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SECURITIES & EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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 (I.R.S. Employer Identification Number)
of Incorporation or Organization)
621 Airpark Road, Napa, CA 94558
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (707) 254-4200
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
No par value common stock
(Title of Class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of June 8, 1999, there were 2,958,922 shares of the Company's voting no par
value common stock, with an aggregate market value of $27,370,029 held by
non-affiliates. For purposes of this disclosure, shares of common stock held by
persons who hold more than 5% of the outstanding shares of the Registrant's
common stock and shares held by officers and directors of the Registrant have
been excluded because such persons may be deemed to be affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the 1999 Annual Meeting of
Shareholders of The Chalone Wine Group, Ltd. (the "Proxy Statement"), to be
filed with the Securities and Exchange Commission within 120 days after March
31, 1999, are incorporated by reference into Part III of this report.
PART I
Item 1. Business.
a. General.
The Company produces, markets and sells super, ultra and super-ultra
premium white and red varietal table wines, primarily Chardonnay, Pinot Noir,
Cabernet Sauvignon, Merlot and Sauvignon Blanc. The Company operates six
wineries; four located in various counties of California, and two located in the
State of Washington. The Company's wines are made principally from grapes grown
at the Chalone Vineyard(R), Carmenet(R) Vineyard, Edna Valley Vineyard(R),
Company-owned vineyards adjacent to the Acacia(TM) Winery in California and the
Canoe Ridge(R) Vineyard in Washington State. These wines are primarily sold
under the labels "Chalone Vineyard," "Edna Valley Vineyard," "Carmenet,"
"Acacia," "Canoe Ridge Vineyard," and "Echelon(TM)".
As a result of a substantial investment in the Company by France-based Les
Domaines Barons de Rothschild (Lafite) ("DBR"), the Company receives an
allocation of DBR wines, including the wines of Chateau Lafite-Rothschild and
Chateau Duhart-Milon, first-growth and fourth-growth Bordeaux region wines,
respectively.
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. Today, the
Company is one of only nine publicly-held U.S. corporations whose principal
business is in the production, marketing and selling of wine.
Change in Fiscal Year-End
In 1997, the Company changed its fiscal year-end from December 31 to March
31. The Company filed a transition report pursuant to Section 13 of the
Securities Exchange Act of 1934 for the three month period ending March 31,
1997.
Significant Events
Echelon Brand: The Company introduced its Echelon brand in April 1998.
Echelon brand wines are blended from small lots of wine from several of the
Company's California properties and purchased grapes and bulk wine. The
suggested retail price for the brand's various wines ranges between $12 and $14.
This price structure is intended to create wines in a lower price category than
the Company's other wines in the super and ultra-premium wine categories. The
Company expects the Echelon brand to increase the number of its wines served
by-the-glass in restaurants. This first Echelon release consisted of 60,000
cases of 1997 California Central Coast Chardonnay, followed by 26,000 cases of
1997 Pinot Noir in September 1998, and 36,400 cases of 1997 Merlot in January
1999. The Company plans to release a Syrah during the next year.
Vintage Lane Property: In April 1998, the Company purchased twenty two
acres of prime vineyard land in Sonoma Valley located approximately seven miles
from the Company's Carmenet Vineyard. The Company intends to use the property,
which includes a winery with a 1,200 ton crush capacity, to expand production of
Carmenet's Dynamite wines. In keeping with the Company's plans to use the
property as a red wine production facility, fourteen acres of existing vineyards
planted to Chardonnay were removed, most of which is expected to be replanted to
Merlot by the end of March 2000.
Exercise of Warrants: The Company received gross proceeds of $1 million in
April 1998 upon the sale of 142,857 new shares of its common stock issuable upon
exercise of the Company's outstanding $7.00 warrants issued as of March 29, 1993
(the "Warrants"). The new shares issuable upon exercise of the Warrants were
issued pursuant to an exemption from the registration requirements of federal
and state securities laws. One institutional warrant-holder, who exercised all
of its outstanding Warrants during March, 1998 also exercised its right to
demand registration of 142,857 shares of the Company's common stock received
upon exercise thereof. The Company filed a shelf registration statement on Form
S-3 in respect of the foregoing shares which became effective on May 7, 1999.
The proceeds received from Warrants exercised were used for general working
capital purposes.
-2-
Carmenet Fire: In July 1996, a wildfire damaged approximately 75% of the
producing acreage at the Carmenet Vineyard. Prior to the fire, Carmenet produced
approximately 38,000 cases of wine annually (of which a significant portion was
estate bottled). Carmenet's 1996 grape harvest was reduced roughly in proportion
to the percentage of the vineyard's overall producing acreage damaged by the
fire.
The Company has completed replanting the damaged acreage. Historically,
newly planted vines produce production-quality grapes in approximately three
years, although the vines are expected to take approximately seven years to
return to the full production levels that pre-dated the fire. Until the damaged
acreage returns to full production, Carmenet's ability to make estate bottled
wines will be limited. Pending the return to full production levels, the Company
intends to continue to attempt to buy suitable grapes on the open market to
supplement Carmenet's reduced harvests. See Item 3(a): Settlement of Litigation
Arising from the Carmenet Fire.
Convertible Debentures: During April 1999, holders of the Company's 5%
Convertible Subordinated Debentures Due 1999 (the "Debentures") converted
Debentures with a face value of $6.5 million into 738,014 new shares of the
Company's common stock. At such time, holders of the remaining $2.0 million in
debentures elected not to exercise their conversion rights and the Company
repaid the $2.0 million using available borrowings under its line of credit.
Additional Financing: On March 31, 1999, the Company moved its borrowings
from Wells Fargo Bank to Cooperatieve Centrale Raiffeisen-Boerlenleenbank B.A.,
"Rabobank-Nederland," New York branch, In connection with this change, the
Company refinanced approximately $24 million of its outstanding secured debt
with Wells Fargo Bank. Rabobank will provide an aggregate of $70 million of
available unsecured financing, an increase of approximately $40 million and a
change from secured to unsecured financing. Copies of the credit agreement and
related promissory notes are attached hereto as Exhibits.
Canoe Ridge Expansion: In September 1998, Canoe Ridge Vineyard purchased
its leased winery facility in a recently renovated historic building in downtown
Walla Walla, Washington, together with two parcels adjacent to the winery, for a
total of $632,000. The adjacent parcels are intended for expansion of the
existing winery's production capacity.
Edna Valley Expansion: In April 1999, the Edna Valley Joint Venture
commenced a $2.1 million, 16,000 square foot construction project, at the Edna
Valley Winery. Upon completion, presently scheduled during the fall of 1999,
this expansion is expected to double Edna Valley Vineyard's production capacity.
Acacia Winery: Lease-Purchase Agreement: During January 1999, the Company
entered into a lease-purchase agreement for approximately 50 acres of vineyard
property adjacent to the Marina Vineyards surrounding the Acacia Winery. The
lease terminates on December 31, 2023, and requires annual rent payments ranging
from $74,000 per year in its first year to $121,000 per year in 2023. As of
March 31, 1999, the Company made the first of four biannual payments of $12,000
for an option to acquire this property for $1.1 million.
Subsequent Event: Acquisition of Washington State Winery and Related Grape
Contracts: On June 15, 1999, the Company purchased 100% of the outstanding
shares of SHW Equity Co., a holding company which, in turn, owns 100% of Staton
Hills Winery and its adjacent vineyards in Yakima County, Washington. The cost
of the acquisition was approximately $6.0 million and was financed with the
Company's long-term bank line of credit.
The Company intends to use the Staton Hills facility as the home of a new
Washington State wine brand featuring Merlot and Cabernet Sauvignon from these
three viticultural regions. The Company's present plan for the new brand,
expected to be named in the fall of 1999, is to initially produce 20,000 cases
for sale to the super-premium wine market.
b. Financial Information about Industry Segments.
The Company presently operates six wineries, and also distributes certain
French, Chilean and Mexican wines and small quantities of domestic wines of
other producers in the United States. The marketing and sales of all of the
wines are handled on a consolidated basis in all of the Company's distribution
channels. Hence, the Company considers all of its business to be within a single
industry segment.
For the last two fiscal years and the previous calendar year, sales of wine
accounted for substantially all of the Company's consolidated revenues and
operating profits.
-3-
c. Narrative Description of Business.
Overview
The Company owns the following seven wineries in the United States and
France, either wholly or in partnership with others, all of which have related
vineyards with the exception of Edna Valley Vineyard. The specific ownership
structure is as follows:
Property Ownership Form of Ownership Location
-------- --------- ----------------- --------
Chalone 100.0% Corporation Soledad, California
Carmenet Vineyard 100.0% Corporation Sonoma, California
Acacia
Acacia Winery 100.0% Corporation Napa, California
Marina Vineyard 50.0% Partnership Napa, California
Edna Valley Vineyard 50.0% Partnership San Luis Obispo, California
Canoe Ridge Vineyard 50.5% Limited liability company Walla Walla, Washington
Chateau Duhart-Milon 23.5% Partnership Pauillac, France
Staton Hills Winery 100.0% Corporation Yakima Valley, Washington
With the exception of Chateau Duhart-Milon ("Duhart-Milon"), the Company
manages and operates all of the above properties and consolidates the results of
their operations. The Company accounts for its investment in Duhart-Milon using
the equity method of accounting.
Each of the six domestic wineries is in a separate "viticultural area."
Viticultural areas are designations granted by the Federal Bureau of Alcohol,
Tobacco and Firearms to identify grape-growing areas distinguishable by their
specific and definable geographic and climatic characteristics. Wineries may
indicate a viticultural area on a bottle label only if 85% or more of the grapes
used to produce the wine were grown in that viticultural area.
All of the Company's wines are vintage dated, and most of its primary label
wines are estate bottled. A vintage dated wine is produced wholly from grapes
that were harvested, crushed and fermented in the calendar year shown on the
label. The "Estate Bottled" designation may be applied only to wines made
exclusively by one winery from grapes grown on land owned or controlled by the
winery, all within a single viticultural area.
For a more detailed description of the Company's properties and its
operations, see Item 2, Properties.
Vineyard Practices
The Company believes that the soils and climates of the vineyards from
which it obtains its grapes are particularly suitable for the varieties of
grapes to which they have been planted. Mountain vineyards, including Chalone
Vineyard and Carmenet Vineyard, normally produce lower yields of grapes than
valley vineyards. Vineyards situated closer to the floor of the valleys,
including the cool Carneros District of the Napa Valley, from which the
Company's Acacia wines are made, tend to produce higher grape yields.
The Company generally manages its vineyards to produce yields which are
lower than average for similarly situated vineyards in California and Washington
State. It believes that relatively low yields enhance the varietal character of
the grapes and improve the quality of the resulting wines.
Agricultural Risks; Phylloxera
Winemaking and grape growing are subject to a variety of agricultural
risks. Various diseases, pests, drought, frosts and certain other weather
conditions can materially and adversely affect the quality and quantity of
grapes available to the Company, thereby materially and adversely affecting the
supply of the Company's products and its profitability.
Many California vineyards, including vineyards in northern California, have
been infested in recent years with Phylloxera, a root louse that renders a vine
unproductive within a few years following infestation. The current strain of
Phylloxera primarily affects vines of a certain type. The Company's vineyard
properties are primarily planted to rootstocks believed to be resistant to
Phylloxera. However, there can be no assurance that the Company's existing
vineyards, or the rootstocks the Company is now using in its planting and
replanting programs, will not become susceptible to current or new strains of
Phylloxera, plant insects or diseases, any of which could adversely affect the
Company.
-4-
Winemaking Practices
The Company's winemaking practices are derived primarily from the
traditional methods of France, adapted to the particular requirements of
California and Washington State. The Company believes that these methods, while
requiring relatively high amounts of hand labor, produce the best wines. At the
Chalone Vineyard and Edna Valley Vineyard facilities, the Company follows the
traditional winemaking practices of the Cote d'Or in the Burgundy region of
France. The wines are made from single grape varieties, principally Pinot Noir
and Chardonnay. The winemaking practices at Acacia Winery, although differing in
some degree from those at Chalone Vineyard and Edna Valley Vineyard, also follow
Burgundian winemaking practices and produce wines from single grape varieties.
At Carmenet Vineyard, the Company follows the practices of the Medoc and Graves
districts in the Bordeaux region of France, whose wines are generally made from
a blend of varieties. At Canoe Ridge Vineyard in Washington State, the Company
follows the winemaking practices of the Pomerol district in the Bordeaux region
of France which emphasizes Merlot rather than Cabernet Sauvignon grapes.
All of the Company's wineries are under the overall supervision of the
Company's President and Chief Executive Officer. In addition, each winery is
operated as a separate profit center, with its own General Manager, who is in
most instances also the winemaker.
The Company imports approximately 75% of its oak barrels from Burgundy and
Bordeaux. The remainder are produced in the United States. The Company's wine
bottles are made to its specifications in the United States and France and are
closed with imported corks, branded with the particular winery's name.
The Company's winemaking practices follow the principle that winemaking is
a natural process best managed with a minimum of intervention, but requiring the
attention and dedication of a winemaker. Notwithstanding the relatively high
level of hand labor utilized in the Company's winemaking processes, the Company
also makes extensive use of modern laboratory equipment and techniques to
monitor the progress of each wine through all stages of the winemaking process.
Wine Production and Wines
This table sets forth the wine production of the Company for the 1998, 1997
and 1996 vintages. The wines' vintage is the year during which the grapes are
harvested. As of March 31, 1999, the current year's vintage (1999) had not yet
been harvested and cannot yet be estimated.
The following information is presented in terms of "equivalent" number of
cases because the subject wine is still being aged in barrels and tanks. For the
purpose of this schedule and the discussion which follows, wines purchased by
the Company for resale are excluded.
VINTAGE
----------------- ------------------ -----------------
1998 1997 1996
----------------- ------------------ -----------------
Equivalent Equivalent Equivalent
Number of % of Number of % of Number of % of
Cases Total Cases Total Cases Total
------- ------ ------- ------- ------- ------
Chardonnay 231,340 55% 243,900 59% 151,900 62%
Sauvignon Blanc 8,750 2% 7,000 2% 7,200 3%
Pinot Blanc 2,200 1% 3,100 1% 5,900 2%
Other white wines 1,405 0% 5,700 1% 2,700 1%
------- ------ ------- ------- ------- ------
Total white wines 243,695 58% 259,700 63% 167,700 68%
------- ------ ------- ------- ------- ------
Pinot Noir 35,100 8% 54,200 13% 35,100 14%
Cabernet Sauvignon 40,900 10% 46,900 11% 26,300 11%
Merlot 85,500 20% 47,200 12% 14,700 6%
Other red wines 16,200 4% 4,500 1% 1,400 1%
------- ------ ------- ------- ------- ------
Total red wines 177,700 42% 152,800 37% 77,500 32%
------- ------ ------- ------- ------- ------
Total production 421,395 100% 412,500 100% 245,200 100%
======= ====== ======= ======= ======= ======
The Company's wines are fermented and aged primarily in new and used oak
barrels before they are bottled. Generally, white wines are aged from six to
nine months and red wines from nine to eighteen months. The wine is then bottled
and stored for further aging. White wines are generally released between two
months and one year after bottling, while red wines are released between three
months to two years after bottling. Although the Company's wines are ready to be
consumed when sold, it generally takes from six months to two years, and may
take longer, for the wine to fully develop.
-5-
Chalone Vineyard: Chalone Vineyard production represented 15% of the
Company's consolidated sales dollars and 10% of the consolidated case sales for
the fiscal year ended March 31, 1999.
Chalone Vineyard has been producing Chardonnay, Pinot Blanc and Pinot Noir
(and small quantities of Chenin Blanc) since 1970. All wines sold under this
label are produced from grapes grown at the Chalone Vineyard or under the
Company's control at adjacent vineyards, and are estate bottled.
