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SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 0-13406
The Chalone Wine Group, Ltd.
(Exact Name of Registrant as Specified in Its Charter)
California 94-1696731
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
621 Airpark Road
Napa, California 94558
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 707-254-4200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes _X_ No ___
The number of shares outstanding of Registrant's Common Stock on November 10,
1998 was 8,691,559.
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<PAGE>
The Chalone Wine Group, Ltd.
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements Page
Consolidated Balance Sheets as of September 30, 1998,
and March 31, 1998. 3
Consolidated Statements of Operations for the three-month
and six month periods ended September 30, 1998 and 1997. 4
Consolidated Statements of Cash Flows for the three-month
and six month periods ended September 30, 1998 and 1997. 5
Notes to Consolidated Financial Statements. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Disclosures about market risk 13
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 17
<PAGE>
<TABLE>
The Chalone Wine Group, Ltd.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<CAPTION>
ASSETS
(unaudited)
September 30, March 31,
1998 1998
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 213 $ 2,232
Accounts receivable, less allowance for doubtful
accounts of $99 and $92, respectively 8,295 6,597
Notes receivable 119 197
Income tax receivable 58 --
Note receivable from officer -- 65
Inventory 34,444 34,277
Prepaid expenses 344 450
Deferred income taxes 14 14
-------- --------
Total current assets 43,487 43,832
Investment in Chateau Duhart-Milon 11,033 9,480
Notes receivable, long-term portion 228 130
Property, plant and equipment - net 34,657 30,131
Goodwill and trademarks - net 6,311 6,473
Other assets 720 248
-------- --------
Total assets $ 96,436 $ 90,294
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 2,793 $ 3,425
Bank lines of credit 11,531 10,952
Other short term debt -- 952
Convertible subordinated debentures 8,500 --
Current maturities of long-term obligations 564 709
-------- --------
Total current liabilities 23,388 16,038
Long-term obligations, less current maturities 8,202 9,624
Convertible subordinated debentures -- 8,500
Settlement advance 4,500 --
Deferred income taxes 2,049 2,049
-------- --------
Total liabilities 38,139 36,211
-------- --------
Minority interest 4,190 3,678
Shareholders' equity:
Common stock - authorized 15,000,000 shares, no
par value; issued and outstanding: 8,691,137
and 8,393,979, respectively 48,861 46,871
Stock subscription receivable (1,007) --
Retained earnings 7,690 5,993
Cumulative foreign currency translation adjustment (1,437) (2,459)
-------- --------
Total shareholders' equity 54,107 50,405
-------- --------
Total liabilities and shareholders' equity $ 96,436 $ 90,294
======== ========
<FN>
The accompanying notes are an integral part
of the consolidated financial statements
</FN>
</TABLE>
3
<PAGE>
<TABLE>
The Chalone Wine Group, Ltd.
