================================================================================
SECURITIES AND 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, 2002
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 [ ] No [ ]
The number of shares outstanding of Registrant's Common Stock on August 12, 2002
was 12,066,634
================================================================================
THE CHALONE WINE GROUP, LTD.
PART I. - FINANCIAL INFORMATION
PAGE
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2002,
and December 31, 2001. 3
Consolidated Statements of Income for the three-month and
six-month periods ended June 30, 2002 and 2001. 4
Consolidated Statements of Cash Flows for the six-month
periods ended June 30, 2002 and 2001. 5
Notes to Consolidated Financial Statements. 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 8
ITEM 3. DISCLOSURE 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
June 30, December 31,
2002 2001
___________ ____________
(unaudited)
Current assets:
Accounts receivable, net $ 11,577 $ 11,475
Notes receivable 203 181
Inventory 70,028 76,658
Prepaid expenses and other 317 700
Deferred income taxes 1,501 1,442
_________ _________
Total current assets 83,626 90,456
Investment in Chateau Duhart-Milon 9,561 7,897
Property, plant and equipment - net 73,315 73,232
Goodwill and trademarks - net of accumulated
amortization of $2,575 and $2,550, respectively 11,395 11,379
Notes receivable, net of current portion 534 653
Other assets 2,073 852
_________ _________
Total assets $ 180,504 $ 184,469
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 7,601 $ 23,882
Revolving bank loan 21,448 12,086
Current maturities of related party note payable 22 18
Current portion of obligations under capital lease 716 716
Current maturities of long-term borrowings 730 2,034
_________ _________
Total current liabilities 30,517 38,736
Long-term borrowings, less current maturities 49,032 47,082
Obligations under capital lease, less current portion 1,778 2,110
Related party note payable, net of current portion 856 869
Liability on interest rate swap contract 865 664
Deferred income taxes 492 492
_________ _________
Total liabilites 83,540 89,953
_________ _________
Minority interest 3,820 3,201
Shareholders' equity:
Common stock - authorized 15,000,000 shares no par value;
issued and outstanding: 12,066,634 and 12,067,504 shares,
respectively 76,371 76,433
Retained earnings 20,432 19,494
Accumulated other comprehensive loss (3,659) (4,612)
_________ _________
Total shareholders' equity 93,144 91,315
_________ _________
Total liabilities and shareholders' equity $ 180,504 $ 184,469
========= =========
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
June 30, June 30,
_________________________ ________________________
2002 2001 2002 2001
________ ________ ________ ________
Gross revenues $ 13,797 $ 13,900 $ 30,455 $ 28,558
Excise taxes (356) (375) (816) (775)
________ ________ ________ ________
Net revenues 13,441 13,525 29,639 27,783
Cost of wines sold (8,391) (8,082) (18,541) (17,400)
________ ________ ________ ________
Gross profit 5,050 5,443 11,098 10,383
Other operating revenues (expense), net 5 31 (402) 84
Selling, general and administrative expenses (3,585) (3,802) (7,461) (6,965)
________ ________ ________ ________
Operating income 1,470 1,672 3,235 3,502
Interest expense, net (782) (1,026) (1,690) (1,964)
Equity in net income of Chateau Duhart-Milon 586 199 734 246
Other income (loss) (33) (34) (13) (11)
Minority interests (413) (111) (619) (171)
________ ________ ________ ________
Income before income taxes 828 700 1,647 1,602
Income taxes (368) (286) (709) (715)
________ ________ ________ ________
Net income $ 460 $ 414 $ 938 $ 887
======== ======== ======== ========
Earnings per share-basic & diluted $ 0.04 $ 0.04 $ 0.08 $ 0.09
Weighted average number of shares outstanding:
Basic 12,069 10,262 12,069 10,255
Diluted 12,309 10,335 12,115 10,335
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)
Six months ended
June 30,
___________________
2002 2001
_______ _______
Cash flows from operating activities:
Net income $ 938 $ 887
Adjustments to reconcile net income to net cash provided
by operating activites:
Depreciation and amortization 2,842 2,075
Equity in net income of Chateau Duhart-Milon (734) (246)
Increase (decrease) in minority interests 619 171
Loss (gain) on sale of assets (4) 45
Changes in:
Deferred income taxes 23 (820)
