Willamette Valley Vineyards Inc: Form 10-Q for the period ended Jun 30, 2020

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As used in this Quarterly Report on Form 10-Q, “we,” “us,” “our” and “the Company” refer to Willamette Valley Vineyards, Inc.

Forward Looking Statements

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Form 10-Q contain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that are based on current expectations, estimates and projections about the Company’s business, and beliefs and assumptions made by management. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” “intends,” “plans,” “predicts,” “potential,” “should,” or “will” or the negative thereof and variations of such words and similar expressions are intended to identify such forward-looking statements. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements due to numerous factors, including, but not limited to: availability of financing for growth, availability of adequate supply of high quality grapes, successful performance of internal operations, impact of competition, changes in wine broker or distributor relations or performance, impact of possible adverse weather conditions, impact of reduction in grape quality or supply due to disease, changes in consumer spending, the reduction in consumer demand for premium wines and the impact of the COVID-19 pandemic and the policies of United States federal, state and local governments in response to such pandemic. In addition, such statements could be affected by general industry and market conditions and growth rates, and general domestic economic conditions. Many of these risks as well as other risks that may have a material adverse impact on our operations and business, are identified in Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, as well as in the Company’s other Securities and Exchange Commission filings and reports. The forward-looking statements in this report are made as of the date hereof, and, except as otherwise required by law, the Company disclaims any intention or obligation to update or revise any forward-looking statements or to update the reasons why the actual results could differ materially from those projected in the forward-looking statements, whether as a result of new information, future events or otherwise.

Critical Accounting Policies

The foregoing discussion and analysis of the Company’s financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires the Company’s management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, collection of accounts receivable, valuation of inventories, and amortization of vineyard development costs. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. A description of the Company’s critical accounting policies and related judgments and estimates that affect the preparation of the Company’s financial statements is set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. Such policies were unchanged during the six months ended June 30, 2020.

Overview

The Company, one of the largest wine producers in Oregon by volume, believes its success is dependent upon its ability to: (1) grow and purchase high quality vinifera wine grapes; (2) vinify the grapes into premium, super premium and ultra-premium wine; (3) achieve significant brand recognition for its wines, first in Oregon and then nationally and internationally; (4) effectively distribute and sell its products nationally; and (5) continue to build on its base of direct to consumer sales.

The Company’s goal is to continue to build on a reputation for producing some of Oregon’s finest, most sought-after wines. The Company has focused on positioning itself for strategic growth through property purchases, property development and issuance of the Company’s Series A Redeemable Preferred Stock (the “Preferred Stock”). Management expects near term financial results to be negatively impacted by these activities as a result of incurring costs of accrued preferred stock dividends, strategic planning and development costs and other growth associated costs.

The Company’s wines are made from grapes grown in vineyards owned, leased or contracted by the Company, and from grapes purchased from other nearby vineyards. The grapes are harvested, fermented and made into wine primarily at the Company’s winery in Turner Oregon (the “Winery”) and the wines are sold principally under the Company’s Willamette Valley Vineyards label, but also under the Griffin Creek, Pambrun, Elton, Maison Bleue, Metis, Natoma, Elton and Tualatin Estates labels. The Company also owns the Tualatin Estate Vineyards and Winery, located near Forest Grove, Oregon. The Company generates revenues from the sales of wine to wholesalers and direct to consumers.

Direct to consumer sales primarily include sales through the Company’s tasting rooms, telephone, internet and wine club. Direct to consumer sales are at a higher unit price than sales through distributors due to prices received being closer to retail than those prices paid by wholesalers. The Company continues to emphasize growth in direct to consumer sales through the Company’s 35,642 square foot hospitality facility at the Winery and expansion and growth in wine club membership. Additionally, the Company’s preferred stock sales since August 2015 have resulted in approximately 5,738 new preferred stockholders many of which the Company believes are wine enthusiasts. When considering joint ownership, we believe these new stockholders represent approximately 9,000 potential customers of the Company.

Periodically, the Company will sell grapes or bulk wine, due to them not meeting Company standards or being in excess to production targets, however this is not a significant part of the Company’s activities. The Company had no bulk wine sales the three months ended June 30, 2020 and $2,800 in bulk wine sales for the same period of 2019. The Company had bulk wine sales of $28,734 for the six months ended June 30, 2020 and $45,563 in bulk wine sales for the same period of 2019.

The Company sold approximately 83,435 and 70,048 cases of produced wine during the six months ended June 30, 2020 and 2019, respectively, an increase of 13,387 cases, or 19.1% in the current year period over the prior year period. The increase in wine case sales was primarily the result of increased case sales through distributors.

