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 December 31, 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 January 30,
2001 was 10,247,241.
The Chalone Wine Group, Ltd.
PART I. - FINANCIAL INFORMATION
PAGE
ITEM 1. FINANCIAL STATEMENTS
Unaudited Consolidated Balance Sheets as of December 31, 2000,
and March 31, 2000. 3
Unaudited Consolidated Statements of Income for the three-month
and nine-month periods ended December 31, 2000 and 1999. 4
Unaudited Consolidated Statements of Cash Flows for the
three-month and nine-month periods ended December 31, 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
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
December 31, March 31,
2000 2000
------------------ ---------
Current assets
Accounts receivable, less allowance for doubtful
accounts of $376 and $129, respectively $ 12,339 $ 9,836
Notes receivable - affiliate 145 119
Income tax receivable 383 1,178
Inventory 64,202 51,826
Prepaid expenses 285 579
Deferred income taxes 894 894
--------- ---------
Total current assets 78,248 64,432
Investment in Chateau Duhart-Milon 9,127 9,146
Property, plant and equipment - net 63,261 64,134
Goodwill and trademarks - net of accumulated
amortization of $2,063 and $1,743, respectively 9,799 7,220
Other assets 746 733
--------- ---------
Total assets $ 161,181 $ 145,665
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued liabilities $ 14,433 $ 5,650
Revolving bank loan 12,960 27,017
Current maturities of long-term borrowings 2,050 1,784
--------- ---------
Total current liabilities 29,443 34,451
Long-term borrowings, less current maturities 50,503 31,041
Deferred income taxes 1,743 1,743
--------- ---------
Total liabilities 81,689 67,235
--------- ---------
Minority interest 4,373 4,758
Shareholders' equity
Common stock - authorized 15,000,000 shares no par value;
issued and outstanding: 10,247,241 and 10,224,521 shares, 61,423 61,377
respectively
Retained earnings 17,428 15,851
Cumulative foreign currency translation adjustment (3,732) (3,556)
--------- ---------
Total shareholders' equity 75,119 73,672
--------- ---------
Total liabilities and shareholders' equity $ 161,181 $ 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 Nine Months Ended
December 31, December 31,
--------------------------- ---------------------------
2000 1999 2000 1999
-------- -------- -------- --------
Gross revenues $ 18,828 $ 16,361 $ 47,557 $ 40,366
Excise taxes (490) (424) (1,252) (1,013)
-------- -------- -------- --------
Net revenues 18,338 15,937 46,305 39,353
Cost of wines sold (11,885) (8,468) (30,125) (21,034)
-------- -------- -------- --------
Gross profit 6,453 7,469 16,180 18,319
Revenues from other operations, net 122 9 160 62
Selling, general and administrative expenses (4,285) (3,826) (12,047) (10,271)
-------- -------- -------- --------
Operating income 2,290 3,652 4,293 8,110
Interest expense (940) (674) (2,887) (1,766)
Equity in net income of Chateau Duhart-Milon 181 168 714 698
Minority interests (213) (338) (315) (967)
Other Income 20 20 868 41
-------- -------- -------- --------
Income before income taxes 1,338 2,828 2,673 6,116
Income taxes (549) (1,159) (1,096) (2,507)
-------- -------- -------- --------
Net income $ 789 $ 1,669 $ 1,577 $ 3,609
======== ======== ======== ========
Net income per common share
Basic $ 0.08 $ 0.18 $ 0.15 $ 0.39
Diluted $ 0.08 $ 0.18 $ 0.15 $ 0.38
Weighted average number of shares outstanding:
Basic 10,244 9,366 10,234 9,332
Diluted 10,244 9,511 10,234 9,451
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 Nine months ended
December 31, December 31,
----------------------- -------------------
2000 1999 2000 1999
-------- ------- -------- -------
Cash flows from operating activities:
Net income $ 789 $ 1,669 $ 1,577 $ 3,609
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 3,414 2,621 5,318 3,960
Equity in net income of Chateau Duhart-Milon (181) 569 (714) 39
Increase (Decrease) in minority interest 213 339 315 968
Loss(Gain) on sale of assets 34 (11) (803) (12)
Changes in:
Deferred Income Taxes - (398) - (398)
Accounts and other receivables (1,196) (401) (1,734) (2,330)
Inventory (15,137) (7,712) (11,776) (9,099)
Prepaid expenses and other assets (230) (1,315) 281 (1,425)
