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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, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _______________
Commission file number: 0-13406
THE CHALONE WINE GROUP, LTD.
(Exact Name of Registrant as Specified in Its Charter)
California 94-1696731
(State or Other Jurisdiction of
Incorporation or Organization) (I.R.S. Employer Identification No.)
621 Airpark Road
Napa, California 94558
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 707-254-4200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No
--- ---
The number of shares outstanding of Registrant's Common Stock on August 8, 2001
was 10,303,283.
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THE CHALONE WINE GROUP, LTD.
PART I. - FINANCIAL INFORMATION
PAGE
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2001,
and March 31, 2001. 3
Consolidated Statements of Income for the three-month
periods ended June 30, 2001 and 2000. 4
Consolidated Statements of Cash Flows for the
three-month periods ended June 30, 2001 and 2000. 5
Notes to Consolidated Financial Statements. 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 7
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 14
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
June 30, March 31,
2001 2001
--------- ---------
(unaudited)
Current assets:
Cash and equivalents $ - $ 56
Accounts receivable net 9,832 10,128
Inventory 58,008 59,333
Prepaid expenses 446 533
Deferred income taxes 1,052 897
--------- ---------
Total current assets 69,338 70,947
Investment in Chateau Duhart-Milon 7,747 7,824
Property, plant and equipment - net 69,242 67,197
Goodwill and trademarks - net of accumulated
amortization of $2,329 and $2,161, respectively 10,586 10,581
Other assets 1,298 1,342
--------- ---------
Total assets $ 158,211 $ 157,891
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 8,086 $ 7,517
Revolving bank loan 19,935 19,999
Current maturities of related party note payable 18 18
Current maturities of long-term borrowings 2,030 2,032
--------- ---------
Total current liabilities 30,069 29,566
Long-term borrowings, less current maturities 48,101 48,608
Related party note payable, net of current portion 878 882
Deferred income taxes 1,012 1,012
--------- ---------
Total liabilities 80,060 80,068
--------- ---------
Minority interest 2,786 2,689
Shareholders' equity:
Common stock - authorized 15,000,000 shares no par value;
issued and outstanding: 10,302,177 and 10,248,491 shares,
respectively 61,770 61,578
Retained earnings 18,315 17,901
Accumulated other comprehensive loss (4,720) (4,345)
--------- ---------
Total shareholders' equity 75,365 75,134
--------- ---------
Total liabilities and shareholders' equity $ 158,211 $ 157,891
========= =========
The accompanying notes are an integral part of the consolidated financial statements
3
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS, EXCEPT PER-SHARE DATA)
Three Months Ended
June 30,
----------------------
2001 2000
-------- --------
Gross revenues $ 13,902 $ 14,518
Excise taxes (375) (388)
-------- --------
Net revenues 13,527 14,130
Cost of wines sold (8,082) (8,718)
-------- --------
Gross profit 5,445 5,412
Other operating revenues, net 31 11
Selling, general and administrative expenses (3,838) (3,668)
-------- --------
Operating income 1,638 1,755
Interest expense, net (1,027) (888)
Equity in net income of Chateau Duhart-Milon 199 318
Minority interests (109) (256)
-------- --------
Income before income taxes 701 929
Income taxes (287) (381)
-------- --------
Net income $ 414 $ 548
======== ========
Net income available to common shareholders $ 414 $ 548
Earnings per share - basic $ 0.04 $ 0.05
Earnings per share - diluted $ 0.04 $ 0.05
Weighted average number of shares outstanding:
Basic 10,262 10,226
Diluted 10,335 10,226
The accompanying notes are an integral part of the consolidated financial
statements
4
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
Three months ended
June 30,
--------------------
2001 2000
-------- --------
Cash flows from operating activities:
Net income $ 414 $ 548
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,516 973
Equity in Chateau Duhart-Milon (199) (318)
Increase (decrease) in minority interest 109 256
Loss(gain) on sale of assets 41 -
Changes in:
Deferred income taxes (86) -
Accounts receivable 296 766
Inventory 1,325 2,435
Prepaid expenses and other assets 131 689
Accounts payable and accrued liabilities 373 (622)
------- -------
Net cash provided by operating activities 3,920 4,727
------- -------
Cash flows from investing activities:
Capital expenditures (3,618) (2,910)
Property and business acquisitions - (3,509)
Proceeds from disposal of property and equipment 27 -
Distributions from Duhart-Milon - 698
------- -------
Net cash used in investing activities (3,591) (5,721)
------- -------
Cash flows from financing activities:
Borrowings (repayments) on revolving bank loan - net (64) 2,257
Distributions to minority interests - (400)
Repayment of long-term and other debt (513) (371)
Proceeds from issuance of common stock 192 -
------- -------
Net cash provided by financing activities (385) 1,486
------- -------
Net increase (decrease) in cash and equivalents (56) 492
Cash and equivalents at beginning of period 56 -
------- -------
Cash and equivalents at end of period $ - $ 492
======= =======
Other cash flow information:
Interest paid, net $ 1,027 $ 655
Income taxes paid 83 81
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, 2001.
