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U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-KSB/A
AMENDMENT NO. 1
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1995
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _________________ to ___________________
Commission File No. 0-26276
R.H. PHILLIPS, INC.
(Name of small business issuer in its charter)
California 68-0313739
(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification No.)
26836 County Road 12A, Esparto, California 95627
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (916) 662-3215
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
No Par Common Stock
(Title of Class)
Warrants to Purchase Common Stock, Expiring April 1, 1997
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. [X]
Issuer's revenues for its most recent fiscal year: $15,498,210
Aggregate market value of the voting stock held by non-affiliates computed by
reference to the price at which the stock was sold on March 20, 1996:
$14,878,854
Number of shares outstanding of each of the issuer's classes of common equity as
of March 20, 1996: 4,632,985.
Transitional Small Business Disclosure Format: Yes No X
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PURPOSE OF AMENDMENT
The following items of the Annual Report on Form 10-KSB of R.H. Phillips, Inc.
(the "Company") for the year ended December 31, 1995 are hereby amended: Items
1, 6, 7 and 13. Each item, as amended, is set forth in its entirety below.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
As used herein, "R.H. Phillips business" shall refer to the R.H.
Phillips vineyard and winery business. The "Company" shall refer to R.H.
Phillips, Inc., the issuer to which this report pertains.
The Company makes and sells premium varietal table vines. The Company's
vineyard, winery and corporate headquarters is located in the Dunnigan Hills
region of California, approximately 30 miles north-east of the Napa Valley wine
region. The Company's wines are sold throughout the United States and in several
other countries. Since John and Karl Giguiere, the Chief Executive Officers of
the Company, founded R.H. Phillips in the early 1980s, shipments of R.H.
Phillips' wines have expanded from 4,552 cases of wine in 1984 to 401,000 cases
of wine in 1995.
BUSINESS OF ISSUER
PRODUCTS
The Company produces and sells wines in the so-called "table wine"
category. "Table wines" are those with 7% to 14% alcohol by volume and which are
generally consumed with foods. Table wines which retail for less than $3.00 per
750 ml (milliliter) bottle are generally referred to as generic or "jug" wines.
Table wines which retail in the $3.00 to $7.00 range are referred to as
"premium" or "popular premium" wines, wines which retail from between $7.00 to
$14.00 per bottle are considered "super premium" wines and those which retail
above $14.00 per bottle are considered "ultra premium" wines.
R.H. Phillips has developed a diverse line of products including
popular premium, super premium and ultra premium cork-finished varietal table
wines. The Company markets its products under primary as well as secondary
labels. Primary label products feature the "R.H. Phillips" name, and are divided
into three brand groups, with each group distinguished by a type of wine and
price structure. The two secondary label wines have a lower cost base and are
intended to compete aggressively with other lower-priced premium wines.
The EXP SERIES is comprised of two Rhone varietals, Syrah and Viognier,
which are traditional to France's Southern Rhone Valley. The EXP Series wines
are bottled in 750 ml bottles, and retail for about $12 each.
Chardonnay and Cabernet Sauvignon are the two R.H. Phillips wines
considered the CLASSIC VARIETALS. R.H. Phillips has become a recognized quality
leader for Chardonnay and Cabernet Sauvignon
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priced under $10 per bottle and receives significant positive recognition from
well-known wine critics such as Robert Parker. The lower viticultural cost
associated with the Dunnigan Hills has made it possible for R.H. Phillips to
improve wine quality by applying a portion of production savings to oak barrel
fermentation and barrel aging. These processes give the wines a definite quality
edge within their price structure. Both the Chardonnay and Cabernet Sauvignon
are bottled in 500 ml, 750 ml and 1.5 liter bottles. Both wines retail for about
$6, $8 or $14 per bottle, depending on the size.
The NIGHT HARVEST series are blends of varietal wines which are named
for the innovative night harvesting methods developed by the Company to retain
grape freshness. The wines in this series consist of Sauvignon Blanc, Mistura
and White Zinfandel. The method of night harvesting allows the processing of
cooler fruit, producing maximum flavor from the grapes without extracting
bitterness which emerges at higher processing temperatures. Wines in this group
are delicate, smooth-textured blends of various varietals, designed to gain
maximum flavor from the blending process. Night Harvest wines are bottled in 500
ml, 750 ml and 1.5 liter bottles. Retail prices for blends in this group,
depending on bottle size, range from about $4 to $10 per bottle.
The DIAMOND G and CHATEAU ST. NICHOLAS labels are two secondary label
wines in which the R.H. Phillips name does not appear on the label. These wines
are not barrel aged, allowing the wines to be produced and sold at a lower
price. Diamond G Chardonnay was introduced in 1993, and Diamond G Cabernet
Sauvignon was added in 1995. Due to its lower retail cost, Diamond G wine is
able to compete with inexpensive varietals from much larger producers such as
Glen Ellen and Sutter Home. Diamond G is produced in 750 ml and 1.5 liter
bottles, and retails for about $6 or $10 per bottle. Chateau St. Nicholas is a
seasonal label, offered both as a blended Chardonnay and as a blended White
Zinfandel, in a 750 ml bottle or a gift pack consisting of two 500 ml bottles.
Chateau St. Nicholas retails for about $6-7 for the 750 ml bottles, and $12 for
the gift pack. Management believes that Chateau St. Nicholas is a mature brand,
sales of which are not likely to change significantly from its 1995 levels.
Although R.H. Phillips primarily focuses on building its brand named
wines, the Company continues to process some private label wine. In 1995,
private label sales represented 7% of total sales. Management intends to reduce
the percentage of private label to approximately 5% by replacing existing lower
margin private label business with specialized private label programs, which
carry higher contribution margins.
SALES BY PRODUCT
The varietal makeup of R.H. Phillips wines has changed since the
business was founded. In the first years of full product line sales, generic
white and red table wine represented a larger portion of R.H. Phillips' sales
than any of its varietals. In 1995, the generic table wines represented only 2%
of total sales, whereas sales of Chardonnay, White Zinfandel, Sauvignon Blanc
and Cabernet Sauvignon equaled 41%, 18%, 18% and 11% of total sales,
respectively.
Management of R.H. Phillips is reducing production of Chateau St.
Nicholas to prevent competition with the R.H. Phillips brand during the
holidays, and to focus the distributors' efforts on building the R.H. Phillips
brand. Sales of Chateau St. Nicholas, which peaked at a high of 68,000 cases in
1991, declined to approximately 32,000 cases in 1995.
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DISTRIBUTION
The Company's sales strategy has focused on the creation, retention and
expansion of a large, nation-wide distributor network supported by in-house
sales personnel. The Company's brands are distributed nation-wide by a network
of 89 unrelated wholesale wine distributors who buy inventory at wholesale
prices. Five direct sales representatives, who are R.H. Phillips employees, work
with the distributors and receive salary plus volume bonuses. Seven independent
R.H. Phillips-appointed wine brokers also work with the distributors and are
paid a commission only on their sales. Each sales representative and broker has
the responsibility of managing the wholesale network established in his or her
region. Each distributor represents a large number of products, so the R.H.
Phillips representative is the critical link between the winery and the
wholesaler, facilitating communication, dealing with special promotions, and
inspecting sales performance.
The Company's non-employee sales representatives and wine brokers are
paid a commission based on a percentage of the dollar amount of wine orders they
obtain from the Company's distributors. The sales representatives generally are
not subject to agreements which obligate them to market the Company's wines for
any specific period, or which prohibit the Company from replacing any sales
representative upon notice to the representative. However, one sales
representative, Citadel Trading Corp. (""Citadel''), which accounted for 48% of
all orders placed by distributors for the Company's wines in 1995, has an
agreement with the Company which provides that Citadel is the exclusive sales
representative of the Company in the states of Maine, New Hampshire, Vermont,
Connecticut, New York, Massachusetts, New Jersey, Pennsylvania and Rhode Island.
The agreement will expire on January 1, 1998, unless terminated prior to that
date by either party for cause. The agreement provides that Citadel will
relinquish its marketing rights to the Company's wines if there is a substantial
decline in sales in Citadel's territory. During the term of that agreement,
Citadel may not act as representative of another California winery in
competition with the Company without the Company's consent.
There has been substantial consolidation among alcohol distributors
during the last several years. Virtually all of the distributors the Company
uses also sell other brands of wine and other alcoholic beverages. As a result,
the Company believes that a strong distribution network which is able and
willing to sell the Company's wines is especially important for the Company.
The three largest distributors of R.H. Phillips' wines are Wine
Warehouse, Lauber Imports, Ltd., and M.S. Walker. In 1995, Wine Warehouse, which
distributes wines in California, accounted for approximately 13% of sales.
Lauber and M.S. Walker, both of which distribute wines in the northeastern
United States, accounted for approximately 12% and 11% of total sales
respectively.
The Company's standard sales terms provide that payments for wines
purchased by distributors are due 30 to 60 days after shipment at prices set
forth on the Company's price lists. The Company does not have contracts with any
of its distributors which obligate them to purchase any specified amount of wine
over any defined period. It is therefore possible for a distributor, including
one of the Company's major distributors, to cease purchases of the Company's
wines at any time.
Management estimates that the end customers of the Company's wine and
spirits distributors include bars and restaurants (approximately 20%), grocery
store chains (40%) and liquor stores (40%).
SALES AND MARKETING
Being a low cost producer of quality varietal wines is a key element of
the Company's business and sales strategy. This is manifested in a retail price
for R.H. Phillips' wines at or below $8 per bottle in the popular premium
category. Many premium winemakers in California with higher cost structures have
priced their wines in the super and ultra-premium categories. The Company
believes that wines in these categories are typically the first prices to yield
to competitive pressures, resulting in reduced cash flow and earnings for those
wineries unable to maintain their prices.
The Company's sales expenditures take various forms. The Company pays
salaries, wages and commissions to its sales personnel. In addition, the Company
uses advertising and sales promotional expenses to promote products in either a
"push" or "pull" manner. "Push" programs include such sales tools as dollar
discounts, product give-aways, and spiffs (dollar sales incentives) for
distributor sales personnel who sell R.H. Phillips products. "Pull" programs
include media advertising, travel and entertainment, point of sale materials,
tasting rooms, and various promotional events. Management considers "push"
programs to be the most productive way to generate new sales per noncompensation
dollar expended at its current sales levels. Although "pull" programs are more
costly to implement, management believes that they will provide a greater return
over the long run by building brand recognition.
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The Company's projected growth will require additional sales and
marketing personnel. R.H. Phillips currently has 5 in-house sales
representatives. The Company added one in-house representative in February,
1996, another in March, 1996. The new representatives work in Arizona and
Colorado. R.H. Phillips also employs a National Sales Manager. The Company plans
to hire a Public Relations Director in 1996.
The Company reviews regional sales performance and the extent of brand
penetration within each region. The Company's wines are sold throughout the
United States and in several foreign countries. Of these regions, the
Northeastern United States was the region which accounted for the single highest
percentage of R.H. Phillips' sales in 1995, constituting approximately 38% of
total sales. The northern Midwest was R.H. Phillips' second largest region, with
approximately 10% of total sales in 1995. California is divided into two regions
(Northern and Southern), which combined accounted for approximately 13% of total
sales in 1995. Approximately 2% of total sales in 1995 were to foreign
countries. These countries consisted primarily of Canada, the United Kingdom,
and the Bahamas.