Carmenet Vineyard: Carmenet Vineyard production represented 15% of the
Company's consolidated sales dollars and 14% of the consolidated case sales for
the fiscal year ended March 31, 1999.
The Company produces Bordeaux-style "Meritage" red and white wines under
the "Carmenet" label. The Carmenet red wine is made from Cabernet Sauvignon,
Merlot and Cabernet Franc grapes grown at the Carmenet Vineyard, is estate
bottled, and bears the "Sonoma Valley" viticultural area designation. The
Company also produces red wines under the "Carmenet Dynamite" label, which are
made from Cabernet Sauvignon and Merlot grapes and bulk wine purchased from
various vineyards in the North Coast area of California. The Carmenet white wine
is made from Sauvignon Blanc and Semillon grapes purchased from Paragon Vineyard
Co., Inc ("Paragon") under a grape purchase agreement and bears the "Edna
Valley" appellation. See Item 1, Significant Events: Carmenet Fire.
Edna Valley Vineyard: Edna Valley Vineyard production represented 23% of
the Company's consolidated sales dollars and 25% of consolidated case sales for
the fiscal year ended March 31, 1999.
Edna Valley Vineyard has been producing mostly Chardonnay and Pinot Noir
wines since 1980. The majority of wines sold under the Edna Valley Vineyard
label are produced from grapes grown by Paragon, the Company's partner in the
Edna Valley Vineyard Joint Venture, and are estate bottled.
Acacia Winery: Acacia Winery production represented 17% of the Company's
consolidated sales dollars and 15% of the consolidated case sales for the fiscal
year ended March 31, 1999.
The Company produces Chardonnay and Pinot Noir wines under the "Acacia"
label. Most of the grapes for the production of Pinot Noir and approximately
two-thirds of the grapes for Chardonnay are acquired from various vineyards in
the Carneros region, in most cases pursuant to grape purchase contracts. The
remaining Chardonnay and Pinot Noir grapes are grown on approximately 134 acres
of vineyards owned and leased by the Company, which are in the vicinity of the
winery.
Canoe Ridge Vineyard: Canoe Ridge Vineyard production represented 7% of the
Company's consolidated sales dollars and 7% of the consolidated case sales for
the fiscal year ended March 31, 1999.
The Canoe Ridge Vineyard commenced operations in 1994 and produces Merlot,
Cabernet Sauvignon and Chardonnay wines under the "Canoe Ridge Vineyard" label.
The grapes for these wines are grown at the Company's vineyard in Benton County,
Washington and bear the "Columbia Valley" viticultural area designation.
Echelon: Echelon production represented 12% of the Company's consolidated
sales dollars and 18% of the consolidated case sales for the fiscal year ended
March 31, 1999.
The 1997 vintage was the first to be released under the Echelon label.
Chardonnay, Merlot and Pinot Noir are produced under the Echelon label and bear
a Central Coast appellation. The Company anticipates releasing a Syrah under the
Echelon label during the next fiscal year.
Custom Brands: Part of each winery's production is occasionally used for
bottling of custom brands in addition to the wines bottled under each winery
label. These custom brands are often comprised of production from other Company
wineries, for which the percentage-of-sales contributions are already stated
above.
Custom brands consist primarily of Chardonnay, Cabernet Sauvignon and Pinot
Noir. Quantities of custom brands bottling is highly dependent upon grape supply
and availability. As grapes become more scarce, the focus of the Company's
production shifts away from custom brands as they are relatively lower margin
products. The Company uses custom brands primarily as a means of marketing and
selling its label wines and does not intend to focus its efforts in this line of
business.
Imports & Other: The remaining 11% of the Company's consolidated sales and
11% of case sales in the year ended March 31, 1999 were primarily comprised of
import wines and, to a lesser degree, domestic wines purchased by the Company
for resale purposes.
Under the terms of various agreements and investments among the Company,
Duhart-Milon and DBR, the Company receives an allocation of the wines of DBR and
Duhart-Milon including the wines of Chateau Lafite-Rothschild and Chateau
L'Evangile of the Pauillac and Pomerol regions of Bordeaux, respectively, and of
Chateau Rieussec of the Sauternes region of Bordeaux. DBR also produces a
Pauillac wine exclusively for the Company.
-6-
General
The principal raw materials used by the Company are oak barrels, glass,
cork and grapes. Oak barrels are purchased mostly from France (75%) and the
United States. French oak barrels are preferred due to Company tradition,
consumer taste and preferences. Cork is produced and manufactured in Portugal,
which is the primary cork-producing country in the world and is purchased in the
United States. Sources of cork elsewhere are relatively scarce. Glass is
purchased from a variety of different sources according to specific needs as
determined by the Company. A substantial portion of the Company's grape
requirements is produced on the Company's own vineyards. The remaining grape
requirements are met through purchases of available grapes and bulk wine from
California and Washington growers.
Marketing and Distribution
The Company's wines are positioned in the higher end of the premium
category (wines selling over $3 per bottle at retail.) The table below presents
the price positioning of its labels across those categories:
The Company sells its wines through direct sales, independent distributors,
brokers and its mailing list. These wines are then marketed through specialty
wine shops and grocery stores, selected restaurants, hotels and private clubs
across the country, in certain overseas markets and, in limited quantities,
directly from its wineries. The Company relies primarily on word-of-mouth
recommendations, wine tastings, articles in various publications and
Company-sponsored promotional activities in order to increase public awareness
of its wines.
Sales Within California
Sales and the marketing of all of the Company's wines within California,
including custom brands, have historically been made through the Company's own
sales force and through a wholesale marketer, who acts as a broker. In the year
ending March 31, 1999, the Company began exclusively using a broker for all
wholesale California sales.
The Company offers its reserve wines, older wines and other special wines
to its approximately 12,000 shareholders and other consumers directly from its
centralized distribution center by telephone or mail order. The Company sends
two major offerings to all mail-order customers each year and frequent
additional catalogs exclusively to and for our shareholders. Due to restrictions
on direct retail sales of wines under the laws of other states, the Company
confines direct mail shipments to purchasers with addresses in California and
thirteen other states which have reciprocal cross-sale arrangements with the
State of California.
-7-
Sales Outside California
The Company's wines are marketed by independent distributors outside
California in 49 states and the District of Columbia and Puerto Rico and,
internationally, in Bermuda, the British West Indies, the U.S. Virgin Islands,
Canada, England, continental Europe, Hong Kong, China and Japan. In 1993, the
Company established a sales and marketing division, operating as Chalone Wine
Estates, to supervise and coordinate sales functions of the Company's business
and its custom brands operations. The Company employs a number of regional sales
managers who work directly with distributors in a particular region and their
customers.
Case Sales by Method of Distribution
The following table sets forth case sales by the Company by distribution
method for the year ended March 31, 1999, fiscal year ended 1998, and calendar
year 1996.
Year ended Year ended Year ended
March 31, March 31, December 31,
------------------ ------------------ ------------------
1999 1998 1996
------------------ ------------------ ------------------
Number of % of Number of % of Number of % of
Cases Total Cases Total Cases Total
------- ------- ------- ------- ------- -------
Independent distributors
United States 210,624 56% 144,328 45% 121,403 41%
International 16,766 4% 12,306 4% 12,574 4%
------- ------- ------- ------- ------- -------
Total distributors 227,390 60% 156,634 49% 133,977 45%
------- ------- ------- ------- ------- -------
Company direct
California wholesale 99,405 26% 93,418 29% 85,378 29%
Custom brands 26,453 7% 46,840 15% 52,233 17%
Catalog and winery retail 26,679 7% 25,639 7% 27,454 9%
------- ------- ------- ------- ------- -------
Total Company direct 152,537 40% 165,897 51% 165,065 55%
------- ------- ------- ------- ------- -------
Total 379,927 100% 322,531 100% 299,042 100%
======= ======= ======= ======= ======= =======
Centralized Administration and Warehousing
The Company's wineries are all supported by a leased 11,500 sq. ft. central
office located in Napa County, California, at the Napa Airport Business Park. In
addition to housing the Company's central executive office, this facility serves
as a central distribution center from which all of the Company's wines are
stored prior to shipping. The Company also rents separate warehouse facilities
as needed in local markets. The central facility lease is for a 15-year initial
term, expiring in November 2008, with a five-year extension option.
Employees
On March 31, 1999, the Company had 130 full-time employees, of which 76
were in grape growing and winemaking, 16 were in sales, and 38 were in
administration. During the spring and summer, the Company adds approximately 11
to 16 part-time employees for vineyard care and maintenance and 70 to 90
part-time employees for the spring bottling. In the autumn, up to 65 part-time
employees are hired for the grape harvest and related winery work. The Company's
hiring and employment policies for both full-time and part-time employees are
believed to comply with all relevant laws, including immigration laws.
None of the employees of the Company (including its subsidiary and joint
ventures) are represented by a union. The Company believes that its wage rates
and benefits are competitive and that its relations with the Company's employees
are excellent.
Regulation; Permits and Licenses
The production and sale of wine are subject to extensive regulation by
various federal and state regulatory agencies, which require the Company to
maintain various permits, bonds and licenses.
In addition to all required winery permits and licenses, the Company holds
federal importer's and wholesaler's permits and California importer's, beer and
wine wholesale, and beer and wine retail (off-sale) licenses. Under these
permits and licenses, the Company is authorized to import wines into the United
States from foreign countries, to import wines into California from other
states, and to warehouse and sell wines other than those of its own production.
The Canoe Ridge Vineyard holds its own winery permit and license. The Company
believes it is in compliance with all currently applicable federal and state
regulations.
The Company's wines are subject to California state and federal excise
taxes (at the aggregate rate of $1.27 per gallon), and varying other state
excise taxes, payable at the time of shipment to customers.
-8-
Trademarks
CHALONE VINEYARD, CARMENET and the Acacia "A" logo are federally registered
trademarks owned by the Company. EDNA VALLEY VINEYARD is a federally registered
trademark owned by Paragon and licensed exclusively to the Edna Valley Vineyard
Joint Venture. CANOE RIDGE is a federally registered trademark owned by Canoe
Ridge Vineyard, LLC. STATON HILLS is a federally registered trademark owned by
Staton Hills Winery Company, Ltd., which is expected to be assigned to the
Company pursuant to the terms of an agreement dated June 15, 1999, among Peter
Ansdell, SHW Equity Co. and the Company. The foregoing marks, except STATON
HILLS, are also registered in Japan with the Japanese Patent Office. These
marks, and other common-law marks, are of significant importance to the
Company's business as label and brand recognition are important means of
competition within the wine industry.
Shareholder Benefits
Shareholders of the Company are entitled to benefits which are not provided
to other mail-order customers at large. For example, certain wines of limited
production are offered only to shareholders. Beneficial owners of 100 shares or
more of the Company's common stock are entitled to a 20%-30% discount from
suggested retail prices on most mail-order or other direct purchases from the
Company. The Company has also provided annual discounts to shareholders based on
their shareholdings in the form of a "Wine Dividend Credit," which allows
shareholders owning 100 or more shares to receive a credit towards the purchase
of wines during the duration of the program. The Wine Dividend Credit may be
used for up to 50% of the wine value of an order and is generally offered in the
fall of each year. The credit amount was $.12 per share for each of the last
three years. The Company also offers to shareholders, at the shareholders'
expense, travel programs to various wine-growing regions of the world. In the
past, the Company has provided travel programs to France, Chile, Australia,
Portugal, South Africa, Italy and New Zealand. Each spring, shareholders are
invited to attend the Company's annual Shareholder Celebration. For a nominal
fee, attendees attend an all-day wine tasting, auction and luncheon, which is
typically held on the grounds of the Chalone vineyards in Monterey County,
California. In 1999, approximately 1450 shareholders and guests from 33 states
and 3 foreign countries attended the luncheon, which featured tastings of all of
the Company's new wines, most of its best wines, and a sumptuous luncheon.
Seasonality
See Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations below for a discussion of the seasonal nature of the
Company's business.
-9-
Item 2. Properties.
The Company's principal winemaking activities presently are conducted at
five locations, four in California and one in eastern Washington. The following
table shows the producing acreage, by grape variety, at the various vineyards
owned, in whole or in part, by the Company, vineyard acreage currently in
development and the remaining undeveloped acreage suitable for future planting.
Acreage listed as "Developing and replanted" may consist of acreage which was
unplanted, or previously producing acreage which has been, or presently is,
being replanted. Due to the relatively recent acquisition of Staton Hills
Winery, data on this property is omitted.
At March 31, 1999
------------------------------------------------------
Developing
Producing & replanted Unplanted Total
------------ --------------- ------------ ------------
Chalone Vineyard:
Chardonnay 110 65 - 175
Pinot Noir 43 109 - 152
Pinot Blanc 30 - - 30
Chenin Blanc 8 - - 8
Other 2 37 - 39
Unplanted - - 98 98
------------ --------------- ------------ ------------
Subtotal 193 211 98 502
------------ --------------- ------------ ------------
Carmenet Vineyard:
Cabernet Sauvignon 19 32 - 51
Cabernet Franc 14 6 - 20
Merlot 4 3 - 7
Chardonnay - - - -
Other 2 5 - 7
Unplanted - 11 8 19
------------ --------------- ------------ ------------
Subtotal 39 57 8 104
------------ --------------- ------------ ------------
Acacia Winery (including leasehold interest):
Chardonnay, Viogner 36 - - 36
Pinot Noir 15 39 - 54
Unplanted - - 44 44
------------ --------------- ------------ ------------
Subtotal 51 39 44 134
------------ --------------- ------------ ------------
Canoe Ridge Vineyard (including minority interest):
Cabernet Sauvignon 40 8 - 48
Merlot 64 10 - 74
Chardonnay 29 - - 29
Other - 6 - 6
Unplanted - - 26 26
------------ --------------- ------------ ------------
Subtotal 133 24 26 183
------------ --------------- ------------ ------------
Total Acreage 416 331 176 923
============ =============== ============ ============
Chalone Vineyard
Chalone Vineyard is located on approximately 950 acres in Monterey,
California (of which 502 acres are plantable), approximately 1,500 feet above
the floor of the Salinas Valley, in a viticultural area called "Chalone." The
soil is composed of volcanic rock over a bed of limestone and is similar to the
soil found in the Burgundy region of France. The elevation of the vineyard
provides natural protection against frost. The area surrounding the vineyard has
an average annual rainfall of 14 inches. The Company's water needs are
supplemented by a reservoir and a well, which the Company believes will supply
sufficient water for the vineyard's current and future needs.
Chalone Vineyard was established in the early 1920s and is the oldest
commercial vineyard in Monterey County. The Company has produced premium wines
from the vineyard since 1969, when it acquired the vineyard from a former
director of the Company, the late Richard H. Graff.
The property includes a tasting room, dining facilities for private parties
and approximately 8,500 square feet of caves for barrel storage. The winery's
current production capacity is 48,000 cases.
-10-
The Company produces primarily Chardonnay and Pinot Noir at this facility
and markets these wines under the "Chalone Vineyard" and "Gavilan(TM)" labels
(production of "Gavilan" vintages was discontinued during 1998).
Carmenet Vineyard
Carmenet Vineyard is located on approximately 300 acres in Sonoma County,
California (of which 104 acres are plantable), located in the "Sonoma Valley"
viticultural area. On July 31, 1996, a fire at the vineyard damaged
approximately 75% of its producing acres which were planted to Cabernet
Sauvignon, Merlot and Cabernet Franc. The Company has replanted these acres with
essentially the same varieties. See Item 1, Business, Significant Events
- -Carmenet Fire.
