WILLAMETTE VALLEY VINEYARDS INC annual report, FY2012

Business context and reporting period

Willamette Valley Vineyards, Inc. produces and sells premium, super-premium and ultra-premium Oregon wines, led by Pinot Noir. This Form 10-K reports on the fiscal year ended December 31, 2012; comparative figures are for 2011. The company sells through winery and wine-club direct sales and independent distributors. In June 2012, it completed the wind-down of its Bacchus Oregon distribution business and shifted distribution of its own Oregon wines to an independent distributor.

Financial results and key metrics

Fourth-quarter 2012 unaudited results: revenue of $3.797 million, gross profit of $2.170 million, operating income of $680,000, continuing-operations income of $517,000, net income of $530,000, and basic and diluted EPS of $0.10. Quarterly figures are reported in thousands and may not precisely equal annual amounts because of rounding.

At year-end, cash was $4.55 million, working capital was $12.9 million, and the current ratio was 6.43:1, versus 8.11:1 in 2011. Long-term debt was $4.03 million, including $209,327 current; the $2.0 million revolving credit line had no outstanding balance. The company reported $2.56 million of operating cash flow from continuing operations, $1.73 million used in investing, and $495,387 used in financing. Contractual obligations totaled $7.52 million, including debt, grape payables and operating leases.

Changes versus the prior year

• Revenue increased 2.4%, mainly from higher retail/direct sales; out-of-state distributor sales fell 5.5%.
• Gross margin improved 1.1 percentage points, attributed to lower distributor depletion incentives and a higher share of direct-to-consumer sales.
• Operating income declined 9.2% as selling, general and administrative expense rose 11.6%, partly reflecting costs no longer shared with the discontinued distribution unit.
• Total net income rose 40.2%, principally because the after-tax loss from discontinued operations fell to $157,385 from $574,976. Bacchus’ 2012 pretax loss was $242,878, compared with $919,961 in 2011.
• Direct sales grew to 27.0% of continuing-operations revenue from 23.9%; one distributor accounted for 18.6% of total 2012 revenue, compared with no customer above 10% in 2011.

Outlook, management commentary and risks

Management reported first-two-month 2013 sales up 3.2% year over year: direct-to-consumer sales increased 19.3%, in-state sales decreased 13.2%, and out-of-state sales increased 2.1%. It planned to bottle approximately 93,000 cases in 2013, versus 91,181 cases produced in 2012. Management said inventory was sufficient for current demand until the 2013 vintage became available, while noting lower 2012 crop yields and reduced planned production for some varieties.

In December 2012, the board approved up to $4.5 million for a Hospitality Center remodel and expansion, intended to support direct sales. Construction began in February 2013 and was expected to finish by year-end. A subsequent $2.0 million Farm Credit Services construction loan was arranged in March 2013 at 4.75%, with estimated monthly payments of approximately $15,500 over 15 years; the remaining project cost was expected to use cash reserves. Management believed operating cash flow and available credit would meet foreseeable needs. The bank line was due for renewal in June 2013; the company said it was covenant-compliant at year-end.

Key risks include weather, pests and disease affecting grape supply and quality; phylloxera at Tualatin and leased vineyards (not detected at the Turner site); dependence on outside grape purchases; distributor and customer concentration; intense competition and changing consumer demand; and potential increases in alcohol taxes or regulation. The company reported no material pending legal proceedings. Its financial statements received an unqualified independent audit opinion; management concluded disclosure controls and internal control over financial reporting were effective, although the auditor did not provide an internal-control audit opinion.

Investor verification priorities

• Verify the cover-page response marked “No” to whether the company filed all required reports during the preceding 12 months, including any filing-history implications.
• Reconcile income-tax figures: MD&A cites a $653,941 provision, while the income statement reports $739,434 for continuing operations and the tax note reports $653,941 as total provision.
• Assess distributor concentration and the sustainability of distributor sales, gross margins and direct-sales growth following the Bacchus wind-down.
• Review the Hospitality Center project’s final cost, funding, completion and expected returns, alongside the June 2013 credit-line renewal and debt covenants.
• Monitor grape availability, the effects of the 2012 harvest, phylloxera exposure, inventory levels and the company’s ability to meet demand without relying excessively on purchased grapes.