SUPPLIERS
The Company purchases supplies from outside parties to conduct its
business. Supplies include bottles, corks, fertilizers and pesticides, labels
and packaging supplies. Management believes it has strong relationships with all
of its major vendors. The Company believes it is not dependent on any single
supplier and would be able to find substitute suppliers if necessary.
To the Company's knowledge, no other California winery of comparable
size produces a majority of wines it sells from vineyards it owns or leases.
Most wineries rely on contracts with individual growers to provide a substantial
portion of their grapes and/or supplement supplies with purchases of grapes and
bulk wine on the so-called "spot market." In 1995, the Company's vineyards
provided approximately 47% of its grape requirements and in addition, the
Company purchased approximately 1,000 tons of grapes, or 14% of its grape
requirements, from Company farmed and managed vineyards owned by C. Mondavi &
Sons d/b/a Charles Krug. The Company has entered into an agreement with Charles
Krug to purchase 700-800 tons of grapes in 1996 and approximately 700 tons of
grapes in 1997 grown on this property. As a part of its expansion program, the
Company intends to increase the percentage of its grape requirements provided by
its own vineyards to approximately 80% in 1998 and 90% in 2000.
The Company satisfies the remainder of its production requirements from
purchases of grapes from outside growers and bulk wines on the spot market. The
supply and price of available grapes have generally been subject to considerable
fluctuations. One factor which has reduced the available supply of grapes is
Phylloxera damage, which has reduced grape harvests in Napa and Sonoma Counties.
See "Business -- Agricultural Hazards." Another factor during 1994 and 1995 was
the unusually wet and cold winter and spring, which further reduced grape
harvests in the Napa and Sonoma grape growing areas. The price which Ernest &
Julio Gallo, the largest purchaser of bulk wine and grapes, pays for these
products has a considerable impact upon the average price of bulk wines and
grapes in the industry.
PRODUCTION
R.H. Phillips shipped approximately 401,000 cases of wine in 1995. Of
the total wine R.H. Phillips sold in 1995, approximately 47% of the grapes
processed into wine by R.H. Phillips were grown in its vineyards. Production is
supplemented by outside bulk purchases of grapes and wine, as required.
Present storage capacity in the Company's warehouse is 55,000 cases of
wine, which is fully utilized. The Company currently owns two grape presses,
with a pressing capacity of approximately 300 tons per day. The Company's
current tank capacity for fermentation and storage is approximately 1,025,000
gallons. The Company owns or leases 4,250 oak barrels, with storage capacity
totaling approximately 246,500 gallons. The Company currently has storage
capacity for approximately 4,500 barrels.
The Company is in the process of expanding its vineyard and winery with
the goal of substantially reducing its reliance on outside grape, bulk wine and
processing costs, thereby improving gross profits. Management plans to increase
wine processing capacity at the winery by expanding the winery, and acquiring
additional cooperage and equipment. The first phase of the winery expansion was
completed in September, 1995,
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and included two new barrel buildings, crush and tank pads, sixty wine tanks,
and other equipment. This phase added approximately 33,000 square feet to the
winery facility.
The Company currently plans to begin the second phase of the winery
expansion in April, 1996, and to complete it prior to the 1996 harvest. The
current plans for this phase include the additions of a 18,000 square foot
barrel building, tank pads and a tasting room. These additions are projected to
add approximately 40,000 square feet to the size of the winery. The Company
currently plans to purchase various equipment, including 26 stainless steel wine
tanks, a bottle labeler, grape press, a grape crusher, a must pump, barrels, and
other equipment. Phase 2 of the winery expansion is expected to cost
approximately $4,100,000. After completion of Phase 2 the Company's grape
pressing capacity will be to a maximum of approximately 500 tons per day. Tank
fermentation and storage capacity will increase to approximately 1,477,000
gallons, and barrel storage capacity will increase to approximately 400,000
gallons. The new barrel building will have storage capacity for approximately
6,700 barrels.
The Company planted approximately 200 acres of vineyards in 1995, and
plans to plant 400 acres in 1996, 375 acres in 1997, 285 acres in 1998, and
90-100 acres each in 1999 and 2000. The vineyard expansion will require the
purchase of miscellaneous vineyard equipment. By the year 2000, the Company
plans to have approximately 1700 acres of land devoted to vineyards, which will
be located both on land which the Company currently owns and land which it plans
to purchase.
RESEARCH AND DEVELOPMENT
R.H. Phillips maintains a three-acre experimental vineyard where new
grape varieties are planted and small-scale viticultural experiments conducted.
Such variables as the amount of irrigation water received by a vine, crop level
per vine, and different approaches to canopy management are tested on the plot.
Promising grape varieties and viticultural practices are then further tested in
the main vineyard. Research is currently being conducted in the following areas:
Dry Land Red Grape Production The Rhone varieties are being moved from
irrigated land to a dry land, semi-arid format. By shrinking the fruit cluster
and berry size, R.H. Phillips hopes to improve wine color, flavor and richness.
Vertical Trellising The Company is investigating ways to increase the
exposure of fruit to the sun in order to increase the fruitiness of the wines;
pH Manipulation In the warm climate of the Dunnigan Hills, high pH can
cause shifts in fruit flavor and reduce the shelf life of the finished wine.
Experiments with soil potassium levels, irrigation amounts and maturity levels
at harvest are being conducted;
Organic Viticulture Experiments are underway to actively promote
elimination of both insecticides and herbicides from the vineyards;
Wine making A number of Winemaking experiments are carried out each
year. Wine variables are changed and the results are evaluated through blind
tastings and statistical analyses. Yeast strains and fermentation temperatures
are examples of two Winemaking variables that are tested.
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R.H. Phillips actively exchanges viticultural and Winemaking
information with other firms in the industry. A close working relationship with
the faculty of the Department of Enology and Viticulture at the University of
California at Davis is also maintained. Staff members of R.H. Phillips have
visited a number of wineries in Europe and personnel from French, Australian and
South African wineries and vineyards have toured its facilities. These visits
have resulted in a valuable exchange of technical information.
COMPETITION
The California table wine industry in 1995 had approximately $3.8
billion in sales according to the December, 1995 edition of WINEDATA published
by Gomberg, Fredrikson and Associates. Of the 34 states that produce wine,
California wineries dominate the industry, producing approximately 72% of the
total wine sold in the U.S. As of mid-1993, California had about 700 wineries
concentrated in the major viticultural regions of the state. The three largest
wineries, known as "the Big Three," are E. & J. Gallo, The Wine Group, and
Canandaigua Wine Company. The shipment volume of the Big Three in 1995 accounted
for approximately 60% of total wine sales in California. The Company is the 22nd
largest shipper of wines in California, according to the December, 1995 Gomberg,
Fredrikson Report.
The California wine industry is extremely competitive. Many new
wineries have been established in the last few years which compete to some
extent with the Company. The competitive environment will continue to be intense
in all likelihood and management believes it is doubtful that many of the
smaller wineries with comparatively high costs of production and limited
financial resources will be able to survive. Management believes that
competition in the wine industry will likely increase, thereby applying pressure
on the Company to reduce its prices, which could potentially reduce future
profits.
Although per capita wine consumption in the United States has declined
since 1983, premium wine shipments and total revenues from premium wines have
increased steadily in the last 15 years. According to the December 1995 edition
of WINEDATA, the overall decline appears to be based on a sharp drop in
consumption of jug wines and a shift by consumers of wine coolers to malt based
beverages. Management believes that the shift in consumer preference from jug
wines to premium wines is due to a number of factors, including health concerns
and greater consumer education regarding higher quality wines. Total revenues
for Ultra-premium table wines increased by 9% for 1995, Super-premium wines
increased 22% and Popular-premium wine sales increased by 36%.
TRADEMARKS
The Company does not have any currently effective federal registrations
covering its trademarks. The Company has adopted a program to establish and
protect its rights in its trademarks and trade names. In 1995, the Company
applied to register certain of its trademarks and trade names with the U.S.
Patent and Trademark Office.
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EMPLOYEES
The Company has approximately 85 full-time employees. In addition to
the full-time positions, the Company employs part-time labor for vineyard
development, pruning, harvest, and peak bottling season. None of the Company's
employees are covered by a collective bargaining agreement and the Company is
unaware of any labor disputes with its employees.
AGRICULTURAL HAZARDS
The growing of grapes for wine production is heavily dependent upon
favorable weather conditions. Drought or excessive rain can adversely affect
production. Excessive heat or cold, especially at or near the time for harvest,
can adversely affect the quality of grapes for wine production. The Company to
date has not generally suffered significant problems with its grape production
due to weather conditions. If adverse weather conditions did adversely affect
production, the Company would need to increase its outside purchases of grapes
and bulk wines, which might in turn increase costs of production without a
corresponding increase in the Company's sales revenues.
PHYLLOXERA, OTHER DISEASES
Over the past several years many California vineyards have been
severely damaged by Phylloxera, an aphid-sized root louse. The pest lives and
propagates in the soil and feeds on the roots of vines. Phylloxera does not
affect fruit quality of the infested vines and is not harmful to humans.
However, Phylloxera causes a progressive decline in grape production until
eventual vine death. Chemical insecticides can slow the progress of vine
deterioration, but once a vine is infested it is not possible to eradicate
Phylloxera. The preferred solution of the Company is to remove the infected
vines and replant them with root stock believed to be Phylloxera-resistant.
There are two different types of Phylloxera, Biotype A and Biotype B.
Biotype A has been known to the industry for many years and has been partially
suppressed through the use of resistant root stock. Biotype B is a new, mutant
strain that is fast-spreading and destroys a vineyard faster, due to increased
reproductive cycles in a given year. Biotype B typically has 6-8 reproductive
cycles while Biotype A usually has 3 reproductive cycles in a given year.
Biotype A was inadvertently introduced to Europe in the 19th Century
through experimental viticulture with American rootstock. The native European
vines had no resistance to the pest and European vineyards were decimated. The
solution was to replant the vineyards with 100% American rootstock that had
evolved a natural resistance to the louse, and then to graft on European bud
stock. However, the 100% American rootstock proved to be deficient in
productivity. In the 1960's, a hybrid rootstock which was largely American in
heritage, but had some European parentage, was developed. This rootstock was
called AxR1, and for nearly 20 years offered grape growers both resistance to
Biotype A and higher yields. During the 1970's and through the mid 1980's,
approximately 80% of the vineyard plantings in Napa and Sonoma were AxR1
rootstock. With the advent of Biotype B, the AxR1 hybrid was discovered to be
vulnerable to this more devastating strain of Phylloxera due to AxR1's partial
European heritage. Biotype B has infested vineyards in Napa and Sonoma Counties,
causing particularly serious damage. According to the August 1994 George M.
Schofield Company Grape Intelligence
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report, approximately 20% of the 73,000 vineyard acres in Napa and Sonoma
countries were infested by Biotype B as of 1993 year-end. Additionally, Biotype
B infestation is beginning to appear in the other coastal vineyard areas of
Monterey, Mendocino and Lake counties.
R.H. Phillips has not been susceptible to the more destructive Biotype
B root louse because of its use of non-AxR1 stock in the original vineyard
plantings. In addition, due to the warmer climate and careful farming practices,
the infestation of the R.H. Phillips vineyards was delayed somewhat. However, of
the 846 acres currently under cultivation, approximately 369 acres of R.H.