Cost of sales includes grape costs, whether purchased or grown at Company vineyards, winemaking and processing costs, bottling, packaging, warehousing, and shipping and handling costs. For grapes grown at Company vineyards, costs include farming expenditures and amortization of vineyard development costs.

At June 30, 2020, wine inventory included approximately 156,657 cases of bottled wine and 258,299 gallons of bulk wine in various stages of the aging process. Case wine is expected to be sold over the next 12 to 24 months and generally before the release date of the next vintage. The Winery bottled approximately 103,893 cases during the six months ended June 30, 2020.

​Willamette Valley Vineyards continues to receive positive recognition through national magazines, regional publications, local newspapers and online bloggers.

Wine Enthusiast awarded the Company’s 2018 White Pinot Noir with 92 points and Editors’ Choice, 2017 Dijon Clone Chardonnay with 91 points and Editors’ Choice, 2019 Whole Cluster Pinot Noir with 91 points and Editors’ Choice, 2017 Vintage 44 Pinot Noir with 90 points, 2018 Estate Chardonnay with 90 points, 2019 Estate Rosé of Pinot Noir with 90 points and 2019 Whole Cluster Rosé of Pinot Noir with 90 points and Editors’ Choice.

The Company’s 2019 Whole Cluster Rosé of Pinot Noir was awarded a Double Gold medal and received a score of 96 points at The Sunset International Wine Competition.

The Company’s 2018 Whole Cluster Pinot Noir was awarded 92 points and the 2017 Estate Pinot Noir was awarded 90 points from Wine.com.

Wine Advocate awarded the Company’s 2016 Fuller Pinot Noir with 90 points and the Elton Florine Pinot Noir, a boutique wine brand from the Eola-Amity Hills AVA, with 90 points.

Forbes included the Company’s Whole Cluster Rosé of Pinot Noir in the article, “Oregon’s Willamette Valley Makes Rosé like no Place Else on Earth.”

The Wall Street Journal featured the Company’s Pinot Gris and quoted its Winemaker Joe Ibrahim in the article, “The Best Wines to Drink with Salmon.”

The Company’s 2018 Whole Cluster Pinot Noir was included in the Prevention Magazine article titled, "10 Best Red Wines Made in the United States to Buy in 2020."

Forbes featured a Question and Answer with the Company’s Founder/CEO Jim Bernau about the preferred stock offering and other financial successes in the article entitled, “Willamette Valley Vineyards: How An Innovative Financial Strategy Fuels Dramatic Growth.”

The Company’s ultraviolet light filtration technology installed in its HVAC system to reduce harmful microorganisms was featured in The Oregonian, Wine Business Monthly, Capital Press, The Corvallis Advocate, KPTV Fox Channel 12 (Fox-affiliated television) and KATU Channel 2 (ABC-affiliated television station).

The Company’s Tualatin Estate Vineyard founded in 1973 was included in more than 30 articles about the new Tualatin Hills sub-AVA of the Willamette Valley, including The Hour, The Oregonian, Times Union and San Antonio Express-News, as well as a KOIN Newschannel 6 (Portland CBS-affiliate television station) broadcast.

Bernau Estate, the Company’s méthode champenoise sparkling wine facility with a biodynamically-farmed vineyard, planned to open in 2022 in the Dundee Hills, was in a feature article with photographs in The Oregonian. The article also touched on the preferred stock offering funding method for the project.

Willamette Wineworks, the Company’s first microwinery outpost featuring wine tasting, food pairings and a barrel blending system to create custom wine blends was featured in Sacramento Business Journal, Gold Country Media, Capital Public Radio News and an on-air interview

Impact of COVID-19 on Operations

The COVID-19 pandemic has been declared a National Public Health Emergency in the United States, and on March 8, 2020, Oregon Governor Kate Brown declared a state of emergency to address the spread of COVID-19 in Oregon. The outbreak in Oregon and other parts of the United States, as well as the response to COVID-19 by federal, state and local governments could have a continued material adverse impact on economic and market conditions in the United States, and likely will negatively affect our business and operations. The COVID-19 pandemic and the government responses to the outbreak presents uncertainty and risk with respect to the Company and its performance and financial results.

With the exception of key operations personnel, we have shifted our office staff to remote workstations, and we expect we will continue to operate remotely until state and local government shelter-in-place orders have been lifted and management determines it is safe for employees to return to offices. Far exceeding the required Oregon Healthy Authority protocols, a new state-of-the-art UV light filtration has been installed in the Company’s HVAC system to reduce harmful viruses in the air at its tasting room locations and staff offices.