The vineyard is situated in the Mayacamas Mountains just north of the town
of Sonoma, at an elevation of 1,200 feet. The grapevines are grown on steep
hillsides in rocky, well-drained soil. The average rainfall is 30 inches. The
Company's water needs are supplemented by two wells, which the Company believes
will supply sufficient water for the vineyard's current and future needs, using
a drip irrigation system. As at Chalone Vineyard, the elevation of Carmenet
Vineyard provides natural protection against frost.
In addition to the production area, the property includes a reception area,
dining facilities for customers and guests, and 15,000 square feet of barrel
caves. The barrel caves are bored into a solid rock hillside adjacent to the
fermentation building and provide an ideal environment for aging wine in barrels
without artificial temperature control.
In March 1998, the Company purchased 22 acres of vineyard land in the Glen
Ellen area of Sonoma Valley, approximately seven miles from the Carmenet Winery.
In addition to the vineyards, the Glen Ellen acquisition included a crush and
fermenting facility with a 1,200-ton capacity, which the Company plans to use to
expand production of Carmenet's "Dynamite" wines. With this recent addition, the
Carmenet winery now has the ability to crush and ferment 92,000 cases.
The Company plans to use the Glen Ellen winery facility as a red-wine
production facility, Fourteen acres of Chardonnay were removed, and three acres
were replanted to Merlot. The Company currently intends to replant nine
additional acres to Merlot later this year.
At this property, the Company principally produces Bordeaux-style red and
white wines which are marketed under the "Carmenet" brand name.
Edna Valley Vineyard
Paragon Vineyard is located on approximately 1,100 acres in San Luis Obispo
County, California, in the "Edna Valley" viticultural area. The property is
operated by Paragon Vineyard Company, which leases the winery to the Edna Valley
Vineyard Joint Venture (the "Joint Venture"). The Joint Venture is 50% owned by
the Company and 50% owned by Paragon, subject to an agreement between the
Company and Paragon entered into on January 1, 1991, as amended on December 27,
1996 (the "Edna Valley Agreement"). The Company is the managing joint venture
partner and it manages and supervises the winery operations and sells and
distributes its wine.
In 1996, the property's ground lease was amended to provide additional land
for planned expansion of the winery, which subsequently was expanded from
approximately 24,000 square feet to over 32,000 square feet. The expanded
facility included a tasting room, dining facilities for private parties and
12,000 square feet of underground cellars for wine fermentation and barrel
aging. This increased the annual production capacity from approximately 60,000
cases to over 100,000 cases.
In April 1999, the Joint Venture began a separate $2.1 million, 16,000
square foot expansion project at the Edna Valley Vineyard. Upon completion,
presently scheduled during the fall of 1999, the latest expansion is expected to
double Edna Valley Vineyard's production capacity.
The Edna Valley Vineyard principally produces Chardonnay and Pinot Noir. It
also produces limited quantities of Viognier, Muscat, Pinot Blanc and Sauvignon
Blanc, all of which are marketed under the "Edna Valley Vineyard" label.
Acacia Winery
The Acacia Winery, and its related vineyards, are located on approximately
134 acres in Napa County, California, in both the "Carneros" and the "Napa
Valley" viticultural areas. The Company owns the winery building and the
winemaking equipment associated with the winery. The land on which the winery is
located (the "Winery Parcel") and a 41-acre producing vineyard surrounding the
winery complex (the "Marina Vineyard") are owned pursuant to a tenancy-in
- -common agreement: one half is owned by the Company and the remaining half is
owned by Mr. and Mrs. Henry Wright (the "Wrights"). The Company leases the
Wright's portion of the Winery Parcel and the Marina Vineyard pursuant to two
long-term leases, which commenced retroactively as of January 1, 1988, and
expire on December 31, 2017, subject to certain exceptions. The annual rent for
the Marina Vineyard was $116,361 in the year ended March 31,1999, subject to an
annual increase determined according to a formula based on premium quality
Carneros district Chardonnay prices.
Pursuant to the terms of the tenancy-in-common agreement, the Wrights have
the ability at any time to offer their interest in the Winery Parcel and the
Marina Vineyard to the Company, and, if the Company declines the offer, to list
the entire property for sale to a third party.
-11-
The Marina Vineyard is planted entirely to Chardonnay grapes on low rolling
hills in well-drained clay-loam soil. The majority of the vines were planted in
the mid-1970s, although significant replanting on new root stock was undertaken
in the early 1980s. The vineyard is not frost protected, but to date has not
experienced any significant losses due to frost damage. The average annual
rainfall is 22 inches. The vineyard is irrigated from a reservoir located on the
property.
The Company owns two vineyards adjacent to the Marina Vineyard to the east
comprising approximately 60 acres planted to Pinot Noir, of which fifteen acres
currently are producing and 45 acres are under development. During January 1999,
the Company entered into a lease-purchase agreement for approximately 50 acres
of additional vineyard property adjacent to the Marina vineyards. The new lease
expires on December 31, 2023 and provides for annual rent payments of $74,000 in
its first year and increases in various increments to $121,000 per year by 2023.
The terms of the lease also provide for the Company to purchase this property
for $1.1 million in consideration of certain biannual option payments. With the
addition of this lease, there are 42 acres of plantable land adjacent to the
Marina Vineyard to the west. The Company plans to plant this acreage to
Chardonnay and Pinot Noir over the next two years. Two reservoirs exist on these
properties and a third reservoir is in the planning stages in order to meet the
vineyards' current and future irrigation needs.
The property's current production capacity is approximately 63,000 cases.
This is expected to increase to approximately 75,000 cases in the future. The
property's principal wines are Chardonnay and Pinot Noir, which are marketed
under the "Acacia" brand.
Canoe Ridge Vineyard
The Canoe Ridge Vineyard is located in eastern Washington State, at an
altitude of approximately 800 feet on the eastern slope of the Canoe Ridge,
overlooking the Columbia River. The vineyard is in the "Columbia Valley"
viticultural area. Of the vineyard's approximately 275 acres (of which 183 acres
are plantable), 100 acres are now planted primarily to Merlot and, to a lesser
extent, to Chardonnay and Cabernet Sauvignon grapes. Although temperatures
during the winter months can fall below freezing, the vineyard's altitude and
easterly exposure, coupled with the Company's viticultural practices, are
believed to reduce the potential for freeze damage. The grapevines are grown in
well-drained, sandy-loam soil. The vineyard has an average annual rainfall of 6
inches and is irrigated with water from the Columbia River under an agreement
with an adjoining farm. The vineyard is owned by Canoe Ridge Vineyard, LLC, a
limited liability company in which the Company holds a 50.5% interest (the
"LLC"). The Company holds 25% of the membership interests of the LLC directly,
and 25.5% indirectly, through a wholly owned subsidiary of the Company.
In the fiscal year ended March 31, 1999, the LLC purchased its leased
winery facility in a recently renovated historic building which originally
served as the engine house for the Walla Walla Valley Railroad in downtown Walla
Walla. Additionally, the LLC purchased two parcels adjacent to the winery to
increase the current winery's capacity.
The Canoe Ridge Winery has an annual production capacity of approximately
27,000 cases, and produces primarily Chardonnay, Merlot and small amounts of
Cabernet Sauvignon.
Staton Hills Winery
Staton Hills Winery is located in Yakima County, Washington, on the banks
of the Yakima River. The vineyard is located in the Yakima Valley viticultural
area. The land on which the winery is located is a 22-acre parcel, of which
approximately 10 acres are planted. In addition to the vineyard area, the
property includes a 20,000 sq. ft. production and tasting facility with an
annual production capacity of 40,000 cases.
The Company plans to use the winery and related property as the core of a
new brand of red wine at the super-premium price point. The new brand, expected
to be named later this year, is expected to consist of Merlot and Cabernet
Sauvignon produced from grapes purchased under supply contracts from vineyards
in the Yakima Valley, Wahluke slopes and Walla Walla Viticultural areas. Staton
Hills Winery will continue to produce wines under this mark (which has been
assigned to the Company), with grapes produced in the Northern Yakima Valley.
Duhart-Milon
Duhart-Milon is located in the Medoc region of Bordeaux, France, in the
town of Pauillac. The Company holds a 23.5% interest in Societe Civile Chateau
Duhart-Milon ("Duhart-Milon"). The remaining 76.5% interest is owned by DBR. The
property consists of approximately 166 acres of producing vineyards adjacent to
the vineyards of the world famous Chateau Lafite-Rothschild and its related
winemaking facilities. In 1855, the French Government classified the top 62
wine-producing estates in the Medoc region, choosing from over 400 such estates.
These top 62 estates were further classified into five "growths," based on their
perceived quality. "First growth" was considered the best. Under this
classification system, Duhart-Milon is rated a "fourth growth" estate. The
average annual production in recent years has been approximately 35,000 cases.
Duhart-Milon wines are sold under the "Chateau Duhart-Milon" and "Moulin de
Duhart" labels.
-12-
Item 3. Legal Proceedings.
a. Settlement of Litigation Arising from the Carmenet Fire (the "PG&E"
Litigation).
As previously disclosed, on July 31, 1996 a wildfire damaged approximately
75% of the producing acreage at the Company's Carmenet Vineyard. Carmenet's
winery structures and barrel inventory were untouched by the blaze and no one
was injured.
An investigation revealed that the fire was caused by the electrical lines
of Pacific Gas and Electric ("PG&E"). Following these findings, PG&E made two
advances to the Company for costs related to the fire in the amounts of $425,000
and $4.5 million in January 1997 and April 1998, respectively. As discussed
previously in the Company's Form 10-K for the period ended March 31, 1997, the
Company used the proceeds of the January 1997 payment of $425,000 to offset the
write-off of inventory and vineyard assets destroyed by the fire. As discussed
previously in the Company's Forms 10-Q, the Company recorded the advance of $4.5
million as a "Settlement Advance" on its balance sheet pending the completion of
a final settlement agreement.
In the quarter ended March 31, 1999, the Company entered into a settlement
agreement with PG&E pursuant to which PG&E agreed to pay the Company a low
six-figure amount in addition to the foregoing advances. The foregoing payment
from PG&E was received by the Company during the last quarter of the fiscal year
and is expected to be the final settlement. The payments received from PG&E
during the year ended March 31, 1999 were recognized in full in the Company's
income statement for the year ended March 31, 1999, net of related legal
expenses.
-13-
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of security holders of the Company during
the period covered by this Report.
Executive Officers of the Registrant
The following persons were executive officers of the Company as of March
31, 1999.
Name Position(s) Age
---- ----------- ---
W. Philip Woodward Chairman of the Board of Directors 60
Thomas B. Selfridge President, and Chief Executive 55
Officer
Francois P. Muse Chief Financial Officer1 33
Daniel E. Cohn Secretary 42
Robert B. Farver Vice President, Sales and Distribution 42
b. Business Experience of Executive Officers
W. Philip Woodward. Mr. Woodward is a co-founder of the Company and has
been a director of the Company since 1972. He has been its chairman since August
1997 and is a member of the Board's Executive Committee. Mr. Woodward served as
Vice President and Chief Financial Officer from 1972 to 1983. In 1974, he became
the Company's President and Chief Executive Officer, a position he held until
October of 1983. Mr. Woodward is a director of Domaines Barons de Rothschild
(Lafite) ("DBR") and president of The Chalone Wine Foundation.
Thomas B. Selfridge. Mr. Selfridge joined the Company as President in
January 1998 and was appointed to the Company's Board of Directors in May 1998.
On July 1, 1998, Mr. Selfridge assumed the title of Chief Executive Officer of
the Company. He also serves as a member of the Company's Operating Committee. He
also serves as a member of the Board's Operating Committee, as a director of
Edna Valley Vineyard and Canoe Ridge Winery, and secretary of The Chalone Wine
Foundation.
Francois P. Muse. Mr. Muse joined the Company as Corporate Controller in
October of 1997. From July 1998 to May 19, 1999, he held the title of (Acting)
Chief Financial Officer. He was appointed the Company's Chief Financial Officer
on May 20, 1999. Mr. Muse also serves as a director of Canoe Ridge Vineyards.
Daniel E. Cohn. Mr. Cohn has served as the Company's secretary since 1998.
He has been a partner of Farella Braun & Martell LLP since 1991 and a member of
its business practice group since 1985.
Robert B. Farver. Mr. Farver joined the Company in 1990 as the Regional
Sales Manager for the Northeast United States and has been the Company's Vice
President, Sales and Distribution since 1996. Previously, he was Director of
National Sales and Marketing. Mr. Farver also serves as a director of Canoe
Ridge Vineyards.
- ----------------------
1 Mr. Muse was appointed the Company's Chief Financial Officer on May 20, 1999.
-14-
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.
The Company's common stock has been traded in the over-the-counter market
since the Company's initial public offering on May 18, 1984, and is listed in
the Nasdaq National Market System, under the symbol "CHLN." The following table
sets forth the high and low closing quotations for the stock for each quarter
during the past two years, as reported by Nasdaq. The prices reflect
inter-dealer quotations without retail mark-ups, mark-downs or commissions, and
do not necessarily represent actual transactions.
Quarter ended High Low
-------------------------- ------------ ------------
March 31, 1999 $ 10.00 $ 7.63
December 31, 1998 10.44 10.00
September 30, 1998 10.56 10.00
June 30, 1998 11.00 10.88
March 31, 1998 11.75 10.13
December 31, 1997 12.00 9.75
September 30, 1997 12.75 10.50
June 30, 1997 12.75 10.50
March 31, 1997 12.00 10.00
December 31, 1996 12.00 9.25
September 30, 1996 10.00 8.00
June 30, 1996 11.13 8.88
March 31, 1996 10.50 9.00
On June 8, 1999, the closing price for the common stock was $9.25 per
share. During the year ended March 31, 1999, the average weekly trading volume
of the stock was approximately 21,700 shares.
b. Holders of Record.
As of June 8, 1999, there were approximately 5,200 holders of record of the
Company's common stock.
c. Dividends.
To date, the Company has not paid any cash dividends.
Under the terms of certain of the Company's credit facilities, the Company
is restricted from paying dividends in excess of 50% of its aggregate net
income.
-15-
Item 6. Selected Financial Data.
The following selected consolidated financial data for the years ended
March 31, 1999 and 1998, and the years ended December 31, 1996 and 1995 are
derived from the Company's audited consolidated financial statements. The
financial data for the years ended March 31, 1997, 1996 and 1995, however, are
derived from the Company's unaudited consolidated financial statements and are
furnished with a view to providing the reader with comparative results for the
prior twelve-month periods which coincide with the Company's current fiscal
year-end (March 31). This data should be read in conjunction with the financial
statements and notes thereto included at Item 8 of this Report.
SELECTED FINANCIAL DATA
(in thousands except per-share data)
Year ended December 31,
-----------------------
1996 1995
-------- --------
Statement of Operations Data:
Net revenues $ 31,044 $ 25,032
Gross profit 12,375 8,792
Other revenues from operations 107 20
Selling, general and administrative expenses 6,283 5,374
Operating income 6,200 3,438
Other income/(expense), net (1,925) (2,701)
Equity in net income of Duhart-Milon 304 74
Minority interest (621) (357)
Net income $ 2,339 $ 207
Net income per common share $ 0.29 $ 0.04
Balance Sheet Data:
Working capital $ 23,504 $ 22,072
Total assets 80,179 72,569
Long-term obligations less current maturities 17,837 13,511
Shareholders' equity 43,246 41,382
Year ended March 31,
--------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ----------
Statement of Operations Data:
Net revenues $ 42,826 $ 36,755 $ 31,188 $ 25,987 $ 20,710
Gross profit 19,625 16,216 12,811 9,243 7,530
Other revenues from operations 196 303 107 20 --
Selling, general and administrative expenses (10,805) (8,147) (6,466) (5,442) (4,754)
Operating income 9,016 8,372 6,452 3,801 2,776
Other income/(expense), net (1,763) (1,857) (1,789) (2,429) (2,584)
Settlement income 4,447 -- -- -- --
Equity in net income of Duhart-Milon 766 341 281 126 --
Minority interest (1,219) (1,125) (681) (387) (156)
Net income (loss) $ 6,636 $ 3,410 $ 2,520 $ 600 $ (26)
Net income (loss) per common share $ 0.75 $ 0.41 $ 0.31 $ 0.10 $ --
Balance Sheet Data:
Working capital $ 49,192 $ 27,794 $ 24,283 $ 22,023 $ 16,680
Total assets 103,471 90,294 75,859 68,973 70,299
Long-term obligations less current maturities 35,273 18,124 18,379 13,415 26,339
Shareholders' equity 58,291 50,405 42,835 41,098 23,931
-16-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Introduction
The following discussion and analysis should be read in conjunction with
the Selected Financial Data presented in Item 6 hereto as qualified by the
Company's Consolidated Financial Statements and related notes presented in Item
8 hereto.