Accounts receivable (102) 3,296
Inventory 6,630 7,736
Prepaid expenses and other assets (258) (184)
Accounts payable and accrued liabilities (16,298) (7,129)
_______ _______
Net cash provided by (used in) operating activities (6,344) 5,831
_______ _______
Cash flows from investing activities:
Capital expenditures (2,807) (7,997)
Property and business acquisitions - 18
Proceeds from disposal of property and equipment 7 18
Net changes of note receivable 97 (443)
Acquisition of minority interest in Canoe Ridge Vineyard - (3,960)
Distributions from Chateau Duhart-Milon 108 737
_______ _______
Net cash used in investing activities (2,595) (11,627)
_______ _______
Cash flows from financing activities:
Borrowings on revolving bank loan - net 9,362 6,975
Net change in capital lease (332) -
Repayment of long-term and other debt (29) (1,526)
(Re-purchase of) proceeds from issuance of common stock (62) 347
_______ _______
Net cash provided by financing activities 8,939 5,796
_______ _______
Net increase (decrease) in cash and equivalents - -
Cash and equivalents at beginning of period - -
_______ _______
Cash and equivalents at end of period $ - $ -
======= =======
Other cash flow information:
Interest paid $ 1,992 $ 2,233
Income taxes paid 638 231
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 reporting 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 nine-month transition period ended December
31, 2001.
The consolidated balance sheet at December 31, 2001, presented herein,
has been derived from the audited consolidated financial statements of the
Company for the fiscal year then ended, included in the Company's annual report
on Form 10-K.
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. See Item 2. for
the Company's critical accounting policies.
ADOPTION OF SFAS 142 - ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLES
As required by Financial Accounting Standards Board pronouncement No. 142,
"Goodwill and Other Intangible Assets", the Company has performed the first of
the required impairment tests for goodwill and other intangible assets. Based on
the results of that test, the Company has determined that goodwill and other
intangible assets were not impaired at January 1, 2002.
NOTE 3 - COMPREHENSIVE INCOME
Comprehensive income includes unrealized foreign currency gains and losses
related to the Company's investment in Chateau Duhart-Milon and gains or losses
relating to derivative instruments. The following is a reconciliation of net
income and comprehensive income (UNAUDITED, IN THOUSANDS):
Six months ended
June 30,
__________________
2002 2001
_______ ______
Net income $ 938 $ 887
Cummulative effect of adopting SFAS No. 133 - (188)
Changes in fair value of derivatives; net of tax effect (119) 80
Reclassification adjustment; net of tax effect 34 9
Foreign currency translation gain (loss) 1,038 (889)
_______ ______
Comprehensive income $ 1,891 $ (101)
======= ======
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 number 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
NOTE 5 - INVENTORIES
Inventories are stated at lower of cost (first-in, first-out) or market and
consist of the following (in thousands):
June 30,
________________________
2002 2001
_______ _______
Bulk wine $34,283 $44,616
Bottled wine 35,095 31,303
Wine packaging supplies 331 313
Other 319 426
_______ _______
Total $70,028 $76,658
======= =======
NOTE 6 - DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses derivative instruments to manage exposures to interest
rate risks in accordance with its risk management policy. The Company's
objectives for holding derivatives are to minimize the risks using the most
effective methods to eliminate or reduce the exposure to interest rate
fluctuations. The Company formally documents the relationship between hedging
instruments and hedged items as well as its risk management objective and
strategy for undertaking its hedging activities. The Company formally designates
derivatives as hedging instruments on the date the derivative contract is
entered into. The Company assesses, both at inception of the hedge and on an
ongoing basis, whether derivatives used as hedging instruments are highly
effective in offsetting the changes in the fair value or cash flows of hedged
items. If it is determined that a derivative is not highly effective as a hedge
or ceases to be highly effective, the Company discontinues hedge accounting
prospectively.