Phillips' vineyards are susceptible to Biotype A Phylloxera. Based on tests
management has performed, management believes that of these 369 acres, portions
of 130-230 acres have the presence of Phylloxera. Of these 130-230 acres,
approximately 60 acres are showing visible symptoms of decline. Management
believes that there exists potential significant loss of production from some of
the infested vines. Many of these vines were scheduled for removal before they
were discovered to have been infested with Phylloxera. The Company had made the
decision to replace a portion of these vines due to changes in market demand of
certain varietals, and recent innovations in trellising and vine spacing. The
Company plans to replant these vines with root stock believed in the wine
industry to be resistant to Phylloxera.
In addition to Phylloxera, grape vines are subject to a variety of
other damaging diseases which have afflicted California vineyards. The Company
is taking steps to reduce the likelihood of infestation. These include use of
chemical treatments and organic methods, such as use of natural insect enemies
of the pests, to control them.
WATER SUPPLY
The Company uses drip irrigation from well water supplies to irrigate
its vineyards. The wells have proven to be a reliable source of water, even
through the six years of drought that California recently endured. Management
believes that these sources of water will remain available for the foreseeable
future. However, there can be no assurance that sufficient water will be
available from underground aquifers. The Company is experimenting with dry land
farming techniques for some of its Rhone varietal grapes which are native to
areas with relatively little rainfall. If successful, this could reduce the
Company's dependence on irrigation.
REGULATION
The U.S. wine industry is subject to substantial federal, state and
local regulation. The Bureau of Alcohol, Tobacco and Firearms ("BATF") is the
federal agency primarily responsible for regulating the production and sale of
wine. The BATF has promulgated the numerous wine industry-related regulations.
These regulations include the licensing of wine producers, limitations on
chemical additives in wines, advertising standards, labeling requirements and
numerous other aspects of wine production and sales.
The BATF also collects federal excise taxes on wine. The amount of
federal excise tax is based on the total volume of wine shipped and the alcohol
content of that wine. The tax on wine with an alcohol content in excess of 14%
is greater than the tax assessed on wine with a lesser alcohol percentage. The
current federal excise tax on wines produced by the Company, all of which
contain less than 14% alcohol, is $1.07 per gallon for a total of $2.55 per
case. The California state excise tax is
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$0.20 per gallon of wine sold into California. Some other states also collect
excise taxes from out-of-state wineries based on the volume of their in-state
sales.
State governments also regulate the production and shipment of wine.
Although the laws and regulatory requirements of the states differ, most states
require that wineries be licensed by the appropriate state authorities before
they are allowed to ship wine into the state. The Company has obtained licenses
from those other states in which it believes it is necessary to be licensed.
Most states also require prior state approval of wine labels and set other
standards for the manufacture and sale of wine. Wineries are subject to periodic
inspections and audits by the BATF and the state alcohol regulatory authorities.
In California, the wine regulatory agency is the Department of Alcoholic
Beverage Control.
In addition to alcohol-related governmental regulations, grape growers,
wine producers and wine shippers are subject to a broad range of other
regulatory requirements. Local zoning regulations are one example. Other
regulations govern the use, storage and disposition of pesticides, fuels and
lubricants and other chemicals. The Company believes it is in substantial
compliance with all material applicable laws and regulations relating to R.H.
Phillips' business. Management is unaware of any environmental problems on or
near the vineyard and winery which could have a materially adverse impact on the
Company's business.
BUSINESS DEVELOPMENT
The Co-Presidents of the Company, John and Karl Giguiere, founded the
R.H. Phillips vineyard and winery business in 1981. The R.H. Phillips vineyard
and winery business was originally operated by two California corporations, The
R.H. Phillips Vineyard, Inc. and RHP Vineyards, Inc., of which the Giguieres
were majority owners. In 1989, the assets of those corporations were transferred
to a limited partnership named R.H. Phillips Partners, of which the two
corporations became the general partners. The Company was incorporated as a
California corporation in February, 1994 to serve as the corporate entity to
operate the R.H. Phillips business. In June 1994, R.H. Phillips Partners was
merged into the Company in order to convert R.H. Phillips from a limited
partnership to a corporation. Pursuant to the merger, the partners of R.H.
Phillips Partners received all of the shares of stock of the Company which were
outstanding at that time.
In November, 1994, the Company commenced an initial public stock
offering of units consisting of two shares of the Company's common stock and one
warrant to purchase one share of common stock. The offering was completed on
March 31, 1995, pursuant to which the Company received gross proceeds (not
including commissions and fees of the underwriter) of approximately $3,578,000.
The Company issued 493,563 equity units in connection with the offering.
On March 27, 1996, the Company sold in a private offering to John
Hancock Mutual Life Insurance Company ("Hancock") shares of the Company's 12%
Senior Redeemable Preferred Stock (the "Senior Preferred Stock") and warrants to
purchase shares of the Company's common stock. The gross proceeds to the Company
(without including offering expenses) from the sale of the Senior Preferred
Stock and the warrants were $5,000,000. A description of the Senior Preferred
Stock is set forth in ITEM
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5, MARKET FOR COMMON EQUITY and RELATED STOCKHOLDERS MATTERS AND ITEM 6,
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
The warrants issued to Hancock allow the holder to purchase shares of
the Company's common stock at a price of $4.00 per share (the "Exercise Price").
The aggregate number of shares issuable upon exercise of the warrants is
1,346,788. The number of shares issuable upon exercise of the warrants and the
Exercise Price is subject to adjustment due to stock splits, stock dividends and
certain other changes in the Company's capital structure. The Exercise Price and
the number of shares purchasable upon exercise of the warrants will also be
adjusted on a weighted-average basis if the Company issues additional shares of
common stock for less than the Exercise Price then in effect or at less than the
fair market value of the common stock at the time of issuance, whichever is
greater. The warrants are exercisable beginning on March 27, 1997 and expire on
the later of the date that all shares of Senior Preferred Stock have been
redeemed by the Company or March 27, 2006.
PART II
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
In reviewing the following management's discussion and analysis, the
reader should refer to the historical financial statements of R.H. Phillips,
Inc. (Formerly R.H. Phillips Partners). The discussion of the results and trends
does not necessarily imply that these results and trends will continue. For the
purpose of the following discussion, a "case" means a 9-liter case of wine.
LIQUIDITY AND CAPITAL RESOURCES
R.H. Phillips has historically financed its capital expenditures and
liquidity needs through a combination of equity infusions and short and
long-term borrowings. To date, R.H. Phillips' cash flows from operations alone
have not been sufficient to satisfy all of the working capital and capital
expenditure requirements needed to keep pace with the Company's growth. As a
result, the Company has historically borrowed funds from commercial finance
lenders, often at comparatively high rates of interest, to satisfy its working
capital and capital expenditure needs. Although the Company has reduced its
dependence on higher interest debt, it continues to rely upon debt and equity
financing for its working capital and expansion needs.
In late 1994 and in 1995, the Company was able to raise additional debt
and equity financing to reduce its dependence on high interest debt and to
finance expansion of its vineyard and winery. In December, 1994, the Company
refinanced $1,500,000 of existing debt by issuing convertible promissory notes
at a lower rate of interest to holders of existing promissory notes of the
Company. In January, 1995, the Company received a loan from Metropolitan for a
longer term and at a lower rate of interest than the Company had previously been
able to obtain. In March, 1995, the Company completed a sale of common stock and
warrants in an initial public offering. The net proceeds the Company received
from the initial public offering, after payment of all commissions and offering
expenses, were approximately $2,873,000. In May, 1995, the Company obtained a
credit facility from U.S. Bank to replace an operating line of credit from a
commercial finance lender. The interest rate on the new credit facility was
lower than that of the line of credit which it replaced.
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Metropolitan has loaned the Company $7,500,000. The first installment
of the loan, which the Company received in January, 1995, equaled $4,600,000,
and was used to pay $2,608,000 owing under a loan from a financing company with
an interest rate of 13% per annum, approximately $1,300,000 owing under certain
promissory notes bearing various rates of interest, certain other obligations of
the Company, and loan fees. The second installment of the Metropolitan loan, in
the amount of $1,500,000, was drawn by the Company in July, 1995, and the third
installment of $1,400,000 was drawn in August, 1995.
The first installment of the Metropolitan loan bears interest at a rate
of 9.05% per annum. The interest rate on the second installment is 8.1% per
annum, and the third installment bears interest at an annual rate of 8.55%.
Interest is payable monthly. Eight percent of the outstanding principal is to be
paid per annum, with payments to be made on a monthly basis beginning in
February, 1996. All remaining principal after such monthly payments will be due
in February, 2005. The rates of interest will be subject to adjustment by
Metropolitan in November, 1997, 2000, and 2003, at which time the interest rate
will be changed to equal that charged by Metropolitan for similar agricultural
loans at those times. Prepayments of the loan are subject to penalty. However,
there will be no prepayment penalty if the loan is prepaid within ninety days
after Metropolitan announces a change in the interest rate. The loan from
Metropolitan is secured by a first priority deed of trust on the real property
of the Company and a first priority security interest in fixtures, equipment,
and certain other assets of the Company.
In December, 1994, the Company issued $1,500,000 in convertible
promissory notes to refinance a like amount of the Company's existing promissory
notes. The convertible promissory notes have a five year term and bear interest
at an annual rate of 6%. Interest is paid annually, and principal is due and
payable upon maturity of the notes. The convertible notes will be converted into
common stock of the Company beginning two years after issuance if the market
price of the common stock, as quoted on a national securities exchange or the
NASDAQ SmallCap Market , equals or exceeds $3.50 per share. The notes are
unsecured, and payment on the notes is subordinate to all other indebtedness of
the Company with certain exceptions. The secured notes for which the convertible
notes were exchanged bore interest at a rate of 11.5% and 13% per annum, and
were secured by a deed of trust on the Company's real property.
In May, 1995, the Company entered into an agreement with U.S. Bank for
a credit facility under which the Company could at that time borrow a maximum of
$6,000,000, and may now borrow a maximum of $6,550,000. The credit facility was
originally comprised of an operating line of credit of $5,000,000 which is
secured by accounts receivable and inventory, and a non-revolving line of credit
of $1,000,000 which was secured by the 1995 grape crop and farm equipment. The
operating line of credit expires in April, 1997, at which time all principal and
unpaid interest will be due and payable. However, the operating line of credit
will be reviewed in April, 1996, at which time U.S. Bank may extend the maturity
until April, 1998. The annual interest rate on the operating line of credit is
either U.S. Bank's prime rate or IBOR plus 200 basis points, at the Company's
option. The 1995 crop line of credit, which bore an annual interest rate of U.S.
Bank's prime rate plus 100 basis points, matured in February, 1996. All
outstanding principal and interest were paid at that time. In December, 1995,
the Company obtained an additional non-revolving line of credit from U.S. Bank
in the amount of $350,000, which bears interest at an annual rate of U.S. Bank's
prime rate plus 100 basis points, and matures in March, 1996. The Company also
obtained another non-revolving line of credit from U.S. Bank in February, 1996.
This line of credit, in the amount of $1,200,000, bears interest at an annual
rate of U.S.
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Bank's prime rate plus 100 basis points, is secured by the 1996 grape crop, and
matures in November, 1996. The credit facility is used to finance the Company's
working capital needs, and replaced a $4,300,000 line of credit from a
commercial finance lender which had a higher rate of interest.
