Willamette Valley Vineyards Inc: Form 10-Q for the period ended Sep 30, 2021

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”, “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 or smoke from forest fires, 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, 2020, 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, 2020. Such policies were unchanged during the nine months ended September 30, 2021.

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 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, Domaine Willamette 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, expansion of our operations, and growth in wine club membership. Additionally, the Company’s Preferred Stock sales since August 2015 have resulted in approximately 8,000 new preferred stockholders many of which the Company believes are wine enthusiasts. When considering joint ownership, we believe these new stockholders represent approximately 12,000 current and 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 of production targets, however this is not a significant part of the Company’s activities. The Company had no bulk wine sales for the nine months ended September 30, 2021 and $28,734 in bulk wine sales for the same period of 2020.

The Company sold 145,153 and 130,705 cases of produced wine during the nine months ended September 30, 2021 and 2020, respectively, an increase of 14,448 cases, or 11.1% in the current year period over the prior year period. The increase in wine case sales was primarily the result of increased direct case sales as well as 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 September 30, 2021, wine inventory included 135,129 cases of bottled wine and 326,685 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 173,319 cases during the nine months ended September 30, 2021.

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

The International Wine Report awarded the Company’s 2018 Bernau Block Pinot Noir with 90 points, 2019 Estate Pinot Noir with a 90 points, 2019 Estate Chardonnay with 91 points and Estate Rose of Pinot Noir with 91 points,

The Wine Panel awarded the Company’s 2019 Estate Pinot Noir with 91 points, 2020 Pinot Gris with 93 points and 2019 White Pinot Noir with 90 points,

Wine Press Northwest described the 2020 Whole Cluster Rose of Pinot Noir with a “Unanimously Outstanding!”

The Company’s 2020 Whole Cluster Pinot Noir was featured in an article by Wine Enthusiast called, “In Oregon’s Willamette Valley, Elegant Pinot Noir for Less than $40,” with the wine’s 90 point score included.

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, which may negatively affect our business and operations. Although the administration of vaccines in Oregon and throughout the United States contributed to the lifting of certain restrictive measures, there remains ongoing uncertainty about the impact of COVID-19 variations on infection levels. The re-emergence of significant increases in infection rates could result in governments re-imposing restrictive measures that could reduce or impair economic activity. Consequently, the COVID-19 pandemic and the government responses to the outbreak presents continued 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 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 yet experienced significant disruptions to our supply chain network; however, any future restrictions imposed by our local or state governments may have a negative impact on our future direct to consumer sales. In response to the previous closure of, and capacity restrictions in, our tasting rooms, the Company launched curbside pick-ups, and complimentary shipping specials with minimum purchase, which were able to more than offset 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 could be reduced in the near-term due to the re-imposition of orders from state and local governments 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, and in particular the response to the COVID-19 variants that have emerged, 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 September 30, 2021 and 2020 were $7,641,228 and $6,918,131, respectively, an increase of $723,097, or 10.5%, in the current year period over the prior year period. This increase was caused by an increase in direct sales of $699,172 and an increase in direct sales through distributors of $23,925 in the current year three-month period over the prior year period. The increase in direct sales to consumers was primarily the result of increased revenue from tasting room sales, phone sales and wine club sales. Sales revenue for the nine months ended September 30, 2021 and 2020 were $22,356,517 and $19,008,680, respectively, an increase of $3,347,837, or 17.6%, in the current year period over the prior year period. This increase was mainly caused by an increase in revenues from direct sales of $2,000,026 and an increase in revenues from sales through distributors of $1,347,811 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, wine club 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 September 30, 2021 and 2020 were $3,179,590 and $2,696,934, respectively, an increase of $482,656, or 17.9%, in the current period over the prior year period. This change was primarily the result of an increase in sales and the mix of vintages sold in 2021. Cost of Sales for the nine months ended September 30, 2021 and 2020 were $9,261,589 and $7,373,909, respectively, an increase of $1,887,680 or 25.6%, in the current period over the prior year period. This change was primarily the result of an increase in sales in 2021 and the mix of sales channels and vintages sold between the two periods.

Gross Profit

Gross profit as a percentage of net sales for the three months ended September 30, 2021 and 2020 was 58.4% and 61.0%, respectively, a decrease of 2.6 percentage points in the current year period over the prior year period mostly as a result of higher cost vintages produced in 2020 that were sold in 2021. Gross profit as a percentage of net sales for the nine months ended September 30, 2021 and 2020 was 58.6% and 61.2%, respectively, a decrease of 2.6 percentage points in the current year period over the prior year period. This decrease was primarily the result of higher cost vintages produced in 2020 and sold in 2021 combined with the mix of products sold in the period.

Selling, General and Administrative Expenses

Selling, general and administrative expense for the three months ended September 30, 2021 and 2020 was $3,768,765 and $2,917,363 respectively, an increase of $851,402, or 29.2%, in the current quarter over the same quarter in the prior year. This increase was primarily the result of an increase in selling expenses of $459,168, or 24.5% and an increase in general and administrative expenses of $392,234, or 37.7% in the current quarter compared to the same quarter last year. Selling, general and administrative expense for the nine months ended September 30, 2021 and 2020 was $10,688,452 and $8,302,825, respectively, an increase of $2,385,627, or 28.7%, in the current year period over the prior year period. This increase was primarily the result of an increase in selling expenses of $1,448,919, or 27.7% and an increase in general and administrative expenses of $936,708, or 30.6% in the current year period compared to the same period in 2020. Selling expenses increased in both the third quarter and nine months of 2021 compared to the same periods in 2020 primarily as a result of our tasting rooms being open for more days in 2021 compared to 2020 resulting in higher labor and related costs associated with operating the tasting rooms. General and administrative expenses increased in the third quarter of 2021 compared to the same quarter of 2020 primarily a result of more maintenance costs and professional fees and increased for the nine months ended September 30, 2021 compared to the same period in 2020, primarily as a result of increased maintenance and compensation related costs compared to the same period in 2020.

