UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS INDEX Page Unaudited Consolidated Balance Sheets as of August 31, 2017 and 2016......... 4 Unaudited Consolidated Statements of Operations for the Six Months Ended August 31, 2017 and 2016............. 5 Unaudited Consolidated Statement of Stockholders Equity for the Six Months Ended August 31, 2017..... 6 Unaudited Consolidated Statements of Cash Flows for the Six Months Ended August 31, 2017 and 2016...7 Notes to Unaudited Consolidated Financial Statements.... 8 2
UNAUDITED CONSOLIDATED BALANCE SHEETS AUGUST 31, 2017 AND 2016 (amounts in thousands, except share data) August 31, 2017 2016 ASSETS CURRENT ASSETS: Cash and cash equivalents..... $ 464 $ 10 Accounts receivable, trade... 4,574 7,664 Accounts receivable, other... 400 717 Inventories 49,226 44,657 Supplies, prepaid expenses and other current assets... 1,857 1,101 Due from Gifft Wine Venture.. 719 562 Income tax receivable.. 13 Total current assets... 57,253 54,711 PROPERTY, PLANT AND EQUIPMENT, net..... 86,449 89,370 NOTE RECEIVABLE - STOCKHOLDER 3,196 2,809 OTHER ASSETS, net.... 756 714 $ 147,654 $ 147,604 LIABILITIES AND STOCKHOLDERS EQUITY CURRENT LIABILITIES: Current portion of long-term debt.... $ 25,970 $ 18,888 Current portion of capital lease obligation... 432 240 Accounts payable and accrued liabilities..... 5,641 5,234 Deferred income taxes.. 434 1,013 Total current liabilities.. 32,477 25,375 LONG-TERM DEBT....... 54,796 63,876 LONG-TERM CAPITAL LEASE OBLIGATION... 785 762 DEFERRED INCOME TAXES... 12,943 11,888 OTHER LONG-TERM LIABILITIES... 142 136 Total liabilities.. 101,143 102,037 STOCKHOLDERS EQUITY: Preferred stock, $.001 par value; 2,000,000 shares authorized; no shares issued and outstanding.. Common stock, Class A, $.001 par value; 4,000,000 shares authorized; 735,617 and 735,117 shares outstanding at August 31, 2017 and 2016, respectively Class B, $.001 par value; 2,000,000 shares authorized; 147,469 shares issued and outstanding at August 31, 2017 and 2016.... 1 1 Additional paid-in capital..... 22,453 22,435 Retained earnings..... 35,777 34,851 Less: treasury stock; 466,539 Class A shares at cost... (11,720) (11,720) Total stockholders equity.... 46,511 45,567 $ 147,654 $ 147,604 See accompanying Notes to Unaudited Consolidated Financial Statements. 3
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (amounts in thousands, except per share data) Six Months Ended August 31, 2017 2016 REVENUES: Cased goods sales.... $ 12,683 $ 12,103 Bulk wine sales....... 1,809 6,232 Winery processing and storage revenues. 543 336 Direct sales revenues........ 924 801 Vineyard management, services and other fees... 233 229 Total revenues.. 16,192 19,701 COST OF SALES.. (12,699) (13,056) GROSS PROFIT...... 3,493 6,645 General and administrative expenses.. (4,091) (3,747) Selling expenses.. (3,320) (2,892) Interest expense, net....... (1,496) (1,555) (Loss) income from investment in Gifft Wine Venture.. (6) 20 Loss on disposal of vineyard improvements.. (581) Gain on sale of equipment... 40 71 LOSS BEFORE BENEFIT FROM INCOME TAXES. (5,380) (2,039) BENEFIT FROM INCOME TAXES...... 2,152 815 NET LOSS......... $ (3,228) $ (1,224) NET LOSS PER SHARE: BASIC. $ (3.66) $ (1.39) DILUTED... $ (3.66) $ (1.39) WEIGHTED AVERAGE SHARES OUTSTANDING: BASIC... 883 882 DILUTED.. 883 882 See accompanying Notes to Unaudited Consolidated Financial Statements. 4
UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY SIX MONTHS ENDED AUGUST 31, 2017 (amounts in thousands, except share amounts) Common Stock Outstanding Number of Class B Shares Number of Class A Shares Amount Additional Paid-in Capital Retained Earnings Treasury Shares BALANCE, March 1, 2017... 735,117 147,469 $ 1 $ 22,435 $ 39,005 $ (11,720) Exercise of stock options 500 18 Net loss....... (3,228) BALANCE, August 31, 2017. 735,617 147,469 $ 1 $ 22,453 $ 35,777 $ (11,720) See accompanying Notes to Unaudited Consolidated Financial Statements. 5
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in thousands, except share amounts) Six Months Ended August 31, 2017 2016 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss........... $ (3,210) $ (1,224) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.. 2,995 2,798 Gain on sale of land and equipment..... (40) (71) Loss on disposal of vineyard improvements. 581 Deferred income taxes...... (2,153) (815) Accrued interest on note receivable stockholder (65) (58) Loss (income) from investment in Gifft Wine Venture... 6 (20) Changes in operating assets and liabilities: Accounts receivable, trade and other......... 6,878 158 Inventories. (9,888) (6,469) Supplies, prepaid expenses and other current assets. (402) (322) Due from Gifft Wine Venture LLC.. 152 Accounts payable and accrued liabilities.. 1,237 1,217 Net cash used in operating activities..... (4,490) (4,225) CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, plant and equipment. (1,787) (2,419) Proceeds from sale of property, plant and equipment. 40 71 Other assets.. (13) (74) Increase in note receivable stockholder (90) (80) Net cash used in investing activities.. (1,850) (2,502) CASH FLOWS FROM FINANCING ACTIVITIES: Increase in long-term debt.... 9,288 6,420 Repayment of long-term debt and capital lease obligations... (2,726) (155) Payment for loan fees... (6) Net cash provided by financing activities. 6,556 6,265 Increase (decrease) in cash and cash equivalents.. 216 (462) CASH AND CASH EQUIVALENTS, beginning of period 248 472 CASH AND CASH EQUIVALENTS, end of period.. $ 464 $ 10 See accompanying Notes to Unaudited Consolidated Financial Statements. 6