In October, 1995, the Company entered into a loan agreement with Heller
Financial under which the Company may borrow a maximum of $1,000,000. Of this
amount, approximately $645,000 was advanced to the Company in October, 1995,
with the balance of $355,000 to be advanced at the Company's option. The loan is
secured by equipment. Principal is payable in sixty equal monthly payments.
Interest is payable monthly on the remaining principal balance. The initial
advance bears interest at a floating monthly rate of the one month LIBOR rate
plus 3.32%.
The obligations of the Company under the loan agreements with
Metropolitan, U.S. Bank, and Heller are personally guaranteed by John and Karl
Giguiere. The guarantees will be released if the Company's tangible net worth
exceeds $8,500,000 and the Company's ratio of consolidated debt to consolidated
total capitalization does not exceed 50%. All principal and interest under each
of these loans will be immediately due and payable, at the option of the lender,
if any person or group other than John or Karl Giguiere or their immediate
families constitute a majority of the Company's Board of Directors. The
provisions in these loan agreements concerning change of control will be
eliminated if and when the Company enters into employment agreements with John
and Karl Giguiere which obligate them to remain employed by the Company for at
least five years. No such employment agreements are currently in place.
In January, 1996, the Company received a letter of commitment from
Hancock to purchase 500,000 newly issued shares of Senior Preferred Stock and
detachable common stock warrants for $5,000,000. The sale of the Senior
Preferred Stock and the warrants was completed on March 27, 1996. The Senior
Preferred Stock bears a cumulative dividend of $1.20 per share per annum,
payable in equal semi-annual installments. Until September 15, 2000, one half of
the dividend will be payable in cash and the other half in common stock valued
at the lesser of $4.00 per share or the fair market value of the common stock as
of the date of the dividend. The Company is required to redeem one-third of the
Senior Preferred Stock by March 15, 2004, one-third by March 15, 2005 and the
remaining outstanding Senior Preferred Stock by March 15, 2006. The redemption
price will be $10.00 per share plus all accrued and unpaid dividends on the
shares of Senior Preferred Stock being redeemed. The total proceeds received by
the Company from the sale of the Senior Preferred Stock and the warrants was
approximately $4,800,000 after payment of offering expenses.
Net cash provided by operating activities in 1995 was $941,000,
consisting of primarily net income of $751,000, depreciation and amortization of
$1,002,000 and cash used in changes in assets and liabilities of $896,000. Net
cash used in investing activities in 1995 was $7,227,000, consisting of
$2,887,000 invested in vineyards, $2,027,000 in buildings, and $2,314,000 in
equipment. Net cash provided by financing activities in 1995 was $6,573,000.
This consisted primarily of $3,047,000 from issuance of Common Stock, $8,530,000
from ITT Financial, $6,571,000 from U.S. Bank, $7,500,000 from Metropolitan Life
and cash used for principal payments to ITT Financial of $12,261,000, U.S. Bank
of $1,200,000, Owens Financial Group of $2,608,000, various notes and capital
leases of $2,450,000 and loan origination fees of $534,000. As a result of these
factors, cash increased by $287,000 during 1995.
The Company's net working capital as of December 31, 1995 was
$5,369,000, compared to $915,000 as of December 31, 1994. The increase in
working capital was primarily due to the completion of the Company's initial
public offering in March, 1995, and to the loan from Metropolitan and the
operating line of credit from U.S. Bank, both of which have maturities greater
than one year and replaced shorter term debt.
The Company has made substantial capital expenditures to expand its
vineyards and winery facilities, and intends to continue these expansions. The
purpose of the expansion is to increase the Company's production capabilities so
that the Company can lessen or eliminate its dependence on outside grape and
bulk wine purchases and processing, thus reducing costs of production and
increasing gross profits.
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The first phase of the winery expansion was completed in September,
1995. This phase included the construction of two new buildings temporarily used
for barrel storage, and new crush and tank pads. Equipment purchased included
sixty stainless steel wine tanks, a grape press, pumps, barrels, and other
equipment. These additions added approximately 33,000 square feet to the size of
the winery facility. The cost of this first phase was approximately $4,540,000.
The Company plans to begin the second phase of the winery expansion in
April, 1996. Management currently plans this second phase to include a new
barrel building, tank pads, a tasting room, and a conference area, and to add 28
wine tanks, a bottle labeler, grape presses and crusher, a must pump, barrels,
and other equipment. As planned, these additions will add approximately 40,000
square feet to the winery facility, and management expects the cost to be
approximately $4,100,000.
The Company planted approximately 200 acres of new vineyards in 1995,
consisting of Cabernet Sauvignon, Zinfandel, Syrah, and Viognier grapes. The
Company intends to plant an additional 400 acres in 1996, 375 acres in 1997, 285
acres in 1998, and 90-100 acres each in 1999 and 2000. The additional acres will
be planted primarily on land the Company has recently acquired and land the
Company intends to acquire in the future. The Company purchased 173 acres of
land in August, 1995. In October, 1995, the Company entered into an agreement to
purchase approximately 900 additional acres. By the year 2000, the Company
intends to have approximately 1,700 acres of vineyard under cultivation.
A substantial portion of the financing for the first phase of the
project came from the proceeds from the Company's initial public offering, from
the Company's long-term debt financing arrangement with Metropolitan and from
working capital lines of credit with U.S. Bank. The Company estimates that the
total costs of the current phase of the vineyard and winery expansion will be
approximately $14,500,000 from 1996 through 1997. The Company plans to fund
this phase of the expansion primarily with the proceeds from: a) the recently
completed financing with Hancock, from which the Company raised $4,800,000
after expenses; b) the exercise of Common Stock purchase warrants issued in the
Company's initial public offering, the net proceeds of which the Company
estimates will be approximately $1,900,000 (assuming the exercise of all
warrants); and c) a proposed public offering of the Company's Common Stock
scheduled to take place in July, 1996, from which the Company estimates it will
receive proceeds of approximately $6,230,000 after underwriter's discounts,
commissions and offering expenses. The Company intends to satisfy additional
financing requirements for the 1996 and 1997 expansion and further expansion in
the years 1998 through 2000 through internally generated funds and borrowings
on working capital lines of credit, although long-term debt or equity financing
may be necessary.
Phylloxera infestation will potentially have a negative impact on the
Company's grape production. Phylloxera is a root louse which feeds on the roots
of grapes, causing reduced production and eventual vine death. Of the 846 acres
currently under cultivation by the Company, 369 acres (437 original acres, less
68 acres removed in 1995), have root stock which is susceptible to Phylloxera.
Management estimates that the commercially productive life of these vineyards is
ten years from January 1, 1994, as compared with the twenty-five year life
generally estimated for vineyards, and that the reduction in the useful life of
these vineyards will result in an increase in depreciation of approximately
$65,000 per year. The Company is treating all vineyards believed to be currently
at risk for Phylloxera with Furadan, a chemical which is believed in the
industry to slow the spread of Phylloxera. The Company estimates that Furadan
treatments will cost approximately $45,000 per year. Both the increased
depreciation charges and the cost of the Furadan will be added to the cost of
grapes harvested,
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thus increasing cost of sales. In addition, the Company is planning to combat
the effects of Phylloxera through the use of innovative grafting methods. In
addition to its replanting program, the Company is planning to reduce the impact
of Phylloxera in areas believed to be susceptible but not yet showing visible
symptoms of decline by the use of approach grafting. Under this program,
existing vines would be grafted onto resistant rootstock. The Company plans to
graft approximately 26 acres in 1996, and 100-125 acres in 1997.
The Company is conducting a program of removing and replacing those
vines which have shown the largest decline in yields due to Phylloxera. In 1995,
the Company removed 68 acres of vines, 63 of which were older, Phylloxera
infested vines consisting of Chenin Blanc, Sauvignon Blanc, and Cabernet
Sauvignon grapes. The Company plans to replace these vines with Chardonnay, for
which the Company has determined there is greater consumer demand and higher
profit margins. Vines used to replace those infested by Phylloxera and all
additional planting will contain rootstock which is believed in the wine
industry to be resistant to Phylloxera.
The seasonality of the Company's sales affects the Company's liquidity
and capital requirements. In the past, the Company has borrowed funds on a short
term basis each year beginning in late February or early March to fund crop
growing costs. Short term borrowings increase substantially from August through
November due to additional costs from harvest, wine production, and increased
bottling activity in preparation for higher sales during the holiday season.
The above discussion concerning future financing needs, vineyard and
winery expansion, the impact of phylloxera and factors affecting liquidity are
forward-looking statements. Although management believes that these statements
are reasonable in view of the facts available to it, past experience and trends
in the industry, there can be no assurance that all of these statements will
prove to be true. There are numerous factors which could have a material impact
upon whether these projections will be realized or whether these trends will
continue. Among these factors are the following:
Availability of Future Financing. The rate at which the Company is able
to expand its facilities is heavily dependent upon its ability to raise
additional debt or equity financing. The ability to raise financing is in turn
dependent upon a variety of factors, some of which are outside of the control of
the Company. The Company plans to use the proceeds derived from the exercise of
the warrants issued in the Company's initial public offering to assist in
financing the expansion of the winery and vineyards. The Company will also need
to raise additional debt or equity financing to pay for the expansion. If some
or all of these warrants are not exercised, or the Company is not able to raise
financing additional debt or equity financing in an amount sufficient to meet
projected expansion costs, the Company will be required to reduce the rate at
which it expands its facilities, perhaps substantially.
Costs of Expansion. Management has based its assumptions concerning the
costs of expansion on estimates which it believes are reasonable. There can be
no assurance, however, that the Company's estimates as to the costs of expansion
will prove to be correct. If these costs are higher than anticipated, the
Company may be required to raise an even greater amount of financing or reduce
the rate of expansion of its facilities.
Market Conditions. Assumptions as to the desirability of expansion are
based to a great extent on management's belief concerning the current status of
and trends in the wine industry. Market
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conditions in the wine industry have changed substantially from time to time. To
the extent that market conditions change substantially in the future, the rate
at which management deems it advisable to expand the Company's vineyard and
winery facilities may be adjusted.
Phylloxera Infestation. The discussion concerning phylloxera
infestation and the costs associated therewith are based on the Company's
examination of its vineyards and industry information concerning phylloxera. If
this information changes or proves to be inaccurate, the Company's costs in
replacing vineyards and treating infested vines could increase.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995 AND DECEMBER 31, 1994
Net Sales
Net sales for the year ended December 31, 1995 were $15,498,000
as compared with $12,896,000, which represented an increase in net sales of
approximately 20%. The number of cases sold in 1995 increased to approximately
401,000, which was approximately 11% greater than in 1994. The average selling
price per case increased to $36.28 in 1995 from $34.85 in 1994. The increase in
the average selling price per case resulted partly from a price increase in the
third quarter of 1995 on certain of the Company's wines and from management's
decision to shift the primary focus of the Company's marketing efforts to wines
with higher gross profit margins, mainly Chardonnay.
Gross Profit
Gross profit increased to $5,838,000 in 1995 from $4,279,000 in
1994. Gross profit also increased as a percentage of net sales to 38% in 1995
from 33% of net sales in 1994. Net sales and cost of sales for 1995 and 1994
included the sales of bulk wines and grapes. Excluding these sales, the gross
margins were 37% in 1995 and 35% in 1994. The higher gross margin in 1995 was
primarily due to the price increase of certain of the Company's wines, the
marketing shift to Chardonnay and lower costs of production for Chardonnay
in 1995 as compared with 1994.
