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 September 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 November 8,
2000 was 10,240,345.
The Chalone Wine Group, Ltd.
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PAGE
Consolidated Balance Sheets as of September 30, 2000, and March 31, 2000. 3
Consolidated Statements of Income for the three-month and six-month periods ended
September 30, 2000 and 1999. 4
Consolidated Statements of Cash Flows for the three month and six-month periods ended
September 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 7
ITEM 3. DISCLOSURES ABOUT MARKET RISK 11
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 15
The Chalone Wine Group, Ltd.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
September 30, March 31,
2000 2000
------------------- -------------------
Current assets:
Cash and equivalents $ 40 $ -
Accounts receivable, less allowance for doubtful
accounts of $162 and $129, respectively 10,256 9,836
Notes receivable - affiliate 568 119
Income tax receivable 847 1,178
Inventory 49,065 51,826
Prepaid expenses 201 579
Deferred income taxes 894 894
------------------- -------------------
Total current assets 61,871 64,432
Investment in Chateau Duhart-Milon 8,312 9,146
Property, plant and equipment - net 63,367 64,134
Goodwill and trademarks - net of accumulated
amortization of $1,956 and $1,743, respectively 9,906 7,220
Other assets 600 733
------------------- -------------------
Total assets $ 144,056 $ 145,665
=================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 5,723 $ 5,650
Revolving bank loan 5,910 27,017
Current maturities of long-term borrowings 1,548 1,784
------------------- -------------------
Total current liabilities 13,181 34,451
Long-term borrowings, less current maturities 51,016 31,041
Deferred income taxes 1,743 1,743
Total liabilities 65,940 67,235
------------------- -------------------
Minority interest 4,460 4,758
Shareholders' equity:
Common stock - authorized 15,000,000 shares no par value;
issued and outstanding: 10,240,345 and 10,224,521 shares, 61,376 61,377
respectively
Retained earnings 16,639 15,851
Cumulative foreign currency translation adjustment (4,359) (3,556)
------------------- -------------------
Total shareholders' equity 73,656 73,672
------------------- -------------------
Total liabilities and shareholders' equity $ 144,056 $ 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 Six Months Ended
September 30, September 30,
------------------------------- -------------------------------
2000 1999 2000 1999
------------ ------------- ------------ ------------
Gross revenues $ 14,211 $ 13,177 $ 28,729 $ 24,005
Excise taxes (374) (330) (762) (589)
------------ ------------- ------------ ------------
Net revenues 13,837 12,847 27,967 23,416
Cost of wines sold (9,522) (7,028) (18,240) (12,566)
------------ ------------- ------------ ------------
Gross profit 4,315 5,819 9,727 10,850
Revenues from other operations, net 27 13 38 53
Selling, general and administrative expenses (4,094) (3,381) (7,762) (6,424)
------------ ------------- ------------ ------------
Operating income 248 2,451 2,003 4,479
Interest expense (1,059) (599) (1,947) (1,092)
Equity in Chateau Duhart-Milon 215 193 533 530
Other Income 848 848
Minority interests 154 (325) (102) (629)
------------ ------------- ------------ ------------
Income before income taxes 406 1,720 1,335 3,288
Income taxes (166) (706) (547) (1,348)
------------ ------------- ------------ ------------
Net income $ 240 $ 1,014 $ 788 $ 1,940
============ ============= ============ ============
Net income per common share
Earnings per share - basic $ 0.02 $ 0.11 $ 0.08 $ 0.21
Earnings per share - diluted $ 0.02 $ 0.11 $ 0.08 $ 0.21
Weighted average number of shares outstanding:
Basic 9,365 10,229 9,293 10,233
Diluted 9,501 10,229 9,421 10,233
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 Six months ended
September 30, September 30,
-------------------------- ----------------------
2000 1999 2000 1999
----------- ------------- ----------------------
Cash flows from operating activities:
Net income $ 240 $1,014 $ 788 $1,940
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 976 665 1,959 1,339
Equity in net income of Chateau Duhart-Milon (215) (193) (533) (530)
Increase (Decrease) in minority interest (154) 325 102 629
Loss(Gain) on sale of property and equipment (837) (5) (837) (1)
Changes in:
Accounts and other receivable (1,306) (1,923) (540) (1,929)
Inventory 926 (462) 3,361 (1,387)
Prepaid expenses and other assets (311) 61 511 (110)
Accounts payable and accrued liabilities 695 (25) 73 2,787
----------- ------------- ---------- -----------
Net cash provided by operating activities 14 (543) 4,884 2,738
----------- ------------- ---------- -----------
Cash flows from investing activities:
Capital expenditures (4,631) (3,565) (7,541) (5,634)
Property and business acquisitions - - (3,518) (6,127)
Proceeds from disposal of property and equipment (net) 7,419 60 7,419 65
Distributions from Duhart-Milon - - 564 738
----------- ------------- ---------- -----------
Net cash used in investing activities 2,788 (3,505) (3,076) (10,958)
----------- ------------- ---------- -----------
Cash flows from financing activities:
Borrowings on revolving bank loan - net (23,364) 1,942 (21,107) 9,222
Distributions to minority interests - - (400) (300)
Proceeds from private placement financing 30,000 - 30,000 -
Repayment of long-term debt (9,890) (23) (10,261) (2,360)
Proceeds from issuance of common stock - (24) - (2)
----------- ------------- ---------- -----------
Net cash provided by financing activities (3,254) 1,895 (1,768) 6,560
----------- ------------- ---------- -----------
Net increase (decrease) in cash and equivalents (452) (2,153) 40 (1,660)
Cash and equivalents at beginning of period 492 2,163 - 1,670
----------- ------------- ---------- -----------
Cash and equivalents at end of period $ 40 $ 10 $ 40 $ 10
=========== ============= ========== ===========
Other cash flow information:
Interest paid $ 695 $ 481 $ 1,867 $1,223
Income taxes paid 58 57 139 1,627
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 for interim financial
information, 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 (loss) includes unrealized foreign currency gains and
losses related to the Company's investment in Chateau Duhart-Milon. The
following is a reconciliation of net income and comprehensive income (loss) (IN
THOUSANDS):
Three months ended Six months ended
September 30, September 30,
---------------------- ----------------------
2000 1999 2000 1999
----------- ---------- ----------- ----------
Net income $ 240 $1,014 $ 788 $1,940
Foreign currency translation gain (loss) (786) 300 (803) (162)
----------- ---------- ----------- ----------
Comprehensive income $ (546) $1,314 $ (15) $1,778
=========== ========== =========== ==========
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 effect of options and warrants was insignificant causing basic
and diluted earnings per share to be the same. This effect is calculated using
the treasury stock method.
6
The Chalone Wine Group, LTD.
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 long-term contract with the owner of Jade
Mountain to purchase Syrah, Viognier, Grenache and Merlot grapes produced from a
related vineyard.
NOTE 6 - BORROWING ARRANGEMENTS
On September 15, 2000 the Company refinanced certain borrowings through the
issuance of $30 million of Senior Unsecured Notes (the "Notes"). Proceeds from
the Notes were used to repay $20 million of the Company's Revolving Bank Loan
and $10 million of a pre-existing $30 million Bank Term Loan. Interest on the
Notes is payable quarterly at rates ranging from 8.75% to 8.90% and principal
repayments are scheduled beginning September 15, 2004 through maturity on
September 15, 2010. The Notes have restrictive covenants that include
requirements to maintain certain financial ratios and restrictions on additional
indebtedness, asset sales, investments, and payment of dividends. In connection
with this refinancing, available borrowings under the Company's Revolving Bank
Loan were reduced from $40 million to $25 million, of which the Company had
borrowed $5.9 million as of September 30, 2000.
NOTE 7 - OTHER INCOME
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 $837,000 included in Other Income.
The property was originally acquired in the Company's fiscal year 2000 as part
of its acquisition of the Hewitt Ranch.
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 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.
7
The Chalone Wine Group, LTD.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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(TM) 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
Vineyards(R)," and "Echelon Vineyards(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.