Consolidated Statements of Operations
(unaudited, in thousands, except per-share data)
<CAPTION>
Three months ended Six months ended
September 30 September 30
--------------------------- ---------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Gross revenues $ 11,361 $ 9,250 $ 20,376 $ 17,537
Excise taxes (248) (243) (451) (454)
-------- -------- -------- --------
Net revenues 11,113 9,007 19,925 17,083
Cost of wines sold (6,282) (5,224) (11,002) (9,882)
-------- -------- -------- --------
Gross profit 4,831 3,783 8,923 7,201
Custom processing operations 23 117 23 117
SG&A expenses (2,612) (1,838) (5,146) (3,758)
-------- -------- -------- --------
Operating income 2,242 2,062 3,800 3,560
Other income (expenses)
Interest expense (423) (518) (842) (973)
Other, net (44) 51 (36) 70
-------- -------- -------- --------
(467) (467) (878) (903)
Equity in Chateau Duhart-Milon 215 -- 531 193
Minority interests (332) (255) (575) (398)
-------- -------- -------- --------
Income before income taxes 1,658 1,340 2,878 2,452
Income tax expense (681) (536) (1,181) (981)
-------- -------- -------- --------
Net income $ 977 $ 804 $ 1,697 $ 1,471
======== ======== ======== ========
Net income per common share:
Basic $ 0.11 $ 0.10 $ 0.20 $ 0.19
Diluted $ 0.11 $ 0.10 $ 0.19 $ 0.18
Average number of shares used
in income per share computation:
Basic 8,692 7,790 8,636 7,665
Diluted 8,892 8,283 8,883 8,370
<FN>
The accompanying notes are an integral part
of the consolidated financial statements
</FN>
</TABLE>
4
<PAGE>
<TABLE>
The Chalone Wine Group, Ltd.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
<CAPTION>
Three months ended Six months ended
September 30 September 30
----------------------- -----------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 977 $ 804 $ 1,697 $ 1,471
Non-cash transactions included in earnings:
Depreciation 468 364 932 745
Amortization 82 41 162 86
Equity in net income of Chateau Duhart-Milon (215) -- (531) (193)
Increase in minority interest 340 255 583 398
Exchange rate gain -- 9 -- --
Loss on sale of equipment 92 1 92 3
Changes in:
Settlement advance -- -- 4,500 --
Accounts and other receivable (2,300) (756) (1,698) (664)
Inventory 741 (2,045) (167) (2,129)
Prepaid expenses and other assets (156) -- (424) (68)
Accounts payable and accrued expense 243 1,646 (632) 1,919
------- ------- ------- -------
Net cash provided by operating activities 272 319 4,514 1,568
------- ------- ------- -------
Cash flows from investing activities:
Capital expenditures (3,350) (2,520) (5,550) (4,539)
Proceeds from disposal of property and equipment -- 95 -- 100
Net increase in notes receivable (20) (125) (20) --
------- ------- ------- -------
Net cash used in investing activities (3,370) (2,550) (5,570) (4,439)
------- ------- ------- -------
Cash flows from financing activities:
Net change under line of credit agreement 4,240 2,968 579 3,826
Decrease in short-term debt -- -- (952) --
Distribution to minority interest -- -- (71) (38)
Repayment of long-term debt (1,110) (760) (1,567) (1,097)
Proceeds from issuance of common stock 4 11 1,048 56
------- ------- ------- -------
Net cash provided by (used in) financing activities 3,134 2,219 (963) 2,747
------- ------- ------- -------
Net increase (decrease) in cash 36 (12) (2,019) (124)
Cash at beginning of period 177 134 2,232 246
------- ------- ------- -------
Cash at end of period $ 213 $ 122 $ 213 $ 122
======= ======= ======= =======
<FN>
The accompanying notes are an integral part
of the consolidated financial statements
</FN>
</TABLE>
5
<PAGE>
The Chalone Wine Group, Ltd.
Notes to Consolidated Financial Statements
NOTE 1 - Consolidated Financial Statements
The consolidated balance sheet as of September 30, 1998, the consolidated
statements of operations for the three-month and six-month periods ended
September 30, 1998, and 1997, and the consolidated statements of cash flows for
the three-month and six-month periods then ended have been prepared by the
Company, without audit. In the opinion of management, all adjustments (which
include only normal recurring adjustments) necessary to present fairly the
Company's financial position, results of operations and cash flow at September
30, 1998, and for all periods presented have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. For further information, reference should be
made to the consolidated financial statements and notes included in the
Company's Form 10-K for the year ended March 31, 1998, on file with the
Securities and Exchange Commission.
NOTE 2 - Reclassifications
Certain prior period amounts have been reclassified in order to conform with the
current period presentation.
NOTE 3 - Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No.130 ("SFAS 130") Reporting Comprehensive
Income. SFAS 130 requires the additional reporting of a new measure of income
which takes into account certain elements otherwise recorded as part of equity.