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-K) 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-K, 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 7, Management's Discussion and Analysis
of Financial Condition and Results of Operations and the President's Letter to
the Shareholders, 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 projected capital spending; (iv) the price
and availability in the marketplace of grapes meeting the Company's quality
standards and other requirements; (v) the effect of weather and other natural
forces on growing conditions and, in turn, the quality and quantity of grapes
produced by the Company and (vi) the risks associated with the assimilation of
Staton Hills Winery. 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.
Change in Fiscal Year-End
Effective with the fiscal year ending March 31, 1997, the Company changed
its fiscal year from one ending on December 31 to one ending on March 31.
Accordingly, the Company reported a three-month transition period ending March
31, 1997. The Company determined that the nature of its business cycle, with
typically heavy sales activity towards the end of the calendar year, coupled
with the fall harvest of its grapes, created difficulty in efficient and
effective planning and budgeting on a calendar year basis. A fiscal year ending
March 31 occurs at the end of what is historically the least active quarter with
respect to sales activity and operations in the production of wine.
The Company elected to file audited financial statements for the transition
period referred to above. In accordance with applicable regulations, this Report
includes consolidated balance sheets as of March 31, 1999 and March 31, 1998 and
consolidated statements of income for the years ended March 31, 1999, and 1998
and December 31, 1996, respectively. This Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations discusses the
Company's consolidated financial information for the years ended March 31, 1999,
1998 and 1997. See Item 6, Selected Financial Data for a schedule of the data
discussed herein.
-17-
Results of Operations
The following table represents financial data as a percentage of net
revenues for the indicated periods:
Year ended March 31, Year ended December 31,
------------------------------------ ------------------------------
1999 1998 1997 1996 1995
---- ----- ---- ---- ----
Net revenues 100 % 100 % 100 % 100 % 100 %
Gross profit 46 % 44 % 41 % 40 % 35 %
Other revenues from operations 0 % 1 % 0 % 0 % 0 %
Selling, general and admin. expenses (25)% (22)% (21)% (20)% (21)%
Operating income 21 % 23 % 21 % 20 % 14 %
Other income (expense) (4)% (5)% (6)% (6)% (11)%
Settlement Income 10 % 0 % 0 % 0 % 0 %
Equity in net income of Duhart-Milon 2 % 1 % 1 % 1 % 0 %
Minority interest (3)% (3)% (2)% (2)% (1)%
Net income (loss) 15 % 9 % 8 % 8 % 1 %
Wine Sales
Net revenues for the year ended March 31, 1999 increased approximately 17%
over the comparable period in the preceding year. This increase was attributable
to a 14% volume increase and a 3% average price increase.
Net revenues for the year ended March 31, 1998 increased by 18% over the
prior year comparable period. This increase was attributable to a 9%
volume-increase and an 8% average price-increase.
Sales-volume in the California market comprised 26% of the Company's total
sales for the year ended March 31, 1999. Although California is the Company's
largest market (no single market outside of California accounted for more than
10% of total sales in these years), management believes that increased unit
sales in markets outside of California will continue to account for most of the
Company's future revenue growth.
Gross Profit
Gross profit for the year ended March 31, 1999 increased by approximately
21%, or $3.4 million, over the comparable period in the preceding year. This was
primarily the result of (i) increased sales volume, (ii) increased average sales
prices, and (iii) less pronounced increases in average production costs partly
due to the relative success and size of the 1997 harvest.
Gross profit for the year ended March 31, 1998 was $16.2 million,
corresponding to a 44% gross margin, as compared to $12.8 million, or 41% gross
margin, in the year ended March 31, 1997. This increase in gross profit was
mostly attributable to increased unit sales, price increases across all brands
and a shift in the product mix of wines sold to higher margin wines.
Other Revenue from Operations
Other revenue from operations consists of (i) revenue obtained from
third-party wineries, net of related expenses, for grape crushing or wine
bottling and (ii) net profit from sales of bulk wine. The Company cannot predict
the materiality of such operations with respect to 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.
The decrease of 35%, from $303,000 to $196,000, for the twelve months ended
March 31, 1999 from the comparable period in the prior year was attributable to
less custom crush demand (driven in part by the relatively lower 1998 harvest
tonnage throughout California as compared to the 1997 harvest tonnage), partly
offset by increased custom bottling demand.
The increase to $303,000 for the year ended March 31, 1998, from $107,000
in the prior period, was mostly due to the increased demand resulting from the
unusually large 1997 harvest experienced in California.
Selling, General and Administrative Expenses
Selling, general and administrative expenses in the year ended March 31,
1999 increased by 33% over the comparable period in the preceding year. This
increase is primarily the result of (i) increased selling and marketing
expenditures normally associated with increased sales quantities and also
related to the launching of the new Echelon brand-name, (ii) expenditures in the
Company's infrastructure and (iii) unusually high severance costs.
Selling, general and administrative expenses in the year ended March 31,
1998 increased by 26% over the comparable period in the preceding year. This
increase was primarily the result of planned increases in marketing
expenditures.
-18-
Operating Income
Operating income for the year ended March 31, 1999 increased by 8% over the
comparable period in the preceding year. This increase was primarily due to
gross profits, offset by increased selling, general and administrative expenses
as discussed above. Additionally, other revenues from operations decreased to 2%
of operating income for the year ended March 31, 1999, compared to 4% in the
prior comparable period.
Operating income for the year ended March 31, 1998 increased 30% over the
prior comparable year. This increase was mostly due to higher unit sales and
gross margins per case, all discussed above.
Other Income/(Expense), Net
The decrease of 5% in net other expense between the years ending March 31,
1999 and 1998 was primarily driven by a 6% decrease in net interest expense
mostly due to lower interest rates.
Interest expense for the year ended March 31, 1998 increased to $1.9
million, an increase of 6% from $1.8 million in the prior comparable period.
This was primarily due to slightly higher borrowing levels.
Settlement Income
As discussed at Item 3(a): Settlement of Litigation Arising from the
Carmenet Fire, the Company recognized in its March 31, 1999 consolidated
statement of income, $4.4 million relating to a settlement with Pacific Gas and
Electric ("PG&E") for the July 1996 fire damage at the Carmenet vineyards.
Equity in Net Income of Duhart-Milon
Effective October 1, 1995, the Company exchanged its 11.3% ownership
interest in DBR for a 23.5% interest in Societe Civile Chateau Duhart-Milon. The
effect of this transaction was to convert an 11.3% interest in DBR, accounted
for using the cost method, into an interest in an active, operating vineyard and
winery operation, accounted for using the equity method.
The Company experienced record results during the twelve months ended March
31, 1999 from its investment in Societe Civile Chateau Duhart-Milon
("Duhart-Milon"). The Company's 23.5% equity interest in the net income of
Duhart-Milon for the years ending March 31, 1999 and 1998, were $766,000 and
$341,000, respectively. This 125% increase is primarily attributable to
exceptionally high demand for the 1996 vintage of Bordeaux wines. The 1996
vintage is expected to be one of the Bordeaux region's most successful vintages
in the past twenty years. Due to the exceptional nature of the 1996 vintage,
this quarter's net income from the Company's investment in Duhart-Milon may not
be indicative of future results.
The Company monitors its investment in Duhart-Milon primarily through its
on-going communication with Domaines Barons de Rothschild (DBR). Such
communication is facilitated by the presence of the Company's chairman on DBR's
Board of Directors, and DBR's representation on the Company's Board of
Directors. Additionally, various key employees of the Company make frequent
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 maintains a reserve for currency translation
which was $2,296,000 as of March 31, 1999. This reserve was reduced from
$2,459,000 as of March 31, 1998 due to the increase in the relative worth of the
French Franc when compared to the U.S. dollar during the twelve months ended
March 31, 1999. Although the transition to the "EURO" currency became effective
as of January 1, 1999, the Company does not anticipate that this transition will
have a material impact on its investment in Duhart-Milon. Currency fluctuations
are recorded in the "Cumulative foreign currency translation adjustment" in the
equity section of the Company's consolidated balance sheet, and in comprehensive
income as defined by the Statement of Financial Accounting Standards No.130
("SFAS 130") - Reporting Comprehensive Income.
Minority Interest
The Edna Valley Vineyard ("EVV") and Canoe Ridge Vineyard, LLC ("CRV")
financial statements are consolidated in the Company's financial statements. The
interest in the equity and net income of EVV and CRV which belongs to parties
other than the Company is accounted for as "minority interest". The minority
interest in the net income of EVV and CRV for the three years ended March 31,
1999 consisted of the following (in thousands):
Year ended March 31,
Minority ----------------------------------------
Venture Minority Owner Percent 1999 1998 1997
- ----------- ------------------ ----------- ------------ ------------- ------------
Edna Valley Vineyard Paragon Vineyard Co., Inc. 50.00% $ 909 $ 906 $ 570
Canoe Ridge Vineyard, LLC Various 49.50% 310 219 111
------------ ------------- ------------
$ 1,219 $ 1,125 $ 681
============ ============= ============
The minority interest in earnings for the year ended March 31, 1999
increased 8% over the comparable period ended March 31, 1998, due to steadily
improving performance at both EVV and CRV primarily as a result of increases in
both
-19-
case sales and gross margins per case.
The minority interest in earnings for EVV for the year ended March 31, 1998
represents an increase of 65% from the prior comparable period. Similarly, the
minority interest for CRV increased significantly. Both increases were due to
improved performance at both EVV and CRV.
Company management believes that EVV and, to a lesser degree CRV, will both
continue to contribute significantly to the Company's consolidated income
statement.
Net Income
Net income for the year ended March 31, 1999 were $6.6 million, an increase
of $3.2 million, or 95%, over the year ended March 31, 1998. This was primarily
as a result of non-recurring settement income of $2.6 million (after tax-effect)
and increased gross profits, offset by higher selling, general and
administrative expenses.
Net income for the year ended March 31, 1998, were $3.4 million compared to
$2.5 million in the year ended March 31, 1997. This 35% increase reflects
increased unit sales at higher gross margins.
Seasonality
The Company's wine sales from quarter to quarter are highly variable due
to, among other things, the timing of the release of wines for sale and changes
in consumer demand. Sales are typically strongest during the fourth quarter
because of heavy holiday sales and because most wines generally are released
between the end of the third and beginning of the fourth quarters.
Year 2000
The year 2000 issue ("Y2K") is the result of computer programs being
written using two digits rather than four digits to determine the applicable
year. As presently programmed, the Company's computer programs and systems that
have time sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. Unless reprogrammed, in the future this could result
in miscalculations causing disruptions of operations, including, among other
things, temporary inefficiencies in processing transactions, sending invoices,
or engaging in similar normal business activities.
The Company has an ongoing program designed to ensure that its operational
and financial systems will not be adversely affected by Y2K software failures.
The Company believes that its exposure to Y2K issues remains relatively minor in
comparison to most industrial enterprises because of its relatively low reliance
on computerized systems. The Company is doing everything technologically
possible to assure its computers function properly upon the turn of the century.
Compliance is to some extent dependent upon vendor cooperation. Preliminary
estimates of the compliance-related costs, based on internal projections, are
approximately $15,000. The Company recognizes that any Y2K system related
compliance failures could result in additional expenses to the Company, the
materiality of which cannot be predicted at this time.
Liquidity and Capital Resources
Working Capital:
During the twelve months ended March 31, 1999, working capital increased by
$21.4 million, or 77%, to $49.2 million from $27.8 million as of March 31, 1998.
This was primarily due to the following: (i) $1.0 million received from the net
proceeds of warrant exercises (which resulted in a purchase of 142,857 shares of
the Company's common stock); (ii) aggregate payments of $4.7 million received
from PG&E relating to the Carmenet vineyard fire of July 1996; (iii) net
inventory increases of $6.6 million; (iv) an increase of 1.7 million in accounts
receivable; (v) a decrease of $7.1 million in outstanding lines of credit from
$11 million from $3.9 million due to debt refinancing, compounded by a change in
classification of the Company's lines of credit from short-term to long-term;
offset by; (vi) capital expenditures of $7.1 million incurred both as a result
of normal operations and selected expansion of certain Company production
facilities; and (vii) payment of $1.7 million in taxes relating to proceeds
received from Pacific Gas and Electric ("PG&E").
The Company's 5% Convertible Subordinated Debentures Due 1999, having a
face value of $8.5 million, matured in April 1999. Upon maturity, the Company
paid cash in the amount of $2.0 million to holders of debentures who elected not
to convert into common stock. Holders of debentures with a face value of $6.5
million elected to convert resulting in the issuance of 738,014 new shares of
the Company's common stock.
During the twelve months ended March 31, 1998, working capital increased by
$3.5 million or 14.5%, from $24.3 as of March 31, 1997 to $27.8 million. This
was primarily a result of (i) a $6.0 million increase in inventory levels and
(ii) capital investments of $6.3 million, which were both funded through our
lines of credit, offset by (iii) $4.8 million received from the net proceeds of
warrant exercises (which resulted in a purchase of 685,714 shares of the
Company's common stock).
-20-
Cash Flows:
During the twelve months ended March 31, 1999, cash flow from operations
decreased by $1.4 million from the comparable period in the prior year. This was
primarily the result of (i) $3.0 million, after-tax, received from PG&E relating
to the aforementioned settlement income, offset by (ii) increased spending on
inventory and (iii) various timing differences in payment of payables and
collection of receivables. Cash flow from investing activities decreased by
$140,000, or 2%, from the comparable period in the prior year, due to (i) an
increase of $781,000 in capital expenditures, (ii) no dividends declared by
Duhart-Milon in the period ended March 31, 1999, offset by (iii) no option
payment made pursuant to the Edna Valley joint venture agreement during the year
ended March 31, 1999. Cash flow from financing activities was $1 million less
than in the prior year due to (i) a decrease in proceeds from issuance in common
stock largely driven by an exercise of warrants of $1.0 million in the year
ended March 31, 1999, vs. $4.8 million in prior year, offset by (ii) a net
increase in debt-financing of $4.9 million in the year ended March 31, 1999, vs.
$2.0 million in the preceding year.
During the twelve months ended March 31, 1998, cash flow from operations
decreased by $1.5 million from the comparable period in the prior year. This was
primarily the result of (i) increased spending on inventory and (ii) various
timing differences in payment of payables and collection of receivables. Cash
flow from investing activities increased by $66,000 from the comparable period
in the prior year, due to (i) a decrease of $847,000 in capital expenditures,
(ii) increased dividends declared by Duhart-Milon in the period ended March 31,
1998, offset by (iii) an option payment of $1.1 million made pursuant to the
Edna Valley joint venture agreement during the year ended March 31, 1998. Cash
flow from financing activities was $3.3 million higher than in the prior year
due to (i) an increase in proceeds from issuance in common stock largely driven
by an exercise of warrants of $4.8 million in the year ended March 31, 1998,
offset by (ii) a net increase in debt-financing of $2.0 million in the year
ended March 31, 1999, vs. $3.4 million in the preceding year.