Changes in the fair value of derivative instruments designated as cash flow
hedges, to the extent the hedges are highly effective, are recorded in other
comprehensive income, net of related tax effects. The ineffective portion of the
cash flow hedge, if any, is recognized in current-period earnings. Other
comprehensive income is relieved when current earnings are affected by the
variability of cash flows relating to the derivative hedged. During the period
ended June 30, 2002, the Company's derivative contracts consisted only of an
interest rate swap used by the Company to convert a portion of its variable rate
long-term debt to fixed rate.
The Company does not enter into financial instruments for trading or
speculative purposes. Payments or receipts on interest rate swap agreements are
recorded in interest expense. Forward exchange contracts are used to manage
exchange rate risks on certain purchase commitments, generally French oak
barrels, denominated in foreign currencies. Gains and losses relating to firm
purchase commitments are deferred and are recognized as adjustments of carrying
amounts of assets acquired or in income when the hedged transaction occurs. The
nominal amounts and related foreign currency transaction gains and losses, net
of the impact of hedging, were not significant for the six months ended June 30,
2002 and 2001.
NOTE 7-LONG-TERM DEBT
In April 2002, the Company successfully completed the renewal
of its revolving bank loans with Rabobank. The bank facility negotiation
involved (1) a $55 million revolving credit facility secured first by inventory
and accounts receivable and second by substantially all of the Company's fixed
assets (other than certain specified assets), and (2) a $17.5 million term loan
secured first by certain of the Company's fixed assets (other than certain
specified assets) and second by the Company's inventory and accounts receivable,
each on a pari passu basis with the holders of the Company's $30 million
previously unsecured senior notes issued in September 2000 (the ONotesO). In
connection with the finalization, the Company amended certain provisions
applicable to the Notes.
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. 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 December 31, 2001.
INTRODUCTION
In the ordinary course of business, the Company has made a number of
estimates and assumptions relating to the reporting of results of operations and
financial condition in the preparation of its financial statements in conformity
with accounting principles generally accepted in the United States of America.
Actual results could differ significantly from those estimates under different
assumptions and conditions. The Company believes that the following discussion
addresses the Company's most critical accounting policies, which are those that
are most important to the portrayal of the Company's financial condition and
results. The Company constantly re-evaluates these significant factors and makes
adjustments where facts and circumstances dictate. Historically, actual results
have not significantly deviated from those determined using the necessary
estimates inherent in the preparation of financial statements. Estimates and
assumptions include, but are not limited to, customer receivables, inventories,
assets held for sale, fixed asset lives, contingencies and litigation. The
Company has also chosen certain accounting policies when options were available,
including:
o The first-in, first-out (FIFO) method to value a majority of our
inventories;
o The intrinsic value method, or APB Opinion No. 25, to account for our
common stock incentive awards; and
o We record an allowance for credit losses based on estimates of
customers' ability to pay. If the financial condition of our customers
were to deteriorate, additional allowances may be required.
These accounting policies are applied consistently for all years
presented. Our operating results would be affected if other alternatives were
used.
8
THE CHALONE WINE GROUP, LTD.
DESCRIPTION OF THE BUSINESS
The Company produces, markets and sells super premium, ultra premium, and
luxury-priced white and red varietal table wines, primarily Pinot Noir, Cabernet
Sauvignon, Merlot, Syrah, Chardonnay and Sauvignon Blanc. The Company owns and
operates wineries in various counties of California and Washington State. The
Company's wines are made primarily from grapes grown at Moon Mountain Vineyard,
Carmenet Vineyards, Edna Valley Vineyard, Chalone Vineyard, Company-owned
vineyards adjacent to the Acacia(TM) Winery, Hewitt Vineyard and Suscol Creek
Vineyard in California and the Canoe Ridge Vineyard in Washington State, as well
as from purchased grapes.