Operating Expenses
Selling, general and administrative expenses increased to $3,803,000
in 1995 from $3,386,000 in 1994. As a percentage of net sales, selling, general
and administrative expenses decreased as a percentage of net sales to 25% in
1995 from 26% in 1994. Although these expenses were higher in 1995 than in 1994,
the percentage of these expenses to net sales declined due to higher revenues.
The increase in expenses was primarily due to increased sales labor expenses and
sales promotion expenses required to support the higher levels of sales in 1995
compared to 1994. Sales labor and commission expenses increased to $1,405,000 in
1995 from $1,236,000 in 1994. Promotional expenses increased to $1,300,000 in
1995 from $1,004,000 in 1994. General and administrative expenses were
substantially the same in 1995 and 1994.
Interest Expense
Total interest expense in 1995 was $1,025,000, or approximately 7%
of net sales. In addition, the Company capitalized approximately $295,000 of
interest pertaining to vineyard development and winery expansion during 1995.
Total interest expense in 1994 was approximately $1,121,000, or 9% of net sales.
Approximately $122,000 of additional interest was capitalized in 1994. The
increase in total interest, consisting of interest expense and capitalized
interest, during 1995 compared with 1994 was primarily due to increased levels
of borrowing by the Company to finance the 1995 phase of the vineyard and winery
expansions. The amount of increase was reduced somewhat by the lower interest
rates the Company obtained from refinancing of its debt during 1995.
Income Taxes
In 1995, the Company had income tax expense of $289,000 compared
with $364,000 in 1994. The 1995 income tax expense was primarily attributable to
federal and state income tax at statutory rates, which was offset primarily by
utilization of net operating loss carryforwards. The 1994 income tax expense was
primarily attributable to the required adoption by the Company of Statement of
Financial Accounting Standards No. 109 (FAS 109), "Accounting for Income
Taxes."
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Net Income
The Company had net income of $751,000 in 1995, compared with a net
loss of $1,001,000 in 1994. The increase in net income in 1995 over 1994 was due
to the factors described above, including substantially increased sales and
increased profit margins.
YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1993
Net Sales
Net sales in 1994 were $12,896,000 compared with $12,147,000 in
1993, representing an increase of approximately 6% in 1994 net sales over those
in 1993. The modest increase in net sales was principally attributable to price
competition which resulted from excessive industry wide inventory buildup.
Gross Profit
Gross profit was $4,279,000 in 1994 compared with $4,447,000 in
1993. This represented a decline in gross profits as a percentage of sales to
33% of net sales in 1994 from 37% of net sales in 1993. The reduction in gross
profit was attributable to a variety of factors, including the increasing use of
discounts to remain competitive in the marketplace, higher production costs and
the increase in the cost of bulk wines that the Company purchased from outside
suppliers in 1994.
Operating Expenses
Selling, general and administrative expenses rose to $3,386,000 in
1994, an increase from $3,092,000 in 1993, which represented approximately 26%
of net sales in each year. The increase in 1994 was due primarily to additional
expenses incurred in sales promotional activities. The single largest
promotional activity in 1994 was the Company's 8-pack program, pursuant to
which the Company sold eight 1.5 liter bottles for the price of six. Total
costs for the 8-pack program, which began in 1993, were $441,000 in
1994.
Other Income and Expense
The Company incurred $409,000 in other expenses in 1994 compared
with $279,000 in other income in 1993. The large increase in other expense for
1994 was primarily due to its write-down to estimated fair market value of
certain R.H. Phillips wines stored at another facility which did not meet the
Company's standards for inclusion in its wine program. This resulted in a
$360,000 charge to other income (expense). In addition, approximately $110,000
of capitalized organizational costs of R.H. Phillips Partners were written
off in 1994 due to the conversion of the R.H. Phillips business from a
limited partnership to a corporation through the merger with the Company. The
single largest item of other income in 1993 was an excise tax refund. In 1993
R.H. Phillips Partners received a refund of federal excise taxes paid for
1991 through 1993 due to the availability of a small producer exemption. The
portion of the refund attributable to 1993 ($90,000) reduced cost of sales for
that year and the remainder of the refund ($180,000) was included in other
income.
Interest Expense
Interest expense was $1,121,000 in 1994 as compared to $1,037,000 in
1993. Interest expense as a percentage of net sales was approximately 9% during
both years. The increase in total interest expense was primarily due to
increased borrowing levels used for working capital and equipment purchases
during the latter part of 1994.
Income Taxes
Effective June 1, 1994, R.H. Phillips converted from a limited
partnership to a corporation by means of a statutory merger between the Company
and R.H. Phillips Partners. In accordance with FAS 109 the Company, as a
tax-paying entity, was required to set forth in its financial statements any
temporary differences between the financial statement basis and tax basis of its
assets. The impact of the change in entities resulted in a one time charge to
income of approximately $352,000 for the year ended December 31, 1994.
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Net Income
The Company had a net loss in 1994 of $1,001,000 in contrast to net
income for R.H. Phillips Partners of $597,000 in 1993. Of the loss in 1994,
$110,000 reflected the write-off of the capitalized organizational costs,
$352,000 consisted of the FAS 109 adjustment and $360,000 from the write-down
of wine inventory. If these events had not occurred, the Company's net loss for
the year ended December 31, 1994 would have been $179,000. Had
R.H. Phillips Partners been a tax-paying entity for income tax purposes, net
income in 1993 would have been $356,000.
ITEM 7. FINANCIAL STATEMENTS
The audited financial statements of the Company are set forth in this
report beginning at page F-1.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Audited Financial Statements of the Company are attached to this
annual report beginning on page F-1. Other exhibits attached to this annual
report are as follows:
Exhibit No. Description
- ----------- -----------
2.1** Merger Agreement between the Company and R.H. Phillips
Partners, a California limited partnership, dated May 31, 1994
3.1* Articles of Incorporation
3.2*** Bylaws
4.1** Warrant Agency Agreement by and between the Company and
American Stock Transfer & Trust Company
4.2** Form of Common Stock Certificate
4.3** Form of Common Stock Purchase Warrant
4.4** Warrant to Purchase Common Stock issued to Capitol Bay
Securities
4.5** Form of 5 Year 6% Convertible Subordinated Note of the Company
4.6* Form of Warrant to Purchase Common Stock issued to John Hancock
Mutual Life Insurance Company
4.7* Form of Senior Preferred Stock Certificate
10.1** Loan Agreement between the Company and Metropolitan Life
Insurance Company and Related Agreements, dated January 20,
1995
10.2*** Loan Agreement between the Company and U. S. Bank and Related
Agreements, dated May 26, 1995
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10.3** Promissory Note by RHP Vineyards, payable to the Company, dated
December 31, 1993
10.4** Selling Agent Agreement between the Company and Sequoia Equity
Securities Corporation, dated November 1, 1994
10.5** Underwriting Agreement between the Company and Capitol Bay
Securities, dated November 29, 1994
10.6** Warrant Purchase Agreement between the Company and Capitol Bay
Securities, dated November 29, 1994
10.7** Form of Convertible Note Purchase Agreement
10.8** Escow Agreement by and between Bank of America NT&SA ("Escrow
Holder"), the Company, RHP Vineyards, Inc., The R.H. Phillips
Vineyard, Inc., R. Ken Coit and David Gemmer with respect to escrow
of certain shares of the Company's stock
10.9** Sale Restriction Agreement by and between the Company, Capitol Bay
Securities and certain shareholders of the Company, dated October 5,
1994
10.10*** R.H. Phillips, Inc. 1995 Stock Option Plan and form of Incentive
Stock Option Agreement and Non-Statutory Stock Option Agreement.
10.10* Loan Agreement between the Company and Heller Financial and related
documents, dated October 20, 1995.
10.11* Securities Purchase Agreement between the Company and John Hancock
Mutual Life Insurance Company, dated March 27, 1996.
10.12 Grape Purchase Agreement between the Company and C. Mondavi & Sons,
dated February 14, 1995.
23.1 Consent of KPMG Peat Marwick LLP.
23.2 Consent of Deloitte & Touche LLP.
* Documents were filed as exhibits to the Annual Report of the Company on Form
10-KSB for the year ended December 31, 1995 and are incorporated by reference.
** Documents were filed as exhibits to the Annual Report of the Company on Form
10-KSB for the year ended December 31, 1994 and are incorporated by reference.
*** Documents were filed as exhibits to the Quarterly Report of the Company on
Form 10-QSB for the quarter ended June 30, 1995 and are incorporated by
reference.
(b) Form 8-K, Item 4. Changes in Registrant's Certifying Accountants,
dated August 1, 1995, was filed with the Securities and Exchange Commission on
August 8, 1995, and is incorporated by reference.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this amendment to its Annual Report on Form 10-KSB to be
signed on its behalf by the undersigned, thereunto duly authorized.
R.H. PHILLIPS, INC.
By: /s/ John E. Giguiere
----------------------------------
John E. Giguiere, Co-President and
Co-Chief Executive Officer
In accordance with the Exchange Act, this amendment to the registrant's
Annual Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ John E. Giguiere Co-President, Co-Chief Executive July 19, 1996
- -------------------------------- Officer, Director (Principal
John E. Giguiere Executive Officer)
/s/ Karl E. Giguiere Co-President, Co-Chief Executive July 19, 1996
- -------------------------------- Officer, Director (Principal
Karl E. Giguiere Executive Officer)
/s/ Lane C. Giguiere Sales Administration Manager, July 19, 1996
- -------------------------------- Director
Lane C. Giguiere
/s/ Richard Allen Pierce Controller (Principal Accounting July 19, 1996
- -------------------------------- Officer)
Richard Allen Pierce
/s/ Robert T. Moore Vice President, Finance (Principal July 19, 1996
- -------------------------------- Financial Officer)
Robert T. Moore
/s/ R. Ken Coit Director July 19, 1996
- --------------------------------
R. Ken Coit
Director
- --------------------------------
Victor L. Motto
</TABLE>
20
<PAGE> 21
R.H. PHILLIPS, INC., DBA
THE R.H. PHILLIPS VINEYARD
(A CALIFORNIA CORPORATION) (FORMERLY R.H. PHILLIPS PARTNERS)
INDEX TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PAGE
<S> <C>
INDEPENDENT AUDITORS' REPORT - 1995 F1
INDEPENDENT AUDITORS' REPORT - 1994 F2
FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 1994 AND 1995:
Balance Sheet F3
Statements of Operations F4
Statements of Partners' Capital and Shareholders' Equity F5
Statements of Cash Flows F6
Notes to Financial Statements F7-F13
</TABLE>
<PAGE> 22
INDEPENDENT AUDITORS' REPORT
The Board of Directors
R.H. Phillips, Inc.:
We have audited the accompanying balance sheet of R.H. Phillips, Inc. as of
December 31, 1995, and the related statements of operations, partners' capital
and shareholders' equity, and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the 1995 financial statements referred to above present
fairly, in all material respects, the financial position of R.H. Phillips, Inc.
as of December 31, 1995, and the results of its operations and its cash flows
for the year then ended in conformity with generally accepted accounting
principles.