Interest Expense

Interest expense for the three months ended September 30, 2021 and 2020 was $96,473 and $103,283, respectively, a decrease of $6,810 or 6.6%, in the third quarter of 2021 over the same quarter in the prior year. Interest expense for the nine months ended September 30, 2021 and 2020 was $293,548 and $314,158, respectively, a decrease of $20,610 or 6.6%, in the current year period over the prior year period. The decrease in interest expense for the third quarter and nine months of 2021 compared to the same periods in 2020 was primarily the result of decreased debt in the current period compared to the third quarter and nine months of 2020.

Income Taxes

The income tax expense for the three months ended September 30, 2021 and 2020 was $172,256 and $343,464, respectively, a decrease of $171,208 or 49.8%, in the third quarter of 2021 compared to the same quarter in the prior year as a result of lower pre-tax income in the third quarter of 2021, compared to the same quarter in 2020. The Company’s estimated federal and state combined income tax rate was 27.4% and 27.7% for the three months ended September 30, 2021 and 2020, respectively. The income tax expense for the nine months ended September 30, 2021 and 2020 was $624,839 and $869,230, respectively, a decrease of $244,391 or 28.1%, in the current year period over the prior year period mostly a result of lower pre-tax income in the first nine months of 2021, compared to the same period in 2020. The Company’s estimated federal and state combined income tax rate was 27.4% for both the nine months ended September 30, 2021 and 2020, respectively.

Net Income

Net income for the three months ended September 30, 2021 and 2020 was $456,191 and $896,799, respectively, a decrease of $440,608, or 49.1%, in the third quarter of 2021 over the same quarter in the prior year. Net income for the nine months ended September 30, 2021 and 2020 was $1,656,427 and $2,304,302, respectively, a decrease of $647,875, or 28.1%, in the current year period over the prior year period. The decrease in net income for the third quarter and nine months of 2021, compared to the comparable periods in 2020, was primarily the result higher gross profits in 2021 being more than offset by increased operating expenses mostly as a result of increased costs associated with our tasting rooms being open for more days in 2021 compared to 2020.

Income Applicable to Common Shareholders

Income applicable to common shareholders for the three months ended September 30, 2021 and 2020 was $95,120 and $640,347, respectively, a decrease of $545,227, or 85.1%, in the third quarter of 2021 over the same quarter in the prior year. Income applicable to common shareholders for the nine months ended September 30, 2021 and 2020 was $573,214 and $1,534,946, respectively, a decrease of $961,732, or 62.7%, in the current year period over the prior year period. The decrease in income applicable to common shareholders in the third quarter and nine months of 2021, compared to the same periods of 2020, was the result of lower net income and higher dividend costs associated with the increased number of shares of Preferred Stock in the current periods compared to the same periods in 2020.

Liquidity and Capital Resources

At September 30, 2021, the Company had a working capital balance of $23.9 million and a current working capital ratio of 3.25:1.

At September 30, 2021, the Company had a cash balance of $13,891,696. At December 31, 2020, the Company had a cash balance of $13,999,755. This decrease is primarily the result of cash used in construction activities being partially offset with the proceeds from Preferred Stock subscriptions. The construction of a new tasting room and winery in Dundee, Oregon is expected to cost approximately $15.6 million, which will be funded through a combination of cash on hand as well as equity financing through Preferred Stock offerings. Construction began in July 2019 and was paused in March 2020 as a result of the uncertainty surrounding the COVID-19 pandemic and has now been restarted. As of September 30, 2021, we had incurred approximately $8.7 million on the project.

Total cash generated from operating activities in the nine months ended September 30, 2021 was $3,770,784. Cash from operating activities for the nine months ended September 30, 2021 was primarily associated with net income, reduced receivables, increased grapes payable and income tax receivable, being partially offset by increased inventory and a reduction in accrued expenses.

Total cash used in investing activities in the nine months ended September 30, 2021 was $6,867,420. Cash used in investing activities for the nine months ended September 30, 2021 primarily consisted of cash used on construction activity and vineyard development costs.

Total cash generated from financing activities in the nine months ended September 30, 2021 was $2,988,577. Cash generated from financing activities for the nine months ended September 30, 2021 primarily consisted of proceeds from investor deposits related to the Preferred Stock offering as well as the issuance of Preferred Stock, being partially offset by the repayment of debt.

In December of 2005, the Company entered into a revolving line of credit agreement with Umpqua Bank that allows borrowing up to $2,000,000 against eligible accounts receivable and inventories, as defined in the agreement at July 29, 2021. The revolving line bears interest at prime less 0.5%, with a floor of 3.25%, is payable monthly, and is subject to renewal. In July 2021, the Company renewed the credit agreement until July 31, 2023. At September 30, 2021 and December 31, 2020, there was no outstanding balance on this revolving line of credit.

As of September 30, 2021, the Company had a 15-year installment note payable of $1,318,301, due in quarterly payments of $42,534, associated with the purchase of property in the Dundee Hills AVA.

As of September 30, 2021, the Company had a total long-term debt balance of $5,649,703, including the portion due in the next year, owed to Farm Credit Services, exclusive of debt issuance costs of $135,796. As of December 31, 2020, the Company had a total long-term debt balance of $5,984,272, exclusive of debt issuance costs of $145,731.

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 September 30, 2021, and December 31, 2020, 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 September 30, 2021 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, 2020, which could materially affect our business, results of operations or financial condition.

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, impact our results of operations or financial condition.