We have not experienced significant disruptions to our supply chain network, however with orders imposed by the local state government, we expect a negative impact on our direct to consumer sales. In response to the closing of our tasting rooms and other restrictions, the Company launched curbside pick-ups, complimentary shipping specials with minimum purchase and a new wine delivery service for locals, which we are hopeful will mitigate some of the expected declines in direct to consumer sales.

Additionally, the demand for the Company’s wine sold directly or through distributors to restaurants, bars, and other hospitality locations will likely be significantly reduced in the near-term due to orders restricting consumers from visiting, as well as in some cases the temporary closure of such establishments.

The extent of the impact of the COVID-19 pandemic on the Company’s business is highly uncertain and difficult to predict, as the response to the pandemic is continuing to evolve. The severity of the impact of the COVID-19 pandemic on the Company’s business will depend on a number of factors, including, but not limited to, the duration and severity of the pandemic and the extent and severity of the impact on the Company’s customers, all of which are uncertain and cannot be predicted.

RESULTS OF OPERATIONS

Revenue

Sales revenue for the three months ended June 30, 2020 and 2019 were $5,568,654 and $5,790,837, respectively, a decrease of $222,183, or 3.8%, in the current year period over the prior year period. This decrease was mainly caused by a decrease in direct sales of $156,802 and a decrease in sales through distributors of $65,381 in the current year three-month period over the prior year period. The decrease in direct sales to consumers was primarily the result of retail sales decreases in tasting room revenue, hospitality and kitchen sales mostly due to the temporary closure and restrictions on the operation of our tasting rooms resulting from the COVID-19 pandemic. The decrease in revenue from sales through distributors was primarily attributed to lower sales to the on-premise market as many of these establishments have been closed or had other restrictions placed on them due to the COVID-19 pandemic. Sales revenue for the six months ended June 30, 2020 and 2019 were $12,090,549 and $10,789,623, respectively, an increase of $1,300,926, or 12.1%, in the current year period over the prior year period. This increase was mainly caused by an increase in revenues from direct sales of $75,332 and an increase in revenues from sales through distributors of $1,225,594 in the current year period over the prior year period. The increase in revenues from direct sales to consumers was primarily the result of increased phone sales and internet sales. The increase in sales through distributors was primarily the result of an increase in off-premise sales.

Cost of Sales

Cost of Sales for the three months ended June 30, 2020 and 2019 were $2,067,122 and $2,292,479, respectively, a decrease of $225,357, or 9.8%, in the current period over the prior year period. This change was primarily the result of an increase in sales and the vintages sold in 2020. Cost of Sales for the six months ended June 30, 2020 and 2019 were $4,676,975 and $4,010,629, respectively, an increase of $666,346, or 16.6%, in the current period over the prior year period. This change was primarily the result of an increase in sales in 2020.

Gross Profit

Gross profit for the three months ended June 30, 2020 and 2019 was $3,501,532 and $3,498,358, respectively, an increase of $3,174, or 0.1%, in the second quarter of 2020 over the same quarter in the prior year. Gross profit for the six months ended June 30, 2020 and 2019 was $7,413,574 and $6,778,994, respectively, an increase of $634,580, or 9.4%, in the current year period over the prior year period. This increase was primarily the result of an increase in case sales over the first six months of the current year compared to the same period in 2019.

Gross profit as a percentage of net sales for the three months ended June 30, 2020 and 2019 was 62.9% and 60.4%, respectively, an increase of 2.5 percentage points in the current year period over the prior year period. Gross profit as a percentage of net sales for the six months ended June 30, 2020 and 2019 was 61.3% and 62.8%, respectively, a decrease of 1.5 percentage points in the current year period over the prior year period. This decrease was primarily the result of more sales coming from distribution sales which have a lower selling price.

Selling, General and Administrative Expenses

Selling, general and administrative expense for the three months ended June 30, 2020 and 2019 was $2,555,958 and $2,901,927 respectively, a decrease of $345,969, or 11.9%, in the current quarter over the same quarter in the prior year. This decrease was primarily the result of a decrease in selling expenses of $292,588, or 15.3% and a decrease in general and administrative expenses of $53,381, or 5.4% in the current quarter compared to the same quarter last year. Selling, general and administrative expense for the six months ended June 30, 2020 and 2019 was $5,385,462 and $5,618,125, respectively, a decrease of $232,663, or 4.1%, in the current year period over the prior year period. This decrease was primarily the result of a decrease in selling expenses of $319,548, or 8.7% being partially offset by an increase in general and administrative expenses of $86,885, or 4.5% in the current year period compared to the same period in 2019. Selling expenses decreased in both the first half and second quarter of 2020 compared to the same periods in 2019 primarily as a result of more sales coming from distributors which have lower selling costs, combined with reduced travel and the temporary closure of tasting rooms as a result of the Covid-19 pandemic. General and administrative expenses decreased in the second quarter primarily a result of less contract labor and professional fees and increased for the six months ended June 30, 2020 primarily as a result of increased insurance and compensation related costs compared to the same period in 2019.