KPMG PEAT MARWICK LLP
Sacramento, California
March 8, 1996,
except as to Note 14, which is as of March 27, 1996
F1
<PAGE> 23
INDEPENDENT AUDITORS' REPORT
R.H. Phillips, Inc.:
We have audited the statements of operations, partners' capital and
shareholders' equity and of cash flows of R.H. Phillips, Inc. (the "Company")
for the year ended December 31, 1994. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all
material respects, the results of the Company's operations and its cash flows
for the year ended December 31, 1994 in conformity with generally accepted
accounting principles.
Deloitte & Touche LLP
Oakland, California
April 7, 1995
F2
<PAGE> 24
R.H. PHILLIPS, INC., DBA
THE R.H. PHILLIPS VINEYARD
(A CALIFORNIA CORPORATION) (FORMERLY R.H. PHILLIPS PARTNERS)
BALANCE SHEET
DECEMBER 31, 1995
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS
CURRENT ASSETS:
Cash $ 317,624
Accounts receivable - net of allowance of $200,000 2,866,688
Inventories 6,354,470
Deferred income taxes and prepaid expenses 416,935
-----------
Total current assets 9,955,717
PROPERTY, PLANT, AND EQUIPMENT - net 16,578,499
OTHER ASSETS:
Note receivable from shareholder 192,340
Deferred loan fees and other, net 666,925
-----------
Total other assets 859,265
-----------
TOTAL ASSETS $27,393,481
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 1,040,000
Notes payable 1,390,139
Accounts payable 1,727,786
Accrued liabilities 428,940
-----------
Total current liabilities 4,586,865
LONG-TERM DEBT 12,587,545
SUBORDINATED DEBT 1,500,000
DEFERRED INCOME TAXES 679,000
COMMITMENTS AND CONTINGENCIES --
SHAREHOLDERS' EQUITY:
Preferred Stock, no par, 5,000,000 shares authorized,
none outstanding --
Common stock, no par, 12,500,000 shares authorized, 4,632,985
shares issued and outstanding 7,623,014
Retained earnings 417,057
-----------
Total shareholders' equity 8,040,071
-----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $27,393,481
===========
</TABLE>
See accompanying notes to financial statements.
F3
<PAGE> 25
R.H. PHILLIPS, INC., DBA
THE R.H. PHILLIPS VINEYARD
(A CALIFORNIA CORPORATION) (FORMERLY R.H. PHILLIPS PARTNERS)
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1994 AND 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1994 1995
<S> <C> <C>
NET SALES $12,895,751 $15,498,210
COST OF SALES 8,617,014 9,660,266
----------- -----------
GROSS PROFIT 4,278,737 5,837,944
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 3,385,597 3,802,538
----------- -----------
OPERATING INCOME 893,140 2,035,406
INTEREST EXPENSE (1,120,715) (1,025,142)
OTHER INCOME (EXPENSE) - NET (408,999) 29,492
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (636,574) 1,039,756
PROVISION FOR INCOME TAXES (364,000) (289,000)
----------- -----------
NET INCOME (LOSS) $(1,000,574) $ 750,756
=========== ===========
NET INCOME (LOSS) PER SHARE $ .17
===========
COMMON AND COMMON EQUIVALENT
SHARES OUTSTANDING 3,645,859 4,386,204
=========== ===========
PRO FORMA AMOUNTS (1):
(LOSS) BEFORE INCOME TAXES
AS REPORTED $ (636,574)
PRO FORMA INCOME TAX BENEFIT 257,200
-----------
PRO FORMA NET LOSS $ (379,374)
===========
PRO FORMA NET LOSS PER SHARE $ (.10)
===========
</TABLE>
(1) Pro forma net (loss) reflects adjustments for income taxes which would have
been provided if R.H. Phillips, Inc. had been organized and operated as a C
Corporation, rather than a partnership, for the entire year ending December 31,
1994. (See Note 1)
See accompanying notes to financial statements.
F4
<PAGE> 26
R.H. PHILLIPS, INC., DBA
THE R.H. PHILLIPS VINEYARD
(A CALIFORNIA CORPORATION) (FORMERLY R.H. PHILLIPS PARTNERS)
STATEMENTS OF PARTNERS' CAPITAL AND SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1994 AND 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LIMITED LIMITED LIMITED
PARTNERS I/ PARTNERS I/ PARTNERS II/ GENERAL RETAINED
SERIES A SERIES A-1 SERIES A-2 PARTNERS/ EARNINGS/
PREFERRED PREFERRED PREFERRED COMMON (ACCUMULATED
STOCK STOCK STOCK STOCK DEFICIT) TOTAL
<S> <C> <C> <C> <C> <C> <C>
PARTNERS' CAPITAL
JANUARY 1, 1994 $ 1,718,814 $ -- $ 1,702,675 $2,214,996 $ -- $5,636,485
DISTRIBUTION TO
PARTNERS -- -- -- (220,000) -- (220,000)
NET INCOME (LOSS) FIVE MONTHS
ENDED MAY 31, 1994 (401,056) -- 126,791 (392,610) -- (666,875)
----------- --------- ----------- ---------- --------- ----------
PARTNERS' CAPITAL,
MAY 31, 1994 1,317,758 -- 1,829,466 1,602,386 -- 4,749,610
MERGER OF R.H. PHILLIPS PARTNERS
AND R.H. PHILLIPS, INC. (1) (230,608) 230,608 -- -- -- --
COSTS OF PUBLIC STOCK OFFERING -- -- -- (173,615) -- (173,615)
NET LOSS SEVEN MONTHS ENDED
DECEMBER 31, 1994 -- -- -- -- (333,699) (333,699)
----------- --------- ----------- ---------- --------- ----------
SHAREHOLDERS' EQUITY
DECEMBER 31, 1994 1,087,150 230,608 1,829,466 1,428,771 (333,699) 4,242,296
ISSUANCE OF COMMON STOCK -- -- -- 3,047,019 -- 3,047,019
CONVERSION OF PREFERRED STOCK
TO COMMON STOCK (1,087,150) (230,608) (1,829,466) 3,147,224 -- --
NET INCOME YEAR ENDED
DECEMBER 31, 1995 -- -- -- -- 750,756 750,756
----------- --------- ----------- ---------- --------- ----------
SHAREHOLDERS' EQUITY
DECEMBER 31, 1995 $ -- $ -- $ -- $7,623,014 $ 417,057 $8,040,071
=========== ========= =========== ========== ========= ==========
</TABLE>
(1) Effective June 1, 1994, in connection with the merger of R.H. Phillips
Partners with R.H. Phillips, Inc., the general and limited partners in R.H.
Phillips Partners exchanged their partnership interests for shares of preferred
and common stock in R.H. Phillips, Inc. At the time of the merger, R.H.
Phillips, Inc. had no assets, liabilities or prior operations.
See accompanying notes to financial statements.
F5
<PAGE> 27
R.H. PHILLIPS, INC., DBA
THE R.H. PHILLIPS VINEYARD
(A CALIFORNIA CORPORATION) (FORMERLY R.H. PHILLIPS PARTNERS)
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1994 AND 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1994 1995
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (1,000,574) $ 750,756
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Deferred income taxes 364,000 62,000
Depreciation and amortization 869,590 1,002,405
Write down of wine inventories 360,000 --
Write off of intangible assets 110,000 --
Loss on disposal of property, plant and equipment 323 22,645
Changes in assets and liabilities:
Accounts receivable 57,988 (630,406)
Inventories (57,777) (285,292)
Prepaid expenses (5,489) (103,895)
Other assets (37,076) (6,370)
Accounts payable and accrued liabilities 718,045 356,741
Deferred revenue (44,780) (227,220)
------------ ------------
Net cash provided by operating activities 1,334,250 941,364
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (1,483,903) (7,284,426)
Proceeds from equipment sold -- 56,810
------------ ------------
Net cash used in investing activities (1,483,903) (7,227,616)
CASH FLOWS FROM FINANCING ACTIVITIES:
Distribution to partners (220,000) --
Issuance of (costs of issuing) common stock (173,615) 3,047,019
Proceeds from long-term debt and notes payable 13,813,532 22,601,355
Principal payments on long-term debt
and notes payable (13,154,497) (18,519,026)
Payment of loan origination fees (122,465) (533,628)
Payments from (loans to) shareholders 21,467 (22,389)
------------ ------------
Net cash provided by financing activities 164,422 6,573,331
------------ ------------
INCREASE IN CASH 14,769 287,079
CASH AT BEGINNING OF PERIOD 15,776 30,545
------------ ------------
CASH AT END OF PERIOD $ 30,545 $ 317,624
============ ============
OTHER CASH FLOW INFORMATION:
Interest paid (including capitalized interest of
$122,000 and $295,000 in 1994 and 1995, respectively) $ 1,015,695 $ 1,382,428
============ ============
NONCASH TRANSACTIONS:
Issuance of notes payable to finance inventory,
property, plant and equipment purchased $ 1,474,977 $ 1,368,757
============ ============
</TABLE>
See accompanying notes to financial statements.
F6
<PAGE> 28
R.H. PHILLIPS, INC. DBA
THE R.H. PHILLIPS VINEYARD
(A CALIFORNIA CORPORATION) (FORMERLY R.H. PHILLIPS PARTNERS)
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization - Effective June 1, 1994, R.H. Phillips Partners, a California
limited partnership, merged into R.H. Phillips, Inc. (the "Company"). Pursuant
to that merger, the Company acquired all of the assets and liabilities of R.H.
Phillips Partners. The general partners of R.H. Phillips Partners received all
of the Common Stock of the Company, and the limited partners of R.H. Phillips
Partners received all of the Series A, Series A-1 and Series A-2 Preferred Stock
of the Company in connection with the merger. All outstanding shares of those
series of Preferred Stock were converted to Common Stock on March 31, 1995. The
total number of shares of Common Stock issued to the general partners as of the
merger and to the limited partners on conversion of the Preferred Stock was
3,645,859. On March 31, 1995, the Company issued 493,563 units in an initial
public offering, with each unit consisting of two shares of Common Stock and one
warrant to purchase one share of Common Stock.
The Company produces, markets, and sells premium quality California table wines.
The Company also farms vineyards located in the Dunnigan Hills region of
Northern California which supply a majority of its annual grape requirements.
Inventories are stated at the lower of FIFO (first-in, first-out) cost or
market. Cost includes the cost of grown and purchased grapes, and harvesting,
production, aging and bottling costs. Wine inventories are classified as current
assets in accordance with recognized trade practice although certain inventories
will be aged for periods longer than one year. Crop costs associated with
farming vineyards prior to the harvest are deferred and recognized in the year
the grapes are harvested.
Property, plant, and equipment are stated at cost and are depreciated using
primarily the straight-line method over the estimated useful lives of the
assets. Vineyards have estimated depreciable lives of 10 to 25 years, buildings
30 years, wine tanks 25 years and furniture and equipment 5 to 7 years. Major
property additions and betterments are capitalized and maintenance and repairs
are expensed as incurred. The cost of property sold or otherwise disposed of,
and the related accumulated depreciation, are removed from the accounts at the
time of sale and any resulting gain or loss is included in operations.
Costs of planting new vines and ongoing cultivation costs for vines not yet
bearing, including interest, are capitalized. Depreciation commences in the
initial year the vineyard yields a commercial crop, generally in the third year
after planting.
Other assets include organization costs, trade name and deferred loan fees.
Deferred loan fees and other costs are amortized using the straight-line method
over the term of the loan, or over lives ranging from 3 to 5 years. Accumulated
amortization was $102,724 at December 31, 1995.