Accounts payable and accrued liabilities 8,710 2,289 8,783 5,076
-------- ------- -------- -------
Net cash provided (used) by operating activities (3,584) (2,350) 1,247 388
-------- ------- -------- -------
Cash flows from investing activities:
Capital expenditures (3,334) (2,216) (10,821) (7,850)
Property and business acquisitions - - (3,518) (6,127)
Proceeds from disposal of property and equipment 99 39 7,518 104
Distributions from Duhart-Milon (7) - 557 738
-------- ------- -------- -------
Net cash used in investing activities (3,242) (2,177) (6,264) (13,135)
-------- ------- -------- -------
Cash flows from financing activities:
Borrowings (Repayments) on revolving bank loan - net 7,050 5,204 (14,057) 14,426
Distributions to minority interests (300) (400) (700) (700)
Proceeds from issuance of notes - - 30,000 -
Repayment of long-term debt (11) (10) (10,272) (2,370)
Proceeds from issuance of common stock 47 (3) 46 (5)
-------- ------- -------- -------
Net cash provided by financing activities 6,786 4,791 5,017 11,351
-------- ------- -------- -------
Net increase (decrease) in cash and equivalents (40) 264 - (1,396)
Cash and equivalents at beginning of period 40 10 - 1,670
-------- ------- -------- -------
Cash and equivalents at end of period $ - $ 274 $ - $ 274
======== ======= ======== =======
Other cash flow information:
Interest paid $ 953 $ 576 $ 3,018 $ 1,689
Income taxes paid 83 624 222 2,241
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 principles
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" that
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires that derivatives be recognized in the balance
sheet at fair value and specifies the accounting for changes in fair value. In
June 1999, the FASB issued SFAS No. 137, that defers the effective date of SFAS
No. 133 until fiscal years beginning after June 15, 2000. The Company plans to
adopt SFAS No. 133 in fiscal 2002 and does not expect it to have a material
effect on the consolidated financial statements.
NOTE 3 - COMPREHENSIVE INCOME
Comprehensive income 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 (IN THOUSANDS):
Three months ended Nine months ended
December 31, December 31,
------------------ -------------------
2000 1999 2000 1999
---- ---- ---- ----
Net income $ 789 $1,669 $1,577 $3,609
Foreign currency translation gain (loss) 627 (557) (176) (719)
------ ------ ------ ------
Comprehensive income $1,416 $1,112 $1,401 $2,890
====== ====== ====== ======
NOTE 4 - EARNINGS PER SHARE ("EPS")
Basic EPS represents net income divided by the weighted average number of
common shares outstanding for the period. Diluted EPS represents net income
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. 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
based on estimated fair values to an intangible asset in the amount of $2.9
million representing the brand name rights with the remaining $600,000 allocated
primarily to inventory. 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 a portion of bank borrowings under a previous
Credit Agreement in the amounts of $20 million of revolving debt and $10 million
of a $30 million term loan. Interest on the Notes is payable quarterly at rates
ranging from 8.93% to 9.05%, as amended on February 9, 2001, and principal
repayments are scheduled beginning September 15, 2004 through maturity on
September 15, 2010. In connection with this refinancing, available revolving
debt borrowings under the Credit Agreement were reduced from $40 million to $25
million, of which the Company had borrowed $13.0 million as of December 31,
2000.
The Notes were issued pursuant to a Note Purchase Agreement which contains
restrictive covenants including requirements to maintain certain financial
ratios and restrictions on additional indebtedness, asset sales, investments,
and payment of dividends. At December 31, 2000, the Company was not in
compliance with one of these covenants and with a covenant requirement under the
Credit Agreement, however, the Note Purchase Agreement and the Credit Agreement
were amended on February 9, 2001 and February 12, 2001, respectively, to waive
such non-compliance retroactive to the quarter ended December 31, 2000 and to
reset interest rates on the Notes.