General:
On March 31, 1999, the Company entered into a credit agreement with
Cooperative Centrale Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland," New
York Branch ("Rabobank"). The Rabobank credit facility provides for a total of
$70 million of unsecured financing, consisting of a seven-year, $30 million term
loan and a two-year, $40 million revolving line of credit. In conjunction with
the closing of the Rabobank credit facility, the Company refinanced
approximately $24 million of its outstanding debt.
The Company is not aware of any potential impairments to its liquidity and
believes its capital resources are adequate to meet current and historic levels
of capital expenditures and its liquidity needs for the at least the next twelve
months.
-21-
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 recently adopted 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 Profits Depend Largely on Sales in Certain States and on Sales of
Certain Varietals
In the twelve months ended March 31, 1999, approximately 70% 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 92% of our net revenues in the twelve months ended March 31,
1999 were concentrated in our top four selling varietal wines. Specifically,
sales of Chardonnay, Pinot Noir, Cabernet Sauvignon and Merlot accounted for
58%, 11%, 16% and 7% of our net revenues, respectively, for the twelve months
ended March 31, 1999.
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.
Additionally, 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 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 peak during
the 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.
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 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.
-22-
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.
The weather phenomenon commonly referred to as "El Nino" produced heavy
rains and cooler weather during the Spring of 1998, which resulted in colder and
wetter soils than are typical during California's grape growing season.
Consequently, the 1998 harvest was postponed by approximately four to six weeks
- - depending on the geographical location and varietals. The unusual weather
conditions resulting from El Nino impacted quantity and quality of the Company's
1998 estate harvest. The size of the Company's most significant crops ranged
from normal-sized yields to 50% of normal yields (depending on the varietal and
the particular estate).
Despite the foregoing reduction in the yield of certain crops, the
harvested estate crops, in combination with contracted grape purchases (most of
which are tonnage-based), are expected to permit the Company to meet originally
anticipated sales-projections for its 1998 vintage Chardonnay, Cabernet and
Merlot varietals which, together, have historically comprised between 80% and
85% of its aggregate annual production.
We May Not Be Able to Grow or Acquire Enough Quality Grapes for Our Wines
The adequacy of our grape supply is influenced by consumer demand for wine
in relation to industry-wide production levels. While we believe that we can
secure sufficient supplies of grapes from a combination of our own production
and from grape supply contracts with independent growers, we cannot be certain
that grape supply shortages will not occur. A shortage in the supply of wine
grapes could result in an increase in the price of some or all grape varieties
and a corresponding increase in our wine production costs.
Industry trends point to rapid plantings of new vineyards and replanting of
old vineyards to greater densities, with the expected result of significantly
increasing the 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 39%, respectively, of our net revenues during
the twelve months ended March 31, 1999. 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 broker in order to sell our wines within
California. Such sales represent 31% of our net revenues during the twelve month
period ended March 31, 1999. The laws and regulations of several states prohibit
changes of distributors, except under certain limited circumstances, making it
difficult to terminate a distributor without reasonable cause, as defined by
applicable statutes. The resulting difficulty or inability to replace
distributors, poor performance of our major distributors or our inability to
collect accounts receivable from our major distributors could harm our business.
New Regulations or Increased Regulatory Costs Could Harm Our Business
The wine industry is subject to extensive regulation by the Federal Bureau
of Alcohol, Tobacco and Firearms and various foreign agencies, state liquor
authorities and local authorities. These regulations and laws dictate such
matters as licensing requirements, trade and pricing practices, permitted
distribution channels, permitted and required labeling, advertising and
relations with wholesalers and retailers. Any expansion of our existing
facilities or development of new vineyards or wineries may be limited by present
and future zoning ordinances, environmental restrictions and other legal
requirements. In addition, new regulations or requirements or increases in
excise taxes, income taxes, property and sales taxes or international tariffs,
could reduce our profits. Future legal or regulatory challenges to the industry,
either individually or in the aggregate, could harm our business.
We Will Need More Working Capital to Grow
The premium wine industry is a capital-intensive business which requires
substantial capital expenditures to develop and acquire vineyards and to improve
or expand wine production. Further, the farming of vineyards and acquisition of
grapes and bulk wine require substantial amounts of working capital. We project
the need for significant capital spending and increased working capital
requirements over the next several years, which must be financed by cash from
operations or additional borrowings or other financing.
-23-
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 also are subject to certain hazards and liability risks, such as
potential contamination, through tampering or otherwise, of ingredients or
products. Contamination of any of our wines could result in the need for a
product recall which could significantly damage our reputation for product
quality, which we believe is one of our principle competitive advantages. We
maintain insurance against these kinds of risks, and others, under various
general liability and product liability insurance policies. However, our
insurance may not be adequate or may not continue to be available at a price or
on terms that are satisfactory to us.
The Loss of Key Employees Would Damage Our Reputation and Business
Our success depends to some degree upon the continued services of a number
of key employees. Although some key employees are under employment contracts
with us for specific terms, the loss of the services of one or more of our key
employees could harm our business and our reputation, particularly if one or
more of our key employees resigns to join a competitor or to form a competing
company. In such an event, despite provisions in our employment contracts which
are designed to prevent the unauthorized disclosure or use of our trade secrets,
practices or procedures by such personnel under these circumstances, 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, packaging
supplies and various wine production needs 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. We do not believe
that our foreign exchange risk and international operations exposure is material
at this time, but 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 strong and vigilant enforcement of our trademarks. There can
be no assurance that competitors will refrain from 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.
-24-
Our Acquisition of Staton Hills Winery and Potential Future Acquisitions
Involve a Number of Risks
Our acquisition of Staton Hills Winery (and potential future acquisitions)
involves risks which include assimilating Staton Hills into our Company;
integrating, retaining and motivating key Staton Hills 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 the two companies; risks inherent in the
production of wine in, and marketing of wine from, Washington State, and the
risks to our Company of the increased negative cash flow and increased operating
expenses arising from the acquisition of, and plans for, Staton Hills.
The integration of the operations, technology and personnel of our Company
and Staton Hills' is expected to be a complex, time consuming and expensive
process and may disrupt our business if not completed in a timely and efficient
manner. Staton Hills and Chalone must operate as a combined organization
utilizing common information and communications systems, operating procedures,
financial controls and human resources practices. We may encounter substantial
difficulties, costs and delays, including potential incompatibility of our
business cultures, perceived adverse changes in our business plans, potential
conflicts in our supplier and customer relationships and the loss of key
employees and diversion of the attention of management from other ongoing
business initiatives.
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.
-25-
Item 8. Financial Statements and Supplementary Data.
THE CHALONE WINE GROUP, LTD.
INDEX TO FINANCIAL STATEMENTS
Page
----
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets.................................. 27
Consolidated Statements of Income............................ 28
Consolidated Statements of Shareholders' Equity.............. 29
Consolidated Statements of Cash Flows........................ 30
Notes to Consolidated Financial Statements................... 31
INDEPENDENT AUDITORS' REPORT....................................... 43
-26-
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
(All amounts in thousands, except share data)
ASSETS
March 31, March 31,
1999 1998
--------- ---------
Current assets:
Cash and cash equivalents $ 1,670 $ 2,232
Accounts receivable, less allowance for doubtful
accounts of $86 and $92, respectively 8,086 6,349
Notes receivable 109 262
Income tax receivable 616 248
Inventory 40,926 34,277
Prepaid expenses 492 450
Deferred income taxes 158 14
--------- ---------
Total current assets 52,057 43,832
Investment in Chateau Duhart-Milon 10,409 9,480
Notes receivable, long-term portion 119 130
Property, plant and equipment - net 33,591 30,131
Goodwill and trademarks - net 6,196 6,473
Other assets 1,099 248
--------- ---------
Total assets $ 103,471 $ 90,294
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 2,494 $ 3,425
Bank lines of credit -- 10,952
Other short term debt -- 952
Current maturities of long-term obligations 371 709
--------- ---------
Total current liabilities 2,865 16,038
Bank line of credit 3,938 --
Long-term obligations, less current maturities 22,835 9,624
Convertible subordinated debentures 8,500 8,500
Deferred income taxes 2,765 2,049
--------- ---------
Total liabilities 40,903 36,211
--------- ---------
Minority interest 4,277 3,678
Shareholders' equity:
Common stock - authorized 15,000,000 shares no
par value; issued and outstanding: 8,720,771 and
8,393,979 shares, respectively 48,965 46,871
Stock subscription receivable (1,007) --
Retained earnings 12,629 5,993
Cumulative foreign currency translation adjustment (2,296) (2,459)
--------- ---------
Total shareholders' equity 58,291 50,405
--------- ---------
Total liabilities and shareholders' equity $ 103,471 $ 90,294
========= =========
The accompanying notes are an integral part of these statements.
-27-
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED STATEMENTS OF INCOME
(All amounts in thousands, except per share data)
Year ended
Year ended March 31, December 31,
----------------------------- ------------
1999 1998 1996
-------- -------- --------
Gross revenues $ 43,973 $ 37,651 $ 31,909
Excise taxes (1,147) (896) (865)
-------- -------- --------
Net revenues 42,826 36,755 31,044
Cost of wines sold (23,201) (20,539) (18,669)
-------- -------- --------
Gross profit 19,625 16,216 12,375
Other revenues from operations 196 303 107
Selling, general and administrative expenses (10,805) (8,147) (6,282)
-------- -------- --------
Operating income 9,016 8,372 6,200
Interest expense (1,761) (1,872) (1,844)
Settlement income 4,447 -- --
Equity in Chateau Duhart-Milon 766 341 304
Minority interests (1,219) (1,125) (621)
Other, net (2) 15 (81)
-------- -------- --------
Income before income taxes 11,247 5,731 3,958
Income taxes (4,611) (2,321) (1,619)
-------- -------- --------
Net income $ 6,636 $ 3,410 $ 2,339
======== ======== ========
Net income per common share
Basic $ 0.77 $ 0.44 $ 0.31
Diluted $ 0.75 $ 0.41 $ 0.29
Average number of shares used
in income per share computation
Basic 8,669 7,786 7,641
Diluted 8,852 8,409 8,169
The accompanying notes are an integral part of these statements.
-28-
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(All amounts in thousands)
Common Stock Foreign
-------------------- Stock Retained Currency Compre-
Number of Subscription Earnings/ Translation hensive
Shares Amount Receivable (Deficit) Adjustment Total Income
-------- -------- -------- -------- -------- -------- --------
Balance, December 31, 1995 7,596 $ 41,557 $ -- $ (66) $ (108) $ 41,383
Sale of common stock 9 22 -- -- -- 22
Options exercised 19 77 -- -- -- 77
Profit sharing 2 18 -- -- -- 18
Foreign currency
translation adjustment -- -- -- -- (593) (593) $ (593)
Net income -- -- -- 2,339 -- 2,339 2,339
-------- -------- -------- -------- -------- -------- --------
Balance, December 31, 1996 7,626 $ 41,674 $ -- $ 2,273 $ (701) $ 43,246 $ 1,746
-------- -------- -------- -------- -------- -------- --------
Sale of common stock 2 14 -- -- -- 14
Options exercised 20 83 -- -- -- 83
Profit sharing 7 70 -- -- -- 70
Foreign currency
translation adjustment -- -- -- -- (888) (888) (888)
Net income -- -- -- 310 -- 310 310
-------- -------- -------- -------- -------- -------- --------
Balance, March 31, 1997 7,655 $ 41,841 $ -- $ 2,583 $ (1,589) $ 42,835 $ (578)
-------- -------- -------- -------- -------- -------- --------
Sale of common stock 11 75 -- -- -- 75
Warrants exercised 686 4,800 -- -- -- 4,800
Options exercised 42 155 -- -- -- 155
Profit sharing -- -- -- -- -- --
Foreign currency
translation adjustment -- -- -- -- (870) (870) (870)
Net income -- -- -- 3,410 -- 3,410 3,410
-------- -------- -------- -------- -------- -------- --------
Balance, March 31, 1998 8,394 $ 46,871 $ -- $ 5,993 $ (2,459) $ 50,405 $ 2,540
-------- -------- -------- -------- -------- -------- --------
Sale of common stock 8 80 -- -- -- 80
Warrants exercised 143 1,000 -- -- -- 1,000
Options exercised 164 882 (1,007) -- -- (125)
Profit sharing 12 132 -- -- -- 132
Foreign currency
translation adjustment -- -- -- -- 163 163 163
Net income -- -- -- 6,636 -- 6,636 6,636
-------- -------- -------- -------- -------- -------- --------
Balance, March 31, 1999 8,721 $ 48,965 $ (1,007) $ 12,629 $ (2,296) $ 58,291 $ 6,799
======== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of these statements.
-29-
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(All amounts in thousands)
Year ended
Year ended March 31, December 31,
-------------------- --------
1999 1998 1996
-------- -------- --------
Cash flows from operating activities:
Net income $ 6,636 $ 3,410 $ 2,339
Non-cash transactions included in earnings:
Depreciation 3,537 2,902 2,873
Amortization 277 236 121
Equity in net income of Chateau Duhart-Milon (766) (341) (304)
Increase in minority interest 1,219 1,125 621
Loss on sale of equipment 25 8 86
Changes in:
Deferred income taxes 572 740 199
Accounts and other receivable (1,737) (2,405) 73
Distribution receivable -- 382 (419)
Inventory (6,649) (4,860) (1,831)
Prepaid expenses and other assets (1,261) (479) (236)
Accounts payable and accrued liabilities (931) 1,624 3,494
-------- -------- --------
Net cash provided by operating activities 922 2,342 7,016
-------- -------- --------
Cash flows from investing activities:
Capital expenditures (7,112) (6,331) (6,635)
Proceeds from disposal of property and equipment 89 105 362
Collection of notes receivable 164 194 33
Investment in Edna Valley joint venture -- (1,050) --
Distributions from Duhart-Milon -- 363 156
-------- -------- --------
Net cash used in investing activities (6,859) (6,719) (6,084)
-------- -------- --------
Cash flows from financing activities:
Borrowings on line of credit - net (7,014) 3,181 (3,745)
Repayment of short-term debt (952) -- --
Distributions to minority interests (619) (638) (200)
Proceeds from new long-term debt 25,182 -- 8,894
Repayment of long-term debt (12,309) (1,210) (5,823)
Proceeds from issuance of common stock 1,087 5,030 117
-------- -------- --------
Net cash provided by financing activities 5,375 6,363 (757)
-------- -------- --------
Net increase (decrease) in cash (562) 1,986 175
Cash at beginning of period 2,232 246 32
-------- -------- --------
Cash at end of period $ 1,670 $ 2,232 $ 207
======== ======== ========
Other cash flow information:
Interest paid $ 1,779 $ 1,895 $ 1,829
Income taxes paid 4,271 2,610 397
Non-cash transactions:
Accrued investment in Edna Valley joint venture -- -- 1,428
Debt assumed in acquisition of real property -- 1,974 940
Profit sharing stock contribution 132 -- 18
Stock issued and subscribed (1,007) -- --
The accompanying notes are an integral part of these statements.
-30-
THE CHALONE WINE GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION AND OPERATIONS
The Chalone Wine Group, Ltd. ("the Company") produces and sells primarily
super and ultra-premium quality table wines. The Company farms its estate-owned
vineyards representing approximately 416 producing acres in Napa, Sonoma,
Monterey counties of California and in eastern Washington state. Approximately
75% of its annual grape requirements for the year ended March 31, 1999 were
purchased from independent growers.
