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R.H. Phillips
Annual Report
1997
[Front Cover]
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R.H. Phillips is an agricultural company which farms approximately
2,100 acres of grapes and produces more than 400,000 cases of
wine. The company specializes in the production of the
Mediterranean varietals Syrah and Viognier, which are showcased
under the EXP label, and Chardonnay, which is sold under the
Toasted Head and Barrel Cuvee labels. John, Karl and Lane
Giguiere founded R.H. Phillips in 1981 on land that had been in the
family for over 50 years. During the last three years the company
has extended its production capabilities by planting 1,000 acres of
new vineyards and increasing wine production capacity to two
million gallons. R.H. Phillips is the 24th largest California wine
producer and is located in the Dunnigan Hills Viticultural Region,
approximately 30 miles east of the Napa Valley.
(in thousands except share data) Years Ended
Dec. 31, 1997 Dec. 31, 1996
Net Sales $ 17,258 $ 16,928
Gross Profit $ 7,204 $ 6,792
Net Income $ 1,334 $ 1,293
Net Income Per Share $ .16 $ .20
Common and Common
Equivalent Shares
Outstanding 6,370,001 5,346,167
[inside front cover]]
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US
You didn't invest in R.H. Phillips because you thought we were
traditional. You didn't invest in R.H. Phillips just because we make
Great wine. You invested in R.H. Phillips because you liked what
made us US: Creative thinkers, pioneers, cutting-edge marketers,
smart about costs. You invested in a company that thinks like you do
- - never satisfied with the status quo; always looking for perfection.
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from the Board
1997 was an important year in the development of the R.H.
Phillips wine company. I use the term "wine company" because that
is exactly how we view ourselves. The distinction - a winery is
typically made up of a single brand while a wine company is based
on multiple brands or wineries. 1997 marks the end of R.H. Phillips
as a winery and the beginning of R.H. Phillips as a wine
company.
Since our April 1995 IPO, we have been repositioning R.H.
Phillips from a premium wine producer to a super premium wine
producer. Hard work by a very dedicated staff has laid the
foundation for this repositioning. We planted new vineyards and
built a state-of-the-art winery to support our new direction. The
1997 harvest reflects the first return from those investments. With
more than 350 acres of Syrah and Viognier in the ground, we are in
position to be a leading producer of Mediterranean varietals. We
moved a compo-
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nent of our Chardonnay program up five price points with the
Toasted Head Series, and our Toasted Head Cabernet-Syrah blend is
meeting great success only months after its official release. The R.H.
Philliips Spanish wine program is set to be launched in 1999 with our
1997 vintage. With brand repositioning well underway, R.H. Phillips
intends to add two new brands to its portfolio; one based in
Mendocino, the other in Sonoma. These additions, and others to
come, position our wine company for strong growth. The new
brands should provide R.H. Phillips with a stronger foothold in the
California wine business by placing the company in new segments of
the marketplace. It affords the Company the opportunity to
accelerate development of its sales force, create new synergies in
production and marketing, and help enhance our business
relationships with the wine trade.
We believe the evolution of R.H. Phillips as a wine company
can open up new avenues of growth. This, combined with an
already exciting growth plan for the R.H. Phillips branded products,
is a formula for increased success in our industry. As a stockholder
in the Company, please take time out to visit our new web site and
learn more about your dYnamic wiNe cOmpAnY.
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1997 Results
Although the increases were small, both revenue and net
income were record highs for the Company. Net sales increased 2%
over 1996. Net income increased 3%. These gains were due primarily
to price increases that were put in place during the first half of the year.
The average case price rose to $43.36 per case in 1997 from $38.87 per
case in 1996. Case sales volume actually declined 8%, from 402,000
cases in 1996 to 371,000 in 1997. The decline in volume was primarily
due to the decreased crop level in 1996 which reduced the amount of
wine produced from that vintage. Although the Company increased net
income to record levels, the additional amount of common shares
outstanding, largely the result of the Company's secondary offering in
1996, reduced earnings per share from $0.20 in 1996 to $0.16 in 1997.
Beyond the numBers, R.H. Phillips
experienced some significant events in 1997.
[on the left hand side of the page are two graphs. First one shows the
Company's revenues from 1994 through 1997. The second graph
shows the gross profit from 1994 through 1997.]
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New Vineyards combined with higher than normal yields made for a
record harvest for our Company. This was welcome news following
the short harvest of 1996. The Toasted Head Series was introduced
to a very receptive audience and received rave reviews. We
embarked on our Spanish wine program with the first commercial
harvest of Dunnigan Hills Tempranillo. We refinanced our loan with
Metropolitan Life Insurance Company at very favorable interest
rates, and increased the loan amount by $4.6 million. We also
entered into a Sale and Lease Back agreement with John Hancock
Life Insurance Company on some of the vineyards as a financing tool
for future expansion. Finally, we hired a new Chief Financial
Officer, Mike Motroni, who adds valuable financial and accounting
strength to our management group.
[at the bottom right hand side is a graph showing the net income
(loss) of the Company for the years ended December 31, 1994
through 1997.]
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Us Bigger
Mendocino
R.H. Phillips has been purchasing Mendocino Cabernet Sauvignon
for the last five years from two vineyards owned by Beckstoffer
Vineyards. In the past, these wines were blended primarily with
R.H. Phillips Cabernet Sauvignon. Now, R.H. Phillips plans to
combine this fruit source with other Cabernet Sauvignon grapes from
Mendocino. We are also working to obtain contracts to purchase
Mendocino Sauvignon Blanc. We intend to make these two varieties
the basis of a new Winery that will concentrate on single vineyard
designated wines with three to four Cabernets and several Sauvignon
Blancs. Initially, our plan is to make the wines at R.H. Phillips, but
production could eventually shift to a location within the Mendocino
appellation when the appropriate winery site has been located. The
acquisition of a Mendocino winery could benefit the new brand.
Consequently, we are currently exploring
acquisition opportunities.
Sonoma
In addition to the Mendocino project, R.H. Phillips is pursuing a
location for a newly established Zinfandel brand, Kempton Clark.
Kempton Clark, for whom the brand name was chosen, has been a
Zinfandel grower in the Dunnigan Hills for the past 35 years. He
was also one of Northern California's top sheep ranchers. The
Basque shepherds who came to the Dunnigan Hills to work for
Kempton planted the first Zinfandel vineyards two miles from
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R.H. Phillips, and those old, gnarly, head pruned vines are
still producing grapes. The original plan for this varietal was to put
the Dunnigan Hills and Cucamonga Zinfandel into the R.H. Phillips
brand under the MAD Zin label. This two-appellation approach has
evolved into a multi-appellation concept utilizing Zinfandel grown up
and down the state of California. R.H. Phillips now intends to
create a winery specializing in the production of Zinfandel.
Sonoma, with its long history of growing this robust and spicy grape,
is the planned home appellation for this new venture. Until the
proper location is found, the Kempton Clark Zinfandel will be made
at the R.H. Phillips winery in the Dunnigan Hills. R.H. Phillips plans
to buy Pinot Noir and Chardonnay fruit from the Central Coast
appellation in 1998. We want to gain experience working with
fruit from this appellation. The Central Coast has a long history of
producing spectacular Chardonnay and Pinot Noir and is rapidly
attracting significant industry interest. This appellation could prove a
valuable addition to the emerging R.H. Phillips wine company.