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.
NOTE 8 - SUBSEQUENT EVENT
On February 7, 2001, the Company purchased the remaining 49.5% of Canoe
Ridge Vineyard, LLC making Canoe Ridge Vineyard, LLC a wholly owned subsidiary
of the Company. The cost of the acquisition was approximately $6 million
including $2 million in debt assumption and was financed with the Company's bank
line of credit. The Company will record this acquisition using the purchase
method of accounting.
The Company plans to continue producing and marketing the existing Canoe
Ridge brand which is primarily Merlot, Cabernet Sauvignon, and Chardonnay
varietals.
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," "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.
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-Rothschild in the town of
Pauillac.
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.
8
The Chalone Wine Group, Ltd.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS - THIRD QUARTER OF FISCAL 2001 COMPARED TO THIRD QUARTER
OF FISCAL 2000
Three months ended Percent Nine months ended Percent
December 31, Change December 31, Change
---------------------------------------- -------------------------- -----------
2000 1999 00 vs 99 2000 1999 00 vs 99
------------- ------------ ----------- ------------ ------------ -----------
Net revenues 100.0 % 100.0 % 15.1 % 100.0 % 100.0 % 17.7 %
Cost of sales (64.8)% (53.1)% 40.4 % (65.1)% (53.4)% 43.2 %
------------- ------------ ------------ ------------
Gross profit 35.2 % 46.9 % (13.6)% 34.9 % 46.6 % (11.7)%
Revenues from other operations, net 0.7 % 0.2 % n/a 0.3 % 0.3 % n/a
Selling, general and admin. expenses (23.4)% (24.0)% 12.0 % (26.0)% (26.1)% 17.3 %
------------- ------------ ------------ ------------
Operating income 12.5 % 23.1 % (37.6)% 9.2 % 20.8 % (47.3)%
Interest Expense (5.1)% (4.2)% 39.3 % (6.2)% (4.5)% 63.4 %
Equity in net income of Chateau
Duhart-Milon 1.0 % 1.1 % 7.7 % 1.5 % 1.8 % 2.3 %
Other Income 0.1 % 0.0 % n/a 1.9 % 0.0 % n/a
Minority interests (1.2)% (2.1)% (36.4)% (0.7)% (2.5)% (67.2)%
------------- ------------ ------------ ------------
Income before income taxes 7.3 % 17.9 % (52.7)% 5.7 % 15.6 % (56.3)%
Income taxes (3.0)% (7.3)% (52.6)% (2.4)% (6.4)% (56.3)%
------------- ------------ ------------ ------------
Net Income 4.3 % 10.6 % (52.7)% 3.3 % 9.2 % (56.3)%
============= ============ ============ ============
NET REVENUES
Net revenues for the three-month and nine-month periods ended December 31,
2000 increased approximately 15% and 18%, respectively, over the comparable
periods in the prior year. These increases were due to increases in the average
revenue-per-case due to selected price increases, changes in product mix, and
increased sales volume.
GROSS PROFIT
Gross profit for the three and nine months ended December 31, 2000,
decreased by approximately 14% and 12% respectively, over the comparable periods
in the prior year. For the quarter ended December 31, the gross margin
percentage decreased from 46.9% in 1999 to 35.2% in 2000, while the gross margin
decreased from 46.6% to 34.9%, respectively, for the nine months ended December
31, 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.
The per acre grape yields for the 1998 and 1999 harvests were below normal
levels resulting in higher per unit wine costs and reduced volumes. These
reduced volumes necessitated buying more grapes at higher costs from other
growers and the purchase of bulk wine. Purchases of bulk wine are significantly
more expensive than wine produced in the Company's facilities. The 2000 harvest
was 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.
REVENUES FROM OTHER OPERATIONS
Revenue from other operations usually consists 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 nine
months ended December 31, 2000, increased approximately $458,000 or 12%, and
$1.8 million or 17%, 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
activities.