1. ORGANIZATION AND BASIS OF PRESENTATION Organization The principal business of the Company is the production of premium varietal wine grapes and wine, the operation of a custom crush winery facility, and the sale of bottled wine through wholesalers and directly to consumers. The Company currently operates premium wine grape vineyards in Monterey County, California. Basis of Presentation The Company conducts all of its business through its wholly owned subsidiary, Scheid Vineyards California Inc., a California corporation. All significant intercompany balances have been eliminated in consolidation. The Company s fiscal year end is the last day of February. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash and Cash Equivalents The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. At August 31, 2017 and 2016, substantially all cash balances were on deposit with the Company s major bank. Cash held at a bank is at times in excess of the amount insured by the Federal Deposit Insurance Corporation. Management does not expect to incur any losses on balances in excess of the limit. Inventories Inventories are stated at the lower of FIFO (first-in, first-out) cost or market. Cost includes the cost of grown grapes, harvesting, production, aging and bottling, and tasting room merchandise. Bulk and bottled wine inventories are classified as current assets in accordance with recognized trade practice although certain inventories will be aged for periods longer than one year. Crop costs associated with farming vineyards prior to the harvest are deferred and recognized in the year the grapes are harvested. On a quarterly basis, the Company evaluates the cost of its inventories and reduces such inventories to market if required. Trade Receivables Allowance The Company s policy is to identify all specific customers from whom a payment would be considered doubtful based upon the customer s financial condition, payment history, credit rating and other relevant factors and reserve for the portion of those outstanding balances where collection does not seem likely. The reserve at August 31, 2017 and 2016 was $5,000 and $38,000, respectively. Major Customers During the six months ended August 31, 2017, the Company s top five customers accounted for 37% of total revenues. During the six months ended August 31, 2016, the Company s top five customers accounted for 21% of total revenues. Property, Plant and Equipment Property, plant and equipment are stated at cost and are depreciated using straight-line and accelerated methods over the estimated useful lives of the assets. Vineyards generally have estimated depreciable lives of 25 to 30 years, buildings 30 to 39 years, and furniture and equipment 5 to 20 years. Development costs incurred during the development period of a vineyard, including related interest, are capitalized. Depreciation commences in the initial year the vineyard becomes commercially productive, generally in the fourth year after planting. Any revenue generated prior to a vineyard becoming commercially productive reduces the capitalized cost of the vineyard. The Company s winery consists of a building and the related equipment necessary to operate the facility. 7
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Accounting for Impairment or Disposal of Long-Lived Assets Whenever facts and circumstances indicate that the carrying value of a long-lived asset may not be recoverable, the carrying value is reviewed. If this review indicates that the carrying value of the asset will not be recovered, as determined based on projected undiscounted cash flows related to the asset over its remaining life, the carrying value of the asset is reduced to its estimated fair value. During the six months ended August 31, 2016, the Company determined that approximately 81 acres of its vineyards were not economically productive and the vineyard improvements were removed. The loss on the disposal of the carrying values of those vineyard acres for the six months ended August 31, 2016 totaled $581,000. Investments Investments are accounted for using the equity method of accounting, if the Company has the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if