[middle left hand side of page is a map of California showing the
growing regions listed in the text.]
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Tech
R.H. Phillips has always had the reputation of being
innovative. We are constantly testing methods to increase wine
quality and decrease the cost of production. Night harvesting and the
V-trellis system both started as experiments and later became part of
our basic vineyard operations when they proved to produce better
products at a lower cost. But we didn't stop there. Viticulturally, we
are looking at a number of new ideas, such as canopy cooling. This is
a technique whereby a fine water mist is sprayed on the
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vine's vegetation during California heat waves in an effort to keep
the vines cool, which should increase grape quality. Last year, we
had a trial plot of a material called Color Up. Rolled out like a carpet
in the rows between the vines, Color Up is a reflective foil that
bounces sunlight back into the fruiting zone of the vine to enhance
pigmentation development in red grapes and fruit flavors in whites.
One of the most exciting and ambitious projects is a belt conveyor
system that spans six rows to "automate" the hand picking process.
To improve quality we plan to increase the amount of white varietals
that are whole-cluster pressed. For R.H. Phillips, that means a lot of
hand picked fruit. Hand picking is a very expensive and labor
intensive process. The belt conveyor system should allow us to
efficiently pick and sort the fruit in the field. The expected results -
higher quality at a lower cost.
On the winery side, R.H. Phillips has established a working
relationship with the University of California at Davis (UCD) to
research issues affecting warm weather viticulture. R.H. Phillips has
been a leader in producing quality grapes in California's warm
climate. Our association with UCD has great potential for advancing
our wine program and for producing long range benefits for the
entire wine industry. The Company has also been
experimenting with various yeast strains to increase complexity in our
wines, and with different enzymes for improved
extraction of phenolic compounds (that's color and tannins). The
winery's on-going experimental barrel program allows us to look at a
broad range of coopers working with different types of oak to
ascertain which wood works best with our Dunnigan Hills fruit.
At R.H. Phillips, we believe that innovation is one of the keys
to success in the wine business. We continue to look for new ways
to improve quality in both the vineyard and the winery.
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Wine Growing
With our Laugenour and Jones ranches coming into production over
the next two years, we will have 800 new acres in prodcution.
Assuming normal yields, the Company is looking to increase fruit
production from 5,000 tons to 9,000 tons by 1999, a 300,000 case
increase. R.H. Phillips is looking beyond these tonnage increases to
the expansion of our super premium varietal program. Chardonnay
Dijon clones and Syrah Noir clones were incorporated in all our new
vineyard plantings. A variety of rootstocks, and a number of new
trellising systems along with tighter vine spacing, should
dramatically impact our EXP and Toasted Head wines. We intend to
use site selection and yield research along with the vast array of our
own blending varieties as the starting point to improve the structure
and ageability of our super premium products.
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Sight
Having placed the sourcing issues behind us, R.H. Phillips is
prepared to enter a new period of growth. The Company has
matured in many ways since our IPO in 1995, and that maturity is
expressing itself in the sophistication of the products we produce.
EXP and Toasted Head are now the Company's focus. We intend to
enhance both programs with the addition of small lot, single vineyard
wines at reserve pricing to help showcase the quality of EXP Syrah
and Viognier as well as Toasted Head Chardonnay and
Cabernet - Syrah. Our new series of Spanish varietals will be
launched in 1999. A Tempranillo and a soon to be planted Alberino
are planned for this portfolio. Our new ventures in Mendocino and
Sonoma should increase the scope of our business, allowing R.H.
Phillips to participate in a wider range of the wine business. We plan
to continue to look for new opportunities in other areas of California
as well as other wine producing regions of the world.
Of course, it is one thing to produce all these wonderful products,
but a winery has to be able to sell them, and sell them in a crowded
marketplace. R.H. Phillips has built a solid reputation for cutting-
edge marketing over the years
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with proven success at selling quality products from a new
viticultural region. We plan to use the anticipated improvements in
our margin structure to invest in the distribution and sales of our
products. We plan to beef up our sales force during the next three
years and build on the relationships with the trade through more
aggressive public relations. We also intend to use advertising to tell
our story to a wider audience in an effort to develop awareness of
our brands.
We are an organization that is constantly evolving, changing
and pushing the limits in an effort to continue to be one of
California's premier wine producers. We understand that the
ability to stand apart from others requires tremendous energy and
great ideas - two charactestics in abundance at R.H. Phillips. Our
forward thinking is the foundation of our success and the key to our
future growth.
John Giguiere
Co-CEO
President
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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. The discussion of the results and trends does
not necessarily imply that these results and trends will continue. For
the following discussion, a "case" means a 9-liter case of wine. All
numbers are approximate.
Forward-Looking Statements
The Company provides in this report and elsewhere from
time to time forward-looking statements regarding the Company,
its products, the wine business, and general business and
economic conditions. Examples of forward-looking statements
include projections regarding future expansion, trends in the wine
industry, sources of supply, costs of production, profit margins,
and availability and sources of financing. The actual results of
the Company may vary due to a variety of factors, including the
following:
Availability of Future Financing. The Company may
continue to heavily depend upon its ability to raise additional debt
or equity financing for its working capital and capital expansion
needs. The ability to raise financing is in turn dependent upon a
variety of factors, some of which are outside the control of the
Company. These factors include, but are not limited to, interest
rates, the availability of financing sources, and general economic
conditions. If interest rates increase or other financing becomes
unavailable or more costly to obtain, the Company may not be
able to raise sufficient capital to supply its needs.
Costs of Expansion. Management has based its
assumptions concerning the costs of expansion on assumptions
which it believes are reasonable. However, there can be no
assurance that the Company's estimates will prove to be correct.
If costs are higher than anticipated, the Company may be required
to raise an even greater amount of financing or reduce the rate of
facility expansion.
Costs of Production. Statements with respect to the
general decline in the Company's cost of production are based on
management's assumptions concerning the likely levels of future
sales by the Company, projected yields from the Company's
vineyards and the cost and availability of bulk wine and grapes
from the spot market. For example, if the Company's sales
increase at a faster rate than anticipated or the Company's grape
production is lower than projected, the Company could be forced
to make additional purchases of grapes and wine on the spot
market. Management believes that such events could increase the
Company's costs of production.
Market Conditions. Assumptions as to the desirability of
expansion are based to a great extent on management's beliefs
concerning the current status of and trends within the wine
industry. Market conditions in the wine industry have changed
substantially from time to time. To the extent market conditions
change substantially in the future, the rate at which the Company
deems it advisable to expand its vineyard and winery facilities
may be adjusted.
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Other Factors. A variety of other factors could affect the
actual results of the Company. These include changes in economic
conditions, unexpected adverse weather or growing conditions,
reduction or increases in consumer demand, changes in
governmental regulation concerning the production and sale of
wine, and increased competition from foreign or domestic wine
producers.
Seasonality
The Company usually experiences substantial seasonal
fluctuations in revenue and expenditures. Sales volumes generally
increase during the holiday season, which causes a large percentage
of sales to occur during the last three months of each year. In 1997,
32% of total sales occurred during this period. The Company's
expenditures fluctuate throughout the year based on vineyard and
winery activities.
