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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, 2000
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 11, 2000
was 10,228,304.
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THE CHALONE WINE GROUP, LTD.
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PAGE
Consolidated Balance Sheets as of June 30, 2000, and
March 31, 2000. 3
Consolidated Statements of Income for the three-month
periods ended June 30, 2000 and 1999. 4
Consolidated Statements of Cash Flows for the three-month
periods ended June 30, 2000 and 1999. 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 30, March 31,
2000 2000
(unaudited)
----------- ---------
Current assets:
Cash and equivalents $ 492 $ -
Accounts receivable, less allowance for doubtful
accounts of $150 and $129, respectively 9,256 9,836
Notes receivable-affiliate 168 119
Income tax receivable 943 1,178
Inventory 49,991 51,826
Prepaid expenses 148 579
Deferred income taxes 894 894
-------- --------
Total current assets 61,892 64,432
Investment in Chateau Duhart-Milon 8,749 9,146
Property, plant and equipment - net 66,187 64,134
Goodwill and trademrks - net of accumulated
amortization of $1,850 and $1,743, respectively 10,013 7,220
Other assets 476 733
-------- --------
Total assets $147,317 $145,665
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 5,028 $ 5,650
Revolving bank loan 29,274 27,017
Current maturities of long-term borrowings 2,266 1,784
-------- --------
Total current liabilities 36,568 34,451
Long-term borrowings, less current maturities 30,188 31,041
Deferred income taxes 1,743 1,743
-------- -----------
Total liabilities 68,499 67,235
Minority interest 4,614 4,758
Shareholders' equity:
Common stock - authorized 15,000,000 shares no par value;
issued and outstanding: 10,226,306 and 10,224,521 shares,
respectively 61,378 61,377
Retained earnings 16,399 15,851
Accumulated other comprehensive loss (3,573) (3,556)
-------- --------
Total shareholders' equity 74,204 73,672
-------- --------
Total liabilities and shareholders' equity $147,317 $145,665
======== ========
The accompanying notes are an integral part
of the consolidated financial statements
3
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS, EXCEPT PER-SHARE DATA)
Three Months Ended
June 30,
----------------------------
2000 1999
------------ ---------------
Gross revenues $ 14,518 $ 10,828
Excise taxes (388) (259)
-------- --------
Net revenues 14,130 10,569
Cost of wines sold (8,718) (5,538)
-------- --------
Gross profit 5,412 5,031
Revenues from other operations, net 11 83
Selling, general and administrative expenses (3,668) (3,086)
-------- --------
Operating income 1,755 2,028
Interest expense (888) (493)
Equity in Chateau Duhart-Milon 318 337
Minority interests (256) (304)
-------- --------
Income before income taxes 929 1,568
Income taxes (381) (642)
-------- --------
Net income $ 548 $ 926
======== ========
Net income per common share
Earnings per share - basic $ 0.05 $ 0.10
Earnings per share -diluted $ 0.05 $ 0.10
Weighted average number of shares outstanding:
Basic 10,226 9,221
Diluted 10,226 9,341
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,
---------------------------
2000 1999
------ ------
Cash flows from operating activities:
Net income $ 548 $ 926
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 973 674
Equity in net income of Chateau Duhart-Milon (318) (337)
Increase in minority interest 256 304
Loss on sale of equipment - 4
Changes in:
Accounts and other receivables 766 (6)
Inventory 2,435 (925)
Prepaid expenses and other assets 689 (171)
Accounts payable and accrued liabilities (622) 2,812
------- -------
Net cash provided by operating activities 4,727 3,281
------- -------
Cash flows from investing activities:
Capital expenditures (2,910) (2,069)
Property and Business Acquisitions (3,509) (6,127)
Proceeds from disposal of property and equipment - 5
Distributions from Duhart-Milon 698 738
------- -------
Net cash used in investing activities (5,721) (7,453)
------- -------
Cash flows from financing activities:
Borrowings on revolving bank loan - net 2,257 7,280
Distributions to minority interests (400) (300)
Repayment of long-term debt (371) (2,337)
Proceeds from issuance of common stock - 22
------- -------
Net cash provided by financing activities 1,486 4,665
------- -------
Net increase in cash and equivalents 492 493
Cash and equivalents at beginning of period - 1,670
------- -------
Cash and equivalents at end of period $ 492 $ 2,163
======= =======
Other cash flow information:
Interest paid $ 655 $ 776
Income taxes paid 81 1,109
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 unaudited consolidated financial statements of the Chalone Wine Group,
Ltd. ("the Company") are prepared in conformity with accounting principals
generally accepted in the United States of America, and the rules and
regulations of the Securities and Exchange Commission. In the opinion of
management, all adjustments necessary for a fair presentation of the financial
position and results of operations for the periods presented have been included.
