts associated with the 20%
increase in net revenues.
9
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
Operating Income
Operating income increased 27%, from $1.6 million to $2.0 million, for the three
months ended June 30, 1998 and 1999, respectively, primarily due to increased
gross profits, offset by a smaller increase in selling, general and
administrative expenses as discussed above.
Interest Expense
Interest expense increased 18% from $419,000 to $493,000, for the three months
ended June 30, 1998 and 1999, respectively, primarily due to higher average
outstanding borrowings.
Equity in Net Income of Duhart-Milon
The Company's 23.5% equity interest in the net income of Chateau Duhart-Milon
("Duhart-Milon") increased 7%, from $316,000 to $337,000, for the three months
ended June 30, 1998 and 1999, respectively, primarily due to continuing demand
for Bordeaux wines.
The Company monitors its investment in Duhart-Milon primarily through its
on-going communication with Domaines Barons de Rothschild (DBR). Such
communication is facilitated by the presence of the Company's chairman on DBR's
Board of Directors, and DBR's representation on the Company's Board of
Directors. Additionally, various key employees of the Company make frequent
visits to Duhart-Milon's offices and productions facilities.
The Company's investment in Duhart-Milon is a long-term investment denominated
in French Francs. The Company's reserve for currency translation adjustment was
$2,758,000 as of June 30, 1999. This increased by $462,000 since March 31, 1999,
due to the decrease in the relative worth of the French Franc when compared to
the U.S. dollar. The European Union's transition to "EURO" currency, which
became effective as of January 1, 1999, is not expected to materially affect the
valuation of the Company's investment in Duhart-Milon. Currency fluctuations are
recorded as a "Cumulative foreign currency translation adjustment" in the equity
section of the Company's consolidated balance sheet, and in comprehensive income
as required by the Statement of Financial Accounting Standards No.130 ("SFAS
130") - Reporting Comprehensive Income.
Minority Interest
The Financial Statements of Edna Valley Vineyard ("EVV") and Canoe Ridge
Vineyard, LLC ("CRV") are consolidated with the Company's financial statements.
The interest in the equity and net income of EVV and CRV attributable to parties
other than the Company is accounted for as a "minority interest". The minority
interest in the net income of EVV and CRV for the three months ended June 30,
1999 and 1998 consisted of the following (in thousands):
Three months
ended June 30,
Minority ---------------------------
Venture Minority Owner Percent 1999 1998
- ----------- ------------------- ---------- ------------ --------------
Edna Valley Vineyard Paragon Vineyard Co., Inc. 50.00% $ 205 $ 172
Canoe Ridge Vineyard, LLC Various 49.50% 99 71
------------ --------------
$ 304 $ 243
============ ==============
The minority interest in the net income of EVV and CRV in earnings increased
25%, from $243,000 to $304,000, for the three months ended June 30, 1998 and
1999, respectively, due to steadily improving performance at both EVV and CRV
primarily as a result of increased case sales.
10
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
Net Income
Net income increased 29%, from $720,000 to $926,000, for the three months ended
June 30, 1998 and 1999, respectively, primarily due to increased gross profits,
only partially offset by (i) higher selling, general and administrative expenses
and (ii) higher financing costs.
YEAR 2000
The year 2000 issue ("Y2K") is the result of computer programs being written
using two digits rather than four digits to determine the applicable year. As
presently programmed, the Company's computer programs and systems that have time
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. Unless reprogrammed, in the future this could result in
miscalculations causing disruptions of operations, including, among other
things, temporary inefficiencies in processing transactions, sending invoices,
or engaging in similar normal business activities.
The Company has an ongoing program designed to ensure that its operational and
financial systems will not be adversely affected by Y2K software failures. The
Company believes that its exposure to Y2K issues remains relatively minor in
comparison to most industrial enterprises because of its relatively low reliance
on computerized systems. Compliance is to some extent dependent upon vendor
cooperation. Preliminary estimates of the compliance-related costs, based on
internal projections, are approximately $15,000. The Company recognizes that any
Y2K system related compliance failures could result in additional expenses to
the Company, the materiality of which cannot be predicted at this time.