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 for the three months and nine months ended December 31,
2000, decreased $1.3 million or 37% and $3.8 million or 47%, 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 $265,000 and $1.1 million for the three months
and nine months ended December 31, 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 the fiscal 2000 year; (iii) the Jade Mountain brand-name
acquisition that occurred in April, 2000 and (iv) continuing capital
expenditures related to winery-expansion.
EQUITY IN NET INCOME OF DUHART-MILON
The Company's 23.5% equity interest in the net income of Duhart-Milon for
the three months and nine months ended December 31, 2000, are $181,000 and
$714,000 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 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 and nine months
ended December 31, 2000 and 1999 consisted of the following (IN THOUSANDS):
Three months ended Nine months ended
December 31, December 31,
Minority --------------------------- ---------------------------
Venture Minority Owner Percent 2000 1999 2000 1999
- ------------ ------------------ -------- ------------ ------------- ------------ -------------
Edna Valley Vineyard Paragon Vineyard Co., Inc. 50.00% $ 83 $ 260 $116 $ 722
Canoe Ridge Vineyard, LLC Various 49.50% 130 78 199 245
------------ ------------- ------------ -------------
$ 213 $ 338 $315 $ 967
============ ============= ============ =============
The decrease in minority interest was $125,000 or 37% and $652,000 or 67%
for each of the periods ended December 31, 2000 when compared to the same
periods last year. These decreases are attributable to increased grape and other
production costs.
10
The Chalone Wine Group, Ltd.
NET INCOME
Net income for the three months and nine months ended December 31, 2000,
was $789,000 and $1.6 million respectively, reflecting decreases of 53% and 56%
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.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased approximately $19 million during the nine months
ended December 31, 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 $13.0 million as of December 31, 2000. On February 9, 2001, the Company
and the holders of the Notes amended the Note Purchase Agreement to revise
certain financial covenants retroactive to December 31, 2000.
The sale of the Hewitt house contributed over $7 million to working
capital.
The Company has historically financed its growth through increased
borrowings and cash flow from operations. During the nine months ended December
31, 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.
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 nine months ended December 31, 2000, approximately 73% 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 90% of our consolidated net revenues in the nine months ended
December 31, 2000 were concentrated in our top four selling varietal wines.
Specifically, sales of Chardonnay, Pinot Noir, Cabernet Sauvignon and Merlot
accounted for 46%, 12%, 19% 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.
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The Chalone Wine Group, Ltd.
BAD WEATHER, PESTS AND PLANT DISEASES COULD HARM OUR BUSINESS
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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 currently 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.
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
impact the quality and quantity of grapes available and can result in lower
volumes and higher costs.
WE MAY NOT BE ABLE TO GROW OR ACQUIRE ENOUGH QUALITY GRAPES FOR OUR WINES
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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.
WE DEPEND ON THIRD PARTIES TO SELL OUR WINE
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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 41%, respectively, of our net revenues during
the nine months ended December 31, 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
nine-month period ended December 31, 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. Any 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.
13
The Chalone Wine Group, Ltd.
NEW REGULATIONS OR INCREASED REGULATORY COSTS COULD HARM OUR BUSINESS
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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
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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
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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
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BUSINESS
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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
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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
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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.
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The Chalone Wine Group, Ltd.
SHIFTS IN FOREIGN EXCHANGE RATES OR THE IMPOSITION OF ADVERSE TRADE
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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 three
months ended December 31, 2000. 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
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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
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RISKS
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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. 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
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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.
None
(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: February 12, 2001 THE CHALONE WINE GROUP, LTD.
- -------------------------- ----------------------------
(Registrant)
/s/ THOMAS B. SELFRIDGE
------------------------------
Thomas B. Selfridge
President and Chief Executive
Officer
Dated: February 12, 2001 /s/ SHAWN CONROY BLOM
- ------------------------- ------------------------------
Shawn Conroy Blom
Vice President and Chief
Financial Officer
16