Estimates - The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Major Customers and Sales Representatives - The Company sells most of its
products to distributors for resale to restaurants, bars and retail outlets. The
Company performs ongoing credit evaluations of its customers and generally does
not require collateral. The Company's credit losses have been minimal and within
management's expectations.
F7
<PAGE> 29
The Company's three largest distributors accounted for 11%, 12% and 11% of sales
for the year ended December 31, 1994 and 13%, 12% and 11% of sales for the year
ended December 31, 1995. Accounts receivable from these distributors at December
31, 1995 totaled $1,037,600.
The Company has 12 sales representatives. The Company's representative who
generated the largest sales volume accounted for $6,127,000, or 47% of total
sales in 1994, and $7,375,000, or 48% of total sales in 1995.
Net income or loss per share - Net income or loss per share has been computed
based on the number of common and common equivalent shares outstanding and the
net income or loss applicable to the period during which the Company operated as
a corporation. The Company's Series A, Series A-1 and Series A-2 Preferred
Stock, which was outstanding at December 31, 1994, is considered to be common
equivalent shares. The Company's warrants to purchase Common Stock and employee
stock options, which were outstanding at December 31, 1995, are anti-dilutive,
and were therefore not included in the calculation of earnings (loss) per share.
Income taxes - The Company accounts for income taxes using the asset and
liability method, under which deferred income taxes are provided for the
temporary differences between the tax basis of assets and liabilities and their
related financial statement amounts using current income tax rates.
Recent Pronouncements - In March of 1995, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 121, Accounting for
Impairment of Long-lived Assets and Long-lived Assets to be Disposed of (FASB
121). The Company is required to adopt the provisions of this statement for
years beginning after December 15, 1995. This statement requires that long-lived
assets and certain identifiable intangibles to be held and used by the Company
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. This statement
requires that long-lived assets and certain identifiable intangibles to be
disposed of be reported at the lower of carrying amount or fair value, less cost
to sell. The impact of FASB 121 is not expected to have a material effect on the
Company.
In October of 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, Accounting for Stock Based
Compensation (FASB 123). The Company is required to adopt the provisions of FASB
123 for years beginning after December 15, 1995. FASB 123 encourages all
entities to adopt a fair value based method of accounting for employee stock
options or similar equity instruments. However, it also allows an entity to
continue to measure compensation cost for those plans using the intrinsic-value
method of accounting prescribed by APB opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). Entities electing to remain with the accounting in
APB 25 must make pro forma disclosures of net income and earnings per share as
if the fair value based method of accounting defined in this statement had been
applied. It is currently anticipated that the Company will continue to account
for employee stock options or similar equity instruments in accordance with APB
25 and provide the disclosures required by FASB 123. The impact of FASB 123 is
not expected to have a material effect on the Company.
2. INVENTORIES
Inventories consist of the following at December 31, 1995:
<TABLE>
<S> <C>
Bulk and bottled wine $5,267,918
Bottling supplies and other 610,907
Deferred crop costs 475,645
----------
Total $6,354,470
==========
</TABLE>
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant, and equipment consists of the following at December 31, 1995:
<TABLE>
<S> <C>
Land $ 1,830,587
Vineyard improvements 3,731,348
Buildings 3,538,227
Machinery and equipment 7,083,874
Vehicles and office fixtures 663,379
-----------
Total 16,847,415
Less accumulated depreciation 3,868,109
-----------
Total 12,979,306
Vineyard improvements under development 3,599,193
-----------
Property, plant, and equipment - net $16,578,499
===========
</TABLE>
Total depreciation expense during the years ended December 31, 1994 and 1995 was
approximately $715,000 and $938,000, respectively.
Property, plant and equipment at December 31, 1995 under capital leases is as
follows:
<TABLE>
<S> <C>
Machinery and equipment $1,010,685
Less accumulated depreciation 353,272
----------
Net $ 657,413
==========
</TABLE>
F8
<PAGE> 30
Depreciation expense for machinery and equipment under capital leases was
approximately $113,000 and $172,000 for the years ended December 31, 1994 and
1995, respectively.
4. NOTE RECEIVABLE FROM SHAREHOLDER
The Company has a note receivable from RHP Vineyards, Inc., a major shareholder,
which bears interest at 7.00% and is unsecured. The note is due June 30, 1996.
The Company intends to extend the note to June 30, 1999.
5. NOTES PAYABLE
Notes payable consist of the following at December 31, 1995:
<TABLE>
<S> <C>
Note payable to bank $ 796,329
Note payable to grower, interest at 9.75%, $77,896 payable monthly
through August 1996, unsecured 593,810
----------
Total $1,390,139
==========
</TABLE>
The note payable to bank represents borrowings on a $1,000,000 line of credit,
which bears interest at prime plus 1.00%, of which approximately $3,500 was
available at December 31, 1995. The note is due in February, 1996 and is
collateralized by farm equipment and the 1995 grape crop. In addition, the
Company had a $350,000 non revolving line of credit which has an interest rate
of prime plus 1.00%, of which $350,000 was available at December 31, 1995.
6. LONG-TERM DEBT
Long-term debt consists of the following at December 31, 1995:
<TABLE>
<S> <C>
Note payable to insurance company, with interest on $4,600,000 of principal at
9.05% per annum, $1,500,000 of principal at 8.10% and $1,400,000 of principal
at 8.55%. Interest payable monthly, principal due in monthly payments
beginning February 1996 through
February 2005, secured by various assets of the Company $ 7,500,000
Notes payable to bank, interest at prime or IBOR
plus 200 basis points, principal due April, 1997
collateralized by accounts receivable and inventory(1) 4,575,025
Note payable to finance company, payable in sixty monthly installments
of $10,744 plus interest at one-month LIBOR plus 3.32%,
due November 2000, secured by certain equipment 633,905
Note payable to individual, payable $1,322 per month including
interest at 9%, balance of $104,729 due September 2000, secured by land 129,500
Notes payable to shareholders and affiliates,
interest at various rates, due June 30, 1996, unsecured 46,992
Capital lease obligations 625,351
Other 116,772
-----------
Total 13,627,545
Less current maturities 1,040,000
-----------
Long-term portion $12,587,545
===========
</TABLE>
(1) Maximum amount that can be borrowed on the note is $5,000,000 of which
$424,975 was available at December 31, 1995.
F9
<PAGE> 31
Principal payments required on long-term debt, (other than capital leases) for
each of the next five years ending December 31, are as follows:
<TABLE>
<S> <C>
1996 $ 781,561
1997 5,351,710
1998 746,743
1999 744,616
2000 827,564
Thereafter 4,550,000
-----------
Total $13,002,194
===========
</TABLE>
The Company leases certain winery and other equipment under noncancelable
capital leases. Future minimum lease payments under these leases for each of the
next four years ending December 31, are as follows:
<TABLE>
<S> <C>
1996 $259,827
1997 201,459
1998 180,223
1999 141,803
--------
Total 783,312
Less amounts representing interest 157,961
--------
Net minimum lease payments $625,351
========
</TABLE>
7. SUBORDINATED DEBT
In December 1994, the Company issued $1,500,000 of unsecured subordinated
convertible five year promissory notes in exchange for the cancellation of
indebtedness under certain promissory notes. The subordinated convertible
promissory notes bear interest at 6% per annum, payable yearly, and will be
converted into shares of the Company's Common Stock beginning two years after
issuance, if the market price of such stock as quoted on a national securities
exchange or Nasdaq equals or exceeds $3.50 per share for five consecutive days.
The number of shares of Common Stock issuable upon conversion shall equal the
amount of unpaid principal and interest divided by the lesser of the quoted
price per share or $3.875. Payment of principal on the notes is due in December
1999 if not converted to Common Stock prior to that time.
8. COMMITMENTS AND CONTINGENCIES
As of January 1995, the Company had a total of 437 acres of vineyards which were
believed by management to be susceptible to Phylloxera infestation (Bio-type A).
During 1995, the Company removed 68 acres of vineyards, 63 of which were removed
because of Phylloxera and five of which were removed for the winery expansion,
leaving a total of 369 acres which management believes may be susceptible to
Phylloxera as of December 31, 1995. Approximately 60 of these 369 acres were
showing visual symptoms of decline. Although this acreage will ultimately
require replanting, at this time management expects that these vineyards will
remain commercially productive for approximately eight more years. As a result,
the Company reduced the depreciable life of these vineyards to reflect the
expected remaining useful life.
The Company has adopted a policy of reducing to 10 years the depreciable life of
all vineyards with non-resistant rootstock showing evidence of Phylloxera
infestation. This policy was based on estimated future production of affected
vineyards derived from historical declines and their projected cash flows.
In October 1995, the Company entered into a contract to purchase approximately
900 acres of land adjacent to the Company's current property for approximately
$1,362,000. Management anticipates closing the land purchase by the end of June
1996.
F10
<PAGE> 32
The Company is party to various legal proceedings arising in the ordinary course
of business. In the opinion of management, the ultimate disposition of these
matters will not have a material adverse impact on the Company's financial
position, results of operations or liquidity.
In connection with the Company's operating plant expansion, the Company has
filed a claim against a contractor, who has in turn filed a counterclaim against
the Company. Management believes that the ultimate outcome of this matter will
not have a significant impact on the Company's financial position, results of
operations or liquidity.
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments. The carrying amounts of cash, note
receivable from shareholder and notes payable approximate fair value because of
the short maturity of those instruments. The carrying value of the Company's
long-term debt is recorded at the present value of amounts due under the
applicable agreements, and therefore, approximate fair value. It is not
practicable for the Company to determine the fair value of its subordinated
debt due to the facts that the subordinated debt is non-transferable (except for
certain limited exceptions) and that no public market for the subordinated debt
exists.
10. SHAREHOLDERS' EQUITY
The Company's authorized and outstanding no par value capital stock as of
December 31, 1994 was as follows:
<TABLE>
<CAPTION>
Shares Shares
Authorized Outstanding
---------- -----------
<S> <C> <C>
Series A Preferred 1,200,000 1,183,065
Series A-1 Preferred 255,000 250,953
Series A-2 Preferred 650,000 631,965
Common Stock 7,500,000 1,579,876
</TABLE>
Effective March 31, 1995, the Company completed its public offering of Common
Stock. A total of 493,563 units were sold at a price of $7.25 per unit. A unit
consists of two shares of Common Stock and one warrant to purchase an additional
share of Common Stock at a price of $3.875. The warrants may be exercised
beginning on April 1, 1996 and will expire on April 1, 1997. The Board of
Directors may lengthen the exercise period for the warrants at any time at its
discretion. The Company may repurchase, or "call", the warrants upon 30 days
notice at a price of $0.25 per warrant while the warrants are exercisable if the
closing bid price per share of Common Stock exceeds $4.50 per share for five
consecutive trading days at any time after April 1, 1996. In addition, the
Company also issued warrants to purchase 98,713 shares of Common Stock at an
exercise price per share of $5.57 to the underwriter of the public offering. In
connection with the public offering, 987,126 shares of Common Stock were issued.
After payment of commissions and other expenses of the offering, the Company
received proceeds from the offering of approximately $2,873,000.
In connection with the public offering, all shares of Series A, Series A-1 and
Series A-2 Preferred Stock were converted into 2,065,983 shares of Common Stock.