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 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible assets
acquired outside of a business combination and the accounting for goodwill and
other intangible assets subsequent to their acquisition. SFAS No. 142 provides
that intangible assets with finite useful lives be amortized and that goodwill
and intangible assets with indefinite lives will not be amortized, but will
rather be tested at least annually for impairment. The Company will adopt SFAS
No. 142 for its fiscal year beginning January 1, 2002. Upon adoption of SFAS
142, the Company will stop the amortization of goodwill with an expected net
carrying value of approximately $10,346,000 at the date of adoption and annual
amortization of $361,000 that resulted from business combinations completed
prior to the adoption of SFAS 141.
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 (IN THOUSANDS):
Three months ended
June 30,
--------------------
2001 2000
------ ------
Net income $ 414 $ 548
Cumulative effect of adopting SFAS No. 133 (188) -
Changes in fair value of derivatives 80 -
Transition adjustment reclassified in earnings 19 -
Foreign currency translation loss (276) ( 17)
----- -----
Comprehensive income $ 39 $ 531
===== =====
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.
NOTE 5 - DERIVATIVE INSTRUMENTS
Effective April 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 as amended by SFAS 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities", requires that
every derivative instrument, including certain derivative instruments embedded
in other contracts, be recorded as assets or liabilities, measured at fair
value. For each period, changes in fair value are reported in current earnings
or other comprehensive income, depending on whether a derivative is designated
as part of a hedge transaction and, if it is, the type of hedge transaction.
SFAS No. 133 also requires the Company to formally document, designate, and
assess the effectiveness of transactions that receive hedge accounting
treatment. Upon adoption of SFAS No. 133, the Company recorded a derivative
liability of $319,000 and, as other comprehensive income, $188,000 ($319,000
pre-tax) for the cumulative effect of change in accounting principle. The fair
value of this derivative (an interest rate swap) as of June 30, 2001 was
$185,000. The change in the swap's carrying value from April 1, 2001 to June 30,
2001 is reflected as a reduction to other comprehensive loss in the balance
sheet.
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
6
THE CHALONE WINE GROUP, LTD.
methods to eliminate or reduce the impacts of these exposures. 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. During the period ended June 30, 2001, 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.
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, 2001.
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 primarily from grapes grown at the Carmenet Winery,
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 "Chalone Vineyard(R)," "Edna
Valley Vineyard(R)," "Carmenet(R)," "Acacia(TM)," "Canoe Ridge Vineyard(R),"
"Jade Mountain(R)," "Sagelands Winery(R)," and "Echelon(TM)".
7
THE CHALONE WINE GROUP, LTD.
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.
RESULTS OF OPERATIONS - FIRST QUARTER OF FISCAL 2002 COMPARED TO FIRST QUARTER
OF FISCAL 2001
Three months ended
June 30,
------------------
2001 2000 2001 vs 2000
------- ------- ------------
Net revenues 100.0 % 100.0 % 0.0 %
Cost of sales (59.7)% (61.7)% (3.2)%
------- -------
Gross profit 40.3 % 38.3 % 5.2 %
Other operating revenues, net 0.2 % 0.1 % 100.0 %
Selling, general and admin. expenses (28.4)% (26.0)% 9.2 %
------- -------
Operating income 12.2 % 12.4 % (1.6)%
Interest expense ( 7.6)% ( 6.3)% 20.6 %
Equity in net income of Chateau Duhart-Milon 1.5 % 2.3 % (34.8)%
Minority interests ( 0.8)% ( 1.8)% (55.6)%
------- -------
Income before income taxes 5.2 % 6.6 % (21.2)%
Income taxes ( 2.1)% ( 2.7)% (22.2)%
------- -------
Net income 3.1 % 3.9 % (20.5)%
======= =======
NET REVENUES
Net revenues for the three-month period ended June 30, 2001 decreased
approximately 4% over the comparable period in the prior year. This decrease was
caused by lower average revenue-per-case caused by changes in product mix and
lower sales volume primarily due to product availability. The problem of product
availability was substantially rectified in late June of 2001.