the Company has an equity ownership in the voting stock of the investee of between 20% and 50%. Under the equity method of accounting, the investment is carried at cost at the time of acquisition, plus the Company s equity in the investee s undistributed net income or loss since the acquisition, less any dividends received. Revenue Recognition The Company generally recognizes revenue from grape sales upon delivery to the customer s winery. The Company does not have any allowance for returns because grapes are tested and accepted upon delivery. The Company generally recognizes revenue from the sale of bulk wine on the speculative market at the time the wine is shipped to the customer. Revenue from wine sold under wine purchase contracts is recognized when title has transferred to the customer, the price is determinable, and collectibility is reasonably assured. Title transfers to the customer upon receipt of a required amount of the contract price and acceptance of the wine. Revenues are deferred when payments or deposits are made by the customer before the delivery of grapes or wine has occurred, and title has not transferred to the customer. Winery processing and other revenues are recognized as the service is performed. Vineyard management and other services are recognized as provided. Cased goods sales are wholesale wine sales recognized at the time of shipment. Direct sales consists of sales of bottled wine and related merchandise through the Company s two retail tasting rooms, and sales of wine to the Company s wine club members. Direct sales are recognized at the point of sale in the retail locations and the date of shipment to wine club members. Substantially all revenues of the Company are derived from customers within the United States. Fair Value of Financial Instruments The fair values of accounts receivable and accounts payable approximate book value because of their short duration. Long-term debt approximates book value because such financial instruments have variable, market driven, interest rates. Interest rate swap agreements are entered into as a means of managing interest rate exposure on debt obligations. These agreements mitigate exposure to interest rate fluctuations on variable rate obligations. These agreements have not been designated as hedges under applicable accounting standards. Accordingly, changes in the fair value of interest rate swaps are reported in the consolidated statements of operations. 8
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy is established based on the type of inputs used in arriving at fair value. The three levels of inputs that may be used to measure fair value are as follows: Level 1: Quoted prices in active markets for identical assets or liabilities. Level 2: Observable inputs other than Level I prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The fair value of the interest rate swap agreement, as reported on in the balance sheet, is estimated by a third party using inputs that are observable or that can be corroborated by observable market data and, therefore, are classified within Level 2 of the valuation hierarchy. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported revenues and expenses during the reporting period. Actual results could differ from reported amounts of assets, liabilities, revenues, and expenses. Earnings Per Share and Classes of Common Stock Weighted average shares outstanding includes both Class A and Class B Common Stock outstanding and the effect of dilutive stock options for the periods presented. The computation of diluted earnings per share does not include stock options which are antidilutive, as the exercise price was greater than the average market price of the Company s Class A Common Stock during the year. Options to purchase 500 and 1,000 shares of the Company s Class A Common Stock are excluded for the six months ended August 31, 2017 and 2016, respectively. Income Taxes Income taxes are recognized using enacted tax rates and are composed of taxes on financial accounting income that is adjusted for requirements of current tax law and deferred taxes. Deferred taxes are the expected future tax consequences of temporary differences between the financial statement carrying amounts and tax bases of existing assets and liabilities. A valuation allowance reduces any deferred tax assets to the amount of future tax benefit that is more likely than not to be realized. The Company accounts for uncertain tax positions using a two-step approach to recognize and measure tax positions taken or expected to be taken in a tax return. The first step is to determine if the weight of available evidence indicates that it is more likely than not that the tax position will be sustained in an audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Interest and penalties related to uncertain tax positions are recognized in the provision for income taxes. 9