For all periods presented, the difference between net income and comprehensive
income consists of the changes in the cumulative foreign currency translation
adjustment included as part of the Company's equity.
<TABLE>
The following is a reconciliation of net income and comprehensive income (in
thousands):
<CAPTION>
Three months ended Six months ended
September 30 September 30
--------------------- ---------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $ 977 $ 804 $ 1,697 $ 1,471
Change in cumulative foreign currency translation adjustment 742 (74) 1,022 (449)
------- ------- ------- -------
Comprehensive income $ 1,719 $ 730 $ 2,719 $ 1,022
======= ======= ======= =======
</TABLE>
NOTE 4 - Earnings per Share
The Company adopted Statement of Financial Accounting No.128 ("SFAS 128") -
Earnings per Share. As a result of the adoption of SFAS 128, earnings per share
amounts for the three month and six month periods ended September 30, 1997, have
been restated to conform to the new standard. This standard requires dual
presentation of two earnings per share ("EPS") amounts, basic EPS and diluted
EPS. Basic EPS represents the income available to common stockholders divided by
the weighted average number of common shares outstanding for the period. Diluted
EPS represents the income available to common stockholders divided by the
weighted average of common shares outstanding while also giving effect to the
potential dilution that could occur if securities or other contracts to issue
common stock (e.g. stock options) were exercised and converted into stock. For
all periods presented, the difference between basic and diluted earnings per
share for the Company is 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.
6
<PAGE>
The Chalone Wine Group, Ltd.
NOTE 4 - Earnings per Share (Continued)
<TABLE>
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)
<CAPTION>
Basic EPS Diluted EPS
------------ -----------
Effect of dilutive securities Income
----------------------------- available to
Income common
available to stockholders
common and assumed
stockholders Warrants Stock options conversion
------------ -------- ------------- ----------
<S> <C> <C> <C> <C>
Three months ended September 30, 1998:
Income $ 977 -- -- $ 977
Shares 8,692 198 2 8,892
-------------- ------------------
EPS $ 0.11 $ 0.11
============== ==================
Three months ended September 30, 1997:
Income $ 804 -- -- $ 804
Shares 7,790 375 118 8,283
-------------- ------------------
EPS $ 0.10 $ 0.10
============== ==================
Six months ended September 30, 1998:
Income $ 1,696 -- -- $ 1,696
Shares 8,636 214 33 8,883
-------------- ------------------
EPS $ 0.20 $ 0.19
============== ==================
Six months ended September 30, 1997:
Income $ 1,471 -- -- $ 1,471
Shares 7,665 538 167 8,370
-------------- ------------------
EPS $ 0.19 $ 0.18
============== ==================
</TABLE>
7
<PAGE>
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
FORWARD LOOKING STATEMENTS
From time to time, information provided by the Company, statements made by its
employees or information included in its filings with the Securities and
Exchange Commission (including this Form 10-Q) may contain statements that are
not historical facts, so called "forward looking statements," which involve
risks and uncertainties. Forward looking statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
When used in this Form 10-Q, the terms "anticipates," "expects," "estimates,"
"believes," and other similar terms as they relate to the Company or its
management are intended to identify such forward looking statements. For
example, statements made herein relating to the 1998 harvest, conversion of a
majority of the currently outstanding convertible debentures, the Company's
working capital requirements, the anticipated future results of Edna Valley
Vineyard joint venture and Canoe Ridge Vineyard, LLC, and the Company's
expectation that sufficient cash flow will continue to be provided from
operations, are forward looking statements. Factors that may cause actual
results to vary include, but are not limited to: (i) future and past weather and
general farming conditions affecting the annual grape harvest; (ii) variations
in consumer taste and preference; (iii) changes in the wine industry regulatory
environment; and (iv) changes in the fair market value of the Company's common
stock. Each of these factors, and others, are discussed from time to time in the
Company's filings with the Securities and Exchange Commission including the
Company's annual report on Form 10-K for the year ended March 31, 1998.