RESULTS OF OPERATIONS - SECOND QUARTER OF FISCAL 2001 COMPARED TO SECOND QUARTER
OF FISCAL 2000
Three months ended Percent Six months ended Percent
September 30, Change September 30, Change
---------------------------------------- -------------------------- -----------
2000 1999 00 vs 99 2000 1999 00 vs 99
------------- ------------ ----------- ------------ ------------ -----------
Net revenues 100.0 % 100.0 % 7.7 % 100.0 % 100.0 % 19.4 %
Cost of sales (68.8)% (54.7)% 35.5 % (65.2)% (55.2)% 45.2 %
------------- ------------ --------------------------
Gross profit 31.2 % 45.3 % (25.8)% 34.8 % 44.8 % (10.4)%
Other revenues from operations 0.2 % 0.1 % - 0.1 % (0.1)% -
Selling, general and admin. expenses (29.6)% (26.3)% 21.1 % (27.8)% (25.8)% 20.8 %
------------- ------------ --------------------------
Operating income 1.8 % 19.1 % (89.9)% 7.1 % 18.9 % (55.3)%
Interest Expense (7.7)% (4.7)% 76.8 % (7.0)% (4.2)% 78.3 %
Equity in Chateau Duhart-Milon 1.6 % 1.5 % 11.4 % 1.9 % 2.7 % 0.6 %
Other Income 6.1 % 0.0 % - 3.0 % 0.0% -
Minority interest 1.1 % (2.5)% (147.4)% (0.4)% (2.9)% (83.8)%
------------- ------------ --------------------------
Income before income taxes 2.9 % 13.4 % (76.4)% 4.6 % 14.5 % (59.4)%
Income taxes (1.2)% (5.5)% (76.5)% (2.0)% (5.9)% (59.4)%
------------- ------------ --------------------------
Net Income (loss) 1.7 % 7.9 % (76.3)% 2.6 % 8.6 % (59.4)%
============= ============ ==========================
NET REVENUES
Net revenues for the three-month and six-month periods ended September 30, 2000
increased approximately 8% and 19%, respectively, over the comparable periods in
the prior year. These increases were due almost equally to increases in the
average revenue-per-case due to selected price increases and changes in product
mix, and increased sales volume.
GROSS PROFIT
Gross profit for the three and six months ended September 30, 2000, decreased by
approximately 26% and 10% respectively, over the comparable periods in the prior
year. For the quarters ended September 30, gross margin percentage decreased
from 45.3% in 1999 to 31.2% in 2000, while the gross margin percentage decreased
from 44.8% to 34.8%, respectively, for the six months ended September 30, 1999
and 2000. These gross margin decreases were primarily the direct result of
higher grape and bulk wine costs associated with 1998 and 1999 vintage wines.
8
The Chalone Wine Group, LTD.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The per acre grape yields for the 1998 and 1999 harvests from our own vineyards
were below normal levels, resulting in higher per unit wine costs. Growing costs
are relatively constant whether yields are high or low which causes per unit
costs in low yield years to be higher than normal. In addition in low yield
years, we buy more grapes from outside producers, which also increases our unit
costs. Usually, low yields are experienced region-wide causing other wine
producers to buy grapes on the open market, which drives grape costs up. If
adequate grapes cannot be purchased then additional bulk wine must be purchased
from other wineries. Purchases of bulk wine are significantly more expensive
than wine produced in the Company's facilities.
Wines are inventoried from six months to two years. As such the higher cost
wines from the 1998 and 1999 vintages were carried in inventory and did not
affect profit until they were sold. Some of the 1998 vintage was sold in the
last fiscal year, but most of last year's sales consisted mainly of lower cost
prior vintages. In fiscal year 2001 almost all wines sold have come from the
high cost 1998 and 1999 vintages, which has reduced the Company's margins. The
harvest for the 2000 vintage has been picked and is back to normal levels, which
will cause future per unit wine costs to return to normal levels and provide the
opportunity for margins to improve.
In the quarter ended September 30, 2000, the pre-tax profit of $0.4 million
would have been a pre-tax loss of $0.4 million except for the one time $0.8
million profit on the sale of the Hewitt house.
REVENUES FROM OTHER OPERATIONS
Revenues from other operations usually consist of processing and other revenue
from third-party wineries and 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 for the three months and six months
ended September 30, 2000, increased approximately $713,000 or 21%, and
$1,338,000 or 21%, respectively, over the comparable periods in the prior year.
These changes are primarily a result of (i) increased selling efforts (ii)
launching of the new Sagelands brand name and (iii) other new promotional
efforts.
OPERATING INCOME
Operating income for the three months and six months ended September 30, 2000,
decreased $2.2 million or 90% and $2.5 million or 55%, due to the decreases in
gross profits and the related increases in selling, general and administrative
expenses as discussed above.