The wines are primarily sold under the labels "Provenance Vineyards(TM),"
"Chalone Vineyards(R)," "Edna Valley Vineyard(R)," "Carmenet(R)," "Acacia(TM),"
"Canoe Ridge(R) Vineyard," "Jade Mountain(R)," "Sagelands Vineyard(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. The Company became a publicly held reporting
company as the result of an initial public offering of common stock in 1984.
RESULTS OF OPERATIONS - SECOND QUARTER AND SIX MONTHS OF 2002 COMPARED TO SECOND
QUARTER AND SIX MONTHS OF FISCAL 2001
Three months ended Percent Six months ended Percent
June 30, Change June 30, Change
_____________________ ____________ ___________________ ____________
2002 2001 2002 vs 2001 2002 2001 2002 vs 2001
_______ _______ ____________ _______ _______ ____________
Net revenues 100.0 % 100.0 % 0.0 % 100.0 % 100.0 % 0.0 %
Cost of sales (62.4)% (59.7)% 4.5 % (62.6)% (62.6)% 0.0 %
_______ _______ _______ _______
Gross profit 37.6 % 40.3 % (6.7)% 37.4 % 37.4 % 0.0 %
Other operating revenues, net 0.0 % 0.2 % (80.0)% (1.4)% 0.3 % (566.7)%
Selling, general and admin. expenses (26.7)% (28.1)% (5.0)% (25.2)% (25.1)% 0.4 %
_______ _______ _______ _______
Operating income 10.9 % 12.4 % (11.8)% 10.8 % 12.6 % (14.3)%
Interest expense (5.8)% (7.6)% (23.7)% (5.7)% (7.1)% (19.7)%
Equity in net income of Chateau Duhart-Milon 4.4 % 1.5 % 193.3 % 2.5 % 0.9 % 177.8 %
Other Income (0.3)% (0.3)% 0.0 % 0.0 % 0.0 % 0.0 %
Minority interests (3.1)% (0.8)% 287.5 % (2.1)% (0.6)% 250.0 %
_______ _______ _______ _______
Income before income taxes 6.1 % 5.2 % 18.1 % 5.5 % 5.8 % (5.2)%
Income taxes (2.7)% (2.1)% 28.6 % (2.4)% (2.6)% (7.7)%
_______ _______ _______ _______
Net income 3.4 % 3.1 % 11.0 % 3.1 % 3.2 % (3.1)%
======= ======= ======= =======
NET REVENUES
Net revenues for the six months ended June 30, 2002 increased approximately
6.7% over the comparable period in the prior year. This increase was caused by
changes in product mix and increased sales volume.
Net revenues for the three months ended June 30, 2002 decreased
approximately 0.7% over the comparable period in the prior year. This decrease
was due to a decrease in shipments in 2002 as compared to the prior year
quarter.
9
THE CHALONE WINE GROUP, LTD.
GROSS PROFIT
Gross profit margin for the six months ended June 30, 2002, was unchanged
as compared to the comparable period in the prior year. Gross profit margin for
the three months ended June 30, 2002 decreased 6.7% over the comparable period
in the preceding year due to changes in product mix and continued discount
pressure in the marketplace.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three months ended
June 30, 2002, decreased approximately $219,000 or 5.8% over the comparable
period in the prior year. This change was primarily a result of lower selling
and general administrative costs at the wineries offset by sales and marketing
expenses due to the Company's increased sales efforts in this challenging
marketplace. Selling, general and administrative expenses for the six months
ended June 30, 2002, increased approximately $496,000 or 7.1% over the
comparable period in the prior year. This change was primarily a result of
increases in sales and marketing infrastructure costs.