LIQUIDITY AND CAPITAL RESOURCES
Working Capital:
Working capital increased 4%, from $49.2 million to $51.4 million, for the three
months ended June 30, 1998 and 1999, respectively, primarily due to financing
the purchase of Staton Hills Winery assets through the Company's long-term line
of credit.
Cash Flows:
During the three months ended June 30, 1999, cash flow from operations decreased
by $961,000 from the comparable period in the prior year. This was primarily due
to a $4.5 million advance received in June 1998 from PG&E relating to settlement
income which was ultimately recognized in the Company's income statement during
the three month period ended March 31, 1999.
During the three months ended June 30, 1999, cash flow from investing activities
decreased by $5.3 million from the comparable period in the prior year. This was
primarily due to the $6.1 million purchase of Staton Hills Winery ("SHW").
During the three months ended June 30, 1999, cash flow from financing activities
increased by $8.8 million from the comparable period in the prior year. This was
primarily due to an increase of $7.3 million in line of credit financing,
largely driven by the $6.1 million purchase of SHW.
General:
The Company is not aware of any potential impairments to its liquidity and
believes its capital resources are adequate to meet current and historic levels
of capital expenditures and its liquidity needs for at least the next twelve
months.
11
The Chalone Wine Group, Ltd.
Item 3. Disclosures About Market Risk
You should read the following disclosures in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations which
have been drafted in compliance with recently adopted regulations of the SEC
concerning the use of "Plain English." These disclosures are intended to discuss
certain material risks of the Company's business as they appear to management at
this time. However, this list is not exhaustive.
Other risks may, and likely will, arise from time to time.
Our Revenues and Operating Results Fluctuate Significantly from Quarter to
Quarter
We believe period-to-period comparisons of our operating results are not
necessarily meaningful, and cannot be relied upon as indicators of future
performance. In addition, there can be no assurance that our revenues will grow
or be sustained in future periods or that we will maintain our current
profitability in the future. Significant factors in these quarterly
fluctuations, none of which are within our control, are changes in consumer
demand for our wines, the affect of weather and other natural forces on growing
conditions and, in turn, the quality and quantity of grapes produced by us,
interest rates and other business and economic conditions. Additionally, our
sales volume tends to be affected by price increases, distributors' inventory
levels and the timing of releases for certain wines, among other factors.
Consequently, we have experienced, and expect to continue to experience,
seasonal fluctuations in revenues and operating results.
A large portion of our expenses are fixed and difficult to reduce in a short
period of time. In quarters when revenues do not meet our expectations, our
level of fixed expenses tends to exacerbate the adverse effect on net income. In
quarters when our operating results are below the expectations of public market
analysts or investors, the price of our common stock may be adversely affected.
Our Profits Depend Largely on Sales in Certain States and on Sales of Certain
Varietals
In the three months ended June 30, 1999, approximately 70% of our wine sales
were concentrated in 20 states. Changes in national consumer spending or
consumer spending in these states and other regions of the country could affect
both the quantity and price level of wines that customers are willing to
purchase.
Approximately 92% of our net revenues in the three months ended June 30, 1999
were concentrated in our top four selling varietal wines. Specifically, sales of
Chardonnay, Pinot Noir, Cabernet Sauvignon and Merlot accounted for 58%, 11%,
16% and 7% of our net revenues, respectively, for the three months ended June
30, 1999.
Competition May Harm Our Business
The premium table wine industry is intensely competitive and highly fragmented.
Our wines compete in all of the premium wine market segments with many other
premium domestic and foreign wines, with imported wines coming primarily from
the Burgundy and Bordeaux regions of France and, to a lesser extent, Italy,
Chile, Argentina, South Africa and Australia. Our wines also compete with
popular-priced generic wines and with other alcoholic and, to a lesser degree,
non-alcoholic beverages, for shelf space in retail stores and for marketing
focus by our independent distributors, many of which carry extensive brand
portfolios.
