WVVI

Business Context and Reporting Period

Company: Willamette Valley Vineyards, Inc. (WVV)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2010
Business Overview: WVV is an Oregon-based producer and distributor of premium, super premium, and ultra premium wines, primarily Pinot Noir, Chardonnay, Pinot Gris, and Riesling. The company operates under three labels: Willamette Valley Vineyards, Tualatin Estate Vineyards, and Griffin Creek. It utilizes a hybrid distribution model comprising direct-to-consumer sales at its Turner, Oregon winery, self-distribution within Oregon (Bacchus Fine Wines), and independent distributors for out-of-state and export markets.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenue increased 4.9% to $17.4 million, driven by a 12.6% increase in retail sales and a 9.4% increase in out-of-state sales. However, in-state wholesale sales of company-branded wine decreased 21.1%.
• Profitability Decline: Net income decreased 43.7% to $411,808. This was primarily due to a 24.2% drop in operating income, caused by increased production costs (reducing gross margin) and a 3.7% increase in selling, general, and administrative (SG&A) expenses.
• Margin Compression: Gross margin percentage declined from 46.6% in 2009 to 44.3% in 2010. The margin on produced wine specifically dropped from 54.0% to 49.7% due to higher grape and production costs.
• Liquidity Improvement: Cash flow from operating activities turned positive, providing $3.0 million in 2010 compared to a use of $1.2 million in 2009. This shift was largely due to a reduction in inventory levels ($1.5 million decrease in inventory value).
• Debt Reduction: The company paid down its revolving line of credit to zero and reduced total long-term debt by approximately $460,000.

Outlook, Risks, and Management Commentary

• First Quarter 2011 Outlook: Management reported sales for the first two months of 2011 were up 17.4% year-over-year. National sales were up 23.5%, attributed to distributors purchasing in advance of price increases.
• Production Constraints: The 2010 harvest yield was approximately 50% lower than the prior year due to agricultural conditions. The company expects the 2010 vintage to produce approximately 72,000 cases.
• Key Risks:
  • Agricultural: Susceptibility to phylloxera (present at Tualatin Estate, not detected at Turner), Pierce's Disease, and weather variability affecting grape quality and quantity.
  • Supply Chain: Reliance on contracted growers and purchased grapes; inability to secure sufficient high-quality fruit could increase costs.
  • Market: Intense competition from larger California wineries and imported wines; potential for increased excise taxes.
  • Financial: Dependence on credit facilities for operations; thin trading volume of common stock limits liquidity for shareholders.
• Internal Controls: Management remediated a material weakness in inventory costing and control identified in 2009 by implementing new tracking spreadsheets and control procedures.

Investor Verification Checklist

• Inventory Valuation: Verify the accuracy of the $10.7 million inventory balance and the assumptions used for the lower-of-cost-or-market valuation, given the significant reduction in inventory levels.
• Grape Supply Contracts: Review the terms of the long-term grape purchase agreements (fixed prices through 2015/2016) to assess exposure to price volatility and the $1.5 million annual maximum payment obligation.
• Debt Covenants: Confirm continued compliance with financial covenants (tangible net worth, debt-to-equity, debt service coverage) required by Umpqua Bank and NW Farm Credit Services.
• Phylloxera Status: Monitor the status of phylloxera at the Turner site, as infestation could materially impact the value of the estate vineyard assets.
• Revenue Mix: Analyze the sustainability of the shift toward higher-margin direct retail sales versus the decline in in-state wholesale branded wine sales.