Interest Expense

Interest expense for the three months ended June 30, 2020 and 2019 was $105,133 and $111,088, respectively, a decrease of $5,955 or 5.4%, in the second quarter of 2020 over the same quarter in the prior year. Interest expense for the six months ended June 30, 2020 and 2019 was $210,875 and $221,502, respectively, a decrease of $10,627 or 4.8%, in the current year period over the prior year period. The decrease in interest expense for the second quarter and first six months of 2020 was primarily the result of decreased debt compared to the second quarter and first six months of 2019.

Income Taxes

The income tax expense for the three months ended June 30, 2020 and 2019 was $231,533 and $134,363, respectively, an increase of $97,170 or 72.3%, in the second quarter of 2020 over the same quarter in the prior year mostly as a result of higher pre-tax income in the second quarter of 2020, compared to the same quarter in 2019. The Company’s estimated federal and state combined income tax rate was 27.2% for the three months ended June 30, 2020 and 2019. The income tax expense for the six months ended June 30, 2020 and 2019 was $525,766 and $284,366, respectively, an increase of $241,400 or 84.9%, in the current year period over the prior year period mostly a result of higher pre-tax income in the first six months of 2020, compared to the same period in 2019. The Company’s estimated federal and state combined income tax rate was 27.2% and 26.6% for the three months ended June 30, 2020 and 2019, respectively.

Net Income

Net income for the three months ended June 30, 2020 and 2019 was $620,421 and $359,911, respectively, an increase of $260,510, or 72.4%, in the second quarter of 2020 over the same quarter in the prior year. Net income for the six months ended June 30, 2020 and 2019 was $1,407,503 and $786,387, respectively, an increase of $621,116, or 79.0%, in the current year period over the prior year period. The increase in net income for the second quarter and first half of 2020, compared to the comparable periods in 2019, was primarily the result of increased gross profits in addition to lower selling, general and administrative expenses.

Income Applicable to Common Shareholders

Income applicable to common shareholders for the three months ended June 30, 2020 and 2019 was $363,969 and $103,459, respectively, an increase of $260,510, or 251.8%, in the second quarter of 2020 over the same quarter in the prior year. Income applicable to common shareholders for the six months ended June 30, 2020 and 2019 was $894,599 and $273,483, respectively, an increase of $621,116, or 227.1%, in the current year period over the prior year period. The increase in income applicable to common shareholders in the second quarter and first six months of 2020, compared to the same periods of 2019, was the result of higher net income in the current periods.

Liquidity and Capital Resources

At June 30, 2020, the Company had a working capital balance of $20.0 million and a current working capital ratio of 4.92:1.

At June 30, 2020, the Company had a cash balance of $5,903,587. At December 31, 2019, the Company had a cash balance of $7,050,176. This decrease is primarily the result of increased cash used in investing activities primarily on the construction of a new tasting room in Dundee, Oregon. The total construction costs for the project is expected to be approximately $13.5 million, which we expect will be funded through a combination of cash on hand as well as equity financing through the current preferred stock offering. Construction began in July 2019 and was paused in March 2020 as a result of the uncertainty on the impact of the COVID-19 pandemic on the Company’s business. As of June 30, 2020, we had incurred approximately $4.6 million on the project.

Total cash generated from operating activities in the six months ended June 30, 2020 was $1,776,123. Cash generated in operating activities for the six months ended June 30, 2020 was primarily associated with cash received from increased net income, reduced inventory and income taxes receivable, being partially offset by cash used in connection with an increase in accounts receivable and a decrease in grapes payables.

Total cash used in investing activities in the six months ended June 30, 2020 was $3,058,607. Cash used in investing activities for the six months ended June 30, 2020 primarily consisted of cash used on construction activity on a new tasting room and vineyard development costs.

Total cash generated from financing activities in the six months ended June 30, 2020 was $135,895. Cash generated from financing activities for the six months ended June 30, 2020 primarily consisted proceeds from investor deposits, being partially offset by the repayment of debt.

The Company has an asset-based loan agreement (the “line of credit”) with Umpqua Bank that allows it to borrow up to $2,000,000. The Company renewed this agreement, in July 2019, until July 2021. The interest rate is prime less 0.5%, with a floor of 3.25%. The loan agreement contains certain restrictive financial covenants with respect to total equity, debt-to-equity and debt coverage that must be maintained by the Company on a quarterly basis. As of June 30, 2020, the Company was in compliance with all of the financial covenants.