Additionally, the wine industry has experienced significant consolidation. Many
of our competitors have greater financial, technical, marketing and public
relations resources than we do. Our sales may be harmed to the extent we are not
able to compete successfully against such wine or alternative beverage
producers.
Our Business is Seasonal
Our business is subject to seasonal as well as quarterly fluctuations in
revenues and operating results. Our sales volume tends to increase during the
summer months and the holiday season and decrease after the holiday season. As a
result, our sales and earnings are typically highest during the fourth calendar
quarter and lowest in the first calendar quarter. Seasonal factors also affect
our level of borrowing. For example, our borrowing levels typically peak during
the winter when we have to pay for harvest costs and may have to make
contractual payments to grape growers. These and other factors may cause
fluctuations in the market price of our common stock.
12
The Chalone Wine Group, Ltd.
Item 3. Disclosures About Market Risk (Continued)
Bad Weather, Pests and Plant Diseases Could Harm Our Business
Winemaking and grape growing are subject to a variety of agricultural risks.
Various diseases and pests and extreme weather conditions can materially and
adversely affect the quality and quantity of grapes available to us. This could
reduce the quality or amount of wine we produce. A deterioration in the quality
of our wines could harm our brand name, and a decrease in our production could
reduce our sales and profits. Future government restrictions regarding the use
of certain materials used in grape growing may increase vineyard costs and/or
reduce production.
Grape growing requires adequate water supplies. We generally supply our
vineyards' water needs through wells and reservoirs located on our properties.
We believe that we have adequate water supplies to meet the needs of all of our
vineyards. However, a substantial reduction in water supplies could result in
material losses of grape crops and vines.
Many California vineyards, including vineyards in Northern California, have been
infested with Phylloxera, a root louse that renders a vine economically
unproductive within a few years after infestation. The current strain of
Phylloxera primarily affects vines of a certain type. Our vineyard properties
are primarily planted to rootstocks believed to be resistant to Phylloxera.
However, we cannot be certain that our existing vineyards or the rootstocks we
are now using in our planting and replanting programs will not in the future
become susceptible to current or new strains of Phylloxera, plant insects or
diseases, any of which could harm our business.
The weather phenomenon commonly referred to as "El Nino" produced heavy rains
and cooler weather during the Spring of 1998, which resulted in colder and
wetter soils than are typical during California's grape growing season.
Consequently, the 1998 harvest was postponed by approximately four to six weeks
- - depending on the geographical location and varietals. The unusual weather
conditions resulting from El Nino impacted quantity and quality of the Company's
1998 estate harvest. The size of the Company's most significant crops ranged
from normal-sized yields to 50% of normal yields (depending on the varietal and
the particular estate).
Despite the foregoing reduction in the yield of certain crops, the harvested
estate crops, in combination with contracted grape purchases (most of which are
tonnage-based), are expected to permit the Company to meet originally
anticipated sales-projections for its 1998 vintage Chardonnay, Cabernet and
Merlot varietals which, together, have historically comprised between 80% and
85% of its aggregate annual production.
We May Not Be Able to Grow or Acquire Enough Quality Grapes for Our Wines
The adequacy of our grape supply is influenced by consumer demand for wine in
relation to industry-wide production levels. While we believe that we can secure
sufficient supplies of grapes from a combination of our own production and from
grape supply contracts with independent growers, we cannot be certain that grape
supply shortages will not occur. A shortage in the supply of wine grapes could
result in an increase in the price of some or all grape varieties and a
corresponding increase in our wine production costs.
Industry trends point to rapid plantings of new vineyards and replanting of old
vineyards to greater densities, with the expected result of significantly
increasing the supply of premium wine grapes and the amount of wine which will
be produced in the future. This expected increase in grape production could
result in an excess of supply over demand and force wineries to reduce, or not
increase, prices.
