WVVI

Business Context and Reporting Period

Company: Willamette Valley Vineyards, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2010
Business Overview: The Company operates in the wine industry with two primary segments: "Produced Wine" (winery operations, retail, and out-of-state sales) and "Bacchus Distribution" (in-state wholesale of produced and purchased wines). The Company is classified as a smaller reporting company.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 5.5% ($240,138) for the three months ended September 30, 2010, compared to the prior year. This was driven by a 12.6% increase in out-of-state distributor sales and a 14.5% increase in direct sales, partially offset by a 9.1% decline in in-state wholesale (Bacchus) sales due to retailer product rotation.
• Margin Compression: Gross profit decreased 7.4% ($158,237) for the quarter. Gross margin percentage dropped from 48.8% to 42.8%. Management attributes this to higher costs for produced wine vintages and an aggressive push to discount aged purchased wine inventory.
• Profitability Decline: Net income for the quarter fell 30.9% to $171,345 from $248,021 in the prior year, despite a 1.8% reduction in selling, general, and administrative (SG&A) expenses.
• Inventory Management: Total inventory decreased by approximately $1.14 million since December 31, 2009, primarily due to a reduction in purchased wine inventory ($747,241 decrease), offset by an increase in produced wine inventory from the record 2009 harvest.
• Debt Reduction: The Company paid down its line of credit entirely, reducing the balance from $140,964 at year-end 2009 to $0 as of September 30, 2010. Total long-term debt decreased to $3,399,442.

Outlook, Risks, and Management Commentary

• Outlook: Management expects gross margins to return to historical levels once the 2009 vintage wines are sold and aged purchased inventory is worked through. The Company believes cash flow from operations and existing credit facilities are sufficient for short and long-term needs.
• Controls and Procedures: Management concluded that disclosure controls and procedures were not effective as of September 30, 2010. A material weakness regarding the allocation of costs to produced wine persists. Remediation efforts, including adding accounting resources, are in progress but not yet fully implemented.
• Risks: Key risks include availability of financing, supply of high-quality grapes, adverse weather conditions, and competition. The Company is also subject to general economic conditions affecting the wine industry.
• Unusual Items: The Company recorded $137,777 in bulk wine sales during the quarter, a new revenue stream not present in the prior year. Additionally, the Company received a $200,000 federal tax refund during the nine-month period.

Investor Verification Checklist

• Cost Allocation Weakness: Verify the progress of remediation for the material weakness in cost allocation for produced wines, as this impacts inventory valuation and COGS accuracy.
• Margin Recovery: Monitor future quarters to confirm if gross margins stabilize as the 2009 vintage enters the sales cycle and aged inventory is cleared.
• Debt Covenants: Confirm continued compliance with the restrictive financial covenants (equity, debt-to-equity, debt coverage) on the $2 million line of credit with Umpqua Bank, maturing June 2011.
• Inventory Turnover: Assess the rate at which the increased produced wine inventory (from the record 2009 harvest) is converted to sales to ensure it does not become obsolete.
• Segment Performance: Track the recovery of the Bacchus Distribution segment, which saw a significant revenue decline due to retailer rotation.