All such adjustments are of a normal recurring nature. These unaudited
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements included in the Company's Form 10-K for the
year ended March 31, 2000.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported financial
statement amounts and related disclosures at the date of the financial
statements. Actual results could differ from these estimates.
RECLASSIFICATIONS
Certain prior-period amounts have been reclassified in order to conform
with the current period presentation.
NOTE 3 - COMPREHENSIVE INCOME
Comprehensive income includes foreign currency translation gains and
losses. The following is a reconciliation of net income and comprehensive income
(IN THOUSANDS):
Three months ended
June 30,
--------------------
2000 1999
-------- --------
Net income $ 548 $ 926
Foreign currency translation loss (17) (462)
-------- --------
Comprehensive income $ 531 $ 464
======== ========
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 EPS for the
Company is due to the dilutive effect of stock options and stock warrants as
shown below. This effect is calculated using the treasury stock method.
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)
Diluted EPS
------------
Basic EPS Income
------------ Effect of dilutive available to
Income securities common
available to --------------------- shareholders
common Stock and assumed
shareholders Warrants options conversion
------------ -------- -------- ------------
Three months ended June 30, 2000:
Income $ 548 - - $ 548
Shares 10,226 - - 10,226
------- -------
EPS $ 0.05 $ 0.05
======= =======
Three months ended June 30, 1999:
Income $ 926 - - $ 926
Shares 9,221 120 - 9,341
------- -------
EPS $ 0.10 $ 0.10
======= =======
NOTE 5 - ACQUISITION OF JADE MOUNTAIN BRAND NAME RIGHTS AND INVENTORY
On April 4, 2000, the Company purchased exclusive brand name rights and
inventory of Jade Mountain Winery, a vineyard located in Napa County, California
producing Rhone varietal wines. The acquisition price of $3.5 million, which was
financed with the Company's available revolving credit facility, was allocated
to an intangible asset in the amount of $2.9 million representing the brand name
rights with the remaining $600,000 allocated to inventory based on estimated
fair values. The brand name rights will be amortized over 20 years. In addition,
the Company has entered into a 10 year contract with the owner of Jade Mountain
to purchase at market price Syrah, Viognier, Grenache and Merlot grapes produced
from a related vineyard.
NOTE 6 - SUBSEQUENT EVENT
On July 14, 2000, the Company sold the 10,000 square foot Hewitt House
and four surrounding landscaped acres located in Napa Valley's Rutherford Bench
area for $7,740,000 resulting in a gain of approximately $800,000. The property
was originally acquired in the Company's fiscal year 2000 as part of its
acquisition of the Hewitt Ranch.
7
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," "estimates,"
"intends," "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., 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
borrowings associated with present and projected capital projects; (iv) the
price and availability in the marketplace of grapes meeting the Company's
quality standards and other requirements; (v) the effect of weather,
agricultural pests and disease and other natural forces on growing conditions
and, in turn, the quality and quantity of grapes produced or purchased by the
Company; (vi) regulatory changes which might restrict or hinder the sale and/or
distribution of alcoholic beverages and (vii) the risks associated with the
assimilation of acquisitions. 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, 2000.
DESCRIPTION OF THE BUSINESS
The Company produces, markets and sells super-premium, ultra-premium, and
luxury-priced white and red varietal table wines, primarily Chardonnay, Pinot
Noir, Cabernet Sauvignon, Merlot, Syrah and Sauvignon Blanc. The Company owns
and operates wineries in various counties of California and Washington State.
The Company's wines are made partially from grapes grown at the Carmenet Winery,
Edna Valley Vineyard, Chalone Vineyard, Company-owned vineyards adjacent to the
Acacia Winery in California and the Canoe Ridge Vineyard in Washington State, as
well as from purchased grapes. The wines are primarily sold under the labels
"Chalone Vineyard(R)," "Edna Valley Vineyard(R)," "Carmenet(R)," "Acacia(TM),"
"Canoe Ridge Vineyard(R)," "Jade Mountain(R)," "Sagelands Winery(R)," and
"Echelon(TM)".
In France, the Company owns a minority interest in fourth-growth Bordeaux
estate Chateau Duhart-Milon ("Duhart-Milon") in partnership with Les Domaines
Barons de Rothschild (Lafite) ("DBR"). The vineyards of Duhart-Milon are located
adjacent to the world-renowned Chateau Lafite-Rothchild in the town of Pauillac.