OPERATING INCOME
Operating income for the three months ended June 30, 2002, decreased
$202,000 or 12.1% primarily due to the higher discount on wine sales. Operating
income for the six months ended June 30, 2002 decreased by $267,000 or 7.6%
primarily due to the higher discounts, a $458,000 loss on sale of bulk wine
which is recorded in other operating expenses, net and higher selling, general
and administrative expenses. The bulk wine sales were part of management's plan
to manage inventory, both in quantity and quality.
INTEREST EXPENSE
Interest expense for the three and six month periods ending June 30, 2002
decreased $245,000and $274,000, respectively, over the comparable periods in the
prior year. The decrease is primarily due to lower interest rates.
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 six months ended June 30, 2002 was $586,000 and $734,000
increases of $387,000 and $488,000, respectively, over the comparable periods in
the prior year. This change was primarily a result of timing of product releases
as compared to the prior year.
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
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.
MINORITY INTEREST
The financial statements of Edna Valley Vineyard ("EVV") are consolidated
with the Company's financial statements. The interest in EVV attributable to
parties other than the Company is accounted for as a "minority interest". The
minority interest in the net income of EVV for the three months and six months
ended June 30, 2002 was $413,000 and $619,000 respectively. The increases in
minority interest were $304,000 and $450,000 for the three and six month periods
ended June 30, 2002, respectively, when compared to the same periods last year.
These increases were due to the higher net income of Edna Valley Vineyard as
compared to the prior year as a result of higher sales volume and lower cost of
sales due to the release of 2000 and 2001 vintage wines. As previously reported,
the 2000 and 2001 vintages were a return to normal crop levels contributing to
historical volumes and expected cost structures.
NET INCOME
Net income for the six months ended June 30, 2002, increased $51,000 or
5.7% compared to the same period in the prior year. The increase was due to
increased shipments offset by higher selling and administrative expenses. Net
income for the three months ended June 30, 2002, increased $46,000 or 11.1%
compared to the same period in the prior year. This was primarily due to the
increase in equity in net income of Duhart-Milon, lower selling, general and
administrative expenses, and lower interest expenses offset by higher minority
interests.
10
THE CHALONE WINE GROUP, LTD.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased approximately $1,389,000 during the six months
ended June 30, 2002, primarily as a result of a decrease of current maturities
of long term borrowing due to the restructure of the Company's borrowing
arrangement.
The Company's revolving bank loan expired March 31, 2002 and two extensions
were provided extending the maturity date to April 30, 2002. On April 22, 2002,
the Company finalized the borrowing arrangement with its bank. The borrowing
arrangement with its bank involves (1) a $55 million revolving credit facility
secured first by inventory and accounts receivable and second by substantially
all of the Company's fixed assets (other than certain specified assets), and (2)
a $17.5 million term loan secured first by certain of the Company's fixed assets
(other than certain specified assets) and second by the Company's inventory and
accounts receivable, each on a pari passu basis with the holders of the
Company's $30 million previously unsecured senior notes issued in September 2000
(the "Notes"). In connection with the finalization, the Company amended certain
of the provisions applicable to the Notes.
The Company has historically financed its growth through increases in
borrowings and cash flow from operations. Management expects that the Company's
working capital needs will grow significantly to support expected future growth
in sales volume. Due to the lengthy aging and processing cycles involved in
premium wine production, expenditures for inventory and fixed assets need to be
made one to three years or more in advance of anticipated sales.
The Company expects to finance these future capital needs through
operations, securities offerings and additional borrowings. There can be no
assurance that the Company will be able to obtain this financing on terms
acceptable to the Company.
ITEM 3. DISCLOSURES ABOUT RISK
You should read the following disclosures in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations. 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, 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.
REDUCED CONSUMER SPENDING COULD LESSEN DEMAND FOR OUR WINES AND HARM OUR
BUSINESS
Consumer spending trends and changes in consumer tastes have a substantial
impact on the wine industry and our business. To the extent that wine purchases
are negatively impacted by economic and other factors, or wine consumers reduce
consumption of wine in favor of other beverages, demand for our wines could
decrease.