DESCRIPTION OF THE BUSINESS
The Chalone Wine Group, Ltd. is a Napa, California-based company that produces,
markets and sells primarily super and ultra-premium white and red varietal table
wines. In California, the company owns and operates Chalone Vineyard(R) in
Monterey County, Acacia(TM) Winery in the Carneros District of Napa County,
Carmenet(R) Vineyard in Sonoma County, and in conjunction with its 50%
joint-venture partner, Paragon Vineyard Co., owns and operates Edna Valley
Vineyard(R) in San Luis Obispo County. In the State of Washington, the Company
owns a 50.5% interest in Canoe Ridge(R) Vineyard. In the Bordeaux region of
France, the Company owns 23.5% of the fourth-growth estate of Chateau
Duhart-Milon in partnership with Domaines Barons de Rothschild (Lafite) ("DBR"),
which owns the remaining 76.5% interest in Chateau Duhart-Milon.
With a view to introducing new consumers to its family of wines, the Company
recently expanded its product line with the launch of the "Echelon(TM)" brand.
Taking advantage of the Company's diverse vineyard resources, the mid-priced
Echelon label is expected to reach a larger and entirely new market segment,
while permitting the Company's super and ultra-premium labels to maintain its
reputation for quality. During the six months ended September 30, 1998, 60,000
cases of Echelon Chardonnay and 25,000 cases of Pinot Noir were made available
for sale. A Merlot and Syrah are planned for the Echelon label during 1999.
In addition to, and as a result of, an investment in the Company by DBR, the
Company receives an allocation of DBR wines for resale, including an allocation
from Chateau Lafite-Rothschild, a first growth Bordeaux chateau, which is
generally regarded as one of the world's most exclusive wine producers.
8
<PAGE>
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
RESULTS OF OPERATIONS
<TABLE>
The following table sets forth the percentage relationship to net revenues of
certain items in the Company's statements of operations for the three month and
six month periods ended September 30, 1998, and 1997, and the percentage change
in such items between the comparable period in those years:
<CAPTION>
Three months ended Percent Six months ended Percent
September 30 Change September 30 Change
---------------------------- ----------- --------------------------- ------------
1998 1997 98 vs 97 1998 1997 98 vs 97
------------ ------------ ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Net revenues 100.0 % 100.0 % 23.4 % 100.0 % 100.0 % 16.6 %
Cost of wines sold (56.5)% (58.0)% 20.3 % (55.2)% (57.8)% 11.3 %
------------ ------------ ------------ ------------
Gross profit 43.5 % 42.0 % 27.7 % 44.8 % 42.2 % 23.9 %
Custom processing operations 0.2 % 1.3 % (80.3)% 0.1 % 0.7 % (80.3)%
SG&A expenses (23.5)% (20.4)% 42.1 % (25.8)% (22.0)% 36.9 %
------------ ------------ ------------ ------------
Operating income 20.2 % 22.9 % 8.7 % 19.1 % 20.8 % 6.7 %
------------ ------------ ------------ ------------
Other income (expenses):
Interest (3.8)% (5.8)% (18.3)% (4.2)% (5.7)% (13.5)%
Other, net (0.4)% 0.6 % (186.3)% (0.2)% 0.4 % (151.4)%
------------ ------------ ------------ ------------
(4.2)% (5.2)% -- (4.4)% (5.3)% (2.8)%
Equity in Chateau Duhart-Milon 1.9 % -- n/a 2.7 % 1.1 % 175.1 %
Minority interests (3.0)% (2.8)% 30.2 % (2.9)% (2.3)% 44.5 %
------------ ------------ ------------ ------------
Income before income taxes 14.9 % 14.9 % 23.7 % 14.4 % 14.4 % 17.4 %
------------ ------------ ------------ ------------
Income tax expense (6.1)% (6.0)% 27.1 % (5.9)% (5.7)% 20.4 %
------------ ------------ ------------ ------------
Net income 8.8 % 8.9 % 21.5 % 8.5 % 8.6 % 15.4 %
============ ============ ============ ============
</TABLE>
Net Revenues
Sales for the three-month and six-month periods ended September 30, 1998,
increased approximately 23% and 17% respectively, over the comparable periods in
the prior year, primarily as a result of increased case sales. The current
quarter's results were materially affected by sales of wines under the new
Echelon label, and improved average sales prices per case resulting from changes
in product mix and selected price increases.