GROSS PROFIT
Gross profit margin for the three months ended June 30, 2001, increased by
approximately 2% over the comparable period in the prior year. This percentage
increase primarily resulted from lower costs attributable to the release of 2000
vintage wines.
OTHER OPERATING REVENUES
Other operating revenues usually consist of processing and other revenue
from third-party wineries. 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.
8
THE CHALONE WINE GROUP, LTD.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three months ended
June 30, 2001, increased approximately $170,000 or 4% over the comparable period
in the prior year. This change was primarily a result of increased selling costs
offset by a delay of other promotional activities as compared with the timing of
similar efforts in the prior year.
OPERATING INCOME
Operating income for the three months ended June 30, 2001, decreased
$84,000 or 5% primarily due to the decrease in sales volume.
INTEREST EXPENSE
Interest expense increased $139,000 for the three months ended June 30,
2001, primarily due to higher average outstanding borrowings which are a result
of business and property acquisitions during fiscal year 2001 and 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 ended June 30, 2001 was $199,000 or 37% decrease from prior
year. This change was primarily a result of product release timing issues.
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 ended June 30,
2001 was $109,000. The decrease in minority interest from the prior year of
$147,000 or 57% was due to the elimination of the Canoe Ridge minority interest
when the Company purchased the remaining 49.5% interest in Canoe Ridge on
February 7, 2001.
NET INCOME
Net income for the three months ended June 30, 2001, was $414,000,
reflecting a decrease of 24% over the comparable period in the prior year. This
decrease was primarily due to lower sales volume and increased interest expense.
LIQUIDITY AND CAPITAL RESOURCES
Working capital decreased approximately $2.2 million during the three
months ended June 30, 2001 primarily as a result of a decrease in inventory and
accounts receivable, partially offset by increases in accounts payable and
accrued liabilities.
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, security 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible assets
acquired outside of a business combination and the accounting for goodwill and
other intangible assets subsequent to their acquisition. SFAS No. 142 provides
that intangible assets with finite useful lives be amortized and that goodwill
and intangible assets with indefinite lives will not be amortized, but will
rather be tested at least annually for impairment. The Company will adopt SFAS
No. 142 for its fiscal year beginning January 1, 2002. Upon adoption of SFAS
142, the Company will stop the amortization of goodwill with an expected net
carrying value of approximately $10,346,000 at the date of adoption and annual
amortization of $361,000 that resulted from business combinations completed
prior to the adoption of SFAS 141.
9
DISCLOSURES ABOUT RISK
These disclosures are intended to discuss certain material risks of the
Company's business as they appear to management at this time. However, this list
is not exhaustive. Other risks may, and likely will, arise from time to time.
OUR REVENUES AND OPERATING RESULTS FLUCTUATE SIGNIFICANTLY FROM QUARTER TO
QUARTER
We believe period-to-period comparisons of our operating results are not
necessarily meaningful, and cannot be relied upon as indicators of future
performance. In addition, there can be no assurance that our revenues will grow
or be sustained in future periods or that we will maintain our current
profitability in the future. Significant factors in these quarterly
fluctuations, none of which are within our control, are changes in consumer
demand for our wines, the affect of weather and other natural forces on growing
conditions and, in turn, the quality and quantity of grapes produced by us,
interest rates and other business and economic conditions. Additionally, our
sales volume tends to be affected by price increases, distributors' inventory
levels and the timing of releases for certain wines, among other factors.
Consequently, we have experienced, and expect to continue to experience,
seasonal fluctuations in revenues and operating results.
A large portion of our expenses are fixed and difficult to reduce in a
short period of time. In quarters when revenues do not meet our expectations,
our level of fixed expenses tends to exacerbate the adverse effect on net
income. In quarters when our operating results are below the expectations of
public market analysts or investors, the price of our common stock may be
adversely affected.
OUR BUSINESS IS SEASONAL
Our business is subject to seasonal as well as quarterly fluctuations in
revenues and operating results. Our sales volume tends to increase during the
summer months and the holiday season and decrease after the holiday season. As a
result, our sales and earnings are typically highest during the fourth calendar
quarter and lowest in the first calendar quarter. Seasonal factors also affect
our level of borrowing. For example, our borrowing levels typically are highest
during winter when we have to pay for harvest costs and may have to make
contractual payments to grape growers. These and other factors may cause
fluctuations in the market price of our common stock.