OUR BUSINESS IS SEASONAL, WHICH COULD CAUSE OUR MARKET PRICE TO FLUCTUATE
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
11
THE CHALONE WINE GROUP, LTD.
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 growers for grapes harvested and make payments related to
the grape harvest. These and other factors may cause fluctuations in the market
price of our common stock.
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 and, by additional borrowings or additional equity.
OUR ACQUISITIONS AND POTENTIAL FUTURE ACQUISITIONS INVOLVE A NUMBER OF
RISKS
Our acquisition of Hewitt Ranch, Suscol Ranch, Staton Hills Winery
(renamed Sagelands Vineyard), the Jade Mountain brand, enlarging Canoe Ridge
Vineyard and buying out our partners, and the possible construction of a new
winery on the Suscol Ranch property we recently acquired (and potential future
acquisitions) involve risks associated with assimilating these operations into
our Company; integrating, retaining and motivating key personnel; integrating
and managing geographically-dispersed operations integrating the technology and
infrastructures of disparate entities; risks inherent in the production and
marketing wine and 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, enlarging Canoe Ridge Vineyard and buying
out our partners and other vineyard land and related assets during the fiscal
year ended December 31, 2001. Consequently our debt-to-equity ratio is high in
relation to our historical standards, even after the successful completion of
our rights offering in November 2001. The interest costs associated with this
debt will increase our operating expenses and the risk of negative cash flow.
OUR PROFITS DEPEND LARGELY ON SALES IN CERTAIN STATES AND ON SALES OF
CERTAIN VARIETALS
In the three months ended June 30, 2002, approximately 89% 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 which could harm our business.
Approximately 90% of our consolidated net revenues in the six months ended
June 30, 2002 were concentrated in our four top selling varietal wines.
Specifically, sales of Chardonnay, Cabernet Sauvignon, Pinot Noir, and Merlot
accounted for 39%, 19%, 14% and 18% of our net revenues, respectively. Changes
in consumer preferences with respect to these varietal wines could adversely
affect our business.
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.
OUR BUSINESS IS SUBJECT TO A VARIETY OF AGRICULTURAL RISKS
Winemaking and grape growing are subject to a variety of agricultural
risks. Various diseases, pests, fungi, viruses, drought, frosts and certain
other weather conditions can affect the quality and quantity of grapes available
to us, decreasing the supply of our products and negatively impacting
profitability.
12
THE CHALONE WINE GROUP, LTD.
Many California vineyards have been infested in recent years with
phylloxera. Our vineyard properties are primarily planted to rootstocks believed
to be resistant to phylloxera. However, there can be no assurance that our
existing vineyards, or the rootstocks we are now using in our planting programs,
will not become susceptible to current or new strains of phylloxera.
Pierce's Disease is a vine bacterial disease that has been in California
for more than 100 years. It kills grapevines and there is no known cure. Small
insects called sharpshooters spread this disease. A new strain of the
sharpshooter, the glassy winged, was discovered in Southern California and is
believed to be migrating north. We are actively supporting the efforts of the
agricultural industry to control this pest and are making every reasonable
effort to prevent an infestation in our own vineyards. We cannot, however,
guarantee that we will succeed in preventing contamination in our vineyards.
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.
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 harvests were postponed by approximately
four to six weeks depending on the geographic location and varietals. The
unusual weather conditions resulting from El Nino impacted the quantity and
quality of our 1998 estate harvest. The size of our most significant crops
ranged from normal-sized yields to 50% of normal yields (depending on the
varietal and particular estate).
Despite the reduction in the yield, harvested estate crops, in combination
with contracted grape purchases, are expected to permit us to meet originally
anticipated sales projections from our 1999 and 1998 vintage Chardonnay,
Cabernet, and Merlot varietals. Together, these varietals have historically
comprised between 80% and 85% of our 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.