Expenditures typically peak during the summer and early autumn,
due to harvest and crush activities and expenditures to fund vineyard
and winery expansions.
Costs of Production
The Company experienced an increase in its cost of goods
during 1997 due to adverse weather conditions during the 1996
growing season, which caused below average crop yields in 1996.
Many other California vineyards suffered similar or greater
reductions of their grape crops. The reduction in the Company's
grape supply compelled the Company to increase its grape and
bulk wine purchases to meet consumer demand for the
Company's wines. At the same time, the market price of bulk
wines and grapes had increased substantially due to below
average California grape harvests in 1995 and 1996.
The Company realized above average yields from its
1997 crop. The Company's vineyards produced 5,100 tons of
grapes in 1997, compared with 2,400 tons in 1996. The increase
was primarily due to above average yields per acre due to
favorable growing conditions, and production from new
vineyards. The increased 1997 grape tonnage reduced the cost
per gallon of wine produced from Company vineyards.
Consequently, management believes that the Company's cost of
goods will likely decline in 1998, and that the Company will have
more wine available for sale. The Company has expanded the
size of its vineyards to lessen its dependence on outside sources
of bulk wines and grapes and further reduce its cost of goods.
The Company anticipates that the full benefit of the vineyard
expansion should continue to be realized over the next several
years as the vines mature.
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Results of Operations
Year Ended December 31, 1996
Net Sales
Net sales for the year ended December 31, 1996 were
$16,928,000, an increase of 9% over net sales in the prior year.
Excluding the sales of bulk wines and other items, net sales were
$15,820,000 in 1996, an increase of 9% over 1995. The average
selling price per case was $39.33 in 1996. The increase in the
average selling price resulted primarily from price increases on the
Company's Chardonnay and Cabernet Sauvignon. The Company
sold 402,000 cases in 1996, substantially the same as 1995.
Gross Profit
Gross profit was $6,792,000 in 1996, an 18% increase over
the previous year. Excluding the sales of bulk wines and other
items, gross profit was $6,554,000 in 1996, a 21% increase over
1995. The higher gross profit in 1996 was primarily due to the price
increases discussed above.
Selling Expenses
Selling expenses decreased $131,000 in 1996 as compared
to the previous year. The decrease was primarily due to lower sales
program expenses.
General and Administrative Expenses
General and administrative expenses increased $179,000 in
1996 as compared to the prior year. The increase was primarily due
to an accounts receivable write off and reclass of certain salary
expense.
Interest Expense
Interest expense for the year ended December 31, 1996 was
$862,000, a 16% decrease from the prior year. The Company
capitalized $599,000 of additional interest pertaining to vineyard
and winery development in 1996. The increase in interest during
1996 was primarily due to increased levels of borrowing by the
Company to finance vineyard and winery expansion in 1996. The
interest is attributable to the Company's borrowings on its bank
lines of credit and other debt obligations.
Other Income (Expense)
Other expense for the year ended December 31, 1996 was
$152,000, compared to other income of $29,000 for the prior year.
The large expense in 1996 was primarily due to a provision for
impairment of vineyards believed to be susceptible to Phylloxera.
An accelerated depreciation schedule had been based on
management's original plan to remove and replace 30 acres per
year. However, 148 acres were removed during 1995 and 1996.
The provision for impairment was recorded to reduce the book value
of the remaining vineyards to their estimated economic value as of
December 31, 1996.
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Net Income
The Company recorded net income of $1,293,000 for the
year ended December 31, 1996, a 72% increase over the previous
year. The increase was primarily due to higher sales prices and
lower product costs, which resulted in higher profit margins.
Year Ended December 31, 1997
Net Sales
Net sales in 1997 were $17,258,000, an increase of 2%
over net sales of $16,928,000 during 1996. Excluding the sales
of bulk wines and other items, net sales were $16,245,000 in
1997, an increase of 3% over sales of $15,820,000 in 1996. The
average selling price per case increased from $39.33 in 1996 to
$43.73 in 1997. The Company sold 371,000 cases in 1997, a
decrease of 8% from 402,000 cases in 1996. The decrease was
primarily due to adverse weather conditions during the 1996
growing season which reduced the availability of wine to sell in
1997.
Gross profit
Gross profit was $7,204,000 in 1997, a 6% increase over
$6,792,000 in 1996. Excluding the sales of bulk wines and other
items, gross profit was $6,999,000 in 1997, compared to
$6,554,000
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in 1996. Gross margins were 42% in 1997, compared to 40% in
1996. The cost per case increased during 1997, primarily due to
higher prices of bulk wines and grapes purchased from outside
parties and the below average harvest experienced by the
Company in 1996. The Company implemented price increases
during 1997 to compensate for higher prices of bulk wine and
grapes. As a result, gross margins increased in 1997 despite
higher costs.
Selling Expenses
Selling expenses were $3,359,000, or 19% of sales, in
1997, an increase from $3,054,000, or 18% of sales, in 1996. The
$305,000 increase is primarily due to increased labor costs.
General and Administrative Expenses
General and administrative expenses were $918,000, or
5% of sales, in 1997, an increase from $800,000, or 5% of sales,
in 1996. The $118,000 increase is primarily due to increased
labor costs.
Interest Expense
Interest expense in 1997 was $908,000, compared to
$862,000 in 1996. The Company capitalized $624,000 of
additional interest pertaining to vineyard and winery development
during 1997, and $599,000 during 1996. The increase in total
interest in 1997 is primarily due to borrowings to fund winery and
vineyard expansions. The interest is attributable to the
Company's borrowings on its bank lines of credit and other debt
obligations.
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Other Income (Expense)
Other income was $105,000 in 1997, compared to other
expense of $152,000 in 1996. The expense in 1996 was primarily
due to an adjustment to accelerated depreciation of phylloxerated
vineyards. The income in 1997 was primarily from vineyard
management fees.
Net Income
The Company generated net income of $1,334,000 in
1997, compared to $1,293,000 in 1996. The $41,000 increase
was primarily due to higher gross profit, which was partially
offset by increases in selling, general, and administrative
expenses.
Liquidity and Capital Resources
The Company has financed its working capital and capital
expansion needs through internally generated funds, outside credit
facilities, equity financing, and the sale and leaseback of certain
assets. The Company has made substantial capital expenditures
to expand its vineyards and winery facilities to obtain production
efficiencies through vertical integration and increased product
sales. The Company's cash flows from operations have not been
sufficient to satisfy all of the working capital and capital
expenditure requirements needed to keep pace with its growth.
Consequently, the Company has depended upon debt, equity, and
lease financing for its working capital and capital expansion
needs.
The Company had cash totaling $109,000 on December
31, 1997, a decrease from $309,000 on December 31, 1996.
Sources of cash during 1997 included cash from operations of
$685,000, proceeds from notes payable of $5,170,000, proceeds
from long-term debt of $21,052,000, and proceeds from the sale
of property and vineyards of $5,419,000. Cash used during 1997
included $6,910,000 invested in plant and equipment, $5,613,000
used to repay notes payable, and $18,985,000 used to repay long-
term debt.