The Company sells the majority of its products to wholesale distributors,
restaurants, and retail establishments throughout the United States, Canada and
Europe. Export sales accounted for approximately 4% of total revenue for the
year ended March 31, 1999. The Company performs ongoing credit evaluations of
its customers and generally does not require collateral. The Company maintains
reserves for potential credit losses and such losses have been within
management's expectations. At March 31, 1999, Domaines Barons de Rothschild
(Lafite) ("DBR"), a French company, owned approximately 40% of the Company's
outstanding common stock, and the Company is DBR's partner in Societe Civile
Chateau Duhart-Milon ("Duhart-Milon"), a Bordeaux wine-producing estate located
in Pauillac, France.
The Company owns 50% of Edna Valley Vineyard ("EVV"), a winery operation in
San Luis Obispo County, California, under a joint venture with the other 50%
owner,Paragon Vineyard Company, Inc. ("Paragon"). The Company, as the managing
joint venturer, manages and supervises EVV's winery operations, and sells and
distributes the wine and is deemed to control the EVV operations for accounting
purposes. The Company has certain commitments related to its continuing
ownership of EVV (see Note M).
The Company also owns 50.5% of, and manages, Canoe Ridge Vineyard LLC
("Canoe Ridge"), a Washington State winery and vineyard operation.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the Company's significant accounting policies consistently
applied in the preparation of the accompanying consolidated financial statements
follows.
Change in Fiscal Year-End
The Company changed its fiscal year-end from December 31 to March 31,
effective March 31, 1998. Accordingly, the Company reported a three-month
transition period ending March 31, 1997. See Note O for financial data relating
to the three-month period ended March 31, 1997.
Basis of Presentation
The consolidated financial statements include the accounts of the Company,
EVV and Canoe Ridge, since they are controlled and managed by the Company. All
significant intercompany accounts and transactions have been eliminated in
consolidation. Additionally, the Company has a 23.5% investment in Chateau
Duhart-Milon, which is accounted for using the equity method (Note F).
Accounting for Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
SFAS 109 requires the Company to compute deferred income taxes based on the
difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse.
Cash and Cash Equivalents
Cash equivalents are highly liquid instruments purchased with original
maturities of three months or less.
Accounting Estimates
The presentation of the financial statements in conformity with generally
accepted accounting principles 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.
-31-
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Inventory
Inventory is stated at the lower of cost or market. Cost for bulk and
bottled wines is determined on an accumulated weighted average basis and
includes grape purchases and supplies, farming and harvesting costs, winery and
bottling costs. Wine production supplies are stated at FIFO (first-in,
first-out) cost. All bulk and bottled wine inventories are classified as current
assets in accordance with recognized industry practice, although a portion of
such inventories will be aged for periods longer than one year.
Property, Plant and Equipment
Property, plant and equipment is stated at cost. Depreciation is provided
in amounts sufficient to allocate the cost of depreciable assets to operations
over their estimated useful lives. The straight-line method is followed for
substantially all assets for financial reporting purposes, but accelerated
methods are used for income tax purposes.
The different ranges of useful lives used in computing depreciation are (i)
15 to 35 years for vineyard development costs, (ii) 80 years for caves, (iii) 15
to 40 years for buildings and (iv) 3 to 20 years for machinery and equipment.
Capitalized costs of planting new vines and ongoing cultivation costs for
vines not yet bearing, including interest, are classified as vineyard
development. Depreciation commences in the initial year the vineyard yields a
commercial crop, generally in the third or fourth year after planting.
Costs attributable to caves represent improvements to the land incurred to
dig into hillsides and structurally reinforce underground tunnels where to store
and age the Company's wines.
Goodwill and Trademarks
The excess of the purchase price paid over acquired net assets is amortized
over 40 years on a straight-line basis. Trademarks are amortized over their
estimated useful lives from the date they are put into use.
The payments made to extend the life of the EVV joint venture and acquire
ownership of the continuing joint venture have been recorded as goodwill and are
being amortized over 40 years beginning in January 1997 (see Note M).
Reclassifications
Certain prior period amounts have been reclassified in order to conform
with the current period presentation.
Foreign Currency Translation
The functional currency of the Company's investee, Duhart-Milon, is the
French Franc and as a result, the Company records the effect of exchange gains
and losses on its equity in Duhart-Milon as a component of shareholders' equity.
Stock-based Compensation
The Company has chosen to account for stock-based awards to employees using
the intrinsic value based method in accordance with APB No.25, Accounting for
Stock Issued to Employees.
Forward Exchange Contracts
The Company has only a limited involvement with forward exchange contracts
and does not use them for trading purposes. 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 or in income when the hedged transaction occurs. As of March
31, 1999, the Company had three outstanding forward exchange contracts totaling
650,000 French Francs, all three of which matured prior to May 31, 1999, with no
significant exchange gain or loss.
-32-
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Net income per Share
Basic net income per share ("EPS") excludes dilution and is computed by
dividing net income available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects 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. As a
result of the adoption of SFAS 128, EPS amounts for the year ended December 31,
1996 have been restated to conform to the new standard. For all periods
presented, the difference between basic and diluted EPS for the Company reflects
the inclusion of dilutive stock options and stock warrants, the effect of which
is calculated using the treasury stock method as shown below. The Company's
convertible debentures are excluded from the computation, as these have had, and
continue to have, an antidilutive effect.
The following is a reconciliation of the figures used in deriving basic EPS
and those used in calculating diluted EPS:
(in thousands, except per share data)
Basic EPS Diluted EPS
---------------- ---------------
Income
Effect of dilutive securities available to
Income ----------------------------- common
available to stockholders
common Stock and assumed
stockholders Warrants options conversion
---------------- ------------- ---------- ---------------
Year ended March 31, 1999:
Income $ 6,636 -- -- $ 6,636
Shares 8,669 183 -- 8,852
---------------- ---------------
EPS $ 0.77 $ 0.75
================ ===============
Year ended March 31, 1998:
Income $ 3,410 -- -- $ 3,410
Shares 7,786 457 166 8,409
---------------- ---------------
EPS $ 0.44 $ 0.41
================ ===============
Year ended December 31, 1996:
Income $ 2,339 -- -- $ 2,339
Shares 7,641 425 103 8,169
---------------- ---------------
EPS $ 0.31 $ 0.29
================ ===============
Recently Issued Accounting Standards
SFAS No. 130, Reporting Comprehensive Income, establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements. This statement requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. The components of comprehensive income are shown in
the Consolidated Statements of Shareholders' Equity.
SFAS No. 131, Disclosures about Segment Reporting of an Enterprise and
Related Information, establishes standards for reporting information about
operating segments in annual financial statements and requires that those
enterprises report selected information about segments in interim financial
reports issued to shareholders. This statement establishes a management approach
to segment reporting and requires reporting of selected segment information
quarterly and entity-wide disclosures about products and services and major
customers. The Company's business is managed on the basis of multiple products
and brands within one segment, the wine industry.
-33-
NOTE C - CARMENET FIRE
A wildfire damaged approximately 75% of the producing acreage at the
Company's Carmenet Vineyard, located in Sonoma, California, on July 31, 1996.
Carmenet's winery structures and barrel inventory were untouched by the blaze
and no people were injured. The damaged acreage was planted to Cabernet
Sauvignon, Merlot and Cabernet Franc grapes used for estate bottled wines
produced under the Carmenet label. Prior to the fire, Carmenet produced
approximately 38,000 cases of wine annually (of which a significant proportion
was estate bottled). Carmenet's 1996 grape harvest was reduced roughly in
proportion to the percentage of the vineyard's overall producing acreage damaged
by the fire.
The Company has completed the final stage of replanting the remaining 25%
of the damaged acreage. Historically, newly planted vines produce
production-quality grapes in approximately three years, although the vines are
expected to take approximately seven years to return to full production levels
prior to the fire. Until the damaged acreage returns to full production,
Carmenet's ability to make estate-bottled wines will be limited. In order to
supplement Carmenet's harvest, the Company attempts to buy suitable grapes on
the open market; however, there can be no assurance that grapes of suitable
quality or variety will continue to be available in sufficient quantity or on
terms acceptable to the Company.
Preliminary investigation indicated that the fire was caused by the
electrical lines of Pacific Gas and Electric ("PG&E"). In conjunction with these
findings, PG&E made two advances to the Company for costs related to the fire in
the amounts of $425,000 and $4.5 million in January 1997 and April 1998,
respectively. The Company used the proceeds of the January 1997 payment of
$425,000 to offset the write-off of inventory and vineyard assets destroyed by
the fire. The Company recorded the advance of $4.5 million as a "Settlement
Advance" on its balance sheet, until such time that a final settlement agreement
would be reached.
In the quarter ended March 31, 1999, a final settlement agreement was
reached with PG&E. As part of the settlement, PG&E agreed to pay the Company an
additional $150,000, which was received by the Company as of March 31, 1999. The
payments of $4.5 million and $150,000 were recognized in the Company's income
statement for the year ended March 31, 1999, net of related legal expenses.
NOTE D - INVENTORY
Inventory consists of the following at March 31 (in thousands):
1999 1998
----------- -------------
Bulk wine $ 25,802 $ 21,800
Bottled wine 14,387 11,493
Wine packaging supplies 417 769
Other 320 215
----------- -------------
$ 40,926 $ 34,277
=========== =============
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at March 31 (in
thousands):
1999 1998
------------- -------------
Land $ 5,216 $ 3,376
Vineyard development 10,910 11,589
Caves 1,678 1,678
Buildings 17,335 15,082
Machinery and equipment 18,888 16,311
------------- -------------
54,027 48,036
Accumulated depreciation (20,436) (17,905)
------------- -------------
$ 33,591 $ 30,131
============= =============
-34-
NOTE F - INVESTMENT IN CHATEAU DUHART-MILON
During the period of April 1989 to June 1993, the Company purchased
approximately 11% of the outstanding ordinary shares of Domaines Barons de
Rothschild ("DBR") in exchange for a combination of 5% convertible subordinated
debentures and warrants which were subsequently exercised.
Effective October 1, 1995, the Company exchanged essentially all of its
existing ownership in DBR for a 23.5% interest in Societe Civile Chateau
Duhart-Milon ("Duhart-Milon"). The remaining 76.5% of Duhart-Milon is owned by
DBR.
Duhart-Milon's condensed balance sheet as of March 31 are as follows
(translated into U.S. dollars at the year-end) (in thousands):
1999 1998
------------ -------------
Inventory $ 3,223 $ 3,200
Short-term note receivable 10,110 6,914
Other current assets 730 340
------------ -------------
Current assets 14,063 10,454
------------ -------------
Property and equipment, net 2,524 2,327
------------ -------------
Total assets $ 16,587 $ 12,781
============ =============
Current liabilities $ 3,111 $ 2,876
Equity 13,476 9,905
------------ -------------
Total liabilities and equity $ 16,587 $ 12,781
============ =============
The results of operations are summarized as follows (translated into U.S.
dollars at the average exchange rate for the period) (in thousands):
Year ended
---------------------------------
March 31, March 31, December 31,
1999 1998 1996
------- ------- -------
Revenues $ 5,941 $ 3,912 $ 3,964
Cost of sales (2,626) (2,337) (2,651)
------- ------- -------
Gross profit 3,315 1,575 1,313
------- ------- -------
Net operating/other (expenses)/revenues 154 112 236
------- ------- -------
Net earnings $ 3,469 $ 1,687 $ 1,549
======= ======= =======
Company's share of net earnings $ 815 $ 396 $ 364
Other (49) (55) (60)
------- ------- -------
Equity in net earnings of Duhart-Milon $ 766 $ 341 $ 304
======= ======= =======
The carrying amount of the Company's investment in Duhart-Milon is greater
than the amount arrived at by multiplying the Company's 23.5% ownership interest
by the historical cost basis of Duhart-Milon's equity by approximately $7.2
million at March 31, 1999 (the "basis difference"). This basis difference is
primarily attributable to the difference between the historical cost of
Duhart-Milon's land holdings versus the fair value of such land that was used as
part of the basis to record the Company's initial investment under the equity
method of accounting. Because land is not a depreciable asset, the original
basis difference attributable to land of $8.5 million is not being amortized by
the Company. The remaining basis difference reflects other fair value versus
book value differences at the date of the Company's initial investment that are
being amortized over the life of the underlying assets.
The Company experienced record results during the year ended March 31, 1999
from its investment in ("Duhart-Milon) primarily due to exceptionally high
demand for the 1996 vintage of Bordeaux wines. Due to the exceptional nature of
the 1996 vintage, the Company's share of Duhart-Milon's net earnings may not be
indicative of future results.
Since the investment in Duhart-Milon is a long-term investment denominated
in a foreign currency, the Company recognizes currency translation adjustments
in shareholders' equity which totaled $2,296,000 as of March 31, 1999. This
amount was reduced from $2,459,000 as of March 31, 1998 due to the increase in
the relative worth of the French Franc when compared to the U.S. dollar during
the twelve months ended March 31, 1999.
-35-
NOTE G - BORROWING ARRANGEMENTS
Borrowing arrangements consist of the following at March 31 (in thousands):
1999 1998
------------ -------------
Credit line of $40,000,000 bearing interest at LIBOR+0.875%, payable
monthly, due March 31, 2001 $ 3,938 $ -
Credit line of $10,300,000 bearing interest at LIBOR+1%, payable monthly,
repaid on March 31, 1999 - 4,000
Credit line of $5,500,000 bearing interest at LIBOR+1%, payable monthly,
repaid on March 31, 1999 - 4,677
Credit line of $2,500,000 bearing interest at LIBOR+1%, payable monthly,
repaid on March 31, 1999 - 2,275
Convertible subordinated debentures due in 1999, bearing interest at 5%
Interest payments on the debentures are due semiannually
(including amounts due to related party - see Note L) 8,500 8,500
Bank term loan, due in March 2006, bearing interest at LIBOR + 1.2%
payable in monthly installments commencing on April 30, 1999, with
principal payable in quarterly installments commensing on December 31, 2000 20,000 -
Note payable, due May 2000 payable in annual installments of principal
and interest. Interest rate of 7% 475 713
Mortgage payable in monthly installments of principal and interest due August
2021. Interest rate of 7% 1,740 1,776
Bank term loan, due in 2001 with monthly installments of principal and interest.
Interest rate of LIBOR plus 1.8%, repaid on March 31, 1999 - 5,516
Bank term loan, payable in monthly installments of principal and interest due
June 2002. Interest rate of LIBOR plus 2.5%, repaid on March 31, 1999 - 215
Note payable, payable in monthly installments of principal and interest due
June 2016. Interest rate of 7.03% (see Note L, related party) 926 934
Note payable, due in August 1999 payable in monthly installments of principal
and interest. Interest rate of 7.85%, repaid on August 3, 1998 - 1,021
Other notes payable, due in varying monthly installments through January 2000,
bearing interest from 6.5% to 10.9%, some of which are secured by equipment 65 158
------------ -------------
35,644 29,785
------------ -------------
Less current maturities (371) (11,661)
------------ -------------
$ 35,273 $ 18,124
============ =============
The credit line and bank term loan effective as of March 31, 1999, are
unsecured. Restrictive covenants, however, include provisions regarding:
maintenance of certain financial ratios; mergers or acquisitions; loans,
advances or debt guarantees; additional borrowings; annual lease expenditures;
annual fixed asset expenditures; changes in control of the Company; and
declaration or payment of dividends.
The $8.5 million of 5% debentures, convertible to 965,098 shares of the
Company's common stock as of March 31, 1999, were subordinate in right of
payment to all senior indebtedness of the Company. On April 20, 1999, such
debentures, matured. At such time, holders of $2.0 million in debentures elected
not to exercise their conversion rights and the Company repaid the $2.0 million
using available borrowings under its long-term bank line of credit. The holders
of the remaining $6.5 million of debentures elected to exercise the conversion
rights and exchanged their debentures for 738,016 shares of the Company's common
stock.
-36-
NOTE G - BORROWING ARRANGEMENTS (Continued)
Since the $8.5 million of convertible debt was either refinanced with a
long-term bank line of credit or was converted to common stock, this amount was
classified as long-term debt in the Company's March 31, 1999 balance sheet.