Gross Profit
Gross profit for the three months and six months ended September 30, 1998,
increased by approximately 28% and 24% respectively, over the comparable periods
in the prior year. The increased gross profit in the current quarter was a
result of increased case sales and higher prices (as mentioned above) without
corresponding increases in production costs.
Selling, General and Administrative (SG&A) Expenses
SG&A expenses for the three months and six months ended September 30, 1998,
increased by approximately 42% and 37% respectively, over the comparable periods
in the prior year. These increases primarily are the result of planned increases
in selling expenses.
Also contributing to these increased SG&A expenditures are certain non-recurring
charges attributable to organizational changes.
9
<PAGE>
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
Custom Processing Operations
Custom processing revenue is obtained from third-party wineries, net of related
expenses for grape crushing or wine-bottling. The Company cannot predict the
materiality of such operations or future operating results, as this source of
revenue is highly unpredictable and entirely contingent on other wineries'
demand for extra production capacity, which can and does vary significantly from
year to year.
The decrease of 80% in both the three-month and six-month periods ended
September 30, 1998 compared to the comparable periods in the prior year were due
to less custom crush demand, partly offset by increased custom bottling demand.
Operating Income
Operating income for the three months and six months ended September 30, 1998,
increased by 9% and 7%, respectively, from the comparable periods in the prior
year. These increases were due to higher gross profits, offset by increased SG&A
expenses and fewer custom processing fees (Other Revenue from Operations), all
of which are discussed above.
Other Income (Expenses)
Interest expense comprised more than 90% of total Other Income (Expenses) for
all periods presented. Interest expense for the three months and six months
ended September 30, 1998, decreased by 18% and 14%, respectively, from the
comparable periods in the prior year, primarily due to improved terms on, and
lower average levels of, outstanding indebtedness.
Equity in Net Income of Chateau Duhart-Milon
The Company experienced record results during the six months ended September 30,
1998 from its investment in Societe Civile Chateau Duhart-Milon
("Duhart-Milon"). Specifically, the Company's 23.5% equity interest in the net
income of Duhart-Milon for the three months and six months ended September 30,
1998, was $215,000 and $531,000 respectively, as compared to $0 and $193,000,
respectively, during the comparable periods in the prior year. These 100% and
175% increases, respectively, are 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, current year results
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
French Francs, the Company maintains a reserve for currency translation which
was valued at $1,437,000 as of September 30, 1998. This reserve was reduced from
$2,459,000 as of March 31, 1998 and $2,179,000 as of June 30, 1998 due to the
steady increase in the relative worth of the French Franc when compared to the
U.S. dollar during the six months ended September 30, 1998.
10
<PAGE>
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
Minority Interest
<TABLE>
The Edna Valley Vineyard ("EVV") and Canoe Ridge Vineyard, LLC ("CRV")
individual financial statements are consolidated in full within the Company's
financial statements. The interests of parties other than the Company in the net
earnings of EVV and CRV are accounted for as "minority interests." The minority
interests for the three-month and six-month periods ended September 30, 1998,
and 1997, were as follows (in thousands):
<CAPTION>
Three months ended Six months ended
September 30 September 30
Minority ------------------------- -------------------------
Venture Minority Owner Percent 1998 1997 1998 1997
- ------------- ------------------------------ --------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
EVV Paragon Vineyard Co., Inc. 50.0% $ 228 $ 235 $ 400 $ 356
CRV Various 49.5% 104 20 175 42
------------ ------------ ------------ ------------
$ 332 $ 255 $ 575 $ 398
============ ============ ============ ============
</TABLE>
The approximately 30% and 45% increase in the minority interests of EVV and CRV
for the three months and six-months periods ended September 30, 1997, and 1998
respectively, reflects the improved net results of EVV and CRV between the those
periods. The Company anticipates that such net results for both EVV and CRV will
continue to improve from year to year, and that minority interest will thus
increase accordingly.