Current assets increased by $1,677,000 during 1997,
primarily due to an increase in inventories from $7,808,000 on
December 31, 1996 to $9,928,000 on December 31, 1997. The
increase is primarily due to larger volumes of bulk wine. Current
liabilities decreased by $1,306,000 during 1997, primarily due to
a decrease in accounts payable from $2,178,000 on December 31,
1996 to $818,000 on December 31, 1997. The decrease was
primarily due to the timing of accounts payable payments at year
end. These factors caused net working capital to increase
$2,983,000, from $7,016,000 on December 31, 1996 to
$9,999,000 on December 31, 1997.
The Company has several long-term loans, the largest of
which was obtained from Metropolitan Life Insurance Company
("Metropolitan"). The Company borrowed $7,500,000 from
Metropolitan in January 1995. In December 1997, the Company
refinanced that loan at a lower interest rate and borrowed
additional funds from Metropolitan, making the total principal
amount of the loan $11,000,000. The unpaid principal under the
loan accrues interest at an annual rate of 7.79%. The Company
is required to make monthly principal payments of $60,000 plus
accrued interest. The loan matures in January 2013, at which
time the Company will be required to make a balloon payment of
$200,000.
The Company has a line of credit of $6,000,000 with U.S.
Bank of California ("U.S. Bank") to finance its working capital
requirements. The line of credit is secured by accounts receivable
and inventory, and matures in April 1999. The annual interest
rate on the line is either U.S. Bank's prime rate or IBOR plus 200
basis points, at the Company's option. The balance on the line at
December 31, 1997 was $3,233,000.
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In May 1997, the Company sold 371 acres of land being
developed into vineyard to John Hancock Mutual Life Insurance
Company ("Hancock"). In connection with that transaction, the
Company now manages, operates and leases the land and
vineyards from a subtenant of Hancock, Farmland Management
Services, for a term that expires on December 31, 2012. The
Company received proceeds from the sale of $4,209,000 in May
1997 and $1,175,000 in June 1997. The lease provides that the
Company will pay rent of $161,000 per calendar quarter
beginning in 1999. The lease is accounted for as an operating
lease.
In March 1996, the Company sold 500,000 shares of
Senior Redeemable Preferred Stock (the "Senior Preferred
Stock") and warrants to purchase up to 1,346,788 shares of
Common Stock to Hancock. The net proceeds the Company
derived from the sale of the Senior Preferred Stock and the
warrants, after payment of offering expenses, were $4,785,000.
The Senior Preferred Stock bears a cumulative annual dividend
of $1.20 per share, payable semiannually. During the first four
years after issuance, 50% of the dividend is payable in cash and
50% of the dividend is payable 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 Company is required to
redeem one-third of the Senior Preferred Stock eight years after
issuance, and one-third in each of the succeeding years at a
price of $10.00 per share.
In April 1997, the Company converted subordinated
promissory notes in the aggregate amount of $1,500,000 into
387,077 shares of Common Stock. The notes became
automatically convertible into Common Stock at a price of $3.875
when the average of the closing bid and ask price for the
Common Stock exceeded $3.50 for five consecutive trading days
subsequent to December 6, 1996.
The Company expanded its winery in 1997 by enlarging
its case goods warehouse, increasing stainless steel tank storage
and fermentation capacity, and purchasing support equipment.
The winery expansion cost $2,381,000. During 1998 the
Company plans to add a tasting room at an estimated cost of
$600,000, and to invest an estimated $3,200,000 in tanks, barrels,
presses and other equipment. Additional winery expansion
projects are anticipated for the future to handle the increased
production from the Company's recently planted vineyards. The
Company planted 347 acres of new vineyard in 1997, which
included 115 acres of vineyard sold to and leased back from
Hancock. The 1997 vineyard expansion, including acres
previously planted but not yet fully productive and excluding
acreage sold to Hancock, cost $2,974,000. The Company plans
to invest an estimated $1,800,000 to continue the development of
recently planted vineyards during 1998. The Company financed
1997 capital projects primarily with the proceeds from the
Hancock sale. The Company plans to fund 1998 capital projects
with internally generated funds and additional debt.
Phylloxera infestation may have a negative impact on the
Company's future grape production. Phylloxera is a root louse
which feeds on grape roots, causing reduced production and
eventual vine death. Of the Company's 1,549 acres of vineyard,
187 acres have root stock which is susceptible to Phylloxera.
Management estimates these vineyards will be commercially
productive for ten years (until 2004), as compared with twenty-
five years generally estimated for vineyards without Phylloxera.
The reduction in vineyard useful life causes an increase in
depreciation and maintenance expense. The increased expenses
are added to the cost of grapes harvested, thus increasing cost of
sales. The Company is in the process of replacing the majority of
Phylloxera-infested or susceptible vines with rootstock believed
to be resistant to Phylloxera.
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The Board of Directors
R.H. Phillips, Inc.:
We have audited the accompanying balance sheet of R.H.
Phillips, Inc. as of December 31, 1997, and the related statements
of operations, shareholders' equity, and cash flows for each of the
years in the two year period ended December 31, 1997. 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 audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of R.H.
Phillips, Inc. as of December 31, 1997, and the results of its
operations and its cash flows for each of the years in the two year
period ended December 31, 1997 in conformity with generally
accepted accounting principles.
//s//KPMG Peat Marwick LLP
Sacramento, California
March 13, 1997
19
<PAGE>22
<TABLE>
R.H. PHILLIPS, INC.
BALANCE SHEET
DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<CAPTION>
ASSETS
<S>
<C>
CURRENT ASSETS:
Cash $ 109
Accounts receivable 2,513
Inventories 9,928
Deferred income taxes and prepaid expenses 846
__________
Total current assets 13,396
PROPERTY, PLANT, AND EQUIPMENT - net 28,870
OTHER ASSETS:
Notes receivable from shareholders and
other affiliates 224
Deferred loan fees and other, net 474
Total other assets 698
__________
TOTAL ASSETS 42,964
==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 1,258
Notes payable 396
Accounts payable 818
Accrued liabilities 925
__________
Total current liabilities 3,397
LONG-TERM DEBT 16,369
DEFERRED INCOME TAXES 1,410
DEFERRED GAIN AND VINEYARD DEVELOPMENT COSTS 892
COMMITMENTS AND CONTINGENCIES -
REDEEMABLE PREFERRED STOCK, redeemable at $5,000,000 4,511
SHAREHOLDERS' EQUITY:
Non-redeemable preferred stock, no par value,
4,500,000 shares authorized, none
issued and outstanding --
Common stock, no par value, 12,500,000 shares
authorized, 6,433,182 shares issued
and outstanding 14,041
Additional paid-in capital 337
Retained earnings 2,007
__________
Total shareholders' equity 16,385
__________
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $42,964
==========
<FN>
See accompanying notes to financial statements.
</TABLE>
20
<PAGE>23
<TABLE>
R.H. PHILLIPS, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 AND 1997
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<CAPTION>
1996 1997
<S> <C> <C>
NET SALES $16,928 $17,258
COST OF SALES 10,136 10,054
_______ _______
GROSS PROFIT 6,792 7,204
SELLING EXPENSES 3,054 3,359
GENERAL AND ADMINISTRATIVE 800 918
EXPENSES _______ _______
OPERATING INCOME 2,938 2,927
INTEREST EXPENSE (862) (908)
OTHER INCOME (EXPENSE) - NET (152) 105
_______ _______
INCOME BEFORE INCOME TAXES 1,924 2,124
PROVISION FOR INCOME TAXES (631) (790)
_______ _______
NET INCOME $ 1,293 $ 1,334
======= =======
NET INCOME $ 1,293 $ 1,334
DIVIDENDS AND ACCRETION ON
REDEEMABLE PREFERRED STOCK (250) (337)
NET INCOME APPLICABLE TO $ 1,043 $ 997
COMMON STOCK
NET INCOME PER SHARE -
BASIC AND DILUTED $ .20 $ .16
COMMON AND COMMON
EQUIVALENT SHARES
OUTSTANDING 5,346,167 6,370,001
<FN>
See accompanying notes to financial statements.