INTEREST EXPENSE
Interest expense increased $460,000 and $855,000 for the three months and six
months ended September 30, 2000, primarily due to higher average outstanding
borrowings which are a result of (i) the Sagelands Winery acquisition which
occurred during the quarter ended June 30, 1999; (ii) the acquisition of the
Hewitt Ranch and Suscol Ranch properties that occurred during the fourth quarter
of fiscal year 2000; (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.
9
The Chalone Wine Group, LTD.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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 and six months ended September 30, 2000,
are $215,000 and $533,000 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 production 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.
OTHER INCOME
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 and realized a $837,000 gain, which has been included in other
income. The property was originally acquired in the Company's fiscal year 2000
as part of its acquisition of the Hewitt Ranch.
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 and six months
ended September 30, 2000 and 1999 consisted of the following (IN THOUSANDS):
Three months ended Six months ended
September 30, September 30,
Minority --------------------------- ---------------------------
Venture Minority Owner Percent 2000 1999 2000 1999
- ------------ ------------------ ---------- ------------ ------------- ------------ -------------
Edna Valley Vineyard Paragon Vineyard Co., Inc. 50.00% $ (183) $ 257 $ 32 $ 462
Canoe Ridge Vineyard, LLC Various 49.50% 29 68 70 167
------------ ------------- ------------ -------------
$ (154) $ 325 $ 102 $ 629
============ ============= ============ =============
The decrease in minority interest of $480,000 or 147% and $528,000 or 84% for
each of the periods ended September 30, 2000, when compared to the same periods
last year, are attributable to increased grape and other production costs.
NET INCOME
Net income for the three months and six months ended September 30, 2000, was
$240,000 and $788,000 respectively, reflecting decreases of 76% and 59% over the
comparable periods in the prior year. These decreases are primarily due to
decreased gross profits and higher selling, general and administrative expenses
and financing costs partially offset by the sale of the Hewitt House.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased approximately $20 million during the six months ended
September 30, 2000 primarily as a result of the Company's refinancing of certain
borrowings through the issuance of $30 million of Senior Unsecured Notes (the
"Notes") which are scheduled for repayment through September 2010. The Company
used the proceeds from the Notes to repay $20 million of Revolving Bank Loan
borrowings and $10 million of a pre-existing $30 million Bank Term Loan. In
connection with this refinancing, available borrowings under the Revolving Bank
Loan were reduced from $40 million to $25 million, of which the Company had
borrowed $5.9 million as of September 30, 2000.
Selling the Hewitt house contributed over $7 million to working capital.
10
The Chalone Wine Group, LTD.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company has historically financed its growth through increased borrowings
and cash flow from operations. During the six months ended September 30, 2000,
the Company's primary uses of its capital has been to purchase the Jade Mountain
Brand name and continued capital projects at all facilities.
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.
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 six months ended September 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 six months ended
September 30, 2000 were concentrated in our top four selling varietal wines.
Specifically, sales of Chardonnay, Pinot Noir, Cabernet Sauvignon and Merlot
accounted for 51%, 9%, 14% and 15% of our net revenues, respectively.
11
The Chalone Wine Group, LTD.
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.
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 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.
Weather fluctuations in both rain levels and seasonal temperatures can
inpact the quality and quantity of grapes available and can result in lower
production volumes and higher costs.
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.
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The Chalone Wine Group, LTD.
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 38%, respectively, of our net revenues during
the six months ended September 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 34% of our net revenues during the six
month period ended September 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.
13
The Chalone Wine Group, LTD.
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.
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
REGULATIONS 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 5% of total consolidated revenue for the six months
ended September 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 have relied on debt financing to purchase Hewitt Ranch, Suscol Ranch,
Staton Hills Winery, the Jade Mountain brand and other vineyard land and related
assets. 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.
14
The Chalone Wine Group, LTD.
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.
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: NOVEMBER 14, 2000 THE CHALONE WINE GROUP, LTD.
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(Registrant)
/S/ THOMAS B. SELFRIDGE
----------------------------------------
Thomas B. Selfridge
President and Chief Executive Officer
DATED: NOVEMBER 14, 2000 /S/ THOMAS B. SELFRIDGE
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Thomas B. Selfridge
Acting Principal Financial and Accounting Officer