Maturities of borrowing arrangements for each of the next five years ending
March 31, are as follows (in thousands):
2000 $ 371
2001 7,771
2002 3,295
2003 3,515
2004 3,750
Thereafter 16,942
--------
Total $ 35,644
========
Company management believes that the fair value of its principal short and
long term borrowings are equal to the book value since the terms were recently
negotiated with the lenders. Interest rates on the Company's mortgage and other
notes payable are not significantly different from current market rates.
As of April 9, 1999, the Company entered into an interest-rate swap
contract for a notional amount of $20 million. This contract effectively
converts the variable LIBOR rate which would otherwise be paid by the Company on
its $20 million bank term-loan balance into a fixed-rate obligation over a
period which corresponds to that of the underlying loan agreement. During that
time, the rate which the Company will be obligated to pay, after including the
lending institution's additional mark-up (which is based on financial ratios,
and varies accordingly) will be fixed between 6.95% and 7.12%.
NOTE H - STOCK BASED COMPENSATION
On February 10, 1997, the Board of Directors adopted the 1997 Stock Option
Plan (the "Plan"). The Plan provides for the grant of stock options to officers
and other key employees of the Company, as well as non-employee directors and
consultants, for an aggregate of up to 1,000,000 shares of common stock, plus
any shares under the Company's 1987 Stock Option Plan, which expired in February
1997, or 1988 Non-Discretionary Stock Option Plan, which expired in December
1996, that become available for issuance as a result of forteitures to the
Company under the terms of such plans. These options generally expire 10 years
from the date of grant and become exercisable after a one-year period. Option
activity under the plans is as follows:
Weighted
Number of Average
Shares Exercise Price
------ --------------
Outstanding, December 31, 1995 (520,381 exercisable at a weighted average price of $8.20) 556,591 $ 8.13
-------- ---------
Granted (weighted average fair value of $7.80) 70,840 9.74
Exercised (35,303) 6.83
Canceled (3,585) 8.67
-------- ---------
Outstanding, December 31, 1996 588,543 8.40
-------- ---------
Granted (weighted average fair value of $5.09) 71,930 10.41
Exercised (25,416) 5.57
Canceled -- n/a
-------- ---------
Outstanding, March 31, 1997 635,057 8.61
-------- ---------
Granted (weighted average fair value of $5.95) 229,150 11.65
Exercised (82,638) 7.79
Canceled (476) 9.50
-------- ---------
Outstanding, March 31, 1998 781,093 9.62
-------- ---------
Granted (weighted average fair value of $5.70) 172,520 11.40
Exercised (308,004) 8.90
Canceled (37,500) 11.23
-------- ---------
Outstanding, March 31, 1999 608,109 $ 10.39
======== =========
-37-
NOTE H - STOCK BASED COMPENSATION (Continued)
Additional information regarding options outstanding as of March 31, 1999
is as follows:
Options Outstanding Options Exercisable
----------------------------------------------------- --------------------------------
Range of Weighted Avg.
exercise Number Remaining Weighted Avg. Number Weighted Avg.
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
------ ----------- ---------------- -------------- ----------- --------------
$ 5.00-$ 8.00 90,900 5.2 years $ 6.50 83,070 $ 6.37
$ 8.00-$ 9.99 93,200 4.5 years 9.28 93,200 9.28
$10.00-$12.38 424,009 7.5 years 11.47 267,129 11.33
------- --------- --------- ------- ---------
608,109 6.7 years $ 10.39 443,399 $ 10.08
======= ========= ========= ======= =========
Employee Stock Purchase Plan
Under the Employee Stock Purchase Plan, (the "Purchase Plan"), eligible
employees are permitted to have salary withholdings to purchase shares of common
stock at a price equal to 85% of the lower of the market value of the stock at
the beginning or end of each three-month offer period or beginning of the
Purchase Plan start (27 months), subject to an annual limitation. Stock issued
under the plan was 7,734 shares, 11,005 shares and 9,049 shares in the years
ended March 31, 1999, 1998, and December 31, 1996, respectively, at weighted
average prices of $9.09, $6.82, and $6.31, respectively. The weighted average
fair value of the awards for each of the years ended March 31, 1999, 1998, and
December 31, 1996 awards was $10.69, $10.48, and $9.84, respectively. At March
31, 1999, 20,607 shares were reserved for future issuances under the Purchase
Plan.
Additional Stock Plan Information
The Company continues to account for its employee stock-based awards using
the intrinsic value method in accordance with Accounting Principles Board No.
25, Accounting for Stock Issued to Employees and its related interpretations. No
compensation expense has been recognized in the financial statements for
employee stock arrangements.
SFAS 123, Accounting for Stock-Based Compensation, requires the disclosure
of pro forma net income and earnings per share had the Company adopted the fair
value method as of the beginning of fiscal year 1995. Under SFAS 123, the fair
value of stock-based awards to employees is calculated through the use of option
pricing models, even though such models were developed to estimate the fair
value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
values. The Company's calculations were made using the Black-Scholes option
pricing model with the following weighted average assumptions: expected life,
102 months following vesting; stock volatility of 21.53% and 24.1% in the years
ended March 31, 1999 and 1998, respectively and 17% in the year ended December
31, 1996; risk-free interest rates of 6.49% and 6.59% for the years ended March
31, 1999 and 1998, respectively, and 6.0% in the year ended December 31, 1996;
and no dividends during the expected term. The Company's calculations are based
on a multiple option valuation approach and forfeitures are recognized as they
occur. If the computed fair values for the years ended March 31, 1999, March 31,
1998 and December 31, 1996 awards had been amortized to expense over the vesting
period of the awards, pro forma net income would have been $5,727,000 ($.65 per
share), $2,895,000 ($.26 per share) and $2,095,000 ($.26 per share),
respectively.
NOTE I - COMMON STOCK
The Company has reserved 1.5 million shares of common stock as of March 31,
1999, in connection with stock option and stock purchase plans, warrants and
convertible subordinated debentures.
On April 20, 1999, convertible subordinated debentures (convertible to
965,098 shares of the Company's common stock as of March 31, 1999) matured. At
such time, holders of $2.0 million in debentures elected not to exercise their
conversion rights and the Company repaid the $2.0 million using available
borrowings under its line of credit. The holders of the remaining $6.5 million
of debentures elected to exercise the conversion rights and exchanged their
debentures for 738,016 shares of the Company's common stock. The Company
received gross proceeds of $5.8 million ($4.8 million in March 1998 and $1
million in April 1998) in connection with the issuance of 828,571 shares of its
common stock upon the exercise by the principal holders of all the Company's
outstanding $7.00 warrants issued as of March 29, 1993 (the "Warrants").
-38-
NOTE J - EMPLOYEE BENEFIT PLANS
The Company has a Qualified Profit-Sharing Plan which provides for Company
contributions, as determined annually by the Board of Directors, based on the
Company's previous year performance. These contributions may be in the form of
common stock or cash as determined by the Board of Directors. The Board has
approved a contribution of $154,000 for the year ended March 31, 1999, $143,000
for the year ended March 31, 1998, and $73,000 for the year ended December 31,
1996. At March 31, 1999, the plan held 18,603 shares of the Company's common
stock.
NOTE K - INCOME TAXES
The provision for income taxes is summarized as follows (in thousands):
Year ended
Year ended March 31, December 31,
---------------------- ------------
1999 1998 1996
------ ------ ------
Federal
Current $3,121 $1,261 $1,056
Deferred 471 585 184
------ ------ ------
3,592 1,846 1,240
------ ------ ------
State
Current 920 319 364
Deferred 99 156 15
------ ------ ------
1,019 475 379
------ ------ ------
$4,611 $2,321 $1,619
====== ====== ======
The composition of the Company's net deferred tax liability is as follows
at March 31 (in thousands):
1999 1998
------ ------
Deferred tax liability:
Property, plant and equipment $2,561 $2,105
Other 204 10
------ ------
2,765 2,115
------ ------
Deferred tax assets:
Inventory 158 14
Tax credit carryforwards -- 66
------ ------
158 80
------ ------
Net deferred tax liability $2,607 $2,035
====== ======
The provision for income taxes differs from amounts computed at the
statutory rate as follows (in thousands):
Year ended
Year ended March 31, December 31,
------------------ -----------
1999 1998 1996
------- ------- -------
U.S. federal income tax at statutory rate $ 3,824 $ 1,949 $ 1,395
State tax net of federal benefit 655 334 230
Reconciling items:
Effect of acquisitions, net 33 33 33
Other 99 5 (39)
------- ------- -------
$ 4,611 $ 2,321 $ 1,619
======= ======= =======
-39-
NOTE L - TRANSACTIONS WITH RELATED PARTIES
The consolidated statements of income include the following amounts
resulting from transactions with related parties (in thousands):
Year ended
Year ended March 31, December 31,
------------------ ------------
1999 1998 1996
---- ---- ----
Interest expense:
Interest on convertible debentures held by Company owners
and directors $325 $325 $325
Interest on note payable to director -- 49 39
Interest on notes payable to joint venture partner -- -- 2
Interest income:
Interest on notes receivable from Company officers and directors -- 2 4
Interest on note receivable from joint venture partner 31 40 48
Amortization expense for joint venture agreement 124 64 --
Lease expense for land and facilities to joint venture partner 20 12 10
Consulting fee to officer of the Company -- -- 33
Consulting fee to affiliate of an officer 270 -- --
The balance sheet includes the following amounts resulting from
transactions with related parties at March 31 (in thousands):
Receivables 1999 1998
---- ----
Note receivable from Company officer $ -- $ 65
Inventory
Wine purchases from related parties 2,651 1,717
Grape purchases from related parties 3,093 2,483
Goodwill - investment in joint venture (see Note M) 3,287 3,619
Notes receivable - joint venture partner (Paragon) 228 327
Property, plant & equipment contributed by joint venture partners (net) 1,102 1,192
Long-term obligations
Note payable to director of the Company -- 934
Convertible debentures held by Company owners and Directors
(see Note G and I) 6,500 6,500
NOTE M - COMMITMENTS AND CONTINGENCIES
As of March 31, 1999, future minimum lease payments (excluding the effect
of future increases in payments based on indexes which cannot be estimated at
the present time) required under noncancelable operating leases with terms in
excess of one year are as follow (in thousands):
Year ending
March 31,
--------
2000 $ 853
2001 860
2002 827
2003 834
2004 826
Thereafter 9,289
--------
Total $ 13,489
========
-40-
NOTE M - COMMITMENTS AND CONTINGENCIES (Continued)
Rental expense charged to operations was as follows $788,000 and $635,000
for the years ended March 31, 1999 and 1998, respectively, and $658,000 for the
year ended December 31, 1996.
In 1991, the Company and Paragon entered into an agreement ("old
agreement") to provide the Company with the option to convert the EVV Joint
Venture ("Joint Venture") into a "permanent partnership" of unlimited duration.
Under the old agreement, the Company had made payments totaling $1,070,000 to
Paragon to have the right to extend the life of the Joint Venture through
January 1997. Under a new agreement, entered into on December 27, 1996 ("new
agreement"), the Company agreed to further payments of (i) $1,590,000 in
November of 1996, (ii) $1,050,000 in December of 1997 and December of 1999, and
(iii) $850,000 in December of 2001. Required payments through March 31, 1999
have all been made pursuant to the new agreement. The completion of all further
payments will guarantee the Company's 50% ownership throughout the remaining
life of the Joint Venture. Should the Company fail to make any further payments,
however, its ownership in the Joint Venture would be reduced to 26.71% as of
December 1999 (the due date of the next payment). Concurrent with the available
investment option in 2001, the Company will also have the option to purchase 50%
of the brand name, Edna Valley, for $200,000 which is currently licensed to the
Joint Venture by Paragon. The payments made to extend the life of the Joint
Venture and acquire ownership of the continuing Joint Venture have been recorded
as goodwill and are being amortized over 40 years.
The Company has contracted with various growers and certain wineries to
supply a large portion of its future grape requirements and a smaller portion of
its future bulk wine requirements. While most of these contracts call for prices
to be determined by market conditions, several long-term contracts provide for
minimum grape or bulk wine prices.
NOTE N - SELECTED FINANCIAL INFORMATION - THREE MONTHS ENDED MARCH 31, 1997
The Company changed its fiscal year from December 31 to March 31, effective
with the fiscal year beginning April 1, 1997. Selected financial information
derived from the consolidated statement of operations for the three months ended
March 31, 1997 and from the consolidated balance sheet at that date, as
previously reported in the Company's transition report on Form 10-K for the
three months ended March 31, 1997, is as follows (in thousands, except per share
data):
Net revenues $ 5,390
Net Income $ 310
EPS $ 0.04
Total assets $ 75,859
NOTE O - QUARTERLY DATA (Unaudited)
The Company's quarterly operating results for the fiscal year ended March
31, 1999, March 31, 1998, the three-month transition period ended March 31, 1997
and the year ended December 31, 1996, are summarized below:
(All amounts in thousands, except per share data)
Gross Gross Net EPS
Quarter ended revenues profit loss/income (diluted)
------------- -------- ------ ----------- ---------
March 31, 1999 $11,024 $ 5,095 $ 3,587 $ 0.40
December 31, 1998 12,573 5,607 1,352 0.16
September 30, 1998 11,361 4,831 977 0.11
June 30, 1998 9,015 4,092 720 0.08
March 31, 1998 8,936 4,137 535 0.06
December 31, 1997 11,178 4,878 1,404 0.17
September 30, 1997 9,250 3,783 804 0.10
June 30, 1997 8,287 3,418 667 0.08
March 31, 1997 5,520 2,384 311 0.04
December 31, 1996 9,857 4,100 888 0.11
September 30, 1996 8,207 3,157 668 0.08
June 30, 1996 8,449 3,170 653 0.08
March 31, 1996 5,396 1,948 130 0.02
-41-
NOTE P - SUBSEQUENT EVENT
On June 15, 1999, the Company purchased 100% of the outstanding shares of
SHW Equity Co., a holding company which, in turn, owns 100% of Staton Hills
Winery and its adjacent vineyards in Yakima County, Washington. The cost of the
acquisition was approximately $6.0 million and was financed with the Company's
long-term bank line of credit.
The Company intends to use the Staton Hills facility as the home of a new
Washington State wine brand featuring Merlot and Cabernet Sauvignon from these
three viticultural regions. The Company's present plan for the new brand,
expected to be named in the fall of 1999, is to initially produce 20,000 cases
for sale to the super-premium wine market.
-42-
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
The Chalone Wine Group, Ltd.
We have audited the accompanying consolidated balance sheets of The Chalone
Wine Group, Ltd. (the "Company") (a California corporation), as of March 31,
1999 and 1998, and the related consolidated statements of income, shareholders'
equity and cash flows for the two years ended March 31, 1999 and for year ended
December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company as of March 31, 1999 and 1998 and the consolidated results of its
operations and its cash flows for the two years ended March 31, 1999 and for the
year ended December 31, 1996 in conformity with generally accepted accounting
principles.
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
May 14, 1999
(June 15, 1999, as to Note P)
-43-
Item 9. Disagreements on Accounting and Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
See Part I, Item 4 - Executive Officers of the Registrant. Additional
information required by this Item is incorporated herein by reference to the
Company's Proxy Statement relating to the 1999 Annual Meeting of Shareholders to
be filed with the Securities and Exchange Commission within 120 days after March
31, 1999.
Item 11. Executive Compensation.
a. Executive Compensation.
The information required by this Item is incorporated herein by reference
to the Company's Proxy Statement relating to the 1999 Annual Meeting of
Shareholders to be filed with the Securities and Exchange Commission within 120
days after March 31, 1999.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this Item is incorporated herein by reference
to the Company's Proxy Statement relating to the 1999 Annual Meeting of
Shareholders to be filed with the Securities and Exchange Commission within 120
days after March 31, 1999.