Net Income
Net income for the three months and six months ended September 30, 1998, was
$977,000 and $1,697,000, respectively, reflecting increases of approximately 22%
and 15% over the comparable periods in the prior year. By comparison, the net
income for the three months ended June 30, 1998 was only 8% higher than in the
comparable period in the prior year. The improved relative performance in the
three months ended September 30, 1998 was primarily attributable to gross
profits and equity in Duhart-Milon.
"EL NINO"
The weather phenomenon commonly referred to as "El Nino" produced heavy Spring
rains and cooler weather, which resulted in colder and wetter soils than are
typical during California's grape growing season. Consequently, the harvest was
postponed by approximately four to six weeks - depending on the geographical
location and varietals. The primary risk associated with such a delay in harvest
is rot, due to possible exposure to early winter rains, which can affect quality
and quantity. Mostly as a result of 1) arctic weather fronts which brought
colder weather conditions than normal during September and October, and 2)
experiencing very few early winter rains, the Company believes that rot was
largely avoided.
The unusual weather conditions resulting from El Nino impacted quantity and
quality of the Company's 1998 estate harvest. Quantities 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 in its Chardonnay, Cabernet and Merlot varietals
which together, historically have comprised between 80% and 85% of its aggregate
annual production.
11
<PAGE>
The Chalone Wine Group, Ltd.
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
LIQUIDITY AND CAPITAL RESOURCES
Working Capital:
During the six-month period ending September 30, 1998, working capital decreased
by $7.7 million, or 28%, from $27.8 million to $20.1 million. This was primarily
due to the following: 1) a change in classification for $8.5 million of
convertible subordinated debentures from long-term debt to current debt; 2)
capital expenditures of $5.6 million incurred both as a result of normal
operations and selected expansion of certain Company production facilities;
offset by 3) $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);
and 4) an advance of $4.5 million from Pacific Gas and Electric ("PG&E") related
to the Carmenet Vineyard fire of July 1996.
The $8.5 million of convertible subordinated debentures are convertible to
965,098 shares of the Company's common stock and will mature in April, 1999. The
Company believes that the majority of such debentures will convert to stock when
due. The advance of $4.5 million from PG&E was recorded as a "Settlement
Advance" on the Company's balance sheet as of September 30, 1998. Upon
settlement, this amount will be recognized in the Company's Statement of
Operations. The Company currently anticipates that settlement will be reached
during the three month period ending December 31, 1998. Both the convertible
debentures and the PG&E advance were more fully described in the Company's Form
10-K for the year ended March 31, 1998, on file with the Securities and Exchange
Commission.
Cash Flows:
Cash flow from operations increased by $2.9 million, or 188%, in the six months
ended September 30, 1998 vs. the comparable period in the prior year. This was
primarily a result of the receipt of the $4.5 million from PG&E discussed above.
Cash flow from investing activities decreased by 30% and 24% from the comparable
periods in the prior year, respectively, in the three-month and six-month
periods ended September 30, 1998, mostly as a result of increased capital
expenditures. Cash flow from financing activities was $3.1 million in the
three-month period ended September 30, 1998, primarily due to increased
borrowing under the Company's line of credit, offset by an early payment of long
term debt of $1.1 million. During the six months ended September 30, 1998,
however, cash flow from financing activities was $(1.0) million primarily as a
result of cash outflows of $2.5 million due to repayments of short-term and
long-term debt, offset by cash inflows of $1.0 million received due to an
exercise of warrants (as mentioned above).