</TABLE>
21
<PAGE>24
<TABLE>
R.H. PHILLIPS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996 AND 1997
(IN THOUSANDS)
<CAPTION>
Non- Common Additional Retained Total
redeemable Stock Paid-in Earnings
Preferred Capital
Stock
<S> <C> <C> <C> <C> <C>
SHAREHOLDERS' EQUITY
JANUARY 1, 1996 $ -- $ 7,623 $ -- $ 417 $ 8,040
WARRANTS ASSOCIATED WITH
REDEEMABLE PREFERRED STOCK -- -- 337 -- 337
ACCRETION OF REDEEMABLE
PREFERRED STOCK -- -- -- (25) (25)
ISSUANCE OF COMMON STOCK
-- 4,550 -- -- 4,550
DIVIDEND ON REDEEMABLE
PREFERRED STOCK -- -- -- (225) (225)
ISSUANCE OF STOCK DIVIDEND -- 150 -- (150) --
NET INCOME YEAR ENDED
DECEMBER 31, 1996 -- -- -- 1,293 1,293
__________ ________ ________ _______ _______
SHAREHOLDERS' EQUITY
DECEMBER 31, 1996 -- 12,323 337 1,310 13,970
ACCRETION OF REDEEMABLE
PREFERRED STOCK -- -- -- (37) (37)
ISSUANCE OF COMMON STOCK -- 1,418 -- -- 1,418
DIVIDEND ON REDEEMABLE
PREFERRED STOCK -- -- -- (300) (300)
ISSUANCE OF STOCK DIVIDEND -- 300 -- (300) --
NET INCOME YEAR ENDED
DECEMBER 31, 1997 -- -- -- 1,334 1,334
__________ ________ ________ _______ _______
SHAREHOLDERS' EQUITY
DECEMBER 31, 1997 $ -- $ 14,041 $ 337 $ 2,007 $16,385
========== ======== ======== ======= =======
<FN>
See accompanying notes to financial statements.
</TABLE>
22
<PAGE>25
<TABLE>
R.H. PHILLIPS, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1997
(IN THOUSANDS)
<CAPTION>
<S> 1996 1997
CASH FLOWS FROM OPERATING ACTIVITIES: <C> <C>
Net income $ 1,293 $ 1,334
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income taxes 126 355
Depreciation and amortization 1,590 1,829
Loss on disposal of property, plant and equipment 231 55
Net changes in assets and liabilities:
Accounts receivable (65) 618
Inventories (1,013) (1,722)
Prepaid expenses 76 (254)
Other assets (85) (83)
Accounts payable and accrued liabilities 758 (1,447)
________ ________
Net cash provided by operating activities 2,911 685
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (12,400) (6,910)
Proceeds from property, plant and equipment sold 49 5,419
________ ________
Net cash used in investing activities (12,351) (1,491)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of (cost of issuing) redeemable
preferred stock 4,798 (13)
Issuance of common stock 4,550 23
Payment of cash dividend (150) (300)
Proceeds from long-term debt and notes payable 18,938 26,222
Principal payments on long-term debt
and notes payable (18,662) (24,598)
Payment for development of leased vineyards
and related fees -- (637)
Other financing activities (43) (91)
_______ ________
Net cash provided by financing activities 9,431 606
DECREASE IN CASH (9) (200)
CASH AT BEGINNING OF PERIOD 318 309
_______ ________
CASH AT END OF PERIOD $ 309 $ 109
======= ========
OTHER CASH FLOW INFORMATION:
Interest paid (including capitalized interest of
$599 and $624 in 1996 and 1997, respectively) $ 1,225 $ 1,438
Income tax paid $ 453 $ 649
NONCASH TRANSACTIONS:
Issuance of notes payable to finance inventory,
property, plant and equipment purchased $ 555 $ 552
Issuance of stock dividend $ 150 $ 300
Accretion of redeemable preferred stock $ 25 $ 37
Accrual of cash dividend $ 75 $ --
Conversion of subordinated debt to common stock
(net of issuance costs of $105) $ -- $ 1,395
<FN>
See accompanying notes to financial statements.
</TABLE>
23
<PAGE>26
R.H. PHILLIPS, INC.
NOTES TO FINANCIAL
STATEMENTS
DECEMBER 31, 1997
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Organization - R.H. Phillips, Inc. (the "Company"), a California
corporation formed in February 1994, produces, markets, and
sells premium quality California table wines. The Company also
farms vineyards which supply a portion of its annual grape
requirements. The Company sells most of its products to
distributors for resale to restaurants, food service, wine shops,
independent liquor stores and, to a lesser degree, grocery stores.
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 wines, production costs, and packaging materials. Wine
inventories are classified as current assets in accordance with
recognized trade practice although certain inventories are 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 the straight-line method over the estimated
useful lives of the assets. Vineyard lives range from 10 to 25
years, buildings and improvements lives range from 12 to 45
years, and equipment lives range from 5 to 30 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 first year the vineyard yields a
commercial crop, generally in the third year after development
began.
The Company's long-lived assets and certain identifiable
intangibles are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceed the fair value of the
assets. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell.
Deferred Loan Fees and Other consists primarily of deferred loan
fees, and are amortized using the straight-line method over the
term of the loan, or over lives ranging from 2 to 5 years.
Accumulated amortization was $289,700 at December 31, 1997.
Estimates and Certain Risks - 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.
24 (Continued)
<PAGE>27
The Company's three largest distributors accounted for 12%, 11%
and 7% of sales in 1997 and 13%, 11% and 10% in 1996.
Accounts receivable from these distributors on December 31,
1997 was $987,000.
The Company employs five sales representatives who work with
certain distributors to sell the Company's products. In addition,
the Company uses independent wine brokers. The Company's
largest sales volume is attributable to a broker, whose
organization generated $7,793,000, or 45% of total sales in 1997
and $7,722,000, or 46% of sales, in 1996.
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.
Net income per share - Net income per share is calculated based
on the weighted average number of common shares and dilutive
potential common shares outstanding, including 50,578 shares
from the stock dividend paid on March 16, 1998 related to the
Preferred Stock. The Company's warrants to purchase Common
Stock and employee stock options, aggregating 2,814,406 at
December 31, 1996 and 2,469,667 at December 31, 1997, were
anti-dilutive and therefore had no effect on net income per share.
Recent Pronouncements - The Company adopted the provisions
of Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") as of January 1, 1997. This
statement requires a change in the method used to compute
earnings per share and the restatement of all prior periods. The
adoption of SFAS 128 did not have a material effect on the
Company.