Item 13. Certain Relationships and Related Transactions.
The information required by this Item is incorporated herein by reference
to the Company's Proxy Statement relating to the 1999 Annual Meeting of
Shareholders to be filed with the Securities and Exchange Commission within 120
days after March 31, 1999.
-44-
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
a(1). Financial Statements.
The following financial statements of the Company are included in Part II,
Item 8:
Page
----
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets..................................... 27
Consolidated Statements of Income............................... 28
Consolidated Statements of Shareholders' Equity................. 29
Consolidated Statements of Cash Flows........................... 30
Notes to Consolidated Financial Statements...................... 31
INDEPENDENT AUDITORS' REPORT............................................... 43
a(2). Financial Statement Schedules.
Schedules are omitted because they are not applicable, not required, were
filed subsequent to the filing of the Form 10-K, or because the information
required to be set forth therein is included in the consolidated financial
statements or in notes thereto.
b. Reports on Form 8-K.
The Company filed one report on Form 8-K during the first quarter of the
period covered by this Report, dated May 8, 1998, covering the issuance of
shares upon the exercise of the Company's 1993 warrants.
c. Exhibits.
A copy of any exhibits (at a reasonable cost) or the Exhibit Index will be
furnished to any shareholder of the Company upon receipt of a written request
therefor. Such request should be sent to The Chalone Wine Group, Ltd., 621
Airpark Road, Napa, California 94558, Attention: Investor Relations.
-45-
EXHIBIT INDEX
Exhibit
Number Exhibit Description
------ -------------------
3.1 Restated Articles of Incorporation, as amended through
June 3, 1985. (i)
3.2 Amendment to Restated Articles, filed June 6, 1988. (ii)
3.3 Amendment to Restated Articles, filed May 17, 1991. (iii)
3.4 Amendment to Restated Articles, filed July 14, 1993 (iv)
3.5 Bylaws, as amended through December 1992. (i)
3.6 1993 Bylaw amendments. (iv)
4.1 5% Convertible Subordinated Debenture Due 1999 (SDBR
Debenture), issued to Les Domaines Barons de Rothschild
(Lafite) ("DBR"), dated April 19, 1989. (v)
4.2 Shareholders' Agreement between the Company and DBR,
dated April 19, 1989. (v)
4.3 Form of 5% Convertible Subordinated Debenture Due
1999 (third-party debentures), issued April 19 and 28, 1989. (v)
4.4 5% Convertible Subordinated Debenture Due 1999 (1991
Debenture), issued to DBR, dated September 30, 1991. (vi)
4.5 Addendum to Shareholders' Agreement between the Company
and DBR, dated September 30, 1991. (vi)
4.6 Common Stock Purchase Agreement, between the Company and
certain designated investors, dated March 29, 1993. (vii)
4.7 Form of Warrant for the purchase in the aggregate of up to 828,571
shares of the Company's common stock, issued to certain designed
investors, effective July 14, 1993. (viii)
4.8 Voting Agreement, between Richard H. Graff, William L. Hamilton,
John A. McQuown, W. Philip Woodward, DBR, Richard C. Hojel,
and Summus Financial, Inc., dated March 29, 1993. (viii)
- ------------------------------
(i) Incorporated by reference to Exhibit Nos. 3.1 and 3.2, respectively, to
the Company's Registration Statement on Form S-1 (File No. 33-8666),
filed September 11, 1986.
(ii) Incorporated by reference to Exhibit No. 3.2 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1988, dated March 11,
1989.
(iii) Incorporated by reference to Exhibit No. 3.3 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1991, dated March 25,
1992.
(iv) Incorporated by reference to Exhibit Nos. 3.4 and 3.6, respectively, to
the Company's Annual Report on Form 10-K for the year ended December 31,
1993, dated March 26, 1994.
(v) Incorporated by reference to Exhibit Nos. 1, 4 and 5, respectively, to
the Company's Current Report on Form 8-K dated April 28, 1989.
(vi) Incorporated by reference to Exhibit Nos. 1 and 3, respectively, to the
Company's Current Report on Form 8-K dated September 30, 1991.
(vii) Incorporated by reference to Exhibit No. 1 to the Company's Current
Report on Form 8-K dated March 31, 1993.
(viii) Incorporated by reference to Exhibits 1 and 6, respectively, to the
Exhibit herein referenced as Exhibit 4.8.
-46-
EXHIBIT INDEX
Exhibit
Number Exhibit Description
------ -------------------
4.9 Common Stock Purchase Agreement, between the Company and
certain designated investors, dated April 22, 1994. (i)
4.10 Form of Warrant for the purchase in the aggregate of up to 833,333
shares of the Company's common stock, issued to certain designed
investors, effective October 25, 1995. (ii)
4.11 Voting Agreement, between the W. Phillip Woodward, DBR,
and Summus Financial, Inc., dated October 25, 1995. (ii)
10.1 Joint Venture Agreement between the Company and Paragon
Vineyard Co., Inc. ("Paragon"), effective January 1, 1991. (iii)
10.2 Revised Grape Purchase Agreement between Edna Valley Vineyard
Joint Venture and Paragon, effective January 1, 1991. (iii)
10.3 License Agreement between Edna Valley Vineyard Joint Venture
and Paragon, effective January 1, 1991. (iii)
10.4 Ground Lease between Edna Valley Vineyard Joint Venture and
Paragon, effective June 1, 1991. (iii)
10.5 Amended and Restated Commercial Winery and
Agricultural Lease, dated July 31, 1986, assigned by
Assignment and Assumption Agreement among
the Company, Lakeside Winery and Vista de Los Vinedos,
dated August 5, 1986. (iv)
10.6 Novation and Modification Agreement, between the Company
and Henry P. and Marina C. Wright, dated July 15, 1988,
amending Agreement incorporated as Exhibit 10.5. (v)
10.7 Tenancy in Common Agreement, between the Company
and Henry P. and Marina C. Wright, dated July 15, 1988. (v)
10.8 Vineyard Lease, between the Company and Henry P. and
Marina C. Wright, dated July 15, 1988. (v)
10.9 1988 Qualified Profit-Sharing Plan, approved May 21, 1988. (vi)
- ------------------------------
(i) Incorporated by reference to Exhibit No. 1 to the Company's Current
Report on Form 8-K dated April 27, 1994.
(ii) Incorporated by reference to Exhibit D to Appendix I to the Company's
Proxy Statement for a Special Meeting of Shareholders, filed October 25,
1995.
(iii) Incorporated by reference to Exhibit Nos. 1, 3, 4 and 2, respectively, to
the Company's Current Report on Form 8-K dated May 30, 1991.
(iv) Incorporated by reference to Exhibit No. 10.10 to the Company's
Registration Statement on Form S-1 (File No. 33-8666), filed September
11, 1986.
(v) Incorporated by reference to Exhibit Nos. 10.22, 10.20 and 10.21,
respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1988, dated March 11, 1989.
(vi) Incorporated by reference to Exhibit Nos. 10.16, 10.17 and 10.24,
respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1988, dated March 11, 1989.
-47-
EXHIBIT INDEX
Exhibit
Number Exhibit Description
------ -------------------
10.11 Amendment No. 2 to Qualified Profit Sharing Plan, incorporated as
Exhibit 10.9, dated February 7, 1990. (i)
10.12 Profit Sharing Trust Agreement. (ii)
10.13 Easement Agreement between the Company and Stonewall
Canyon Ranches, dated August 19, 1988. (ii)
10.14 1987 Stock Option Plan, as amended effective May 16, 1991. (iii)
10.15 1988 Non-Discretionary Stock Option Plan, as amended effective
May 16, 1991. (iii)
10.16 Employee Stock Purchase Plan, as amended effective May 16, 1991. (iii)
10.17 Amendment/Extension of Employee Stock Purchase Plan,
effective July 13, 1993. (iv)
10.18 Agreement of Joint Venture, between the Company and Canoe
Ridge Vineyard Incorporated [CRVI], dated December 31, 1990. (v)
10.19 Credit Agreement between the Company and Wells Fargo Bank,
dated July 20, 1992. (vi)
10.20 Industrial Real Estate Lease, dated February 19, 1993. (vi)
10.21 First Amendment to Credit Agreement between the Company
and Wells Fargo Bank incorporated as Exhibit 10.19, dated
March 18, 1993. (vi)
10.22 First Amendment to Industrial Real Estate Lease incorporated as
Exhibit 10.20, dated December 8, 1993. (iv)
10.23 Credit Agreement between the Company and Wells Fargo Bank,
dated August 30, 1993. (vii)
10.24 First Amendment to Credit Agreement between the Company and
Wells Fargo Bank, attached as Exhibit 10.22, dated March 24, 1994. (vii)
- ------------------------------
(i) Incorporated by reference to Exhibit Nos. 10.17 and 10.18, respectively,
to the Company's Annual Report on Form 10-K for the year ended December
31, 1989, dated March 27, 1990.
(ii) Incorporated by reference to Exhibit Nos. 10.22, 10.20 and 10.21,
respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1988, dated March 11, 1989.
(iii) Incorporated by reference to Exhibit Nos. 10.23, 10.24 and 10.25,
respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1991, dated March 25, 1992.
(iv) Incorporated by reference to Exhibit Nos. 10.22 and 10.29, respectively,
to the Company's Annual Report on Form 10-K for the year ended December
31, 1993, dated March 26, 1994.
(v) Incorporated by reference to Exhibit No. 10.27 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1990, dated March 26,
1991.
(vi) Incorporated by reference to Exhibit Nos. 10.24 through 10.27,
respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1992, dated March 29, 1993.
(vii) Incorporated by reference to Exhibit Nos. 10.23 through 10.27,
respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1994, dated March 27, 1995.
-48-
EXHIBIT INDEX
Exhibit
Number Exhibit Description
------ -------------------
10.25 Credit Agreement between the Company and Wells Fargo Bank,
dated July 29, 1994. (i)
10.26 Canoe Ridge Winery, Inc., Shareholders' Agreement, among the
Company and designated Washington state investors, dated
November 30, 1994. (i)
10.27 Amendment to Employee Stock Purchase Plan, effective
January 1, 1995. (i)
10.28 Omnibus Agreement between the Company, DBR,
and Summus Financial, dated August 22, 1995. (ii)
10.29 Credit Agreement between the Company and Wells Fargo Bank, (iii)
dated December 29, 1995.
10.30 Credit Agreement between Edna Valley Vineyard and (iv)
Wells Fargo Bank, dated July 31, 1995.
10.31 Purchase Agreement between the Company, (iv)
Richard H. Graff, Trustee, Graff 1993 Trust Dated June 10, 1993,
a trust and Richard H. Graff an individual, dated July 1, 1996.
10.32 Promissory Note between the Company and Richard H. Graff, (iv)
dated July 1, 1996.
10.33 Secured Purchase Money Promissory Note between the Company (iv)
and Richard H. Graff, Trustee, Graff 1993 Trust, dated July 1, 1996.
10.34 Residential Lease between the Company and Richard H. Graff, (iv)
dated July 1, 1996.
10.35 Consulting and Non-Competition Agreement between the Company (iv)
and Richard H. Graff, dated July 1, 1996.
10.36 Credit Agreement between the Canoe Ridge (iv)
Vineyard, LLC, and Wells Fargo Bank, dated
August 15, 1996.
10.37 Credit Agreement between the Company and Wells Fargo Bank, (iv)
dated September 25, 1996.
10.38 Amendment To Joint Venture Agreement
of Edna Valley Vineyard between Paragon Vineyard Co., Inc., (iv)
and the Company, dated December 23, 1996.
- ------------------------------
(i) Incorporated by reference to Exhibit Nos. 10.23 through 10.27,
respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1994, dated March 27, 1995.
(ii) Incorporated by reference to Appendix I to the Company's Proxy Statement
for a Special Meeting of Shareholders, filed October 25, 1995.
(iii) Incorporated by reference to Exhibit No. 10.21 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(iv) Incorporated by reference to Exhibit Nos. 10.30 through 10.38,
respectively, to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996.
-49-
EXHIBIT INDEX
Exhibit
Number Exhibit Description
------ -------------------
10.39 Credit Agreement between the Company and Wells Fargo Bank, (i)
dated July 30, 1997.
10.40 Credit Agreement between Edna Valley Vineyard and (i)
Wells Fargo Bank, dated July 30, 1997.
10.41 Credit Agreement between Canoe Ridge Vineyard, LLC, (i)
and Wells Fargo Bank, dated July 30, 1997.
10.42 First Amendment to Credit Agreement between the Company (i)
and Wells Fargo Bank incorporated as Exhibit 10.39, dated
January 5, 1998.
10.43 Second Amendment to Credit Agreement between the Company (i)
and Wells Fargo Bank incorporated as Exhibit 10.39, dated
June 9, 1998.
10.44 First Amendment to Credit Agreement between Edna Valley (i)
Vineyard and Wells Fargo Bank incorporated as Exhibit 10.40,
dated June 9, 1998.
10.45 First Amendment to Credit Agreement between Canoe Ridge (i)
Vineyard, LLC and Wells Fargo Bank incorporated as Exhibit 10.41,
dated June 9, 1998.
10.46 Lease-Purchase Agreement between the Company and Frances
Goodwin, Trustee of Lois Martinez Trust, dated December 30,
1999.
10.47 Credit Agreement by and between Cooperative Centrale
Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland," New York
Branch and the Company, dated March 31, 1999.
10.48 Term Loan Promissory Note between Cooperative Centrale
Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland," New York
Branch and the Company, dated March 31, 1999.
10.49 Revolving Loan Promissory Note between Cooperative Centrale
Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland," New York
Branch and the Company, dated March 31, 1999.
10.50 Purchase Agreement among Peter Ansdell, SHW Equity Co., and the
Company, and SHW Equity Co., dated June 15, 1999.
- ------------------------------
(i) Incorporated by reference to Exhibit Nos. 10.39 through 10.45,
respectively, to the Company's Annual Report on Form 10-K for the year
ended March 31, 1998.
-50-
EXHIBIT INDEX
Exhibit
Number Exhibit Description
------ -------------------
24 Consent of Deloitte & Touche LLP to incorporation by
reference, dated June 28, 1999.
27 Financial Data Schedule
-51-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
THE CHALONE WINE GROUP, LTD.
By /s/ Thomas B. Selfridge
---------------------------------------
Thomas B. Selfridge
Chief Executive Officer
(Principal Executive Officer)
By /s/ Francois P. Muse
---------------------------------------
Francois P. Muse
Chief Financial Officer (Principal
Financial and Principal Accounting Officer)
Dated: June 28, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ Thomas B. Selfridge President, and Chief June 28, 1999
------------------------------ Executive Officer
Thomas B. Selfridge
/s/ W. Philip Woodward Director, and Chairman June 28, 1999
----------------------------- of the Board
W. Philip Woodward
/s/ Christophe Salin Vice Chairman of the June 28, 1999
-----------------------------
Christophe Salin Board
/s/ C. Richard Kramlich Director June 28, 1999
-----------------------------
C. Richard Kramlich
-52-
/s/ Cristina G. Banks Director June 28, 1999
-----------------------------
Cristina G. Banks
Director
-----------------------------
William G. Myers
/s/ James H. Niven Director June 28, 1999
-----------------------------
James H. Niven
/s/ Eric de Rothschild Director June 28, 1999
-----------------------------
Eric de Rothschild
/s/ Mark Hojel Director June 28, 1999
-----------------------------
Mark Hojel
/s/ Yves-Andre Istel Director June 28, 1999
-----------------------------
Yves-Andre Istel
/s/ Phillip M. Plant Director June 28, 1999
-----------------------------
Phillip M. Plant
-53-