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Excise Taxes, Sales Taxes and Shipping and Handling Excise taxes are levied by government agencies on the sale of alcoholic beverages, including wine. These taxes are not collected from customers but are instead the responsibility of the Company. Excise taxes are expensed at the time of sale of the related product. The Company collects applicable sales tax from nonexempt customers and remits the entire amount to the state where the sales tax is collected. Shipping and handling costs are included in cost of sales. Union Agreement The United Farm Workers, AFL-CIO ( UFW ) has represented the Company s farm workers since 1993. The Company signed a five-year contract with the UFW in March 2017, which will expire on December 31, 2021. Approximately 50% of the Company s employees are represented by the UFW. 3. INVENTORIES Inventories consist of the following: August 31, 2017 2016 (in thousands) Bulk wine... $ 20,062 $ 19,213 Deferred crop costs 14,597 13,864 Cased goods inventories. 12,653 8,711 Winery supplies.. 399 407 Vineyard supplies...... 504 293 Cased goods supplies. 877 1,997 Direct sales inventories...... 134 172 Total.... $ 49,226 $ 44,657 4. PROPERTY, PLANT AND EQUIPMENT, net Property, plant and equipment consists of the August 31 following: 2017 2016 (in thousands) Vineyard land and buildings...... $ 12,186 12,141 Vineyard improvements. 51,697 52,688 Vineyard improvements under development. 3,226 1,466 Vineyard machinery and equipment... 11,637 11,367 Equipment under capital lease.... 1,785 1,236 Winery buildings.... 46,124 46,024 Winery machinery and equipment. 31,396 30,599 Construction in progress.... 296 945 Tasting room building and equipment... 1,803 985 Office furniture and equipment.. 3,010 2,509 Leasehold improvements 484 410 Total... 163,644 160,370 Accumulated depreciation and amortization.. (76,856) (70,790) Accumulated depreciation vineyard equipment under capital lease.. (339) (210) Property, plant and equipment, net. $ 86,449 $ 89,370 10
5. INVESTMENT IN GIFFT WINE VENTURE LLC In May 2014, the Company entered into a wine venture with Kathie Lee International, LLC ( KLG ) to blend, bottle, market and sell wine under the Gifft name utilizing the name, likeness and image of Kathie Lee Gifford. Under the term of the LLC agreement, the Company will make capital contributions of working capital in the form of costs to grow and harvest wine grapes, blend and bottle wine, and market and sell the finished bottled and labeled wine. KLG will make capital contributions in the form of granting licenses to the venture to use KLG s name and likeness. The Company and KLG are equal members in the venture, and share equally in the net profits in the venture. The Company will be reimbursed for its contribution of inventories and certain selling expenses before any sharing of profits, which resulted in a net receivable of $719,000 and $562,000 at August 31, 2017 and 2016, respectively.. 6. NOTE RECEIVABLE-STOCKHOLDER The Company has a note receivable from the Chairman of the Board of Directors of the Company in the amount of up to $5,000,000. The note is secured by an assignment of life insurance policies on the stockholders life in favor of the Company. Proceeds from advances on the note are to pay for the premiums on the life insurance policies. The note bears interest at the rate of 4.1% per annum, and payment is due at the earlier of the death of the stockholder or October 1, 2019. Interest accrued on this note totaled $66,000 and $58,000 for the six months ended August 31, 2017 and 2016, respectively. 7. LONG-TERM DEBT The Company s borrowing facility is with Rabobank, N.A, which allows for total borrowings in the amount of up to $95,000,000. The facility has a term component in the amount of up to $70,000,000, which is secured by deeds of trust and leasehold interests in the Company s vineyards, as well as a deed of trust on the Company s winery building and equipment. The note is due January 15, 2029. There was $58,828,000 outstanding on this portion of the facility at August 31, 2017, bearing interest at a weighted average rate of 4.05%. There was $60,988,000 outstanding on this portion of the facility at August 31, 2016, bearing interest at a weighted average rate of 3.65%. The facility also has a line of credit note for up to $25,000,000 in borrowings, which is intended to fund annual operating costs of the Company. This note is secured by the cash, receivables, crop and other inventories, and equipment of the Company. This portion of the note is due September 15, 2018. There was $22,500,000 outstanding under this portion of the facility at August 31, 2017, bearing interest at a weighted average rate of 4.09%. There was $22,250,000 outstanding under this portion of the facility at August 31, 2016, bearing interest at a weighted average rate of 3.34%. Interest on the facility is currently payable at the 0.5% over the bank s prime rate or the LIBOR rate plus a percentage based upon certain financial ratios of the Company. At August 31, 2017, this additional percentage above LIBOR was 2.50%. The outstanding principal balance of long-term debt as presented on the balance sheet is net of unamortized loan fees of $562,000 and $474,000 at August 31, 2017 and 2016, respectively. 11