The Company also adopted the provisions of Statement of
Financial Accounting Standards No. 129, "Disclosure of
Information about Capital Structure" ("SFAS 129") as of
December 31, 1997. This statement lists required disclosures
about capital structure that had been included in a number of
previously existing, separate statements and opinions. Adoption
of SFAS 129 did not have a material effect on the Company's
financial statements.
Prospective Accounting Developments - In June 1997, the
Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130") and Statement of
Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information", ("SFAS
131"). SFAS 130 establishes standards for reporting and display
of comprehensive income and its components (revenues,
expenses, gains and losses) in annual financial statements. SFAS
131 establishes reporting standards for operating segments in the
annual financial statements of public entities, and requires those
entities to report selected information about operating segments
in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and
services, geographic areas, and major customers. Both of these
Statements are effective for periods beginning after December 15,
1997. Management believes that the adoption of these Statements
will not have a material impact on the Company's financial
position, results of operations, or liquidity.
Reclassification - Certain 1996 amounts have been reclassified
for comparative purposes to conform to present year presentation.
(Continued) 25
<PAGE>28
2. INVENTORIES
Inventories consist of the following at December 31, 1997:
(In thousands)
<TABLE>
<S> <C>
Bulk wine $ 7,632
Bottled wine 1,083
Bottling supplies and other 464
Deferred crop costs 749
_______
Total $ 9,928
=======
</TABLE>
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following
at December 31, 1997:
<TABLE>
<CAPTION> (In thousands)
<S> <C>
Land $ 2,619
Vineyard improvements 6,526
Buildings 5,176
Machinery and equipment 13,727
Vehicles and office fixtures 920
________
Total 28,968
Less accumulated depreciation 6,043
________
Total 22,925
Construction in progress 5,945
________
Property, plant, and equipment - net $ 28,870
========
</TABLE>
Total depreciation expense during the years ended
December 31, 1996 and 1997 was approximately
$1,383,000 and $1,693,000, respectively.
Plant and equipment under capital leases as of December
31, 1997 is as follows:
<TABLE>
<CAPTION> (In thousands)
<S> <C>
Machinery and equipment $ 886
Less accumulated depreciation 391
__________
Net $ 495
==========
</TABLE>
Depreciation expense for machinery and equipment under
capital leases was approximately $118,000 and $100,000
for the years ended December 31, 1996 and 1997,
respectively.
26 (Continued)
<PAGE>29
4. NOTES RECEIVABLE FROM SHAREHOLDERS
AND OTHER AFFILIATES
Notes receivable from shareholders and other affiliates
consist of the following as of December 31, 1997:
<TABLE> (In thousands)
<CAPTION>
<S> <C>
Note receivable from RHP Vineyards, Inc. $ 155
Notes receivable from employee and affiliate 69
_____
Total $ 224
=====
</TABLE>
The notes receivable bear interest at 7%, are unsecured,
and mature July 30, 2000. RHP Vineyards, Inc. is a major
shareholder of the Company. Interest receivable pertaining
to the notes receivable was approximately $49,000 at
December 31, 1997.
5. NOTES PAYABLE
Notes payable at December 31, 1997 consists of a note
payable to a grower in the amount of $396,000. The note
bears interest at an annual rate of 9.5% and is unsecured.
All outstanding principal and interest were paid in January
1998.
(Continued) 27
<PAGE>30
6. LONG-TERM DEBT
Long-term debt consists of the following at December 31,
1997:
<TABLE>
<CAPTION> (In thousands)
<S> <C>
Note payable to insurance company, interest at 7.79%, $11,000
principal and interest payable monthly through January 2013,
secured by various assets of the Company
Note payable to bank, interest at prime or IBOR plus 200 3,233
basis points, principal due April 1999, interest payable
monthly, collateralized by accounts receivable
and inventory (1)
Note payable to bank, interest at one month LIBOR plus 330 basis 1,589
points, principal and interest due in 42 monthly payments of
$19,911 followed by 42 monthly payments of $29,867,
balance due December 2003, secured by certain equipment
Note payable to finance company, interest at 7.95%, principal 878
and interest payable in sixty monthly payments of $18,027,
balance due December 2002, secured by certain equipment
Note payable to finance company, payable in sixty monthly 360
installments of $10,744 plus interest at one month LIBOR
plus 332 basis points, due November 2000, secured by
certain equipment
Notes payable to shareholder and employee, interest at 7%, 49
due June 1999
Capital lease obligations 441
Other 77
_______
Total 17,627
Less current maturities 1,258
_______
Long-term portion $16,369
=======
</TABLE>
(1) Maximum amount that can be borrowed on the note is $6,000,000.
The amount outstanding as of December 31, 1997 consists of
$2,552,000 borrowed against the line and $681,000 in outstanding
checks. $2,767,000 was available at December 31, 1997.
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>
<CAPTION> (In thousands)
<S> <C>
1998 $ 1,088
1999 4,367
2000 1,194
2001 1,187
2002 1,215
Thereafter 8,135
_______
Total $17,186
=======
</TABLE>
28 (Continued)
<PAGE>31
The Company leases certain winery and other equipment
under noncancellable capital leases. Future minimum
lease payments under these leases for each of the next
five years ending December 31 are as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
1998 $ 211
1999 224
2000 33
2001 26
2002 16
________
Total 510
Less amounts representing interest 69
________
Net minimum lease payments $ 441
========
</TABLE>
7. INCOME TAXES
The provision for income taxes consists of the following
for the years ended December 31:
<TABLE>
<CAPTION> (In thousands)
1996 1997
<S>
Current: <C> <C>
Federal $ 490 $ 439
State 15 (4)
_____ _____
Total current provision 505 435
Deferred:
Federal 155 259
State (29) 96
_____ _____
Total deferred provision 126 355
_____ _____
$ 631 $ 790
===== =====
</TABLE>
Deferred income taxes included in the balance sheet at
December 31, 1997 are as follows:
<TABLE>
<CAPTION> (In thousands)
<S> <C>
Current deferred tax assets:
Nondeductible reserves and difference between
book and tax basis of inventory $ 379
State manufacturer's investment credit 124
Noncurrent deferred tax assets:
Difference between book and tax basis of
intangible assets 220
Other 2
_____
Total deferred tax asset 725
Noncurrent deferred tax liability:
Difference between book and tax basis
of property, plant and equipment 1,632
______
Net deferred tax liability $ 907
======
</TABLE>
(Continued) 29
<PAGE>32
Management believes that it is more likely than not that all
the deferred tax assets as of December 31, 1997 will be
realized and, therefore, no allowance for deferred tax assets
was made as of December 31, 1996 or December 31, 1997.
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 of $1,924,000 and $2,124,000 for the
years ended December 31, 1996 and 1997, respectively, as
a result of the following:
<TABLE>
<CAPTION> 1996 1997
<S> <C> <C>
Expected U.S. Federal income tax 34% 34%
State franchise tax, net of federal benefit 6% 6%
Permanent difference in basis of assets 1% 1%
State manufacturer's investment credit (7%) (6%)
Other (1%) 2%
___ ___
Total 33% 37%
=== ===
</TABLE>
The Company utilized $138,000 of the state
manufacturer's investment credit in 1996 and $119,000 in
1997. The remaining carry forward of $124,000 is due to
expire in 2007.