OUR PROFITS DEPEND LARGELY ON SALES IN CERTAIN STATES AND ON SALES OF
CERTAIN VARIETALS
In the three months ended June 30, 2001, approximately 86% of our wine
sales were concentrated in 20 states. Changes in national consumer spending or
consumer spending in these states and other regions of the country could affect
both the quantity and price level of wines that customers are willing to
purchase.
Approximately 89% of our consolidated net revenues in the three months
ended June 30, 2001 were concentrated in our four top selling varietal wines.
Specifically, sales of Chardonnay, Pinot Noir, Cabernet Sauvignon and Merlot
accounted for 45%, 12%, 19% and 13% 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.
10
THE CHALONE WINE GROUP, LTD.
BAD WEATHER, PESTS AND PLANT DISEASES COULD HARM OUR BUSINESS
Winemaking and grape growing are subject to a variety of agricultural
risks. Various diseases and pests and extreme weather conditions can materially
and adversely affect the quality and quantity of grapes available to us. This
could reduce the quality or amount of wine we produce. A deterioration in the
quality of our wines could harm our brand name, and a decrease in our production
could reduce our sales and profits. Future government restrictions regarding the
use of certain materials used in grape growing may increase vineyard costs
and/or reduce production.
Grape growing requires adequate water supplies. We generally supply our
vineyards' water needs through wells and reservoirs located on our properties.
We believe that we 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. The
Company is actively supporting the efforts of the agricultural industry to
control this pest and is 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.
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
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
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 46%, respectively, of our net revenues during
the three months ended June 30, 2001. 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 38% of our net revenues during the three-month
period ended June 30, 2001. 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.
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THE CHALONE WINE GROUP, LTD.
NEW REGULATIONS OR INCREASED REGULATORY COSTS COULD HARM OUR BUSINESS
The wine industry is subject to extensive regulation by the Federal Bureau
of Alcohol, Tobacco and Firearms and various foreign agencies, state liquor
authorities and local authorities. These regulations and laws dictate such
matters as licensing requirements, trade and pricing practices, permitted
distribution channels, permitted and required labeling, advertising and
relations with wholesalers and retailers. Any expansion of our existing
facilities or development of new vineyards or wineries may be limited by present
and future zoning ordinances, environmental restrictions and other legal
requirements. In addition, new regulations or requirements or increases in
excise taxes, income taxes, property and sales taxes or international tariffs,
could reduce our profits. Future legal or regulatory challenges to the industry,
either individually or in the aggregate, could harm our business.
WE WILL NEED MORE WORKING CAPITAL TO GROW
The premium wine industry is a capital-intensive business, which requires
substantial capital expenditures to develop and acquire vineyards and to improve
or expand wine production. Further, the farming of vineyards and acquisition of
grapes and bulk wine require substantial amounts of working capital. We project
the need for significant capital spending and increased working capital
requirements over the next several years, which must be financed by cash from
operations, additional borrowings or additional equity.
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 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
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 4% of total consolidated revenue for the three
months ended June 30, 2001. The volume of international transactions is
increasing and may increase these risks in the future.
INFRINGEMENT OF OUR TRADEMARKS MAY DAMAGE OUR BRAND NAMES OR OUR BUSINESS
Our wines are branded consumer products, and we distinguish our wines from
our competitors by enforcement of our trademarks. There can be no assurance that
competitors will refrain from infringing our marks or using trademarks,
tradenames or trade dress which dilute our intellectual property rights, and any
such actions may require us to become involved in litigation to protect these
rights. Litigation of this nature can be very expensive and tends to divert
management's time and attention.
OUR ACQUISITIONS AND POTENTIAL FUTURE ACQUISITIONS INVOLVE A NUMBER OF RISKS
Our acquisition of Staton Hills Winery (renamed Sagelands Winery), 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
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.
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THE CHALONE WINE GROUP, LTD.
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K.
The Company filed a report on Form 8-K, dated May 17, 2001, to report
the Company's final determination to change its fiscal year (Item 8.)
from one ending on March 31 to one ending on December 31.
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 8, 2001 THE CHALONE WINE GROUP, LTD.
----------------------- ----------------------------
(Registrant)
/s/ THOMAS B. SELFRIDGE
------------------------------------------
Thomas B. Selfridge
President and Chief Executive Officer
DATED: AUGUST 8, 2001 /s/ SHAWN CONROY BLOM
---------------------- ------------------------------------------
Shawn Conroy Blom
Vice President and Chief Financial Officer
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