The facility prohibits the payment of dividends without the consent of the lender and contains various financial covenants, including current working capital amounts, interest coverage ratios, the amount of total liabilities to tangible net worth, and capital expenditure limits 7. LONG-TERM DEBT (Continued) The scheduled reductions in the term facility for each of the next five years ending February 28, are as follows (in thousands): 2018...... $ 3,470 2019... 3,470 2020... 3,470 2021 3,470 2022... 3,362 Thereafter.. 41,586 Total $ 58,828 8. COMMITMENTS AND CONTINGENCIES Lease Obligations The Company has various operating lease agreements for office and retail space and farm land. The Company s office space lease expires January 31, 2022, and contains a provision for annual rent adjustments based upon the Consumer Price Index ( CPI ). The Company s retail space lease is currently on a month to month basis, and contains a provision for annual CPI increases, as well as a provision for additional rent to be paid upon reaching certain sales levels. Farm land leases cover approximately 1,800 acres with initial terms ranging from 24 to 30 years. The land leases provide for options to renew ranging from 10 to 20 years and contain provisions for rent adjustments based upon the prevailing market rate, CPI, or revenue generated by the property, and also provide for payments of taxes, insurance and maintenance costs. The Company also has entered into various lease agreements for vineyard and winery equipment which has been classified as capital leases. Aggregate minimum rental payments for each of the next five years ending February 28, are as follows (in thousands): Capital Lease Operating Leases 2018... $ 341 $ 1,064 2019.. 372 1,074 2020... 313 1,101 2021.. 286 1,128 2022.... 129 1,130 Thereafter.. 15,715 Total minimum lease payments.. 1,441 $ 21,212 Less: interest payments. 136 Present value of minimum capital lease payments... 1,305 Less: current obligations under capital lease. 432 Long-term capital lease obligations.. $ 873 12
8. COMMITMENTS AND CONTINGENCIES (Continued) Rent expense during the six months ended August 31, 2017 and 2016 totaled $900,000 and $723,000, respectively. Pension Plans The Company has two 401(k) Profit Sharing Plans. The first plan is for the benefit of the Company s employees who are covered by the United Farm Workers of America Collective Bargaining Agreement. All union employees of the Company are eligible to participate after having worked 500 hours within a one-year period. The Company contributes 15 cents for each hour worked by eligible employees, subject to the limitations imposed by the Internal Revenue Code. The Company s contribution to the union employees plan amounted to $40,000 and $35,000 for the six months ended August 31, 2017 and 2016, respectively. The second plan covers the Company s non-union employees. All non-union employees of the Company are eligible to participate in the plan after nine months of employment. Employees may contribute between 1% and 15% of their annual compensation. The Company matches 50 cents for every dollar of employee contributions up to 6% of their annual salaries, subject to the limitations imposed by the Internal Revenue Code. The Company s contribution to this plan amounted to $135,000 and $78,000 for the six months ended August 31, 2017 and 2016, respectively. 9. COMMON STOCK Rights Each share of Class A Common Stock is entitled to one vote and each share of Class B Common Stock is entitled to five votes on all matters submitted to a vote of the stockholders. The holders of the Class A Common Stock, voting as a separate class, elect 25% of the total Board of Directors of the Company, rounded up to the nearest whole number, and the holders of the Class B Common Stock, voting as a separate class, elect the remaining directors. Each share of Class B Common Stock is convertible into one share of Class A Common Stock at the option of the holder or automatically upon transfer to a person other than certain specified persons. Except for the differing voting rights, the shares of Class A and Class B common stock have substantially identical rights, preferences and privileges. 10. SUPPLEMENTAL CASH FLOW INFORMATION Supplemental disclosures to the statements of cash flows are as follows (in thousands): Six Months Ended August 31, 2017 2016 Interest paid.... $ 1,490 $ 1,706 Income taxes paid (net of refunds).. $ $ 13