The total number of shares of Common Stock issued and outstanding as of April 1,
1995, immediately after the public offering and the conversion of the Preferred
Stock, was 4,632,985 shares.
11. OTHER INCOME (EXPENSE)
Other expense for the year ended December 31, 1994 includes $360,000
representing a write down of wine inventories to lower of cost or market.
Management determined that certain bulk wines did not meet minimum quality
standards for inclusion in the Company's wine programs and a write down was
recorded based on the expected sales price of the wine in the bulk market. Other
expense in 1994 also includes approximately $110,000, representing the write-off
of intangible assets of R.H. Phillips Partners at the time of the merger with
the Company, since such assets were of no continuing value.
F11
<PAGE> 33
12. INCOME TAXES
The provision for income taxes consists of the following for the years ended
December 31:
<TABLE>
<CAPTION>
1994 1995
-------- --------
<S> <C> <C>
Current:
Federal $ -- $219,200
State -- 7,800
-------- --------
Total current provision -- 227,000
Deferred:
Federal 282,000 (11,000)
State 82,000 73,000
-------- --------
Total deferred provision 364,000 62,000
-------- --------
$364,000 $289,000
======== ========
</TABLE>
Deferred income taxes included in the balance sheet at December 31, 1995 are as
follows:
<TABLE>
<S> <C>
Current deferred tax assets:
Nondeductible reserves and difference between
book and tax basis of inventory $155,000
State manufacturer's investment credit 98,000
Noncurrent deferred tax assets:
Difference between book and tax basis of intangible assets 141,000
Other 7,000
--------
Total deferred tax asset 401,000
Noncurrent deferred tax liability:
Difference between book and tax basis of property, plant and equipment 827,000
--------
Net deferred tax liability $426,000
========
</TABLE>
Management believes that it is more likely than not that all the deferred tax
assets as of December 31, 1995 will be realized and, therefore, no allowance for
deferred tax assets has been made.
The provision for income taxes is at an effective rate different from the
statutory tax rate of 34% when applied to the pre-tax income (loss) of
($636,574) and $1,039,756 for the years ended December 31, 1994 and 1995,
respectively, as a result of the following:
<TABLE>
<CAPTION>
1994 1995
--------- --------
<S> <C> <C>
Expected U.S. Federal income tax at 34% $(216,435) $353,517
State franchise tax -- 7,800
Effect of non-taxable partnership losses prior to merger 226,737 --
Deferred tax liability recognized due to change in
Company's tax status 352,000 --
Permanent difference in basis of assets -- 22,825
Net operating loss carry forward from 1994, federal -- (99,175)
Other 1,698 4,033
--------- --------
Total $ 364,000 $289,000
========= ========
</TABLE>
F12
<PAGE> 34
Due to the Company's change in tax status, $352,000 of deferred tax liabilities
were recognized in 1994. In 1995 the Company utilized all of the net operating
losses that were generated in 1994 resulting in a tax benefit of approximately
$117,000. The Company utilized approximately $62,000 of the state manufacturer's
investment credit in 1995. The remaining carry forward of approximately $98,000
is due to expire in 2005.
13. STOCK OPTION PLAN
On May 17, 1995, the Board of Directors of the Company adopted the R.H.
Phillips, Inc. 1995 Stock Option Plan (the "Plan"). Under the Plan, the Company
may grant options to purchase shares of the Company's Common Stock to eligible
directors, officers, employees and consultants. The Company may issue a maximum
of 815,000 shares of Common Stock under the Plan, which amount may be changed
due to stock splits, stock dividends and other adjustments to the Company's
outstanding shares. The options consist of incentive stock options, as described
in Section 422 of the Internal Revenue Code of 1986 ("ISO's") and options which
do not qualify for the tax treatment specified in that section of the Internal
Revenue Code ("NSO's"). The price at which the holder of an option may purchase
the stock is set forth in individual option agreements between the Company and
the holder. In any event, the price at which the stock may be purchased (the
"Exercise Price") may be no less than 100% of the fair market value of the stock
as of the date the option is granted in the case of an ISO or 85% of the fair
market value for an NSO.
On July 11, 1995, the Stock Option Committee of the Board of Directors (the
"Stock Option Committee") approved the grant of options to purchase 449,460
shares of Common Stock under the Plan. Of these options, the Company granted
ISO's to purchase an aggregate of 272,400 shares of Common Stock to various
officers and employees. The Exercise Price of these ISO's was $3.75 per share,
which the Stock Option Committee determined to be the fair market value of the
Company's Common Stock as of that date. The Company also granted NSO's to
purchase an aggregate of 177,060 shares to John, Karl, and Lane Giguiere with an
Exercise Price of $4.125 per share, which was 110% of the fair market value of
the Common Stock on that date. The options discussed above generally vest
prorateably over four years, are exercisable to the extent vested, and expire
ten years from the date of grant.
14. SUBSEQUENT EVENTS
On March 27, 1996, the Company sold to John Hancock Mutual Life Insurance
Company ("Hancock") in a private placement at a price of $5,000,000 Redeemable
Preferred Stock and warrants to purchase Common Stock of the Company. The
Company issued 500,000 shares of Redeemable Preferred Stock to Hancock and
warrants to purchase up to 1,346,788 shares of Common Stock at a price of $4.00
per share. The warrants are exercisable beginning on March 27, 1997 and will be
exercisable for ten years following the date of grant.
The Redeemable Preferred Stock bears a 12% cumulative annual dividend, payable
semi-annually. During the first four years after issuance, 50% of the dividend
will be paid in cash and 50% of the dividend will be paid in shares of Common
Stock at a price equal to the lower of the market price at the dividend payment
date or $4.00 per share. The Redeemable Preferred Stock will be redeemable by
the Company beginning approximately five years after issuance. The Company will
be required to redeem one-third of the Redeemable Preferred Stock on March 15,
2004, one-third on March 15, 2005 and the remaining shares on March 15, 2006.
The net proceeds from the offering were approximately $4,807,000 after expenses.
The Company has used the proceeds to fund a portion of the 1996 winery and
vineyard expansions and to pay down existing debt used for the 1996 vineyard
development, started in 1995.
F13
<PAGE> 35
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
2.1** Merger Agreement between the Company and R.H. Phillips
Partners, a California limited partnership, dated May 31, 1994
3.1* Articles of Incorporation
3.2*** Bylaws
4.1** Warrant Agency Agreement by and between the Company and
American Stock Transfer & Trust Company
4.2** Form of Common Stock Certificate
4.3** Form of Common Stock Purchase Warrant
4.4** Warrant to Purchase Common Stock issued to Capitol Bay
Securities
4.5** Form of 5 Year 6% Convertible Subordinated Note of the Company
4.6* Form of Warrant to Purchase Common Stock issued to John Hancock
Mutual Life Insurance Company
4.7* Form of Senior Preferred Stock Certificate
10.1** Loan Agreement between the Company and Metropolitan Life
Insurance Company and Related Agreements, dated January 20,
1995
10.2*** Loan Agreement between the Company and U. S. Bank and Related
Agreements, dated May 26, 1995
10.3** Promissory Note by RHP Vineyards, payable to the Company, dated
December 31, 1993
10.4** Selling Agent Agreement between the Company and Sequoia Equity
Securities Corporation, dated November 1, 1994
10.5** Underwriting Agreement between the Company and Capitol Bay
Securities, dated November 29, 1994
10.6** Warrant Purchase Agreement between the Company and Capitol Bay
Securities, dated November 29, 1994
10.7** Form of Convertible Note Purchase Agreement
10.8** Escow Agreement by and between Bank of America NT&SA ("Escrow
Holder"), the Company, RHP Vineyards, Inc., The R.H. Phillips
Vineyard, Inc., R. Ken Coit and David Gemmer with respect to escrow
of certain shares of the Company's stock
10.9** Sale Restriction Agreement by and between the Company, Capitol Bay
Securities and certain shareholders of the Company, dated October 5,
1994
10.10*** R.H. Phillips, Inc. 1995 Stock Option Plan and form of Incentive
Stock Option Agreement and Non-Statutory Stock Option Agreement.
10.10* Loan Agreement between the Company and Heller Financial and related
documents, dated October 20, 1995.
10.11* Securities Purchase Agreement between the Company and John Hancock
Mutual Life Insurance Company, dated March 27, 1996.
10.12 Grape Purchase Agreement between the Company and C. Mondavi & Sons,
dated February 14, 1995.
23.1 Consent of KPMG Peat Marwick LLP.
23.2 Consent of Deloitte & Touche LLP.
* Documents were filed as exhibits to the Annual Report of the Company on Form
10-KSB for the year ended December 31, 1995 and are incorporated by reference.
** Documents were filed as exhibits to the Annual Report of the Company on Form
10-KSB for the year ended December 31, 1994 and are incorporated by reference.
*** Documents were filed as exhibits to the Quarterly Report of the Company on
Form 10-QSB for the quarter ended June 30, 1995 and are incorporated by
reference.
<PAGE> 1
EXHIBIT 10.12
[CHARLES KRUG LETTERHEAD]
February 14, 1995
R.H. Phillips
26836 County Road 12A
Esparto, CA 95627
Attn: Bob Moore and Karl Giguiere
Pursuant to our conversation today, C. Mondavi & Sons agree to sell
approximately 1000 tons of Dunnigan Chardonnay in 1995, 700-800 tons in 1996
and 700+ tons in 1997. We do need 500 to 550 tons in 1995, so this should be
no problem.
Terms are eight (8) equal monthly payments beginning January 15 and ending
August 15 of each year. Price is to be the previous year's average of District
11 as published in the CDF&A final report. Interest is to begin on November 1
and is based on Bank of America's prime rate +1% as published on November 1,
each year. Buyer may prepay without penalty.
If these terms are agreeable with you, please sign and date in the appropriate
space below, and return the original to me.
C. Mondavi & Sons Acknowledge and agree to above terms:
/s/ M. C. Mondavi 3-16-95 /s/ R. Moore 3-31-95
- ----------------------------------- --------------------------------------
Seller Date Buyer Date
MCM/clp
Marc/Contrac1
<PAGE> 1
EXHIBIT 23.1
[KPMG PEAT MARWICK LETTERHEAD]
The Board of Directors
R.H. Phillips, Inc.
We consent to incorporation by reference in the post-effective amendment no. 2
on Form S-3 to the registration statement (No. 33-83914-LA) on Form SB-2 of R.
H. Phillips, Inc. of our report dated March 8, 1996, except as to Note 14,
which is as of March 27, 1996, relating to the balance sheet of R. H. Phillips,
Inc. as of December 31, 1995, and the related statements of operations,
partners' capital and shareholders' equity, and cash flows for the year then
ended, which report appears in the December 31, 1995, annual report on Form
10-KSB/A amendment no. 1.
July 19, 1996
<PAGE> 1
EXHIBIT 23.2
(DELOITTE & TOUCHE LLP LETTERHEAD)
INDEPENDENT AUDITOR'S CONSENT
We consent to the incorporation by reference in the Post-Effective
Amendment No. 2 to Registration Statement No. 33-83914-LA of R.H. Phillips,
Inc. on Form S-3 of our report dated April 7, 1995 appearing in the Annual
Report on Form 10-KSB/A of R.H. Phillips, Inc. for the year ended December 31,
1995, and to the reference to us under the heading "Experts" in the
Prospectus, which is part of such Registration Statement.
Deloitte & Touche LLP
July 19, 1996