We Depend on Third Parties to Sell Our Wine
We sell our products primarily through independent distributors and brokers for
resale to retail outlets, restaurants, hotels and private clubs across the
United States and in some overseas markets. To a lesser degree, we rely on
direct sales from our wineries, our wine library and direct mail. Sales to our
largest distributor and to our nineteen largest distributors combined,
represented approximately 4% and 39%, respectively, of our net revenues during
the three months ended June 30, 1999. Sales to our nineteen largest distributors
are expected to continue to represent a substantial portion of our net revenues
in the future. We use a broker in order to sell our wines within California.
Such sales represent 32% of our net revenues during the three month period ended
June 30, 1999. The laws and regulations of several states prohibit changes of
distributors, except under certain limited circumstances, making it difficult to
terminate a distributor without reasonable cause, as defined by applicable
statutes. The resulting difficulty or inability to replace distributors, poor
performance of our major distributors or our inability to collect accounts
receivable from our major distributors could harm our business.
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The Chalone Wine Group, Ltd.
Item 3. Disclosures About Market Risk (Continued)
New Regulations or Increased Regulatory Costs Could Harm Our Business
The wine industry is subject to extensive regulation by the Federal Bureau of
Alcohol, Tobacco and Firearms and various foreign agencies, state liquor
authorities and local authorities. These regulations and laws dictate such
matters as licensing requirements, trade and pricing practices, permitted
distribution channels, permitted and required labeling, advertising and
relations with wholesalers and retailers. Any expansion of our existing
facilities or development of new vineyards or wineries may be limited by present
and future zoning ordinances, environmental restrictions and other legal
requirements. In addition, new regulations or requirements or increases in
excise taxes, income taxes, property and sales taxes or international tariffs,
could reduce our profits. Future legal or regulatory challenges to the industry,
either individually or in the aggregate, could harm our business.
We Will Need More Working Capital to Grow
The premium wine industry is a capital-intensive business which requires
substantial capital expenditures to develop and acquire vineyards and to improve
or expand wine production. Further, the farming of vineyards and acquisition of
grapes and bulk wine require substantial amounts of working capital. We project
the need for significant capital spending and increased working capital
requirements over the next several years, which must be financed by cash from
operations or additional borrowings or other financing.
Adverse Public Opinion About Alcohol May Harm Our Business
A number of research studies suggest that various health benefits may result
from the moderate consumption of alcohol, but other studies suggest that alcohol
consumption does not have any health benefits and may in fact increase the risk
of stroke, cancer and other illnesses. If an unfavorable report on alcohol
consumption gains general support, it could harm the wine industry and our
business.
We Use Pesticides and Other Hazardous Substances in the Operation of Our
Business
We use pesticides and other hazardous substances in the operation of our
business. If hazardous substances are discovered on, or emanate from, any of our
properties, and their release presents a threat of harm to public health or the
environment, we may be held strictly liable for the cost of remediation. Payment
of such costs could have a material adverse effect on our business, financial
condition and results of operations. We maintain insurance against these kinds
of risks, and others, under various insurance policies. However, our insurance
may not be adequate or may not continue to be available at a price or on terms
that are satisfactory to us.
Contamination of Our Wines Would Harm Our Business
We also are subject to certain hazards and liability risks, such as potential
contamination, through tampering or otherwise, of ingredients or products.
Contamination of any of our wines could result in the need for a product recall
which could significantly damage our reputation for product quality, which we
believe is one of our principle competitive advantages. We maintain insurance
against these kinds of risks, and others, under various general liability and
product liability insurance policies. However, our insurance may not be adequate
or may not continue to be available at a price or on terms that are satisfactory
to us.