8
THE CHALONE WINE GROUP, LTD.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS - FIRST QUARTER OF FISCAL 2001 COMPARED TO FIRST QUARTER
OF FISCAL 2000
The following table represents financial data as a percentage of net revenues
for the indicated periods:
Three months ended Percent
June 30, Change
----------------------------- ---------------
2000 1999 2000 vs 1999
------------- ------------ ---------------
Net revenues 100.0 % 100.0 % 33.7 %
Cost of sales (61.7)% (52.4)% 57.4 %
------------- ------------
Gross profit 38.3 % 47.6 % 7.6 %
Other revenues from operations 0.1 % 0.8 % (86.7)%
Selling, general and admin. expenses (26.0)% (29.2)% 18.9 %
------------- ------------
Operating income 12.4 % 19.2 % (13.5)%
Interest Expense (6.3)% (4.7)% 80.1 %
Equity in Chateau Duhart-Milon 2.3 % 3.2 % (5.6)%
Minority interest (1.8)% (2.9)% (15.8)%
------------- ------------
Income before income taxes 6.6 % 14.8 % (40.8)%
Income taxes (2.7)% (6.1)% (40.7)%
------------- ------------
Net Income (loss) 3.9 % 8.7 % (40.8)%
============= ============
NET REVENUES
Net revenues increased by $3.6 million or 34% reflecting a 50% increase in case
sales offset by lower average revenue-per-case due to changes in product mix.
COST OF WINES SOLD
Cost of wines sold increased by $3.1 million or 57%, reflecting increased sales
volume and a shift in product mix sold to more wines with higher average costs
per case as a percentage of selling price.
GROSS PROFIT
As a result of the above factors gross profit as a percentage of sales decreased
from 47.6% to 38.3%.
REVENUE FROM OTHER OPERATIONS, NET
Revenue from other operations, net consists primarily of processing and other
revenue obtained from other wineries, net of related expenses, and net profit
from sales of bulk wine. This aspect of the Company's operation is not
significant although 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 and quarter to quarter. Such
revenues decreased $72,000 to $11,000, which was entirely attributable to less
custom-bottling activities.
9
THE CHALONE WINE GROUP, LTD.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $582,000 or 19% primarily
as a result of (i) increased selling efforts normally associated with increased
sales volumes (ii) launching of the new Sagelands brand name and (iii) other new
promotional efforts.
OPERATING INCOME
Operating income decreased $273,000 or 13%, primarily due to the increases in
selling, general and administrative expenses as discussed above partially offset
by increased gross profit.
INTEREST EXPENSE
Interest expense increased $395,000 primarily due to higher average outstanding
borrowings which are a result of (i) the Sagelands Winery acquisition which
occurred in June, 1999; (ii) the acquisition of the Hewitt Ranch and Suscol
Ranch properties that occurred during the fourth quarter of the 2000 fiscal
year; (iii) the Jade Mountain brand-name acquisition that occurred in April,
2000 and (iv) continuing capital expenditures related to winery-expansion over
the past two years.
EQUITY IN NET INCOME OF DUHART-MILON
The Company's 23.5% equity interest in the net income of Chateau Duhart-Milon
("Duhart-Milon") for the three months ended June 30, 2000 and June 30, 1999, was
$318,000 and $337,000, respectively. These results are primarily driven by sales
of the 1997 vintage of Duhart-Milon, which are consistent with sales of the 1996
vintage reflected in the prior-year results.
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 periodic
visits to Duhart-Milon's offices and productions facilities.
Since the investment in Duhart-Milon is a long-term investment denominated in a
foreign currency, the Company records the gain or loss for currency translation
in other comprehensive income or loss, which is part of shareholders' equity.
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,
2000 and 1999 consisted of the following (IN THOUSANDS):
Three months ended
June 30,
Minority ------------------
Venture Minority Owner Percent 2000 1999
- ------------ ------------------ -------- ------ ------
Edna Valley Vineyard Paragon Vineyard Co., Inc. 50.00% $ 215 $ 205
Canoe Ridge Vineyard, LLC Various 49.50% 41 99
------ ------
$ 256 $ 304
====== ======
The minority interest in the net income of EVV and CRV decreased $48,000 or
(16%) during the three months ended June 30, 2000 when compared to the same
period last year as a result of decreased sales volumes.
10
THE CHALONE WINE GORUP, LTD.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
NET INCOME
Net income decreased $378,000, a decrease of 41% primarily as a result of higher
interest expense and selling, general and administrative expenses, which were
partially offset by higher gross profits.
LIQUIDITY AND CAPITAL RESOURCES
Working capital decreased by $4.7 million to $25.3 million for the three months
ended June 30, 2000 from $30.0 million at March 31, 2000, primarily due to
increased borrowing under the Company's revolving bank loan agreement and lower
inventories resulting from first quarter sales. The Company's cash balance
increased to $.4 million since March 31, 2000 as cash from operations and
borrowings exceeded cash needed for capital expenditures and investment in
vineyards.