8. DEFERRED GAIN AND VINEYARD
DEVELOPMENT COSTS
In May 1997, the Company sold 371 acres of land being
developed into vineyard to John Hancock Mutual Life
Insurance Company ("Hancock"). In connection with that
transaction, the Company now manages, operates and
leases the land and vineyards from a subtenant of Hancock,
Farmland Management Services, for a term that expires on
December 31, 2012. The Company received proceeds
from the sale of $5,384,000. The lease provides that the
Company will pay rent of $161,000 per calendar quarter
beginning in 1999. At June 30, 1997, the Company held
an option to repurchase the land and vineyard at the end of
the lease term. The lease was accounted for as a long-term
capital lease.
On September 30, 1997, the Company renegotiated the
lease agreement with Hancock whereby the option to
repurchase the land and vineyard at the end of the lease
was given up by the Company in exchange for a right of
first refusal. The lease is therefore accounted for as an
operating lease.
The Company recognized deferred gain and vineyard
development costs of $1,529,000 at the time of closing,
which consists of the difference between the actual costs of
the property sold and the funds received by the Company.
The Sale and Leaseback agreement with Hancock requires
that the Company complete the vineyards that are still
under development. The Company expended $637,000
between the date of closing and December 31, 1997 on the
development of the vineyards and related expenses,
decreasing the deferral to $892,000 at December 31, 1997.
Management estimates that the remaining costs to
complete the development will be $479,000. This amount
will reduce the deferral as incurred. The remainder,
estimated to be $413,000, will be amortized to income
over the life of the lease.
9. COMMITMENTS AND CONTINGENCIES
As of December 31, 1997, the Company believes that up
to 187 acres of vineyard may be susceptible to Phylloxera.
Based on tests performed, management believes that
portions of these 187 acres show physical symptoms of
decline. The Company is using a variety of methods to
combat Phylloxera infestation. Although this acreage will
ultimately require replacement, management estimates
that these vineyards will remain commercially productive
for six more years. The Company has reduced the
depreciable life of these vineyards to reflect the expected
remaining commercial productivity.
30 (Continued)
<PAGE>33
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 operation, or liquidity.
10. REDEEMABLE PREFERRED STOCK
In March 1996, the Company completed a private
placement sale of 500,000 shares of Senior Preferred
Redeemable Stock ("Preferred Stock") and warrants to
purchase up to 1,346,788 shares of Common Stock.
500,000 shares of Preferred Stock are issued and
outstanding as of December 31, 1997. The net proceeds
the Company derived from the sale of the Preferred Stock
and the warrants, after offering expenses, totaled
$4,785,000. The Preferred Stock bears a 12% cumulative
annual dividend, payable semiannually. 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 average
daily market price over a period of 20 consecutive trading
days before the dividend payment date or $4.00 per share.
Thereafter, the dividend will be payable in cash. The
Company will be required to redeem one-third of the
Preferred Stock eight years after issuance and one-third of
the Preferred Stock in each of the succeeding years at a
price of $10.00 per share. The carrying value of the
Preferred Stock was originally $4,449,000, net of offering
expenses and the estimated value of the warrants. The
carrying value was $4,511,000 at December 31, 1997, and
the Preferred Stock is redeemable at $5,000,000. The
difference between the carrying value and the redemption
value is being accreted over the life of the Preferred Stock
using the interest method.
11. SHAREHOLDERS' EQUITY
In connection with its initial public offering of Common
Stock in March 1995, the Company issued 493,563
warrants to purchase one share of Common Stock at a
price of $3.875. The warrants are currently exercisable
and expire October 1, 1998. The Board of Directors may
lengthen the exercise period for the warrants at any time.
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.
The Company completed a second public offering of
Common Stock in July 1996. The Company issued
1,270,000 shares of Common Stock in connection with the
offering at a price of $4.375 per share. The net proceeds
from the offering, after payment of underwriting discounts
and offering expenses, totaled approximately $4,484,000.
In April 1997, the Company converted subordinated
promissory notes in the aggregate amount of $1,500,000
into 387,077 shares of Common Stock. The notes became
automatically convertible into Common Stock at a price of
$3.875 when the average of the closing bid and ask price
for the Common Stock exceeded $3.50 for five consecutive
trading days subsequent to December 6, 1996. All
outstanding interest and fractional shares were paid in cash
at the same time. In connection with the conversion, the
Company charged the remaining deferred issuance costs of
$105,000 resulting in a net value of $1,395,000 being
recorded in the Statement of Shareholders' Equity.
As of December 31, 1997, warrants to purchase 19,065
shares of Common Stock had been exercised, with net
proceeds to the Company of approximately $74,000. The
Company has issued 119,969 shares of Common Stock to
the holder of its Redeemable Preferred Stock as stock
dividends.
(Continued) 31
<PAGE>34
In addition to the warrants issued in connection with the
Company's initial public offering, warrants have been
issued to the underwriters of both public offerings and to
the holder of its Redeemable Preferred Stock. The
Company issued warrants to purchase 98,713 shares of
Common Stock to the underwriter of the initial public
offering. These warrants are exercisable at $5.57 per
share. The Company issued warrants to purchase 122,000
shares of Common Stock at a price of $5.25 to the
underwriter of its secondary public offering. The holder of
the Company's Redeemable Preferred Stock received
warrants to purchase 1,381,321 shares of Common Stock
at a price of $3.90. All underwriter warrants and warrants
held by the holder of the Company's Redeemable
Preferred Stock are currently exercisable. The total number of
warrants outstanding as of December 31, 1997 was 2,076,532.
Payment of dividends on the Common Stock is subject to
certain limitations under the Company's loan agreements
. In addition, the Senior Preferred Stock of the Company
provides that semi-annual dividends payable on those
shares must be paid in full or set aside for payment before
any dividends are paid on the Common Stock.
12. STOCK COMPENSATION PLANS AND
WARRANTS
At December 31, 1997, the Company had three stock-
based compensation plans, which are described below.
The Company applies APB Opinion No. 25 in accounting
for its stock compensation plans. Accordingly, no
compensation cost has been recognized for its fixed stock
option plan and underwriter warrant plans. Had
compensation cost for the Company's three stock-based
compensation plans been recognized consistent with FASB
Statement No. 123, the Company's net income and
earnings per share would have the pro forma amounts
indicated below. For purposes of pro forma disclosures,
the estimated fair value of the options is amortized to
expense over the options' vesting periods.
<TABLE>
<CAPTION> 1996 1997
<S>
Net income (in thousands): <C> <C>
As reported $1,293 $1,334
Pro forma 1,233 1,243
Earnings per share:
As reported $ 0.20 $ 0.16
Pro forma 0.18 0.14
</TABLE>
Fixed Stock Option Plan - Under the 1995 Employee Stock
Option Plan, the Company may grant options to its
employees for up to 815,000 shares of Common Stock. The
exercise price of each option is no less than the market price
of the Company's stock on the date of the grant and an
option's maximum term is ten years. Options generally vest
ratably over the four years following the date of grant.
The fair value of each option grant is estimated on the date
of grant using the Black-Scholes option pricing model. The
fair value of options granted during the year ended
December 31, 1997 assumed a dividend yield of 0%, an
expected volatility of 37%, a risk free interest rate of 5.71%
and an expected term of six years. All assumptions in the
Black-Scholes option pricing model were based on
weighted averages.