As of June 30, 2020 and December 31, 2019, the Company had no balance outstanding on the line of credit.

As of June 30, 2020 the Company had a 15-year installment note payable of $1,427,151, due in quarterly payments of $42,534, associated with the purchase of property in the Dundee Hills AVA.

As of June 30, 2020, the Company had a total long-term debt balance of $6,207,114, including the portion due in the next year, owed to Farm Credit Services and Toyota Credit Corporation, exclusive of debt issuance costs of $152,354. As of December 31, 2019, the Company had a total long-term debt balance of $6,423,517, exclusive of debt issuance costs of $158,978.

The Company qualified and obtained a PPP loan for $1.655 million, but quickly returned the funds after obtaining a $5 million commercial loan commitment from Farm Credit Services, which is intended to provide the Company with additional liquidity in the event the Company was to experience operating losses from sales disruptions due to the COVID-19 pandemic. This Commitment came into effect in July 2020 and as of the filing date the Company has not drawn down any funds on this commitment.

The Company believes that cash flow from operations and funds available under the Company’s existing credit facilities will be sufficient to meet the Company’s short-term needs. Due to the uncertainty surrounding the future impact of the COVID-19 pandemic on the Company we will continue to evaluate funding mechanisms to support our long-term funding requirements.

Off Balance Sheet Arrangements

As of June 30, 2020 and December 31, 2019, the Company had no off-balance sheet arrangements.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a smaller reporting company, the Company is not required to provide the information required by this item.

CONTROLS AND PROCEDURES

Disclosure Controls and Procedures – The Company carried out an evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to paragraph (b) of Rule 13a-15 and 15d-5 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that review, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective, as of the end of the period covered by this report, to ensure that information required to be disclosed by the Company in the reports the Company files or submit under the Exchange Act (1) is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting – There have been no changes in our internal control over financial reporting during the quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (the “2019 Annual Report”), which could materially affect our business, results of operations or financial condition. The risk factor below updates the risk factors contained in our 2019 Annual Report,

The COVID-19 pandemic could adversely affect our financial results, operations and outlook for an extended period of time.

The COVID-19 pandemic and restrictions imposed by federal, state and local governments in response to the outbreak have disrupted and will continue to disrupt our business. In the State of Oregon where we operate the Winery and most of our vineyards, individuals are being encouraged to practice social distancing, are restricted from gathering in groups and, in some areas, are mandated to stay home except for essential activities. In response to the COVID-19 pandemic and government restrictions, we have at various times closed our tasting rooms and have launched curbside pick-ups and complimentary shipping specials with minimum purchase. We expect the ongoing restrictions and the sudden increase in unemployment caused by the closure of businesses in response to the COVID-19 pandemic to adversely affect our sales revenues, which adversely impacts our liquidity, financial condition, and results of operations. Even after stay-at-home orders are loosened or lifted, the impact of lost wages due to COVID-19 related unemployment may dampen consumer spending for some time in the future.

Our operations could be further disrupted if a significant number of our employees are unable or unwilling to work, whether because of illness, quarantine, restrictions on travel or fear of contracting COVID-19, which could further materially adversely affect our liquidity, financial position and results of operations. To support our employees and protect the health and safety of our employees and our customers, we may offer enhanced health and welfare benefits, provide bonuses to our employees, and purchase additional sanitation supplies and personal protective materials. These measures will likely increase our operating costs and adversely affect our liquidity.

The COVID-19 pandemic may also adversely affect the ability of our grape suppliers to fulfill their obligations to us, which may negatively affect our operations. If our suppliers are unable to fulfill their obligation to us, we could face shortages of grapes, and our operations and sales could be adversely impacted.

We have also modified our plans for expanding our operations due to the COVID-19 pandemic. To preserve our liquidity, we have delayed some planned capital expenditures. These changes may adversely affect our ability to grow our business, particularly if these projects are delayed for a significant amount of time.

We cannot predict how long the COVID-19 pandemic will last or if it will recur, if new government restrictions and mandates will be imposed or how long they will be effective, or how quickly, if at all, our customers will return to their pre-COVID-19 purchasing behaviors, so we cannot predict how long our results of operations and financial performance will be adversely impacted.

The COVID-19 pandemic may also have the effect of heightening other risks disclosed in the Risk Factors section included in our 2019 Annual Report, such as, but not limited to, those related to cybersecurity threats, consumer behavior, supply chain interruptions and labor availability and cost.

Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may eventually prove to materially adversely affect our business, results of operations or financial condition.