General:
As of October 26, 1998, the Company had lines of credit totaling $16.3 million,
of which $11.6 million had been drawn.
The Company is not aware of any potential impairments to its liquidity and
believes that its capital resources are adequate to meet current and historic
levels of capital expenditures and liquidity needs of the Company, including all
amounts potentially due in April 1999 to repay the convertible subordinated
debentures.
YEAR 2000
The year 2000 issue is the result of computer programs being written using two
digits rather than four to determine the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. 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 year 2000 software failures.
However, the Company believes that its exposure to year 2000 issues remains
relatively minor in comparison to most industrial enterprises because of its
relatively low reliance on computerized systems.
While the Company believes it is doing everything technologically possible to
assure year 2000 compliance, it 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
year 2000 compliance failures could result in additional expenses to the
Company, the materiality of which cannot be predicted at this time.
12
<PAGE>
The Chalone Wine Group, Ltd.
Item 3. Disclosures About Market Risk
You should carefully consider, among other factors, the matters described below
before purchasing any Chalone common stock. This list of factors is not
exhaustive.
Unpredictability of Future Operating Results; Likely Fluctuations in Quarterly
Operating Results
We have experienced, and expect to continue to experience, significant
fluctuations in revenues and operating results from quarter to quarter. As a
result, we believe that 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, 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.
Geographical Concentration of Sales; Dependence on Certain Types of Wines
In its fiscal year ended March 31, 1998, approximately 66% of our wine sales
were concentrated in [number] of 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. Reduced consumer confidence and spending also may result in reduced
demand overall for wines which may limit our ability to increase prices or
require us to increase selling and promotional expenses.
Approximately 90% of our net revenues in the fiscal year ended March 31, 1998
were concentrated in our top four selling varietal wines. Specifically, sales of
Chardonnay, Pinot Noir, Cabernet Sauvignon and Merlot accounted for 61%, 76%, 9%
and 4% of our fiscal 1998 net revenues, respectively.
A sudden and unexpected shift in consumer preferences or a reduction in sales of
wine generally or in a particular geographic area, in wine varietals or types,
particularly Chardonnay, could have a material adverse effect on our business.
Competition
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 and Australia. Our wines also compete with popular-priced generic wines
and with other alcoholic and, to a lesser degree, nonalcoholic 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. In
view of these factors, there can be no assurance that we will be able to
continue to compete effectively with larger or better capitalized companies.
Risks of Seasonality
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. Our sales volume typically decreases after
the holidays. 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.
13
<PAGE>
The Chalone Wine Group, Ltd.
Item 3. Disclosures About Market Risk (Continued)
Agricultural Risks
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
materially and adversely affect the quality and supply of our wines and our
operating results. Future government restrictions regarding the use of certain
materials used in grape growing also may have a material adverse effect on
vineyard costs and 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.
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 adversely affect our business.
Risks of Fluctuations in Quantity and Quality of Grape Supply
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.
Risks of Dependence on Distribution Network
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 seventeen largest distributors combined,
represented approximately 5% and 36%, respectively, of our net revenues during
fiscal 1998. Sales to our ten largest distributors are expected to continue to
represent a substantial portion of our net revenues in the future. 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 have a material adverse effect on our business.
Risk of Government Regulation
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. Expansion of our existing facilities
and development of new vineyards and 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 and international tariffs,
could materially adversely affect our financial results. Future legal or
regulatory challenges to the industry, either individually or in the aggregate,
could have a material adverse effect our business.
14
<PAGE>
The Chalone Wine Group, Ltd.
Item 3. Disclosures About Market Risk (Continued)
Need for Additional Capital
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.
Risks from Consumer Perception of Health Issues Related to Alcohol Consumption
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 have a material adverse effect on
the industry and our business.