32 (Continued)
<PAGE>35
The Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options which
have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of
highly subjective assumptions including the expected stock
price volatility. Because the Company's employee stock
options have characteristics significantly different from
those of traded options, and because changes in the
subjective input assumptions can materially affect the fair
value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure
of the fair value of its employee stock options.
A summary of the status of the Company's fixed option
plan as of December 31, 1996 and 1997 and changes during
the years ended on those dates is presented below:
<TABLE>
<CAPTION> 1996 1997
Average Average
Exercise Exercise
Shares Price Shares Price
<S> <C> <C> <C> <C>
Outstanding at beginning of year 449,460 $ 3.90 427,668 $ 3.90
Granted -- -- 196,548 4.14
Exercised -- -- (4,086) 3.75
Forfeited (21,792) 3.75 (58,566) 3.75
_______ _________ _______ _________
Outstanding at end of year 427,668 $ 3.90 561,564 $ 4.01
======= ========= ======= =========
Options exercisable at year end 106,917 $ 3.90 202,509 $ 3.96
======= ========= ======= =========
Weighted average fair value of
Options granted during year $ -- $ 1.26
========= =========
</TABLE>
The following summarizes information about fixed
options outstanding at December 31, 1997:
<TABLE>
<S> <C>
Range of exercise prices $3.25 to $4.25
Number outstanding at December 31, 1997 561,564
Options outstanding:
Weighted average remaining contractual life 8.2 years
Weighted average exercise price $4.01
Options exercisable:
Number exercisable at December 31, 1997 202,509
Weighted average exercise price $3.96
</TABLE>
Underwriter Warrant Plans - The Company granted
warrants for shares of Common Stock to each of its
underwriters for its two public stock offerings. The number
of shares granted was 98,713 for the Company's initial
public offering, and 122,000 for the Company's secondary
public offering. Under both plans, the exercise price was
above the market price of the Company's stock on the date
of the grant and each warrant's maximum term is five years.
The fair value of each warrant grant is estimated on the date
of grant using the Black-Scholes option pricing model. No
warrants were granted during the year ended December 31,
1997. The fair value of warrants granted during the year
ended December 31, 1996 assumed a dividend yield of 0%,
an expected volatility of 15%, a risk free interest rate of 6%
and an expected term of five years. All assumptions in the
Black-Scholes option pricing model were based on weighted
averages.
(Continued) 33
<PAGE>36
A summary of the status of the Company's underwriter
warrant plans as of December 31, 1996 and 1997 and
changes during the years ended on those dates is presented
below:
<TABLE>
<CAPTION> 1996 1997
Average Average
Exercise Exercise
Shares Price Shares Price
<S> <C> <C> <C> <C>
Outstanding at beginning of year 98,713 $ 5.57 220,713 $ 5.39
Granted 122,000 5.25 -- --
Exercised -- -- -- --
Forfeited -- -- -- --
_______ _________ _______ _________
Outstanding at end of year 220,713 $ 5.39 220,713 $ 5.39
======= ========= ======= =========
Warrants exercisable at year end 98,713 $ 5.57 220,713 $ 5.39
======= ========= ======= =========
Weighted average fair value of
Warrants granted during year $ 0.69 $ --
========= =========
</TABLE>
The following summarizes information about
underwriter warrants outstanding at December 31, 1997:
<TABLE>
<S> <C>
Range of exercise prices $5.25 to $5.57
Number of warrants outstanding at December 31, 1997 220,713
Warrants outstanding:
Weighted average remaining on contractual life 2.9 years
Weighted average exercise price $5.39
Warrants exercisable:
Number of warrants exercisable at December 31, 1997 220,713
Weighted average exercise price $5.39
</TABLE>
13. 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, notes
receivable from shareholders, accrued liabilities and notes
payable approximate fair value because of the short
maturity of those instruments. The fair value of the
Company's long-term debt is estimated based on the
quoted market prices for the same or similar issues or on
the current rates offered to the Company for debt of the
same remaining maturities, and is approximately the same
as the carrying value.
34
<PAGE>37
PRICE RANGE OF COMMON STOCK AND DIVIDEND
POLICY
The Company's Common Stock and warrants to purchase Common
Stock are listed on the Nasdaq National Market. As of March 13,
1998, there were 318 holders of record of the Company's Common
Stock.
The high and low bid prices for the Common Stock by quarter for the
past two years are as follows:
Year Ended December 31, 1996
High Low
First Quarter . . . . . . . $6.75 $3.00
Second Quarter . . . . . . . $6.75 $4.88
Third Quarter . . . . . . . . $6.50 $3.75
Fourth Quarter. . . . . . . . $4.12 $2.75
Year Ended December 31, 1997
First Quarter . . . . . . . . $4.13 $2.75
Second Quarter . . . . . . . $4.38 $3.06
Third Quarter . . . . . . . . $4.44 $3.44
Fourth Quarter. . . . . . . . $4.25 $3.00
The information concerning the high and low bid prices is based on
reports the Company received from the Nasdaq National Market.
The Company has not paid dividends on its Common Stock to date.
Management intends to reinvest earnings in the development of its
business and does not anticipate paying Common Stock dividends for
the foreseeable future. The Board of Directors may reevaluate its
policies with respect to the payment of Common Stock dividends in
the future.
Payment of dividends on the Common Stock is subject to certain
limitations under the Company's loan agreements with Metropolitan
and U.S. Bank of California ("U.S. Bank"). In addition, the Senior
Preferred Stock of the Company provides that semi-annual dividends
payable on those shares must be paid in full or set aside for payment
before any dividends are paid on the Common Stock.
35
<PAGE>38
BOARD OF DIRECTORS
John E. Giguiere
Chairman of the Board and
Co-Chief Executive Officer of RHP
Karl E. Giguiere
Vice Chairman of the Board and
Co-Chief Executive Officer of RHP
Lane C. Giguiere
Director and Vice President of RHP
R. Ken Coit
Director and President of
Coit Financial Group
Victor L. Motto
Director and Partner of
Motto, Kryla & Fisher
EXECUTIVE OFFICERS
John E. Giguiere
Chairman of the Board and Co-CEO
Karl E. Giguiere
Vice Chairman of the Board and Co-CEO
Lane C. Giguiere
Director, Vice President
Michael J. Motroni
Chief Financial Officer
Barry L. Bergman
Winemaker
Steven L. Crosta
National Sales Manager
Richard A. Pierce
Controller, Chief Accounting Officer
36
<PAGE>39
[inside back cover]
Announcements
New Tasting & Conference Facility Construction is slated to begin in
May 1998, on new hospitality center. This new tasting room and
conference facility will allow our company to promote its wines on
site and provide a resource for meetings and events that will generate
a new source of income.
Annual Party
The 1998 R.H. Phillips Investor Party is scheduled for Sept.
19. This is a great time of the year to trek out to the Dunnigan
Hills. Everyone will have a chance to see old friends and meet
fellow wine lovers and to taste the freshly pressed '98 vintage. Don't
miss out on this popular annual event. Invitations will be mailed out
in August.
Web Site
Our in-house design team has updated our web site with new
graphics and information sites. This is a great way to find out what's
hot and what's new at R.H. Phillips. We will keep posting
new information on a regular basis, so bookmark
www.rhphillips.com on your internet page.