The Company has historically financed its growth through borrowings and cash
flow from operations. During the three months ended June 30, 2000, the Company
used these sources of financing to fund a $2.9 million increase in property,
plant and equipment and a $3.5 million acquisition of Jade Mountain's brand name
rights and inventory.
On March 31, 1999, the Company entered into a credit agreement with Cooperative
Centrale Raiffeisen-Borenleenbank B.A., "Rabobank Nederland," New York branch
("Rabobank"). The Rabobank credit facility provides for a total of $70 million
of unsecured financing, consisting of a seven-year, $30 million term loan and a
two-year, $40 million revolving loan facility. The Company is currently
negotiating a private placement of debt which would restructure a portion of its
Rabobank debt.
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 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 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 are highest
during 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.
OUR PROFITS DEPEND LARGELY ON SALES IN CERTAIN STATES AND ON SALES OF
CERTAIN VARIETALS
In the three months ended June 30, 2000, approximately 71% 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 89% of our consolidated net revenues in the three months
ended June 30, 2000 were concentrated in our top four selling varietal wines.
Specifically, sales of Chardonnay, Pinot Noir, Cabernet Sauvignon and Merlot
accounted for 47%, 13%, 15% and 14% of our net revenues, respectively.
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.
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.
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 either have, or we are currently planning to insure, 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.
It is also possible that the vineyards could be infested by new strains of
Phylloxera, insects, fungi, viruses or similar perils. For example, a new strain
of the sharpshooter (glassy winged), a flying insect that is believed to carry
Pierces' Disease and can kill vines with which it comes into contact, recently
was discovered in Southern California and is believed to be migrating north.
The weather phenomenon commonly referred to as "El Nino" produced heavy
rains and cooler weather during the Spring of 1999 and 1998, which resulted in
colder and wetter soils than are typical during California's grape growing
season. Consequently, the 1999 and 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 1999 and 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.
Current trends in the domestic and foreign wine industry point to rapid
plantings of new vineyards and replanting of old vineyards to greater densities,
with the expected result of significantly increasing the worldwide 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.
13
THE CHALONE WINE GROUP, LTD.
ITEM 3. DISCLOSURES ABOUT MARKET RISK (CONTINUED)
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, 2000. 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 single broker in order to sell our wines within
California. Such sales represent 33% of our net revenues during the three month
period ended June 30, 2000. 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.
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 are subject to certain hazards and product 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.
14
THE CHALONE WINE GROUP, LTD.
ITEM 3. DISCLOSURES ABOUT MARKET RISK (CONTINUED)
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, the Company
cannot be certain that it would be able to enforce these provisions or prevent
such disclosures.
SHIFTS IN FOREIGN EXCHANGE RATES OR THE IMPOSITION OF ADVERSE TRADE REGULA-
TIONS COULD HARM OUR BUSINESS
We conduct some of our import and export activity for wine and packaging
supplies 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. Export sales
accounted for approximately 6% of total consolidated revenue for the three
months ended June 30, 2000 and 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 enforcement of our trademarks. There can be no assurance that
competitors will refrain from infringing our marks or 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 ACQUISITIONS AND POTENTIAL FUTURE ACQUISITIONS INVOLVE A NUMBER OF
RISKS
Our acquisition of Staton Hills Winery (renamed Sagelands Winery) and the
possible construction of a new winery on the Suscol Ranch property we recently
acquired (and potential future acquisitions) involve risks which include
assimilating these operations into our Company; integrating, retaining and
motivating key 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
disparate entities; risks inherent in the production of wine in, and marketing
of wine from, Washington State; and the replanting of existing vineyards from
white wine grapes to red wine grapes.
We relied on debt financing to purchase Hewitt Ranch, Suscol Ranch, Staton
Hills Winery, the Jade Mountain brand and other vineyard land and related assets
during the fiscal year ended March 31, 2000. Consequently our debt-to-equity
ratio is high in relation to our historical standards. The interest costs
associated with this debt will increase our operating expenses and the risk of
negative cash flow.
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.
None
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 14, 2000 THE CHALONE WINE GROUP, LTD.
- ---------------------- ----------------------------
(Registrant)
/s/ THOMAS B. SELFRIDGE
--------------------------------------------
Thomas B. Selfridge
President and Chief Executive Officer
Dated: August 14, 2000 /s/ PAUL R. OGORZELEC
- ---------------------- --------------------------------------------
Paul R. Ogorzelec
Principal Financial and Accounting Officer
16