The Loss of Key Employees Would Damage Our Reputation and Business
Our success depends to some degree upon the continued services of a number of
key employees. Although some key employees are under employment contracts with
us for specific terms, the loss of the services of one or more of our key
employees could harm our business and our reputation, particularly if one or
more of our key employees resigns to join a competitor or to form a competing
company. In such an event, despite provisions in our employment contracts which
are designed to prevent the unauthorized disclosure or use of our trade secrets,
practices or procedures by such personnel under these circumstances, we cannot
be certain that we would be able to enforce these provisions or prevent such
disclosures.
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The Chalone Wine Group, Ltd.
Item 3. Disclosures About Market Risk (Continued)
Shifts in Foreign Exchange Rates or the Imposition of Adverse Trade Regulations
Could Harm Our Business
We conduct some of our import and export activity for wine, packaging supplies
and various wine production needs in foreign currencies. We purchase foreign
currency on the spot market on an as-needed basis and engage in limited
financial hedging activities to offset the risk of exchange rate fluctuations.
There is a risk that a shift in certain foreign exchange rates or the imposition
of unforeseen and adverse trade regulations could adversely impact the costs of
these items and have an adverse impact on our operating results.
In addition, the imposition of unforeseen and adverse trade regulations could
have an adverse effect on our imported wine operations. We do not believe that
our foreign exchange risk and international operations exposure is material at
this time, but the volume of international transactions is increasing and may
increase these risks in the future.
Infringement of Our Trademarks May Damage Our Brand Names or Our Business
Our wines are branded consumer products, and we distinguish our wines from our
competitors by strong and vigilant enforcement of our trademarks. There can be
no assurance that competitors will refrain from using trademarks, tradenames or
trade dress which dilute our intellectual property rights, and any such actions
may require us to become involved in litigation to protect these rights.
Litigation of this nature can be very expensive and tends to divert management's
time and attention.
Our Acquisition of Staton Hills Winery and Potential Future Acquisitions Involve
a Number of Risks
Our acquisition of Staton Hills Winery (and potential future acquisitions)
involves risks which include assimilating Staton Hills into our Company;
integrating, retaining and motivating key Staton Hills personnel; integrating
and managing geographically-dispersed operations because Staton Hills is in
Washington State and our Company is headquartered in California; integrating the
technology and infrastructures of the two companies; risks inherent in the
production of wine in, and marketing of wine from, Washington State, and the
risks to our Company of the increased negative cash flow and increased operating
expenses arising from the acquisition of, and plans for, Staton Hills.
The integration of the operations, technology and personnel of our Company and
Staton Hills' is expected to be a complex, time consuming and expensive process
and may disrupt our business if not completed in a timely and efficient manner.
Staton Hills and Chalone must operate as a combined organization utilizing
common information and communications systems, operating procedures, financial
controls and human resources practices. We may encounter substantial
difficulties, costs and delays, including potential incompatibility of our
business cultures, perceived adverse changes in our business plans, potential
conflicts in our supplier and customer relationships and the loss of key
employees and diversion of the attention of management from other ongoing
business initiatives.
The Market Price of Our Common Stock Fluctuates
All of the foregoing risks, among others not known or mentioned in this report,
may have a significant effect on the market price of our shares. Stock markets
have experienced extreme price and volume trading volatility in recent months
and years. This volatility has had a substantial effect on the market prices of
securities of many companies for reasons frequently unrelated or
disproportionate to the specific company's operating performance. These broad
market fluctuations may reduce the market price of our shares.
15
The Chalone Wine Group, Ltd.
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit Number
--------------
27 Financial Data Schedule
(b) Reports.
One report to shareholders, filed on June 30, 1999 with the
Securities and Exchange Commission on Form 8-K, with respect
to the acquisition of Staton Hills Winery.
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.
Dated: August 13, 1999 The Chalone Wine Group, Ltd.
- ---------------------- ----------------------------
(Registrant)
/s/ Thomas B. Selfridge
-------------------------------------------
Thomas B. Selfridge
President and Chief Executive Officer
Dated: August 13, 1999 /s/ Francois P. Muse
- ---------------------- -------------------------------------------
Francois P. Muse
Chief Financial Officer and Treasurer
16