AN OVERSUPPLY OF GRAPES MAY ALSO HARM OUR BUSINESS
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 us to reduce, or not increase, our prices.
WE DEPEND ON THIRD PARTIES TO SELL OUR WINE
We sell our products primarily through independent distributors and brokers
for resale to retail outlets, restaurants, hotels and private clubs across the
United States and in some overseas markets. To a lesser degree, we rely on
direct sales from our wineries, our wine library and direct mail. Sales to our
largest distributor and to our nineteen largest distributors combined
represented approximately 6% and 41%, respectively, of our net revenues during
the three months ended June 30, 2002. 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 to sell our wines within California. Such
sales represent 28% of our net revenues during the three months ended June 30,
2002. Effective July 1, 2002, the Company switched from a single broker to a
distributor in California. The laws and regulations of several states prohibit
changes of distributors, except under certain limited circumstances, making it
difficult to terminate a distributor for poor performance without reasonable
cause, as defined by applicable statutes. Any
13
THE CHALONE WINE GROUP, LTD.
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.
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 principal competitive advantages. We
maintain insurance against these kinds of risks, and others, under various
general liability and product liability insurance policies. However, our
insurance may not be adequate or may not continue to be available at a price or
on terms that are satisfactory to us.
THE LOSS OF KEY EMPLOYEES WOULD DAMAGE OUR REPUTATION AND BUSINESS
Our success depends to some degree upon the continued services of a number
of key employees. Although some key employees are under employment contracts
with us for specific terms, the loss of the services of one or more of our key
employees could harm our business and our reputation, particularly if one or
more of our key employees resigns to join a competitor or to form a competing
company. In such an event, despite provisions in our employment contracts, which
are designed to prevent the unauthorized disclosure or use of our trade secrets,
practices or procedures by such personnel under these circumstances, we cannot
be certain that we would be able to enforce these provisions or prevent such
disclosures.
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 2% of total consolidated revenue for the six months
ended June 30, 2002. We expect the volume of international transactions to
increase, which may increase our exposure to future exchange rate fluctuations.
14
THE CHALONE WINE GROUP, LTD.
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.
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. The
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 and could
similarly affect our market price.
DECREASED CASH FLOW COULD LIMIT OUR ABILITY TO SERVICE OUR DEBT
As a result of incurring debt, we are subject to the risks normally
associated with debt financing, including the risk that cash flow from
operations will be insufficient to meet required payments of principal and
interest. Our ability to satisfy our obligations to pay interest and to repay
debt is dependent on our future performance. Our performance depends, in part,
on prevailing economic conditions and financial, business and other factor,
including factors beyond our control.
OUR DEBT FINANCING AGREEMENTS CONTAIN RESTRICTIVE COVENANTS WITH WHICH WE
MAY NOT BE ABLE TO COMPLY
Our existing line of credit and long-term debt financing agreements contain
restrictive financial covenants. These covenants require us, among other things,
to maintain specified levels of net income, working capital, tangible net worth
and financial ratios. Our ability to comply with restrictive financial covenants
depends upon our future operating performance. Our future operating performance
depends, in part, on general industry conditions and other factors beyond our
control.
15
THE CHALONE WINE GROUP, LTD.
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
During the second quarter ended June 30, 2002, the Company filed the
following Current Reports on Form 8-K:
April 22, 2002 (Item 5). The Company reported finalization of the
borrowing arrangement with its bank.
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 12, 2002 THE CHALONE WINE GROUP, LTD.
(Registrant)
/s/ THOMAS B. SELFRIDGE
____________________________________________
Thomas B. Selfridge
President and Chief Executive Officer
DATED: AUGUST 12, 2002 /s/ SHAWN M. CONROY BLOM
____________________________________________
Shawn M. Conroy Blom
Vice President and Chief Financial Officer
16