Operating Hazards
We necessarily use pesticides and other hazardous substances in the operation of
our business. Although we take many precautions to minimize and manage the risks
of contamination, if hazardous substances are discovered on, or emanating 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. These costs could be substantial and have a material adverse effect
on our business and financial condition.
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.
Risks of Loss of Key Personnel
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 have a material adverse effect on our business, 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.
Risks From Foreign Operations
We conduct some of our import and export activity for wine and packaging
supplies in foreign currency. We purchase our 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.
Risk of Dilution or Infringement of Company Trademarks
Our wines are branded consumer products, and we distinguish our wines from our
competitor by strong and vigilant enforcement of our trademarks. There can be no
assurance that competitors will refrain from using trademarks, trade-names 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.
15
<PAGE>
The Chalone Wine Group, Ltd.
Item 3. Disclosures About Market Risk (Continued)
Possible Volatility of Stock Price
The market price of our common stock fluctuates. All of the foregoing risks,
among others not known or mentioned in this prospectus, may have a significant
effect on the market price of the our shares. Additionally, 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 adversely affect the market price of our shares.
16
<PAGE>
The Chalone Wine Group, Ltd.
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit Number
20.8 Form 8-K: Item 5, Exercise of Warrants
27 Financial Data Schedule
(b) Reports. One report to shareholders was filed with the Securities and
Exchange Commission on Form 8-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: November 16, 1998 The Chalone Wine Group, Ltd.
- ------------------------ ----------------------------
(Registrant)
/s/ Thomas B. Selfridge
-----------------------------------
Thomas B. Selfridge
President and Chief Executive
Officer
Dated: November 16, 1998 /s/ Francois P. Muse
- ------------------------ -----------------------------------
Francois P. Muse
(Acting) Chief Financial Officer
and Treasurer
17
EXHIBIT 20.8
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): May 8, 1998
The CHALONE Wine Group, Ltd.
-------------------------------------------
(Exact Name of Registrant as Specified in Charter)
California 0-13406 94-169731
- ------------------------------- ----------- -------------
(State or Other Jurisdiction of (Commission (IRS Employer
Incorporation) File Number) Identification No.)
621 Airpark Road
Napa, California 94558
- --------------------------------------- ----------
(Address of Principal Executive Offices (Zip Code)
Registrant's telephone number, including area code 707-254-4200
------------------------------
<PAGE>
Item 5. Other Events.
The Chalone Wine Group, Ltd. (the "Company") recently completed the
issuance of 828,571 shares of its common stock upon the exercise by the
principal holders of all the Company's issued and outstanding $7.00 warrants
issued pursuant to that certain Common Stock Purchase Agreement dated March 29,
1993 (the "1993 Warrants").
All of the shares issued on the exercise of the 1993 Warrants have
been, or will be, issued pursuant to an exemption from the registration
requirements of federal and state securities laws and, consequently, the
certificates representing the shares bear an appropriate restrictive legend. The
terms of the 1993 Warrants provide all warrantholders with certain registration
rights. The Company has received notice that certain warrantholders intend to
demand registration of 185,714 shares of the Company's common stock received on
the exercise of the 1993 Warrants. The Company believes that no other
warrantholders intend to exercise registration rights. The Company anticipates
filing a registration statement to effect the foregoing registration in June
1998 at its cost. The shares registered thereby may be resold into the trading
market for the common stock of the Company anytime after the registration
statement is declared effective by the Securities and Exchange Commission,
pursuant to the prospectus included therewith.
Since December 31, 1997 the Company has received gross proceeds of
$5,799,997 from the exercise of the 1993 Warrants. The Company anticipates using
such proceeds for the reduction of existing short-term indebtedness and working
capital.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
The CHALONE Wine Group, Ltd.
---------------------------------
(Registrant)
By: /s/ William L. Hamilton
---------------------------------
William L. Hamilton
Executive Vice President, Chief
Financial Officer, and Director
Dated: May 8, 1998
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